In This Economy, Every Silver Lining Has A Dark Cloud

The road to recovery is getting bumpier by the week. Rising interest rates threaten the housing recovery. A more expensive dollar and weak foreign economies are hurting exports. Weak orders are blocking a pickup in factory output and employment. And poor job prospects generally have driven consumer confidence to levels that raise serious doubts about a turnaround in consumer spending.

To be sure, there are some glimmerings of recovery in the data of recent weeks. All measures of the money supply have accelerated sharply, an indication that the Federal Reserve's past cuts in interest rates are beginning to have some impact. Better looking retail sales, car sales, and housing starts round out the list. However, each bit of good news that comes along seems to get hammered by bad news later on.

The latest example: Consumers spent a little more in January, and one survey's readings for early February showed a slight improvement in consumers' spirits. All this engendered hopes that a consumer-led upturn was imminent. Then came the Conference Board's report that consumer confidence in February dropped to a 17-year low (chart). So much for the hope that consumers are ready to lead the recovery.


Recoveries just don't get off the ground while consumer confidence is sinking. The Conference Board's index fell to 46.3 in February, from 50.2 in January. That's the lowest since the depths of the 1973-75 recession.

The survey shows that job security continues to be the prime concern among households. The percentage of consumers who characterize jobs as "hard to get" rose to 49.3% in February, and the uptrend of the past year shows no sign of abating. Unlike past recessions, consumers are increasingly aware that many job losses this time are permanent, not just temporary.

Not only were consumers more downbeat about their view of present economic conditions but they were markedly more pessimistic about the near future. The Conference Board's conclusion: "The economy will not be convincingly in a recovery phase until there is a marked improvement in consumers' spirits."

An economic revival also needs a growing manufacturing sector, and stronger consumer spending is imperative to get factories humming again. Weak consumer buying at the end of last year left retail and wholesale inventories bulging. Efforts to reduce that overhang will depress factory orders and output in the first quarter.

Indeed, the trend of manufacturers' orders for durable goods is clearly down. New orders rose 1.5% in January, but that followed a 5.1% plunge in December, and the three-month average of orders has been declining since October. Moreover, the backlog of unfilled orders fell 0.3% in January, the fifth consecutive drop (chart). These trends imply little output strength in coming months.

Federal Reserve Board Chairman Alan Greenspan sounded a little more guarded on Feb. 25, when he put forth his forecast of a spring recovery during the second leg of his semiannual testimony to Congress on the conduct of monetary policy. The optimism in his remarks only one week earlier was far less qualified.

This time, Greenspan cautioned that recent positive signs "should not be exaggerated." He repeated his warning of a week earlier that, like last year, "the prospective incipient recovery could peter out." The chairman called the drop in consumer confidence "quite disturbing" and said that it "does not support the view that things are improving."

Although Greenspan said that it was too soon to tell if the recovery was on the way, he did say that he expected to see positive signs within weeks, not months. Translation: Barring a negative surprise in the data, the Fed is not likely to cut interest rates in the next few weeks, as it waits for more convincing evidence to emerge. The next big signpost: The February job report on Mar. 6.


Clearly, domestic demand--especially by consumers--is the recovery's immediate roadblock. However, foreign trade also weighs heavily on the outlook. It was a big plus to economic growth in 1991, but trade prospects do not look as promising in 1992.

Indeed, foreign trade was a saving grace for the economy last year. Without the positive effects of a shrinking trade deficit, real gross domestic product would have declined slightly in 1991 instead of rising a bit.

Looking to 1992, America's insatiable thirst for imports is one problem. Also, export growth may not be very strong this year. That would remove a key prop under the factory sector: Exports now account for 18.6% of industrial output--a gain from the 11.8% share in 1983, when the U.S. was coming out of its last recession.

Foreign trade ended last year on a sour note. The merchandise trade deficit widened to $5.9 billion in December, from $4.2 billion in November. Imports increased by 2.3%, to $42.1 billion in the month, while exports fell by 2.2%, to $36.1 billion.


Imports seem likely to pick up once a recovery gets under way. For all of 1991, merchandise imports fell by 1.5%, but that mainly reflects the weakness in domestic demand. Shipments from Europe accounted for almost all of the decline. Oil imports also slumped, the result of falling prices, some supply disruptions during the gulf war early in 1991, and the weak U.S. economy.

But even as imports were declining last year, their share of domestic spending for goods other than petroleum continued to rise, hitting a record 21.9% in the fourth quarter. With no letup in the U.S. propensity to consume imports, purchases of foreign goods are likely to rise when domestic demand starts to grow faster.

Moreover, many U.S. companies should take a close look at their own operations before they start chanting the "buy American" mantra. A BUSINESS WEEK analysis shows that imports of consumer goods, including autos, have remained fairly steady in recent years, when measured as a percentage of domestic spending on goods other than petroleum.

Meanwhile, business-related imports of industrial materials and capital equipment are rising as a percentage of domestic demand (chart). Since 1987, businesses have accounted for virtually all of the country's increased appetite for foreign goods.

The export side of the trade ledger does not look bright, either. Exports did perform well last year, rising 7.2% for all of 1991. Most of the growth came from Latin America, especially Mexico, Brazil, and Venezuela. Gains were more modest in shipments to Canada and the European countries, who are big purchasers of U.S. goods, but whose economies are slowing or in recession.

However, maintaining an edge in world markets will be especially difficult for U.S. producers this year. Economic growth, particularly in the industrialized countries, will not be robust even when recovery comes. That will limit foreign demand for U.S. goods.

U.S. exporters must also deal with a stronger dollar--a result of rising interest rates in the U.S. Compared with the currencies of our 10 major trading partners, the dollar has risen nearly 5% since mid-January (chart). Profit-taking may cause the dollar to lose some ground in foreign exchange markets in the next few weeks, but the upward pressure on the currency will exist as long as long-term rates are rising.

As a result, export growth will be sluggish this year. Combined with a pickup in imports once the U.S. recovery starts, that means foreign trade in 1992, at best, will not add very much to economic growth this year.

More worrisome is that the foreign sector will actually subtract from growth if the global slowdown worsens, or if domestic demand for imports grows more strongly than expected. Added to the potholes created by skittish consumers and the slump in manufacturing, a deteriorating trade deficit is shaping up to be yet another detour on the rocky road to recovery.