IP: Where's the Boom?

[Dave Farber <dave () farber net>]

Where's the Boom?
By PAUL KRUGMAN

 ummertime, 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 me. 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 enthusiasm? 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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