October 20, 1999
An October Bust? Not This Time
By BRUCE STEINBERG
or those who tirelessly warn that the economic boom is a bubble overdue to burst, these must seem like perilous days. Last week, worries about inflation and possible interest-rate increases sent stock prices into their biggest swoon in a decade -- in what some noted was the week before the anniversary of the infamous Black Monday of 1987. When stocks rebounded this week, after consumer prices showed only a modest increase, there was talk of volatility.
But the doomsayers are looking for signs of disaster where none exist. The American economy has performed better in the 1990's than at any time in history, and there is no end of that success in sight.
The bubble theory rests on arguments that the stock market is overvalued, Americans are not saving and the trade deficit is at a dangerous level. Assets are said to have become overvalued, leading to overconsumption and an overheating of the economy that will inevitably end in a violent correction -- a stock market crash. But this argument will not stand up to a careful analysis.
The pessimists' misinterpretations begin with stock prices, which have indeed grown rapidly. Even after a 10 percent correction in the past two months, stocks in the companies that make up the Standard & Poor's 500 index are trading, on average, at more than 24 times their 1999 operating earnings per share -- near-record levels. However, values are highest in the sector where growth prospects are highest and demand is accelerating: technology. With the technology stocks excluded, the price-earnings ratio for the rest of the companies in the index is around 19. Adjusted for interest rates, that's comfortably in line with the experience of the past few decades.
Some analysts also think they see a real estate bubble -- a dangerous trend if it were real.
Who can forget Japan's bubble economy of the 1980's, when the grounds of the Imperial Palace were supposedly worth as much as California? But in the United States, mortgage borrowing has been relatively weak in the 1990's and, despite dizzying prices in pockets like Manhattan and Silicon Valley, the national median price of existing homes rose just 4.5 percent a year.
The negative national savings rate is another fiction. The official savings rate has plunged from 5 percent at the end of the 1980's to minus-1.5 percent now, leading alarmists to say that Americans are on a spending binge fueled by rising asset prices and excessive borrowing. But the figures are flawed. Wage income has actually grown faster than consumer spending during the past several years. And while total income grew more slowly than spending because interest and dividend income grew slowly during the 1990's, that weak growth was more than offset by the rise in the value of stocks. The official calculations of the savings rate do not count capital gains income -- though Americans who pay taxes on it can attest that it is quite real. When it is included, the savings rate is 8 percent.
As for the trade deficit, it is indeed at a record level, but it doubled during the past two years because weak growth in the rest of the world hurt American exports. Now the world economy is recovering. In September, export orders rose to the highest level in 30 months.
What the unprecedented performance of the American economy in this decade really reflects is a revolution in productivity. Productivity grew during the past five years at double the pace of the prior 25 years. That is what allowed the economy to grow by more than 4 percent last year while the core inflation rate dropped by half a percentage point and the unemployment rate was stable.
The economy may have to slow a bit now to keep the Fed happy. But although the United States will undoubtedly have a recession someday, don't look for it anytime soon.
Bruce Steinberg is chief economist for Merrill Lynch.
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