A BLACK, billowing cloud of recession is about to engulf the U.S. economy. The only questions are how long and how severe it will be.
A recession starts when our gross domestic product begins to contract. GDP is calculated using four components -- consumption, investment, government spending and net exports (exports minus imports). Three of these are entering free fall.
The problem started with the Asian crisis. Weaker Asian currencies have made U.S. exports less attractive and foreign imports more attractive, while recessions in Asia have greatly reduced the income of Asian consumers and hence their purchases of U.S. goods. The result has been a sharp decline in U.S. net exports and a soaring trade deficit.
Initially, this decline was perversely comforting because it saved us from a nasty round of interest rate hikes by the Federal Reserve aimed at cooling the economy. Now, however, with two other GDP components -- consumption and investment -- about to plunge, the Asian crisis has come home to roost.
Wall Street plunge
It began several months ago with a slight decline in consumer confidence. Since consumption represents about 70 percent of the GDP, even a small change in consumer confidence can't be taken lightly. But this small change has been magnified by the recent and jarring drop in the stock market.
When the stock market was rising, investors saw their portfolios rise dramatically. Feeling wealthier, consumers went on a binge, snatching up everything from refrigerators and cars to houses. But with the stock market in sharp decline, this "wealth effect" has reversed. Now consumers are going to be more frugal. While this is rational behavior at the individual level, the collective effect could be devastating.
Which brings us to a third GDP component about to go into free fall -- investment. When stock prices plunge, corporations are loath to issue new shares at bargain basement prices to finance growth. In a bear market, businesses also are much less likely to invest for fear of being caught with high inventories.
It follows, then, that with net exports, consumption and investment all heading south, a recession is inevitable. What, if anything, can be done?
