Pessimists find themselves
outnumbered
Washington Observed,
By Joanne Gray
At times this week, Robert Rubin and Larry Summers,
the Treasury secretary and his deputy, seemed to be the
only two people in Washington who were still worried
about the precarious recovery of the world economy.
They warned international officials who had gathered for
the spring IMF and World Bank summit that Japan and
Europe had to boost their economies. And they told
executives that the US economy while robust, was
troubled; the trade deficit was too high, savings were too
low, complacency could create bad lending decisions and
overleveraging.
But they had a hard time convincing their audiences to
quell their exuberance.
"The improved global outlook has generated some
understandable relief," said Summers in one of many
speeches this week. "But I had a tennis coach who spoke
an important truth when he used to say 'You're never as
good as you think you are when you are good, and
you're never as bad as you think you are when you are
bad'.
"It's still a dangerous world out there."
The problem is, hardly anyone in America seems to be
taking notice. These continue to be the best of times for
the US economy, which has been almost solely
responsible for helping the world get over the Asian
financial crisis.
Warnings that world growth cannot run on the one
American engine for much longer do not seem to cut it
with corporate executives or economists. Growth
forecasts continue to be raised, and will come in closer to
3.5 per cent this year. Inflation has yet to reach 1 per
cent. And unemployment has sunk to 4.2 per cent.
Conventional wisdom held that growth could not hit 4 per
cent plus for three years straight without triggering
inflation, and requiring a rate rise. But is it possible that,
having largely benefited from the world financial crisis, the
US economy now stands to benefit as it repairs?
A lot could depend on whether Federal Reserve
chairman Alan Greenspan is correct. His new paradigm,
which is gaining adherents, tries to explain why the
economy is in such miraculous form and gives much of
the credit to information technology, which may have
broken the link between growth and inflation.
Greenspan's new paradigm is that the technology and
communications revolution has finally unleashed
significant productivity gains. In the current climate of
mute inflation (which is helped by low commodity prices,
intense competition and low import prices) in order to
increase profits, businesses must increase productivity
because they cannot raise prices.
For the past five years, businesses all over the US have
been investing heavily in computing and
telecommunications technology which has finally started
to deliver on its promises. (Investment may have been
high because it was cheap to borrow, because interest
rates were low - a possible pay-off of the elimination of
the federal deficit.)
In any case, since 1996 productivity measures have
jumped significantly, and are double the levels of 1973 to
1995. The service sector is not showing the same
productivity gains, but many economists say this is
because it is not measured properly.
Technology has created efficiencies by allowing
companies to set up low-cost links with customers and
suppliers. Routine transactions have been automated.
Economist Paul Simon of Stanford University has
investigated the technology revolution and likens it to the
introduction of electricity, which also took time to deliver
benefits because business had to learn how to organise
around it.
The policy implications of the increase in productivity are
immense. Economists now say that Greenspan took a
calculated guess in the past three years in that instead of
using higher interest rates to slow the economy, he left
rates largely alone, allowing it to expand faster than
theory would have deemed possible without igniting
inflation.
This suggests that, unless there is a powerful and
unexpected pick-up in inflation, the Fed will let growth
continue at current rates, and will not have to step in and
raise interest rates to stop "overheating" for some time.
(As well, if the Treasury and the Fed are right, and the
global economic recovery is precarious, the Fed will be
loathe to raise rates until early 2000 anyway, says Steve
Roach, Morgan Stanley's global economist, because this
could disturb still vulnerable Asian economies.)
But if there is not a bubble in the US economy, is there
one in the stockmarket that loose monetary policy is
fuelling?
America's most famous bull, Goldman Sachs analyst
Abby Joseph Cohen, is convinced that current stock
valuations are justified on current earnings estimates. And
she says early signs are that corporate profits, after
lagging in 1998, are on the rise again.
"US corporations have re-established themselves as
leaders in any number of global industries, and more
importantly our companies have taken a leadership role in
developing the newer industries," she said at an
Economic Strategy Institute conference this week.
"We've done an extraordinarily good job ... in terms of
active research and development, long-term capital
investment, scientific innovation that is the hallmark of
these new industries ... which in the US are propelling
profit growth and ... employment growth."
Even though the top10 US stocks are valued at more
than the total capitalisation of the Japanese and Chinese
stockmarkets, she still believes stocks are approaching
fair value.
But even if the market takes a tumble, analysts have
predicted that a 25 per cent fall in the Dow would only
occasion a 1 per cent decline in consumer spending,
trimming 1 per cent off GDP growth. Even under that
scenario, the already record-breaking US economic
expansion, now in its ninth year, has some way to run.
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