The Balance of the Risks
The economic forecast is mostly sunny, with some clouds, and a chance of storms.
11:00 PM, Oct 27, 2003 • By IRWIN M. STELZER
GOOD NEWS about the U.S. economy is easy to come by. "The good times are back," chortles the Wall Street Journal. Most analysts are guessing that the economy is now growing at an annual rate of somewhere between 6 percent and 7 percent. It seems that the happy recipients of this summer's tax refunds surprised most analysts by dropping fully three-quarters of their refunds into shop tills.
Everyone seems happy.
* Investors have been watching share prices pursue an upward course that has taken the Standard & Poor's index of 500 companies to about 25 percent above its March lows.
* Consumers are happier with the current state of the economy, and more optimistic about the future than they have been for a while, reports a University of Michigan survey, which may explain why new housing starts rose by a surprising 4.3 percent in September.
* `Workers are encouraged by reports from the jobs market that show that new claims for unemployment insurance are at an eight-month low.
* Businessmen are permitting themselves something between a sigh of relief and a grin. Seventy-four percent of the chief financial officers surveyed by Financial Executives International and Duke University said they were more optimistic in the third quarter than they had been in the previous three months. No wonder. Third-quarter earnings are up about 20 percent, compared with 2002. Those fatter profits beat analysts' estimates by 7.5 percent, report analysts at Thomson First Call. More important, the gains are widespread, with some 70 percent of the firms covered by the S&P index reporting earnings increases. It seems that a combination of cost cutting and continued strong consumer spending are driving earnings. As is the decline in the dollar, which allows American companies with overseas operations to buy more dollars with the foreign currencies they earn overseas, driving up profits, which are reported in dollars.
Unfortunately, every silver lining has a cloud--in the case of the U.S. economy, enough clouds to provide a backdrop for more than one Constable painting. The real question is whether these will scud harmlessly by, or pour down enough rain to snuff out the recovery.
FOR ONE THING, it now seems certain that interest rates will continue to move up. That's what Treasury Secretary John Snow says he is expecting will happen as the recovery takes hold. The markets, of course, are already predicting an upward move of half a percentage point by mid-2004, and about 1.5 percentage points by the end of next year. Nevertheless, the sight of an important member of the Bush team calling for interest rates to rise immediately before the next election caused concern, perhaps because it shook such confidence as remains in the coherence of the administration's economic policy, especially after the Treasury secretary's alternating calls for a weak dollar, a strong dollar, and a market-determined dollar.
Rising interest rates will be of real consequence to consumers, until now the bellwether of the economy. There are already some signs of an end to a consumer-led boom. After the one-off rebate checks fueled rather spectacular increases in spending in July and August, when the checks were falling into letterboxes, retail sales fell in September, pulled down by falling auto sales. Excluding cars, sales rose, but by less than one-third of the increase recorded in the two previous months. Goldman Sachs's economists conclude, "The implication is that the spending growth will likely slow very sharply in the fourth quarter, unless other sources of income growth accelerate sharply."
With real wages more or less stagnant, no such "other sources" are on the horizon. So, heavily indebted consumers--many at the lower end of the income scale--may find themselves caught in a vise between stagnant incomes and rising interest rates. Indeed, mortgage delinquencies rose in the second quarter, and that was before interest rates started moving up.
Worse still, rising rates will prevent consumers from refinancing their mortgages, and therefore deprive them of the ready cash that kept them in auto showrooms and cruising the nation's malls. Higher rates will also discourage home buying, no small thing in an economy in which the 100,000 increase in construction jobs provided the labor market's bright spot, and in which residential construction accounted for 16 percent of the economy's entire growth in the first half of the year, according to estimates by BusinessWeek's James Cooper and Kathleen Madigan.
INTEREST RATES are not the only cloud on the economic horizon. China's soaring demand for oil, combined with OPEC's decision to cut back output, is keeping oil prices well above the target the Saudis continue to allege is their goal. Many worry that share prices are overvalued, or at minimum "that the market has fully discounted a very solid recovery," to quote former White House economic advisor Larry Lindsey. Excess capacity remains high, making price increases an impossibility and threatening profit margins since most cost savings have already been wrung out of the system. The collapse of the Doha round of trade talks means there will be no fillip to growth from increased trade. President Bush returns empty-handed from Asia, having failed to persuade the Chinese and Japanese to allow the dollar to fall against the renminbi and the yen, which would have brought America's trade deficit under control.
But these clouds do not a downpour make. Economic growth at anything like current rates should shine through, driving profits to levels that just might support something like current share prices, strengthen the jobs market, and reduce the deficit; and the absence of inflation should keep interest rates from rising to recovery-threatening levels. In short, "the balance of the risks," to borrow a term from the Fed, is tipped towards fair, rather than stormy, weather.
Irwin M. Stelzer is director of economic policy studies at the Hudson Institute, a columnist for the Sunday Times (London), a contributing editor to The Weekly Standard, and a contributing writer to The Daily Standard.