It is becoming increasingly obvious that the U.S. economy will not perform any better in 2003 than it did in 2002. For manufacturing executives and everyone else that means inflation-adjusted GDP will grow just 2.5% this year, profits will be flat, the stock market won't improve, payroll employment won't increase and the overall U.S. unemployment rate will rise. Although interest rates will remain near their current low levels, real recovery for the U.S. economy won't come until 2004. By then, three factors -- currency exchange rates, higher capital spending and inventory building -- will be combining to boost real growth to about 4%.
- The lower value of the U.S. dollar relative to other major currencies will begin to have a significant stimulus on net exports later this year. While the dollar has already fallen sharply, there is usually a lag of about one year before this is translated into major gains in net exports.
- Capital spending will begin to improve later this year, a result of less excess capacity, the renewed need to purchase more technologically advanced machinery and the lagged impact of unusually low interest rates.
- As capital spending and net exports start to improve, inventory investment will rise rapidly because currently stocks are at rock-bottom levels.
What about consumer spending? Consumer spending isn't on this list of initial growth factors because consumers will continue to spend everything they earn. True, when employment improves, so will consumption, but only proportionately. Indeed, once interest rates start to rise -- and they will rise -- the part of consumer spending that currently is being fueled by "zero-interest" motor-vehicle loans and home equity loans will wither on the vine. A significantly better performing stock market in 2004 is not in the forecast either. Following a flat 2003, it will not improve very much in 2004. The reason: Next year's rise in real growth will be accompanied by an increase in interest rates that will dampen any gain in stock prices. After all, the Federal funds rate cannot remain at 1.25% once real growth moves above 3% and the overall unemployment rate starts to decline. This scenario is not greatly different from what happened a decade ago. The U.S. economy started to improve rapidly in 1993, but stock prices did not rise despite higher profit margins because some investors were worried about higher interest rates. Indeed, interest rates did rise in 1994. When interest rates then declined in 1995 and rapid growth resumed, the stock market finally took off. If the same scenario plays out this time, another bull market is not likely to start until 2005. By that time, I assume the price-earnings (P/E) ratio will have declined to a "normal" 15. Based on expected earnings, interest rates, inflation and the federal budget deficit ratio, the P/E ratio is still above its equilibrium value. This forecast has very little to do with war jitters or the aftermath of a military action and much more to do with the previously overvalued U.S. dollar and excess capacity. After the victory at the Persian Gulf in 1991, real GDP rose at an annual rate of only 2.5% during the following six calendar quarters, and the unemployment rate rose a full percentage point, from 6.6% to 7.6%. So even if a war is successful, it will not give much of a boost to the economy. Any euphoria is likely to be short-lived, particularly in view of repeated terrorist threats once hostilities cease.
Michael K. Evans is chief economist for American Economics Group, Washington, D.C., and president of the Evans Group, an economics consulting firm in Boca Raton, Fla.