Signs of economic slowdown were apparent before October
Hardly an article or an editorial commenting on the debacle in the stock market has failed to proclaim, ``The United States economy is strong.'' Often, the declaration has been followed by ``There is no recession in sight.'' The unprecedented magnitude of the decline in stock prices in and of itself reveals that the underlying economy is not strong, for the stock market is part and parcel of the economy. But other considerations, as well, reveal that talk of a strong economy at this time is misleading.
While a more realistic near-term outlook probably includes an economic slowdown, however, the longer-range outlook could be brighter, if the money that was flowing to a stock market that had become highly speculative now goes into more savings and more investment in the goods-producing portion of the economy. First and foremost, it must be noted that the economy is almost always strong at the time the stock market goes into a tailspin.
Common-stock prices are a so-called leading indicator. They tend to decline many months before the economy does. In post-World War II years, stock prices have peaked and started a decline an average of 10 months before a recession.
In other words, the economy has continued to move upward for another 10 months after common stock prices have peaked. Thus, at the time of a stock market downturn the economy is high and moving higher - it is strong.
Accordingly, in a sense there is no recession in sight. After all, 10 months these days is an eternity. Putting behind us this initial realization as to the relationship between the economy and the stock market, one can go on to (1) just how strong the economy is and (2) what signs there are, not of a recession, but of the things that happen prior to a recession.
There are two major considerations for questioning the relative strength of today's economy.
One is that the long-term growth of the United States economy was devastated in 1980-82 by a minor recession, an insipid short-lived recovery, and a major prolonged recession. At the end of those three periods, economic activity as measured by economic indicators was below its level at the end of the 1980 recession.
Such a situation was unprecedented in post-World War II history. No previous recession had pushed economic activity below its preceding recession low.
Starting from such weak levels, the mild economic growth since then leaves the economy far below the growth potential suggested for 1987 by pre-1980 growth trends. The economy has yet to make up the growth potential lost in 1980-1982.
Thus, the underlying strength of the current economy is relatively low.
Second, the point just made is true of employment data as well as other economic data. Employment today, despite all the political rhetoric, has not come close to creating the jobs that were suggested for 1987 by the growth in employment before 1980.
But more is involved than an employment level below its 1980 growth potential. The employment we do have is as high as it is because of an amazing increase in part-time employees during recent years. Even in terms of employment, then, the strength of the economy is relatively low.
What about signs of the things that happen prior to a recession? One is the decline in common-stock prices, which has been designated as one of the best indicators of a coming recession. Other signs include the failure of the average workweek to rise since as far back as last February; little inclination in the formation of new businesses to improve since as far back as last March; a decline in the rate of change of total credit during most of 1987; the lack of any improvement in orders received by manufacturers of durable consumer goods and materials since last March; a most unusual 1987 weakening in the deflated M-2 money supply (including currency and money in checking accounts, savings, and money market mutual funds) until August; and a downtrend in new-housing permits since early 1986.
Other signs that would be expected prior to the beginning of a recession include a leveling off thus far through 1987 of personal income; the upward movement of the prime interest rate since early 1987; and the rise in commercial and industrial loans in more recent months.
Despite all the negative factors, the relatively unimpressive strength of the economy outside the making-money-from-money portion of the economy and the signs normally preceding a recession have encouraging implications for the longer-term strength of the economy.
Probably the major reason for the lackluster behavior of the goods-producing economy in recent years has been that too much money has been flowing into the stock market and away from the goods-producing economy.
It should be realized that before the current plummeting of stock prices, the Standard & Poor's 500 stock price index had enjoyed an unprecedented post-World War II cyclical advance of more than 200 percent. That compared with previous S&P cyclical gains ranging from 32 percent to 110 percent and averaging 71 percent.
The cyclical advance of the economy, on the other hand, was essentially normal, even from the unusually low level from which it had started.
If the current slump in stock prices induces individuals to save more and businesses to invest more in plant and equipment and the money flow turns away from the stock market and into the goods-producing economy, we could have a rejuvenation of the economy that brings it closer to its growth potential.
While a recession may precede a return to a goods-directed economy, getting rid of speculative excesses has always made for a stronger economy.
It would be far more realistic to look toward that stronger economy than to believe there is a strong economy today.
Mr. Lempert is director of Statistical Indicator Associates in North Egremont, Mass.