Jewish World Review Jan. 25, 2001/ 2 Shevat 5761
http://www.jewishworldreview.com -- THE COLLAPSE of the Philly Fed manufacturing index to a minus 36.8 reading, its lowest level since the September 1990 recession month, could just be a Philadelphia thing. After all, they lost to the New York Giants in the pro-football play-offs. And, well Philly is still Philly.
But it could also be yet another indication that the U.S. economy is fast slipping into recession. Nationwide industrial production fell 1.1% at an annual rate in the fourth quarter. The December production drop of six-tenths of 1% represents a third consecutive monthly drop of this key coincident indicator of the economy. Manufacturing production over the past three months has deflated at a 7.3% annual rate. Even the technology components of the index have slowed.
Over four-quarter periods industrial production has an 80% correlation with real GDP growth. Over one-quarter periods the fit is slightly weaker but still significant at 60%. So the recession threat grows larger.
It appears that what's keeping the U.S. out of recession is a build-up of inventories. But these are unwanted inventory accumulations in the light of declining retail and business sales. Over the past three months inflation-adjusted retail sales declined 4.2% at an annual rate, while real business sales fell 4.9% annually. As a result a 2.5% build-up of real business inventories, representing perhaps an $85 billion rise in 4th quarter inventories, is a sign of economic weakness, not strength. In particular, large inventory overhangs in computers and autos must be run down in the months ahead.
So even if fourth quarter GDP is reported to rise at 2½% or 3%, it may likely
be setting up a negative GDP rate in the first quarter. Depending on how
fast the inventory correction runs its course, Q2 2001 could be slightly
positive but it could also be slightly negative. That leaves open the
possibility of a two-quarter recession in the first half of this year. Even
in the information economy, an old- fashioned inventory correction is in the
But wait. All this gloomy bean counting aside, this is not the end of the world. Stock markets last year were discounting a mild economic downturn. More to the point, the Federal Reserve finally woke up to the recession threat and is now easing policy. Following their 50-basis point rate cut on January 3, they'll drop the funds rate at least another one-quarter and quite possibly another one-half point at the FOMC meeting on January 30-31.
More important than Fed rate cuts, the growth of high-powered Federal Reserve liquidity is showing signs of a rebound. Two-month growth of the St. Louis monetary base has moved up to the 6% range, from the 1% growth squeeze last summer. Meanwhile, the gold price continues to languish in the low $260s and the 10-year Treasury rate hovers between 5% and 5¼%.
These market signals of price stability give the Fed clear sailing to continue its expansion of high-powered bank reserves without any fear of re-igniting inflation. I still believe the Fed funds target will drop to 4¾% this year. Importantly, and optimistically, average stock market performance rises roughly 20% in the first year of Fed easings.
The sooner the central bank moves, the better off the economy will be. Not just because of a much needed liquidity expansion, but also because consumers and investors will not defer activity if the Fed easings are front-loaded. Ditto for the Bush tax cut plan, which will lower income tax-rates across-the-board and then some.
Treasury-designate Paul O'Neill gave a good accounting of himself and the new Bush policies in his confirmation hearing. The former Alcoa CEO strongly hinted at an acceleration of the tax cut program and expressed his full support for turning budget surpluses into lower personal tax-rate burdens. O'Neill left the door open for additional reductions in business taxes, capital gains taxes and the alternative minimum tax. He underscored his tax reform bias by stating that "our tax system is not worthy of an advanced civilization."
O'Neill also pledged support for a strong and stable dollar and he showed his free-market instincts by labeling California's energy and electricity policies as "lunacy". O'Neill indicated that he understands that large trade deficits in the U.S. are a sign of economic strength and he repeated his long-held view that corporate taxes need to be reformed or abolished altogether.
So looking at the whole economic picture, I'd say that the downturn will be brief. Both monetary and fiscal policies are set to improve. Inflation is rock- bottom. The interest rate structure, never terribly high to begin with, will move even lower, especially among short-dated maturities. And the nation is in good hands as Team Bush takes over the helm.
Remember, over the past fifty years the U.S. has experienced nine recessions, but through it all average yearly economic growth has been 3.5%. Pretty impressive. This is because, with very few exceptions, U.S. economic history is characterized by substantial market freedoms and entrepreneurial opportunities. Certainly in the past twenty years entrepreneurship and wealth creation has been on the rise.
I would say even more economic freedom is coming, even in
JWR contributor Lawrence Kudlow is chief economist for CNBC. He is the author of American Abundance: The New Economic & Moral Prosperity. Send your comments about his column by clicking here.
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