Those Upbeat Numbers Are Mainly Window Dressing

The U. S. economy is trying valiantly to mount an economic recovery. That doesn't mean it's succeeding. True, consumer confidence has rebounded smartly. The Federal Reserve Board has pushed short-term interest rates lower. The money supply is growing faster. The stock market is still well above its mid-January reading. And housing is beginning to show a pulse. Looks like the beginnings of a turnaround, right?

Take another look. Unemployment claims are still rising--to an eight-year high. Long-term interest rates have moved back up. Car sales aren't showing any postwar bounce. Corporate earnings look shakier than expected. Factory orders are falling. And prospects for exports are dimmer, because of the growing threat of a global economic downturn. For now, recession minuses still outweigh recovery pluses, suggesting that victory in the gulf will not bring the quick and easy upturn that many had hoped for.

What's more, the recession will not wash away the economy's multitude of longer-term problems, such as massive debt, weak banks, overvalued real estate, government deficits, and poor productivity growth. These virtually guarantee that, when the recovery finally does arrive, it will be disappointingly meek by past standards.


The economy's near-term fate is in the hands of consumers, and they are ill-equipped to lead a recovery. Real incomes are falling, the saving rate is historically low, and household debts are so high--relative to incomes--that taking on more would be foolhardy.

Consumers just don't have the money to match their optimism. Consumer confidence posted the sharpest increase on record in March. The Conference Board's index rose to 81, up from 59.4 in February, as Americans heaved a collective sigh of relief after the war.

The record jump came only five months after the record decline posted in October. Still, confidence remains far below the 101.7 reading in July, the month before Iraq invaded Kuwait. With the "Mideast effect" now gone from the index, economic conditions will rule future measures of consumer attitudes.

Therein lies a bit of a paradox. The March reading showed a decided split between how consumers feel about the future and how they feel right now (chart). All the increase in confidence reflected a surge in expectations that better times lie ahead, but consumers' assessment of their present condition continued to deteriorate.

This is a clear sign that consumers are increasingly concerned about jobs and incomes. Until they see their present situation improving, consumers are unlikely to act on their optimism by splurging on a new car or any other big-ticket item that means taking on more debt. As long as the job market is sinking, this is a catch-22 that is likely to prevent a quick rebound in spending.


For now, at least, interest rates present another roadblock to recovery. A steeper yield curve--that is, a wider spread between short-term and long-term rates--typically presages a turnaround. This is clearly the case right now, resulting from the Fed's efforts to push down short-term rates. But this time, there's a difference.

In the past, short-term rates typically have dropped three times as much as long-term rates during a recession and into the early stages of recovery. This time, however, the gap has been widening in recent weeks, partly because long-term rates have been rising (chart).

The Federal Reserve's easing of short-term rates has done little to push down rates further out on the yield curve. One problem is that the recent increases in the price indexes have spooked the bond market, which remains vigilant against any signs of faster inflation.

But long-term rates will have to start falling before a recovery can lift off. That's particularly true because consumers haven't benefited much from the downturn in short-term rates. If anything, the lower rates on such investments as bank certificates of deposits have cut into interest income.

At the same time, banks have been reluctant to lower their prime lending rate, which determines the interest costs for many consumer loans, such as home equity borrowings. The spread between fed funds and the prime is now at its widest in more than nine years.

The Fed also can do little to lower the still lofty interest rates on credit cards. And since consumers are wrestling with large debt burdens, the high cost of borrowing may dissuade many from using credit to increase their spending.

Businesses are also laden with debt, and high rates increase the cost of servicing that debt. That's an acute problem right now because interest payments are rising while corporate earnings are falling. The Commerce Dept. reported that fourth-quarter corporate profits before taxes fell 2.4%, to an annual rate of $310.8 billion. First-quarter earnings are shaping up to be weak as well, particularly in view of IBM's disappointing projection.


The rejuvenating power of lower long-term rates was evident in the latest report on existing-home sales. Mortgage rates dipped below 10% in February, and resales shot up 7.9%, to an annual rate of 3.13 million.

The February gain was the biggest in almost five years, but does the jump signal a rebound for the beleaguered housing industry? Probably not, because a sustained pickup in house buying depends on affordable mortgages. And mortgage rates followed the rise of other long-term yields in March. This suggests that home sales may have retrenched last month.

The higher cost of financing is also hitting the other big-ticket consumer item: new cars. Despite the euphoria from peace in the gulf and anecdotal reports of heavier showroom traffic, consumers are doing more browsing than buying.

In mid-March, new U. S.-made cars sold at an annual rate of just 6 million. That's the same mediocre pace as in the past two months. Consumer buying of cars--as well as other expensive durable goods--won't pick up until households see some gains in real aftertax incomes and job growth.

The trend in new filings at state unemployment offices isn't favorable. Jobless claims surged in the week ended Mar. 9, to an annual rate of 519,000. In the past, new claims have tended to top out about two months before the start of an upturn in the economy, but there is no sign yet that they have stopped rising. The latest number was the highest since early 1983, and the four-week average continues to track upward (chart). That suggests that the job market deteriorated further in March.


With consumers sitting on the fence and long-term interest rates rising, businesses may be rethinking their capital-spending plans. Weak factory orders indicate that demand for equipment is sluggish so far this year, although companies had indicated in the fourth quarter of 1990 that most of the rise in capital spending for 1991 would take place in the first half.

The Commerce Dept. reported that new orders for durable goods fell by 0.3% in February, after a 1.5% drop in January. Because of a computer problem, the government could not tally actual levels of orders, but the latest declines indicate that ordering in the first quarter has fallen below the pace of the fourth quarter of 1990.

Durable goods manufacturers are also watching their order backlogs shrink. In February, unfilled orders slipped 0.1%, after no change in January. Excluding aircraft, which still enjoys high demand, backlogs are down 5% from a year ago. That means companies will continue to slash payrolls and output until orders pick up. And with long-term interest rates still relatively high, businesses may be disinclined to invest in new equipment.

All this creates a vicious cycle for the economy. Consumers won't spend until income and jobs start to increase. But businesses won't add to payrolls or production until demand for their goods begins to rise, which depends on consumers buying more. Without lower long-term interest rates, this circle seems likely to corkscrew the economy into an even deeper hole--and push the recovery into the second half.

Before it's here, it's on the Bloomberg Terminal.