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Slowdown: Not If, But How Long

Economic Trends

Slowdown: Not If, but How Long

Why sluggishness may linger

In early December, most economists still saw a soft landing ahead for the economy. Now, following a spate of downbeat economic news, expert opinion has swung toward the view that either an outright recession or something approaching it is unfolding, and the critical question has become whether the slowdown will be V-shaped or U-shaped--that is, relatively short- or long-lived.

One seasoned observer anticipating a U-shaped slowdown is James Paulsen, chief investment officer of Wells Capital Management, whose growth forecast of just 1.7% for 2001 was the most bearish among the 53 private-sector economists cited in BUSINESS WEEK's yearend survey (Dec. 25). Paulsen believes the next year or two will resemble the prolonged sluggishness that characterized the economy in the early 1990s.

The Minneapolis-based economist ticks off several reasons for his dour outlook. With consumer spending in recent years tied to a stock-market-driven "wealth effect," he worries that the impact of the Federal Reserve's easing on the market may be diminished--that it may be seen by investors as proof that the economy is in trouble. Until stock prices fully recover, households will be prone to save more and spend less.

Even if the market recovers, Paulsen thinks consumption may stay restrained. The reason: The economy in the '90s experienced its longest big-ticket spending spree ever, bringing outlays on durable goods and structures to a postwar high (chart). "Households are flush with new homes, furniture, cars, and computers," he says, "and many businesses are overinvested. Demand is saturated for a while, no matter what the Fed does."

The Fed is also hamstrung, Paulsen believes, because monetary policy won't get much help from the refinancing of debt at lower interest rates. In the 1970s and much of the '80s, he notes, it didn't pay for most consumers and businesses to refinance their long-term debt because interest rates stayed relatively high. In the 1990s, by contrast, rates hit new lows several times, allowing households and businesses to reap huge cash-flow injections via refinancing. "Much of the economy is now refi'ed out," says Paulsen, "and it would take a massive further drop in rates to start the refi ball rolling again."

He also is concerned about the uncertain shape of the technology cycle. While the high-tech boom seems to be fading, many economists believe the sector marches to its own tune and is less sensitive to monetary policy and the general state of the economy than other sectors. Although this implies that tech spending won't tank in a slowdown, it also suggests that it may not respond very much to lower yields.

Finally, Paulsen worries that the Fed cannot count on a weaker dollar to help revive the economy by spurring exports and restoring domestic pricing power. With growing fears of a global slowdown, he says, foreign investors may still prefer the dollar as a safe haven even as U.S. interest rates are cut.

In sum, Paulsen thinks the chances of a bounceback in growth are small. "The Fed," he says, "is likely to find that the economy is far less responsive to monetary ease than earlier in the cycle."By Gene KoretzReturn to top

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What the Payroll Data May Hide

The "plug factor" skews job figures

Payroll employment, contends economist Ed Hyman of ISI Group, investment advisers, is probably a lot weaker than reported. That's because the Labor Dept. adds a "plug factor"--an estimate of those hired by new businesses that aren't yet in its data base--to the job numbers derived from its survey of employers. Since this estimate is based on past history (in this case the hefty final readings for last year), it tends to exaggerate job gains when the economy enters a slowdown.

To buttress his claim, Hyman points out that employment based on the Labor Dept.'s other survey, its canvass of households, has hardly changed since April, while unemployment insurance claims have surged higher. The plug factor has added an average 162,000 jobs to the monthly payroll count since April, converting what would have been an average decline of 70,000 in private sector jobs into an average reported monthly gain of 92,000. By comparison, private sector payrolls over the prior eight months posted an average monthly increase of 238,000.By Gene KoretzReturn to top

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