It may be difficult to fathom, given the U.S. economy’s myriad of problems, but more than two years after the beginning of the latest recession, and a full 3-1/2 years after the bursting of the stock market and technology bubbles, the dark clouds that have enveloped much of U.S. business appear to be lifting. For a number of reasons that will be examined in detail below, the outlook for economic growth, corporate profits – and even jobs – has brightened considerably. Since this anticipated change in the economy would follow an exceptionally dark period for most businesses and many households, it will be even more noticeable once it arrives.
And quite a dark period it has been. Although the U.S. economy has been expanding nonstop for the past six quarters, the rate of growth has averaged little more than 2-1/2 percent. By contrast, for the 40-year period from 1961 to 2001, the average growth rate for the real (inflation-adjusted) gross domestic product (GDP) was nearly 3-1/2 percent; between 1995 and 2000, the GDP rose at an average annual rate of 4 percent.
The economy’s current rate of growth has been too low to create jobs, given the burst of productivity that developed in the wake of the investment boom of the 1990s. As a consequence, instead of growing as it usually does during a period of economic expansion, the number of jobs in the U.S. economy has shrunk, leading many to call this a “jobless recovery” (Economic Report – January/February 2003).
Although the national unemployment rate at the start of last month, 6.1 percent, was well below the 7.8 percent level it reached following the end of the 1990-91 recession – not to mention the postwar high of 10.8 percent it hit in the wake of the 1981-82 downturn – it feels a lot worse than today’s relatively modest jobless numbers would suggest.
There are several reasons for this. First, while relatively few have lost a job, those who did have had an extremely difficult time finding a new one. The percentage of those out of work for six months or longer is now at one of its highest points in more than half a century. What is more, an increasing share of the jobless are white-collar workers – managers and professional specialty workers, to be specific. Their share of the unemployed today is 17-1/2 percent, compared with only 10 percent during the previous recession and little more than 7 percent in the early 1980s. And as you might have expected, relatively more of today’s unemployed have a college degree than in past cycles.
A key reason why so many people have been jobless not just for months, but in some cases, for years, is that most of these jobs appear to be permanently lost. This is because of such factors as downsizing, technology, the demise of the dot-coms, outsourcing via the Internet, a special government program that allowed companies that claimed they could not find workers at home to bring in people from overseas on extended visas, as well as over-expansion in a wide variety of fields, including construction of new office buildings, shopping centers and factories.
The combination of many firms that are operating at less than ideal capacity along with sales that are growing only slowly would by itself be enough to depress corporate profits. Add to this a distinct lack of pricing power in most industries, a by-product of the Federal Reserve’s “victory” over inflation, and you have a situation where corporate profits today are well below their peak reached back in 1997. By contrast, earnings dipped only briefly prior to the 1990-91 recession – and were actually on their way back up when the rest of the economy turned down.
This weak profits performance puts the nascent rebound in the stock market at risk. While the major market averages are still more than 20 percent below their all-time highs set in early 2000, they have bounced up by about the same percentage from their low point of last October. Many stocks are selling for 30 or more times their past 12 months’ earnings. This is twice their long run average, suggesting that further gains in stock prices will have to await equal or better increases in corporate profits. And until the stock market does go back into a bull phase, such activities as trading, investment banking and money management, to name just three, will remain at low levels, keeping jobs and revenues weak in the process.
But as the headline implies, it’s always darkest before the dawn. As bleak as things may seem to a broad swath of individuals in most parts of the country, that’s how bright things look, going forward. If I am correct, it won’t be long before you’ll be hearing many hailing the return of “Rosy Scenario.”
Any discussion of the business outlook must begin with an analysis of economic policy. In the main, one can say that the proverbial pedal has been pushed to the metal – in other words, every aspect of economic policy is in the wide open throttle position. And unless the laws of economics and human nature have been repealed, this is bound to lead to faster growth as early as the second half of this year and certainly by 2004.
Let’s begin with monetary policy. As many already know, interest rates are at multi-decade lows, thanks to a succession of reductions by the central bank beginning in January 2001. This has pushed real, or inflation-adjusted, interest rates down below the rate of inflation by the largest amount since 1980 (Chart 1).
When real interest rates are negative, it provides a tremendous incentive for people and businesses to borrow, which, in turn, invariably leads to more spending, thus an increase in economic activity. To be sure that this is not simply a by-product of a dearth of demand, I have also examined the growth in the money supply, which is shown in Chart 2. As you can see, recent rates of growth in the real M2 measure are a lot greater than they were coming out of the 1990-91 recession; they are more like the period that followed the 1981-82 recession, which, in turn, preceded the lengthy expansion of the 1980s. This means that the Fed is actively pumping liquidity into the economy through the banking system – a development that will reinforce the expansionary tendencies produced by today’s negative real interest rates.
Fiscal policy is working in tandem with monetary policy, when it comes to pushing the economy ahead. Government spending on a wide variety of programs has been stepped up while taxes have been cut several times over the past three years. One tax cut in particular is aimed at reviving moribund capital spending by giving businesses a temporary boost in depreciation allowances – provided that they make these investments before the end of 2004. The combination of increased spending and lower taxes can be seen in Chart 3, which shows a dramatic change in Washington’s fiscal policy. Over a very short period of time, the federal budget has swung by a massive $600 billion – from a 12-month surplus of close to $300 billion, to a deficit of approximately that much. That’s a lot of fiscal stimulus – even in an economy as big as ours.
Internationally, the markets have pushed down the value of the dollar compared with many other currencies at a most propitious time (Chart 4). With a modest lag, this will do a number of things for our flagging economy, all of them very much needed. A lower dollar will make our exports more competitive while it causes imports to rise in price. That will boost the real GDP. To the extent that there is a better balance between supply and demand, especially with more higher-priced imports in the mix, pricing power will return, helping corporate profits in turn. Earnings for multinational companies will also be increased when higher-priced foreign currencies translate into more dollars.
Besides these, there are other developments that promise positive results for the U.S. economy. These include lower oil prices, a rebound in consumer confidence, and the previously noted jump in productivity, as well as the rise in stock prices already alluded to. One way or another, all of these will put buying power into the hands of businesses, consumers and investors, which, along with an improvement in confidence, should lead to stepped-up spending beginning later on this year and continuing into 2004.
Along with more spending should come some pickup in the rate of inflation – a development that will not be unwelcome in corporate boardrooms, as well as at the Board of Governors of the Federal Reserve. In turn, this might send interest rates higher at the longer end of the maturity spectrum, even as the Fed holds down rates at the short end. Eventually, the combination of increased economic growth and the waning effects of the investment boom of the 1990s should drive economic growth high enough to offset the combination of productivity and labor force growth that has caused the job market to contract for an unusually long period of time, thereby adding at least some jobs before too long.
The conclusion I derive from this exercise is “do it now,” while everything is cheap and plentiful. Hire now while potential workers are available and eager to work; borrow now, since the cost of money will never be cheaper; and build or lease now, while space is available and costs are low.
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Dr. Irwin Kellner is the Weller Professor of Economics at Hofstra University and Chief Economist at North Fork Bank and CBS MarketWatch.