SYNOPSIS: Where will the recovery come from? Residential Investment might stop growing soon. Businesses still have excess capacity. Consumers might stop spending with this lousy job market. And foreign investors might be losing confidence in the U.S.
Summertime, and the living is iffy. Double-dippers — economists who believe that the economy will turn down again — are still a small minority. But we're no longer hearing the triumphalist predictions of roaring recovery that were so prevalent back in March.
The funny thing is that there hasn't been much negative economic news, just an absence of the good news that we were told to expect. Above all, business investment, whose plunge led us into this slump, has yet to show any serious signs of life.
How did so many business economists convince themselves, and each other, that a great boom was imminent? No doubt it was the result of wishful thinking on several levels: the investment community wants to sell stocks, and it also wants to believe that Republican administrations are good for business. But I suspect that a big factor in the premature declarations of victory was a false analogy between George W. Bush and Ronald Reagan, which led people to expect that 2002 would play like 1983.
At a superficial level, there are strong parallels between the second year of the first Reagan administration and the first year of the second Bush administration. Both men pushed through large tax cuts and big military buildups; both inveighed against evil (empire, axis, whatever). And in 1982, as in 2001, the Fed reversed a previous policy of raising interest rates to fight inflation, cutting rates dramatically to fight recession instead. So why shouldn't it be morning in America all over again?
Because the recessions were very different. In 1982 the economy was held back by high interest rates; it was ready to surge forward as soon as the restraints were released. In 2001 the economy slowed because businesses had overreached themselves; there are no obvious sources of pent-up demand.
Perhaps the most striking difference between the Reagan recession and the Bush recession involves housing. In 1982, thanks to several years of very high interest rates, home building was moribund: real residential investment was at a 13-year low, more than 40 percent below its previous peak. So there was a lot of demand ready to roll as soon as interest rates fell. In fact, during the first year of the Reagan recovery residential investment rose 46 percent. Basically, it was a housing-led boom.
This time, residential investment kept rising through the recession, thanks to the Fed's interest rate cuts. It's hard to see a dramatic further increase; if anything, housing may be in a mild bubble.
So what will lead us into a full-fledged recovery? Beats me.
The truth is that instead of the vigorous recovery we were supposed to have by now, our economy seems to be in a state of suspense, waiting for something to happen. Optimists think that business investment will, finally, turn up; but businesses still have lots of excess capacity, and show little inclination to go on another investment spree. Pessimists think that consumers, faced with a still-worsening job picture, will finally stop spending. But consumers have stayed doggedly optimistic, as if they really believe in the T-shirt slogan: When the going gets tough, the tough go shopping.
There is, however, one more wild card, which is also a key contrast with the Reagan years: the attitude of foreign investors. During the Reagan recovery overseas investors, who had previously been down on America, flocked in. This time we start from a very different position. Foreigners have been wildly enthusiastic about America for years — an attitude we have come to count on, because we need $1.2 billion in capital inflows every day to cover our foreign-trade deficit. What happens as they lose their enthusiasm?
One of the largely unreported stories of the last few months — in the U.S. media, anyway — is the precipitous decline of foreign confidence in American leadership and institutions. Enron, aggressive accounting, budget deficits, steel tariffs, the farm bill, F.B.I. bungling — all of it adds up, in European minds in particular, to what Barton Biggs of Morgan Stanley calls a "fall from grace." Foreign purchases of U.S. stocks, foreign acquisitions of U.S. companies, are way off.
I don't want to sound like a doomsayer here. But one thing is clear: Those confident declarations, several months ago, that our troubles were over look pretty foolish now.
Originally published in The New York Times, 5.28.02