Transcript PROSPECTS FOR 2002-2003 PROSPECTS FOR 2002

The 2001-2002
Recession
LECTURE
OUTLINETOPICS
Review of 2001
Prospects for 2002-2003
The global economy
Inflation
REVIEW OF 2001
My forecast of a year ago
Almost exactly a year ago, at the MVEA meetings in
Kansas City, I predicted that 2001 would see recession.
While I am happy to be credited with calling a recession
before it occurs, my forecast for 2001 was off the mark.
The March 2001 peak identified by the NBER dating
committee does not mark the beginning of the recession
that I foresaw.
REVIEW OF 2001
The Strange Anatomy of the 2001 Recession
The NBER looked at four indicators to determine the
onset of recession
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Employment
Industrial production
Real manufacturing and trade sales
Real personal income less transfers
REVIEW OF 2001
Employment
Peaked in March 2001.
Industrial production
Peaked in July 2000 and by March 2001 was 3 percent
below its previous peak.
Real manufacturing and trade sales
Too erratic to say what direction it is going in.
Real personal income less transfers
Still climbing in March 2001. Peaked in October 2001.
REVIEW OF 2001
Labor Market
The major sign of recession is in the labor market.
Employment has fallen faster than average.
Aggregate hours and unemployment rate on track with
previous recessions.
The next slides look at the labor market during 2001
and compare it with the previous six recessions.
REVIEW OF 2001
REVIEW OF 2001
Real GDP
The NBER dating committee doesn’t look at real GDP
when it identifies a turning point
But another standard definition of recession looks for a
two quarter decline in real GDP
On this criterion, we’re still not in recession.
And the slowdown is mild.
REVIEW OF 2001
PROSPECTS FOR 2002-2003
Four scenarios
Recovery and resumption of rapid growth
Recovery but slower growth
Double dip recession—normal depth and length
Double dip recession—deeper and longer than normal
PROSPECTS FOR 2002-2003
A quick overview
Long-term prospects are very promising, but …
We will have a double dip recession and it will probably
be a serious one.
Two major reasons:
• The saving problem
• The growth and profits problem
PROSPECTS FOR 2002-2003
The Saving Problem
Well known that the private saving rate is low and has
been falling.
Fallen from 8 percent in 1991-1992 to around 1 percent
in 2000-2001.
PROSPECTS FOR 2002-2003
PROSPECTS FOR 2002-2003
Measurement Issue
Two measures of saving:
• Income minus consumption
• Change in net worth
Argued during 1990s that the falling saving rate isn’t a
problem because based on first measure, which ignores
changes in stock and house prices.
Figure on next slide looks at second measure.
PROSPECTS FOR 2002-2003
PROSPECTS FOR 2002-2003
Measurement Issue
Income minus consumption since 1996 is $6.7 trillion.
Change in net worth since 1996 is $11.4 trillion.
If the excess of $4.7 trillion were realized, it would be
the equivalent of claiming 50 percent of 2001 GDP!
PROSPECTS FOR 2002-2003
Are stock prices too high?
Based on the P/E ratio, the stock market looks
overpriced.
To sustain the current P/E ratio, profits must grow much
faster than their historical growth rate.
If profits don’t grow faster, stock prices must fall.
PROSPECTS FOR 2002-2003
PROSPECTS FOR 2002-2003
Stock prices correction?
If stock market prices fall to restore long-term average
P/E ratio, $3.3 trillion of the $4.7 trillion disappears.
If stock market prices fall to achieve a low P/E ratio, all
of the $4.7 trillion disappears.
PROSPECTS FOR 2002-2003
Bottom Line on Saving
The saving rate is sustainable only if stock prices
remain at historically high levels relative to earnings.
The saving rate will rise and consumption expenditure
will fall if stock prices fall to normal long term level.
Most likely that consumption expenditure will fall sharply
at some point during 2002 or 2003.
PROSPECTS FOR 2002-2003
The Growth and Profits Problem
The growth rate and profits are being systematically
overestimated by creative accounting “Enron style.”
The extent and full implications of this problem are only
beginning to be seen.
A joke that is doing the rounds of the world’s financial
centers makes the key point nicely
PROSPECTS FOR 2002-2003
Normal capitalism
You have two cows.
You buy a bull.
Your herd multiplies and the economy grows.
PROSPECTS FOR 2002-2003
Enron capitalism
You have two cows.
You sell three of them to your publicly listed corporation,
using letters of credit opened by your brother-in-law at
the bank.
You then execute a debt/equity swap with an associated
general offer so that you get all four cows back, with a
tax exemption for five cows.
PROSPECTS FOR 2002-2003
Enron capitalism
The milk rights of the six cows are transferred via an
intermediary to a Cayman Island company secretly
owned by your chief financial officer who sells the rights
to all seven cows back to your listed corporation.
Your annual report states that your corporation owns
eight cows, with an option on six more.
PROSPECTS FOR 2002-2003
Inflating Growth and Profit
We know that practices similar to the ones in the joke
are widespread.
We know that growth and profits of the corporate sector
are exaggerated.
We don’t know whether these practices have
contaminated the national accounts, but the matter
needs investigating.
PROSPECTS FOR 2002-2003
Bottom Line on Growth and Profit
As dubious accounting practices are revealed and
corrected growth and profit will look less rosy than the
current numbers suggest.
The stock market will correct.
Most likely, sometime during 2002 or 2003, a very large
correction will come.
Stock prices will fall by a large amount.
PROSPECTS FOR 2002-2003
Bottom Line on Prospects for 2002-2003
The stock market will correct.
Consumption expenditure will fall.
A deeper and longer than normal recession will occur.
THE GLOBAL ECONOMY
THE GLOBAL ECONOMY
Global growth outlook for 2002
Consensus US forecast: real GDP will grow between
0.3 percent and 1.8 percent, median at 1.2 percent
Consensus forecasts for rest of advanced economies
EU
1.1
Canada
1.4
Japan
Asia NICs
-1.3
3.6
THE GLOBAL ECONOMY
If the U.S. Economy stumbles
EU and Canada will slow in line with US
Japan will shrink even faster
Asia NICs will slow to a near standstill
INFLATION OUTLOOK
Current inflation numbers suggest low rate through
2002.
Current money supply growth numbers point to higher
inflation rate when economy eventually recovers.
The End