Economic Double-Dip Fears Rising

WASHINGTON:The U.S. recovery seemed a sure bet only a few months ago but a relentless stock market slide and a batch of gloomy data have raised fears a second recession could emerge before the first has faded into memory. Most economists are hopeful the world's richest economy can avoid falling victim to a so-called double-dip recession, in which the economy suffers a renewed contraction after several months of recovery from a downturn.

But the scenario -- barely on the radar screens for most analysts in the early part of this year -- is starting to seem a plausible threat to some. As 2002 began, an economic recovery from the 2001 recession seemed to be in place even though its pace was expected to be modest. Those hopes for a moderate but solid recovery are still voiced by administration and Federal Reserve officials alike, but there is again what President Bush last year called "a warning light" flashing on the economic dashboard.

With the Democrats planning to turn the economy into a talking point in the run-up to the mid-term elections, Bush is likely hoping these warning lights will prove false. Weeks of severe declines in the stock market are threatening to knock the wind out of consumer spending, the stalwart of an economy that has already taken a bruising from sharp cutbacks in business investment.

Further doubts have emerged over the last week as fresh data showed a paltry 1.1 percent advance in gross domestic product in the second quarter as well as weakness in the job market and factory sector. "The odds of the United States slipping back into recession have risen," said economist Nicholas Perna of Perna Associates in Ridgefield, Connecticut. "We're in a very dicey situation." Perna still pegs the odds of a double-dip at only one-third but says it is a concern that cannot be ignored.

Morgan Stanley chief economist Stephen Roach has been a maverick in warning early on of the possibility of a double-dip recession. However, maverick or not, he was also one of the first to predict last year's recession. Roach puts the odds of a double-dip at two-thirds.

His pessimism stems in part from his belief the business-investment slump is only one part of the correction the economy may have to endure to wring out the excesses of the 1990s equity market bubble. The other imbalance was consumer spending, he said. "We went through the biggest financial bubble in modern history," Roach said. "It distorted both business and consumer decision-making."

Roach noted that the saving rate of U.S. households shriveled to nothing during the boom. Last year's recession -- one of the mildest of the post-World War II period -- wasn't enough to push it back up to levels that predated the boom. Recent data will certainly get the attention of Fed officials, he added, although in public they have stayed stoically optimistic. "The last few days of data have really been an eye-opener," Roach said.

No longer rock of stability

The GDP report was among the economic news that surprised economists. In addition to depicting a big drop-off in momentum in the spring quarter, the data included revisions to 2001 that showed the economy contracted last year for three straight quarters instead of the originally reported one quarter.

Although they show that the economy suffered a deeper and more prolonged slump than first thought in 2001, such revisions don't shed light on the immediate outlook for the economy. They have, however, helped shake a sense that the U.S. economy was virtually invincible. In its closely watched monthly employment report, the Labor Department reported Friday that the economy generated only 6,000 jobs in July after a 66,000 increase in June.

The average job growth of 36,000 over the two-month period is a mere fraction of the 150,000 that would be consistent with healthy expansion. Another government report showed that factory orders tumbled 2.4 percent in June -- their biggest drop in seven months. A survey from the Institute for Supply Management, which had in recent months been pointing to a good recovery for the industrial sector, shocked economists with its softness. The ISM factory index fell in July to 50.5 -- a level that just barely indicates expansion -- from 56.2 in June.

Case for fed action not yet made

The latest stack of economic reports prompted investment bank Goldman Sachs to predict in an e-mail to clients that the Fed would chop a hefty three-quarters of a percentage point off U.S. interest rates by the year-end. The bank was more optimistic than Roach that a double-dip could be avoided but it said worries about that prospect would spur the Fed into action. The central bank has already slashed rates to a 40-year low of 1.75 percent following a spree of 11 reductions in 2001.

Most other economists think more evidence of economic weakness or a serious crisis in the financial markets would be required to persuade the Fed to act. Fed policymakers next meet to mull interest rates on Aug. 13. In a Reuters poll Friday, major Wall Street firms assigned odds of 20 percent to the prospect of a double-dip recession. That was up from 13 percent in a survey conducted just over two weeks ago.

"I would say the odds of a double-dip are one in five. They are not zero," said former Fed governor Lyle Gramley, who is with Schwab Washington Research. "Certainly, the Fed is not going to raise rates. If the Fed continues to see signs of weakness, they will act very aggressively."

Gramley said that while the evidence for a rate cut is still not there, if the data continue to disappoint, the Fed has an added reason to act forcefully. Inflation is so low that some economists warn a weak enough period for demand could threaten to touch off deflation, a dangerous self-sustaining trend to falling prices.

© Reuters