Why the U.S. Recovery Could Fall Short
By Rick MacDonald
While we at Standard & Poor's would not disagree with the Fed's expressed view that the longer-term outlook for the U.S. economy remains on solid ground, the risk is that any recovery in the second half of the year could fall short of optimistic forecasts. Indeed, the outlook for consumption and investment suggests that the U.S. economy is not yet out of the woods.
The growth engine for the economy in the second half of the 1990's has been robust investment in information technology. But a case can be made for why this locomotive will not return to its glory days soon.
In fact, technology spending may be lucky to break even in 2001 after putting up annual growth at a robust 13% rate over the prior five years.
Overall, the divergence between supply and demand in the tech sector has probably never been wider. And until this pruning of overcapacity has run its course, we are likely to see more pain before gain. Unfortunately, this can be a very ugly and drawn-out process, squeezing profit margins until this version of Survivor plays out.
Surging demand for technology over the last few years has resulted in a huge build-up in capacity. Data from the Fed suggest that high-tech capacity growth was still growing at a record 48% year-over-year rate at the end of 2000, which is all the more impressive given the law of large numbers. Unfortunately, this growth peak in supply has hit exactly as demand (both in and out of the tech sector) has stalled.
Robust underlying demand in recent years, combined with the dot- com boom, fueled an investment bubble in the tech sector on top of the equity bubble. But, we are now experiencing the deleveraging effect of unwinding these excesses, as a shortage of cash, lack of financing alternatives, languishing stock prices, and inevitable shake-out in many of the sub-industries has put a freeze on spending.
Compounding these woes within the tech sector is that demand outside of the tech industry is being impacted by the current profit recession. And with the second-half earnings outlook deteriorating by the day, non-tech companies have not surprisingly put a halt to many new spending initiatives.
Growth in consumption is also under ongoing pressure. The bottom line is that consumers won't spend what they don't have. The sharp slowdown seen in the economy and soaring tax payments over the past few quarters has left disposable income growing at one of the slowest year-over-year rates in the past five years.
And given the risk of a soft labor market in the months ahead suggested by the recent rash of announced layoffs, this figure might still get worse before it gets better.
Also, much has been made of the 2% decline in household net wealth in 2000, which marks the first decline dating back to at least 1955. The further sell-off in equities in the first quarter suggests that household balance sheets are only getting worse. Thus, not only is the wealth effect likely gone (something Greenspan believes has boosted consumption roughly 1% in recent years), but we could eventually see a negative wealth effect emerge, as households shore-up lost wealth through increased savings.
Finally, underlying domestic weakness could be exacerbated over the near-term by the deteriorating global economy, the California power crisis, and looming ill-timed strikes at several airlines and in the entertainment industry.
MacDonald is a Senior Economist for Standard & Poor's