CUTTING RATES

November 17, 1998

The Federal Reserve cut short-term interest rates a quarter of a point. Elizabeth Farnsworth is joined by four regional analysts to discuss the impact.

JIM LEHRER: Elizabeth Farnsworth in San Francisco has the interest rate story. ELIZABETH FARNSWORTH: In cutting short-term interest rates a quarter of a point today the Federal Reserve released a statement saying that "although conditions in financial markets have settled down materially since mid-October, unusual strains remain." Four regional economic analysts now help us see the strains, as well as continued strengths in the US economy. Morton Marcus is Professor of Economics at Indiana University's Kelley School of Business; Keith Phillips is senior economic for the San Antonio branch of the Federal Reserve Bank of Dallas. Don Ratajczak directs the regional forecasting center at Georgia State University; and Mary Bechmann is a venture capitalist in California's Silicon Valley. ELIZABETH FARNSWORTH: Morton Marcus, were the Fed cuts today the right thing for your region's economy? MORTON MARCUS, Indiana University: I think it's very clear that these cuts will help in the Midwest. The Midwest is very dependent on the production of durable goods, which means that we're looking forward to more consumer spending as a result of this. Now, whether that's the right thing for the national economy as opposed to the regional economy I think is a different story. These Fed cuts may indicate much more weakness in the financial system of the United States than any of us may have anticipated. ELIZABETH FARNSWORTH: What do you mean? MORTON MARCUS: Well, if you're going to cut these rates and make reference not to a weaker economy but make the reference to the financial markets and to the financial institutions, then the Fed is sort of signaling that it isn't the economy on which they have their eyes, as much as it is the condition of our banks. ELIZABETH FARNSWORTH: Interesting. Is that - that's not what you're seeing in your region, I gather, the weak bank - MORTON MARCUS: No. ELIZABETH FARNSWORTH: You're rather seeing the capital goods weaknesses. MORTON MARCUS: Banks in the Midwest by and large are not heavily involved in lending to Brazil or to Southeast Asian countries. That generally takes place in the big money market centers. But I think this has to be something of concern to the country. ELIZABETH FARNSWORTH: Well, Keith Phillips, what do you think about that? You're an economist with a Fed bank. KEITH PHILLIPS, Federal Reserve Bank of Dallas: Well, I can't really comment on the reason behind the Fed cuts. I can say that this region of the country has been performing quite well over the past several years, and we do see signs of slowing in the economy. While overall employment growth has been steady over the last six months, our leading indicators suggest that growth is likely to slow. And we're seeing some effects, particularly in the energy sector and petrochemicals and agriculture of the Asian situation. And we are seeing some - once again, some signs of slowing. ELIZABETH FARNSWORTH: And will the cuts that were announced today help, do you think? KEITH PHILLIPS: Well, in general, lower interest rates do stimulate economic activity, and as we've seen. We've seen drops in mortgage rates and other financial long rates through the first half of this year, and we've seen strength in construction. So certainly lower interest rates do promote faster growth. ELIZABETH FARNSWORTH: Mary Bechmann, what are we seeing? What are you seeing in California, a slowdown here like other people are reporting? MARY BECHMANN, Venture Capitalist: Well, we've certainly seen some cooling off. You know, the housing market's slowed, real estate prices have stabilized, although not dropped, up and down the western corridor, and we've seen the IPO market still remain shut. ELIZABETH FARNSWORTH: What's that? MARY BECHMANN: The Initial Public Offering marketplace for young startup companies to go public and gain liquidity for the shareholders for the first time. But at the same time we've seen some slowing, we've also seen some surprising signs of a rebound. For example, in the - we've seen companies report some surprisingly good earnings. We've seen also some comeback from certain sectors up in the Pacific Northwest, for example, because their economy is more diverse. That's good news and bad news. But, by and large, I think I'd describe what we got out here really has focusing on the Internet and kind of dancing around with that 900-pound guerrilla. That's really what's driving optimism out here, what's driving confidence both at the corporate level and at the consumer level, and people are focused on what's the next great Internet play, how is electronic commerce going to affect my life and my job and my holiday season, for that matter. ELIZABETH FARNSWORTH: So you're saying that the kinds of weakness in the global economy that we've been focused on that have caused the ups and downs in the stock market, that have caused the Fed to have three interest rate cuts since September, that's not what the people you are talking to are worried about. MARY BECHMANN: That's not what I'm hearing and feeling and seeing out there. Certainly, Asia is still an issue, and, in fact, it's an important issue because if you do look a bit at some of these earnings announcements that have been surprisingly on target or good lately, if you peel back the onion a bit, what you can see is perhaps the skittish quality of earnings. And what I mean by that is that instead of earnings growth coming from high revenues or good margins, instead, you've got cost cutting moving to the fore and declining margins are still occurring across the board, but by and large, you've got people really kicking into gear with cutting overhead and still doing some layoffs, although the survivors and the smart companies have pretty much done their layoffs two to three quarters ago, and they're now poised to take advantage of whatever bounces there may be in demand. ELIZABETH FARNSWORTH: Don Ratajczak, how about the Southeast, what strains and strengths have you got? DON RATAJCZAK, Georgia State University: Well, we monitor 13 states in the Southeast. We have indicators on a quarterly basis. Of those thirteen states we only see one state, Louisiana, that has any recessionary tendencies, and we're not yet ready to say that that state, which is a heavy energy-producing state, is about to fall into recession; however, there's no question that the region has slowed its rate of growth. And in some areas like in the apparel area, well, in girls and outer garments we've seen a 20 percent drop in employment in the last 12 months. ELIZABETH FARNSWORTH: How will today's move by the Fed affect some of those strains? DON RATAJCZAK: Well, quite frankly, I don't think ¾ percentage point drop in interest rates over the past eight weeks is going to have any easing effect upon the competition that's basically driving out the apparel industry. In other areas, perhaps housing will see some moderation. We've also - this is a region where we have lower than national average per capita incomes, but we have faster population growth. We need to grow, but we can't finance it internally, so we need to depend upon those money center banks in Chicago and New York and even international banks. And I have heard some problems of some financing moving forward. And the hope is that these Federal Reserve reductions will make it a little bit easier to put development deals and business deals together. ELIZABETH FARNSWORTH: You're talking about - when you talk about finance moving forward, you're talking about some reports of a credit crunch for companies. DON RATAJCZAK: Some businesses that a year ago would readily receive financing from a money center bank, those businesses are now being told that they're not welcome there. Now, those businesses have been finding alternative financing, usually in some of the regional banks. But they're not quite the same deal. And it is a little bit of a struggle to get financing. ELIZABETH FARNSWORTH: Martin Marcus, in your region, do you think that the worst of the effects of the economic crisis from Asia are over? Has bottom been hit and now the economy is coming back, or could there be worse to come? MORTON MARCUS: I don't think there's much worse to come. It does seem as though we've hit bottom in most of Southeast Asia and East Asia. The effects on American companies, however, are not fully known until we start bringing back the earnings. You have to remember that when the value of the dollar grows so dramatically compared to many of these foreign currencies, we ended up with a situation that the earnings we were bringing back were worth much less in dollars. Now, as the dollar declines, that will actually improve the situation for American corporations here in the Midwest that own facilities overseas. ELIZABETH FARNSWORTH: And then you were saying also that this action today by the Fed may indicate problems nationally that haven't really been publicized much. MORTON MARCUS: We find that large numbers of people still believe that everything is absolutely wonderful. The signs of slowing haven't really been widely understood and widely perceived. I think that the other economies are quite right in observing them. And we certainly observe them here in the Midwest. But by and large, most people tend to believe that everything is going very well. What's going to happen from here on out is probably those signs of slowing will come to people, they'll begin to recognize them, and this activity of the Fed will make it clear that there is some problem that has to be addressed. And what we can hope is that this cut helps. But you really have to examine this economy, which had been in some respects terribly overheated. And I'm not sure that cutting interest rates is a movement in the right direction. I think that we really want to ask ourselves how much more consumption do we want to encourage? ELIZABETH FARNSWORTH: Keith Phillips, do you think the worst is over in your region of the economy? You mentioned oil and other prices that have been caused by the global economic slowdown. KEITH PHILLIPS: Yes. I don't - for one thing we, once again, have been growing at a quite healthy rate. I think we'll see further slowing. The oil companies entered this year with very strong capital. They had a very good year last year with oil prices hanging around $20 per barrel for most of the year. The decline in oil prices or the lower level of oil prices is now seen as a prolonged situation. And the oil companies are now just starting to cut back. And we should see further cutbacks based on announcements of layoffs into the future. As Dr. Ratajczak mentioned, Louisiana is starting to see employment declines. And they're the state that's most sensitive to oil price declines. This enters directly through oil price effects on our state through royalties and other such things and direct employment in oil and gas but also enters - also through the effects on Mexico. Mexico - about 40 percent of Texas exports goes to Mexico, and right now they're experiencing quite a bit of a crunch since 40 percent of their government revenues comes from oil exports. So we expect to see further slowing next year based on the situation in the energy markets, but, once again, we don't perceive recession, just a slowing from very healthy rates of growth and more moderate rates of growth. ELIZABETH FARNSWORTH: And Don Ratajczak, how about in your area, strains under the surface that could get a lot worse, or do you think the worst has passed? DON RATAJCZAK: We're going to slow down further. We have some problems in our forestry, in our paper products, as I mentioned already, in our apparel industry. We are seeing some slowing in the growth of temporary - demand for temporary workers, and that's not a good sign, but we're far from anything that's - could be called an actual downturn. In fact, our consumers really feel very comfortable at the present time. ELIZABETH FARNSWORTH: How about here? MARY BECHMANN: Well, I disagree a little bit with the theory that we've seen the worst in Asia, and it's over, because I think there's a psychological issue here. And what I mean is that we had the big meltdown in Hong Kong and throughout the rest of the region, but only recently have we seen increased volatility in places like Malaysia, which were until fairly recently regarded as being more of a safe haven, especially for companies - [network difficulty - audio lost] - JIM LEHRER: Yes. We've lost audio from San Francisco on the whole segment, but it was almost over anyhow, and Malaysia was just mentioned, and this is our very next story, and after that, waiting for Starr and a cosmic shower.

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