Wall Street lives in a world of extremes.
Today’s raging bull market may morph into tomorrow’s angry bear. Forecasts of inflation and deflation can be found on the same page. The Federal Reserve’s plans for an early exit from its emergency stimulus were derailed by the need to re-enter the treatment arena.
And now, just when you thought fears of a double-dip recession had faded and the coast was clear, along comes a new hobgoblin: overheating.
That’s the last word I expected to see in association with the U.S. economy. But there it was, in bold print, on page one of the Jan. 3 edition of the Wall Street Journal.
Investors’ forecast for 2011 is “sunny with a chance of overheating,” according to the headline.
It sounds more like a weather forecast than an investor outlook. An economy emerging from a long and deep recession can grow at elevated rates for “an extended period,” as the Federal Reserve might say, before overheating becomes an issue. Steep declines in real gross domestic product typically give way to sharp snapbacks in growth of as much as 8 percent in the first year of recovery, even as inflation falls.
With the unemployment rate at 9.8 percent, the economy heating past the boiling point would be something of a feat.
So where exactly is the risk of overheating?
In the Journal’s too-hot-to-handle scenario are 4 percent real GDP growth, an unemployment rate that quickly dives below 8 percent and inflation rising to 2 percent from about 1 percent now. Such a scenario would be compounded by a falling dollar, rising commodity prices and surging yields on long-term Treasuries.
Real GDP growth of 4 percent this year is certainly feasible; a dive in the unemployment rate and rise in inflation are less likely. Economic growth of about 3 percent in 2010 “didn’t do much to bring down the unemployment rate,” says Jim Glassman, senior U.S. economist at JPMorgan Chase & Co. “You have to wonder why the Fed keeps forecasting -- i.e. hoping -- the economy will grow 4 percent if that represents overheating.”
The context -- in this case, the point in the business cycle -- is important in determining when growth is too hot, too cold or just right, Glassman says. The recession may be over, but the U.S. has a lot of what economists refer to as “excess capacity” to provide a buffer if growth exceeds potential. (Potential growth is circumscribed by the growth in the labor force plus the growth in productivity.)
Room to Grow
Currently there’s a surfeit of unemployed, underemployed and discouraged workers -- those who have stopped looking for work, are no longer part of the labor force and are not counted as unemployed -- who can be redeployed before employers start bidding up wages to attract labor. That’s only one reason why the too-hot-to-handle scenario of a tighter labor market driving up wages is off the mark.
There is no such thing as “wage inflation.” Wages are a price: the price of labor. Like other prices, they respond to changes in supply and demand.
Rising wages don’t cause inflation any more than rising oil prices do. The central bank is the culprit when it prints more money than the public wants to hold. Both wages and prices are manifestations of the inflation impulse.
Like the labor market, U.S. industry is operating well below its version of full employment, or capacity. The capacity utilization rate for manufacturing stood at 73.2 percent in November, up from an all-time low of 65.2 percent in 2009 but well below the four-decade average of 79 percent. Factories can bring idled production facilities back on line, even add extra shifts, before they’re supply constrained.
As for too-hot growth driving up interest rates and putting a damper on growth, all I can say is, consider the alternatives. Falling long-term interest rates are symptomatic of weak economies, especially when the central bank has been dragging its feet in lowering short-term rates. Remember those 30-year mortgage rates at multigeneration lows of close to 4 percent? It didn’t trigger booming demand because it was a result of slack demand, not a cause of stronger demand in the future.
Maybe one day economists will figure out a way for credit demand to increase without pushing up the price. Until then, we should hope it happens sooner rather than later.
Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.)
To contact the editor responsible for this column: James Greiff at firstname.lastname@example.org