This is the tidal wave that could overwhelm the Bush presidency. A deep recession or prolonged slowdown could take control of the new administration. It would hurt Bush’s popularity, destroy his budget projections, compromise his domestic agenda, intensify pressures for trade protectionism and complicate his foreign policy with messy trade and economic conflicts–with Europe, Japan, China and Mexico. “Trade policy could get very ugly,” says Fred Bergsten of the Institute for International Economics in Washington. Given the stakes, incoming Bush officials have taken pains to establish that any slump began in Clinton’s term. After a few months, it may not matter. “Presidents take credit for everything good on their watch and get blamed for everything bad,” says presidential scholar Stephen Hess of the Brookings Institution.
For the record, few economists (including Bergsten) yet believe that Bush is condemned to such a dire fate. Most expect nothing more than a slowdown. A late-December survey of 54 economists by The Wall Street Journal found only two predicting a recession in 2001. Even if there is a recession, the consensus is that it can be handled easily. “We’ve gotten out of every U.S. recession since World War II with monetary policy [cuts in interest rates] or fiscal policy [tax cuts on increases in government spending],” says economist Rudiger Dornbusch of the Massachusetts Institute of Technology. Interest rates “have a long distance between here and zero. As for fiscal policy, we have huge [budget] surpluses. In the past, no one would have blinked at a tax cut. Where’s the problem?”
Maybe nowhere. The Federal Reserve has already cut its key interest rate from 6.5 to 6 percent. Economists expect more cuts. Bush and congressional Republicans are already talking up a tax cut as a way to protect the economy. Not to worry.
But the case for complacency isn’t airtight. There’s scattered evidence that the few economists who expect a recession could be right. Railroad freight carloadings, a traditional business-cycle indicator, fell in both November (3.9 percent from a year earlier) and December (3.6 percent). And some companies are announcing layoffs based on disappointing sales. Last week the personal-computer maker Gateway said it would cut its work force by 13 percent. What’s more worrisome is that America’s longest boom has created economic conditions that have rarely, if ever, existed before. They’re unfamiliar and not well understood. What surprised pleasantly on the way up could surprise unpleasantly on the way down. Consider:
The consumer-spending spree has reduced the personal savings rate (savings as a percentage of disposable income) to zero. People have borrowed, cashed in stock profits or stopped saving. But if consumers suddenly retrenched–because their stocks are down, their credit is strained or their jobs are threatened–the effect could be fearsome. Consumer spending represents two thirds of the economy, or gross domestic product (GDP).
Many stocks, despite recent declines, remain well above historic price ranges. In 1995 the value of stocks (the market’s “capitalization”) hit 100 percent of GDP–a level reached only once before, in 1929, says finance expert Jeremy Siegel of the University of Pennsylvania. In early 2000 capitalization exceeded 180 percent of GDP, according to Macroeconomic Advisers of St. Louis. By year-end, the figure was about 150 percent of GDP. Still, this was triple the 1990 level (about 55 percent of GDP). No one knows the “right” relationship, but the gap suggests the market could drop further.
Since 1995 a growing share of business investment has been financed by high-risk capital–from venture capitalists and new sales of stock. In 1995 these sources provided $86 billion, estimates Morgan Guaranty Trust Co. By the first half of 2000 the amount had increased to $350 billion (at an annual rate). Investors were enticed by soaring prices for technology stocks. Now falling prices for tech stocks–and the dot-com bankruptcies–are drying up this source of funds. Inevitably, business investment will suffer.
The U.S. trade and current-account deficits have entered un-explored territory. In 2000 the current-account deficit hit an estimated $430 billion. It is now approaching a record 5 percent of GDP. In the 1980s the high point was 3.4 percent of GDP, in 1987. (The current account includes trade and other overseas spending, such as travel.) For years, the U.S. appetite for imports has aided economies in Asia, Latin America and Europe. But if the U.S. deficits subside, an American slump might spread worldwide.
The dangers are hard to gauge, precisely because they’re fairly novel. Most post-World War II recessions have stemmed from rising inflation and interest rates. Although the Fed increased interest rates in 1999, the trigger for this slowdown seems to lie in new technology (computers and the Internet) and the stock market–and the market’s effects on consumer spending and business investment. “This is a classic form of business cycle that was more common in the 19th century with railroads and canals,” says economist John Makin of the American Enterprise Institute. “There’s innovation, excitement, overinvestment, a [temporary] stock-market bubble–and a ’new era’ proclaimed. Then: oops! We overdid it.”
So the economy Bush inherits is an enigma. It may have entered a harmless pause–or taken a more ominous turn. The largest threat is a vicious circle of weakening consumer and business spending, poor profits and dropping stock prices. There is a delicious irony in the rival efforts of the Bush and Clinton camps to twist the uncertainty to their advantage. Speaking to The Wall Street Journal, Bush said he was “relatively pessimistic” about the outlook. Meanwhile, Martin N. Baily–the outgoing chairman of the White House’s Council of Economic Advisers–stated flatly: “We don’t think we’re going into a recession.” Surely, the Bush people must secretly hope that the Clinton people are right.
