The “new economy” has quickly gotten old. A few weeks ago, I cautioned against the soothing notion that we had entered a prolonged period of economic bliss. Right on cue (it seemed) came the thumping 554-point drop in the Dow Jones industrial average. Tossed in for good measure were stock market slides and currency crises in Asia, Latin America and Europe. Almost no one predicted the turmoil. Yet the instant wisdom is that the U.S. economy is better off for it. Stocks were too high anyway. The drop may have a silver lining. The economy will slow just enough to keep inflation in check. The Federal Reserve won’t have to raise interest rates. All this sounds plausible–but it may not happen.
Our economy is a confidence game that plays the same trick over and over. When things are going well, hardly anyone thinks they will ever get worse. And when things are going badly, hardly anyone thinks they will ever get better. The moods repeatedly mislead, because things always change. Economic life is a ceaseless reaction to new products, technologies, perceptions, excesses and opportunities. New information is constantly received and evaluated; new implications–sometimes correct, sometimes not–are drawn. Everything connects with everything else, and it’s hard to predict how the connections will be made.
The case for the silver lining is strong. In the past year, the economy has generated roughly 2.5 million jobs. Inflation is lower in 1997 than in 1996. True, the stock market is down from its peak. But recall the peak. In early August, the “capitalization” of the New York Stock Exchange–the value of all its stocks–was $9.3 trillion. After the plunge on Oct. 27, it was $8.6 trillion. This was still up from $7.3 trillion at the end of 1996 and $4 trillion at the end of 1992. There’s been a huge explosion of wealth. How could such a small setback crush consumer optimism?
As for the Asian crisis, it will hurt U.S. exports only slightly. The reason: Thailand, Indonesia and the Philippines (the three countries most directly affected) account for less than 3 percent of U.S. exports. Even adding South Korea and Taiwan brings the total to only 10 percent. It’s hard to get too worried. The investment banking firm, Goldman Sachs, thinks the U.S. economy will grow 3 percent in 1998.
It could happen. But let’s sketch a more somber picture. Start with the fact that the present economic expansion is 6 1/2 years old. Consumers have already bought a lot of cars, computers, couches and clothes. More ominous is the little-noticed fact that consumer spending has been rising faster than personal income since 1993, notes Susan Sterne of Economic Analysis Associates. The personal savings rate (the share of disposable income not spent) is a mere 3.8 percent in 1997, down from 6.1 percent in 1992.
People have been borrowing more or saving less to prop up spending; this cannot go on forever. Consumer spending could be pinched at both ends. Debt-laden poor and middle-income buyers may decide they’ve overborrowed–or their creditors may decide for them. Meanwhile, upscale buyers may see the stock market’s drop as a warning. They’ve been able to skimp on saving in part because their stock portfolios have risen so rapidly. Sterne scoffs at the notion that people don’t adjust spending to stock fluctuations. In 1987, she notes, stocks and mutual funds represented only 11 percent of consumers’ net worth; now that’s 22 percent.
Finally, the export impact could extend beyond a few Asian nations. Japan will surely suffer, because about half its exports go to Asia. With its own growth hurt, Japan will buy few U.S. exports. Other developing countries could also be affected if skittish foreign investors become more stingy in their investments. Altogether, it’s conceivable that about half of U.S. exports might be adversely affected. And if both exports and consumer spending weaken, it’s hard to see how business investment–until now a powerful force for expansion–could remain strong.
So the silver lining might turn out to be lead. And pessimism could feed on itself. If profits disappoint, stocks would probably drop further. Of course, there might be offsetting factors. Greater competition from imports (as Asian economies try to recover) might further reduce inflation. This could drive interest rates lower, which would provide debt relief for both consumers and businesses. And that could sustain both spending and profits. Either the silver or lead theory might come true. Or some unimagined combination. Who knows?
Uncertainty. Risk. Surprise. These are the unchanging characteristics of a constantly changing economy. No one should be surprised that today’s stock market is erratic. It tumbles one day, then zips up the next. We call that “volatility,” but volatility is really an indicator of ignorance. Market players are making hunches on the unknown. What we can expect is the unexpected.