January 4, 2001
Whew! We are beginning to steer away from what was brewing as a "perfect" recession. Just as the confluence of two minor weather disturbances can combine into a major storm, two minor economic disturbances were about to collide. The dramatic interest rate reduction by the Federal Reserve indicates that it was aware of the danger and is taking steps to avoid as much damage as possible.
Because I am no longer making quarterly forecasts at Georgia State University from which I can be tested every year, it is now necessary for me to provide my annual outlook in a column. Rarely has one been more interesting than now.
The two economic problems are as follows: First, exuberance early this year led to excessive ordering for the Christmas season. As a result, the economy is plagued with too many cars, computers, electronic gadgets, toys, and almost everything else except natural gas, where we have too little to meet heating needs for a major winter. Because we could not sell our way out of this stack of goods, we must now shut down production lines to drop activity below quantities demanded.
Second, the consumer sector has spent more than it earned because asset appreciation made households feel wealthy. With the stock market slumping 10 percent, wealth no longer is sufficient to sustain current expenditures.
Now combine the needed shutdowns and temporary layoffs with a consumer struggling to rebuild assets and you have the makings of a major recessionary condition.
If anyone thinks the stock market rally following the Federal Reserve action ends the risk, they are mistaken. Some economic rain will fall. Employment will actually decline in the next few months. Indeed, year over year employment in Atlanta may actually decrease before the winter is over.
Moreover, the latest analysts' estimates of earnings for the Standard & Poor's companies is a first quarter gain of 5 percent. If my outlook is correct, first quarter earnings will be down by 3 to 5 percent. Wall Street may not have discounted all these earnings difficulties.
However, what the Federal Reserve action suggests is that the weakness will be limited. Construction should hold ground. Fixed investment should grow modestly. Consumer confidence should stabilize and spending should gradually rebound. After a first half of less than 1 percent GDP growth, a return to more than 3 percent gains is now likely in the second half of this year.
Surprisingly, the reduction in interest rate targets will not lower fixed mortgages. The fear of recession already had pushed long term interest rates sharply lower in recent weeks. Indeed, the timely Federal Reserve action may actually raise mortgages back above 7 percent for 30 year loans. Those adjustable mortgages, however, will experience substantial relief, plunging well below 6 percent by spring.
Now, having outlined the seriousness of the developing economic conditions and extolling the timeliness of the Federal Reserve action (and I assume more will follow), here are the major projections for 2001 that I wish to make:
Gross domestic product will grow only slightly more than 2 percent as consumer spending slows to 2.5 percent gains and inventory investment drops dramatically. Construction will be stable, with residential and public construction growing but commercial activity slowing slightly. Non-construction fixed investment should grow about 7 percent.
Government spending will provide some stimulus as military spending begins to rebound to more than offset the absence of a Census but state and local expenditures will remain on a 2 percent growth path.
Trade will continue to deteriorate, although the rate of decay will stall toward the end of the year.
Employment growth will average less than 50,000 per month for the year and unemployment will rise to more than 4.5 percent by year end. Wage pressures will intensify about half a percent but show no further upside potential at the end of the year.
Inflation as measured by the CPI will grow about 2.7 percent next year as energy prices drop, food inflation surfaces, and core inflation rebounds to nearly 3 percent.
The dollar will continue to slide against the Euro and the Canadian dollar and begin weakening against the yen after their fiscal year ends in March. On average, the dollar should drop about 5 percent against major currencies in 2001.
It now appears that short term interest rates will decline a full percentage point to insure that consumer confidence does not erode much further. All the declines will be completed by mid-spring, when employment gains begin resurfacing. This means a prime rate of 8.5 percent for much of the year. Long term interest rates may actually rise slightly for high quality government bonds to about 5.5 percent but lower quality bonds will sustain a major rally during the year.
After the Federal Reserve rally of January and February, equity values will suffer some pullback before the employment rebound is assured by the end of spring. However, anticipated heavy gains in bank stocks and multi-national companies, which are heavily weighted in the Dow Jones, assures record highs of over 12500 for that index. Nasdaq will have trouble going much above 3300 by year end.
Clearly, the dangers are more on a weaker economy before the recovery begins than forecast above. However, I believe the shift in U.S. policy is sufficiently timely to keep our economy from being in the center of the storm. Hopefully, policy makers in other countries also are taking note.