Betting On A Recovery

Alan Greenspan isn't the type to give high-fives or dance in the end zone. But if his Federal Reserve colleagues were an NFL team, they might be sending the waterboy to the locker room to ice the champagne. One year after chairman Greenspan began the most aggressive recession-fighting offensive of his tenure, the economy is showing early signs of an upturn. Despite huge layoffs, two years of stock-market declines and the momentary paralysis that hit the economy after September 11, experts and the public are growing optimistic. Economic data is always confusing and often contradictory, but many of the latest stats are encouraging. Consumer confidence is rising. Job losses are slowing. From Silicon Valley to Wall Street, there's a growing consensus that a rebound is in sight. A few economists already talk about this recession in the past tense. Even more cautious ones, like Allen Sinai of Primark Decision Economics, expect growth to return by summer vacation. "The worst of the slide is behind us," says Sinai.

Let's hope he's right. In the immediate aftermath of September 11, fears ran rampant that the attacks would capsize our already teetering economy. The terrorist acts certainly contributed to the recession that ended our 10-year expansion, the longest in U.S. history. But now, just four months later, it appears that America's indomitable urge to shop may help us declare victory in the defense of our economy even before our military finishes up in Afghanistan. Some of the fuel for recovery has come from patriotic spenders like R. J. and Marge Costa, a retired New Jersey couple who recently booked a $40,000, two-month cruise for September. "The American people are survivors," says R.J., "and we as a people aren't going to let the economy go down the tubes." But it also comes from the surprising nonchalance so many households have shown about this slowdown. Many families have glided through the first 21st-century recession living by that bumper-sticker motto: NO FEAR. From coast to coast, they're still buying and borrowing nearly as much as they did in good times.

That behavior is just one of the mysteries economists will puzzle over if the new optimism proves well founded and the recession of'01-'02 soon enters the history books. They started scratching their heads during the '90s boom, when the U.S. economy grew so feverishly that it forced policymakers to rethink some basic assumptions about how the world works. Now they'll factor this recession--which appears to be milder than many experts feared--into their models to answer a crucial long-range question: can the economy eventually regain the record pace it set during the Long Boom? The answer, still unknown, will help determine how well America lives in the '00s.

Of course, the growing optimism about a quick recovery could prove premature. It's built largely on just a few key pieces of data. Any number of events--another terrorist attack, another Enron-style implosion, an oil-price spike, a stock-market tremor, another Latin American default--could send the numbers south. More troubling, much of the new buoyancy is based on economists' forecasts, which have a track record only slightly better than fortune cookies'. And even as the consensus estimates move higher, a group of gloomier analysts continue to worry. Among their fears: consumers are carrying too much debt, other countries' recessions will limit U.S. exports and the current run of good news may be an artificial blip.

Even if the bullish pundits are correct in calling a rebound, it won't necessarily end the sting of this recession. Companies have shed more than 1 million jobs since it began, and 8.3 million people are still seeking work. Unemployment will likely rise throughout 2002, causing more pain for workers. It could also cause problems for the Bush administration. Last week Senate Democrats resumed criticizing the president's handling of the economy. And Bush recalls all too well how even after the 1990-91 recession ended, high unemployment gave Bill Clinton what he needed to defeat George H. W. Bush.

Despite those risks, more people are deciding there's no better time to begin betting on a recovery. Cyndi Lee, owner of a four-year-old Manhattan yoga studio, recently hired a CEO and will soon move to a much larger space. She compares her fearlessness to the "warrior postures" she teaches her students. Expanding during a recession takes courage, she says, but it's a savvy move. "After hard times, there are always better times," she says. "It's that kind of positive thinking that helps a person and a business grow." Last month veteran car dealers Harry Gray and Tony Schwartz spent $12 million to buy a Los Angeles luxury dealership. In their first week of business they took 104 orders for new Ferraris (sticker prices start at $150,000). "The people we're selling to aren't concerned so much about their cash flow," says Schwartz.

To help understand why this recession may have entered the home stretch, let's recap how America's boom turned to bust in the first place. Start by recalling a few rules from Econ 101. Until a few years ago every college freshman learned that the mature U.S. economy rarely grows much faster than 3 percent a year. They also learned that unemployment couldn't drop below a "natural rate" of around 6 percent without sparking inflation. During the '90s the Fed decided to challenge those assumptions by allowing interest rates to stay low even as the economy accelerated. The result: unprecedented prosperity. The nation's output grew by more than 4 percent annually, unemployment dropped to 3.9 percent (the lowest in a generation), the stock market boomed and inflation remained innocuous. Experts tried explaining this "New Economy" by exploring how workers were using high-tech tools to increase their productivity at far faster rates than they did in the 1970s and 1980s. New Economy Pollyannas even wondered whether we might stop having recessions altogether.

That dream ended with an alarm bell: the crash of the high-tech Nasdaq stock index in early 2000. Those skyrocketing stocks had given companies access to cheap money and fueled the glut of venture capital that went to start-ups. Much of that cash was spent on Internet initiatives, so tech companies built new plants to produce chips, servers, fiber-optic cable and other gizmos to fuel the booming Internet economy. At one point before the bust, market darling Cisco Systems was selling $100 million of routers, switches and other Internet goodies every business day. But the Nasdaq crash made many of its customers--from dot-coms and telecom start-ups that evaporated to big companies that slowed Internet expansions--stop buying. Sales of nearly every tech product plummeted; companies like Lucent, Motorola and Hewlett-Packard cut thousands of jobs. Those layoffs, higher oil prices and the falling stock market spread distress far beyond the tech sector.

By early 2001, corporate profits entered their steepest decline in years. Unemployment began its rise to six-year highs. To fight the slowdown the Fed furiously cut rates: by last month it had lowered the federal funds rate 11 times, from 6.5 to 1.75 percent, the lowest level in 40 years. Economists hoped that stimulus, along with the Bush administration's tax cut, might let us squeak by without entering an official recession (defined as an extended period of economic contraction). Then came September 11, and businesses of every kind saw buyers disappear. Some experts--including Larry Lindsey, the president's top economic adviser--argue we still might have avoided a recession if it weren't for Mohamed Atta and his conspirators. But by November the data were unambiguous, and the National Bureau of Economic Research announced the recession had begun in March.

Before this slowdown entered the record books, analysts had been puzzling over its strange mix of vital signs. Even discounting for the effects of the terrorist attacks, this isn't your father's recession. Usually, downturns are preceded by flare-ups of inflation. This one wasn't. Usually, consumers turn into tightwads; in particular, sales of cars and houses slow dramatically in most recessions. Surprise: during 2001, both industries' sales hardly dipped from the boom years.

Despite that quirky behavior, some economists still insist there's nothing abnormal about this recession. They say the Federal Reserve's tightening in 2000, coupled with rising fuel prices and the falling stock market, snuffed out growth. But the majority of experts call this recession an anomaly. They say it's the deep cuts in spending by businesses, not by consumers, that led to the current malaise. Despite initial fears of a lasting consumer pullback after September 11, "it turned out to be a less worrisome factor than we thought at first," says Richard Berner, Morgan Stanley's chief U.S. economist. And if this recession ends soon, consumers deserve credit for powering us through.

How'd we get back in the game so quickly? Give some credit to the Fed. Its quick, sharp interest-rate cuts kept mortgage-rates low, spurring home sales and causing a trickledown effect that's helped support sales of things from building materials to new furniture and appliances. Many homeowners also jumped at the chance to refinance mortgages, lowering monthly payments and freeing up cash to spend. Low rates also allowed U.S. carmakers to juice sales with big incentives throughout 2001--and to launch a zero-percent financing bonanza that sent sales soaring after September 11. The Bush tax cuts helped. So did falling fuel prices. And though unemployment grew, it started at such a low level that fewer people have been jobless than during the depth of a typical recession. "I've never been through a recession where the consumer has remained so healthy," says economist Susan Sterne of Economic Analysis Associates. "It's just phenomenal."

Demographics and psychology deserve some credit, too. Economist Joel Naroff figures 50 to 55 percent of today's work force isn't old enough to have experienced the painful double-dip '80-'82 recessions. If you've never seen the damage a bad recession can inflict, he says, you're less likely to pull back spending and boost savings. Today's layoff victims are also more likely to be college-educated and to have job-hunting experience, lessening the sting of unemployment. Among people laid off during the first nine months of 2001, nearly 20 percent were under 30 years old, and one third worked at tech companies, where workers are typically younger and more mobile. Indeed, today's laid-off workers have been at their firm an average of just five years, according to outplacement experts Challenger, Gray and Christmas, down from 10 years in 1990. This suggests they'd job-hopped at least once during the boom, increasing their network of contacts and easing the anxiety of a job loss, making them more likely to keep spending. When facing a layoff, "it's very different being a college-educated 30-year-old rather than being a 50-year-old steelworker," says economist Carl Steidtmann of Deloitte Research. Steidtmann points to another factor adding to worker resiliency: today many more households rely on two incomes than in past recessions, providing a cushion when one spouse loses a job.

Thomas Sullivan embodies this new breed of out-of-work professional. Sullivan, a 33-year-old with an M.B.A. from Boston University, was laid off in mid-August as manager of market strategy at a telecommunications firm. By November his severance had run out and two of his key networking contacts had been axed themselves. Now, nearly five months into his search, he remains optimistic. Lately he's noticed more postings for suitable jobs on The hiring folks he's contacted say they might have more openings in April if first-quarter numbers look good. In the meantime he's trying to arrange for some freelance consulting work. "I've had 10-plus years of work experience, and I know the right position is going to come along," Sullivan says. "In every downturn there has to be an upturn."

The latest numbers suggest the upturn is imminent. Last week's employment report shows the United States lost 124,000 jobs in December, a sharp improvement from the average of more than 400,000 lost in each of the two previous months. A survey of supply managers showed orders for manufactured goods are growing. Inventories are falling, another sign factories might hum again soon. In a survey by the National Federation of Independent Businesses, small companies said they're increasing capital spending and looking to hire. "They seem to be incredibly optimistic," says Bill Dunkelberg, the NFIB's chief economist. The stock and bond markets are clearly anticipating a recovery. The economists surveyed by Blue Chip Newsletters expect the economy will grow slightly over the next three months, and be back to a respectable 3.9 percent growth rate by late 2002.

Perhaps the most encouraging signs of recovery come from the region that's been in this recession's cross hairs: Silicon Valley. Michael Murphy, publisher of The California Technology Stock Letter, sees signs of an uptick in sales of PCs, software and cell phones. Computer-chip sales, fueled by rising demand for DVD players, videogames and digital cameras, rose in October and November; the Semiconductor Industry Association expects 2002 worldwide sales to climb 6 percent (albeit after a whopping 43 percent drop in U.S. sales last year). The big question mark surrounds the telecom sector, where demand for fiber-optic gear remains weak. Even in industries that look poised to grow, executives are tempering their optimism with realism about the limits of a recovery. "Things are going to get better," says Bill Archey, president of the American Electronics Association, the largest high-tech trade group. "But anybody who thinks we're going back to the days of the late 1990s is nuts."

Just how close the economy can come to reprising those halcyon times has become one of the dominant questions facing the dismal science. In truth, there's no definitive explanation for why the economy was able to break so many records in the '90s, so the debate over whether it can be replicated is arcane and inconclusive. Princeton professor Alan Blinder, a former Fed vice chairman, says a complete return to the high-growth, full employment of the '90s is "not terribly probable, but not impossible." But with luck and smart Fed policy, he thinks we might come close. Alan Greenspan seems to be even more optimistic. In his carefully hedged speeches, he's talked of how the big productivity gain that drove the boom wasn't necessarily a one-time phenomenon.

For everyday Americans, the more pressing issue is how quickly the strengthening economy will lead companies to start hiring again. This is one of the big disconnects between economists, who focus on measures of the nation's output (like GDP), and real people, whose sense of the economy is influenced more heavily by the strength of labor markets. "The unemployment rate is much more tangible to people," says Gus Faucher, senior economist with And GDP and unemployment don't always move in lockstep. During the '90-'91 slowdown, the unemployment rate didn't reach its prerecession low until 35 months after the downtown ended. Last week the unemployment rate hit 5.8 percent, and nearly every analyst expects it to rise above 6 percent and remain high until late 2002.

The Bush administration hopes those numbers begin falling sooner. Lindsey, the director of the National Economic Council, makes a strong case for why the "jobless recovery" of the '90s won't be repeated. Labor markets are more flexible today, he says, with firms more able to use temps, part-time workers and reduced hours to fine-tune their payrolls. Like other economists, he says the last recession was exacerbated by a major banking and credit crisis that impeded the strength of the recovery. And despite the 1.9 percent rise in the jobless rate since it bottomed out in October 2000, the numbers remain low by historical standards. "We had record levels of employment in this country, and I think that will pay off for us in this downturn as it paid off for us during this expansion," he says.

Recessions, unlike wars, end slowly and undramatically. The good news comes in dribs and drabs; the only official declaration of victory comes long after the downturn has ended. There will definitely be setbacks on the road to a rebound. Spending may soften in the new year--particularly in autos--because people sated their appetites last fall. "You sort of borrowed what demand you might have had in 2002 in the latter part of 2001 due to the auto financing deals," says Michael Prell, formerly the Fed's chief forecaster. But with luck, the rosy numbers will keep coming. The biggest indication of whether America's new economic optimism is warranted will come after the Federal Reserve's next meeting on Jan. 29. Further cuts will mean members' crystal balls still show reasons for worry. But if the Fed halts its limbo dance of rate reductions, it may mean its members see a recovery taking hold. Even if that happens, says former Fed vice chairman Blinder, don't expect to catch Greenspan smiling. "He'll have that same inscrutable face on he always has," says Blinder. "But he'll be smiling internally." If there's to be a victory dance at the end of this downturn, it'll have to be performed by the American people who helped drive the turnaround.