January 2, 2002

We are currently in recession, although some signs suggest that the degree of weakness is slowly lessening.For example, the coincident indicators, which are designed to show current economic conditions, fell 0.5 percent in September, 0.3 percent in October but only 0.2 percent in November.

As we know, the leading indicators have turned positive, the index of hours worked was virtually unchanged in November, and industrial production showed its smallest decline of the year in November.

Unfortunately, recessions rarely end with a whimper. More likely, some over-reaction on the downside punctuates the end of the recession.  Then, plunging interest rates unleash housing and consumer durables, while falling inflation bolsters the purchasing power of the 94 to 96 percent of workers who did not lose their jobs.

September 11th may have altered this timing.Consumer pessimism has restrained Christmas sales while a 21 percent decline in operating profits from previous year levels is restricting capital spending. Lower occupancy rates for hotels and apartments are restraining construction.

Low interest rates have allowed housing and autos to rebound before the economy.This may have reduced the degree of weakness but also will subtract from the thrust that will aid the recovery.GDP probably will fall about the same in the fall as in the summer, but will not then be supported with above trend growth from consumer durables and housing.

Fortunately, lower inflation, especially for energy, has allowed real purchasing power to grow more than 2 percent.Even with no growth in jobs, this will allow consumption to grow between 1 and 2 percent in 2002.>

Some economists have argued that rising consumer debt and lower consumer confidence will prevent even that magnitude of consumption growth. In fact, much of the increased debt has been for auto loans, or for equity loans that have been used to pay off credit card balances. Monthly housing and auto payments are lower now than when the year began.

Therefore, I think consumer spending will grow at the upper range of that growth in purchasing power, but not higher. Auto sales actually will fall to less than 16 million units next year.

Fixed investment will remain weak.Operating profits will be virtually flat with 2001 averages in 2002, though cash flow should improve to a 3 percent gain from a 6 percent decline that currently is being felt by corporations. Capacity currently is growing an anemic 1.7 percent and possibly could fall to 1 percent gains before capital spending rebounds later in the year.

With little gains from housing, where units may actually fall to slightly less than 1.5 million but size will make up the difference, fixed investment probably will decline between 3 and 4 percent next year.

Inventories almost certainly will improve from the more than $60 billion depletion suffered this year. Indeed, actual growth in inventories should be desired by the end of next year.

Exports continue to suffer from an unusually strong dollar. The dollar should lose value to the euro during the year, but trade probably will take away another half percent of GDP as imports decline more slowly than exports.  Even at the end of 2002, trade deficits will tend to rise rather than fall.

State and local spending will be neither as strong as the 5 percent gains early in 2001 or the negative gains during the summer.Because of falling revenues, growth will be minimal, between 1 and 2 percent.  Rainy day funds and capital spending programs for sewers, highways, and schools will provide that meager gain.

Federal government will grow, probably between 3 and 4 percent adjusted for inflation(as are all the earlier estimates).>

When all the numbers are combined,  growth should be between 1 and 1.5 percent. With minimal growth in the first quarter, this allows about 1.5 percent gains during the spring and about 3 percent growth in the second half of the year.

Unemployment grows to 6.5 percent and tops out near the end of the year. Short term interest rates remain below 2 percent into the summer and then climb slowly to only 3 percent by the end of the year.

Long term rates may actually fall in the next two months, but then will rise slowly.A gain of only about a quarter percentage point is likely by the end of 2002.

Stocks will continue their rally, but only to 11250 on the Dow and 2400 on Nasdaq Inflation will be slightly more than 2 percent but show rising tendencies later in the year.

Strong growth must await 2003, and virtually all forecasters assume that no further damage to our confidence is suffered because of terrorism. Still, a weak recovery is a lot better than what we have just suffered.  


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