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Is Another Economic Slide Around the Corner?

We all have seen brighter days of the U.S. economy than the present (not to mention, on a personal level, those of the current labor market).

There is substantial hope that brighter days are to come. In reality, there is a possibility of a longer than expected recuperation period and a deeper economic crisis in the U.S.. How probable is this scenario? Why is it something we should consider as relevant? And is our school helping us address a possible future more complex than our present?

During the bubble of the late 90’s most of us lived convinced that the U.S. economy had achieved unprecedented gains, that it could grow at very high rates. No need to get into the details, but people lived convinced of this fact. Now, most of us think that the economic crisis of the U.S. is soon to end and that a more promising future is to come.

Trying to build an argument that supports that view, or the opposite scenario is relatively simple. But first, just think about the fact that the majority has proven to be a misleading source, and that, as during the bubble times, people want to reinforce positive messages and make big efforts to discard negative outlooks from peoples minds. While that is an interesting exercise, it is not a very useful framework for thinking ahead.

There are some encouraging statistics about the future. For example, employment in January was on the rise (If you are interested in employment and want to get a 5-minute glimpse of what the latest is, this is a great link: www.bls.gov/news.release/empsit.nr0.htm.) But, are there possible reasons for a worse future economic crisis? These are a number of reasons why the future might get tougher. I don’t have a definite stance on any of them; I only consider them a good starting point to ask tougher questions about the U.S. economy.

Is there a bubble in the housing market? If so, when will it burst? What will be its consequences?

Housing prices are still at the highest levels in years, fueled by the large availability of credit. As the shock of the layoffs advance through the economy, and people go into bankruptcy, it is possible that credit institutions will suffer great losses. And, as the market adjusts to a more sustainable level, people will realize reductions in their assets that might affect their spending patterns.

Will there be secondary effects of personal bankruptcies?
As credit institutions start to receive the trickle down effects of their default, creditors might gradually face serious trouble. We’ve seen the impact this had from the first crisis in corporate America of large banks.

Have we yet seen the effects of this crisis on commercial credit?

Will their be a credit crunch?

Consumption might be reduced as credit institutions face an extremely challenging environment. Many companies won’t be able to continue to subsidize their sales with mega-cheap credit (i.e., cars) and those companies might face tough conditions because of this.

Will there be deflation in the U.S.?

This is the worst economic nightmare in people’s minds. This phenomenon of pricing decreasing consistently in the economy, as is currently happening in Japan, might hit closer to home as the Fed. virtually can’t lower interest rates any more. If deflation were to set in, as an effort for producers to promote consumption, the U.S. economy would face a very difficult situation in terms of savings and investment.

Will there be another substantial market correction?

Historically, past crises had consistent, larger downward corrections than what we currently see in the market value vs. book value ratios of the equity markets. A larger correction would affect the value of the assets of consumers and investors leading to lower levels of consumption.

What will happen to the Public Deficit?

The U.S. government and governments around the world are finding their finances worsening as they try to pump money back into the economy to stimulate growth. As they continue to fall more heavily into debt, the public sector credit resources for the private sector become more scarce.

What is the impact of the excess capacity?

Investment is not expected to increase any time soon as most companies still face overcapacity.

The illusion and uncertainty of war

Many economic agents might be moving slower because they are waiting to see what the future departs in terms of a war; this creates confusion in the market. The war might only bring higher government deficits that would threaten the availability of credit for the private sector.

I haven’t gathered the data to back a position that predicts a grayer future for the economy, but I think that is something we should start talking about. I don’t know how probable it is, but it certainly is possible.

And, I believe we don’t talk about it enough. Are we systematically overoptimistic? Some might say that we are also at times overly pessimistic – is this the case?

In any scenario these are questions worth addressing given the enormous impact they will have on our lives, from a personal perspective and also in terms of the overall business community. Is our education at HBS objective in addressing the possibility of a future deflationary U.S. economy? Are we ready to lead in a worse economic future than the one we face today? Just think of the demographic challenges the U.S. is about to face as baby boomers get older – larger healthcare and social services costs, for example. Should we start to talk about it?

Hopefully I am wrong about all the points outlined above and we’ll have a great economy soon in the U.S., I don’t think that is very probable, do you? Please contribute to this conversation by writing to the HARBUS at Harbus-viewpoints@mba2004.hbs.edu. Your views will be published to continue with this dialog.

February 24, 2003
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