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April 1, 2001

Gathering Storm Clouds

By Kathryn M. Welling

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  • Gathering Storm Clouds

David Levy, who with his father, S. Jay Levy, publishes the Levy Institute Forecast, is not the sort of economist who waffles. Yes, he was early in forecasting that the economy would stumble. But now, while most dismal scientists still cling to the fence, his call is dismally unhedged: "The U.S. economy is in the early stages of a recession that will prove unusually severe and long."

The reason: as David runs through all the many and various factors that are affecting the business climate, from labor trends to the financial and political environment, he just can't come up with any reasonable scenarios that will produce a pick-up in profits and the economy, at least until next year.

Hit Bottom

In fact, he doesn't see this recession hitting even its initial bottom until early in 02. "Not sooner, not with inventories having to go into liquidation and capital spending developing downward momentum. Not with consumers retrenching, especially given that they've been so awfully aggressive. Whatever the aggressive spending scale is, if it's 1-10, they've been at about a 27."

That the financial community is in denial, he shrugs, is nothing new. "Once business activity begins to decline it often takes months for most people to recognize the decline- and then become convinced that it will last long enough to qualify as a recession."

David explains that the Levy Institute's forecast is based on their assessment of the interaction between what they've been calling four economic storms that have been brewing on top of the staggering mountain of private debt the U.S. has been growing - at the same time our government has been celebrating the "retirement" of the public debt. The first of those storms encompasses the more familiar cyclical issues: "Too many inventories, over-capacity developing, cycles in consumer spending."

More disturbing, David says, are the three other storms: the stock market's vanishing wealth effect, the dubious health of the credit markets and international instability.

Wealth Effect

The decline in the wealth effect, David opines, "is increasingly starting to effect people. "My guess is that, it, more than anything else, is behind consumer confidence coming down. That combined with the sense that the economy is weakening. One of the reasons it has happened kind of all at once is that, at the end of the year, people start to look at their tax situations. It's a forced time of reckoning where you really are. It makes it harder to say, "Well, I just try not to look too hard and hope it'll come back."

"Given the extraordinary levels of consumer spending we've seen, there's a very strong empirical and also common sense case that if the market fails to recover (and I don't expect any sustained recovery), then we're going to see much, much deeper reactions by consumers as time passes. And I mean in a matter of months rather than in a matter of years."