By John W. Schoen Senior producer
updated 10/6/2008 4:50:37 PM ET 2008-10-06T20:50:37

Forecasting the economy’s next move has never been easy.

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But as an association of business economists and forecasters gathers here for its 50th annual meeting, the group faces the most difficult challenge in its history. Amid the worst credit panic since the Great Depression, the rulebook for giving guidance to their companies and clients is pretty much out the window.

But the experts are giving it their best shot. In their official forecast released Monday, members of the National Association of Business Economists said they expect U.S. economic growth will come to a virtual halt in the fourth quarter. Two-thirds say the U.S economy is in recession or will be by the end of the year — up from a little over half of those surveyed in May.

And unless the credit markets get back on their feet by the end of the year, the group is looking for a GDP drop of 1.1 percent in the fourth quarter and a half-percent drop in GDP for the first quarter of 2009. That would be the first back-to-back quarterly reversal since the last recession ended in 2001.

Still, the group is hopeful things will gradually improve next year with the GDP back to 3 percent growth by the last three months of 2009. (The survey was taken Sept. 8-19 and updated last week.)

“If financial conditions fail to improve quickly, near-term economic prospects could deteriorate markedly,” said Charles Varvares, NABE’s president-elect and president of Macroeconomic Advisors.

As the group was releasing its report Monday, global financial markets were tumbling on concerns about the worsening conditions. London's FTSE index fell nearly 8 percent and the Dow Jones industrials, which were down nearly 800 points in midday trading, ended with a loss of 370 points or 3.6 percent.

On Friday, the government reported the economy lost another 159,000 jobs were lost in September, bringing the total for the year to more than a quarter-million. Ominously, the losses — which had been concentrated in hard-hit industries like housing and finance — have spread across almost every sector.

With wages stalled, home prices falling, mortgage defaults rising and jobs disappearing, the rapidly spreading credit drought is forcing consumers to tighten their belts yet another notch. The latest data suggest consumer spending is “collapsing,” according to Merrill Lynch economist Alex Patelis.

"U.S. oil demand dropped like a rock in September, down 9 percent in the last three weeks," he said in a recent note to clients. "All the evidence suggests a massive retrenchment of consumer spending in September, which will hit the rest of the world badly in due course.”

Cruide oil prices, which only a few months ago were near $150 a barrel, have fallen precipitously and are now below $90.

Retailers and other businesses that rely on short-term credit to finance inventories are getting hit hard. As that credit dries up, businesses that can't buy fresh inventory from cash flow or savings could run out of options fairly quickly. Car dealers — who maintain high-cost inventories while operating on razor-thin margins — have been hit especially hard by the credit drought.

Car dealers were already coping with a slowdown in sales and overcapacity before the credit panic hit. In addition to being shut out of inventory financing, auto buyers are having a harder time getting a car loan, according to Michael Jackson, CEO of AutoNation, the country’s largest chain of car dealers.

“We’ve gone from a credit crisis or credit squeeze to a credit panic," he said Friday. "I’ve been across the country in our stores these past couple weeks, and it is not pretty. The banks are looking for every excuse in the world to say no. And they're saying no to good customers with good credit that would be very good business for them.”

Until recently, about 90 percent of customers with good credit were approved for a loan; that rate has fallen to about 60 percent, said Jackson. For customers with a poor credit record, the approval rate has fallen from 50 percent to about 10 percent, he said.

Those lost sales are going to bring more job losses at auto manufacturers, parts suppliers and  car dealerships. Even if credit begins flowing again relatively quickly, Jackson thinks the damage to the industry has already been done.

“There's going to be a significant fallout,” he said. “Where the industry used to lose a couple hundred dealerships a year, I think over the next couple of years, that is going to break into the thousands.”

Car dealers aren't the only ones struggling with the sharp cutback in consumer lending. Retailers slashed 40,000 jobs in September, nearly double the average pace in the prior two months. Mesirow Financial chief economist Diane Swonk expects that number to continue to rise into the critical holiday shopping season.

“Most retailers cannot get funding for their inventories right now for the holiday season,” she said. “They're planning on store closures and not hiring the usual seasonal hires that they put in. All of that will work against the employment situation and make things worse before they get better going into the holiday season.”

Going into September, the economy was being dragged down by some of the usual suspects: weakness in manufacturing, the slump in housing, and the spike in energy costs. But when trying to assess the impact of a full-blown lending panic, there are few historical reference points to turn to.

“All of a sudden, in the last two weeks, things have deteriorated,” said Brian Wesbury, chief economist at First Trust Advisors. “And I think this is due to this credit crunch, this kind of panic. Never in modern-day history have we had a panic-induced recession. If it's confidence, that can be a very quick thing down. And once things get stabilized, we can come back up, and we will make up all our lost ground on the other side.”

That’s the hope, anyway. The big unknown is how much damage the structure of the economy will suffer before lending confidence returns. Once businesses close their doors, it becomes much more difficult to start up again. The collapse of several large banks and Wall Street investment firms means there will be fewer lenders when the economy revives.

The outlook also depends heavily on how widely and quickly the credit panic in the U.S. spreads to the global economy. Much of the recent strength in the U.S. has come from a surge in exports driven by a weak dollar; if overseas buyers of U.S. products get hit with their own downturn, that will cut into demand, accelerating the downturn here.

Fed officials meet Oct. 29 to decide their next move. Leery of inflation, the U.S. central bank has held its overnight lending rate steady — hoping to unfreeze the lending system instead by flooding it with cash. Now, the panic of the past two weeks may have forced the Fed’s hand. Many Fed watchers believe the Fed will cut rates by another half-point at the end of the month, if not sooner.

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