Does America Have A Bubble Economy? No

Does the U.S. have a Japanese-style bubble economy? And should the Federal Reserve burst it with higher interest rates, even at the risk of recession? A growing chorus says yes. Asset inflation, they argue, requires an immediate tightening of monetary policy and a throttling-back of the economy. Just look at the soaring stock market or surging house prices. Even movie tickets and admission prices at Disneyland are going up. Unless the Fed acts, they say, the U.S. economy will overheat and crash, just like Japan's.

Certainly, the bubbles are troublesome. It is true that high-priced stock is being used as cheap currency to pay for gigantic mergers that may not make sense. Telecom companies are bootstrapping themselves up with high-multiple equity. Prices are going up for hotel rooms, airline tickets, New York condos, and Silicon Valley houses. We would all be more comfortable if these things weren't happening. But they do not mean that it's Japan redux.

Look at the fundamentals. Japan's bubble was built on leverage. Individuals and corporations borrowed enormous sums against their stock market gains to invest in everything--Tokyo real estate, overseas factory capacity, American golf courses, gold, and Picassos. When the Nikkei cracked, the leverage reversed, crushing Japan's economy. That's not happening--yet--in the U.S. There are a lot of stock deals. But total national borrowing is only 8.8% of nominal gross domestic product--low compared with previous decades. New federal borrowing as a percentage of GDP is practically zero, offsetting moderately rising private debt. Consumer borrowing, while high, has slowed sharply since mid-1996. Producer prices are falling, and the consumer price index is up a mere 1.4% from a year ago. There are, as yet, no major imbalances.

Japan's bubble was built on the quicksand of ever-expanding manufacturing capacity financed by virtually free capital. Corporate profits were made in stock market speculation, not just in selling products. This is not the case in the U.S. The shift to an information economy is generating a steady stream of enterprise. Innovation is throwing up new companies and new products faster than you can say "electronic commerce." Restructuring and downsizing are an obsession. Productivity is paying for much of the recent real gain in wages. Growth in corporate profits, although under some pressure this quarter, has been great for three years. Most CEOs continue to focus on top-line revenue growth, profits, cutting costs, and shareholder value.

But what about rising prices? A good many reflect the amazing growth of wealth at the top. The jump in real estate prices is sharply skewed to very expensive houses. Airfares are up for first class and business, not steerage. Memberships in golf clubs are up, but prices for local gyms are not. Price tags for new and used cars, clothing, and beer have fallen. Personal-computer prices are way down, as are stock-trading commissions and mortgages. The rise in prices for luxury goods is worrisome, but prices for most things that most Americans consume are not rising nearly as much, if at all.

Strong economic growth has done wonders for America. It has made many more people rich, and they have largely balanced the federal budget through their capital gains and income taxes. It has raised real wages and tightened the labor markets, providing jobs for college grads as well as high school dropouts. It has even revived the cities--newly minted centers for information technology and innovation. This is not the time for a rate hike that threatens this progress.

The fundamentals are sound--and are what the Fed should focus on. First quarter growth was strong but due in large part to unusually warm weather. If the economy doesn't slow in the second half and if profit growth gets weaker, the market will correct itself with no help. The one thing that could threaten the economy is a debt explosion--and the Fed is already exhorting banks to be cautious. That's enough. The U.S. is not Japan.

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