RateWatch #346 - Recession
March 8, 2003 By Dick Lepre

Is a Recession on the Way?

Interesting question. First, let's remind ourselves of the technical definition of a recession. Even if the economy is slowing down a recession does not occur unless we have two consecutive quarters of decrease in GDP.

It is obvious that there is concern about a recession. There are a lot of ugly earnings reports. Energy prices have increased. A large number of high-profile layoffs have occurred. The Federal Reserve lowered rates 1% in January because they were concerned that the economy was slowing too rapidly. The 0.5% decrease on January 3 was unexpected - at least in its timing - and served as a loud wake-up call that the Fed was very concerned.

Economists like to look at hard data and see what the best precursors of recession are. Examples of recession precursors are: declining construction permits, increasing unemployment claims, waning consumer confidence and something that I would call frivolous spending. The best indicator of frivolous spending is business in Las Vegas. When a recession starts folks tend to cut back on the things they don't really need. As much as I love Las Vegas (I used to live there) I would not regard gambling as a "necessity." Las Vegas is a place to go to burn money.

The last two recessions 1981-1982 and 1990-1991 both occurred subsequent to decreased business in Las Vegas. Room occupancy there started dropping in September 2000. Of somewhat greater repute as a precursor is the Index of Leading Economic Indicators which started declining last spring. In December 2000 LEI was -0.6%. Leading Economic Indicators are an indication of what the economy will do 6-9 months into the future.

One that is somewhat loosely correlated is Consumer Confidence. Consumer Confidence is a measure of predisposition to spend. The problem is that it often sends false inflation warnings. In any case, Consumer Confidence is 40 points beneath where it was last spring. Consumers are sending an interesting message. The message is that they think that the economy is not slowing now but that it will start slowing in the near future. Also there is a large geographic variation in the
data. In the Midwest, where the economy depends on automobile manufacturing, consumer confidence is in the tank. Another strong correlative of GDP is the NAMP (Purchasing Managers) Index. At present this index shows that the manufacturing sector of the economy is in the worst recession since the '80's. The question then is this: is our economy now so much of a service economy that the manufacturing sector can go into recession and not take the whole economy with it?

How Are Recessions Avoided?

At present, we are seeing two approaches to avoiding recession. The Fed avoids recession by lowering rates. Business does its part by being very quick to react to the perceived slowdown with broad-based layoffs. Profits are being protected. Corporate layoffs will have the effect of increasing the size of the job pool and should avoid any "wage inflation" residual to the large increase in the jobs. If all goes well, unemployment will stay low (under 6%) and the economy will recover with little or no inflation.

Something Different Now

Business seems to have behaved more sanely now than they did before the previous recession in 1990-1991. One notable thing was an overbuilding of commercial real estate at that time. This has not occurred in the present expansion. This will be good news to owners of commercial real estate and the banks that make loans on these properties.

Consumer Debt

One thing that is sure is that consumers have not learned as much as businesses from past recessions. There is a large amount of credit card debt that will wind up in bankruptcy court this year. One repercussion in this regard may be that folks who obtained 125% LTV loans on their homes to replace credit card debt are stuck. This may result in a backlash against these kinds of loans as politicians find someone to blame for people's stupidity.

A Soft Landing

To a large extent, this slowdown has been deliberately engineered by the Federal Reserve with the intention of avoiding inflation. In all likelihood GDP will flatten out. If it actually results in a technical recession there is little reason to believe that it will be a lengthy one.

The "joker" is always the unknown. For example, no one seems to know what the implications of the energy shortage in California are. Hopefully, with conservation we can conserve electricity enough until we have more capacity.

It would be most advantageous if this downturn produced a serious look at the importance of energy to the economy and a realization that our economy depends, perhaps, on three things: a strong dollar and fiscal policy, a pool of talented labor and a sufficient supply of energy at a predictable cost. The backbone of the US economic strength is the confidence that folks all over the world have in it. A few months ago we had a "crisis" regarding the presidential election. It got a lot of attention but the fact is that it resulted in no diminution in confidence in the U.S.

Let's hope that we can get through this with the same outcome. Perhaps the best thing we have going is the utter confidence that everyone has in Mr. Greenspan.

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