The 2001 Recession Explained

The 2001 Recession came after a long period of growth, and after the dot-com boom in the early years of the internet and the world wide web. But a drop in manufacturing across sectors also contributed. Companies stopped investing and jobs of all kinds were lost. On the plus side, it was considered a mild recession and also didn’t last very long.

Here’s the breakdown of the 2001 recession.

A recession is when the economy slows down for more than a few months. It’s usually felt in job losses, a drop in production, stagnant wages and a pullback on investments.

The good news is that expansion is the normal state of the economy and most recessions are brief. However, the time that it takes for the economy to return to its previous peak level of activity may be quite extended.[1]

The technical definition of a recession is generally accepted as when a country has at least two consecutive quarters of negative gross domestic product, or GDP (the value of goods and services produced), although this happening isn’t the sole indicator of a recession[3]. Recessions begin when the economy has reached its peak and end when it starts coming back from its lowest point, or trough [4].

In 2001, we saw the country’s longest postwar expansion come to an end after a full decade of unprecedented growth. While commonly linked to the dot-com boom and bust (we’ll get into that more below), there were several factors that caused this recession. The good news is that it was considered a mild recession, all things considered, and lasted a relatively short time, from March to November 2001 (officially, anyway).[5]

Declining auto sales and unfavorable foreign trade were early factors in the slowdown, but it was the drop in business investment, especially in information technology goods that became the dominant factor. In 2001, factories eliminated more than 1.2 million jobs and sharply dropped output.

In fact, already by late summer of 2000, U.S. automakers anticipated a decline in overall demand for new vehicles and responded by reducing output and employment, laying off 89,000 people in 2001.[6]

Steel prices also collapsed because of a drop in demand, and many U.S. steel companies filed for Chapter 11 bankruptcy protection. Paper and allied products, like primary metals, suffered from a combination of falling demand from other domestic manufacturers and falling export demand. That industry slashed 28,000 jobs.

With lower manufacturing profits, there was less demand for capital, especially high-technology goods and orders for machinery and computer equipment slumped.

And then we have the dot-com boom and bust. Internet startups flooded the market, eager to tap into the potential of the world wide web.

“The successful dot-coms of the late ‘90s and early ‘00s had a few things in common: they all vowed to “change the world”, had crazy-high valuations, and were wildly unprofitable,” internet historian Brian McCullough said in a Ted Talk.[7]

He gives Priceline.com as a prime example. The company was founded in 1998 to solve the problem of 500,000 airline seats that were going unsold every day. “Priceline offered these seats to online customers who could name the price they were willing to pay. Consumers got cheaper flights; airlines sold excess inventory; inefficiencies were ironed out of the market; and Priceline took a cut for facilitating the process: your garden-variety win-win-win-win that only the internet could make happen.”

Priceline attempted to expand into hotel bookings, car rentals and home mortgages, etc.

In March 1999, Priceline went public at $16 a share, soaring on its first day of trading to $88, giving Priceline a market capitalization of $9.8 billion. But, the company was wracking up losses.

Many other companies followed similar paths, and by the second half of 1999, “it wasn’t a question of whether or not a bubble existed, it was a question of how big a bubble it was, and when it would pop.”

By April 2000, Priceline had dropped 94%. Many of those ambitious companies collapsed, thousands of jobs were lost and everyday investors got hammered in the stock market.

“During the 1990’s we saw the birth of the internet and along with this, there was a frenzy to get onboard any internet-related stocks as the entire sector increased in value exponentially,” according to author and finance expert David Delisle. “As these stocks continued to increase in price, people became less cautious and were less interested in the fundamentals of a company and just wanted in at any cost.”

Fun Fact

In a 10-month span—between March 10, 2000 and the end of 2000—the NASDAQ index plunged more than 50%.

As you can see, there were a lot of different factors that converged to tank the economy in 2001.

On Sept. 11, 2001, terrorists attacked the U.S., flying planes in the World Trade Center in New York, the Pentagon and in a field in Pennsylvania, killing thousands of people and shocking the world.

The Federal Reserve reduced the federal funds rate target four times in the three months following the attacks, starting on Sept. 17, 2001, when it lowered the target by one-half percentage point, to 3 percent. That was interpreted as a “confidence-boosting measure” for the reopening of the New York Stock Exchange later that morning. Three more rate cuts resulted in a 1.75% rate by January 2002.

“When interest rates are low—because companies can borrow at a much lower cost—they are more likely to invest and this is when we typically see the most growth and expansion,” Delisle says. “This results in more profitable companies and a rising stock market. Interest rates affect the cost of borrowing for companies and in turn encourage, or discourage, investment and growth.”

The rate cuts were one of the biggest determining factors in getting out of the recession.

Recessions all have a few things in common, including a drop in GDP for at least two consecutive months. But it’s also important to pay attention to what we were doing before the recession that might’ve been a warning sign.

“The biggest thing to notice with any recession is how the growth becomes exponential just before the crash,” Delisle says. “Once people become less and less cautious and everyone begins to think that a recession is impossible, that’s when a recession is most likely to happen. And the greater the increase, the greater the resulting crash and recession.”

GDP growth went from 4.8% in 1999, the most since 1984, to 1% in 2001.

If you think a recession is coming like the one that happened in 2001, you can look out for some things that could tell you if a recession is on the horizon.

“When we hear that a stock market is overvalued, what that means is that we are paying much more for companies than what they actually earn,” Delisle says. “We forget that a stock is an ownership in a company and we should be aware of how profitable the company actually is.”

The dot-com bubble was a prime example of companies that were overvalued and producing zero profit and plenty of losses. Between 1995 and 2000, the Nasdaq rose a whopping 500%. By 2002, it had fallen by 77%, and wouldn’t return to its 2000-level glory for another 15 years.

“The more overvalued a stock market becomes, the closer we are getting to a potential crash,” Delisle says. “Conservative investors will always think the crash is just around the corner while more aggressive investors will think the crash is further away. The reality is somewhere in between.”

A crash doesn’t always trigger a recession, but in many instances, it’s a sign one is coming. Lots of stock market fluctuation can cause consumers to lose confidence, which may also cause a recession. With a few different ways to spot a possible recession, see what happened in other recessions throughout history as a predictor for what’s to come.