[OPE-L:7271] NYTimes.com Article: Where's the Boom?

From: Rakesh Bhandari (rakeshb@stanford.edu)
Date: Tue May 28 2002 - 04:51:22 EDT

Fred may want to comment!

Where's the Boom?

May 28, 2002

Summertime, and the living is iffy. Double-dippers -
economists who believe that the economy will turn down
again - are still a small minority. But we're no longer
hearing the triumphalist predictions of roaring recovery
that were so prevalent back in March.

The funny thing is that there hasn't been much negative
economic news, just an absence of the good news that we
were told to expect. Above all, business investment, whose
plunge led us into this slump, has yet to show any serious
signs of life.

How did so many business economists convince themselves,
and each other, that a great boom was imminent? No doubt it
was the result of wishful thinking on several levels: the
investment community wants to sell stocks, and it also
wants to believe that Republican administrations are good
for business. But I suspect that a big factor in the
premature declarations of victory was a false analogy
between George W. Bush and Ronald Reagan, which led people
to expect that 2002 would play like 1983.

At a superficial level, there are strong parallels between
the second year of the first Reagan administration and the
first year of the second Bush administration. Both men
pushed through large tax cuts and big military buildups;
both inveighed against evil (empire, axis, whatever). And
in 1982, as in 2001, the Fed reversed a previous policy of
raising interest rates to fight inflation, cutting rates
dramatically to fight recession instead. So why shouldn't
it be morning in America all over again?

Because the recessions were very different. In 1982 the
economy was held back by high interest rates; it was ready
to surge forward as soon as the restraints were released.
In 2001 the economy slowed because businesses had
overreached themselves; there are no obvious sources of
pent-up demand.

Perhaps the most striking difference between the Reagan
recession and the Bush recession involves housing. In 1982,
thanks to several years of very high interest rates, home
building was moribund: real residential investment was at a
13-year low, more than 40 percent below its previous peak.
So there was a lot of demand ready to roll as soon as
interest rates fell. In fact, during the first year of the
Reagan recovery residential investment rose 46 percent.
Basically, it was a housing-led boom.

This time, residential investment kept rising through the
recession, thanks to the Fed's interest rate cuts. It's
hard to see a dramatic further increase; if anything,
housing may be in a mild bubble.

So what will lead us into a full-fledged recovery? Beats

The truth is that instead of the vigorous recovery we were
supposed to have by now, our economy seems to be in a state
of suspense, waiting for something to happen. Optimists
think that business investment will, finally, turn up; but
businesses still have lots of excess capacity, and show
little inclination to go on another investment spree.
Pessimists think that consumers, faced with a
still-worsening job picture, will finally stop spending.
But consumers have stayed doggedly optimistic, as if they
really believe in the T-shirt slogan: When the going gets
tough, the tough go shopping.

There is, however, one more wild card, which is also a key
contrast with the Reagan years: the attitude of foreign
investors. During the Reagan recovery overseas investors,
who had previously been down on America, flocked in. This
time we start from a very different position. Foreigners
have been wildly enthusiastic about America for years - an
attitude we have come to count on, because we need $1.2
billion in capital inflows every day to cover our
foreign-trade deficit. What happens as they lose their

One of the largely unreported stories of the last few
months - in the U.S. media, anyway - is the precipitous
decline of foreign confidence in American leadership and
institutions. Enron, aggressive accounting, budget
deficits, steel tariffs, the farm bill, F.B.I. bungling -
all of it adds up, in European minds in particular, to what
Barton Biggs of Morgan Stanley calls a "fall from grace."
Foreign purchases of U.S. stocks, foreign acquisitions of
U.S. companies, are way off.

I don't want to sound like a doomsayer here. But one thing
is clear: Those confident declarations, several months ago,
that our troubles were over look pretty foolish now.


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