As uncertainty looms over the status of the U.S. economy, we find ourselves constantly asking a very simple but relevant question -- when will the economy finally turn around?
Clearly, there is no straightforward answer to this question. A combination of negative shocks to the economy -- namely the corporate scandals and now the possibility of war with Iraq -- coupled with low consumer confidence and low capital investment consequently has delayed the notion of a full recovery.
Moreover, if you view the idea of a recovery from a different perspective, the recovery may in fact prove short-lived and headed in the direction of a double-dip recession. Additionally, there has been speculation that we could face some of the shortcomings Japan has suffered throughout the past few years.
No economic indicators have given us a definitive answer to our question. Although we have shown positive growth in GDP over the past three quarters, albeit very modest at best, it has not shown us the growth necessary to stage a full recovery. The growth in GDP averaged 3 percent over the past three quarters and growth was only 1.1 percent in the last quarter. Thus, at this sensitive stage in our economy, any movements, such as decisions made by the Fed and military action taken in Iraq, could tip the balance of our economy.
More importantly, we must analyze the situation now at hand through various lenses of economic fundamentals in order to understand the factors helping dictate the condition of our economy.
Consumer spending is one vital aspect that drives our economy. For example, in the past quarter, consumer spending on durable goods, such as housing and automobiles, has proved a main factor keeping our economy afloat and out of the recession. In particular, the housing boom has played a substantial part -- existing home sales rose by 4.5 percent and new-home sales increased 6.7 percent. Such dramatic growth in housing has been fueled by low mortgage rates of about 6 percent for a 30 year fixed loan and lower interest rates. But we cannot continue to count on the housing sector to support our economy -- this sector has a limited capacity to expand in the second half because mortgage rates appear to have bottomed out and housing ownership is at a record high.
Moreover, in a somewhat contradictory fashion to the increase in spending on durables, the Consumer Confidence Index fell from 97.4 in July to 93.5 in August, the lowest reading since November 2001. Thus, consumer's expectations down the road look glum. Once the housing boom blows over, consumer spending may decrease substantially.
Consequently, for real consumer spending to advance forward, it also is pertinent that job prospects improve, which, in turn, is contingent on business's outlook on the economy.
In addition to the influence businesses exercise on consumer spending, the corporate sector also plays an integral role in driving the economy via other means, such as capital investment.
With the pressure on decreasing capital spending, the notion of a recovery may be prolonged at best, because the effects of reductions in capital investment combined with job cutbacks will spill over to the consumers. Thus, this could have serious implications and mark a force driving us to recession.
From a broader viewpoint, the international implications of imports and exports also play an important role in our economy. For example, U.S. exports rose 12.3 percent in the second quarter, due in part to a weaker dollar. Imports rose by 22.8 percent, an unusually large amount, which indicates that U.S. consumers still are spending.
Nevertheless, in the future, the United States cannot count on international trade alone to spark a recovery, because the rest of the world is struggling along with us. In addition, we have no control over the economic decisions of other countries. Therefore, the logical solution is to look domestically for recovery.
The potential of war with Iraq is another dark cloud looming over our economy. Oil prices already have risen significantly due to what most economists believe is a "war premium." The recent decline in consumer confidence and the continued reluctance of businesses to spend also could be partially attributed to renewed fears of war.
If war does indeed break out, it could mark the deciding factor that would lead us to a double-dip recession. The longer a war would last, the longer it would take for the economy to recover.
Another method of analysis is to look at various examples, historical and current, to make some deductions about our situation.
Take Japan, for example, which has suffered from stagnation and a liquidity trap in the past decade. Despite the obvious differences between the United States and Japan, the basis for comparison stems from the "boom and bust" cycle that occurred within Japan in the 1990s and in the United States in 2000. However, there are further similarities between the two economies that have begun to develop, namely loss of confidence in the business sector and a potential housing bubble. Nevertheless, deflation, a decline in general price levels often caused by a reduction in the money supply, is the greatest cause for concern.
When deflation occurred in Japan, corporations and consumers could keep their cash under their mattresses and watch it gain in real value. If they would use their cash to purchase goods and services, the value of those goods and services would fall. That explains why the Japanese savings rate is so high, and why the Japanese economy continues to suffer.
Although the United States does not currently have deflation, the inflation rate is only around 1 percent. The problem is that inflation will continue to fall as long as economic output is below its potential. Once inflation falls below 0 percent, the Fed loses its ability to stimulate the economy through further interest rate cuts, a problem known as a liquidity trap.
Fiscal stimulus has many well-known lags that decrease its effectiveness. Therefore, it is necessary that Fed Chairman Alan Greenspan use monetary policy to cut interest rates, before deflation has a chance to strangle both the Fed and the economy.
From a historical perspective, the occurrence of double-dip recessions has been rare -- there has only been one double dip recession since World War II, which resulted in high unemployment levels and GDP output contractions. This said, it is necessary that we hesitate when making any conclusion that would suggest a double-dip recession. The comparison with Japan has to be taken with a grain of salt, as there are significant differences that would preclude any direct comparison indicating a double-dip recession.
A more likely situation is that our economy would experience sluggish growth rather than fall back into recession. Of course, there could be a string of negative shocks, such as war with Iraq, which could bring about a double dip recession, but many negative elements would have to fall into place for that to occur. However, with the current information available, the most likely conclusion is that a double-dip recession is unlikely. Due to pervasive uncertainty, time is the only element that can definitively answer the question of a double-dip recession.
Howard Kung is a third-year College student. Michael Lovinger is a scond-year College student.
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