The United States: Economic Outlook

C.R. Charlton

Honoured guests, ladies and gentlemen: On a June week-end in 1915, twenty-three people met by design at a secluded retreat in New York State. Each was a leader in his particular industry. Each had problems. Each was willing to share his problems and his experience with the others. Most important - each recognized the fact that most of the problems did not stem from any particular industry, but, in essence, were common to all.

From that conference, and from that concept, an organization grew over the next seventy years into the prestigious Conference Board. The name of this organization is the simplest thing about it. It is called simply "The Conference Board". It defines itself as "a management information service whose purpose is to help senior business executives and other leaders around the world reach sound decisions on management practice, public policy and economics". It could be described as a vast, world-wide think-tank - a pragmatic think-tank.

It is a catalyst, working through continuing networks of top businessmen, organized as the Board's various research councils, with a staff of more than 350 persons in New York, Ottawa, and Brussels.

The Conference Board's staff of research specialists produce a steady flow of information from six program groups in various fields, such as Corporate Relations, Human Resources, Economic Policy, and so on. In addition, there is a Consumer Research Center, and the Office of the Chief Economist and Senior Vice President who is to be our speaker today.

Mr. Albert T Sommers, after earning a B.A. from Columbia University and a Master's from New York University, joined the Conference Board in 1950. He was appointed Senior Vice President and Chief Economist in 1972. His publications on economic subjects, always pertinent to the problems of the day, would fill a large bookcase. He has received honours and awards from both the business and the academic world, such as the Butler Prize from the New York Association of Business Economists, and the Wollman Distinguished Lecturer Award from Baruch College.

Mr. Sommers produces the well-known and authoritative "Sommers Letter" in which he uses his insight to analyse economic conditions in the United States and elsewhere. He himself epitomizes the three attributes which make the Conference Board so special - independence, objectivity and pragmatism.

Ladies and gentlemen, the Chief Economist and Senior Vice President of the Conference Board, Mr. Albert Sommers.

Albert Sommers

The degree of bewilderment that prevails in the United States is the highest in my long years of experience with this subject. I attribute it to a number of conditions, all of which I will touch upon, but one opening comment with respect to the confusion is called for. Economists, in the course of their professional life, have an opportunity to observe seven or eight or nine business cycle events. Economics being - in some small degree at any rate - a pragmatic, empirical science, one can draw generalizations and inferences from the observation of so many individual episodes. We really do know something about the business cycle. Under ordinary circumstances, if the business cycle is alive and well, we have something to say about the future, one would think. The trouble is, there is no business cycle in the United States now and all that accumulated knowledge is, for the time being, irrelevant.

I will describe in detail what I do think is going on in the United States, but it bears very little resemblance to the historical information that economists have spent their lives accumulating - or at least, the forecasting, practising wing of economics with which I am associated. There is not any cyclical strength in the United States; and for some obvious reasons that I will come to, neither are there any great visible weaknesses. This is by no means a normal exhaustion of a business cycle developing the typical signs of impending recession. Those signs are clear enough: inventory growth suddenly becomes unintended - involuntary - because demand is falling short of an oncoming rate of the supply: capital spending plans undergo sharp revision - not the spending itself of course, because that is a planned activity, but the intentions to spend. A brand new plant created in the last burst of plant equipment outlay in an expansion goes onstream and there is no demand for its output; the result is that everybody revises downward his intentions and curtails his ordering rate as quickly as he can. There is no monetary crisis visible in the United States. That is also typical of the last stages of a business cycle. Typically in such conditions, our Central Bank grows reluctant, credit growth is curtailed, interest rates are rising, a sense of threatened unavailability of credit begins to hang over the system. All of these things taken together - the reversal of attitudes toward need for output, a sense of the dominance of supply over demand, and the rising cost of borrowing - are familiar characteristics of a maturing business cycle.

These signs are simply not present now. This morning's report comes from our Department of Commerce, which is now in a position to be fairly knowledgeable about early 1985 (unlike a month ago, when those of you who follow the figures know that the Commerce Department, with a magnificent combination of courage and stupidity, produced a "flash" estimate before the quarter was even over). Deducing what can be deduced from that sudden blinding insight, we all felt that inventory accumulation was proceeding rather slowly in the United States and the remarks I have made up to now about inventory suggest no involuntary accumulation. The revised estimate of inventory growth in the United States is uncomfortably high and adds a little incremental note to the cautions about what is happening.

But taking the U.S. system as a whole, it is hard to argue that it is about to fall on its face - to use a technical expression for recession. The inventory demand is moderate, but is not in a position to collapse; inventory ratios are really quite conservative. The capital spending has been devoted so heavily to cost reduction and so lightly to expansion of basic capacity, that there is no real overhang of new capacity coming onstream that is not going to meet its demand. Our defence rate, which reacts very sluggishly to what goes on in the Congress (for our purposes today, although not for all purposes, we can practically dismiss the debate over defence spending insofar as 1985 and much of 1986 is concerned) is rising at ten per cent a year in dollars. State and local governments have a new-found prosperity; it has not been there very long and it probably will not last, but for the time being state and local governments are rebuilding the spending rates they tore apart in the early 1980s when things were very bad for them.

... The conclusion is that the U.S. economy is sluggishly making its way through time ...

The whole structure of the system thus lacks any sense of teetering over a brink. The conclusion that all of these fast characterizations would suggest is that the U.S. economy is sluggishly making its way through time. It faces no acceleration. There are differences of opinion on this, particularly in financial markets. I understand many of you are from financial markets and doubtless watch the U.S. market very closely; you know that every day the Wall Street Journal still quotes financial economists who, having predicted recovery and rising interest rates, have for a month been staring with great discomfort at rates that are falling rather than rising. They are still claiming that we are at the very edge of a new acceleration, which will induce caution in the Federal Reserve, and that interest rates will be rising. Just speaking pragmatically, and without even mentioning what my own prior forecast might have been, it does not look that way now. It is very doubtful that this system has in it the strength to re-accelerate to a growth rate that anyone would call cyclical. The issues we confront in the United States are really not business cycle issues. Neither recession nor new acceleration can be documented as a strong, probable outlook. My own impression is that this is a period of slow, sluggish, continuing growth but that the energy that underlies even that modicum of growth is being depleted, and it is not being regenerated.

In our present circumstances, it looks very much as if there is a constant supply of energy or voltage available to this system and that it is being drawn on so that the ensuing energies available are going to be less and less. My reasons for arguing this are unavoidably complicated. Let me spend some time on them.

... This is a kind of haunted prosperity that we are experiencing ...

Beyond the short-term data stream that we can observe about the U.S. economy, there are some enormous paradoxes. This is a kind of haunted prosperity that we are experiencing. I do not think that you will find much objection to that phrase - all of the discussions in the United States carry a very uncertain quality. The origins of the uncertainty, and of the paradoxes, is what I have come to call, out of my vast ignorance of physics, a "new molecule": a policy molecule - I will lay out all my ignorance at once - that was born in the "big bang" of Reaganomics. Something like a new world developed in the United States out of the applications of Reaganomics. Without any real intention to do so, we created a collection of abnormalities in the system, each of which is wildly beyond our ordinary range of observation of these variables, but which, when taken altogether, have a mysterious consistency; they have learned to support each other and therefore continue, even though if we took each one individually we would say that it is doomed by its abnormal relationship with the rest of the system.

I am not a believer in a balanced budget at all. I think some degree of budget deficit is probably a neutral event in a system put together the way the United States is. But the $200 billion deficit is no neutral event; it is an immense fact of life in the United States. It contributes, I believe, to a level of real interest rates in the United States that is a great suppressant, you would think, to activity. The interest rates, in turn, help to support - although they are not the only causal factor by any means - a level of the dollar that is even now probably thirty-five per cent above what would be a tradeable goods par value with our trading partners. That dollar, of course, contributes to a trade deficit that really has to be stared at to be comprehended.

Now, all of these figures are off the scale of experience, but look at what they do. It can be argued that the trade deficit flow - the payoff to settle our international current account - returns to the United States, drawn in part by the high real interest rates that prevail in the United States, and helps to finance the budget deficit which is way up at the beginning of this chain of abnormalities. Moreover, the trade deficit - which is a terrible blow to major American industries - has its nice side too. It absolutely forestalls inflation. If you are asked to depend upon one element of the U.S. system that can reconcile a $200 billion budget deficit with three per cent rate of inflation, the obvious answer is the volume of import competition faced by the goods sector in the United States. The services rate of inflation is six to six and a half per cent; the goods rate of inflation is one per cent. So out of this peculiar evolved molecule, which is four crazy particles accommodating to each other, comes suppressed inflation and sufficient credit availability (for the time being, at any rate) to finance the biggest budget deficit we have ever had, while also providing the credit required for very vigorous private expansion. Its present consequences have to be said to be the kind of gentle, aggregate stimulus that is consistent with the description of the behaviour of the system that I gave you. That is where we are. The energy that is being provided to this system comes out of abnormalities, each one of which we deplore individually; but we find that in aggregate, they are in a way still serving our purposes.

Phrased that way, the question becomes - what is the future of this molecule? Can it be sustained? Again, I have to offer you a very cautionary conclusion. I do not think so. I think it is beginning to decay now, and that means not only that the energy available from it is falling, but that it raises great uncertainties about where the American economy is likely to go in 1985 and 1986.

Apart from the pleasant stimulus provided by a big budget deficit, of course the budget deficit means that the growth rate in U.S. federal debt outstanding is much faster than the growth rate of the economy - right now, about twice as fast. The economy is growing at six and a half per cent in dollars, and the federal debt is growing at about thirteen or fourteen per cent in dollars. The growth of the federal debt produces service costs on the federal debt that go all the way back into the beginning of this process and tend to enlarge the budget deficit itself. There are thus accumulative wheels within wheels, simply in the budget deficit alone.

And the same thing is true of the trade deficit - the current account of which it is a part, and the capital inflow that is said, rather loosely, to represent the return flow from the current account deficit, features a cumulative process at work. The borrowing from abroad, which is what we are doing in settling our international account, is swelling the ownership of U.S. assets abroad. The earnings on those assets of course go abroad - they are not owned by resident Americans - and the investment side of our current account is, accordingly, deteriorating very rapidly. That is the essential fact about our international condition. It is not, as we have announced to the world recently, that somewhere around Valentine's Day we became a debtor nation; that is not a terribly important fact. The important fact is that the

... the investment side of our current account with the rest of the world has already fallen from about $35 billion to somewhere between $10 billion and $15 billion ...

investment side of our current account with the rest of the world has already fallen from about $35 billion (annual rate) to somewhere between $10 billion and $15 billion. The reduction in the earnings on the current account swells the current account deficit, which provides - in fact demands - the return flows of funds that enlarge the ownership of U.S. assets abroad and hence ']iroduces further deterioration in the current account. If the budget deficit were small and the capital inflow were small, these cumulative effects outside the policy molecule would not be very important. But they are not small; they are very, ver-'big. In both cases, I get from them a sense of cumulative instability.

In national accounting the budget deficit is a stimulus to a business system. Almost all economists would agree with that statement. They would also agree that the current-account deficit is a suppressant of the system. In 1983 we had a gorgeous budget deficit stimulus, without much trade depressant. Now the budget deficit is offset about two-thirds by the size of the current-account deficit.

Next in this list of cautions about how long this can go on - the debt requirements to finance even this stable level of activity in the United States are simply phenomenal. In 1984 we had the largest percentage growth of aggregate debt outstanding - of course, this includes the public debt as well as the private debt - of any year

... what is left of economic policy in the United States to confront recession, ifit should actually occur? ...

in the postwar years. It is obviously still going on in 1985. The financing requirements of the Treasury are no smaller. Apparently the U.S. consumer sector now requires an enormous amount of debt incurrence to maintain the ongoing rate of spending. In February, we set a new record for consumer short-term credit extension; this is instalment credit, revolving credit, unsecured personal loans. The aggregate growth of debt in the United States - even setting apart the debt that is being formed in our mergers and acquisitions explosion - is, I believe, ground for caution. Finally, this is a tough time for profits in the United States. My own calculations suggest that it takes about seven and a half per cent growth rate of dollar income in the system as a whole to maintain a stable level of corporate profits. We did not make seven and a half percent in the GNP in the first quarter. The Commerce estimate is 6.7 per cent - a number that, other things being equal, would be suggestive of lower earnings in the first quarter than in the fourth quarter. What we know about earning thus far from company reports certainly supports that conclusion. In addition to all the other characteristics of this situation, we would have to add that it is very hard, under present circumstances and in the presence of that molecule, to generate a rising level of corporate earnings.

A final question: what is left of economic policy in the United States to confront recession, if it should actually occur? Normally, in the course of a vigorous business expansion, a budget deficit shrinks. As you know, in the presence of a progressive income tax, expansions produce a faster growth of federal revenue than of expenditure. In fact, some of the expenditure forms, such as unemployment insurance, actually go down, so that we move toward a balanced budget in the ordinary course of expansion. Keynesians call this "fiscal drag" because it makes the budget deficit, which is a stimulus, smaller and smaller as the expansion goes on. Well, of course, we did not do that this time; the budget deficit stands at $200 billion at a time when, if I am right, much of the energy of the system has already been consumed. Certainly, if we were to experience recession, it would be hard to imagine that fiscal policy would have discretionary opportunities open to it at all. Recession would very quickly raise our budget deficit to $300 billion; it would be a little difficult to legislate tax reductions starting from such a level. Some of the options normally open to fiscal policy have been relinquished in the course of this history.

With respect to monetary policy, some of the same things might be said. It is true that the Federal Reserve's range of options widens very substantially under recession. That is mainly because monetarists, under conditions of deep recession and rapidly rising unemployment, have to keep their thoughts about the growth rate of money to themselves. That gives the Federal Reserve the opportunity to engage in very rapid growth of money. As long as the fear of recession (or actual recession) prevails, the Federal Reserve's options at that end of the spectrum grow rapidly, as they did in the fall of 1982 when the Federal Reserve produced money at twenty per cent annual rate and produced a 700 point drop in interest rates - precisely the reverse of what monetarists would have expected.

If we were to enter recession there is no question in my mind about the dedication of the Federal Reserve to do something about it, and its power to do something about it. However, we would have to remember that it is going to have to overcome a lot of things on the way to achieving much in the way of lower rates. First of all, under conditions of great uncertainty about the American economic outlook, the U.S. dollar would be falling. I consider the recent fall in the dollar in early April as primarily not an interest rate phenomenon, but a subtle alteration, in the eyes of foreigners, of the outlook for endless onward and upward earnings in the United States, including earnings from new fixed-income securities. Secondly, the recession would widen the budget deficit, which means that the Federal Reserve has to first of all take care of the demands of the Treasury, which would be growing even at a time when the falling dollar is discouraging flows into our capital market from the rest of the world. And thirdly, recession always widens credit risk and I think those of you in the financial community would agree with me, that perceived credit risk in the United States has been elevated in the course of the past six months by events in Ohio, and elsewhere, and by events in the government securities markets. The rapid rise in debt itself would suggest that the risk in further lending would be subject to re-appraisal.

My conclusion on the monetary side is that if things really look very testy and nervous, you can count on the U.S. Federal Reserve foregoing its more theoretical considerations, looking squarely at the facts, and making a very substantial - and partially successful - effort to get U.S. interest rates down. But I have to say partially because it would be facing a dollar problem, a federal finance problem and possibly - probably, I would say - a risk appraisal problem on the part of lenders.

I think you will agree that it is not an excessively comfortable view of the United States that I have offered you today. The outcomes in numbers that I carry around in my pocket would look like this for 1985 and 1986: I think the growth rate of the U.S. economy will be about three per cent this year and about two and a half per cent next year; I think the inflation rate - I see no great prospects of massive revival of inflation in the U.S. no matter what the dollar does - will be about three and a half per cent this year and close to four and a half per cent next year. The best market in the United States is going to continue to be capital outlay. In spite of the cautions I have given you, and in spite of the importation rate, we should get a ten per cent increase - these are all current dollars, not corrected for inflation - in capital spending by business this year and seven per cent next year. For profits after tax, doing the accounting on a tax basis the way it enters into our national accounts, I think profits will probably be down slightly this year - maybe three per cent or so - and then perhaps up five per cent next year.

Finally a note on the pattern. I think the U.S. system will grow slowly into the fall. I do not see any reasons to expect more imminent alteration than that. I do think the growth rate will fall sharply in the last quarter of this year, possibly continuing very low in the first quarter of next year. After the first quarter of 1986, I see no reason to expect anything but a modest resumption of what we are experiencing now - that is, sluggish growth - while we work our way out of that decaying policy molecule, toward a better balance of fiscal and monetary policy, toward a lower dollar and, ultimately, toward a better export-import relationship. With regard to interest rates, I do not think they are going to change much either until the fall and then I think they will go down a hundred basis points, pretty much across the board, although somewhat less than that in short rates and more - perhaps 150 points - in long rates. Compatible with the description I gave you there would be an erratic, unclear trend in the dollar for several months, and then a considerable decline late this year and into early 1986.

The description I have given you is really not all that bearish. What it says is that with significant but bearable cost, in terms of sluggish growth and a kind of profitless quasi-prosperity for a couple of years, we can work out of this unique animal that Reaganomics produced in the early 1980s. I do not assess the cost as being any greater than this, but I think it is unwise to assume that we can extricate ourselves from our problem molecule without having to pay some price in a prolonged and uneasy stability, in which earnings are going to be hard to come by.

The appreciation of the audience was expressed by Sydney Hermant, Senior Past President of the Club.