Less Than A Bubble,

More Than A Burst

Randall Dodd
Financial Policy Forum
EPI Brownbag
November 1, 2002
• COINCIDENT INDICATOR.
• Payroll employment picks up the turning point like it did in 1990. Although in the present case the
turning point was not nearly so sharply defined.

Employment
134000
132000
130000
128000
126000
124000
122000
120000
118000
116000
114000
112000
110000
108000
106000
104000
102000
1989.01
1989.07
1990.01
1990.07
1991.01
1991.07
1992.01
1992.07
1993.01
1993.07
1994.01
1994.07
1995.01
1995.07
1996.01
1996.07
1997.01
1997.07
1998.01
1998.07
1999.01
1999.07
2000.01
2000.07
2001.01
2001.07
2002.01
2002.07
• COINCIDENT INDICATOR.
• Industrial production picks up the turning point early in this cycle, but not far from the three month lag
in the prior recession.

152
Industrial Production
150
148
146
144
142
140
138
136
134
132
130
128
126
124
122
120
118
116
114
112
110
108
106
104
102
100
98
96
94
92
90
88
• COINCIDENT INDICATOR.
• Total business sales (retail, wholesale and manufacturers) picks up the turning point, and does so in a
sharply defined manner. Figures are seasonally adjusted but not adjusted for inflation.

1200000 Total Business Sales

1150000

1100000

1050000

1000000

950000

900000

850000

800000
1992.01

1993.01
1993.07
1994.01

1995.07

1996.07
1997.01
1997.07
1998.01

1999.01
1999.07

2000.07
2001.01
2001.07
2002.01
1992.07

1994.07
1995.01

1996.01

1998.07

2000.01

2002.07
• COINCIDENT INDICATOR.
• Crude Oil prices is not a typical coincident economic indicator but it worth a look. The price hike
occurred after the prior recession started (note bold vertical lines in chart) and the hike started prior to
the current one. The high prices nonetheless acted as a drag in both.

WTI Oil
36
34
32
30
28
26
24
22
20
18
16
14
12
10
1989.01
1989.07
1990.01
1990.07

1991.07
1992.01
1992.07
1993.01
1993.07

1995.07
1996.01
1996.07
1997.01
1997.07
1998.01
1998.07
1999.01
1999.07
2000.01
2000.07
1991.01

1994.01
1994.07
1995.01
• LEADING INDICATOR.
• New orders for investment goods picks up the turning point almost six months early, and does so in a
sharply defined manner. Figures are seasonally adjusted but not adjusted for inflation.

70000 New Orders: Capital Goods

65000

60000

55000

50000

45000

40000

35000

30000
1992.01

1993.01

1994.01
1994.07

1998.01
1998.07
1999.01
1999.07
1992.07

1993.07

1995.01
1995.07
1996.01
1996.07
1997.01
1997.07

2000.01
2000.07
2001.01
2001.07
2002.01
2002.07
• Unlike in prior recession, real consumption has not declined. The pace of growth has slowed in
comparison to the last half of the 1990s. If the Wealth Effect has played a role, it has not been strong
enough to turn consumption negative. (annual rate of % change from quarter to next)

8% GDP $96
7%
6%
5%
4%
3%
2%
1%
0%
89.1
89.3
90.1
90.3
91.1
91.3
92.1

93.1
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98.1

99.3
00.1
00.3
01.1
01.3
02.1
02.3
92.3

98.3
99.1
-1%
-2%
-3%
-4%
• Unlike in prior recession, real consumption has not declined. The pace of growth has slowed in
comparison to the last half of the 1990s. If the Wealth Effect has played a role, it has not been strong
enough to turn consumption negative. (Amount change from quarter to quarter.)

7% Consumption $96
6%
5%
4%
3% v

2%
1%
0%
90.1
90.3

92.1

93.1

96.1
96.3

97.3
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92.3

93.3
94.1
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95.3

97.1

02.3
-1%
-2%
-3%
-4%
• Real Weekly Wages Stay Up.
• They don’t continue their progression upwards, but by staying up they sustain consumption.

285 520

280
W eekly Wages 500
480
275 460
440
270 420

265 400
380
260 360
340
255
320
250 300
1991.01
1991.07
1992.01
1992.07
1993.01
1993.07
1994.01
1994.07
1995.01
1995.07
1996.01
1996.07
1997.01
1997.07
1998.01
1998.07
1999.01
1999.07
2000.01
2000.07
2001.01
2001.07
2002.01
2002.07
• Wealth is likely to have dampened consumption spending, but not much. It appears to have had an
arresting impact on real retail sales. Retail sales make up 50% of Consumption, health care and
housing make up another about 15% each. The remaining 20% is an unknown for me.

Retail Sales ($82)

175000
170000
165000
160000
155000
150000
145000 Stock market peak

140000
135000
130000
125000
120000
115000
1992.01

1994.07
1992.07
1993.01
1993.07
1994.01

1995.01
1995.07
1996.01
1996.07
1997.01
1997.07
1998.01
1998.07
1999.01
1999.07
2000.01
2000.07
2001.01
2001.07
2002.01
2002.07
• Household Debt -- nominal value, SA
• Consumer debt, in nominal terms, has risen throughout the recession (unlike the decline in non-
revolving debt during the prior recession). Growth in revolving, i.e. credit card, debt has flattened
off considerably only to begin rising again in the last few months.

1,100,000 Consumer Debt

1,000,000 Revol
900,000 Non-Rev

800,000
700,000
600,000
500,000
400,000
300,000
200,000
1994.07

2000.01
1990.01
1990.07
1991.01
1991.07
1992.01
1992.07
1993.01
1993.07
1994.01

1995.01
1995.07
1996.01
1996.07
1997.01
1997.07
1998.01
1998.07
1999.01
1999.07

2000.07
2001.01
2001.07
2002.01
2002.07
Auto Debt - rate and terms
• Rates have fallen substantially since the start of the recession, and the terms of credit have also eased
at maturity has risen and the loan/value has jumped up. (At finance companies, terms are not as
favorable at banks.)

100 Auto Debt 14

90 12
10
80
8
70 Maturity
Loan/Value 6
60 Rate
4
50 2

40 0
1990.01

1991.01

1992.01
1992.07
1993.01
1993.07
1994.01
1994.07
1995.01

1996.01
1996.07
1997.01
1997.07
1998.01
1998.07

1999.07

2000.07
2001.01
2001.07
2002.01
2002.07
1990.07

1991.07

1995.07

1999.01

2000.01
• Household Debt - Mortgage Debt
• Total home mortgage debt owed by households has risen rapidly and has not been affected by the
recession. Home Equity debt, which is a component of total household mortgage debt, has risen
far more rapidly since early 1999 and the torrid pace has slackened only slightly since2000:III.

7,000,000 Mortgage Debt 300,000

6,500,000 280,000
6,000,000 260,000

5,500,000 240,000
5,000,000 Mortgage 220,000

4,500,000 Hom e Eq 200,000

4,000,000 180,000
3,500,000 160,000

3,000,000 140,000
2,500,000 120,000
2,000,000 100,000
90.4
91.2
91.4

92.4
93.2
93.4
94.2

95.2
95.4
96.2
96.4

97.4
98.2
98.4
99.2

00.2
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01.2
01.4
92.2

94.4

97.2

99.4

02.2
 •

4
5
6
7
8
9
10
11
12
1987.01
1987.07 of 2000.
1988.01
1988.07
1989.01
1989.07
1990.01
1990.07
1991.01
1991.07
1992.01
1992.07
1993.01
1993.07
Mortgage Interest Rates.

1994.01
1994.07
1995.01
1995.07
1996.01
1996.07
Mortgage Rates

1997.01
1997.07
1998.01
1998.07
1999.01
1999.07
2000.01
2000.07
2001.01
2001.07
2002.01
Rates have fallen substantially since the start of the recession, after rising through 1999 and first half

2002.07
• While the amount of total household debt and consumer debt have increased greatly, the cost of debt
service (principle and interest) as a percentage of disposable household income has NOT. In fact
current ratios are lower than in the mid-1980s and no more than 2% points higher than the beginning
of the decade. This cannot explain much of the slower pace of consumer spending.

15 Debt Service Burden

14
13
12
11
10
9
8
7
6 Total Debt
5 Cs m Debt
4
80.1
81.1
82.1
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86.1

88.1
89.1

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98.1
99.1

02.1
87.1

90.1

97.1

00.1
01.1
• Delinquencies at banks are not high, especially in comparison to the last downturn.
• Delinquencies at banks (where payments are 30 days past due) are measured as the
percentage of debt written-off and expressed as an annual rate for each month. This does not
include debt at non-bank financial institutions.

8
Debt Delinquencies
Real Es tatel
7 Credit Cards
Total Cs m
C&I
6 Loans +Leas es

1
87.1

88.1

91.1

92.1

93.1

94.1

95.1

96.1

97.1

99.1

00.1

01.1

02.1
89.1

90.1

98.1
• Although delinquencies are not high, especially in comparison to the last downturn, the amount of
charge-offs is rising.

• Charge-offs are measured as the percentage of debt written-off and expressed as an annual rate for
each month.

9
Charge-Offs
Real Es tate
8 Credit Cards
Total Cs m
7 C&I
Loans +Leas es
6
5

4
3
2

1
0
85.1

86.1

87.1

88.1

89.1

90.1

91.1

92.1

93.1

94.1

95.1

96.1

97.1

98.1

99.1

00.1

01.1

02.1
 Wealth Effect
• Most losses likely amongst richest 9%. In 1998, the SCF showed that 80% of
total unrealized capital gains were amongst the top 9%.
• SCF (1998) showed that stock ownership concentrated amongst wealthiest 10%
of households (82.2%) and top 1% (42.8%). Bottom 89% held less than 18%.
• Both the large cap S&P500 and the NASDQ Composite peaked about the same time in March of 2000.
This differ in how they have fallen before and after September 11th and before and after October 16th
of 2002 (hereafter known as Enron Day. The NASDQ Composite fell 66% from its peak by September
10th, then rose 9% by Enron Day and has then fell again by 35% by October 9th 2002. The S&P500
fell 28% from its peak to September 10th, then rose 6% by Enron Day and then fell 29% by Oct. 9th.

1500 5000
1400 Equity Indices
1300 4500
1200 4000
1100 S&P500
NASDQ Comp 3500
1000
900 3000
800
2500
700
600 2000
500 1500
400
300 1000
200 500
100
1992.05

1994.09
1990.01

1991.03

1993.07

1995.11

1997.01

1998.03

1999.05

2000.07

2001.09
0 0
• Margin Debt
• The chart shows that the use of margin debt (debt/market capitalization) declined sharply starting in 1986
as the bull market gathered steam. Margin debt flattened out in 1991, was up and down a bit until 1995,
while the bull market charged onwards. When margin use rose decidedly in 1998 it did so as the market
rose to its peak in March 2000. They fell together, then margin use surged and then fell back again.
20,000,000 2.5%

18,000,000

16,000,000 2.0%

14,000,000

12,000,000 1.5%

10,000,000

8,000,000 1.0%

6,000,000
Margin Debt
4,000,000 Market Cap 0.5%
Value/Debt
2,000,000

0 0.0%
55.1
56.1
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58.1
60.1

63.1
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01.1
02.1
52.1
53.1
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59.1
61.1
62.1
64.1

74.1
75.1
76.1
77.1
78.1

84.1
85.1
86.1
87.1
88.1

96.1

00.1
• Margin Debt -- smaller interval
• The chart shows that the use of margin debt (debt/market capitalization) declined sharply starting in 1986
as the bull market gathered steam. Margin debt flattened out in 1991, was up and down a bit until 1995,
while the bull market charged onwards. When margin use rose decidedly in 1998 it did so as the market
rose to its peak in March 2000. They fell together, then margin use surged and then fell back again.
20,000,000 2.5%
18,000,000

16,000,000 2.0%
14,000,000

12,000,000 1.5%
10,000,000

8,000,000 Margin Debt 1.0%

Market Cap
6,000,000
Value/Debt
4,000,000 0.5%
2,000,000

0 0.0%
82.1

86.1

88.1

93.1

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99.1
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Stock Prices: The Bull Charge
• Two Reasons
• First -- fundamentals
• Low inflation, low interest rates
• Low volatility of GDP
• Long-wave of tech innovation
• Longest expansion in US history
• Second -- financial
• Higher ‘plowback’ rate п
• Higher firm specific ROE

• Problems
• Herding - although with some rational basis,
and poor assessment of risk
• Difficult to price new technologies
• Manipulation from skewed market analysis
• Manipulation from false reports on market
Stock Prices: The Bear Dance
• Two Stages
• First -- March 2000 to Oct 2001
• Fed raised rates starting Spring ‘99
• Rising market volatility
• Lowered E1 forecast
• First - part two
• Sharp fall in long-term E forecast
• Second -- Oct. 2001 to Oct 2002
• Despite Fed lowering rates
• More market volatility
• Worse earnings forecasts
• Sharp, negative Enron “corrections”
• Some firms lower п
• This is a different picture of the role of government expenditure than you might expect. It has become
a source of volatility to the U.S. economy! It has has a positive net effect although its magnitude is
modest. Non-defense federal spending is also volatile, and has been negative twice since the current
downturn.

45 Government $96

40 Total Fed Non-Def

35
30
25
20
15
10
5
0
93.1
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95.3

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-5
-10
-15
-20
• Note that S&L, while presumed to be more cyclical, has been less volatile from quarter to quarter.
Defense spending has been much more volatile from quarter to quarter, and over this period it has been
counter-cyclical even if the reason for the changes has not been primarily macroeconomic
management.

25 Government $96

20 Def S&L

15
10
5
0
90.1

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-5
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-25
• The role of real net exports has been novel. Usually real imports decline during a downturn due to the
fall income and overall consumption and investment spending. This occurred in both the present and
prior downturns. This time this was matched with a great degree of correlation by a downturn in
exports! This is unusually and suggests that the U.S. economy is more positively correlated with
economies in the rest of the world. (Chained ‘96 dollars, and net exports are on right axis.)

1600 International Trade 100

1500 50
1400 0
1300
-50
-100
1200 -150
1100 Exports -200
Imports
1000 Net Exports -250
900 -300
800
-350
-400
700 -450
600 -500
500 -550
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• The Strong Dollar.
• The dollar appreciated prior to the start of the recession and continued up until 2002. Since then it has
depreciated against the Euro, Sterling and Yen

Exchange Rates
170
160
150
140
130
120
110
100
90
80
70 UK Japan Euro-DM
60
50
1990.01

1992.01
1992.07
1993.01

1994.07
1995.01

1996.07
1997.01

1999.01

2000.01
2000.07

2002.01
2002.07
1990.07
1991.01
1991.07

1993.07
1994.01

1995.07
1996.01

1997.07
1998.01
1998.07

1999.07

2001.01
2001.07
• The role of Investment appears to play a more important role. While investment in residential
structures has played a persistent positive role, that for non-residential structures has turned down and
continues to decline. More importantly, investment in equipment turned sharply downward, and is
only slowly recovering.

1100 Investment $96

1000
Struct
900 Equip
800 Res
700
600
500
400
300
200
100
90.1
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• The composition of the changes in investment is telling. Growth is entirely attributed to Information
Processing while that for Trans and Industrial continues to decline. (Again chained ‘96 dollars.)

600 Equipment Investment

550
Info Process ing
500
Indus trial
450
Trans port
400
350
300
250
200
150
100
50
90.1

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• Information processing is comprised of computers, software and other (including communications,
instruments, office equipment and photographic equipment). Of these, software declined the least and
computers rebounded most quickly. (Again chained ‘96 dollars.)

Info Processing
280
Com puter
240 Software
Other
200
160
120
80
40
0
90.1

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• Change in Inventories.
• Inventories took a sharp drop, much larger than in the prior recession. Orthodox Keynesians take
note. (Changes from quarter to next in chained 1996 dollars)

120 Inventories $96

100
80
60
40
20
0
90.1
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02.1
-20
-40
-60
-80
-100
• Change in Inventories.
• Not just the prior recession, but all prior recessions in the post-war era.

120 Inventories $96

100

80

60

40
20
0
47.2

50.3

63.3

66.4

79.4

83.1

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02.3
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-20

-40
-60

-80

-100
Inventories and Inventory Sales Ratio.
• Inventory sales ratio rose just as the stock market fell and real retail sales flattened out. The drop in
sales pushed up I/S ratio initially before liquidation of inventories (which is shown beginning in early
2001) turned ratio downward.

1200000 Inventories 1.6

1150000
1.6
1100000
1.5
1050000

1000000 1.5

950000
1.4
900000
1.4
850000

800000 1.3
1992.01
1992.07
1993.01
1993.07
1994.01
1994.07

1995.07
1996.01
1996.07
1997.01

1998.01
1998.07
1999.01
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2000.07
2001.01
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1995.01

1997.07

2000.01

2002.01
2002.07
• SUMMARY: CAUSES
• Not just any one factor. Over determined as Freud would say, or as the great wit and
sage, “we made too many wrong mistakes.”
• Three themes:
• Market Crash:
– Fed raised interest rates and deflated market
– Virtuous tech cycle came to an end: part stumble, part exhaustion and part hitting of wall
– One word, “Enron”
• Rest Of World slowed
– U.S. is more correlated with ROW and especially during downturn
– US dollar stayed up
• Investment Crunch
– Tech boom stumbled, played out
– Higher interest rates
– High dollar
– Higher capital costs
– Drought of new capital
• PROSPECTS
• CONSUMPTION
– depends on employment and wages
– further household debt accumulation less likely, especially if housing prices fall. Maybe more
retailer credits.
– Wealth effect NOT likely to turn positive in near term.
• INVESTMENT
– Inventories show little gain even after liquidation
– Equipment is coming back, though mostly computers and other info processing. Industrial
and transportation and “other” is still slack.
– Structures are smaller in magnitude but still declining. This may need to wait upon new
business start-ups. Market rebound may help.
– Residential has not slowed and thus not likely to speed up and therefore not likely to
contribute to turn-around and rebound.
• GOVERNMENT
– CR for Fed spending, eventually national security spending will surge.
– S&L is pro-cyclical, but not in a leading way.
• NET EXPORTS
– Misery loves company. US growth increasingly correlated with ROW and thus will find
downturn is aggravated and upturn is awaited.
– Export component did show some growth in 2002:III.
– US dollar remains strong, though may drop with another Fed ease.
• POLICY PROPOSALS
• MINIMUM WAGES
– will help consumption
• INVESTMENT TAX CREDITS
– Bigger bang for buck, and targeted to sector that has turned down the most.
• LOWER INTEREST RATES
– Fed can lower rates to help stock market, lower cost of capital and possibly ease drought on
new capital
• REAL REFORM OF FINANCIAL MARKETS
– gets financial markets working again. True for energy markets as well as stock markets.
• RENEW GLOBAL GROWTH
– reform IMF policies towards expansion
– resolve LDC debt problems
– reform Japanese financial system
– reform EU macropolicy to eliminate downward bias
• ROLL-OUT BROADBAND
– Auction spectrum in order to free resources for further innovation.