Speed Bump Ahead

"Is it an earthquake or simply a shock?" asked Cole Porter 70 years ago. That question, or one almost like it, is puzzling economists today as they try to decide whether the American economy has merely hit a speed bump in the road to recovery or driven into a ditch.

The nervous types worry that high oil prices will scare consumers out of the malls, that a house-price bubble is about to burst, that the Chinese economy is about to implode, and that America's huge trade deficit will cause a heavy sell-off of the dollar, forcing the Federal Reserve Board to raise interest rates to recession-causing levels. And that's before we mention the possibility of a terror attack. There's more ... but you get the idea.

The easy answer is that there always have been, and always will be, risks out there. As Steve Friedman, director of the president's National Economic Council, put it last week: "There's never been a perfect economy."

But the American economy somehow manages to move ahead. After all, the traumatic shock of the attack on September 11 wore off more quickly than anyone thought it would, even though the assault hit the economy when it was just beginning to recover from the bursting of the dotcom bubble and a recession.

Nevertheless, the pessimists are not paranoid: there are real facts that are worrying -- until you examine them closely. The economy added only 96,000 jobs in September, well below expectations of 145,000, but it did add 1.6 million new jobs this year, and the 5.4% unemployment rate is the lowest since October 2001. Consumer confidence is at its lowest since May, but it is still above the low point of early 2003, and consistent with an entirely satisfactory 3.0%-3.5% increase in consumer spending. Durable goods orders fell in August, but if we exclude highly volatile aircraft and other transport-equipment sales, new orders rose by 2.3%.

Oil prices hit and passed the $ 50-a-barrel mark, but only 3% of the average household budget is now spent on energy products, half the level during the 1979-80 oil shock.

So much for the past. The more interesting question is what lies ahead. Let's start with the dollar. Several Federal Reserve officials warned last week that the current trade deficit, seemingly headed towards 6% of GDP, means that the dollar is headed for a decline, creating future inflationary pressures. Cynics are saying that is part of a Fed effort to justify ratcheting up interest rates, even though last Friday's job report was so disappointing. After all, as long as China and Japan pursue export-led growth by refusing to let the dollar fall against their own currencies, the greenback will avoid a huge decline.

Next, look at the prospects for growth. There is general agreement about two things. Oil prices will stay high, at least for a while. Production in the Gulf of Mexico will take a month to recover from the ravages of recent hurricanes, China's appetite for fuel shows no sign of abating, Vladimir Putin remains intent on destroying Russia's most efficient oil producer, and insurgents continue to threaten production in Iraq and Nigeria.

The second consensus view is that consumer spending will grow at, or far faster than, the satisfactory rate of 3%. The unemployment rate is low, average hourly earnings rose 2.4% in the past 12 months, personal incomes are up, and consumers' total net worth rose sharply in the past year, with stocks and mutual funds rising in value by $1,400 billion. If the rule holds that every dollar by which wealth increases results in spending of between three and five cents, consumers should continue to keep credit cards swiping even though tax refunds are no longer arriving in their mailboxes.

It is the business sector that has the experts at odds with one another. Optimists argue that companies are awash with cash and their balance sheets are strong.

Business spending is rising. Computers and other high-tech goods overdue for retirement are finally being replaced, demand for longer-lived capital equipment is rising, and business construction of buildings and the like is up almost 6% on last year. Two interesting indicators --global chip sales and global air-cargo shipments -- are soaring. The former rose 34% in the past year, and the latter by 14% so far this year.

Add to that, argue economists at Business Week, the fact that low inventories presage an increase in orders so shelves can be restocked.

Wrong, say economists at Goldman Sachs. "The US inventory cycle is about to turn. Inventory investment is about to become at least a modest growth drag ... slowing (factory output) to about 2% growth over the next year from 6.75% over the past year."

This is why Alan Greenspan, who has to decide who is right, gets paid the big bucks, to use a Wall Street expression that is inapplicable in the case of the modestly remunerated Fed chairman (not counting psychic income). He has to decide whether to continue raising interest rates -a good idea if we have hit only a speed bump -or stop raising rates -a necessary policy reversal if a period of stunted growth is ahead.

My guess is that Greenspan is a member of the temporary "shock" school rather than the "earthquake" school. He will go on raising rates, and will be vindicated when the growth rates for the rest of this year and next are tallied.

Before that, however, America will have elected a president, a far more consequential decision than whether interest rates should be raised by a quarter of a point.

A version of this article appeared in The Sunday Times (London) on October 10, 2004.