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Update on the Economy

December 15, 2001

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Update (from the Dismal Scientist - www. dismal.com)
on Economic Forecasts
November 15, 2001

Prior to September 11, the economy was just barely expanding, and the terrorist attacks were enough to push it into recession. Both Republicans and Democrats agree that the economy needs a stimulus package. Unfortunately, they are very far apart on what that package should be. In late October, the House passed a Republican stimulus package almost exclusively along party lines. In the Senate, the Finance Committee passed a Democratic alternative on a party line vote last week. (Senator Jim Jeffords, an independent, also voted for the bill.) There's little in common in the two bills, and prospects for compromise do not look good. Both of the House and Senate bills have serious flaws. Republicans see the stimulus package as a way to pass business tax cuts that were excluded from this summer's tax bill. As it is not tied to any sort of behavior and is not incentive driven, it would have little direct impact on investment decisions, and would provide little economic stimulus. The economy is in recession because demand is weak. Some areas for possible stimulation include: rebates for low-income taxpayers who did not benefit from the earlier rebates over the summer; increased aid for state and local governments, who are facing severe budget crunches; a temporary reduction in payroll taxes; and temporary investment tax credits, to encourage businesses to invest immediately. The most effective way to provide a quick economic boost would be a temporary cut in payroll taxes. Cutting payroll taxes could be implemented overnight as they are under the complete control of federal policymakers, and they would show up in paychecks and checking accounts nearly as quickly. A cut in payroll taxes would also benefit the nation's least advantaged workers, with less in the way of savings and other assets.

October 1, 2001

Wartime Recession?

A war is supposed to throw a life preserver to a floundering economy. This one is sinking it

By Daniel Eisenberg

Before the U.S. military has fired its first $1 million missile at Osama bin Laden, the high price of America's new war is already starting to add up. Last week was the worst since the Great Depression for the Dow Jones industrial average, which lost almost 1,400 points, or 14%, in five frantic trading days, erasing nearly $1.4 trillion in investor wealth--at least 10 times the property damage caused by the terror attacks against the World Trade Center and the Pentagon. The nation's airlines announced that they are sending more than 80,000 workers to join the growing ranks of the pink-slipped, now up to 1.2 million for the year. And given that travelers are staying firmly planted at home, the nation's tourism business has suddenly ground to a near standstill.

Even aerospace giant Boeing, which has a sizable defense division that should pick up some of the slack from its commercial jet business, said it will lay off as many as 30,000, or 15% of its work force, by the end of 2002. For most observers, it's no longer a question of whether we are in a recession but how long it will last. Mark Zandi, chief economist at economy.com, calls the terror attacks "a disaster of nationwide proportions."

What's going on here? A war is supposed to throw a life preserver to a floundering economy, not sink it. Well, as Americans are starting to realize, this is not your typical war. This time there won't be any massive arms buildup and full-scale mobilization of resources. We won't be launching Liberty ships or new fleets of bombers to fight terrorists armed with box cutters.

Indeed, with the home front threatened, consumer confidence waning and businesses hunkering down and putting expansion plans on hold, the U.S. is experiencing the worst aspects of a wartime economy with few of the benefits. Many observers think the 4.9% August unemployment rate, which had already risen a full percentage point over the previous 11 months, could now hit 5% to 6% early next year. Foreign investors, who lately have plowed $500 billion a year into the U.S. economy, no longer view the dollar as the safe haven it once was. And housing, one of the last sectors of the economy to show resiliency, seems to be dragging; housing starts fell nearly 7% in August, the government reported last week.

In the aftermath of the terrorist attack, consumers and business leaders alike are in mourning. "We're all walking around with heavy hearts, and when you add light wallets to heavy hearts, it's even more devastating," says Nicki Grossman, president of the Greater Fort Lauderdale Convention and Visitors Bureau. All across Florida, where more than half the visitors arrive by air, the once thriving tourism industry has been decimated. In the Orlando area alone, 253 groups representing 32,531 attendees have canceled visits set for September, and an additional 82 groups have nixed their plans for October. In Las Vegas, only half the city's 125,000 hotel rooms were occupied last week, down from 94% a year ago; Park Place Entertainment announced last week it was postponing the $475 million construction of a hotel tower at Caesars Palace. From New York City to Los Angeles, waiters, travel agents and Broadway actors are all losing work.

The pain looks likely to spread to other industries as corporate profits get hit. Many companies, such as Intel and United Technologies, are bracing for the call-up of the Reserves, which will sap those organizations of expertise that isn't easily replaced. And new, tougher security measures for cargo at airports, shipping ports and border crossings could disrupt the just-in-time supply chain that has been one of the key accelerators of growth during the past decade. Companies could be forced to carry higher, costlier levels of inventory. With critical parts delayed at the U.S.-Canada border, Ford, General Motors, Chrysler and Toyota have had to idle assembly lines and reduce production. And some florists have had trouble getting their regular supplies from South America. "The biggest economic cost of being victims of terrorism is through lost productivity," says Neal Soss, chief economist at Credit Suisse First Boston.

Once the initial shock and grief wears off, people may return to shopping as an escape from the barrage of harrowing TV images. "Fashion is emotive, and female consumers in particular shop to make themselves feel good," says David Wolfe, creative director at the Doneger Group, a market-research firm in New York City. Automakers are trying to kick start customers; in the past week, with sales slipping, Ford and GM rolled out interest-free financing for new cars bought before the end of October. At an art gallery in Santa Fe, N.M., a show that opened only three days after the tragedy quickly sold out. "I think people wanted something beautiful to look at amid all this death and destruction," says owner Charlotte Jackson.

So far, though, most people seem willing to stock up on just the bare essentials. "I'm only spending money that I absolutely have to, like for gas and food," says Roxanne Steiny, the operations manager of a Los Angeles e-commerce firm. Some nervous home buyers are backing out of deals just before closing. Michelle Dykstra, a real estate agent in La Jolla, Calif., outside San Diego, has already seen one client walk away before signing for an $850,000 home.

It's no wonder, then, that the National Retail Federation predicted a decidedly uncheery holiday shopping season, cutting its sales growth outlook for the fourth quarter from 4% to 2.2%--a forecast that may still be overly optimistic. Or that luxury department store Bergdorf Goodman has canceled the remainder of its fall orders.

That sort of thrift would have been applauded during World War II, when the Federal Government imposed rationing of food, gasoline and tires. But now Washington is doing all it can to get consumers to open their wallets. The Federal Reserve Board slashed short-term interest rates half a point, its eighth cut this year, and the Bush Administration signed a $40 billion stimulus package to help with the recovery effort and the fight against terrorism.

That appropriation may be just the beginning. There is talk in Congress of an unprecedented bailout of the tourism industry, though that could turn into the biggest pork barrel project ever. President Bush is pushing for an increase in charitable deductions, while Citigroup executive committee chairman and former Treasury Secretary Robert Rubin, who joined Federal Reserve Board Chairman Alan Greenspan in a private meeting with congressional leaders last week, is recommending moves to stimulate consumer spending.

Many rank-and-file Republicans have seized on the tragedy to renew their push for cuts in corporate taxes, an idea that threatens to unravel Congress's newfound bipartisanship. "Before we can even bury our dead, they're asking for tax breaks," grumbles Charles Rangel of New York, the ranking Democrat on the tax-writing Ways and Means Committee.

Any such stimulus would probably cost $80 billion over two years. Greenspan, who also testified before a Senate hearing, cautioned that Washington shouldn't move too quickly with a massive, budget-busting relief package until the full extent of the fallout is known. Treasury Secretary Paul O'Neill, who has had disagreements with the Bush Administration's tax policy and was curiously absent from the closed-door session with Greenspan and White House chief economic adviser Larry Lindsey earlier in the week, told the committee that the government shouldn't resort to "off-the-shelf political things that have been paraded around." As both Greenspan and O'Neill pointed out--to the discomfort of many in the White House--permanent new tax cuts or spending programs can hurt the economy more than they help by pushing up long-term interest rates and making business loans and mortgages more expensive.

None of those concerns, however, will keep Congress from rescuing the airlines. Every airline job, the industry says, helps create another six, from travel agents to food-service and assembly-line workers. Thanks to high labor costs and a reduction in business travel, though, the major carriers were already facing their worst year in a decade before Sept. 11, with $2.5 billion in potential losses.

That seems like chump change now. After a two-day complete shutdown of U.S. air space, bookings are off more than 40%, and the carriers could easily lose $25 billion by mid-2002. "This is a catastrophe for an industry that struggles even in normal times," says Richard Clarke, director of travel and transportation at Giga Information Group.

By Friday, airline executives had managed to wrestle a $15 billion package from a somewhat skeptical Congress--including $5 billion in immediate aid, an additional $10 billion in loan guarantees and some liability protection for United and American in connection with the terrorist attacks. Some observers think even that level of assistance won't avert trouble--and that the only solution is for the airlines to get together, much like the bankrupt railroads in the '70s, to carve up territories and raise ticket prices.

Insurers, which are probably facing a bill of more than $30 billion for the costliest disaster ever, won't need such drastic measures to survive. That doesn't mean, though, that they are not hurting. Warren Buffett's General Re reinsurance outfit stands to lose about $2 billion, and European giants Munich Re, Swiss Re and AXA aren't far behind. Direct underwriters such as AIG, Chubb, Travelers and Hartford could lose hundreds of millions of dollars each. Many underwriters have jacked up the premiums for airlines and are sure to slash the level of coverage available for damage on the ground. In the future, companies will probably have to pay extra to be covered for an act of terrorism. It hasn't all been bad for the industry, however. With millions of individuals and businesses now worried about new risks, sales of life and business-interruption insurance are expected to soar.

One industry that always gets a lift from war is the defense sector, and weapons contractors such as Raytheon and Northrop Grumman were among the few bright spots on Wall Street last week, with the sector shooting up a collective 37%. But investors may be assuming a bit too much. While the defense budget is now expected to rise from $316 billion this year to as much as $400 billion next year, the higher figure will still represent less than 4% of GDP--as compared with the 38% the U.S. spent in 1944.

The government will plow more funds into precision-guided munitions, sophisticated communications and surveillance systems, and unmanned aerial vehicles, but "it's not clear this is going to be a Reagan-era buildup," warns Michael Vickers of the Center for Strategic and Budgetary Assessments.

Weapons makers weren't the only winners on Wall Street last week. Web and video-conferencing companies such as WebEx, Polycom and Raindance, expecting order books of potential new customers wary of employee travel, briefly became investor darlings. Cell-phone companies such as Nokia and Verizon also benefited from the wireless industry's sudden image overhaul; no longer the objects of universal derision, cell phones are now seen, even by Luddites, as essential tools in case of emergency.

An emergency is just what last week felt like for investors. Baby boomers who were counting their nest eggs before they hatched may have to rethink their early-retirement plans; a diversified 401(k) that tracks the S&P 500, for instance, lost nearly 12% last week alone--and has lost 33% in the past 12 months. "This is not the time to be gambling with your life savings," says financial planner Robert Wacker, of San Luis Obispo, Calif., who like many Americans shifted more of his portfolio--perhaps a bit late--into the relative safety of bonds.

Still, even in the middle of the current economic doldrums, many Americans are trying, as they are wont to do, to look at the bright side. "I was chairman for two days, and then I had jets with my engines hit a building I insured, which was covered by a network I owned, and we are still growing 2001 earnings by 11%," General Electric's new chairman, Jeffrey Immelt, told an analyst meeting in New York City on Friday, after he slightly pared the company's growth outlook. "I think we're in pretty good shape. We're looking at this unmistakable tragedy as a time of strength for the company." In the next few months, Americans will learn whether the same can be said for the economy.

--Reported by Sally Donnelly, Mark Thompson, Karen Tumulty and Michael Weisskopf/Washington; Bernard Baumohl, Laura Koss-Feder, Julie Rawe and Eric Roston/New York; Jeanne McDowell, Margot Roosevelt and Stacie Stukin/Los Angeles; and Cathy Booth Thomas/Dallas, with other bureaus

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Update on the Economy

Update (from the Dismal Scientist - www. dismal.com) on Economic Forecasts November 15, 2001

October 1, 2001

Wartime Recession?

A war is supposed to throw a life preserver to a floundering economy. This one is sinking it

Update (from the Dismal Scientist - www. dismal.com)
on Economic Forecasts
November 15, 2001