How the bottom fell out of US economy so quickly

Answer lies in stock market, consumer psychology, and the bumpers in Mr. Wainwright's backroom.

Nelson Wainwright, president of a St. Louis-area firm that stores automotive parts, got caught in an inventory storm. One of his key customers, General Motors, recently found itself with too many vans on its sales lots and stopped calling up bumpers and dashboards from the company. The result: Mr. Wainwright had to shut down one of his plants for two weeks.

In the backrooms of Wainwright Industries Inc. lies one explanation of why the US economy has turned from prosperity to near recession almost overnight.

For decades, US businesses often carried substantial inventories in their warehouses. When sales were brisk, they sold them off. When slow, they built them up.

But now, in an era of sophisticated computer tracking, industries try to produce only as many goods as demand requires, thus doing away with the need to carry rooms full of costly axles and radios.

Yet the result is that, when one industry slows, like the car business, the impact can ripple through to the Wainrights and the rest of the economy with Porche speed.

In fact, the tighter connection between supplier and manufacturer is one of several reasons - some of them unusual - that the longest period of economic expansion in US history has abruptly come close to an end.

Indeed, the economy has turned so quickly that even the Federal Reserve, it seems, was caught off guard. As the calender flipped into 2001, the nation's central bankers found themselves no longer worried about inflationary pressures, but about recession.

"The speed of this slowdown caught us by surprise," says Wayne Ayers, chief economist of FleetBoston Financial. "Everything turned south at once."

On one level, the slowdown was expected, given the Fed's boosting of interest rates over the past 18 months, and soaring energy prices. But there were other factors at work as well that may hold lessons for policymakers trying to offset business cycles in the future.

One was the popping of a stock market bubble in which more Americans than ever own stocks and shifting sentiments are transmitted instantly on cable TV. Investors felt poorer, and debts became a heavier burden, making business and consumers more cautious in their spending.

Among the other unusual factors:

Too many factories. Toward the end of most booms, business is struggling to produce enough to keep up with demand. Not this time. Business invested so much it kept ahead of demand. "Capacity utilization," a measure of how busy factories are, has fallen during the 1990s boom. "We are in a strange position," says Ayers. Capital spending has dropped sharply and quickly.

Wall Street affects Main Street. In recent years, share prices zoomed to sky-high levels, especially for high-tech and Internet stocks. Investors, almost 50 percent of households, relished the capital gains so much that they spent freely -a phenomenon called "the wealth effect."

Overall personal savings fell below zero. Consumers spent all their income, plus some accumulated assets. "Many enthusiastic analysts and eager advertisers sold the wonders of the 'new economy' to a great many naive new investors," says Victor Zarnowitz, an economist at the Conference Board, a New York research group.

The tech-stock bubble burst last spring, and last year was the first down year for stock markets since 1990. Weak Christmas sales indicate consumers have cut back already. If they try to start saving again, the slowdown could deepen.

The Federal Reserve, by cutting interest rates half a percentage point early this month, is trying to make sure consumers keep on buying big-ticket items - including vans - and keep some interest in stocks, thereby sidestepping a recession.

Modern communications. The Internet and wall-to-wall TV news have spread the news of a slump especially fast. "It is remarkable that there is such rapid diffusion of the news and economic warnings," says Dr. Zarnowitz. This ignites a self-feeding mechanism. Consumers and businesses slow their spending because others are doing so.

Debt overload. Both business and consumers are burdened by high levels of debt accumulated during the fearless boom years. Joseph Stiglitz, a former top economic adviser to President Clinton, sees this as "a precarious element."

During the boom, companies bought back their own stock at "bubble prices" and acquired other companies by buying their stock, again at high prices. As a result, by one measure corporate debt exploded in the past years by $2.3 trillion.

In the same period, companies on average failed to raise a dime through the issue of new stock. "A lot of corporations will be unable to meet their interest payments," predicts Robert Parks, a financial economist at Pace University in New York. "I expect to see a wave of bankruptcies."

Already, companies such as Xerox have struggled to acquire needed financing. Many dotcoms have closed their doors, profitless. Something similar may trouble those consumers who have "maxed out" their credit cards or piled up home-equity loans. Consumers account for 70 percent of spending in the nation.

Still, not all is negative with this economy. Inflation remains low. So the Fed can continue to drop interest rates to stimulate output and restore confidence. Computers and the new economy have brought a burst of new productivity. And the economy's shift from the production of goods to services, has made it less recession-prone. Business expansions have become longer, contractions shorter.

(c) Copyright 2001. The Christian Science Publishing Society

You've read  of  free articles. Subscribe to continue.
QR Code to How the bottom fell out of US economy so quickly
Read this article in
QR Code to Subscription page
Start your subscription today