The Recovery: Why So Slow?By
For a brief time this spring, it looked as if three years of economic stagnation, including two quarters of outright decline, were over. The economy expanded for four quarters in a row, housing was reviving, corporate profits were zooming, and consumer confidence was rebounding. The classic upturn in the business cycle seemed to be unfolding, just as in the prior eight recoveries since 1949. America was getting back off the canvas.
Yet as spring began to turn to summer, the numbers somehow weren't falling into place. With 2.7% growth in the first quarter, the economy should have created 200,000 jobs, enough to keep recovery on track. Instead, private payrolls declined. And April and May brought further hints that business was reluctant to hire and consumers were hesitant to spend. It was June's jobless rate, though, that shocked business executives and policymakers around the world: Unemployment surged to 7.8%, and payroll employment nose-dived by 117,000, erasing almost all the private sector job gains since the turn of the year. Suddenly, instead of expanding, the U.S. economy appears ready to stall out, just as it did last summer.
What's going wrong? Everyone knew that the financial excesses of the 1980s had left behind some structural barriers to growth. But the economy's long-term problems are turning out to be far more pervasive and far harder to overcome than economists, the Bush Administration, and even the Federal Reserve Board ever imagined. And this failure to understand just how deep-seated the barriers to growth really are led to a series of bad economic forecasts and feeble policy responses.
When the recession first started in July, 1990, most forecasters--including Federal Reserve Chairman Alan Greenspan--blamed it on the Persian Gulf war and expected a few modest cuts in interest rates to get the economy moving once the war was over. Then, when the recovery didn't materialize in 1991, most people thought that a few more interest-rate cuts by the Fed would do the trick, as they have in every recession since 1948. But that, too, failed to work. By now, the Fed has cut interest rates 18 times since 1989, and the economy is still mired in the longest period of stagnation since World War II.
And every time one problem seemingly abates, another unpleasant surprise pops up. Everyone worried about leveraged buyouts and the debt burden that corporations piled up in the 1980s. But even as companies get their borrowing under control, it's consumer debt that's still too high. The banking system has avoided the collapse that some feared and returned to profitability again, but business and consumers are still paying through the nose for loans. Forecasters knew about coming defense cuts, but they thought that it would be a gradual process so the economy would be able to absorb most of the laid-off workers. Instead, the defense cuts have been deep and sudden. Everyone knew the glut of office space would linger for years, but the impact on local economies of plummeting construction spending has been far worse than anyone anticipated.
Companies that were supposed to have nearly completed restructuring seem to have started a new round of firings. In the past two weeks alone, many blue-chip companies have announced new layoffs. A second wave of firings is not supposed to happen when the economy is turning up.
Add all the unforeseen structural problems together, and the economy could stay flat for months. Before Election Day rolls around, the unemployment rate is almost sure to top 8%. And some fear that stagnation could continue into 1993 and beyond. Says Conway G. Ivy, vice-president and treasurer of Sherwin-Williams Co.: "We don't see signs of fundamental problems in our economy being corrected, so we see a likelihood of a sluggish, slow-growth economy for the next couple of years."
BIG PLUS. That doesn't mean the U.S. is going to sink into a new recession. Economic growth, however slow and halting, is still being propelled by many of the same cyclical forces that have driven recoveries in the past. Low short-term interest rates--the lowest in 29 years--are making some types of borrowing more attractive. From cereal makers to mobile-home manufacturers, many businesses have seen a sales rebound. Auto sales at the end of June were running at a relatively strong 7.5 million annual rate. Housing has revived from its 1990 lows. And while weakness abroad has slowed U.S. export growth, exports still remain a big plus for the economy.
Washington seems to have done a heroic job in rescuing the banking system. Sure, the cost of the savings and loan bailout has soared, but few savers have lost money, and there have been no bank runs. Two years ago, commercial banks, too, were in their worst shapein 60 years, reeling under an avalanche of commercial real estate loans gone bad. Yet over the past year, the profits of financial corporations, including banks, are up 40%, compared with 23% for all other corporations--a stunning reversal.
But the recovery is being hurt because the gains for the banks have come at the expense of savers and borrowers. As the Fed cut short-term interest rates from 9.85% in 1989 to 3.25%, the banks eagerly slashed the rate they paid depositors while hardly lowering their lending rates to borrowers. The widening spread between long and short rates hurt depositors, while keeping the cost of borrowing high. If the prime rate had fallen as much as CDs, banks would be charging 4.5% instead of 6% for borrowing, which would sure
ly stimulate the economy. "The shape of the Treasury yield curve is `bankfare' or bank welfare," says David A. Levy, director of the forecasting center at the Jerome Levy Economics Institute.
What's more, bankers are shoring up the bottom line by being stingy with loans to businesses that could stimulate the economy. Instead, bankers are being cautious and investing unprecedented sums in default-free government securities. Over the past year, commercial banks invested $115 billion in Treasury securities and cut back on their commercial and industrial loans to business by $28 billion, which is hardly a recipe for recovery.
BUSTED BOOMERS. Economists were overly optimistic on recovery because they failed to fully grasp the new dynamics of consumer debt. In the past, consumers cleaned their balance sheets in recessions and the first year of recovery, which left them room to boost demand by borrowing more. But over the past two years, household debt rose by 10.2%, while aftertax income rose by only 9.4%. That's much different, for example, from the recession of 1974-75, when income rose much faster than consumer debt from the spring of 1974 to the beginning of 1976.
True, the most obvious type of consumer debt has fallen. Installment credit, including auto loans, has dropped by 10 billion over the last year. But that's far outweighed by the increase in second mortgages, including home equity loans, which rose by $27 billion in 1991 alone. What's more, the government's figures for consumer debt don't even count auto leasing, which has become increasingly popular. For example, General Motors Corp.'s SmartLease program leased 195,000 cars and trucks in 1991, up 86% from the previous year. In the first quarter of 1992, their lease volume was up 15% over a year ago--and none of these auto-lease obligations show up in the consumer-debt numbers.
In the past, consumers have been bailed out of their debt binds by rising incomes and by inflation--especially rising home values, which lowered the real value of their debt. Not this time. Real wage rates are declining at about 0.4% a year, putting the squeeze on consumers, and inflation has fallen to a negligible 3% annual rate. And last year's plunge in housing prices left many families with no financial cushion. The result: Consumer credit delinquencies are rising, and, according to the American Financial Services Assn., personal-bankruptcy filings in the first quarter of 1992 are up 10% over a year earlier. "We have a long way to go in rebuilding household balance sheets," says John Lonski, economist at Moody's Investors Service Inc.
And while consumers are still struggling with their debt burdens, anyone with savings is being hurt by the falling interest rates that were supposed to revive the economy. For example, after the Fed cut the discount rate, California's Bank of America cut its passbook savings rate from 3.25% to an astonishingly low 2.75%, and others followed suit. And rates below 3% could soon be common.
JOB FREEZE. Even before the most recent cuts, low interest rates were devastating people who depend on savings. Maria Smith (not her real name), a widow who lives in a condo in Orlando, Fla., put her money into certificates of deposit when her husband died 18 months ago. Everthing was fine when those CDs were paying around 7%. But now that CDs are paying 3%, her income dropped from $25,000 in the first quarter of last year to $14,800 in the first quarter of this year. And she ran into a cash-flow crunch when her payments for income taxes and expenses outstripped her income by $4,600 this year. Although she is still comfortably well-off, she is worried. "You don't want to use your principal," she says. "You would like to live on the interest that is coming in."
As hard as low interest rates are on the elderly, the threat of job losses is shattering the average worker's confidence. Normally, companies would have started to hire at this stage of the business cycle. But not this time. Unable to raise prices in today's disinflationary environment and battered by global competition, companies feel that they need to shed even more workers in order to survive. Since the June drop in employment was announced on July 1, Amoco Corp. said that it will cut 8,500 jobs by the end of 1993. Aetna Life & Casualty Co., the giant insurance company in Hartford, will eliminate 10% of its total work force, or 4,800 jobs, by the end of next year. That comes on top ef 2,600 jobs cut last year. "Many companies really are now realizing they are living in a global economy," says Christopher J. Steffen, executive vice-president and chief financial and administration officer for Honeywell Inc., which expects to cut 100 jobs this year by attrition. "They have to be substantially more efficient, and they're not hiring people like they did."
POLITICAL GRIDLOCK. Look at Ryder System Inc., one of the nation's largest truck-rental and -leasing companies. It has pared its employees down from 46,000 to 40,000 over the past three years. And even though Ryder's earnings of $17.4 million were a long shot better than the loss of $2.2 million a year earlier, the company doesn't have any plans to add workers soon, says M. Anthony Burns, chief executive at Ryder. And Dallas-based SnyderGeneral Corp., one of the country's largest makers of commercial air-conditioning and air-filtration products, has had a hiring freeze on for the past six months. The $850 million revenue company also cut its 1992 capital-spending budget by about 20%, to $2.8 million. "Our major concern is that we could fall back into a recession awfully easy," says Richard W. Snyder, the company's chief executive. "We need to make sure the economy has really turned."
What's holding back new hiring in many cities is the plunge in commercial construction. Since May, 1991, construction of office buildings, hotels, and the like has dropped by 27%, compared with the 18% gain after the last recession, when it was a major engine of growth. This decline has affected more than just construction workers and real estate developers: The ripple effects have hit everyone from lawyers to cement manufacturers. There's no hope for a turnaround anytime soon. "You've got to be a real advanced stage, black-belt masochist" to lend to developers, says Richard L. Huber, vice-chairman of Continental Bank Corp. Without loans, developers can't even start to think about building.
Much of the job weakness in manufacturing has one cause: The continuing demobilization of the U.S. defense economy. Defense contractor Hughes Aircraft Co., based in Southern California, recently announced plans to lay off more than 9,000 workers, or 15% of its current work force. In Massachusetts, Raytheon Co. is cutting an additional 700 jobs on top of last year's 4,900 job cut.
Without the defense cuts, manufacturing would be much stronger. Indeed, out of the 190,000 jobs lost in manufacturing over the past year, about two-thirds were in defense-related industries such as aerospace and communications equipment. And with these layoffs hitting some of the nation's most skilled and best-paid workers, the cuts are having a disproportionate impact on income.
Indeed, with defense spending dropping, the government sector has become a drag on the recovery rather than a plus. Paralyzed by a $350 billion budget deficit, Congress and the Bush Administration had hoped that the economy could recover without help from fiscal policy. And for a while in the spring, it looked as if they were right. Now, the economy is staggering, but the huge deficit and political gridlock make it hard to increase federal spending or to cut taxes.
Yawning budget deficits at the state and local level are also holding back the recovery. In California, for instance, the governor and legislature are battling over how best to eliminate a nearly $11 billion deficit hobbling a state economy that accounts for more than 13% of the nation's output.
For all the structural problems, the U.S. economy is not about to shift into reverse. It does have a forward momentum that will keep it growing, albeit slowly. Autos are getting a kick from easy money and pent-up demand. In June, Detroit sold cars at a 6.8 million annual rate, up substantially from May. And dealers say people are now coming in to buy, not just to look. Karen M. Tibus, the owner of Saturn of Plymouth in Plymouth, Mich., says things have been going so well for her dealership that customers have to wait an hour-and-a-half to talk to a salesperson. "We're gonna have a very empty lot real soon," she reports.
The $5.8 billion mobile-home industry is also looking up. After seven years of depressed results that wiped out half the industry, shipments started turning up sharply at the beginning of 1992. "It's about time," says Nicholas J. St. George, president and CEO of Oakwood Homes Corp. in Greensboro, N. C., which is the second-largest company in the industry.
Other types of businesses are also doing well. General Mills Inc., for example, racked up a 16% gain in net income in the fiscal year that ended May 31, and the company intends to boost capital spending somewhat over the next three years. Even small businesses are seeing improvement. With his MBA in telecommunications complete in 1991, Stephen K. Morris, 37, of Piedmont, Calif., opened a consulting practice. "Clients are increasing the number of projects and the hours involved," he says. "They are definitely looking at an improved economy and improved sales."
HOT FRIDGES. The housing market, too, is getting better, despite some erratic swings. In Pittsburgh, for example, housing starts and home sales are holding up, and loan demand for mortgages and refinancings remains sturdy, says Stuart G. Hoffman, chief economist at PNC Financial Corp. And sales of refrigerators, stoves, washers, and other major appliances have been reasonably strong, perhaps because consumers simply have to replace models as they break down. Through May, major-appliance shipments were up 5.7% from a year earlier, and appliance makers such as General Electric Co. and Frigidaire Co. expect a modest increase in sales in the second half of the year.
Another piece of good news is that unlike individuals, corporations have streamlined their balance sheets. In each of the past two quarters, nonfinancial corporations raised new net equity capital at an annual rate of $50 billion. They've also taken advantage of lower interest rates to reduce their overall debt payments. Carnival Cruise Lines Inc., for instance, called a zero-coupon convertible paying an interest rate of 7.5% and replaced it with a $100 million convertible paying 4.5% and some bank borrowings. Ryder has also cut its debt from $3.1 billion to $1.9 billion in the past two years. "Our financial condition is stronger than it has been in a decade," says Chief Executive Burns.
As a result, corporate debt has hardly grown over the past year. This has left companies poised for expansion once the economy shows some real signs of strength. For the first time in months, healthy companies are visiting First Union Corp., a major bank in Charlotte, C., window-shopping for rates and loan terms. And in Boulder, Colo., loan demand is particularly strong among high-tech and biotechnology companies that are expanding or relocating to the area.
Exports are still a source of strength for the U.S. economy, even though their growth has slipped in recent months as Europe and Japan slowed down. Lackluster growth overseas accounts for the leveling off in semiconductor sales, says James D. Feldhan, executive vice-president at market researcher In-Stat Inc. America's largest exporter, Boeing Co., is busy building planes, but its backlog of overseas orders is starting to fall.
Still, U.S. companies are no longer hobbled by a higher cost of capital than their foreign competitors, and hourly labor costs in the U.S. are among the lowest in the industrialized world. Combined with the falling dollar, that has kept U.S. goods and services competitive abroad.
Right now, that is not enough to overcome the structural barriers and spark a healthy rebound. But monetary policy is easy enough and pent-up demand for housing and autos strong enough to ensure that the recovery will not abort.
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