For decades, the conventional wisdom has been that voters ultimately vote their pocketbooks when choosing a president. Never was this more apparent than in 1992, when Bill Clinton's mantra was, "It's the economy, stupid." Yet, oddly, this year, Al Gore and George W. Bush seem to be all but ignoring the economy. Both seem to take for granted that it is doing well and will continue to do so for the foreseeable future. However, there are growing indicators that the end may be in sight for the longest economic expansion on record. Whomever is elected president in November is increasingly likely to find himself dealing with a recession soon after taking office.
Although most economists agree that the growth and spread of high technology and the Internet have raised the long-run growth potential of the U.S. economy, this rise in structural growth is still subject to cyclical ups and downs. In other words, there is no reason to believe that the business cycle has been repealed. Although every recession is different, there are a number of factors currently present that in the past have helped to trigger economic downturns.
The recession that ran from November 1973 to March 1975 was fundamentally driven by higher oil prices. The price of imported oil tripled between 1973 and 1974. Now, energy prices are rising again, with the price of oil being about three times higher today than it was early last year. Fortunately, this oil price shock comes at a time when inflation is much lower than it was 25 years ago. With Federal Reserve policy steadily tightening since the middle of 1999, there is less danger that higher oil prices will trigger an inflationary episode or further Fed tightening. But it also means that higher energy prices must be absorbed by pushing down the prices of other commodities.
Economist Victor Canto of La Jolla Economics believes that the Fed is now operating on a "price rule" and will not allow the overall price level to rise. Since the general price level is just the average of all prices throughout the economy, this means that if one key price is forced up -- in this case, oil -- then for the average to remain unchanged, other prices must fall.
The decline in industrial commodities, such as lumber and metals, has already plunged some industries into a de facto recession, according to economist Susan Hickok of Prudential Economics. These are construction, lumber, textiles, apparel and leather. And she thinks the following industries are on the brink of recession: primary and fabricated metals, motor vehicles, food processing, paper and metal mining.
Hickok believes that the overall gross domestic product figures are disguising the slowdown in the industrial sector because of the way growth is measured in the high-tech sector. "Any increase in the speed or power of computers," she notes, "is classified as 'growth.' Such technological improvements mean that even if there is no physical increase in the economy's output, real GDP still registers a positive advance."
But the high-tech sector cannot grow in isolation from industry. Indeed, much of the growth in high-tech last year came from traditional businesses buying new computers to deal with the Y2K problem embedded in their old computers. This also had the effect of giving short-term profits to high-tech companies that had to fall once the Y2K problem ended. The slowdown in high-tech this year, therefore, is partly a return to trend from an abnormally high base of growth and profits last year, Canto believes. This means that high-tech stocks should rebound next year. But in the meantime, the one-third fall in the tech-heavy NASDAQ market this year is likely to have repercussions of its own.
The fall in financial wealth and income for workers accustomed to receiving much of their compensation in stock options is already depressing consumption, according to economist Stephen Roach of Morgan Stanley Dean Witter. He warns of a "negative wealth effect" that is "a clear risk factor for the world in 2001." Although Roach is not yet predicting a recession, he believes that the risks have risen substantially and that it would not take much to push the economy over the edge.
Other economists are also ratcheting up the recession odds. Economist Alan Reynolds of the Hudson Institute puts the chances of a recession at 60 percent next year. He cites the lagged effect of a tight Fed policy and high real interest rates. Reynolds also notes that growth remains weak in Japan and is slowing in Europe. Together with a strong dollar, which makes U.S. exports more expensive, we can therefore expect a further rise in the trade deficit, which reduces GDP dollar-for-dollar.
Economist Brian Wesbury of Griffin, Kubik, Stephens and Thompson puts the odds of a recession at one-in-three next year. He notes that the federal budget surplus almost doubled from $124 billion in 1999 to $232 billion in 2000, and will double again by 2006, according to the Congressional Budget Office. Since surpluses are viewed by most economists as having a depressing effect on growth in the short-term, Wesbury thinks that Bush's tax cut may be our last line of defense against a recession.
It is too soon to say that a recession is definitely in the cards. But the early signs are there and ought to be an issue in the presidential campaign. Voters may later wish that the candidates had addressed it before casting their votes.