Business Activity Indicators
Financial Indicators - United States
Selected International Transactions - United States
The U.S. economy declined significantly during the third and fourth quarters of 2000. GDP growth in the second half averaged 1.7 percent as compared with 5.2 percent in the first half. At the same time the technology sector of the stock markets experienced a drastic decline from its highs. The NASDAQ index fell from 4803 in March to 2657 in January 2001, a decline of 45 percent.
These developments raise the possibility that we are at a historical turning point marking the end of the great postwar boom that dominated the second half of the 20th century. If this is the case, it is not too early to begin investigating the basic factors responsible for the long economic expansion that brought unprecedented prosperity to the American people. This endeavor will no doubt lead in many direction and to many false trails, but nevertheless it must be done. We cannot really go forward until we have identified the factors that led us to where we are today.
As this is written, the most prominent feature of the downturn is a pronounced decline in consumer and business demand for durable goods, particularly demand for information processing equipment and software. This slowdown has undermined the irrational enthusiasm for stocks of technology companies which had risen to absurd valuations. This market bubble has now burst, with the NASDAQ down, as noted above, 45 percent from its high. The slowdown in demand, however, must be rooted in more tangible factors than the self-delusion of stock market speculators, and it is this aspect we will address.
A slowdown in demand can be produced by simple saturation of the market - consumers simply do not need more of a certain good and reduce their purchases of it. This condition, however, has prevailed for some time, but consumers have still been enticed to keep on buying. The suddenness and breadth of the slowdown suggest that something more than satiation is at work.
One of the most prominent economic developments of the past two decades has been the great growth of debt. Nonfinancial debt, which includes government, households, and business, rose from $3,957.9 billion in 1980 to $18,344.3 billion in 2000, an increase of 363.5 percent. Thus, three and one-half times more outstanding debt was created in 20 years than in all the years preceding this period. Financial debt, which includes banks, life insurance companies, mortgage companies, finance companies, REIT's, etc, rose even faster - from $578.1 billion in 1980 to $8,430.8 billion in 2000, an increase of 1,358.4 percent. An increase in nonfinancial debt results in one form or another in an increase in the demand for goods and services: over the two decades, $14,386.4 billion, an average of $719.3 billion per year. The problem with this dynamic is that it must not stop: if debt ceases to grow, the economic stimulant is removed. Moreover, because of inflation the dollar amount of the increase in debt must continue to grow just to maintain the same amount of stimulant.
As the chart shows, debt and nominal GDP accelerated moderately until 1980 when they turned up sharply. It may be significant that debt consistently grew faster than GDP. In 1980 debt was 141.6 percent of GDP, but by 2000 it was 184.1 percent of GDP If the upward momentum of GDP depends on an even faster upward momentum in debt, the relationship is not sustainable, since debt obligations must be serviced and paid off out of GDP derived income.
For a period from 1980 to 1986, federal debt grew faster than non-federal, and again from 1990 to 1994 it grew faster; from that date to the present, non-federal debt growth exceeded federal, which actually became negative in 1998-99-00. Total nonfinancial debt, nevertheless, rose 6.9 percent in 1998 and again in 1999. This result was due to an increase of 9.6 percent in non-fedeeral debt in 1998 and 9.5 percent in 1999. These increases helped lay the foundation for the strong GDP growth of the past two years, but they also created new problems.
As this chart shows, household debt rose from $1,404.0 billion in 1980 to $7,169.1 billion in 2000, or 410.6 percent. Disposable personal income was also rising rapidly, but debt as a percent of d.p.i. still increased from 69.5 percent in 1980 to 102.6 percent in 2000. During that same period, personal saving as a percent of disposable personal income fell from 10.2 percent to -0.1 percent. This decline in saving augmented the rise in debt in raising the level of consumption. Here, again, we have a dynamic that cannot be sustained.
Much of the increase in consumer spending is ascribed
to the "wealth effect". The Economist (12/9/00)
"In the five years to 1999, rising share prices
boosted the wealth of American households by
$10 trillion. These gains encouraged households to save less out of their current income, pushing the personal
saving rate into negative territory for the first time since the 1950s. This happened at the same time as business
investment soared. As a result the private sector is running a record financial deficit (the difference between the
saving of households and firms and their investment) of about 6 percent of GDP. Over the previous four decades
net saving has never before turned negative for more than a year.
"----If share prices fall further, the reverse wealth effect on consumer spending could be bigger than in the past. Households will be starting with negative saving, giving them no cushion to fall back on, and they have never before had so much of their wealth tied up in shares."
Business Week (1/22/01, p 30) amplifies the effects of this situation as follows:
"Even if the market recovers, (James) Paulsen (of Wells Capital Management) thinks consumption may stay
restrained. The reason: The economy in the 90s experienced its longest big-ticket spending spree ever, bringing
outlays on durable goods and structures to a postwar high. 'Households are flush with new homes, furniture,
cars, and computers.' he says, 'and many businesses are over invested. Demand is saturated for a while no matter
what the Fed does.'"
This view is echoed by the Long Island Business News (1/12/01):
"Americans generally have been responsible in handling of money, balancing improved lifestyles with their ability
to earn and save. But several signs suggest overconfidence have grown in recent years.
"While incomes rose, expectation often grew faster. You can read it in the growing size of houses, in the more elaborate vacations, in the 17 million car sales per year, in casino operations and in luxury oddities.
"The 'wealth effect' was and still is, a factor in such behavior. And the destruction of the wealth effect could be compared to pulling the rug out from under millions of Americans."
Business debt, like household debt, grew steeply from
1980 to 2000, fourfold in 20 years. But unlike household
debt, business debt as a percent of income (measured as
profits before tax with inventory valuation adjustment)
did not change significantly. The level of debt in relation to
income has been considerably higher, however, and
serious questions need to be considered. One is raised by
"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."
Another concern is pointed out by the Economist (1/21/01):
"There is always a tension between the owners of a firm and its creditors. Owners want to earn the best returns;
creditors want their loans repaid with something extra to compensate for the risk of default. Until the 1990s,
most companies put the interests of bondholders first. Having a top-notch credit rating was an article of faith.
Since then, corporate America has been downgraded, both intentionally and unintentionally, to the detriment of
bondholders. Few companies now boast a top-notch credit rating. In recent years the exuberance of shareholders
has been matched only by the pessimism of their bond counterparts."
The Economist reviews several reasons why companies have favored debt over equity in recent years. One is a
financial theory that debt is cheaper than equity, primarily because it receives different tax treatment than equity
(interest is deductible but dividends are not.)
"The second reason why companies preferred debt is because it had become easier to raise. Competition among
suppliers of credit had increased hugely. Banks used to be the kings of corporate finance; in recent years they
have become the handmaidens. In the early 1970s banks had three-quarters of the lending market in America;
now they have less than half. Capital markets have ballooned: think, for example, of the development of the
junk-bond and asset-backed market in the 1980s.
"Until recently , this increased competition meant that companies both big and small had unparalleled access to credit. Over the past 20 years, mutual funds, banks and other lenders have been trying to discover how low down the credit spectrum they can go, and how finely priced their lending can be.
"So in recent years companies have been buying back their own shares in huge quantities. American firms, for example, have bought back a net $2.7 trillion worth in the past five years. Many of these purchases are financed not with retained profits but with debt, thus increasing firms' leverage and reducing their credit worthiness. By last November, Moody's, a big credit-rating firm, had downgraded 36 companies during 2000 for buying back their shares--the same as the combined total for the previous three years.
"The urge to borrow has been exacerbated by the growing habit of handing out stock options as incentives to senior employees. These are supposed to align the interests of a firm's managers and its shareholders, but in reality they do no such thing. Holders of options--unlike shareholders--have every reason to bet the firm, because they share in any upside but not in most of any downside. If things go wrong, they simply refrain from exercising their options.
"Bond investors were the first to spot that all was not well. Banks have taken much longer; indeed, in the past two years, they have been filling the gap left by choosier bond investors. Only now that their bad loans have started to mount have they reigned in their lending. Suddenly credit is no longer so cheap and plentiful; instead, America is seeing the first signs of a credit crunch. This does not bode well for the country's stockmarkets, which have already come off their highs."
At the beginning of 2000 and even at the end, there was almost universal optimism that the economy would continue
to boom at the rate with which it started the year. Then, out of the blue, things changed. Business Week (1/29/01),
describes it as follows:
"During all of 1999 companies were churning out goods at an increasingly rapid rate in an effort to catch up with
the even stronger growth in demand. By the middle of 2000, however, sales were slowing sharply, and by
yearend, the pace of stockpiling was far ahead of demand."
The question then arises of what caused the sudden slowdown. We have already noted the mounting debt loads taken on by households and business. We have also noted the evaporation of the wealth effect following the collapse of the technology stocks (and stagnation of other established stocks). The following data shed additional light on the onset of the downturn:
|Annual Growth in Percent|
As these data show, income and investment continued strong in 2000. Only debt slowed. This suggests that the weakness in demand stemmed largely from the slowdown in the growth of debt, and that slowdown was the culmination of a long expansion that could not be sustained.
New stimuli may yet be found, as so often in the past. The proposed tax cut is not likely to accomplish this. When the federal government cuts taxes, it puts more money into the pockets of tax payers, but it takes money out of the pockets of investors whose securities would have otherwise been redeemed (instead of being rolled over). No one can say which group of recipients would have done the most to stimulate demand. In addition, if debt growth slows further, it will create additional weakness.
It is still too early to draw a definitive conclusion, but it appears that the economic growth engine has run out of fuel - and that fuel has been the phenomenal growth of debt since the 1970s.
|Canada||Germany||Japan||United Kingdom||United States|
|Real GDP (% chg. at annual rate)|
|Industrial Prod. (1992=100)|
|Retail Sales (volume chg. 1 yr.)|
|Consumer prices (1995=100)|
|Interest Rates (3 months)|
|Stock Indices (ending)|
|Current Acc't Bal's ($bn) latest 12 months|
|Foreign Exchange Rates|
|Currency units per U.S. $
UK pound in U.S. $s
U.S.: index of major trading partners : January 1997=100
# Euro zone
|Sources: Economist, Economic Indicators, F.R. Bulletin|
The GDP data show a fairly persistent pattern of a rise in 1999 followed by a moderate decline in 2000. The exception is Japan which continued to rise in 2000. This seems somewhat at odds with industrial production which continued to rise in 2000 except in Japan. Retail sales however (which compare December volume with one year earlier) indicate that a sharp downturn occurred at year-end which includes the all-important Christmas season. It seems rather remarkable that such a downturn occurred simultaneously in all five economies. The slowdown could explain the production cutbacks that are now occurring in many industries.
As we have noted before, consumer prices seem to march to their own drummer - a constant upbeat. Again, the exception is Japan which has had stagnant demand for several years.
Unemployment tends to follow, not lead, the economy, and this is borne out by the fact that the rate continued to fall in 2000, except in Japan which had an .01 percent increase. Interest rates rose after having fallen in 1999.
The Canadian stock index is the only one of the five to register a gain in 2000, and it fell to the 7650 level in March 2001. For the U.S. it was the first year that many investors have experienced in which the average finished lower that where it started.
Current account imbalances widened in Germany, Britain, and the U.S., but Canada's account turned positive and Japan's surplus increased. The U.S. deficit was the largest ever, despite a 0.7 percent decrease in imports in the fourth quarter, the first such decrease in almost 10 years.
The U.S. dollar appreciated about 7 percent against the euro and against major foreign industrial countries in 2000. Much of the rise was based on a perception of better growth prospects and rates of return in the U.S., and weakened somewhat in the fourth quarter.
|Business Activity Indicators - United States|
|Industrial Production (1992=100)||134.0||139.6||147.5|
|Manufacturers' New Orders (billions of $s)||336.1||356.6||381.0 #|
|New Construction Expenditures (billions of $s)||711.8||764.2||808.3|
|Real Gross Priv. Dom. Invest. (chained$s)||1,566.8||1,669.7||1,840.4|
|Business Sales - Mfg. & Trade (billions of $s)||779.4||833.1||893.8 #|
|Business Inventories (ending) (billions of $s)||1,100.2||1,151.1||1,220.5|
|Retail Sales (billions of $s)||228.8||249.6||269.3 #|
|Retail Inventories (ending) (billions of $s)||343.2||372.1||398.7|
|Per Cap. Personal Consump. Expend.'s (chained  $s)||20,989||21,901||22,854|
|Nonagricultural Employment (millions)||125.9||128.8||131.4 #|
|# Monthly average||Source: Economic Indicators|
Overall, U.S. real domestic product rose 5 percent in 2000, an increase of 0.8 percent over 1999. The quarterly rate, however, fell to 2.2 percent in the third quarter and to l.l percent in the fourth.
The production of goods decreased 2.8 percent in the fourth quarter, the largest quarterly decline of the current expansion that began in the second quarter of 1991.
Industrial production rose more in 2000 than in 1999, with a moderate decline in production and capacity utilization during the fourth quarter. Manufacturers' new orders peaked in June, then fell, with most of the decline in durable goods, Construction expenditures remained high through 2000 but did not rise as much as in 1999. The value index was 145 in January, 2001. Real gross investment, however, was considerably higher in 2000 than in 1999, with some pullback in the fourth quarter.
A graph of business sales shows a very strong uptrend in 1999 that was maintained through June 2000 but then faltered. December sales were lower than any of the months June through September. This really shows the fragility of the current economy: even a faltering in growth panics markets and shakes public confidence. In this environment inventories rose, leading to cutbacks in production and employment. These same developments occurred to a lesser extent in the retail sector.
The pattern we have been seeing is borne out by per capita income and consumption data. Real per capita income fell slightly in the fourth quarter while real per capita expenditures rose only from $22,956 in the third quarter to $23,061 in the fourth (annual rates). The personal saving rate was negative in both the third and fourth quarters.
Overall, employment growth was maintained in 2000, but the pace slowed after the first quarter. Construction employment was almost unchanged, manufacturing employment fell 183 thousand from January to December, but services employment continued to grow.
|Financial Indicators - United States|
|National Income (billions of $s)||7,038.2||7,469.7||7,997.6 *|
|Per Cap. Disp. Personal Income (chained $s)||22,672||23,191||23,636|
|Avg. Real Gross Wkly Earnings (1982=100)||268.32||271.25||271.96|
|Gross Saving "||1,654.4||1,717.7||1,820.4|
|Commodity Price Index (1995=100)||na||73.5||72.7|
|Producer Price Index (1982=100)||130.7||133.0||138.0|
|Corp. Profits (with i.v.a.&c.c.a.) (billions of $s)||815.1||856.0||942.3|
|Interest Rates - 10 year Treas.||5.3||5.7||6.0|
|Money Supply - M3 (ending) "||6,027.3||6,526.8||7,092.6|
|Fed. Res. Open Mkt. Operations @ "||27.5||135.8||-63.9|
|Commercial Bank Credit (ending) "||4,538.8||4,772.0||5,223.6|
|Consumer Credit (ending) "||1,301.0||1,393.7||1,533.8|
|Credit Market Debt (ending) "||23,461.9||25,731.4||27,513.9|
|@ Net purchases/sales||Sources: Economist, Economic Indicators, F.R. Bulletin, F.R. Flow of Funds|
National income rose more in 2000 than in 1998 or 1999, but once again we find weakness in the fourth quarter when income actually fell slightly from the third quarter, with declines in farm income and corporate profits. Real per capita income grew a little less than in 1999, while real weekly earnings ended the year a little below where they began.
Gross saving expanded considerably more in 2000 than in 1999. A long decline in personal saving culminated in 2000 in a negative figure of $-9.2 billion. Simply, this means that personal outlays were greater than disposable personal income for the first time since the 1950s. Business saving - primarily depreciation allowances - rose strongly, but capital expenditures rose even more strongly, resulting in a steep rise in business debt. Government saving was propelled by a growing current surplus plus growing depreciation allowances on investment.
Weakness in commodity prices persisted in 2000, down 0.8 point from a year earlier; both food and industrial items remained weak. Producer prices rose 5.0 points compared with 2.3 in 1999; all groups participated in the rise.
Corporate profits grew more than in 1999 but fell markedly in the fourth quarter, a decline that affected both financial and nonfinancial firms. The ten year Treasury yield averaged over 6 percent for the first seven months of 2000 but then fell below that level and has gone down further in 2001. Concerns about credit risk apparently led some investors to prefer Treasuries over corporate debt, pressing yields lower.
The Federal Reserve Bulletin (3/01) comments on the M-3 money supply as follows: "For the year as a whole, M-3 expanded 9-1/4 percent, well above the 7-3/4
percent pace in 1999. This advance again outpaced that of nominal income. and M-3 velocity - the ratio of nominal income to M-3 - declined for the sixth year in a row."
Federal Reserve open market operations were dominated by two factors in 2000. The first was an enormous infusion of funds in November and December, 1999, - $105.2 bn - followed by a withdrawal in January 2000 of $95.3 bn; these operations were in anticipation of an increased demand for cash prior to the century-changing date to a new millennium. The second factor was a series of increases in the federal funds target rate to 6.5 percent, that restrained open market purchases. The result was a net $-63.9 bn for the year. The Fed comments: "[Currency growth] was surprisingly sluggish...given the rapid pace of income growth, with weakness apparent in both domestic and foreign demands."
The Fed also comments: "Bank credit expanded at a particularly brisk rate through late summer when banks, given their ample capital base and solid profits, were willing to meet strong demand by households and business. Over the remainder of the year, the growth of bank credit declined appreciably, as banks became more cautious lenders and as several banks shed large amounts of government securities."
Consumer credit increased $140.1 billion in 2000, the largest increase in over a decade. But total credit market debt expanded at a slower rate than in either 1998 or 1999, thanks to the net payback by the federal government and a slowdown in the growth of financial debt.
|Selected International Transactions - United States|
|Trade Balance on Goods & Services ($bns)||-166.9||-265.0||-368.5|
|US Owned Assets Abroad, net [inc/capital outflow(-)] "||-375.4||-430.2||-552.3|
|Foreign Owned Assets in US, net [inc/capital inflow(+)] "||482.2||753.6||952.4|
|Net change in Foreign Owned U.S. Securities|
|Sources: Economic Indicators, Survey of Current Business|
As in the prior two years, the balance on goods and services fell sharply in 2000 to another record of $-368.5 bn. The most interesting development of the year, however, may have been the changes that occurred in the fourth quarter. Exports decreased for the first time in almost two years, and imports decreased for the first time in almost ten years. Most end-use categories of both exports and imports experienced declines.
The gap between U.S. investment abroad and foreign investment in the U.S. grew to $400.1 bn in 2000. Foreign purchases of U.S. securities were exceptionally strong, eclipsing the record set in 1999. Purchases of U.S. Treasury securities were again negative, but these sales were offset by foreign purchases of government agency securities--$110 bn in 2000 compared with $72 bn in 1999. Foreign purchases of corporate debt and U.S. equities also exceeded the records set in 1999.
Copyright © Andrew Caughey, 2001
The Pulse of Capitalism is published quarterly. Comments may be sent to Pulse Publication, P.O. Box 140, Gibsonia, PA 15044. Telephone: (724) 443-2396
Material may be reprinted with acknowledgement of the source. Economic statistics are revised routinely and may, therefore, differ from one report to another.
Published May 2001