http://www.thetimes.co.uk/article/0,,37-2001223994,00.html

TUESDAY JULY 03 2001

US slowdown turns out to be the recession that never was

ECONOMIC VIEW BY ANATOLE KALETSKY

IS THAT IT, then? The recession that never was appears to be over before it started. This was the clear message from yesterday’s monthly survey of US purchasing managers. Coming on top of the favourable revisions of US and British GDP figures published last week, the purchasing managers’ survey suggested that the present economic slowdown would not even result in a single quarter of negative GDP growth. This may come as a surprise to readers who follow the pronouncements of financial analysts and business leaders. For the past six months, the terrors of recession — or even of a Japanese-style depression — have dominated media headlines and mesmerised the captains of industry and analysts on Wall Street. But this recession has turned out to be as much of an illusion as the equally irrational fads that obsessed the global business community in the previous three years.

In 1998 the world was supposedly thratened by the greatest financial collapse since the 1930s, after the Russian devaluation crisis. But this crisis ended before it had even begun. In 1999 apparently sane company directors spent hundreds of billions of dollars on new computers and software in order to save Western civilisation from the millennium bug. The bug, of course, turned out to be the greatest confidence trick in human history. But thanks to the lunatic behaviour of investors around the world, it took only a few months for an infinitely bigger scam to outdo even the bug. Wall Street’s love affair with the “new economy” of Internet and telecommunications companies is likely to hold the record for many decades as the biggest and maddest speculative mania of all time.

One would have thought that after this hat-trick of humiliating blunders, the soothsayers of Wall Street would have toned down their wild prognostications. But even before the debris of the dot-com crash was cleared, the so-called analysts on Wall Street had come up with another bizarre idea: that the collapse of the technology investment and profits would trigger a deep recession in America and the global economy.

The idea that a serious recession might occur in 2001 always seemed bizarre for both theoretical and practical reasons. Let me start with the theory.

Since the Keynesian revolution in economic theory it has been recognised that, in terms of controlling economic cycles, demand is more important than supply, consumption is more important than investment and wages are more important than profits. Thus the Federal Reserve Board should in principle have had no problem in maintaining US economic growth. Monetary and fiscal policy simply had to be expanded sufficiently to over-ride the impact of the supply shock cuased by the dot-com crash.

However many Internet companies might go bust and however much the business community might cut back on electronic investments, consumption, housebuilding and government spending could always take up the slack, provided interest rates and taxes were cut aggressively enough.

From a theoretical standpoint, therefore, only two things could have caused a recession this year. The Fed could have misjduged the impact of last year’s crash on Wall Street and acted too late to boost demand. Or the Fed could have deliberately refused to act, either because of concerns about inflation or because of an ideological opposition to the whole concept of demand management.

Fortunately, neither of these conditions applied in the US this year. As a result, a US recession was, in principle, very unlikely. Still, it has been a nerve-wracking few months and it is now a relief to see the theoretical efficacy of demand management backed up by more and more economic facts.

Yesterday’s survey of purchasing managers and the positive GDP revisions last week did not come out of the blue. In the four months since February there has been a definite recovery in consumer confidence, a strengthening of retail sales, a reduction in weekly unemployment claims and record levels of activity in the housing markets (see charts). Taken together, all these positive indicators suggest that the low point of the global economic slowdown almost certainly occurred as long as six months ago — at the end of last year, during the period of terrible weather and post-election angst in the US.

This may not be the impression conveyed by corporate announcements on profits, investment and employment, which are likely to continue deteriorating throughout this year. But GDP figures give a far more accurate picture of broad economic conditions than corporate announcements. Profits, investment and hiring plans are backward-looking indicators that reflect demand conditions in the recent past, not the future. Experience shows that at turning points in economic activity, the comments of businessmen and financial analysts are rarely worth heeding.

So instead of worrying about the businessmen’s obsessions of declining profitability and collapsing technology investment, it may be more appropriate to start thinking about some other clouds on the global economic horizon.

In the US, the Fed will remain under strong pressure to continue easing because profits and investment will continue to disappoint Wall Street, even as economic growth accelerates. But if Alan Greenspan, the Fed chairman, yields to Wall Street pressure and starts to support corporate profits, instead of focusing on broad economic indiactors such as GDP and employment, he is likely to make a serious mistake. The US monetary expansion may go on for too long. With the Federal budget moving back towards deficit, the dollar becoming increasingly overvalued and the US productivity miracle turning into a statistical mirage, there could be a serious inflation problem for America by mid-2002.

In Europe, meanwhile, we can see the opposite danger. The current slowdown has been caused mainly by the European Central Bank’s refusal to emulate the Fed and use monetary policy actively to manage demand and sustain employment. In the next six months European business and consumer confidence should nevertheless recover alongside the US economy — but with a lag of three or four months. As a result the European economy may look for the next few months as if it is getting weaker, even as the US accelerates. This perception could put the euro under further downward pressure. It could also aggravate doubts about the competence of the ECB and weaken Europe’s commitment to structural reform. Political troubles in Germany and France ahead of next year’s elections could make matters worse.

In the short term, therefore, there is a serious danger of a further loss of confidence in the euro and the EU economy. By the end of the year the stimulus to European demand from the weak euro and the recovering US economy should overwhelm these negative confidence effects. But for Europe to rely on export-led growth for the rest of this year could be very destabilising to transatlantic relations in the medium-term.

Turning to Britain, the main cloud on the economic horizon is likely to be the impact of the strong pound on manufacturers and exporters. Britain was probably the strongest economy in the G7 in the first half of this year — and in the next few months consumption, housing and government spending are all likely to accelerate. As a result, hopes of any further interest rate cuts from the Bank of England are probably forlorn. In fact, the Bank would probably be on the point of raising interest rates today were it not for the strength of the pound. The pound, in turn, is likely to stay strong as long as the Bank does a better job of demand management than the ECB and Britain’s economic performance continues to surpass Europe’s.

So life will remain pretty tough for British manufacturers and exporters who had hoped to enjoy a quick boost to profits from a weak pound. But looking ahead to the rest of this year and beyond, efficient British exporters should have ample opportunity to increase their sales and profits, despite the challenge of a strong pound — provided only that the US and international economies really do pick up. Fortunately, such a pick-up looks more likely with every day that goes by.

-- Anonymous, July 03, 2001