U.S.: So How Much Momentum Is There, Exactly?
Back in September, Federal Reserve Chairman Alan Greenspan warned that "it is just not credible that the U.S. can remain an oasis of prosperity in a world that is experiencing greatly increased stress." Well, so far it has done just that. In fact, the economy's pace appears to have been faster in the second half of 1998 than it was in the first half.
Indeed, the economy may well have grown in the neighborhood of 5% in the final quarter of 1998. No one will know for sure until the Commerce Dept. reports on gross domestic product on Jan. 29. There are still plenty of unknowns that could sway the upcoming GDP result, especially since Commerce will have to estimate still unavailable December data on foreign trade and inventory growth. These two swing factors, by themselves, often account for one or two percentage points in the overall growth rate. But based on available monthly data, domestic demand appears to have powered growth far beyond what nearly all economists thought possible only a few months ago.
The important question is: How much of the economy's momentum carried over into 1999? Already, economists are nudging up their forecasts for this year's growth, based on the expectation of peppier growth early in the year. However, threats to the U.S. oasis have not gone away. Brazil's decision to devalue the real will worsen the economic outlook for Latin American countries, key markets for U.S. exports. Also, Wall Street's volatile reaction to the devaluation suggests that equity gains may not contribute as much to consumer and capital spending this year as they did in 1998.
RISING STOCK PRICES and their impact on the economy were very much on Greenspan's mind when he testified before Congress on Jan. 20. He noted their importance in the economy's robust performance of late, especially in the consumer sector. However, he also said that some slowing in economic growth might be required to sustain this nearly eight-year expansion. "Through the end of 1998," he said, "the economy continued to grow more rapidly than can be currently accommodated on an ongoing basis, even with higher technology-driven productivity growth."
Much of the economy's rapid growth has been powered by consumers. That was especially true in the fourth quarter. Strong December retail sales and a gusher of auto purchases mean that growth in real consumer spending may well have hit 6%, at an annual rate, last quarter--and that's two-thirds of GDP. If so, growth in consumer outlays during the four quarters of 1998 would end up at a phenomenal 5.5%, the strongest four-quarter pace since 1984.
WILL CONSUMER SPENDING come back to earth in 1999? The answer is crucial to the outlook, because last year it accounted for some 90% of the growth in overall GDP. Add in homebuilding, and the two sectors more than accounted for last year's total economic growth (charts). But consumers in 1999 are unlikely to receive the support from the labor market and stock prices that they enjoyed in 1998. More likely, consumers will pull back a notch, as companies restructure to cut costs and as stock prices grow in more normal ranges.
Greenspan noted that capital gains have significantly boosted consumer spending by allowing households to outspend their incomes, resulting in a negative saving rate. Greenspan said that all or most of the decline in the saving rate is accounted for by the upper income quintile, where capital gains have disproportionately accrued. However, he also pointed out that "a flattening of stock prices would likely slow the growth of spending, and a decline in equity values, especially a severe one, could lead to a considerable weakening of consumer demand."
Indeed, some of the fourth quarter's momentum in consumer spending, housing, and business investment may fade as early as the first quarter, given that some one-time factors boosted the fourth quarter. For one, dealer incentives lifted the quarter's car sales, which accounted for more than a percentage point of the growth in consumer outlays. Some December vehicle sales were likely borrowed from early 1999 sales. Retail sales in December rose a strong 0.9%, although excluding car buying, sales rose only 0.4%.
Dining out was popular last quarter. Sales at restaurants and bars posted the largest quarterly increase in six years, perhaps related to the unseasonably mild weather during most of the quarter. A return to winter weather this quarter will cut restaurant receipts back to normal.
A similar, but more consequential, weather-related swing is likely for housing. Residential construction in the fourth quarter appears to have posted another quarter of double-digit growth, helped partly by the good weather. December housing starts rose 3.5%, to an annual rate of 1.72 million.
Sales and starts in 1998 ran far ahead of new household formations, and some pullback in 1999 appears likely. But housing fundamentals remain solid, according to builders. The National Association of Home Builders' housing market index, which comprises builders' assessments of current and expected market conditions, dipped two points in January, to 76%, but that was down from a record 78% in December. Builders were less confident about future demand, although the readings on current sales and buyer traffic through model homes declined only a bit.
BUSINESS INVESTMENT in new equipment also made a solid contribution to fourth-quarter GDP growth, but equipment outlays are especially vulnerable to slower growth in 1999 in the face of weak profits, tighter lending standards by banks, and recent low rates of capacity utilization in manufacturing. In fact, additions to manufacturing capacity have already started to slow. Growth had reached 6.4% in 1996, but by the end of 1998, growth had fallen to 5.6%.
Still, since early 1998, manufacturing capacity has been growing far faster than output (chart). Factory output rose only 0.2% in December after a slim 0.1% gain in November. The rate of factory capacity use fell in December to 79.9%. Except for the strike period at General Motors Corp. last year, that is the lowest utilization rate in more than five years. Even if weak cashflow and costlier financing weren't standing in the way, manufacturers would have little incentive to add to their already plentiful capacity.
To what did we owe 1998's extraordinary growth? Low inflation and interest rates top the list. They boosted consumer buying power and demand, and they fueled the stock market's exceptional gains that also lifted spending. Can growth remain that powerful in 1999? The fourth-quarter numbers seem to answer yes, but don't count on it.
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