So Much For The Quick, Painless RecessionBy
This is a recession that Rodney Dangerfield would love: It don't get no respect. A few weeks ago, no one wanted to call it a recession. Now, even the Bush Administration admits we're in one, but most economists still think it will be only a mild inconvenience between now and a spring recovery.
Look again. The labor markets are weakening faster than they have at the onset of the average downturn (chart). Consumer spending last quarter probably posted its sharpest drop in a decade. New factory orders in December plunged by a record amount. And the Bank of New England is now the third-largest bank failure in U. S. history.
All of which is clear evidence that the ninth postwar recession will not be quick and painless. And growing financial stress clearly raises the ante on the prospects for a severe downturn. Indeed, the problems that the slump could create for an already fragile banking system are a big reason why the recession is getting more respect from the Federal Reserve Board.
On Jan. 8, the Fed eased monetary policy yet again. It cut the federal funds rate on interbank loans by another 1/4 of a percentage point, to 6 3/4%. That is the fifth quarter-point decline in nine weeks, and it highlights the central bank's new aggressiveness toward pushing interest rates lower. Federal funds have not traded that low in three years.
Even further Fed easing seems assured, although war uncertainties could delay the next move. Oil prices--and inflation fears--could soar in the event of a desert war, which seems increasingly likely in the wake of the Baker-Aziz stalemate in Geneva on Jan. 9.
Interest rates will have to go much lower to stimulate consumer borrowing--and spending. Right now, households are in their worst financial shape in years because of heavy indebtedness, low savings, and a drop in real aftertax income that is steep even for a recession.
SERVICE WORKERS FEEL THE PINCH
The latest report on the labor markets makes it easy to see why consumers are hurting. Nonfarm payrolls lost 76,000 jobs in December, and the unemployment rate rose to 6.1%--the highest in 3 1/2 years. The weakness was widespread among industries and regions.
So far, the recession's job casualties have been concentrated in manufacturing and construction. In last year's second half, factories let 434,000 workers go, while the construction industry handed out 275,000 pink slips.
Further job losses in manufacturing seem likely. New factory orders have slowed to a trickle. They dropped a record 5.9% in December, to $235.4 billion, and the order backlog is shrinking.
The soaring aircraft industry has kept the rate of unfilled orders rising, but excluding aircraft, backlogs have been declining for nearly two years. The drop has been particularly sharp in recent months (chart). That means factories are likely to be trimming output and employment even further in the months to come.
Heavy job losses in the goods-producing industries are a classic recession pattern, but this time the slowdown in service-sector employment also has been especially steep, compared with similar stages of past recessions. Since September, private service jobs have fallen by 70,000, but excluding the booming health care industry, service employment has dropped by 223,000. The declines have been broad, and retail trade has shown the most weakness.
In the past, losses in service jobs have tended to lag behind overall employment. With the service sector already so weak, that could mean that service employment will shoulder a greater burden of the job losses during this recession than in past downturns.
Moreover, the service losses include a lot of white-collar workers. Employment among production workers in the service sector peaked in September, but jobs among nonproduction workers hit their high point back in June. Since then, they have fallen by 186,000, even though nonproduction workers account for only one-fifth of service employment.
INFLATION WILL SLOW, FOR A GRIM REASON
With further cutbacks in output and employment on the way, consumers--and the economy--are a long way from getting back on their feet. Weakening demand means that businesses must hold the line on wage growth to salvage sinking profits. But the upside of that is an improving outlook for inflation.
Although average hourly earnings jumped 0.6% in December, that probably reflected a quirk in the government's seasonal adjustment instead of reality. For the fourth quarter, nonfarm wages grew only 3.6% from a year earlier--the slowest pace in two years (chart).
Wage growth responds to economic conditions with a lag, but once a slowdown starts, pay hikes can shrink fairly rapidly. That's what happened in the last recession, when wage growth was cut in half by the time the economy started to recover in late 1982. This delayed reaction is a big reason why the inflation outlook for 1991 is getting brighter. And once the Persian Gulf crisis is over, fuel costs should fall quickly.
For nonoil items, the small gains in wages will temper the upward pressures on prices, especially in services. Wages in service industries grew by 4.1% in the year ended in the fourth quarter, down from 4.6% at the end of 1989. This slowdown in wage growth lowers the floor under the inflation rate in the service sector.
Manufacturing wages grew by 3.8% at the end of 1990, a bit faster than their 3.6% pace of the third quarter. But this acceleration was more than covered by gains in factory productivity. That means the pay increases won't cause any upward pressure on prices of manufactured goods--which have already been growing slowly because of slack demand.
For this year, wages will continue to show only meager gains. According to a mid-December survey of 412 companies by the consulting firm of Sibson & Co., employers have trimmed their 1991 salary projections. Instead of raises in excess of 5%, most workers will get hikes of about 4.6%.
The downside of smaller pay gains is that income growth suffers. That, plus the uncertainty of job prospects, means that any rebound in consumer spending isn't likely in the next few months--at least not until oil prices come down. Slower income growth also means that a turnaround in the housing sector isn't on the horizon. Consumers won't buy homes if they aren't sure of their future finances.
In November, new single-family home sales rose 2.8% to an annual rate of 506,000, but that was only the third monthly increase in 1990. For the first 11 months of last year, home sales were down 17% from a year earlier. Home prices in November were also down, for both new and existing homes. That means homeowners aren't feeling as wealthy as they were a few years ago.
CONSUMERS ARE STILL ADDICTED TO CREDIT
Even with income growth and home values shrinking, consumers haven't curbed their borrowing habits, however. In November, installment debt rose by $1.7 billion. Revolving credit--including credit cards and credit lines at banks--jumped $1 billion, on top of the $1.6 billion added in October.
What's fueling the debt increase? Clearly, the rise in installment credit isn't boosting consumer spending. Retail sales just aren't growing fast enough to account for the large monthly increases in revolving debt. Instead, shoppers may now be using plastic to purchase items that they previously bought with cash. Credit at gasoline stations, for example, has been growing at a double-digit pace ever since the August invasion of Kuwait.
The rise of credit may also reflect the increasing strains on household budgets. Consumers may be paying off their debt balances as slowly as possible. This would raise overall debt totals, and it would mean that large interest charges are being added to monthly credit bills.
The heavy debt loads of consumers, along with the growing numbers of jobless, bankruptcies, and bank failures, are all adding to the downturn's severity. And because so many of these problems are embedded in the economy's structure, this recession is sure to get more respect as the year drags on.