Spring Forward, Don’t Fall Back

Southern Californians may not fully appreciate it, but April is a month of change. In most of the rest of the country, cold weather and gray skies give way to sunshine and warmth. Lawns, trees and bushes respond by greening up, while splashes of color dot the landscape, providing a picturesque setting for the return of migratory fowl.

We mark the occasion by switching to daylight savings time. This way, the rest of the country gets to do what Southern Californians do practically all year around--enjoy the great outdoors.

To help us remember which way to move the clock, we are taught the phrase “spring forward, fall back.” This might also be a good lesson for economists to learn, as they sift through each batch of statistics searching for clues regarding the direction of the economy and the financial markets.

Too many economists these days seem to be falling back, rather than springing forward. They are worried too much about the past and not enough about the future.

The current fixation with inflation is a good example of concentrating on the past; focusing on tight money and the growing possibility of recession constitutes looking ahead.

Inflation is nothing new. We’ve had inflation every year in the postwar era except two--1949 and 1955. In the other years the price level went up, the only difference being the rate of rise.

In some years, price inflation was moderate, while in others it was more severe. On three occasions, the rate of inflation reached double-digits (10% or more); these and five additional flare-ups led to our eight postwar recessions.

Since 1983, however, we have managed to keep inflation fairly steady at moderate rates. As I observed in my last column, this can be traced to a rather unusual set of developments, ranging from the severity of the last recession, to the earlier rise in the dollar, to the fall in oil prices--and to the stock market crash.

This latter event, you will recall, persuaded labor and management not to raise prices because of the widespread fear that the stock crash was a prelude to a recession--or worse.

Ironically, when a recession did not develop, the markets came to the conclusion that inflation was about to break out of its trend and worsen. Their reasoning was that any economy that could weather 1987’s stock market crash must be strong enough to generate a new round of inflation.

Twisting around the words of the late Will Rogers, the markets from that point on never met a statistic they liked. Every number seemed to contain the seeds of inflation. As a result, the markets provoked the Federal Reserve into tightening money with a vengeance:

Short-term interest rates shot up more than three percentage points during a year’s time.

This produced an inverted yield curve, where short-term rates rise above long-term rates--a development that has appeared before every postwar recession.

Bank reserves and the money supply have hardly grown at all for more than a year.

Not surprisingly, the expansion is beginning to show its age:

Employment growth has slowed, while the number of hours in the average work week has begun to decline.

Consumer spending has softened, with purchases of goods no higher than levels first reached 2 1/2 years ago.

New car sales last month skidded to their lowest levels since November, 1987--right after the market’s crash.

Southern California notwithstanding, the residential real estate market has softened dramatically, as rising interest rates have kept an increasing number of families from buying homes.

Factory output is declining, as are new orders, capacity use, imports and exports.

Unsold goods are beginning to pile up.

As plentiful as this evidence of a slower economy is, it is not sufficient for the inflation-conscious markets. They will not let the Federal Reserve take its foot off the monetary brake until they are certain that this slowdown is for real--not just another false signal.

This will also want to see signs that inflation is moderating.

The trouble is, by the time the markets are satisfied with the trend of inflation and the pace of economic activity, it may be too late.

For one thing, inflation usually does not respond immediately to a softening in the economy. The record shows that many times inflation has continued to worsen months after a slowdown--or a recession--has begun.

The record also shows that once an economy loses forward momentum, it doesn’t just stand still--it slips backward.

This is because inventories pile up, and as business try to reduce them, they wind up slashing orders, which in turn forces suppliers to cut output and employment, further depressing spending, which causes goods to pile up even more.

Then there are the problems peculiar to the current expansion. Besides its record length, these revolve mainly around the unprecedented debt burdens of consumers, business and the developing countries. Let us not forget the plight of the savings and loan firms and Washington’s budget deficit, which would grow--not contract--in the event of a recession.

It is to be hoped that April will turn out to have marked a change in the direction of interest rates, thus ensuring the continuation of the expansion, rather than a change from expansion to recession. Time will tell.