| BUSINESSWEEK ONLINE : JUNE 14, 1999 ISSUE | |||||||||||||||||||||||||||
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| COVER STORY
Commentary: Why the U.S. Will Keep On Soaring Last September, just after the Dow had shed about 2,000 points, Federal Reserve Chairman Alan Greenspan said--twice--that the U.S. economy likely couldn't remain an ''oasis of prosperity'' in such a troubled global economy. Forecasters were impressed, especially as the Fed began a series of interest-rate cuts aimed at warding off a possible U.S. recession. Economists issued some of the most dreary forecasts in years, on average predicting only 1.9% growth for 1999. Boy, were they wrong. The U.S. not only remains an oasis, it is thriving. Even as many prognosticators put out their grim outlooks, the economy was surging 6% in the final quarter of 1998, and it grew 4.1% in the first quarter of 1999. Recent strength in domestic demand, especially by consumers, is unprecedented this late in a business cycle. Economists now expect fourth-quarter to fourth-quarter growth of 3.3% in 1999, according to a survey by Blue Chip Economic Indicators. Why is demand so resilient, and likely to remain so? The strongest labor market in a generation heads the list of reasons, plus a strong stock market and relatively low interest rates. But the real glue holding this splendid economic structure together is inflation's decline to the closest thing to price stability since the 1960s. And to a great extent, the outlook for the economy boils down to the outlook for inflation. Despite the recent uptick in consumer prices and interest-rate jitters in the markets, the outlook for inflation is buoyed by powerful anti-inflation forces. First, investment in new technologies is lifting productivity and curbing unit-labor costs. Second, any global recovery will be too slow to absorb a worldwide capacity glut quickly, and lots of U.S. capacity remains idle. Third, growth and interest-rate differentials between the U.S. and other nations will support a strong dollar and hold down import prices. Plus, past deregulation in transportation, finance, telecom, and other industries is boosting U.S. competition, and both monetary and fiscal policy are anti-inflationary. STOCK EFFECT. As a result, Blue Chip's economists see consumer inflation rising to 2.1%, from 1.5% in '98--but that pickup reflects the 67% hike in oil prices in March and April. Core inflation should hold steady. And oil prices are down nearly $3 per barrel since early May. Continued low inflation works its magic in several ways. First and foremost, it is the key to the stock market's seeming invincibility. Increased stock wealth has accounted for up to 1 percentage point of the economy's 4% growth rate. Low inflation justifies higher price-earnings ratios, because it helps the two key factors in stock valuations: profits and interest rates. Low inflation holds rates down by keeping the Federal Reserve on the sidelines, and it makes companies more cost-conscious and more efficient, which supports profits even amid weak pricing power. At the same time, falling inflation boosts household buying power. In the 1980s, workers' wages grew 4.2% per year, but real wages stagnated. Since 1995, pay is rising at a slower 3.4% rate, but growth in real pay is the fastest in three decades. Also, low inflation helps to hold down the cost of capital as companies rush to invest in new technology. In order to ensure that inflation stays bottled up and the Fed keeps to the sidelines, growth may have to slow a notch--from red-hot to merely strong. And that seems likely. Consumer spending will power the economy, fueled by fine fundamentals, but continued growth at its torrid 5.5% pace is unlikely. Capital spending is already slowing a bit, and housing may be topping out. Also, a further widening in the trade deficit will be a sizable drag. So, are there any worries on the horizon? Here are the top three: a large and sustained swoon in the stock market, tight labor markets, and the huge U.S. trade gap, which could weaken the dollar. But these are not new worries, and judging by the economy's surprising performance so far in 1999, they are likely to remain on the back burner a while longer. BY JAMES C. COOPER _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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