What Greenspan Knows About Sustainable

Alan Greenspan thinks the U.S. and world economies are growing faster than most people believe--and he’s right.

The Federal Reserve Board chairman cooled off the stock and bond markets in a hurry last week when he told a House committee that the U.S. economy “has been on an unsustainable track.” The specter of inflation could push the Fed to apply the brakes by raising interest rates, he suggested.

Many investment pros are muttering that Greenspan is behind the curve, that the U.S. economy, despite Friday’s report on wholesale price rises, has been slowing down.

But the Fed chairman was looking at the larger reality of the world economy, which is picking up speed, and at vast flows of funds around the world causing some distortions in U.S. markets.

Rightly, he injected a note of caution to a roaring bull market.

If we step back and look at some clues in the world economy right now, we can not only understand Greenspan’s perspective, but also get an idea of what’s ahead for business and financial markets.

And we may also glean answers to questions of what sustains the U.S. stock and bond markets, which have created trillions of dollars in new wealth for pension and mutual fund holders in recent years, and--equally important--what could knock those markets down.

The markets are sustained by extraordinary strength in the underlying economy. Motorola gave a clue to the real pace of the world economy last week when it forecast a 15% to 17% rise in semiconductor sales next year.

Dataquest, the San Jose-based research organization, confirmed that forecast and more--predicting that worldwide semiconductor sales will take off in 1998 and keep growing for the next three years, from $150 billion to $300 billion.

That’s significant because semiconductors are the raw material of modern industry. Motorola’s microchips go into automobile engines and air bag assemblies, into computers, telephones, microwave ovens and industrial machines.

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All aspects of its $8-billion semiconductor business--one quarter of the company’s $30 billion in total sales--will be growing rapidly, the company said. And sales will be expanding fastest in North and South America and in the Asia Pacific region--where economic growth will continue despite present currency troubles.

To meet the anticipated demand, Motorola last week announced a $1.1-billion investment to more than double capacity and add 500 jobs at its plant in Chandler, Ariz.

“The business is being driven by a new cycle of demand for computers that serve Internet traffic and by telecommunications overseas,” explains George Sollman, vice chairman of Centigram Communications, a San Jose-based supplier of cellular phone message systems.

What’s happening is that countries around the world are using electronics to modernize production and services, to do things faster, better, less expensively.

That adds up to gains in productivity and is not inflationary. It’s a new economy, say critics, who ask loudly whether Greenspan understands that.

Sure he understands the new economy. But he also sees labor shortages and delays in getting spare parts driving up the cost of doing business if the U.S. economy grows too fast.

“It’s simple. If there is more economic activity, you need truck drivers to haul the goods around,” notes economist David Jones of Aubrey G. Lanston Co., a Wall Street investment firm. “Greenspan is trying to head off a strained economy.” Indeed, shortages of software programmers and long-distance truckers are already evident.

Greenspan also understands flows of money around the world. U.S. interest rates on Treasury bills and bonds have been high compared with rates in Japan and Germany, so financially adept people borrowed in those countries and invested in U.S. Treasuries and U.S. stock markets.

This has been happening on a huge scale. Morgan Stanley’s chief economist Stephen Roach reports that net foreign purchases of U.S. securities exploded in the last two years to $465 billion, more than 2 1/2 times the previous two-year period.

And it’s likely to have been $200 billion greater than that. “Government statistics are terribly flawed,” says Woodside, Calif., investment advisor Kenneth Fisher.

The money is a boon, but not a particularly stable one. The great inflows of foreign money hold interest rates down here and support stock prices.

But a hike in foreign interest rates, such as occurred in Germany last week, could cause such money to flow away from the U.S. again.

And a pickup in European and Asian economies, plus the stronger growth going on in Latin America, could cause investment to flow back to those parts of the world.

Don’t panic. A reallocation of world investments wouldn’t cause a collapse of U.S. stock and bond markets. But it could diminish their luster. And with so many Americans feeling richer these days thanks to their mutual funds, 401(k) accounts and pension funds--and so many borrowing against such wealth--a market drop could feed a psychological and economic downturn.

So Greenspan issued his warning, and Fed policymakers may indeed raise interest rates at their meeting in November.

That wouldn’t necessarily be a bad thing for the markets, says William Gross, managing director and a bond market expert at Pacific Investment Management in Newport Beach. “The United Kingdom and Canada recently raised basic interest rates and their markets rallied,” Gross observes.

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Greenspan’s purpose is to lean against the wind. He understands all the theories about the new economy, but he can’t afford to gamble. If he does nothing and the financial markets spiral upward, as they have lately, he could be risking a crash that would hurt the whole economy.

If he keeps a firm hand on the tiller, raises interest rates a notch, the risk is that markets will pause in their long ascent. The U.S. and world economies, in their present strength, certainly won’t be knocked for a loop.

The investment research department at Bessemer Trust put the situation very well in a letter last week. The most important factor behind the strength of the economy and the markets is American technology, creating new industries and enabling people everywhere to do things faster, better, less expensively. “Productivity is not a mirage,” says Bessemer’s letter.

Bessemer Trust should know. It is the financial descendant of the fortune built up by Henry Bessemer, who in 1875 invented the process for making steel from pig iron that powered the previous industrial revolution.

In short, the factors driving the world economy, financial markets and even Greenspan’s thinking are complex, but not mysterious.

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In the Chips

An important sign of a robust world economy is the accelerating sales growth in semiconductors, the raw material of industries from automobiles to computers to telephones. The chart projects worldwide sales in billions of dollars.

2001: $300 billion

Source: Dataquest Research