Fed Prompted by Gloom at Heart of the Economy

Less than two months ago, the Federal Reserve proclaimed that the business slowdown was not much of a worry and that the real threat to the economy was inflation.

What happened since then to trigger Wednesday’s rare move by the Fed? What did Chairman Alan Greenspan see that drove him to suddenly engineer a half-point cut in interest rates?

He saw people like Chris Ashworth, general manager of the Toyota of North Hollywood auto dealership, grappling with the effects of a rapidly deteriorating economy.

For most of the last three months, Ashworth’s business has been getting weaker, a lament shared by auto dealers around the country, not to mention the workers who make the cars and the steel and glass and transmissions that go into them.

The Federal Reserve’s surprise cut in short-term interest rates, Ashworth said, “can only help” encourage consumers to start spending again.

Not everybody is persuaded that lower interest rates will provide much immediate relief. Lloyd Medal, a co-owner of Vertiflex Co., an office furniture company with operations in Irwindale and the Chicago area, said his problem is that his customers are burdened with too much inventory and thus have stopped placing orders.

“Frankly, I don’t think it’ll do anything for us,” Medal said.

Even so, the slowdown that Ashworth and Medal have experienced provides much of the explanation for why, at a time when the overall U.S. economy still is growing and unemployment remains extremely low, the Fed decided to act dramatically.

Perhaps most telling was an economic report earlier this week showing that U.S. manufacturing industries--including autos, appliances, computers and other bellwether products--may have already entered a recession.

“There are segments of the economy where things are painful,” said Sung Won Sohn, Minneapolis-based chief economist of Wells Fargo & Co.

“We might avoid a macroeconomy-wide recession, but I think we are seeing what I’d call rotational economic recession in progress,” he said. Industries, Sohn said, “are taking turns” at sinking into slowdowns.

More bad economic news piled up Thursday. Reports showed that December was the worst month for layoff announcements in more than eight years; new claims for unemployment insurance climbed to their highest level in more than two years; and retailers posted even worse holiday sales than forecast.

Even though strength in some industries is fueling continuing growth and keeping overall unemployment low, enough was starting to go wrong--reflected daily in a long-running stock market slump--that consumers and businesses began to worry. And in an economy that is two-thirds driven by consumers, attitude is everything.

Recent consumer confidence statistics show that the public’s expectations about the future have fallen sharply. That, in turn, prompts consumers to pull back further on spending, creating a downward spiral. As a result, economists say, the Fed wants to turn around the increasingly gloomy mood of consumers and business managers who make the spending decisions.

While the Fed rate cut is a psychological tool, it also has a very real dimension. It should translate into lower interest charges on credit card balances and lower home mortgage rates--two developments that put more money in consumers’ pockets and, presumably, make them more willing to spend on other items.

What’s more, the immediate surge in the stock market following the announcement of the Fed’s move also, on paper, means more wealth for millions of investors who had begun to feel poorer under the burden of last year’s slumping stock values. A market revival could fuel more spending.

Likewise, many businesses paying off floating-rate loans also get a break when interest rates decline. And so do their business customers, a fact that might induce more business spending.

Economists insist that continuing interest rate cuts are a proven tonic for a stumbling economy. Bruce Steinberg, chief economist at Merrill Lynch & Co., predicted that the federal funds rate, which was cut from 6.5% to 6% on Wednesday, could be slashed to as low as 5% by midyear.

Steinberg, while acknowledging the Fed cut’s immediate benefits for consumer psychology and the stock market, said the advantages for the “real economy” will start to show up in six to nine months. “The economy, in all likelihood, will be weak in the first half of 2001, which is why the Fed felt it had to act now,” he said.

Still, what economists are calling weak these days would be growth of 2% to nearly 3% in the gross domestic product. That’s roughly the same pace of growth the nation experienced in the second half of 2000, albeit down from the blistering pace of 5.2% in the first half of last year.

This falls well short of the standard definition of recession: two consecutive quarters of declines in the nation’s output of goods and services.

The main problem, economist Sohn said, is that “we’ve become so used to having a wonderful economy. It’s like living in a five-star hotel and now having to move into a three-star hotel. We’re not going to the poorhouse.”

For many working people, though, there is reason to fret. Challenger, Gray & Christmas Inc., a Chicago-based outplacement firm, said Thursday that layoff reports surged in December to a total of 133,713 jobs--almost triple the December 1999 number. It capped a trend of accelerating layoffs in the last six months, making 2000 the third-worst year for job-cut announcements since the Challenger firm started following the reports in 1989.

“It feels to me like all of a sudden, Dec. 1, things seriously began to change. Many employers threw in the towel and said, ‘We can’t keep holding on,’ ” said John Challenger, the outplacement firm’s chief executive.

Meanwhile, employers are girding for things to get worse. That’s becoming the case even in California--despite reassuring predictions from forecasters that the state is more protected from the risk of recession than the country as a whole. The decline in spending on technology, along with the state’s current electricity crisis and soaring natural gas costs, are clouding California’s prospects.

At Fenwick & West, a law firm in Palo Alto, labor and employment attorneys are coaching dozens of Silicon Valley companies on how to handle layoffs in the weeks ahead, said partner Patricia Nicely Kopf.

“What we’re seeing here is companies that have only known good times and they have built up the work force in the hopes of continued economic prosperity,” she said.

“Seeing the stock market tank in the last few months and seeing the Internet companies have difficulties has been somewhat of a rude awakening.”