Recognizing a deflationary or no-growth economy and planning your way through it.
Look around. Evidence suggests we're entering a deflationary period not seen since the 1930s. Here's how to recognize its signs and plan your way through
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Most of what we do as businesspeople we do because those things make sense -- like borrowing to make long-term investments in plants and equipment that will accommodate growth. Or buying real estate that will appreciate in value. We give workers annual raises partly because they've come to expect them, and because as long as the raises don't exceed the annual inflation rate, they don't really cost us anything. We plan for growth, for higher production of whatever our companies make or deliver. We borrow to finance research. All that makes sense. But change just one important characteristic of the economic environment in which U.S. companies operate, and most of what business owners and managers have seen as sensible behavior for nearly 50 years would make no sense at all.
The conventional wisdom that has defined good sense in the American business world since the close of World War II has rested on the assumption of steady inflationary growth. Not the kind of devastating inflation that cripples the economies of debt-ridden emerging nations or of the former Soviet republics. Not even the double-digit stagflation we experienced for a brief time in the late 1970s. Our business decisions are based on the assumption that inflation will be steady, mild, and offset by slightly higher economic growth, year in and year out. We make that assumption because that's the way our economy has worked, on average, since before most of us went into business. We don't give it much thought, but it shapes our notions of what makes sense.
If one assumes inflationary growth, borrowing makes sense because inflation reduces the real cost of the debt, and growth opportunities can more than offset the rest. Across-the-board nonmerit raises for employees make sense because inflation absorbs their cost. Steady growth pardons poor planning that leaves companies with too much inventory. Inflation props up the balance sheets of companies, including poorly operated ones, by driving up the value of their assets -- real estate, for instance. Inflationary growth forgives a measure of sloppiness and the occasional miscalculations of even the most scrupulous among us. But what if there were no inflation and steady growth stopped?
In 1988, when I was managing a young health-care-services company, several smudges appeared on the economic horizon that might have signaled a change in the inflationary growth trend and therefore a change in a good deal of what makes sense in business decision making. I decided to watch those and keep a lookout for other signals. Since then, here's what I've seen: falling commodity prices. In the mid-1980s farm commodity prices began to decline, which reduced the value of agricultural land. The prices of industrial commodities -- metals and chemicals -- also began to drop, which depressed the value of the land from which they were extracted and the plants in which they were refined and pro-cessed. Similar commodity-price declines preceded the stock-market crash of 1929 and the financial panic of 1893, the last two events marking the onset of catastrophic economic change in the United States.
Falling commercial and residential real estate prices. The value of U.S. commercial and residential property is no longer rising. In fact, it is falling and in some regions plunging at a horrifying rate -- 1%, 2%, 3%, 5%, even 8% per year, the reverse of its annual rise just a few years ago. A similar precipitous decline in commercial and residential real estate prices occurred in the Great Depression of the 1930s.
Plummeting foreign-stock prices. Since December 1989 Japanese stocks have lost the same percentage of their value as U.S. stocks did between 1929 and 1932. European stocks are down, too, and investors in the East and West have seen billions of dollars of wealth evaporate. The health of the Japanese banking industry now resembles the battered condition of U.S. banks in 1932. That U.S. stock prices are still as high as they are may be an aberration. In an economic storm, not all the waves move in unison.
Falling domestic interest rates. The Federal Reserve Board has lowered interest rates time after time since 1989 and has gotten little or no response from the U.S. economy from that monetary stimulation. Bank lending rates are as low as they have been in years, but borrowers aren't borrowing. Between 1929 and 1932, the Fed cut interest rates by 70% -- a reduction similar in magnitude to today's cuts -- but that action failed to rekindle economic growth.
Persistent consumer pessimism. Month after month the Conference Board's consumer-confidence index sinks lower. By this past October, it was down to 56.4, nearly half the 1985 level. It's no wonder, with reports like the one from the Bureau of Labor Statistics that 85% of layoffs between July 1990 and June 1992 were permanent, compared with an average of 56% in the previous four recessions. Alfred Sindlinger, the 85-year-old pioneer of consumer-confidence surveys and publisher of "Outlook," a newsletter in Wallingford, Pa., told Investor's Business Daily that today's conditions are "strikingly similar" to those of the 1930s. "We are now in a structural change just as we were in the 1930s," he said, "and it took World War II to get us out of that."
Confusion. I see and hear profound confusion, just as in the 1930s, among the people best trained and equipped to read the signals and understand what is happening in and to the economy. Is this just a recession we're having, a blip in the business cycle that, for all its apparent differences from other recessions, will nonetheless melt away? Yes. Maybe. No. Who knows?
