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Tuesday, 21 August, 2001, 15:40 GMT 16:40 UK
Q&A: What caused the US slowdown?
The US economy has slowed sharply in the first half of 2001, renewing fears of a world economic slump. But what are the reasons for the sudden downturn? BBC News Online's Steve Schifferes explains.

Where did the US slowdown start?

Unlike some previous recessions, the current US slowdown seems to have been caused not by reluctant consumers, but by a sudden slump in company spending.

During the boom years, many US firms invested heavily in information technology systems.

Overall investment grew by nearly 20% each year, helping companies boost productivity and achieve higher output with fewer workers.

Much of this was financed by borrowing.

But these investments were based on very optimistic forecasts for US economic growth.

But when the dot-com bubble on the stockmarkets burst, and some experts began to downgrade their optimistic forecasts, companies realised that they needed to cut back on their investment.

For the last six months, many businesses have been dramatically scaling down their investment plans for the coming year.

How did the investment freeze affect other sectors?

The first to feel the effects of the slowdown in company investment were high-tech firms who supply equipment to companies.

They were forced to cut back production, but many were left with surplus inventories that they had to sell fast and at low prices. This hit their profits.

And in order to preserve their profit margins, they had to cut back on expenses and lay-off workers, which had a further effect on confidence.

How did the stock market impact on companies?

Companies, like individuals, were basing many of their acquisitions on the fact that their stock price was so high, making it easy to justify investment in both equipment and the acquisition of other companies.

But the high stock price was also based on unrealistic estimates of how fast profits and sales could rise.

When profits began to crumble, share prices plunged, which in turn hit confidence in the corporate sector.

The fall in share prices also meant that it was difficult for new start-up companies to raise money. This hurt for example the internet and the telecoms sectors.

An additional problem was the fact that many vendor-financing schemes went wrong.

What is vendor financing?

Vendor financing means that manufacturers lend money to their customers, to help them buy more equipment.

That probably encouraged some firms to buy more new equipment than they needed, and increased the size of their debts.

When growth slowed, and share prices slumped, they were unable to raise money for further expansion.

That meant they were unable to pay off those debts, and the balance sheets of equipment suppliers suffered even more.

Will interest rate cuts do the trick?

Many of the companies with huge debts have decided that they need to cut back dramatically on their spending, whatever the level of interest rates - so rate cuts may be less effective as a policy instrument.

The Fed can ease the burden of debt, but it cannot encourage companies to spend money as long as these firms do not see an increasing demand for their products.

And it cannot restore company profits through rate cuts in the short-term.

However, interest rate cuts may help reassure consumers, who are also burdened by a high level of debts and have been hit by the fall in stock prices.

They may also help undermine the stock and bond market, thus protecting people's savings.

How will the slowdown effect the wider economy?

Many recessions occur because consumers cut back on spending, often because of an 'external shock', for example a sharp increase in the price of oil.

However, the corporate-led slowdown also hurts many consumers through job cuts.

That is having a broader effect on consumer confidence, making individuals more likely to postpone the purchase of expensive items like automobiles.

And since many US consumers own shares, the fall in their value also makes them feel less wealthy, discouraging spending.

If the corporate slowdown results in a drop of consumer spending, then the US economy could be in real trouble.

However, so far although consumer confidence has fallen, consumer spending has fallen far less.

US consumers may be worried by the alarming reports about the future of the economy, but they are still feeling relatively prosperous - for now.

How long will the slowdown last?

The truth is that no one knows.

The corporate sector, although a smaller part of the economy, tends to make more rapid adjustments.

It started to cut back capital spending rapidly at the end of 2000, but has also cut back its production and shed jobs.

If the consumer sector - which makes up two-thirds of the economy - also starts to decline, then the US could be headed for a recession.

The US government hopes that the combination of interest rate cuts and a modest tax cut which is being distributed to all taxpayers this summer will help the economy to recover, and keep consumers spending.

It predicts growth next year of over 3%, double the rate expected in 2001.

But a prolonged slowdown could affect growth throughout the rest of the world - already Asian exporters to the US are suffering badly.


Terror's impact

Signs of a slowdown

Rate cuts

Analysis

Key players

FULL SPECIAL REPORT
Links to more Business stories are at the foot of the page.


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