U.S.: Growth Is Near Zero--and That's Good News

With bloated inventories shrinking fast, the worst could soon be over

With his typical homespun delivery, Dallas Federal Reserve Bank President Robert D. McTeer Jr. cautioned recently: "The blues are contagious. Don't get near people with them. Just go out and buy something."

The trouble is, consumers and businesses don't seem to be taking his advice. Retail sales and car purchases did perk up considerably in January, but the University of Michigan's index of consumer sentiment continued to plunge in early February (chart), and the National Federation of Independent Businesses' index of small-business optimism fell again. Both are plumbing levels not seen since the 1990-91 recession.

Does that mean a recession in 2001? Not necessarily. True, households and companies are coming down from the economic euphoria of the late 1990s, when stock prices were increasing 25% per year, the economy was growing at a 5% rate, and profits were in the double digits. The adjustment will take a while longer to complete, but more and more data suggest that it is already well advanced.

In the absence of huge additions to stock wealth, households are realigning their spending with the pace of income growth, a process that has already cut two or three percentage points off the unsustainable 5% to 6% growth rate of a year ago. Likewise, capital spending by businesses is adjusting to slower demand growth, softer profits, and tighter credit. All this requires that inventory growth must slow, which is why manufacturing output and employment are getting hit so hard.

The risks during this downshift are clearly great, especially since the quicker flow of information is speeding up the adjustment. With indicators falling fast, confidence measures are bound to reflect heightened concern. But the latest data suggest that the imbalances in the economy are being cleared away in a manner that will allow growth to pick up later in the year.

SOME OF THE BEST NEWS for the outlook came with the latest inventory data. Stock levels at manufacturers, wholesalers, and retailers increased only 0.1% in December, much less than expected and well below what the Commerce Dept. had estimated when it issued its preliminary report on fourth-quarter gross domestic product in late January.

In fact, the new inventory data, which were unavailable for the first reading on GDP, suggest a sizable downward revision to inventory growth when the GDP information is released on Feb. 28. Of course, revisions to other components will affect the overall final number, but the inventory refiguring, taken alone, could knock between 0.5 and 1.0 percentage point off of the originally reported 1.4% growth rate for GDP.

If growth is revised to near zero, how can that be good news? Because it would mean that the inventory reduction is proceeding rapidly, and that the adjustment required in the first quarter will be lower than many economists had expected. As long as consumer and business demand continues to grow--even at a subdued pace--the contraction in industrial output may well have run its course by midyear. That is especially likely since the lion's share of the excess inventories is in the auto industry, and because much of the weakness in factory output reflects auto industry cutbacks to reduce that overflow.

LOOK AT THE LATEST DATA on manufacturing output and auto inventories. Factory production fell 0.1% in January, but excluding vehicle output, production actually rose 0.3% (chart). Since factory output peaked in September, it has fallen at an annual rate of 5.4%, but excluding vehicle production, it has declined only at a 1.7% rate, and that figure includes auto-related softness in industries such as metals, rubber, and plastics.

The reduction in car and light-truck inventories will yield another big subtraction from first-quarter GDP. As it stands now, the inventory of domestically made light-vehicles at the end of January was a "very high" 90 days, according to Ward's Automotive Reports, up from 82 days in December. Ward's says that if February sales meet its expectation and indicate a 16.2 million annual rate, the supply will fall to 74 days. But that level is still greater than last year's more normal 61 days, suggesting additional production scalebacks in February and March.

Elsewhere in manufacturing, output is slowing, but not as sharply as the impact of the auto cutbacks would suggest. Clearly, production of high-tech equipment, including computers, electronic components, and telecommunications equipment, has slowed from its exceptionally strong pace of late 1999 and early last year. But that pace--before and after the Y2K date change--was the exception, not the current slower rate.

High-tech output, up 2.2% in January, averaged monthly gains of 2.4% during the past six months. That was down from the powerful 4.5% monthly clip averaged during the months before and after Y2K, but during the previous 2 1/2 years, output averaged 2.7%. High-tech output, therefore, appears simply to be returning to its normal trend. The stiffest cutbacks in capital spending so far have been in low-tech transportation equipment and industrial machinery.

THE KEY TO THE OUTLOOK is consumers. Their spending is crucial to the rapid elimination of excess inventories and to the willingness of businesses to keep shelling out money for new equipment and buildings. So far in the quarter, the news is good, if somewhat difficult to read because of the weather.

Sales at retailers and car dealers rebounded strongly in January. The same bounce relative to weaker results in both November and December showed up in January job growth and hours worked, as well. The connection could be that January weather was milder than normal, while weather at the end of last year was more severe than usual. The pattern of "heating degree days" for those months bears that out. If so, the January bounce may overstate the strength in demand at the beginning of the year.

Nevertheless, the January data on housing starts and car sales still look encouraging. Households would surely cut back on those two areas first if they felt overburdened or excessively worried. In fact, despite the bad November and December weather, housing starts increased in both of those months, and in January they gained an impressive 5.3%, hitting an annual rate of 1.65 million--the highest in nine months (chart).

Amid layoff announcements, investor nervousness, and recession talk, the Dallas Fed's McTeer may have a tough time getting his persistently upbeat message across. But the way things are going so far this year, consumers and businesses are apt to look around a few months from now and realize that the economy, while far from being as vibrant as it was, is nowhere near as gloomy as they fear.

By James C. Cooper & Kathleen Madigan

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