Faith deepens in Santa Greenspan

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Opinion from down under.

Saturday, August 26, 2000

Faith deepens in Santa Greenspan The US economic fairytale continues - partly because the rest of the world believes in it, writes Ross Gittins.

The way things seem to be falling into place in the United States economy, you're tempted to think there really must be a Santa Claus - or at least that the wise and white-haired Dr Alan Greenspan makes a good substitute.

This week the Great Man was able to announce that he didn't think another rise in US official interest rates was needed, and the financial markets' faith in his ability to bring the high-flying economy down to a painless "soft landing" took another leap.

Naturally, such a soft landing would be good news Down Under. It would remove the greatest single threat to our own long-running economic expansion.

The lovable old boy explained America's good fortune thus: "Recent data have indicated that the expansion of aggregate demand is moderating towards a pace closer to the rate of growth of the economy's potential to produce. The data also have indicated that more rapid advances in productivity have been raising that potential growth rate as well as containing costs and holding down underlying price pressures."

Let me help you unwrap that Chrissie present. When he was raising interest rates earlier this year, Dr Greenspan explained that demand was outpacing supply, thereby threatening to lift inflation. His judgment this week, however, was that demand is starting to slow while, at the same time, supply is speeding up - thanks to faster growth in productivity.

Put the two together and the inflation threat recedes. What's more, if higher productivity has lifted the economy's "potential" growth rate, demand doesn't need to slow as much as was first thought. The economy's safe cruising speed is a lot higher than it used to be. And when you look at the US "data", you can see what the man's talking about. The rate of growth in retail sales has slowed in recent months and the housing industry is turning down.

The growth in wages has been picking up, with the employment cost index rising by 4.4 per cent in the year to June. But growth in the productivity of labour has kept pace, so that labour costs per unit of production haven't changed.

It was always expected that the labour market would be the place where inflation pressure first became apparent. And it's true the market is very tight. After all, the unemployment rate is down to a 30-year low of 4 per cent.

But despite the economy's continuing strong growth, the total number of hours worked in the economy hasn't increased in the past year and the unemployment rate has been steady at 4 per cent for the past six months.

Now, when he announced the decision not to raise rates this week, Dr Greenspan was quick to add that the Federal Reserve retained a "bias to tighten" - that is, it fears it may yet have to do more.

A lot of people in the markets, however, suspect the tightenings may be over. And there are even a few wondering when the Fed will start lowering rates.

But I'm too old to believe in Santa - or even in infallible central bankers. I'll be surprised if Dr Greenspan doesn't need to raise rates further before he's through. The Yanks are nowhere near achieving a soft landing. And when you examine the fairytale economy more closely, you see there's a host of things that could still go wrong.

For a start, the signs of slowdown are pretty modest. Business investment is still roaring along and the annual rate of growth in (nominal) retail sales has gone from 10 or 11 per cent to 8 per cent. Call that slow?

So the slowdown could easily prove temporary - or even illusory. Don't forget that people thought they saw a slowdown in the June quarter, only to find from the national accounts that it was actually a speedup. The economy grew by 6 per cent in the year to June, its fastest rate for a decade.

Then there's the pickup in productivity growth. Actually, what Dr Greenspan's referring to is a pickup in the pickup. The improvement in US productivity is well established, having begun in the second half of the '90s. But in just the past three quarters the improvement's been even greater.

Old Saint Al is convinced the higher rate is "structural" (that is, lasting) rather than "cyclical" (temporary), and time may prove him right.

But it's probably a bit of both. And the point is that the present rate of productivity growth needs to fall back only a bit for the sums to change. If wage growth keeps accelerating but productivity growth slows, inflation pressure starts building.

Then there's oil. So far, US economists and financial markets - as opposed to motorists - have been surprisingly relaxed about the rise in crude oil prices, mainly because they believe their economy is much less oil-dependent than it was during the OPEC oil shocks of the 1970s.

That's true, but there are limits. The rise isn't proving to be as temporary as we'd hoped, nor can we be sure how high it will go. A stretched economy and sky-high petrol prices could yet make an explosive combination, so to speak.

Are you starting to doubt the certainty of a happy ending? I've just got started.

Despite its remarkable performance on growth, productivity, inflation and unemployment, the fairytale economy has built up a number of serious "imbalances": a pathetically low rate of private saving, a still greatly overvalued sharemarket and a record current account deficit (see graph).

They're all linked. For most of the '90s, America's businesses have been investing hugely in new equipment, particularly computers and IT. This has been both a cause and an effect of the productivity surge. It's also contributed greatly to the rapid rate of economic growth. (Remember, economies are circular.)

But have America's households been saving a higher proportion of their incomes to finance this surge in investment? No, they haven't.

A decade of unbounded business optimism has lifted share prices very high and share-owning households, assuming this to represent a permanent increase in their wealth, have allowed their consumption to rise faster than their current income, thereby cutting their current saving to zero.

Put the high investment and consumption together, and America's spending has grown even faster than the remarkably strong growth in its production. As a result, imports have outstripped exports and the current account deficit is at record levels.

Is this a problem? It hasn't been. People all round the world (including not a few in Oz) have been happy to ship their savings to the States to invest in a piece of the action. The profits have been terrific.

So keen has the rest of the world been to pump capital into the US that the Yanks have been able to finance their rising current account deficit (their excess of spending over production) while their exchange rate has gone up, not down. The inflow of foreign capital has been an important factor in keeping US share prices so high.

And for as long as the foreigners remain convinced they'll earn more on their savings in the US than they would somewhere else in the world, the great American tale can roll on.

But, as we know, global financial markets can be fickle. The day the foreigners start having doubts is the day the fairytale turns ugly. The US dollar comes down, US share prices come down and US households, suddenly discover they're not as wealthy as they thought they were, slash their spending and start saving again. US businesses realise that even a New Economy isn't foolproof.

I don't know how the story will end. But I do know the US is a long way from achieving a soft landing and the risk of a hard landing remains high.

http://www.smh.com.au/news/0008/26/business/business7.html

-- Martin Thompson (mthom1927@aol.com), August 26, 2000

Answers

After a remarkable gain of 6.9% in the 4th quarter of last year, productivity slowed to 1.9% in the first quarter of this year, giving some credence to those of us who suspected y2k to be playing a role.

But. . .when productivity jumped back up to 5.3% in the second quarter, it pretty much put y2k to rest.

-- JackW (jpayne@webtv.com), August 26, 2000.


I certainly would never have guessed it, but it's time to put y2k--finally--to rest. It's dead, buried, kaput, no more.

-- Uncle Fred (dogboy45@bigfoot.com), August 26, 2000.

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