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Good riddance, 2001
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December 17, 2001: 2:08 p.m. ET
Silver linings were few as first recession hit U.S. in a decade.
By Staff Writer Mark Gongloff
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NEW YORK (CNN/Money) - So much for 2001.
Arthur C. Clarke thought the year would feature luxury trips to the moon and contact with super-intelligent aliens. But the best we could manage was getting a probe to orbit Mars - a roaring success, compared with the performance of the U.S. economy.
After the tech-stock bubble burst last year, the United States sank into recession in 2001 following 10 years of growth - ending the longest expansion on record that some optimists had been saying would be a new era of endless, technology-driven growth.
But an unusual confluence of events - from the tech bust to an untimely jump in oil prices to the Sept. 11 attacks - ended up bringing that old bear, the business cycle, out of its cave.
"Yes, the economy was slow and would have come within a hair's distance of a recession," said Anthony Chan, chief economist at Banc One Investment Advisors. "But Sept. 11 was the fatal blow to the economy this year. That probably will be the most important market and economic event of the year."
The group of private economists that dates U.S. business cycles said the economy sank into recession in March. The downturn surely was exacerbated by the events of Sept. 11 - a day that took about 4,000 American lives and forever altered the lives of the rest of us.
Even Alan Greenspan and the Federal Reserve couldn't come to the rescue. While the central bank started cutting interest rates in January, apparently concerned that weakness was coming, it could not ward off a downturn.
Most analysts define a recession as two straight quarters of shrinking gross domestic product, the broadest measure of the nation's economy. By that definition, a recession hasn't come yet; but we're most of the way there, since GDP shrank in the third quarter and most economists expect more contraction in the fourth quarter.
After the technology bust, which pulled the Nasdaq market down 39 percent last year, business spending on technology and other improvements dried up this year - a far cry from 1999 and much of 2000, when it seemed the "new economy" would expand forever, a now misguided view that likely sowed the seeds of this year's downturn.
"We had economic growth of 8.3 percent in [the fourth quarter] of 1999, and a lot of business plans were based on that oversized growth," Chan said. "When you make capital spending plans based on that kind of economic growth, you're going to get a lot of problems."
One of those problems was "inventory overhang," an oft-repeated catch-phrase referring to all the shiny new gizmos that suddenly nobody wanted to buy, leading to drastic cutbacks in production, a manufacturing recession and more than a million job cuts.
Corporate profits also suffered, leading to more job cuts and a further slump in stock prices that, along with the tech-bubble bust, erased billions of dollars in paper wealth.
In fact, the deflation of Nasdaq stock prices in 2000, which continued at a slower pace in 2001, likely was the first sign that people had to temper their optimism about the "new economy."
"How so many people went so far astray from the mainstream and were wrong is probably unprecedented," said Sung Won Sohn, chief economist at Wells Fargo & Co., referring to the speculation in tech and "new economy" stocks. "We were talking about the new paradigm, the stock market going through the ceiling. In hindsight, many smart people went astray themselves and misled many other people."
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Economics fit into the social system; you change the economic climate when you rip the social climate apart, as [the attacks] did.
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Delos Smith,
Conference Board economist |
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As stock prices fell back to earth, consumers weren't feeling so exuberant any more. Few may remember it, but consumers told the University of Michigan way back in March that they thought the United States already was in a recession, according to a Reuters report at the time.
"If you look back at the data we had in July and August, they were not very positive," Brown Brothers Harriman economist Lara Rhame said. "Even before Sept. 11, we weren't seeing growth anywhere, except in housing and [automobile sales]."
Home sales were propped up much of the year by falling mortgage rates, while auto sales got a boost from financing incentives. Otherwise, retail sales struggled all year, and there was anecdotal evidence that consumers used tax rebates to pay off debts, rather than for spending.
Meanwhile, the Fed kept cutting rates. And amazingly, some on Wall Street were disappointed when the central bank cut rates for the seventh time in August and indicated it was ready to cut again. They had been hoping the Fed would be more optimistic, especially with signs that businesses were starting to clear inventories, setting the stage for production to increase again.
Click here for more on the Fed and rates
But Wall Street didn't like much of anything the Fed did in 2001, despite its 11 rate cuts, a record for a calendar year, taking short-term bank lending rates from 6.5 percent to 1.75 percent, a level not seen since 1961.
Maybe investors remembered the Fed raising rates six times in 1999 and 2000 in a bid to brake runaway growth - rate increases that hurt slowing capital spending even further. Meanwhile energy prices surged and hurt spending even more.
"The predicament that we're in with our economy is the mistake the Fed made two years ago," Robert Froehlich, chief investment strategist at Zurich Scudder Investments, told CNNfn's Before Hours program. "I believe they know they made a mistake, and they have to give it back to us."
Others think the Fed may not have raised rates soon enough.
"The 'new economy' was a new beast to some extent, and the Fed was too lenient in terms of letting consumer exuberance get ahead of itself," Brown Brothers' Rhame said. "They should have been moderating growth in 1997 and '98."
It may be years before the Fed's performance in recent years can be adequately graded. For the most part, however, economists think the Fed's policy has been on target, even if its timing has not.
"If it weren't for the terror attacks, we would have avoided a recession, and [Fed] Chairman Greenspan would have been credited for another soft landing," Wells Fargo's Sohn said. "Given the information the Fed had in 1999 and 2000, they did the right things."
Even the full impact of the terrorist attacks will be difficult to judge for years to come. After the attacks, President Bush, Greenspan and others promised that the foundation of the world's largest economy had not been affected, and that assessment seems correct so far.
Though the attacks shut down air transportation and consumer spending for days, retail sales and most other activities - except for travel and tourism - have more or less returned to pre-attack levels, however anemic those were.
"The story of Sept. 11 is the tremendous resilience of the U.S. economy," said Robert Goodman, chief economist at Putnam Investments. "We took a shot, a real shot, and came back. It shows you the power of this system."
Congress and President Bush could add fuel to the economic fire by agreeing on a stimulus package soon. The House recently passed a bill that mostly gave tax cuts to corporations, but the Democrats in control of the Senate would like to focus more on helping unemployed workers.
Most economists think a combination of a stimulus package from Congress, Fed rate cuts and low energy prices will lead to a rebound by the second half of 2002.
But that outlook depends in large part on a recovery of consumer confidence, which is especially vulnerable right now to further terrorist incidents or other setbacks - not to mention an unemployment rate that jumped to 5.7 percent last month and is likely to move higher. Consumer spending fuels two-thirds of the U.S. economy, the world's largest.
Click here for CNN/Money's economic calendar
Despite the lightning-quick success of the effort to overthrow the Taliban regime in Afghanistan, Americans still are recovering from Sept. 11. Until they do - and no one knows how long that will take - economic sluggishness could continue.
"Sept.11 is still very much with us," said Delos Smith, an economist at the Conference Board, which tracks consumer confidence and other business data. "Economics fit into the social system; you change the economic climate when you rip the social climate apart, as [the attacks] did."
Despite calls for patriotic consumption and warnings that changing their lifestyle means a victory for terrorism, Americans have adjusted their priorities, if only temporarily, staying at home and focusing on their families and loved ones.
"I gave a speech last week to a mortgage group at their Christmas party, a group of people in their 20s and 30s," Smith said. "In years before, basically the hormones were jumping all over the place. This time, there was the Pledge of Allegiance, we sang 'America the Beautiful' and had toasts for Sept. 11. They took my speech much more seriously. No one was thinking about sex.
"Does that have economic implications? To me, the answer is yes," Smith said. "In a sense, we have to wait for recovery until this group wants to sleep with each other again." 
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