LOWER LONG RATES: THE LAST PIECE IN THE PUZZLE?
Wake up, folks. The world is changing. That may well be the message from the surprising pickup in economic growth at the end of 1992.
Some three years have passed since analysts began to talk about the economy's structural problems, mostly born of the policies of the 1980s. But after struggling with growth of only 0.4% annually from the second quarter of 1989 to the same quarter of 1992, the economy has suddenly posted its strongest two-quarter advance in nearly five years (chart). That could be a signal that the economy has made significant progress in working through some of those structural barriers to growth.
What's more, with long-term interest rates falling, those obstacles are going to crumble even faster. First and foremost, lower long rates directly address the economy's debt burdens. In particular, the race to refinance will continue to free up billions for Household and Corporate America (page 26). The rate drop will also float a lot of sunken residential and commercial real estate.
In addition: Falling long-term rates will fatten bank profits, as banks realize gains from their huge holdings of Treasury securities, and they will boost competition among banks for private loans. They are pushing down the cost of capital just when businesses are investing more in new high-tech equipment. And they will hold down the foreign-exchange value of the dollar, making U.S. goods more competitive abroad.
Finally, the plunge in long-term rates will lift demand generally, which will encourage companies to hire more workers. Sure, jobs have been the missing ingredient in this expansion, but so have lower long rates, especially in the context of the steep drop in short-term rates and the stellar outlook for inflation. Unusually high long rates are one key factor that has held job growth down.
All this doesn't mean that the economy's problems will suddenly evaporate. But it does suggest that economic growth for 1993 is shaping up to be a bit better than most forecasters had previously anticipated. Earlier projections had generally called for 3% growth this year.
However, those forecasts were based on higher long-term interest rates, at about 8% by yearend. Now, long rates have already dropped a full percentage point during the past four months, to about 6.8%, and projections that they will fall to 6.5%, or lower, are increasingly common. Many economists believe that declining rates could add 0.5 to 1 percentage point to economic growth this year.
Already, last year's growth has turned out to be a lot better than expected. The Commerce Dept. now says that real gross domestic product posted a fourth-quarter gain of 4.8%, at an annual rate, instead of 3.8% as first reported. Bigger numbers for exports, consumer spending, and inventories accounted for the revision. Third-quarter growth had weighed in at 3.4%, bringing growth for the full year to 3.2%, the best showing since 1988.
Growth this quarter is bound to slow from last quarter's clip, but the pace is likely to go from robust to merely respectable. The weak 0.1% increase in the January index of leading indicators probably overstates the slowdown, particularly since the January reading follows a 1.7% surge in December (chart).
Consumers and foreigners will be hard-pressed to match their recent spending gains. Consumer outlays jumped 4.8% in the fourth quarter, following a 3.7% advance in the third. Exports surged 9.8% last quarter, after a 9.2% gain. Still, both sources of demand have some support.
In fact, with the rest of the industrialized world in recession since mid-1992, the sharp acceleration of U.S. export growth is just as surprising as the bounce in consumer spending. Exports had barely grown in the first half of 1992. Strong demand from Latin America and elsewhere accounts for some strength, but the cheaper dollar has also played a role. And those factors will continue to buoy U.S. exports this year.
The pace of consumer spending will also cool this quarter, but maybe not by as much as many economists previously feared. Real consumer outlays for goods and services dipped 0.1% in January. But because of the upward path of spending during the fourth quarter, the first-quarter level of buying is already 2%, at an annual rate, above last quarter's level. With only modest gains in February and March, real consumer spending could post a gain of 3% or better this quarter.
A key factor for future spending: Income growth is holding up. Personal income rose 0.5% in January. After inflation and taxes, real disposable income was flat, but that followed a big gain in December. January real income is also well above the fourth-quarter level.
More important, the quality of the recent growth in income is improving. At one point, government transfer payments--unemployment benefits and other types of income support--were contributing all of the growth in real incomes. The latest data say that's changing (chart).
Also, the disparity between the growth of spending and income that had developed last year is now gone. During the past six months, real spending has risen at a 3.8% annual rate, while real income is up 3.7%.
But the best news for consumers in coming months could come from the labor markets, as slow but steady improvement continues. The four-week average of initial jobless claims is declining. And according to the latest survey by Manpower Inc., hiring plans for the second quarter are well above the normal seasonal expectations. The fact is, much of the momentum that the economy generated toward the end of 1992 has not yet made its way into 1993 data for output and employment.
That's especially true for manufacturing and housing. It's very likely that many factories were caught flat-footed by the blistering 5.2% annual rate of growth in final demand in the fourth quarter. Inventories rose at wholesalers and retailers last quarter, according to the GDP report, but stock levels in manufacturing plunged by $16.7 billion. Factories will have to lift output to replenish their depleted inventories.
Factories looked healthier in February, according to the National Association of Purchasing Management. The NAPM's index of industrial activity slipped to 55.8%, from 58% in January, but a reading greater than 50% means the factory sector is expanding (chart). Before February, the index had risen for four months in a row, and the January level was the highest in 41 2 years.
To be sure, managing with lower inventories has been a long-term goal of most manufacturers. However, inventories in December hit a record low relative to shipments, suggesting that stock levels are, in fact, too low.
Home sales and homebuilding are in for a good spring also, thanks primarily to falling mortgage rates. Bad weather really hammered the housing numbers for January. Sales of new single-family homes dropped 13.8% in the month, to an annual rate of 561,000. It was the largest monthly decline in 11 years. However, the largest plunges occurred in the Northeast and the West, two regions that were hit especially hard by severe weather. Sales of existing homes fell 6.4% in January, and housing starts were down as well.
That weakness won't last. Mortgage applications to buy homes are surging, according to the Mortgage Bankers Assn. Also, the Federal Deposit Insurance Corp.'s latest survey of real estate conditions shows widespread improvement in both residential and commercial real estate, including much more optimistic readings for the Northeast than in prior surveys.
To be sure, the outlook for 1993 is improving. The only hazard in sight right now is the economy's increasing dependence on the politics of the budget process. But as long as Congress keeps the bond market happy by voting for deficit reduction, lower long-term interest rates will lift growth in the short term, as they continue to chip away at the economy's long-term problems.JAMES C. COOPER AND KATHLEEN MADIGAN