Is the Economy in Crisis or Clover?
July 9, 2002
by Irwin Stelzer
The Fourth of July has come and gone, and the feared terrorist threats that had F-16s circling over my house in Washington, and security teams deployed at major events held to celebrate America’s liberation from British tyranny, did not materialize. So Americans returned to a lesser, but financially important conflict: Ph.D.s vs. CEOs.
The debacle in the stock market needs no elaborate re-telling here: the major indexes at one point dropped below the post-September 11 panic levels. If Friday’s bounce proves sustainable, boardroom gloom may lift. Otherwise, CEOs see nothing but horrors wherever they look. Colleagues are falling like ten pins as more and more accounting irregularities are uncovered; the list of companies failing to meet Wall Street’s earnings expectations grows every day; security analysts are being revealed as either hucksters for their investment banking partners or tipsters to privileged insiders; and short sellers, who profit from falling share prices, are eagerly circulating a combination of fact and fiction to add to the general mayhem on the floors of the exchanges.
Little wonder that share prices seem headed towards the level the Bush economic team long ago predicted they would hit by November of this year—some 10 percent below where they now stand. Watching all of this with mounting concern are the CEOs who are scrambling to get their own accounts in order, and to persuade investors that, whatever they might think of other companies, the prospects for mine are just fine.
They can’t. It is the rare company indeed that is unaffected by the crisis of confidence in the integrity of corporate reporting and of the markets in which shares are traded. We have the ludicrous image of George Bush being lectured by Vladimir Putin on the crucial role of honest markets in driving capitalism forward, and an angry president promising to read the riot act to corporate America in a speech today.
So it is easy to understand why CEOs are gloomy. Well, easy for everyone except most Ph.D. economists to understand, for just about every sign they see says “recovery ahead.” The economy should grow at an annual rate of 3.3 percent in the current quarter, 3.7 percent in the last quarter of this year, and 3.6 percent in the first half of 2003, if we believe the average expectations of the 55 leading economists polled by the Wall Street Journal. The results, say Journal analysts, reflect “nearly complete and uncharacteristic unanimity.” The 27 economic seers surveyed by Business Week are a bit less optimistic, but agree that respectable growth will be achieved in the next hear-and-a-half: on average they are expecting the economy to grow at an annual rate of 3 percent during the balance of this year, and 3.5 percent in the first half of 2003.
The Ph.D.s say they are looking past the day-to-day market traumas that are coloring the views of the CEOs. The three policies on which a recovery must be built—monetary policy, fiscal policy, and exchange rate policy—are in place. The Federal Reserve Board’s monetary policy committee has kept interest rates low, and there is talk of adding another reduction to the eleven cuts made last year if the unemployment rate rises much further and inflation remains virtually non-existent. Loose monetary policy is being supplemented by loose fiscal policy, as tax cuts and unrestrained spending turn budget surpluses into deficits. Topping all of this is a decision not to intervene massively in foreign exchange markets, allowing the dollar to fall.
Low interest rates are shoring up the housing market and the economy, even as consumer spending tapers off a bit. A strong housing market means a strong construction market, and the sale of lots of fridges, furniture, and fixtures. And low interest rates are allowing consumers to refinance their mortgages so as to get their hands on billions of dollars of extra cash.
Loose fiscal policy is pumping money into the economy. Consumers are getting tax refunds and keeping more of their earnings, even as those earnings rise in real terms. Meanwhile, the government is starting to open the spigot on spending for defense, farm subsidies, and a host of other items that have special appeal to congressmen who must stand for re-election in November.
Add to these stimulants the falling dollar. The Institute of Supply Management’s index of manufacturing activity rose in June to its highest level in two-and-a-half years, and has now been above the 50 level that signifies expansion for five consecutive months. New export orders are at a two-year high, and manufacturers of everything from textiles to capital equipment are reporting that they are once again competitive with European firms. The best news is that the trade-weighted value of the dollar (how its value compares with the average of all of the currencies of America’s trading partners) has fallen by only 5 percent since February, leaving it still 39 percent above 1995 levels. As White House chief economist Larry Lindsey points out, we are hardly witnessing an inflation-inducing run on the greenback, just enough of a decline to stimulate economic growth a bit.
Finally, say the economists, it is important to look behind the grim profit restatements that are dominating the news. Stimulated by their nervousness, CEOs are cutting costs and increasing productivity, the surest way to increase profits in an environment in which price increases have been beyond the reach of most firms.
Before breaking out the bubbly, keep two things in mind. Consumer spending, although strong, shows signs of weakening. A leading owner of shopping malls tells me that overall sales are “flat” compared with last year, because declines in department store sales are offsetting growth in sales by discounters such as Wal-Mart and Target. And auto manufacturers have been forced to reinstitute deep discounting in the form of “0 percent financing” after sales dropped in May when incentives were withdrawn or scaled back.
Second, a new terrorist attack, which most CEOs with whom I speak agree with Vice President Dick Cheney is inevitable, will send economists scrambling back to their crystal balls for another look.
This article originally appeared in London’s Sunday Times on July 7, 2002, and is reprinted with permission.
Irwin Stelzer is a Senior Fellow and Director of Economic Policy Studies for the Hudson Institute. He is also the U.S. economist and political columnist for The Sunday Times (London) and The Courier Mail (Australia), a columnist for The New York Post, and an honorary fellow of the Centre for Socio-Legal Studies for Wolfson College at Oxford University. He is the founder and former president of National Economic Research Associates and a consultant to several U.S. and United Kingdom industries on a variety of commercial and policy issues. He has a doctorate in economics from Cornell University and has taught at institutions such as Cornell, the University of Connecticut, New York University, and Nuffield College, Oxford.