November 3, 2004
Are we economists collectively whistling in the dark?
After a year of strong economic growth marred only by a
slight slowing last spring, most forecasts assume only modest retrenchment
in the next year. Almost
without exception, I see forecasts assuming that employment growth will
maintain the 1.5 million annual rate of the past year and that consumption
will continue to grow almost 4 percent after adjustment for minimal
inflation (other than in energy).
For example, the shopping centers are assuming sales
this Christmas will grow 4.5 percent, only marginally less than the 5.1
percent gains last year. And
this is despite disappointing back-to-school traffic.
My problem with these forecasts occurs when I ask what
can make the forecasts wrong.
On the negative side I am increasingly worried by the
four consecutive declines in the leading indicators and the three
consecutive drops in consumer confidence.
When declines bunch like that, they usually establish trends.
To be sure, most of the monthly declines in the
indicators are small and, at 92.8, consumer confidence remains well above
recessionary levels. But they
might be presaging a stronger slowing than economists are expecting.
Also negative are what I call internal dynamics.
Inventory investment already has swung from $50 billion of depletion
at annual rates to more than $60 billion of accumulation.
How much more industrial growth can come from warehouse restocking?
Consumer savings rates are in the 1 percent range,
having never regained stature in the past recession.
To preserve a balance between assets and spending, I estimate that
the savings rate should be closer to 7 percent.
Unsold housing inventory, while remarkably low, is
beginning to climb. Office
vacancy remains at decade highs. Capacity
utilization is still well below expansion rates (although innovation may be
distorting the significance of this measure.)
Then we move to economic policy. Even the latest corporate tax cutting does not fully
compensate for the accelerated depreciation that is lapsing at the end of
this year. About 2 million more
households will climb into the alternative minimum tax when they file their
taxes next year. No further tax
cuts are in store, unless you are in states with sales taxes and no income
taxes. At best, tax policy is neutral following several years of
And monetary policy definitely is providing less
stimulus. Liquidity remains
ample, but the price of borrowing definitely is trending upward for most
people. (The home mortgage
could be the one exception.) That
upward trend will not be reversed next year, especially if the consensus
forecast is correct.
Finally, energy prices are dragging down spending.
After averaging more than $43 per barrel this year, oil prices may
begin the new year at more than $50. Even
if prices weaken later in the year, an average of $40 per barrel for 2005
now seems optimistic. Two years
ago, oil prices were in the mid twenties.
So what do we have on the positive side of the ledger?
Profits are strong and corporate cash flow is more than
ample to step up investment activity. Also,
strong productivity gains (above 7 percent in manufacturing recently)
suggest that returns on investment remain strong.
Corporations easily could step up their purchases of capital goods.
Of course, hesitancy from CEOs may prevent them from doing so.
The grueling collapse of state revenues appears to be
over. Some deferred projects
may be restarted.
Somehow, I hesitate to count the continued use of $80
billion for military operations in the Middle East as a positive.
However, it sustains an economic thrust.
A weak dollar has improved the competitiveness abroad
of American producers. If world
growth remains strong, and the indicators in Europe remain much more
favorable than our U.S. measures, then an expansion of trade could offset
weakness elsewhere. Unfortunately,
continued high energy prices are beginning to lower growth prospects around
So, the negatives clearly overwhelm the positives. To be sure, almost everyone is forecasting economic growth that is smaller in 2005 than 2004. However, those falling indicators and confidence measures suggest that we might need to think even smaller.