Anxiety Over U.S. Economy Grows as Political and Economic Woes Mount

Perhaps it was too much to hope for: Tuesday's Wall Street rally – and the sense of relief that came with it – was erased Wednesday by another precipitous drop in stocks.

The Dow Jones Industrial Average, the Nasdaq, and Standard & Poor's each closed more than 4 percent lower, the steep drop in their composite prices a reflection of the sinking feeling shared by investors and economists worldwide. It was the third time in five trading days that the indexes fell by more than 4 percent, the Dow Jones by more than 400 points.

Financial experts have cited a number of factors for the sudden malaise on Wall Street:

• The rancor in Congress as legislators hammered out a deal to raise the country's debt ceiling;
• A sense of dissatisfaction regarding the terms of that deal;
• Standard and Poor's downgrade of America's long-term federal debt rating; and
• The expanding European debt crisis, which now threatens to engulf Spain.

It's a lot to take in. To help get a handle on what's happening in the world economy, and how it may affect Scotch Plains and Fanwood's residents, businesses, governments and schools, we spoke with local economists, CFOs and financial planners.

Should we have seen this downturn coming?

Roger Scher, Professor of International Political Economy at the Whitehead School of Diplomacy, Seton Hall University

No one ever can foresee the exact outcome of events, but I was concerned that the rosy outlook that most in the markets were seeing around May was too overdone. We had decent growth last year, 2-percent growth in GDP after two years of recession in 2008 and 2009, but that was really based on the extraordinary fiscal stimulus in both fiscal and monetary policy, which we are not going to see so easily now, repeated especially on the fiscal side. 

In 2008 and 2009 there was stimulus. The strategy behind a government stimulus is that the government steps in with a stimulus and hopefully some of the confidence is returned to the private sector. Consumers are still burdened over a heavy debt load and the housing market is pressing on them. There has been some improvement in the job market but not enough for a resurgence for the consumer. Corporations are in pretty good financial shape. They are a part of our economy that is not so cash burdened. They are building up cash, licking their wounds and repairing themselves rather than taking on hiring and increasing investment. They are also seeing what's going on in Washington and trying to cope with the S&P credit downgrade and are concerned with laying out funds for expansion going forward.

James Hughes, Dean of the Edward Bloustein School of Planning and Public Policy, Rutgers University-New Brunswick
The two indicators are usually gross domestic product and unemployment. The government revised GDP data recently, and it shows that the recession was a lot deeper than we thought. Instead of declining by 4.1 percent, it declined by 5.1 percent.

They revised the current GDP data this year and it shows that the first quarter was actually 0.4 percent growth. That was the weakest quarter since the recovery began in the third quarter of 2009. However, second quarter GDP growth was 1.3 percent.

There are two ways of looking at it: The first and second quarters of this year were the weakest of the recovery. On the other hand, GDP went from up from 0.4 percent to 1.3 percent. Both are anemic, but that suggested that the trend was up in the second quarter and that we hit a soft patch in the first quarter. That is not a recession by any means. It is a definite slowdown. Before we lost confidence in the past few days, it was all attributed to rising energy prices, the Japan tragedy, weather events. The expectation was that the economy would pick up in the second half of the year. Now the expectation is that we will be bumping along.

David G. Dietze, Chief Investment Strategist, Pointview Financial Services in Summit
The joke on Wall Street is that the market has predicted three out of the last 10 recessions. Sometimes a steep selloff does foreshadow a downturn in economic growth – the feared 'double dip' – but many times in history, it has gone down and we have not had a recession. Will we have a recession? I don't think so but we might.

The negative side of the ledger is that we just had the downgrade of the U.S. debt, the problems over in Europe in terms of the sovereign credit. This could be a blow to confidence if people feel that this is a recession and become self-fulfilling. On the downgraded debt, we don't know what the ripple effect will be because we have not seen it before. That could cause us to fall into a recession.

On the other side if the ledger, the market is providing its own stimulus. Crude oil prices were $118 in April and are now in the mid-$70s. That's a 30-percent reduction. Instead of seeing $5-a-gallon gas by Labor Day, we might see $3-a-gallon. That is like a tax cut.

Some stimulus is present in terms of real estate. Thirty-year mortgages were 5.5 percent at the start of the year, now they are down closer to 4 percent. That could translate into a 30-percent reduction in monthly mortgage and interest payments for someone buying a home. That is going to give some stabilization.

Third, you've got a U.S. dollar that has dropped about 12 percent, so that makes anyone who is dealing with foreigners, anyone who exports anything in America, and reduces it by 12 percent.

In terms of portfolio management, just because we are going into a recession doesn't mean that you can't make money in the stock market. The stock market leads. It may have fallen enough to reflect a recession. When you look at history, you've always made money by holding your ground or adding to your portfolio. The $64,000 question is, 'How long will that take before we see a meaningful gain?' That could be anywhere from a month to three years. We are saying that for people with longer-term goals, this is certainly the time to be bringing your exposure to equities back to your pre-existing target.

The other thing is your investment alternatives – fixed income investments, such as  CDs look unattractive now. CDs have gone from 1.5 percent to a two-year CD to 1 percent. We would not encourage longer-term investors to bail.

Ray Miller CFO and partner, 
B2BCFO, Inc., located in 
Union and Morris Counties
What I see, and what my clients have seen, is that they never got out of recession. Most small businesses and mid-market companies have been scared to death over the past three years, and that is why we don't have any hiring, because those are the ones who do all the hiring.

The story is we have too much leverage in the system all the way around. We have spent beyond our means for a couple of decades now, and it's coming home to roost. It's the federal government, state governments and municipalities, businesses and individuals. It's time to pay the piper. When credit gets pulled, that is what happens. Credit remains tight for the vast majority of small businesses. I deal with a lot of bankers and they would love to be able to lend money but it's just that they can't find qualified borrowers. 

Did the debt debate in Washington have an impact on the economic downturn?

Scher, Professor of International Political Economy, Seton Hall
It certainly did, and it is not only political, but definitely financial as well. I have some sympathy with S&P's move. The government did the right thing by stimulating the economy in 2008 and 2009. They avoided the mistakes of the Great Depression. Having done that though, on the fiscal side you see these massive deficits, 10 percent of GDP, rising government debt and you don't see any movement that is going to improve that. The gridlock in Washington has made the government unable to take actions in the medium term on deficits.

On the point of the S&P downgrade – what they were focusing on was the lack of consensus in the U.S. government on what polices need to be formed to reduce the national debt. In other developing countries there is a consensus with the political actors that this is what we have to do.

In the first and second quarter we have seen some expansion of the economy, albeit lukewarm, but this show in Washington and how clear it has become to people that there is no policy consensus, is likely to cause actors in the private sectors not to spend – consumers, corporations, not to invest and people to pull money out of the stock market.

Are we in a recession?

Scher, Professor of International Political Economy, Seton Hall
The jury is still out. We'll see it when the third-quarter numbers come out...you will see the effect on consumer spending, actions by corporations and banks, et cetera. We won't know the full effect of it until well into next year. From the end of June till today, if you were thinking about things such as snagging jobs, buying a house and taking a vacation, that kind of thing, maybe people will put off some of those expenditures as a hedge against things getting worse. Corporations are thinking the same way.

Hughes, Dean of Edward Bloustein School of Planning and Public Policy, Rutgers
I think it's too soon. It's like you never know when you are in a bubble until it bursts. Job growth has actually improved in 2011. Here is the positive trend. In 2009...the U.S. lost five million jobs. In 2010 for the entire year, we gained 1,173,000 jobs, so that is a pretty dramatic turnaround. In the first seven months through July this year, we added 1,148,000 jobs. In seven months we are just 25,000 shy of all of last year. Now whether companies are going to be gridlocked again and stop hiring – I still think we'll beat last year but not at the pace we had been going.

Are investors uneasy?

Dietze, Chief Investment Strategist, Pointview Financial Services
Obviously anxiety is high, because no one has a crystal ball. They all remember the downturn in 2008, and the $64,000 question is, 'Is this 2008 all over again? 
Are we headed for a recession? ’
I think there is a 30 percent chance. You can't rule it out. Corporate America has slashed expenses dramatically. They are running with a lot less leverage and a lot more cash. But you don't have people managing their business on the edge as they were in 2008.

How has the downturn affected small businesses?

Miller, CFO and partner, 
B2BCFO, Inc.
They are afraid to take any chances…. They do not want to take on additional debt. I hear story after story from bankers about their clients who have cash. Rather than take on additional debt and leverage it, they are going into their cash reserves if they need to, and there is a lot of delaying in purchases of capital items and maintenance. The big thing is that they are more willing to do that than to hire people.

Robert Evans contributed to this story.