Cleared For A Soft Landing

Once again, the economy seems to be responding to Greenspan's tuning

When Federal Reserve Chairman Alan Greenspan treks to Congress on July 20 to deliver his semiannual review of the U.S. economy, he is likely to sound every bit the cautious central banker. Despite a spate of indicators pointing to a slowdown, the Fed chief is expected to insist that it's too soon to declare victory in the year-long campaign to rein in runaway growth. He may even cluck about the inflationary peril posed by the nation's insatiable appetite for workers.

But don't be fooled by the chairman's typically somber affect. Inside the hushed halls of the Federal Reserve, Greenspan & Co. are really quite pleased these days. While Greenspan is unlikely to pat himself on the back in public--and probably not even in private--it is becoming increasingly clear that he and most of his Fed colleagues believe that they're on the verge of pulling off an unprecedented second soft landing for the economy. And with it, they may have extended the life of an already long expansion.

The Fed chairman should sit back and smile: The U.S. is currently enjoying an almost idyllic economy. Unemployment is down to historic lows, even as job growth itself has started to slow. That, along with continued gains in productivity, is taking some pressure off harried employers and wages, which have been rising at a slightly higher pace of late. Despite a raft of price pressures on the raw-material front, however, core inflation has remained well-behaved. And after six doses of monetary tightening, Fed policymakers believe that growth has been slowed to a more sustainable pace that can be maintained through the end of the year.

Of course, the slowdown itself carries some risks for the Fed, not the least of which is the danger that it could snuff out the stellar productivity growth that has been at the center of the success of the New Economy. Productivity usually slackens as growth ebbs because companies have typically been slow to cut back on hiring plans and curb wage increases. That leads to higher labor costs per unit of output, pinched profit margins, and a push by companies to raise prices to make up the difference.

BULLETPROOF. But like so many economic relationships that have been altered by the New Economy, Greenspan is betting that this time productivity will not falter with a slowdown. He believes that much of the productivity increase is not just a response to a cyclical upswing. Companies are using information technology to revolutionize the way they do business and increase efficiency. So today's productivity gains are more structural, a shift that becomes part of the permanent shape of a business. And Greenspan does not see that process being derailed as the economy cools. "There are no indications that the process of reengineering business operations is slowing," he said on July 11 in a speech to the nation's governors.

In fact, even at the earliest signs of a slowdown, employers already seem to be responding. Over the last two months, private-sector payrolls have expanded by a paltry 31,000, while aggregate hours worked have fallen 0.3%. In his July 11 speech, Greenspan singled out that kind of labor-market flexibility as a key reason for the country's economic success. Some of the flexibility may be the product of the new reliance on temporary workers to handle sudden bursts of demand. Nearly 3% of the labor force--more than 3 million people--work for temporary-help agencies. That's double the share at the end of the 1980s. An additional 10% of workers are either independent contractors or temps hired by their companies.

The increased ability of employers to react quickly to a changing economic landscape also bodes well for corporate profits. "Reducing hours worked right along with output allows productivity gains to be sustained," says Banc of America Securities Chief Economist Mickey D. Levy. "That keeps unit-labor-cost growth modest and minimizes the impact of the economic slowdown on profit margins."

In fact, despite a recent spate of profit warnings, Wall Street seers expect overall profits to stay strong even as the economy slows and the pricing power of companies diminishes. Chuck Hill, director of research at consultants First Call, says analysts expect companies in the Standard & Poor's 500-stock index to rack up year-on-year earnings gains of 19% in the second quarter, 18.5% in the third, and 16.7% in the fourth--hardly a recipe for a recession.

ORDER BACKLOG. Further reinforcing Greenspan's belief that productivity growth can be sustained--even as the economy cools--is strong corporate investment, with companies pouring money into computers, software, and other efficiency-enhancing equipment. The Commerce Dept. reported on July 6 that unfilled orders for industrial machinery and equipment rose for the 11th straight month in May, to nearly $90 billion. That huge backlog of unfilled orders is a guarantee that corporate investment will stay strong for months.

If the economy keeps performing as Greenspan hopes, the Fed's Open Market Committee members look increasingly likely to take a pass on raising rates when they next meet to map monetary strategy on Aug. 22. In fact, there's a chance that the Fed is through tightening credit for the year, despite what are likely to be repeated admonitions from the central bankers about the risks of inflation. "The Fed is done hiking rates, but it's not finished jawboning," says David L. Littmann, chief economist at Detroit-based bank Comerica Inc.

To be sure, not everyone at the Fed is as sanguine as Greenspan seems to be. A minority of policymakers fear that it may have let the economy run too hot for too long before starting to raise rates 12 months ago. Led by Fed Governor Laurence H. Meyer, they are less convinced of the staying power of the productivity miracle and worry that inflation will pick up later this year as workers' wages climb and unit labor costs begin to rise. Their prescription: Growth has to slow decidedly below 3 1/2% to 4% to boost unemployment and keep price pressures in check.

For now though, even the worry-warts at the Fed have to admit that the economy is going Greenspan's way. While the National Association for Business Economics is reporting that as many as half of the 127 businesses it polled expect to raise prices later this year, many key industries are having trouble supporting their current prices. Cases in point: the housing sector, where builders are now beginning to pick up closing costs and financing points, and the auto industry, which recently was forced to hike its incentive plans to maintain the 17-million annualized sales rate of May and June. Overall retail sales are down as well, falling 0.6% in April and 0.3% in May. And retailers are cutting prices or offering easier credit terms to keep volume up.

True, those signs of ebbing pricing power could prove ephemeral if the economy revs up in the second half of the year. In 1999's last half, the economy spurted ahead as the stock boom goosed growth via the wealth effect. But this year, the shine is off the market, in part because of the repeated rate hikes. Investors are also far less sure that every new tech startup is a gem. The Wilshire 5,000 index, the broadest measure of the stock market--and the Fed's favorite equity gauge--has barely budged. That's boosting Fed confidence that this time the slowdown will stick.

But Greenspan & Co. are still wary of a rebound in the market. That's why they'll want to keep investors on edge by talking tough about the economy--no matter how cheerful they're feeling.

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