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Volume CXXXII, Number 8 |
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A fork in the road
TIMOTHY J. RIEMER
COLUMNIST
The past week's economic news seem to indicate that the economy is approaching a fork in the road that will determine whether it continues to recover or whether it loses the little steam that it has gained and falters once again. The economy appears to be coming to a screeching halt. In the economic news for October that has been released since Tuesday, there has been only one positive economic indicator. The growth rate of the service sector decreased. Factory orders fell 2.3 percent and manufacturing declined. The unemployment went back up one tenth of a percent to 5.7 percent. The only positive indicator about the economy from October is that its growth rate, or annualized gross domestic product surged 3.1 percent from 1.3 percent in the previous quarter. This rapid boost in GDP, however, was driven by strong sales in the auto industry. Without the auto industry, the economy only grew by 1.5 percent, a rather daunting figure that suggests that the current growth rate might not be able to last. Even with this strong growth rate, the economy looks as if it might enter the red once again.
In light of all these negative indicators, the Federal Reserve Board decided in their Wednesday meeting to cut interest rates 50 basis points, or half a percentage point to 1.25 percent. The vote to cut the interest rate was the first unanimous vote by the Fed in almost a year. This seems to indicate that the members of the Fed Board feel that the economic recovery might stall. The Fed also changed their risk assessment stating that the risks that they saw for the economy were not only weakness of the economy but also inflation as they lowered interest to below the inflation rate of 1.8 percent. This seems to worry many people, because the last time the Fed cut rates to below the inflation, we saw the high inflation rates of the 1970s. However, this, in my opinion, raises a bigger concern than inflation. This seems to indicate that the Fed might be trying to curtail the possibility of deflation, which is becoming an increasing concern as prices fall. Deflation is one of the economic crises that have kept the Japanese economy in stagnation for more than a decade now. Many signs indicate that prices will continue to drop. The increase in the unemployment rate and the 0.4 percent decrease in consumer spending are only two of the factors that point to deflation. These factors suggest that consumers will not be able to purchase goods and services as they do not have the money. The lack of demand, will in return drive down prices to the point where consumers can once again afford goods and services.
The most interesting aspect surrounding all of this news is the performance of the stock market. In the past five days of trading, the Dow has ended up each day. Since the close on October 31, the Dow has increased 373.94 points to close at 8771.01 on Wednesday. Since October 9, when the Dow reached its lowest point in several years at 7286.27, the Dow has risen 1484.74 points. In this whirlwind of bearish news on the economy, this, in my opinion, is the light at the end of the tunnel. Changes in the market usually precede changes in the overall economy. The strength of the market, despite weak economic news, could mean that the economy is gearing towards a solid recovery. This relationship between market changes and changes in the economy, however, is not very strong and is not a solid sign of future improvement in the economy but the market does appear to be recovering, and this is always good. In this economy, with business investment being one of the weakest parts of the economy and consumer spending, although declining, having been a strong part of the economy during these tough times, the turnaround in the markets would, in my mind, lead to an economic recovery riding on the coattails of increased business investment. The turnaround in the markets would lead to an increase in business investment because the market turnaround means that firms would have more money, which in turn means they can spend more.
This potential market turnaround could be hurt by economic problems stifling investor confidence. If we run into further economic problems before the economy truly recovers, then this might make the investor very wary about investing his or her money in the markets amid economic uncertainty. The economy and the markets are truly at a fork in the road. The economy and markets could go just as easily go into another recession as it could recover.