The Q4 01 US GDP growth was dramatically revised upward from 0.2% to 1.7%. As a result, the downturn starting in March 2001 saw only one quarter of negative GDP growth in Q3 01, making it possibly the shallowest recession in the post war history. Yet, the debate on the likelihood of a double-dip for the US economy rages on. If a double-dip indeed emerges, not only will consumption and investment confidence be dealt a huge blow, real economic recovery will also be delayed, and the US economy, as well as the global economy that relies on it as the engine of growth, will be negatively affected.

Double-dips used to take place during recessions

The definition of a double-dip is that GDP growth slides back to negative after a quarter or two of brief positive growth. Theoretically, it can happen during recessions as well as recoveries. But historically, it took place mostly during recessions. According to Business Week, during the nine recessions since world war II, six of them saw double-dips or even triple-dips. However, when the US economy started to recover, as defined by the business cycle dated by NBER, never once did a double-dip take place. Rather, GDP growth fluctuated but stayed positive. The idealistic straight-line continuous growth never happened either.

Double-dips or triple-dips during recessions

Source: Commerce Department

Recoveries saw no double-dips, growth rate alternated

The first four quarters of real GDP growth during recoveries (annual rate)

Source: International Strategy & Investment

Currently, the market's general perception is that the US economic recovery has started. Nevertheless, NBER stopped short of declaring the end to the recession back in mid March. Therefore, if the US economy contracts again after the surprised growth in Q4 01, it will strike home the notion that the recovery hasn't begun and the Q4 rebound was nothing more than a temporary bounce brought by the stimulus measures imposed after the 9.11 incident.

The concerns about a double-dip are based on the unique features of this recession as well as the hidden obstacles to the current recovery. They include the personal consumption that held strong during the recession might lose steam in the future, the low personal savings rate and heavy debt burden, the excess capacity that has not been completely absorbed, the large current account deficit, and the negative wealth effect due to the sagging stock market.

None of the major GDP components is pointing to a double-dip

In order to evaluate the likelihood of a double-dip, we must analyze one by one the major components of the GDP. The followings are the performances of the major components of the GDP during the three quarters since March 2001:

From above, it becomes clear that personal consumption and government expenditures contributed the most to the Q4 01 GDP rebound, with inventories and fixed investment providing most of the drag. The future performances of these four categories warrant our attention.

The advocators of the double-dip argue that the growth of personal consumption (2/3 of the economy) cannot be sustained and its collapse will directly lead to a double-dip. However, latest data on housing, auto sales, durable goods and chain store sales for the first two months of this year continue to point to healthy growth. Then why can the US consumers consume as usual in spite of heavy personal debt burden, low savings rate, negative wealth effect from the stock market and high unemployment rate? The answer lies in the monetary and fiscal stimulus measures and the US consumers' wealth structure. The Fed's eleven rate cuts in the past year were the primary driving force behind the boom of the housing market. By taking advantage of the lower mortgage rates, consumers reduced their debt burden. The average housing price was up 6% last year. When you consider 2/3 of Americans own their own houses vs. 1/2 owning stocks, and average household real estate values at USD100,000 vs. investment in stocks of USD25,000, and with tax cuts, it is no wonder then that the consumers' balance sheets were being repaired even during the recession. Moreover, the job market seems to have stabilized. February's non-farm payrolls recorded its first rise since last July, and unemployment rate declined for two consecutive months to 5.5%. All these bode well for consumer confidence. The USD51bn stimulus package will further ease the unemployment situation. Thus, barring disastrous collapses of the housing or stock markets, it is unlikely that personal consumption will contract and lead to a double-dip.

The government expenditures that went to disaster relief, cleanup, salvaging related industries, and the anti-terror war effort in Q4 01 are unlikely a one timer. As a matter of fact, most efforts are continued up to date. Bush's tax cuts are not a one timer either, and the stimulus package argues for an expansionary, not contracting fiscal policy. Judging from these, the government expenditures will maintain growth, albeit at slower speed. And because it has a smaller weight in GDP than personal consumption, it is unlikely to lead to a double-dip either.

This recession was caused mainly by the rapidly contracting capital investments. The slump took away an average of 1.6 percentage points of growth in each of the three quarters, four times of the previous averages. So far, the guidance from CEOs paints a dubious picture of the future of capital investments. In this latest earnings report season, most CEOs were very cautious in future earnings guidance, far more conservative than most economists. But they are the ones who ultimately make the investment decisions. And if they withhold it, its contribution to GDP will remain negative. However, just as they tended to overestimate earnings in the past two years when the economy began to slow, they tend to underestimate them in the initial phase of the recovery and take a conservative approach, especially when the latest data show that headwinds to investments have begun to abate.

The future of capital investments depends on possible improvements in earnings and successful absorption of the excess capacity. The high operational and financial leverages used by the US corporations resulted in multiple times of decreases in profits and earnings when economic growth slowed down. To counteract, companies had to resort to cost cutting and reigning in investments, which led to the collapse in capital investments and waves of job cuts. According to Morgan Stanley Dean Witter, margins for US corporations have declined by 1/3 from the high reached in 1997, giving up almost all the gains throughout the 1990's, and resulting in worsening returns on invested capital (ROCI). However, signs are emerging that margins may have stabilized. Rebounds in margins will provide incentives for capital investments. Firstly, the pace of job cuts has slowed down considerably, signaling that cost cutting may have approached its target. Secondly, productivity continues its healthy growth. During the three quarters of recession, it grew at an annualized rate of 2.8%. It even recorded a growth of 5.2% in Q4 01, resulting in a 2.7% decline in unit labor cost during the same period. This is the first time in the post war history that productivity continued to grow during the recession. Rising productivity and declining unit labor cost will eventually lead to improved margins. Moreover, leading indicators such as ISM orders index has risen for two consecutive months and non-defense capital orders have risen for three consecutive months. Net earnings revisions for the last three months have risen from -20% to +1%, the first such rise in almost two years. Although CEOs remain cautious, margins may improve faster than expected. The USD51bn stimulus package also provides tax incentives to US corporations to encourage capital investments. Therefore, when we see weekly work hours begin to climb and capacity utilization begin to firm, we can safely conclude that capital investments are revived. Based on the analysis, although investments remain the weakest link for the recovery, further downfall and an ensuing double-dip are also unlikely.

By the same argument, the chance of inventory cutting leading to double-dip is also slim. While the Q4 GDP surprisingly rebounded, inventories recorded its largest decline and cut into GDP by more than 2 percentage points. However, inventory streamlining has resulted in the inventory to sales ratio falling to 1.38, the lowest level in two years and important evidence of the bottoming of the economy. In fact, as inventory drops to a low level and sales pick up, inventory rebuilding has begun, factories have increased production and inventories are being rebuilt in both the wholesale and retail levels. Instead of declining, January business inventory rose by 0.2%, the first rise since January 2001, and became the main driving force behind the recovery. The low inventory to sales ratio makes it less likely for inventory to drop further and lead to a double-dip.

Pace of growth may slow after the initial surge

Although the chance for a double-dip is slim and the rebound is coming sooner and stronger, the US economy will unlikely record the same strong growth as in the first year of recovery in the past. And it cannot be ruled out completely that growth might slow afterwards after the initial surge due to technical reasons such as a low base-year figure. The economic recovery still faces uncertainties such as (a) there was little penned-up demand in personal consumption and housing during the recession. Moreover, the sustainability of the post 9.11 patriotic consumption is still unclear. (b) Inventory rebuilding is serving as the main driving force of the recovery. But the IT revolution enables real time inventory management and thus, inventory rebuilding will not be of a large scale and long lasting. (c) The current recovery, if it indeed is a recovery, is only a partial one because investments are still declining. Constraints to recovery include low capacity utilization, lack of new industries as the engine of growth, high corporate debt ratio, subdued earnings, and possible rate hike by mid year. In view of these, investments are unlikely to grow at high rates seen before the recession.

Impacts on Hong Kong

Nevertheless, as long as the US economy avoids a double-dip, it will grow on last year's base. Its impacts on Hong Kong will be favorable, only that the extent is hard to pin down. The first sector to benefit will be trade. Hong Kong's exports to the US declined by 10% last year due to the US recession, larger than the decline of 6% of Hong Kong's total exports (the US statistics showed an even larger decline of 15.7%). But in January, US imports was up by 3.5% on the economic rebound, and consumer products imported from Hong Kong was also on the rise. So if the US economy continues to recover, Hong Kong may start to benefit from the increase in demand in the second half of the year. The second sector to benefit will be tourism. The double impacts from the recession and the 9.11 incident resulted in a 3.1% decline of tourists from the US last year. An economic recovery will at least bring a rebound in US tourists. The third sector to benefit will be the stock market. Although so far this year, the synchronization of the US and Hong Kong stock markets is slightly reduced, their correlation coefficient is still large, especially in down markets. If the US stock market improves upon economic recovery, Hong Kong's stock market should outperform last year as well. Last, Hong Kong will benefit indirectly from global economic recovery. Countries around the world will be able to benefit from a US led recovery, especially Southeastern Asian countries. Hong Kong will therefore see growth in its export and increase in service demand. Naturally, if the US economic recovery loses momentum or slows down subsequently to a larger extent, benefits to Hong Kong may be limited.