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Signs Say Economy Slowing Down, Recession Unlikely

Now what? For the past 18 years, the US economy has been in a recession for only eight months. What about this year—economic growth or recession?

Robert Fry, DuPont's senior associate economist, believes that although the economy will slow down to a gross domestic product (GDP) growth rate of 2.5%, down from more than 5% in 2000, a full-blown recession is not the most likely scenario.

Interest rate hikes by the Federal Reserve and a big oil price hike are responsible for the slower growth rate.

"Interest rates," Fry says, "tend to work with about a 12-month lag, much longer than most people think. Interest rates started rising in mid-1999, and the economy slowed down right on schedule in mid-2000."

As for crude oil, "we've gone from $11.00 a barrel in late '98 to around $34 to $35 a barrel in the fourth quarter of last year."

But not even higher interest rates and $30 oil prices are likely to tip the US into a recession. "Oil is only about half as important to our economy as it was in the seventies and early eighties," Fry explains. "If we'd had this kind of hike in oil prices in the 1970s, we certainly would have been in a recession by now. But because the economy has changed, we can handle oil price hikes a lot better than we could before. But oil prices do contribute to the slowing of the economy."

Fry thinks oil prices could come down, most likely in the spring. "If we can get through the rest of the winter, things could brighten up with spring weather. If oil prices come down or even just stabilize, inflation will probably peak. In fact, inflation probably has peaked at about 3.5 percent." By the end of this year, Fry expects inflation to stand at approximately 2.5%.

Bricks and Mortar
Excluding computers, semi-conductors, and communications equipment from the equation, "there was no growth in the manufacturing sector of GDP from October 99 to October of last year," Fry reports. "Industrial output probably will be flat in the early part of this year and then pick up around mid-year.

"Now, look at the high-tech sector of GDP. October to October, computers were up about 43 percent. Electronic components, including semiconductors and printed circuit boards, were up almost 85 percent, September to September. Communications equipment, through the same period, was up about 25 percent."

"But," Fry adds, "there's a caveat to all of this: All of these numbers are adjusted for quality changes. For example, if you bought a computer last year and then buy a new one this year, you'd probably pay about the same this year as you did last year. But, this year's computer has twice the processing speed, twice the memory, and twice the hard drive capacity. When the government computes industrial production, they count this year's computer as more production than last year's computer. So you get an increase in the Fed's idea of industrial production for computers, even though the number of computers produced has not changed at all."

According to Fry, the amount of materials going into computers has not changed—if anything, the new model probably has less—but in terms of industrial production, it counts as an increase.

"And, because you get more computer for about the same money [after quality adjustments], it counts as a price decrease. So it shows up as an increase in industrial production and a decrease in price indexes even though the same number of computers is being sold for the same prices charged last year."

Fry continues, "If you make good use of the improvements in your new computer, industrial production is a legitimate measure of the increase in what we are producing in terms of its contribution to our standard of living. However, if you are using that new computer just to read e-mail, there's no advantage in buying this year's model, and the government's numbers are misleading.

"Furthermore, if you are a supplier to the computer industry, you may be misled by the government's numbers. You're not going to see a 43 percent increase in the amount of materials you sell to computer manufacturers. In a way, this biases upward the overall economic growth numbers. October to October total industrial production in the US, including high tech, was up 5.2 percent. Excluding high tech, it was down 0.1 percent. All of the growth in industrial production is, then, due to the high-tech sector."

Interest Rates and Employment
Regarding interest rates, Fry says, "The Fed stopped raising interest rates last May, and if our forecast for a slowing economy is correct, interest rates might be cut in the second quarter. Twelve months later, that cut will show up in an accelerating economy.

"However, the Fed under Alan Greenspan has shown a willingness to let interest rates stay flat for very long periods, sometimes as long as 18 months. They aren't going to be in any hurry to move rates right now. I think they like the way the economy is slowing down, even though some of the leading indicators suggest they really should be cutting rates.

"Employment has already been dropping rather steeply in manufacturing," Fry points out. "So far, it has had little effect on overall unemployment, because people find jobs elsewhere. Total employment growth has slowed but not enough to cause the unemployment rate to rise significantly; it's just slowed to a rate that is more consistent with population growth."

The Squeeze Is On
"This year, profits aren't going to boom the way they have for the last several years," Fry reports. "We have a very tight labor market, and we look for increases in real wages and salaries. Also, for energy-intensive companies, feedstock and energy costs have risen with oil and gas prices. But it is very difficult to push a price increase through, because the consumer will resist directly or indirectly through a national retailer or a manufacturer such as an automobile company....The result is a classic profit squeeze.

The automotive industry, says Fry, "will probably see a bigger downturn than a lot of other industries, because it has been so strong for the last year and a half. Sales have been at an unsustainable level, and vehicle production will have to come down. Industries tied to motor vehicle producers, such as glass, steel, rubber, paint, and similar products, are going to feel the impact on their businesses.

"Housing tends to by cyclical, too. We have probably seen most of the decline in this industry. But we won't see much growth in that sector any time soon. Housing starts have been level the last four months, but they may decline further this year until they are down to a level consistent with population growth."

Fry sums up: "We aren't carrying much momentum from 2000 into 2001. The first half of this year is probably going to be weak, but by the second half—especially if oil prices come down and interest rates don't go up—things should start looking brighter. We should leave 2001 with more momentum than we entered the year. The overall economy may pull off another soft landing, but it won't seem that way for the cyclical industries of the manufacturing sector. Remember, even soft landings are scary if you're hanging onto the landing gear."

Robert C. Fry, Jr. joined DuPont's Economist's Office in 1987, following a three-year stint in Conoco's Coordinating and Planning department. As senior associate economist, he analyzes and forecasts global macro-economics and its impact on DuPont. He assists DuPont businesses by interpreting economic data and using it to forecast DuPont performance. He is also author of the monthly newsletter Current Business Developments.

Fry received his B.S. in economics from Ohio University and an M.A., as well as his Ph.D. in economics from Harvard. He is president of the Board of Visitors of the Honors Tutorial College of Ohio Univ., a member of the Economic Roundtable of the Ohio Valley, the National Association for Business Economics, and the Economist's Club, an international group of chemical industry economists.

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