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To: PaulM who wrote (14972)	7/28/1998 5:30:00 AM
From: paul ross	Respond to of 116759

A different take on inflation Conventional wisdom looks for a slowdown to fend off inflation. Here's someone who sees it another way. By Michael Brush moneydaily.com Fed Reserve Board Chairman Alan Greenspan has done his share to help rock the markets in the past week, cautioning that weakness in Asia may not be enough to slow down the U.S. economic juggernaut over the next several quarters. His comments have worried investors, who know that an economy that grows too fast could spur inflation, which could lead the Fed to raise interest rates. And you know what that can do to stocks. Sure, investors are increasingly concerned about other things. But since Greenspan spoke last Tuesday, the Dow Jones industrial average is down about 316 points or 3.4%, and Nasdaq is off about 95 points for a decline of 4.7%. The problem, says one economist, is that even an economic slowdown might not bring good news on the inflation front. Usually, a slowdown takes the pressure off inflation and interest rates. This time, though, it's possible that some of the things that make the economy slow down could also put upward pressure on prices, says Goldman Sachs economist Alex Patelis. What's more, a slowdown may reverse many of the trends that have kept a lid on prices. Sounds counterintuitive, but consider the effects on prices of the following scenarios that Patelis says may occur if the economy continues to slow following the weak second quarter. * Oil prices. One of the main factors behind the solid economic growth and low inflation in the U.S. has been the 40% collapse in the price of oil over the last year or so. Lower oil prices have helped contain inflation, of course, and have also kept costs down. This has helped economic growth. If oil prices move up a lot, the whole process will reverse. Growth would slow, and prices would go up. * The dollar. The strength of the U.S. economy has driven up the stock market, which has helped push up the value of the dollar as foreigners buy the U.S. currency to get in on the action in stocks. And that stronger dollar, of course, has kept prices down by pushing import prices lower. But if U.S. growth slows and the stock market levels off as a result, that would likely bring down the value of the dollar, says Patelis, leading to higher import prices. * Benefits costs. The booming stock market in the past several years has helped employers in at least two ways. First, they have had to contribute less than usual to pension funds as solid stock performance has taken up the slack. Second, the tight job market means they are paying less in severance costs. If the economy slows, both of these trends would reverse, meaning that companies may be more keen to raise price to make up the difference. * Productivity. The high-growth economy has also kept productivity gains respectable. Employees are working harder and companies are at near full capacity. If the economy slows, productivity gains would decline as well, which would put pressure on profit margins. That would make companies want to raise prices to make up for the lower margins. * Lags. Often, there is a big delay in the effects of growth on inflation. If that is the case right now, inflationary forces might be working their way through the system and turn up soon, says Patelis. "It is possible that a growth slowdown over the next few quarters may coincide with the emergence of inflationary pressures that are already in the pipeline." In the UK, notes Patelis, wage and price inflation are picking up now just as the economy is showing signs of a slowdown. To be sure, many economists don't go along with Patelis' scenario. "I still have a hard time thinking interest rates will make a sustained move up here," says James Paulsen, the chief investment officer at Norwest Investment Management. "That is not to say the 30-year bond won't go back up to 6%, in the short term. But I think the long term trend is still down." Even Patelis admits there are few signs that the current conditions of decent annual growth with minimal inflation will end soon. If he is right, though, and an economic slowdown accompanied by higher inflation arrives, there won't be many places to hide. Because that will be bad for both bonds, and stocks. ###