It's not that any of Wessel's disaster scenarios are likely. But I didn't use to think that they were possible. Now--and this is his main thesis--they definitely are possible:
WSJ.com - Capital: It is hard to be optimistic about the prospects for the economy. The list of things that could go wrong grows daily. Unwelcome developments once deemed "impossible" are now seen as merely "unlikely." Right now, the U.S. economy is doing surprisingly well when you consider what has been happening: President Bush seems determined to go to war with Iraq, and oil prices are rising in anticipation. The stock market is valued at half of what it was in March 2000, and our 401(k)s are now 201(k)s, as one joke making the rounds puts it. Fear of another terrorist attack persists, and the devastating accuracy of the gunman stalking Washington, D.C., suburbs intensifies our sense of vulnerability.
Optimists note correctly that the economy is still expanding, albeit slowly. Americans are still shopping. Unemployment is still falling. Productivity, the amount we produce for each hour of work, is still growing impressively. But the number of big clouds on the economic horizon is unnerving. Besides the threat of war or a continuing slide in stock prices, here are three others to watch: Deflation.... A big default.... More corporate scandals...
It is hard to be optimistic about the prospects for the economy. The list of things that could go wrong grows daily. Unwelcome developments once deemed "impossible" are now seen as merely "unlikely."
Right now, the U.S. economy is doing surprisingly well when you consider what has been happening: President Bush seems determined to go to war with Iraq, and oil prices are rising in anticipation. The stock market is valued at half of what it was in March 2000, and our 401(k)s are now 201(k)s, as one joke making the rounds puts it. Fear of another terrorist attack persists, and the devastating accuracy of the gunman stalking Washington, D.C., suburbs intensifies our sense of vulnerability.
Optimists note correctly that the economy is still expanding, albeit slowly. Americans are still shopping. Unemployment is still falling. Productivity, the amount we produce for each hour of work, is still growing impressively.
But the number of big clouds on the economic horizon is unnerving. Besides the threat of war or a continuing slide in stock prices, here are three others to watch:
Deflation. In the 1990s, deflation was Japan's problem. The rest of the world enjoyed an easing of inflation produced by savvy central bankers and an information-technology revolution that made a lot of things cheaper. Falling prices at a time of persistently strong economic growth is great. But falling prices at a time of weakening growth can be bad. The risk is a self-reinforcing cycle: When revenues fall, producers cut costs, delay investments and squeeze wages to try to preserve profits. That causes suppliers and workers to do the same. And that leads producers to make further cuts. The result is depressed demand and overcapacity.
This bad deflation is particularly bad for borrowers. Think of the homeowner who sees his house fall in value but still has to pay off a mortgage based on what it used to be worth. And U.S. consumers are pretty deeply in hock. "Never before have debt burdens been as high in quite as unfriendly a world for debt management," UBS Warburg economists caution.
A big default. The markets are treating Ford Motor Co., whose $61 billion in bonds outstanding make it the largest corporate issuer, like a junk-bond credit. Fannie Mae, the mortgage giant, is squeezed by a refinancing tsunami. J.P. Morgan Chase & Co., the nation's biggest corporate lender, took a $1.4 billion hit, largely because of bad loans to telecommunications and cable-television companies. Brazil, with $259 billion in short-term debt that needs to be rolled over constantly, is about to elect a leftist who frightens global lenders.
Each of these borrowers is making reassuring comments. Each is getting scrutiny that makes a huge surprise unlikely. That's good. The Asian financial crisis of 1998 turned global only after Russia's default stunned those who figured its nuclear arsenal gave it unlimited borrowing rights at the International Monetary Fund.
Maybe Ford, Fannie and Brazil will get by. But what else is lurking out there? Is there a big borrower who will surprise us? Have we heard all the bad news from insurance companies, coping with the triple whammy of downturns in their core businesses, stock portfolios and the credit-derivative deals that shifted corporate-default risks from banks to insurers? Is there a big player in financial markets, another Long-Term Capital Management, that isn't quite as well hedged as it thinks it is?
More corporate scandals. Even a cynical newspaper reporter is surprised by the magnitude of the corporate thievery now being exposed. We knew that chief executives, even failures, got exorbitant salaries. The "infectious greed," as Alan Greenspan calls it, at Enron Corp. and Tyco International Ltd. is still stunning. We knew, from reporting in this newspaper in 1997, that Wall Street routinely rewarded executives of favored corporate clients with shares in hot initial public offerings that could be sold for quick profit. We didn't know how many executives and how much money. Even if no laws were violated, it is hard to distinguish this from Wall Street bribing executives to win their companies' business.
Maybe all the dirt in corporate boardrooms has been exposed now. If not, we run two big risks. One is that business simply seizes up, as executives and directors are distracted and deposed, shareholders are disgusted and flee the stock market, and business-investment decisions are put off. The other is that disgust and distrust of business interferes with what may be needed to resuscitate the economy. If a tax break for business or a dose of deregulation made economic sense, are politicians bold enough to act?
Economists at Goldman Sachs Group made a bold prediction the other day that nicely captures the current anxiety: Either the U.S. is going to have "a sluggish recovery" but one "sufficient to keep the unemployment rate from rising sharply" or it's going to have "a renewed recession with risks of outright deflation." Either it's going to be partly cloudy or we're going to have a monsoon. Keep your boots handy.
Posted by DeLong at October 09, 2002 10:11 PM | TrackbackI'm probably parading my ignorance here but there's something I don't understand:
the economy is growing slowly, unemployment is falling BUT productivity is rising impressively. Surely if productivity is going up so impressively and more people are working, the economy should be rising impressively as well? Or are people working fewer hours?
I'm obviously not an economist.
OK, Brad should jump in here. He not only teaches this stuff, but his writing on the web suggests he is a bit of a productivity bug. Brad?
Meanwhile, I can offer a few bits and pieces. Aggregate hours worked in the private sector peaked in January of 2001, and didn't steady till around November 2001. They have not risen enough to matter since then.
Two things about the jobless rate. First, it doesn't tell you as much about total hours as you would like, in part for the reason you suggest - some people are working less hours. Overtime hours fell from a recent peak of 4.9 hours per week in April of 2000 (notice how it leads total hours?) to a low of 3.8 hours in late 2001, before picking up to between 4 and 4.2 hours recently. Second, the jobless rate is determined by asking households how many jobs they have and how many of their members are "in the labor market" (a condition which is fairly closely defined in the quesition households are asked). Most of the rest of the data that you hear from the labor market comes from asking firms, rather than households, for their tally of labor market activity. If resutlts from the two surveys diverge much, you can get very different answers. Over the past 6 months, firms have been reporting an average of 26,000 new hires each month. Households are reporting something like 225,000. That can mess up one's impression of what is going on in the labor market and in the wider economy.
Interesting the differing views of financial risks that Brad's log shows, too. The post you are responding to lists three threats to the stability of US economy, two explicitly financial (deflation is partly financial, partly in the goods and services side of things). Two posts earlier, Brad's headline for an Economist article tells us a first world financial crisis is not near at hand. Take your pick.
K
Posted by: K Harris on October 10, 2002 07:58 AMDon't pay attention to the unemployment rate, it's close to meaningless with all the caveats attached.. Watch the payroll survery (although it is often revised as well) and look at the labor force numbers and the labor force participation rate. In particular it is necessary to watch the percentage of people of working age who are working - a different number - because right now more people are moving into working age than out of it and that inflates certain numbers. Bottom line, there have been a lot of job losses, with a mild "recovery" over the last few months that still leaves a lot of people out in the cold. IMO (obviously possibly wrong) there is worse to come when the housing bubble pops (as it is beginning to do). And do bear in mind this is after the Fed has applied a huge stimulus - and all we got was a very mild recovery with very mild job gains.
As for productivity - that's Brad's game - but it's worth noting that the least productive workers are assumed to be shed first, so part of the gain is due to that. That can't possibly account for the huge gains, mind you, but it is part of it. And increasing productivity is actually a negative in terms of jobs in the short term - since curent workers are so productive one doesn't need to hire new workers. In the middle to long run it'll be a positive thing - assuming that we don't run into severe demand problems caused by the fact that the gains from productivity increases have not been widespread over the last couple decades but have been concentrated in the hands of a few.
Posted by: Ian Welsh on October 10, 2002 08:48 AM"A big default..." It doesn't take a genius to see another one is coming, either in the U.S. or Europe. A 5-year Credit default swap on Alcatel (France's Lucent) is bid at 50, i.e. you pay 10 every year and receive 100 should Alcatel go bankrupt. So the market thinks a default is pretty damn "possible." On Monday the FT reported about an eMail suggesting Commerzbank was having liquidity difficulties (denied by the bank), and it is rumoured that other banks are cutting back certain dealings. There is probably at least one other bank in the same situation. Not to mention all the U.S. firms which are deferring losses because they are assuming their pension plans will grow at 10% a year, when 1-year interest rates are below 2%. There are not many hedge-fund traders who are getting 8% better than LIBOR. Not to mention that new lows in the stock market tend to shake the vermin you didn't know about out of the carpet.
Posted by: Andrew Boucher on October 10, 2002 09:40 AMWe had better be about saving in America. We are an aging population, we have suffered significant investment losses, we have long been savings short.
Well, shopping is more fun and better just now for the economy. Oh well.
Posted by: on October 10, 2002 01:28 PMBrad--Larry Kudlow believes that, "...Perhaps today's disappointing economic recovery and stock-market decline can be traced to a recent growth slump in the money supply."
Most of the piece is based on arguments put forth by Milton Friedman. Full article is here:
http://www.nationalreview.com/kudlow/kudlow100402.asp
Are Friedman and Kudlow right?
Posted by: Kurt Brouwer on October 10, 2002 04:06 PM"Surely if productivity is going up so impressively and more people are working, the economy should be rising impressively as well?"
If you take the productivity increase and add to that that growth in population the sum is the rate at which the economy needs to grow in order for the unemployment rate to remain unchanged. This is called Okun's law. Or higher productivity growth must translate into higher growth in order for unemployment to remain unchanged . This not automatic, I can produce more cars per hour of labor , if these cars are not sold, then growth will slow. (Unless you are Mr. Kudlow , who believes supply always creates its own demand.)
>>(Unless you are Mr. Kudlow , who believes supply always creates its own demand.)<<
For the record it's known as Jean-Baptiste Say's Law. It's considered with a lot of derision among economists... It's always interesting notice how die-hard this idea is, though.
In the long-run, economic growth models are written on the basis of such assumptions, however. One might conclude that there are just trade-offs between short- and longer-term growth.
While that's almost a truism, I have always thought that this kind of simplification ignores a good deal of feedback effects from the current business cycle on the determinants of long-run growth and oncome. Go tell Argentinians that in the long-run they're better off then ever from swallowing the IMF's bitter medecine...
Posted by: Jean-Philippe Stijns on October 10, 2002 08:37 PMThe IMF does not have the track record to say that it's reccomendations make economies better. In fact the opposite argument has been made and imho it's pretty strong.
Posted by: Ian Welsh on October 10, 2002 09:55 PMIt is rather harsh to claim that Say's Law is "regarded with derision" by economists. Say's arguments are pretty solid, and if it's a fallacy, it's one into which economics falls again and again. Forming a coherent argument against Say's Law took up most of Keynes' General Theory, and the argument relies on the use of concepts of time and uncertainty which are by no means mainstream Keynesianism. (Marx's critique of Say's Law is even better, I think, but we are hardly describing the majority of economists here).
Most models which solve to equilibrium can usually be shown to imply some version of Say's Law. It is often derided by actually existing economists, but should not be.
PS: Scholars of economic thought often get quite irate if you quote that formulation of Say's Law at them. It's apparently a complete caricature of what Say actually said, but one which has become ubiquitous through its adoption by Keynes.
Posted by: Daniel Davies on October 11, 2002 02:41 AM>>A big default....<<
Would Japan count? All eyes on Tokyo please.
Posted by: Edward Hugh on October 11, 2002 02:56 AMDaniel: I see your point. At the aggregate level, Say's Law makes a lot more sense than in the case of a specific industry or company. Nonetheless, I find it amusing that economists would argue that demand follows supply, given how hard people in the industry work at nurturing demand for their product.
I suspect that what we think we observe at the aggregate level (and thus allow ourself to assume in our model) is in fact the product of demand driven increases in supply. In other words by the time aggregate supply and demand walk hand-in-hand, markets have already operated and unwanted supply has already gone off the shelf and the corresponding workers have been hopefully realocated to other industries / companies.
Posted by: Jean-Philippe Stijns on October 11, 2002 09:10 AMRobert Rubin has long believed that Japan is strong enough to defend its banks. Of course, Japan has handled th deflation poorly indeed, but a large bank default is remote.
Posted by: on October 11, 2002 12:57 PM