GDP indicates trouble ahead for economy

WBy Ken Moritsugu

wASHINGTON (KRT) – Every time the U.S. economy seems to be picking up, it loses momentum.

It grew at a respectable 3.1 percent annual rate this summer, the federal government reported Thursday, but other indicators say the recovery is petering out again this fall.

The problem? Persistently weak business spending on new equipment and facilities. Strong consumer spending has kept the economy afloat, but it’s not enough to sustain a healthy growth rate over time. For that, business also has to spend.

Companies are reluctant to invest for several reasons. Many overbuilt during the 1990s boom, so they already have too much production capacity. Their profits remain weak, so they are focused on cutting costs. Stock market uncertainty and a possible war with Iraq cloud the economic outlook, so many have adopted a wait-and-see attitude.

The Federal Reserve is virtually powerless to deal with this situation. The central bank promotes growth by lowering interest rates, which encourages businesses and consumers to spend by reducing their borrowing costs. The Fed may cut its benchmark short-term interest rate next Wednesday. But lower rates will do little to address the causes of flat business spending.

“The problems really aren’t interest-rate-related,” said Maury Harris, chief U.S. economist for the UBS Warburg investment bank in New York. “They have to do with working off excess capacity. They have a lot to do with the passage of time. Some of these things just take time to heal, and you don’t know if rates will make much of a difference at this point.”

A surge in auto sales created this summer’s economic spurt, pushing up the gross domestic product at a 3.1 percent annual rate from July through September, the Commerce Department said in a quarterly report. The GDP is the total value of all the goods and services produced in the United States.

Auto sales have since slowed, and most forecasters expect the GDP to grow at less than a 2 percent annual pace in the last three months of the year.

It would be the second time this year that the economy has cooled off after showing signs of reviving. In the first three months of the year, the GDP grew at a 5 percent annual rate, only to slow to a 1.3 percent pace in the April to June quarter.

With the recovery still on an unsure footing, the Fed has kept its benchmark short-term interest rate at 1.75 percent all year, an unusually low level.

“That’s the quandary the Fed finds itself in,” said Greg McBride, a financial analyst at Bankrate.com, a Web site based in North Palm Beach, Fla., that tracks consumer interest rates. “Rates are sufficiently low enough to spur economic growth, yet that growth hasn’t materialized.”

Firms have become even more cautious about investment spending in the past three months, according to a survey released Thursday by the National Association for Business Economics, a group that represents economic analysts.

The percentage of firms that expect to cut investments in the next 12 months rose to 26 percent from 16 percent in July. Those that expect to increase investments ticked up from 38 percent to 39 percent.

One factor is overcapacity. Companies are using only 75.9 percent of their production capacity. Historically, they have not begun to invest until capacity utilization rates reached at least 78 percent.

The rate steadily improved from 75 percent in February to 76.3 percent in July, but slipped back in August and September.

Corporate profits have stopped falling, but they aren’t growing fast enough to spur a new round of investment.

“It seems like we’re moving in the right direction, but we’re not really there yet,” said Michael Moran, chief economist for Daiwa Securities America in New York.

Business investment turned slightly positive in Thursday’s GDP report for the first time in two years, rising at a 0.6 percent annual rate. Within that category, purchases of equipment and software rose 6.5 percent, while commercial construction slumped 16 percent.

The gain appears to have been short-lived, as other economic reports indicate that companies retrenched in September amid a plunging stock market and growing talk of war with Iraq.

Business spending will pick up eventually, but exactly when is difficult to say. Many analysts think it will be spring at the earliest. For the overall economy, that means several more months of sluggish growth at best. That could push unemployment above 6 percent by next summer.

In a worst-case scenario, consumer-spending growth could slow so sharply that it sends the economy into a recession.

Consumer spending has been growing faster than consumer income, a situation that analysts say can’t continue indefinitely. Also, consumer confidence fell last month to the lowest level in nine years.

A surprisingly strong housing market has offset much of the economy’s weakness, but economists expect home sales to decline somewhat next year.

Most analysts think the economy is headed for a very slow recovery rather than a recession. But with growth slumping, the Fed may decide to lower its benchmark interest rate Wednesday as an “insurance policy” against the outside risk of recession.

A rate cut could put a little more cash in the pockets of consumers, encouraging them to keep their wallets open a little longer amid the agonizing wait for a revival in business spending.

A reduction in the Fed rate would lead to lower rates on home equity loans and lines of credit, on auto loans and on unpaid balances on credit cards.

Most mortgages wouldn’t be affected much. Because they are long-term loans, they don’t closely track the Fed rate, which is the interest charged on overnight loans between banks.