Economy down, but looking up

Tax rebates and lower energy costs are helping, but a weakening GDP shows how close the US is to recession.

After eight months of anxious decline, the United States economy may have just hit bottom. Finally.

Tax rebates, lower energy costs, and previous interest-rate cuts by the Federal Reserve should help the economy start to grow again - even if painfully slowly. A turnaround - any turnaround - would be welcome, from the machine-tool plants of Ohio to the truffle farms of France.

"The ducks are all in a row to produce better economic times," says Sung Won Sohn, chief economist for Wells Fargo Banks in Minneapolis.

Yet, economists say risks remain that could undermine a fragile recovery. Red ink continues to flow at many corporations. In fact, one company last week wrote off an astounding $44.8 billion, and some firms are starting a second or third round of layoffs.

The headlines from these cutbacks may scare consumers into saving their federal-tax-rebate checks instead of spending them. If consumers were to pull back, economists warn of still worse times ahead.

Little wiggle room exists, at present, for the economy. An indication of how close the nation is to recession came last week, when the government reported that the second-quarter gross domestic product (GDP) rose by only 0.7 percent, after a first-quarter performance of 1.3 percent. The reading was its weakest since 1992. Although this is the initial estimate - likely to be revised - economists believe the report is important for several reasons:

* Since there is still some growth, the headlines won't read that the economy slipped into negative territory. This could have frightened consumers.

* The government report shows that inflation is not a problem. This may give the Federal Reserve some leeway to lower interest rates another notch when the central bank meets Aug. 21.

* The collapse of the high-tech sector is worse than expected. New orders for computers were down at a 45 percent annual rate, while orders for new telecommunications equipment fell at a 74 percent annual rate. One sign of the collapse: Last week JDS Uniphase, a telecom supplier, wrote off almost $45 billion, a record amount for any company.

The Fed's next move

Economists are not certain how the Federal Reserve will react to the economic news. The consensus is that the central bank will cut rates by another quarter percentage point when it meets in three weeks.

"This report makes the move a little bit easier for them," says Mark Vitner, a senior economist at First Union Bank in Charlotte, N.C.

The Fed will get an even closer look at the state of the economy this Friday, when the government releases the July unemployment rate. Richard DeKaser, chief economist at National City Corp., a Cleveland bank, expects it will increase to 4.7 percent, from 4.5 percent in June. If new job growth shrinks by another 100,000 jobs, then Mr. DeKaser thinks the Fed will act. Otherwise, he says the inflation hawks, which argued against a rate cut last month, will prevail in keeping interest rates unchanged.

"My sense is that they will be more judicious, since there are some members who are concerned about providing too much liquidity for when the economy starts to grow again," he says.

Without question, the Fed's interest-rate cuts are starting to have some impact, especially in the housing market. In the second quarter, new residential housing rose by 7.4 percent. "Very strong housing price increases are fueling the investment demand to own," says David Seiders, chief economist for the National Association of Home Builders in Washington.

But while carpenters are busy nailing in joists and studs for new homes, the commercial construction market is starting to collapse. After a strong start to the year, new business construction fell by 11.2 percent.

This is not a surprise to economists, however, because businesses that are laying off thousands of employees don't need extra office space.

The changes have economists starting to become concerned about how consumers will react. "If they lose their cool, there will be no recovery," says Rajeev Dhawan, director of economic forecasting at Georgia State University in Atlanta.

In the second quarter, consumers started to slow their spending - something that hasn't happened for some time. In the coming months, they will start to spend again, armed with federal-tax rebate checks, which Mr. Dhawan thinks will be used for back-to-school items.

"The spending will mask weakness," says Richard Curtin, director of consumer surveys at the University of Michigan.

Mr. Curtin is concerned that consumers will become alarmed if the unemployment rate begins to rise over the summer and fall. In that event, he says, "We could see a relapse in the fourth quarter and further weakening in the beginning of the year."

Although this won't mean a recession, he says it could mean a long period of very slow growth.

On the bright side

Despite the concerns, Mr. Sohn of Wells Fargo is more optimistic. "At the bottom, you get a lot of mixed economic reports," he explains. While most people were focused on the layoffs at the high-tech companies, he says, there were some positive changes.

For example, the automobile companies have reduced their inventories down to 60-day supply. As a result, they plan on boosting production and recalling some laid-off workers in the next few weeks.

"These tail winds," he says, "will hopefully offset the negatives."

(c) Copyright 2001. The Christian Science Monitor