THE RECESSION: A SNOWBALL ROLLING FASTER THAN ANYONE EXPECTED
It's been said that a pessimist is an optimist who has all the facts. That's why so many U. S. consumers and businesses are down in the dumps these days. It's not just idle worry: The facts are too overwhelming.
Most of the December economic data are still to come, but it's already clear that the fourth quarter was a disaster. In December, a BUSINESS WEEK survey showed that economists expected last quarter's real gross national product to drop at an annual rate of about 2%, but the decline is shaping up to be far greater.
Despite strong exports, manufacturing fell off a cliff last quarter. That's clear from the plunge in the National Association of Purchasing Management's index of industrial activity (chart). The December reading was the lowest since the severe 1981-82 recession, a sign that the 1991 outlook for U. S. industry is not bright (page 62).
The speed with which the current recession is developing means that the fourth-quarter weakness will almost certainly spill over into 1991. The downturn is feeding on itself in classic recession style: Flagging demand is causing cuts in output and jobs, which further depress incomes and spending.
The leading indicators, which are designed to forecast the economy's direction, are still in a free-fall. The government's index of 11 such indicators sank 1.2% in November, and since June, it has plunged 4.4%. The index has only fallen that fast in a recession.
And the downturn is very near to being official. The Business Cycle Dating Committee of the National Bureau of Economic Research released a statement on Dec. 26 saying that the committee will likely set the recession's starting point at sometime between June and September. It will meet again probably after the release of the fourth-quarter report on GNP set for Jan. 25.
Of course, that will only tell consumers and businesses something they already know. Going into the new year, both sectors are the most downbeat about their economic and financial situation since the last recession. And as the Jan. 15 deadline for Iraq's withdrawal from Kuwait looms, the growing threat of a desert war only heightens the air of uncertainty.
Business expectations for sales, profits, and employment in the first quarter of 1991 are all down sharply, according to a Dun & Bradstreet survey of 1,500 companies. Optimism for the fourth quarter had also fallen, but the drop in first-quarter expectations for sales is even steeper than the previous quarter's decline.
Moreover, there are more signs that the recession is leaving few areas and sectors untouched. First-quarter expectations are down in all nine regions of the country, and every industry group reported a drop.
Consumers, meanwhile, have their own set of concerns: disappearing jobs, shrinking incomes, low savings, and high debts. It's not surprising that the Conference Board's index of consumer confidence continued to languish at an eight-year low in December (chart).
Jobs are a growing worry. The percentage of people saying that jobs were "hard to get" jumped sharply in December to its highest level in almost four years. That's not hard to figure. The Board also reported that its index of help-wanted advertising fell to a five-year low in November, with declines in every region.
The recession is already hitting consumers' pocketbooks. Personal income rose a slim 0.3% in November, and real disposable income--what's left after inflation and taxes--has been declining since July.
The fourth-quarter drop was particularly steep. If real income in December holds at the November level--an optimistic assumption--it will post a quarterly decline of more than 4.5%, at an annual rate. Real income did not fall that fast in any quarter during the 1981-82 recession. That plunge comes after a 0.7% fall in the third quarter and no growth in the second quarter.
Consumers don't have much in the way of savings to draw on, either. During the past three months, savings as a percentage of disposable income has fallen to 3.8%, the lowest in nearly three years. The saving rate usually rises in a recession, but consumers are so strapped for cash that rebuilding their nest eggs will take time.
Not surprisingly, real consumer spending last quarter is on track to drop at an annual rate of 3%--the largest decline in a decade. The slide could be even greater if buying fell in December, which is likely. Sales of domestically made cars stalled to a 5.1 million annual rate in mid-December, the lowest 10-day pace in eight years.
A lower prime rate, to which many consumer loans are tied, will eventually help spur spending. Many of the nation's largest banks have cut their prime from 10% to 9.5%, but further cuts will be necessary to get the consumer sector--and the economy--back on its feet.
ORDERS PLUNGED IN
With consumers in such a deep retrenchment, businesses are reeling. Orders are drying up, output is falling, and layoffs are on the rise. In that environment, it's becoming increasingly difficult for companies to justify any major expansions. And that is robbing the economy of yet another source of demand in 1991--capital spending for new plants and equipment.
Factory order books ended 1990 with lots of blank pages. In November, new orders for durable goods took a header, falling 10.5%, to $115.9 billion. The November plunge matched the record drop in January, 1990. Falling demand for aircraft and other transportation equipment led the latest loss, but other orders declined as well.
In addition, the backlog of unfilled orders shrank by a large 1.1%, and the purchasing managers reported more softness in new orders during December. All this means even more cuts in factory output and jobs.
IDLE IN `91
Against that backdrop, the outlook for capital spending is looking bleak. After price adjustments, sales of nondefense capital goods--used by industries that make other business and consumer goods--are going nowhere. That means investment in new equipment didn't add much, if anything, to last quarter's real GNP.
The 1991 prospects for capital outlays aren't any rosier, particularly when you throw in the dreary outlook for construction. The Commerce Dept.'s survey of plant and equipment spending plans of nonfarm businesses found that capital budgets will rise by 2.4% this year (chart). That's just 0.4% after taking estimated inflation into account, which would be the smallest gain in five years.
The survey, taken in October and November, found that manufacturers plan to increase capital spending by a mere 0.7%, even before price adjustments. Nonmanufacturing companies--mostly trade, finance, and other services--expect outlays to rise by 3.4%.
But plant and equipment spending won't provide much help to the economy as this year progresses. That's because all of the gain in business investment is slated for this quarter and next. If businesses follow their planned pattern of spending, capital outlays will be slashed by more than 10%, at an annual rate, in the second half of the year. That means makers of durable goods won't get much relief anytime soon.
Builders of plants and other projects are also facing a bleak new year. In 1990, times were already tough for the housing and office sectors. Now, the bad news is spreading to other construction projects. Construction spending fell 0.6% in November, but excluding a second consecutive jump in public-works outlays, spending in the private sectors dropped 2.1%.
And there are more declines to come. The F. W. Dodge Div. of McGraw-Hill Inc. reports that new building contracts--an indicator of future construction--fell by 0.7% in November, to their lowest level in five years. That means construction will be yet another drag on economic growth in the first half of 1991.
With the economy heading into the new year amid so much weakness, the current wave of pessimism seems justified. The best hope is that the cutbacks in output so far have been sufficient to prevent a buildup of inventories that would cause even more cutbacks later on. But because last quarter's demand shock was so great, even that bit of optimism is open to question.
JAMES C. COOPER AND KATHLEEN MADIGAN
Re-blogged from: Businessweek.com