August 14, 2002

Double dips can be very good on an ice cream cone.  They usually create problems when they are part of a recession. 

The first dip puts strain upon cost structures and credit quality.  By the time recovery begins, prices and costs are being slashed to preserve earnings while bankruptcies soar.  The second dip entrenches low prices in the costs of capital equipment and the contracts of workers. 

Banks are more aggressive in shutting the credit windows while investors are even more leery about providing funds to risky ventures.  Not surprisingly, the double dip recession in 1970 spawned the Penn Central crisis that almost caused a collapse of short term lending. 

The dual recessions of 1958 and 1960 on the one hand, and 1980 and 1982 on the other were followed by substantial reductions in inflation. 

The reason why I am discussing these outcomes is because the current economic climate is beginning to look a lot like one of these double dip affairs.  If so, we can look for more credit shocks, strain in equity markets, and substantially lower inflation. 

Because inflation already is low, substantial reductions could lead to the problem of deflation that has plagued Japan for more than a decade.  Frankly, for most people, this double dip prospect of recession is not very appetizing.  

I still have difficulty believing that stimulative monetary and budgetary policy could coincide with the return to recession.  Indeed, much  of the speculative excesses and over-investment already has been wrung from the economy.  Except for commercial construction, capital no longer is being expanded faster than output. 

Inventory deficiencies have replaced inventory excesses.  Even the consumer has increased savings from nearly nothing to 4 percent of disposable income.  While the trade deficit remains huge, the falling dollar is beginning to stimulate sales abroad.  (Unfortunately, there is no evidence yet that a weakening dollar also is slowing penetration at home by international producers.)

Nevertheless, the plunge in financial wealth is beginning to undermine consumer confidence.  Also, more than two thirds of the inventory deficiency has been restored with little measurable growth in economic output.  Indeed, except for increased production as an alternative to selling from the warehouse, there would have been no economic growth in the spring. 

Falling stock market values have stalled capital spending.  As enterprise values recede and bank credit becomes less available, corporate spending continues to be slashed. 

In the latest employment report, layoffs were even more severe in the revenue scarce state and local governments than in the struggling communications sector.  Also, employment agencies saw a sharp drop in jobs following six months of growth while the workweek fell significantly. 

Both measures are early signals of the direction of employment growth.  Also, the shrinking workweek means smaller paychecks.  I estimate that purchasing power fell by 0.8 percent in July alone. 

So many companies have lost investment status in their credit rating that high yield market has been overwhelmed with this supply of bonds from fallen angels.  There simply is not enough credit in that sector of the market to meet all high yield needs. 

Usually, stimulative economic policy would offset such disturbing trends.  However, monetary policy already has pushed interest rates well below equilibrium levels.  More can be done in managing the interest rate spread and in using changes in margin requirements to reduce instability in equity valuations. 

However, a Federal Reserve that was thinking about when to raise rates now is reluctant to consider further lowering of rates. 

Once again, tax changes that take years to be completed have had muted effect upon the economy.  The 1982 recession began a year after Reagan's tax reductions were enacted.  Must Bush discover the same problems in using multi-year tax reductions. 

In other words, because the policy powder already has been used, little is left to ensure that the second recessionary dip will not arrive.  What a shame. 











The President and Treasury Secretary must feel fortunate that they are not required to sign the National Income and Product Accounts to attest to their fair representation of the state of the economy.  The restatements made in the latest GDP release would initiate Congressional investigations if similar adjustments had been made by private corporations. 

Those wondering how economists can declare a recession when only one quarter of economic activity showed declines need no longer worry.  The new data show that economic activity fell for three consecutive quarters beginning in the winter of 2001.  (Thank you Dating Committee members for looking at monthly data to draw the appropriate conclusion about the recession.)

Actually, the national accounts use more assumptions and estimates than any private corporation should be allowed to make.  Every July, changes in Censuses on Retailing, Manufacturing and other entities are used to recalibrate the estimating procedure. 

GDP estimates also are altered because of changes in methodology, but no major procedural changes occurred in these revisions. 

Finally, more complete income information from tax compilations are used to improve estimates of property, partnership, and corporate income.  For example, interest earnings (and expenses) were much higher than originally reported for 2000 while corporate profits were dramatically lower. 

Indeed, before tax profits were over estimated by $88.3 billion in 2000.  This is missing the target by more than eleven percent.  No wonder that capital spending began to plunge early in 2001.

The initial  profits estimates are made by adjusting public statements about profits to remove asset swaps and other distortions to operating profits.  Those estimates are then refined as tax statements become available.  Those large adjustments suggest that the discrepancy between what corporations were telling their investors and what they were reporting to the tax collector widened dramatically in 2000. 

The good news is that the downward profits estimates have been smaller since then.  Now that corporate executives are more accountable for what they report to shareholders, perhaps such large adjustments will not reappear. 

Adjustments in the inflation estimates were relatively modest and need not concern us further. 

However, overall production was 1.3 percent lower in the first quarter of 2002 than previously reported.

Of the largely $125 billion downward adjustment in the level of GDP, about $80 billion was in consumption.  Most of that overstatement was in other services. 

The $40 billion downward adjustment in investment was more than explained by a $50 billion drop in investment of computers and peripheral equipment.  Investment in transportation equipment also was seriously revised downward, while office space and other structure spending was revised upward. 

The revision in the trade accounts was largely in service imports.  Some of this is higher tourism from the U.S. than originally expected.  However, the largest change appears to be in financial remittances.  This probably reflects insurance premia flowing to reinsurance companies in Europe . 

What have we learned from these revisions in addition to the three consecutive quarterly declines that spell recession in almost any economic language?

First, productivity will be revised downward.  The downward adjustment in the past four quarters could be as much as 1.5 percentage points. 

Second, underlying growth in this economy probably is closer to 3.3 percent than to the 3.7 percent that previous information led me to believe. 

Third, corporations have much less liquidity and are earning much less on their capital than originally reported.  This probably will prevent any strong rebound in capital spending until a strong rebound in profits develops first. 

Fourth, the computer based economy is substantially smaller and has a much lower growth path than originally expected.  Does this not explain IBM's desire to provide more services through its purchase of the Price Waterhouse Cooper consulting activity?

Finally, all those administration economists declaring that the economy is sound and the recovery is strong, and that includes the President, either learned economics from a different textbook then I did, or they have not yet had time to read this report. 


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