All Good Things Must End, but Try Telling That to the U.S. Economy
In many respects, the U.S. economy is daring Federal Reserve Chairman Alan Greenspan and his cohorts to raise interest rates. But when they get together on Tuesday and Wednesday for a regular policy meeting, odds are they won’t.
Despite a brisk 4.7% (annualized) gain in real U.S. growth in the fourth quarter, as reported by the Commerce Department on Friday, the economy continues to amaze and confound--in the best possible way.
Faster growth usually generates higher inflation, which then puts the Fed on war footing, driving interest rates up. Yet the “core” consumer inflation rate last year, excluding food and energy, was just 2.6%, matching the 30-year low rate of 1994.
In the fourth-quarter gross domestic product report, the government said the GDP implicit price deflator, another gauge of inflationary pressures in the economy, rose at an annualized rate of just 1.4%--the lowest since 1967, even as economic growth picked up speed.
The data left many an analyst searching through the thesaurus for new superlatives with which to describe the American economy, because “nirvana” has become so overused.
As far as the Fed is concerned, Friday’s numbers suggest that the “long, good cycle” is still more or less intact--meaning the cycle of economic growth and benign inflation that has been the rule all through the 1990s.
This long cycle has been the basis for the U.S. stock market’s terrific rally since 1990, and for the job growth that has pushed unemployment to a seven-year low.
But like all cycles, this one will eventually end. And that is what preoccupies the Fed and every Wall Street strategist: They are all watching for some sign that the economy’s equilibrium is threatened--specifically, that growth is reaching a pace that would imply greater inflation ahead.
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By some measures, Greenspan could argue that the Fed would be justified in tightening credit now to brake growth, because even if he can’t yet see the whites of (higher) inflation’s eyes, he can see from a distance the glint off that devil’s Ray-Bans.
For one, fourth-quarter growth was above expectations, thanks in large part to strong consumer spending--those tales of dismal holiday retail sales notwithstanding. “This report is telling us that the consumer is doing very well,” said Sung Won Sohn, economist at Norwest Corp. in Minneapolis.
And many consumers ought to be feeling better about their spending power: Average U.S. hourly wages grew 3.8% last year, the fastest pace since 1990.
For workers, bigger pay raises undoubtedly seemed overdue, and something to celebrate. But for Greenspan, with the labor market extremely tight in many regions of the country, last year’s wage growth is the most worrisome aspect of the economy: He fears the beginning of a classic inflationary spiral, whereby faster wage growth drives spending, which allows more goods producers to raise prices, which then causes workers to demand even bigger raises, etc., etc.
“I believe that Greenspan believes that inflation and [worker] compensation move hand in hand,” said Donald Straszheim, economist at Merrill Lynch & Co. in New York.
Yet as the fourth-quarter GDP report again demonstrated, Greenspan’s feared compensation/inflation equation is incomplete, because inflation isn’t playing along--not in the official statistics anyway.
“Wage pressure is growing. The puzzle is why that has not led to more overall inflation,” said Sohn. The favored theories for why this is so: Global competition limits companies’ ability to raise product prices, and companies can afford to pay higher wages, without raising prices, because their workers are so incredibly productive.
In any case, as long as inflation is subdued, the Fed faces political pressure to relax its trigger finger and leave interest rates alone. For all the Fed knows, the “long, good cycle” can run a lot longer.
True, Greenspan raised rates in 1994 without any whiff of higher inflation in the air. But at that time the Fed was holding short-term rates at 3%--a 30-year low--while the economy was clearly gaining steam. Today, short-term rates are around 5.25%, which is above their levels for most of the 1960s--the last time the economy was expanding with low inflation.
If the Fed needs another reason to hold back from tightening credit, it’s this: There is little belief among forecasters that global economic growth will reach a robust pace any time soon.
As another story in today’s Business section details, Japan’s economy finally rebounded an estimated 3.4% last year. But given the dismal growth rate of 1991-95, “that is uninspiring for a snap-back,” said Merrill Lynch’s Straszheim. And he sees no chance that Japan, struggling with massive structural changes, will be an engine of economic growth for the world this year.
Europe, meanwhile, also is dealing with tremendous structural upheaval as it careens toward monetary union in 1999. With unemployment at frightening levels, worried European consumers holding back on spending and most governments reining in fiscal policy to cut budget deficits, the International Monetary Fund sees European real growth this year at 2.5%--up from an estimated 1.6% in 1996 but still below 1994’s 2.8%.
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For the United States, the potential depressants on GDP in 1997 are slower export growth because of the stronger dollar (essentially, a transfer of growth potential from here to Europe and Japan) and a slower pace of business investment, as corporate profit growth ebbs.
In short, for both the industrialized world and the developing world that still relies in part on the former for its growth, 1997 could look a lot like 1996 and 1995: a year of moderate expansion.
As far as world stock and bond markets are concerned, that would probably be just fine, because it suggests that the “long, good cycle” still has legs.
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Two Worlds
Economic growth in the industrialized world is still far below the levels of the late-1980s. In the developing world, meanwhile, growth has been faster than the late-80s pace, but even there it has plateaued in recent years. Real gross domestic product growth, as calculated by the International Monetary Fund:
1997*
Industrialized countries: 2.5%
Developing countries: 6.2%
* Estimate
Source: International Monetary Fund
