Economy’s Off in New, Better Direction

The Federal Reserve may have cut interest rates to their lowest point in 18 years, but they will go lower still.

The White House may be crowing about a strong recovery from recession, but knowledgeable financial people see a lot more suffering to go in parts of the economy--a lot more vacant office space in major cities, more unemployed white-collar workers.

Those conclusions reflect the views of several investment experts whose analyses are sobering but not really frightening. Most agree that the recession is ending; they question only the strength of the recovery. And long term, some see cause for jubilation--a stronger, healthier U.S. economy within a few years.

In fact, underlying their analyses is a belief that the U.S. economy has embarked in a new direction, one that will yield an era of lower prices for goods and services accompanied by good profits and low capital costs for business. It could be a period recalling the 1950s and ‘60s--the now distant glory decades when reasonable mortgages were available for young families, companies were productive and growing and solid investment opportunities abounded.


But don’t get carried away. Spring may be a little late this year.

Last week the Federal Reserve, attempting to “jump start” the economy, lowered to 5% the rate it charges on loans to banks--a move that could bring bank loans to business down to 7.5% and fixed rate mortgages below 9%.

But the engine is failing to kick over. This is the third time the Fed has lowered interest rates this year, and so far the response has been a deafening silence.

Borrowing has not picked up. In fact, notes Charles Clough, chief investment strategist for Merrill Lynch, growth of private debt is at its lowest level ever. Bank lending actually fell in July.


That’s serious. Without credit creation, economic expansion will remain slow.

But won’t business borrow now with rates at an 18-year low? Probably not. These days “interest rates are not the determining factor,” says Clough, “viability is.”

He means that banks are afraid to lend, just as they were in Texas after the 1980s depression devastated that state’s economy. Banks found they had loaned too much money on oil rigs, office building and condominium projects.

Today in Los Angeles and New York, Boston, Washington, Chicago and other cities, banks are gun-shy after lending an incredible $365 billion in the ‘80s for office buildings, shopping centers and other commercial real estate.


The result is glut. “The United States has a 10-year supply of office buildings,” says David Shulman, managing director and head of real estate research at Salomon Brothers. London, Paris and Tokyo have an even greater oversupply.

Vacancies are increasing, and as they do, rental income falls, values of buildings go down. Banks are stuck with bad loans, and insurance companies--major lenders to real estate--find themselves owners of unprofitable properties. The burden forces insurance firms to forgo new business and lay off existing staff.

Meanwhile, banks are merging to reduce expenses and to share the burden of their bad real estate loans. In the process, tens of thousands of jobs are eliminated, many in businesses that serve banks and insurance companies, such as accounting and law firms, electric and telephone companies, computer and stationery suppliers, desk and lunchroom suppliers.

Service industry restructuring, in a word, will make for relatively high levels of white-collar unemployment in the next few years. And that doesn’t promise a strong recovery in consumer spending for cars or homes or suits or dresses.


Inflation is fading, deflation is taking over as airlines cut fares, hotels cut rates and stores cut prices.

And don’t forget the shrinking banks. They are not going to offer high interest rates to get deposits they cannot lend out profitably. So the $1.7 trillion in certificates of deposit will have to find other investments. And with Treasury bills paying only about 5%, depositors’ best hope may be in government bonds of longer maturities, five years or more, which still pay 7% to 7.5%.

“Still” is the operative word. Interest rates could return to 3%-4% levels of the ‘50s and ‘60s, say analysts such as Rao Chalasani of Kemper Securities in Chicago. Such low interest levels may be what’s needed to spur new business to grow in all the cheap office space opening up.

The important point is that new business will grow, in hundreds of fragmented, scarcely predictable ways. Big banks won’t simply become bigger. Rather, companies of all sizes will specialize and reform their operations. That’s how U.S. manufacturing restructured in the 1980s: Many firms shrank, but hundreds were born.


Right now, manufacturing provides a reassuring lesson that mending mistakes doesn’t cripple business, it restores it. Growth in manufacturing is carrying the U.S. economy out of recession.

And periods of restructuring can yield great investments: Ford Motor Co. was a standout stock in the early ‘80s while the company was recovering from near mortal illness. Then, as now, investors bet on the future--which is the only way that makes sense.