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Don’t Believe All the Bad Economic News

We may be looking good. A spate of government statistics and Federal Reserve surveys released last week show the economy to be in relatively good health after a slow period.

Or we may be looking bad. A Federal Reserve official worried that rising inflation in the strong economy could force a hike in interest rates.

In short, another case of the two-handed economy: sunshine on the one hand, rain on the other.

What should you believe? Very little. When it comes to most claims about the economy, it’s best to be skeptical and to look behind the statistics, where, as it happens, the story is often reassuring.

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A clear eye could be particularly useful this week because the U.S. government will offer $30.5 billion of new Treasury bonds for sale in one of its periodic refundings of the national debt. The bonds, in maturities of 3, 10 and 30 years, are expected to offer high interest rates--approaching 9%.

Experts are calling them a good deal for the small investor, who can buy bonds directly from the Federal Reserve or through banks or brokers in $5,000 increments for the three-year maturities and in lots of $1,000 for the longer durations.

But this is where you need a feel for inflation, because a rise in the consumer price index on the order of the 8.5% jump that occurred in the first three months of 1990 could wipe out the return on the bonds. At 9% interest, a $5,000 investment will pay $450 interest per year, or $324 after 28% federal income tax. If inflation stays at 4.5% or less, that would give you a real gain of $100 a year or more. But if inflation were higher, your Treasury bond would be a loser.

Moreover, higher inflation would bring still higher interest rates, causing your bonds to sell at a discount--meaning you would lose principal if you sold before maturity. The upshot is that if the outlook is higher inflation, you’d be better off in a short-term money fund, which can keep abreast of rising interest rates.

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So it’s important that you know the real story on inflation--which is reassuring. Experts are agreed that the first quarter was a fluke--food and fuel prices rose because of extreme cold weather. The April-June quarter will show inflation below 4%, says Stacy Kaufman of Georgia State University’s Economic Forecasting Project, and the rate for the year should settle at 4.5% or so.

Even that may overstate the case, if you consider what goes into the government’s inflation index. Apparel, for example, is a major component of the CPI. But clothing prices jump around as stores go from discounting older styles to charging more for new spring fashions. Later, as those fashions are discounted in turn, prices fall and with them the inflation rate. Apparel is a big industry to be sure, but nobody believes that fashion should determine interest rates for the whole economy.

In any event, 4.5% inflation is no crisis.

As to the economy, the good times returning are not boom times and so are unlikely to force a boost in interest rates. The recovery owes a lot to 230,000 workers regaining their jobs in the automobile, metals and rubber industries, explains John Paulus, chief economist at Morgan Stanley. The rise in unemployment last month reflects a slowdown in construction.

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Meanwhile, the defense-aerospace industries, which employ roughly 1.3 million nationwide--perhaps 400,000 in Southern California--remain vulnerable to budget cuts being debated in Congress. Cutting back will present problems, but not inflationary ones.

“Business is gradually regaining momentum, but there is no boom,” says Adrian Dillon, chief economist of Eaton Corp., a Cleveland maker of automotive and electrical equipment. And good profits are hard to come by, especially with global competitors setting up right in the U.S. market. The result is that American companies are having to cut costs--which is why the latest figures show rising investment in computers and other automated equipment. That spending will result in more production at less cost--higher productivity, in other words, and thus lower inflation.

But even there, measures of the economy may not fully reflect reality. It is said, for instance, that medical costs keep pushing up inflation. But that may be measuring the cost more than the economic benefit of the expensive new heart monitor that saves lives. More simply, if the dentist fills a tooth less painfully because of new materials or equipment, the bill may go up to reflect the equipment but the gain in painlessness may go unrecorded.

The point is that simple statistics seldom capture the complex and resilient U.S economy--$5.4 trillion a year in goods and services. And fears about its fragility are usually overblown.

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In that regard, you may recall the Treasury’s last refinancing, in February, and the widespread worry then that Japanese investors wouldn’t be big buyers. As it happened, Japanese investors bought their customary percentage, but the real story of that $30-billion auction was that U.S. investors were eager buyers.

And this week should see brisk demand for the Treasury’s new bonds. Why? Because the American people have recently increased their personal savings by $200 billion and so have plenty of investable funds. Those are the same Americans who only recently were said to be saving so little that the whole economy was threatened. The moral, again: Don’t believe everything you hear and keep your eyes open.


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