U.S.: A Recession May Be Inevitable
There's no escaping the conclusion: The surprise attack on the U.S. on Sept. 11 almost surely pushed this fragile economy into a recession.
Consumer confidence is undoubtedly plunging as Americans struggle with the once unimaginable idea of a large-scale terrorist attack on U.S. soil (table). The near-term implications for U.S. financial markets remain uncertain, and investors around the world are stunned. With the political repercussions not fully played out, the extent of the economic damage may not be known for months.
Forecasters label any surprise to the economy an exogenous shock, an unpredictable event that can't be programmed into an econometric model. That's why the destruction of the World Trade Center and the damage to the Pentagon leave the outlook more unknown than at any time since World War II. History simply cannot tell us how American consumers and business will react over the next few quarters to a crisis of this magnitude.
The closest precedent may be the gulf war and its resulting recession. The Iraqi invasion of Kuwait caused oil prices to skyrocket, and fear of a U.S. war with Iraq ruined consumer confidence. The Conference Board's index of consumer confidence fell 47 points from August, 1990, the month of the invasion, to January, 1991, the end of the war.
Keep in mind, though, that about 300 Americans were killed during that conflict. The current disaster surpassed that total in its first few seconds. Moreover, the Persian Gulf War was fought on foreign soil. The tensions generated by this at-home attack are greater and will linger longer.
CERTAINLY, THE TERRORISM is forcing immediate changes to the way business is conducted. After the attack, travel was suspended, sporting events canceled, business offices closed, and the financial markets were shut down. All that represents a huge volume of lost economic activity.
On a positive note, policy actions at home and overseas will help to keep business going. The Federal Reserve announced that it is ready to inject liquidity into the system as needed. The Bank of Japan and the European Central Bank pumped a total of $80 billion into their markets. The united front stabilized the dollar after it plunged on the day of the attack.
The outlook over the next few quarters, however, will come down to how U.S. consumers and businesses behave. Typically, their response to a crisis has been to freeze. Spending stops, and decisions about the future are put on hold. If this disengagement lasts only a few days, then the economy will probably soldier on--still weak, but growing.
But given how the attack has shattered U.S. complacency, the impact will likely persist. If so, capital spending, already falling like a stone, seems apt to decline even more, and consumers will be more likely to save their rebate checks than spend them. In an economy already weakened by inventory problems and rising unemployment, any new suspension in overall demand will mean the end of the expansion and a further reduction in profit expectations that will fall back on stock prices.
THE ECONOMY WAS TEETERING even before the disaster (chart). The most recent data came in mixed, as they usually do when the economy's fortunes are about to change. Factory numbers showed that tech continued to struggle, but old-line manufacturers were getting a better handle on their excess inventories, and their orders were picking up. Consumer confidence fell early in 2001, but it had stabilized at a still historically high level. Profits continued to swoon, but the tax rebate checks were boosting the aftertax income of households.
Then on Sept. 7, the economy got some bad news. The August employment report said that nonfarm payrolls fell 113,000, and the unemployment rate bounced up to 4.9%, from 4.5%. The unexpectedly large job loss unnerved investors, who had been looking for better economic news. Instead, the Dow Jones industrial average closed down 235 points for the day, bringing the losses since mid-August to about 800 points. Higher joblessness and the market plunge had undoubtedly hit consumer and business confidence hard.
Easily the most downbeat news from the August employment report was the continued large drop in hours worked, which in the first two months of the third quarter were down at a 2.6% annual rate from their second-quarter average, well faster than the 1.5% drop in the second quarter. The September number will make the quarter's decline even worse, especially since the World Trade Center disaster happened during the Labor Dept.'s survey week. A 3% drop in hours worked means that productivity would have to grow at a 3% annual rate just to bring economic growth to zero.
For the first time this year, the possibility of two consecutive negative readings on gross domestic product cannot be ruled out, since the fourth quarter may well be at risk in the aftermath of the Sept. 11 events. Moreover, the skimpy 0.2% gain in the second quarter could yet be revised down.
CONSUMERS WERE GETTING SKITTISH before September. August chain-store sales increased, but only at a modest pace. (Buying was expected to be up strongly because of the tax rebate checks.) In addition, consumers took on no new credit in July after paying down their debts by $1.8 billion in June. That was the biggest two-month pullback in borrowing in nine years. Households may already have been concentrating on sprucing up their finances rather than spending more.
Will consumers completely retrench now? Again, the gulf war offers a discouraging example. Real consumer spending fell at a 1.2% annual rate in the second half of 1990. Factor in the new job worries (table), and consumers have every reason to cut back on their spending.
If that's the case, then this recession could be a prolonged one. Capital spending will offer no help, since businesses were already grappling with an overhang of equipment. Foreign trade is unlikely to be a buffer. If anything, the U.S. may turn more protectionist in coming months. The one source of growth may well be the government, especially funds for the military and rebuilding.
Before Tuesday, the consensus view of economists was that the U.S. would muddle through this sluggish time and that the worst was over. Now we are in uncharted waters. Consider that most recessions are the result of exogenous shocks: the oil crisis of 1973, the credit controls of 1980, and, of course, the gulf war. This time around, the shock--so sudden, so deadly, and so near--opens a new door in U.S. history and a new chapter in the economic outlook.
By James C. Cooper & Kathleen Madigan