NOW FOR A GOOD OLD-FASHIONED INVESTMENT SPLURGE
Can even the lowest interest rates in 25 years give the U.S. economy a capital-investment boom? On the face of it, there's reason to be skeptical: Commercial construction is dead for now, no matter how far rates drop. Many big companies, beset by weak markets, say they have no plans to increase their capital budgets. Capacity utilization in manufacturing stands at only 79%, down from 85% in 1989. And other industries suffer from excess capacity as well. "You won't find commercial airlines stepping up their orders of new aircraft because of lower interest rates," says John Lonski, chief economist at Moody's Investors Services Inc.
But despite these factors, the heady brew of low interest rates, falling computer prices, and investment tax credits may be enough to produce a powerful surge in capital spending over the next couple of years. Low rates make investment cheaper and give small and midsize companies a better chance of getting credit. The computer price wars allow companies to buy more computers without raising their capital-spending budgets. And Bill Clinton's proposed two-year investment tax credit should encourage businesses to move future investment spending into 1993 and 1994.
WHOSE GAIN? To be sure, soaring business investment may not mean boom times for U.S. capital-goods makers, since much of the new equipment and machinery is being imported from overseas. Over the last year, imports of capital goods, adjusted for inflation, surged by 25%, while domestic production only increased by 6.1%.
Still, an investment boom should help the U.S. economy increase productivity and boost competitiveness. And so far, the outlook for capital spending is good. Over the past three months, orders for new machinery rose 12%, to their highest level ever. Business spending on equipment such as machinery and computers increased at a 14.4% annual clip in the fourth quarter, far faster than overall growth. And equipment investment could surge 12.9% this year, says Chris Varvares, an economist at Laurence H. Meyer & Associates. That means more than 8% of national output would be going to business equipment, its biggest share ever (chart). Adds Bruce Steinberg, an economist at Merrill Lynch & Co.: "The capital-goods sector will be the strongest part of the economy in 1993."
Underlying much of this strength are low interest rates, which have a powerful stimulant effect on capital spending across the economy. In part, lower rates make borrowing cheaper and encourage companies to consider a wider range of capital investments. For example, a new factory, unprofitable when financed at 10%, may be worthwhile when rates are down to 7%.
Equally important, low rates should prompt a flood of capital investment by small and midsize companies. This is how it works: When interest rates are up, such companies are too high-risk to get loans from banks, which can get good returns just by putting their money into safe government securities. But as rates come down, banks will have to start lending again to make profits. Individual investors, too, will have to take risks to get higher returns, either by putting money into the stock market or investing directly in growing businesses.
That's already starting to happen as a torrent of money floods into the stock market, making it easier for companies to float new offerings. That could boost capital investment by high-tech companies. Such outfits typically don't get any direct benefit from lower interest rates. "Most Silicon Valley companies are equity-financed, not debt-financed," explains Keith E. Sorenson, CEO of RasterOps Corp. in Santa Clara, Calif., which sells circuit boards and other products that enhance computer graphics. "We're all $30 million to $40 million companies considered high-risk."
ANGELIC RESCUE. Lower rates may also enable small companies and startups to tap into new sources of funds. Edward Foote, executive director of a nonprofit business-development firm in upstate New York that helps nurture high-tech ceramics companies, already sees a new wave of "angel" investors willing to put money into growing small companies. "They're looking for a better return on their dollar," says Foote. "Now, companies will have access to capital that was just parked in more conservative investments."
Banks, too, may be finally ready to lend again. With rates dropping, the amount of Treasuries held by commercial banks declined in January for the first time in four years. And if Clinton relaxes regulatory pressure on banks, as he promised on Mar. 10, it could help growing businesses that can't get credit. "If you can get the banks to want to find customers," says Robert Breault, head of Breault Research, a high-tech optics company in Tucson, "firms like ours would be willing to borrow, and we would be able to create jobs and expand."
For years, the U.S. has struggled with high interest rates. Now that they have come down, the nation may finally see just how powerful low rates can be. Michael J. Mandel in New York, with Richard Brandt in San Francisco