If America’s economy goes into a tailspin in the wake of the terrorist attacks in Washington and New York, the world economy would move into perilous territory. That risk is real, because America can only go one of two ways: up or down. Sufficient confidence no longer exists to keep drifting sideways.
If America and its stock market go down, Europe’s downturn will become a recession and Japan, already stuck in a mild recession, will plunge into a deeper downturn carrying vast financial risks. Worldwide, emerging markets will collapse. This means the stakes are high and patience is running out.
Unless serious hostilities break out, there are two reasons for optimism about a fourth quarter recovery in the United States. First, American inventories have fallen to very low levels. If demand keeps up, production will have to increase to support continuing sales.
But will strong demand continue? The recent tax cut, now being mailed to households, was intended to provide stimulus for continued, even higher, spending. Low inventories and the tax cut — the mechanism that has brought the US out of every recession since 1945 — should work, particularly with today’s recession that hardly looks like one. It should work, that is, unless the terrorist attacks have so shaken consumer confidence that people go into a form of spending hibernation in fear of the future.
From here the script goes further: the numerous interest rate cuts of the past year have made the costs of capital favorable so that, once production and capacity utilization rise, capital spending by business will rise some time early next year. In the end, the biggest lag on recovery — spending on high tech — will gradually come back to life in the second half of next year.
At a downturn’s bottom things never look good. Bad news about production and employment dominate the headlines, confidence is weak, and capacity utilization is low. So there is nothing new about today’s downturn, and in the past, no matter how bad the downturn, America’s economy was revived due to monetary and fiscal policy, and usually at a rapid pace. That scenario remains plausible today, but there are specific weak links that create fragility. Consumers have been spending more than their income for well over a year. Will the tax cut let them keep doing so even though unemployment is rising? Shouldn’t the failure of consumer confidence to recover spell trouble, and don’t the poor balance sheets within US households form a real cause for alarm? Moreover, if households put off spending, why should businesses consider making new investments? They rightly will run down their inventories, won’t boost production and will avoid adding to their capital stock.
Thus consumer confidence must be of paramount concern. Before the World Trade Center collapsed, a Gallup poll revealed that during this year, the number of people rating economic conditions as “excellent/good” fell from 67% to only 36%. But that should not surprise. After all, who could possibly think that the US now looks great?
More relevant is probably the question about where America is going. In the same survey, a (small) majority of people judged their present situation worse than last year. Still, a little more than half anticipated improvement over the coming year. A Gallup poll taken before the attacks, and addressed to investors, optimism hit a near five-year low; few believe a recovery is already underway. Only 10% expect it in the coming six months, and 50% believe it will come only in a year or two.
Hence, there is not much exuberance there either. The numbers indicate how touchy the situation was before the terrorists struck. How much confidence is shaken remains to be seen. True, everything nowadays is judged relative to the euphoria of recent years. Yet optimism is required to keep the music playing. If an upturn does not come, a downturn will! What do economists, those masters of doom and gloom, have to say? The latest survey of professional forecasters predicts a gradual upswing, with growth rising from an annual rate of 2.8% in the fourth quarter to 3.9% next year. Up to a third believe there might be a negative quarter soon, but by next year confidence should have fully rebounded, with unemployment peaking at 5%, a number comfortably below historical standards.
Few will gain great confidence from these predictions, because economists keep getting surprised by developments. Nonetheless, economists remain the best way to judge what lies ahead. From the economics of the situation there is a simple message: inventories are low and running out; confidence is not plunging and hence spending will hold up; the bottom is in sight; hold out for a vigorous upturn.
And if not? Without cynicism, the answer is much the same. If the economy slips into recession more interest rate cuts will come, more tax cuts, and in the end just as in every one of the ten postwar recessions an upturn will come. True, unemployment will be higher, the budget deficit larger and the dollar lower, but every situation has its bottom, even a tough one.
Indeed, no one thinks that the US economy is deeply unstable: there are no banking problems, there is no real estate problem, there is no mass unemployment, there is no inflation holding the Fed back from cutting interest rates. Yes, euphoria has vanished and will not come back to 1999’s ecstatic levels, but in times of threat, Americans usually rally round the flag; they don’t hide in a bunker. Thus, although the world seems uncertain, the economic outlook is not as black as the skies in New York might have the world believe.
