July 21, 2004
I have now heard talk about a “soft” versus “hard” landing for the economy. This officially launches the cyclical worry that the economy is stalling when the economy more likely is settling to orderly growth following the typical early surge after recession.
Normally, the early phase of a recovery begins slowly as producers gradually become aware that rising sales and orders are stronger than normal. Then, they all rush to order to restore the inventory from rapidly depleting warehouses.
It is not unusual for commodity prices to surge temporarily as orders grow faster than can be met from inventory. Of course, once production rises to a level that meets sales and also adds to inventory, then the surge is over.
At that point, longer term trends, such as spending by newly employed people, updating of technology through capital spending, growing exports after the world economy helps to supply some of those needed inventories here, all come into play.
Not surprisingly, a gap sometimes develops between the inventory surge and the restoration of orderly expansion from these longer term growth factors. When that gap is accompanied by rising interest rates and a faltering stock market, cries of a “hard” landing begin to surface.
I do not wish to belittle the significance of that gear shifting for the country. Just such an economic stall may have undermined the election of the first President Bush.
Indeed, the cyclical pattern is so typical that most economists are brushing aside the clear evidence of a temporary stall that the June economic data are revealing. The plunge to a six year low in vehicle sales, a drop in retail sales even after those dismal auto sales are extracted, slowing gains for employment and weak industrial production activity all attest to the gear shifting that currently is occurring.
Why will this time not be something more than the gear changing that is so typical of most recoveries?
The case for something weaker than usual is probably stronger than normal. Although only economists would agree, the downturn ended after November, 2001. This makes the current expansion 31 months old. The recovery is young, but we clearly have experienced even shorter spans of growth between recessions.
Downturns are preceded by unsustainable economic conditions such as over-building, inventory excesses, credit deterioration, and almost always, restrictive economic policies.
While no one would argue that economic policies are inconsistent with economic expansion (the high employment budget at the federal level is in deficit and the spread between short term and long term interest rates are unusually wide), some of the tax cuts will begin to lapse after this year. Also, the Federal Reserve is trying to raise short term rates until more normal interest rate relationships are restored.
The short expansions, such as between 1958 and 1960 and 1980 and 1982, were terminated by much more restrictive economic policies than we should observe.
However, economic imbalances are apparent in the spending behavior of the household sector and the enormous trade deficits that the U.S. economy is experiencing. Fortunately, these are problems that will lead to offsetting economic responses.
The trade deficits preserve a very competitive dollar, which aids economic expansion. Thus, any fall-off in consumer spending can be countered by rising exports.
While every economic cycle has some common features, each expansion shows unique behavior. The consumer savings rate is so low that consumers might forego spending to try to rebuild depleted retirement assets.
Such behavior would be surprising, especially as some economists declare that lower tax rates have enhanced the purchasing power of accumulated assets sufficiently to offset the depletion in market value of those same assets.
(While I am intrigued by that tax argument, consumers have not previously showed much response in their savings habits because of temporary tax changes. Only if we thought those changes were permanent would such spending behavior be reasonable.)
Furthermore, the world economy could falter and undermine our exports, although I see few unduly restrictive economic policies anywhere in the world.
The next few months could be trying for White House economists, but I agree with most of my forecasting colleagues that this stall is temporary. More sustainable economic growth with favorable economic statistics should resume shortly.