The Economy Will Keep Growing And Growing And...
Can anything stop the U.S. juggernaut? Economists don't see many impediments, at least for the Year 2000. Indeed, early next year, this already amazing economic expansion, with its unparalleled combination of rapid growth and tame inflation, will become the longest in U.S. history.
Healthy, if somewhat cooler, spending by U.S. consumers and businesses, plus a rebound in exports aided by a global recovery, will keep the economy humming at a 3.1% pace next year, measured by real gross domestic product from fourth quarter to fourth quarter. That's the average projection of 50 of the nation's business economists surveyed by BUSINESS WEEK, and it's also the forecast of economists at BUSINESS WEEK (table).
"Growth in 2000 will not be that much different from 1999," says Allen Sinai at Primark Decision Economics Inc. "But the mix of spending will change--less domestic demand, more exports." Sinai and others agree that the overall pace will be down a bit from the 3.9% expected for 1999, when growth blew by projections made in December, 1998, by two percentage points.
SPEED LIMIT. The pace in 2000 will ease back because higher interest rates will temper spending on interest-sensitive items, such as housing, consumer durables, and business equipment, and because high oil prices will cut into household buying power. Note that the forecasters expect a dip in first-quarter growth due to Y2K-related adjustments, but they expect any such effects to be temporary.
Moreover, growth at 3.1% will not be inflationary, the forecasters say, because it is within the economy's higher noninflationary speed limit, now generally agreed to be about 3% to 3 1/4%, up from the 2 1/4% to 2 1/2% range broadly accepted before the Commerce Dept.'s 1999 revisions to gross domestic product and the Labor Dept.'s subsequent upward revisions to productivity growth.
The economists see inflation at 2.4% in 2000, based on the consumer price index, down from the 2.7% expected in 1999. They believe productivity gains will offset growth in compensation and that global competition will limit pricing power. "Our success in getting inflation rates down stems from the cost-cutting zeal of new-era corporate managers," says Wayne D. Angell at Bear, Stearns & Co. "Faster global growth will reinforce that zeal."
Let's hope that's true, since rising costs for labor and materials, along with higher interest rates, will test Corporate America's ability to continue generating earnings at a rate that will keep investors happy. Economists think healthy economic growth, a rebound in foreign earnings, and a leveling off of the dollar will support profits in 2000. "I expect a decent year for earnings, especially for leading-edge areas of technology, telecom, and the Internet," says Michael R. Paslawskyj at CIT Group Inc.
MORE RATE HIKES. A key uncertainty that could rock the boat is Federal Reserve policy, especially since the economy is barreling into the new year. Specifically, will the Fed's three quarter-point rate hikes in 1999 be enough to assure policymakers that they're ahead of any inflation risks? Most Fed watchers say no. But policymakers are unlikely to do anything until they are assured that the financial system is safe after the century-date change on the world's computers.
But how much more tightening? Kevin Logan at Dresdner Kleinwort Benson Securities believes that the Fed's 1999 reversal of 1998's three quarter-point rate cuts will be enough. But he has one caveat: "If the stock market continues to rise, it will not be sufficient." Increased stock wealth has lifted consumer spending well in excess of income gains, adding a percentage point to economic growth.
Others, like Kenneth T. Mayland at KeyCorp in Cleveland, think several more rate hikes are likely. But there's a problem: The Fed must walk a fine line between slowing the economy a little and slamming the stock market, which could hit the economy harder than the Fed would want. Warns Mayland: "The period of maximum vulnerability for the stock market: summer, 2000."
Policy decisions will depend largely on how already tight labor markets bear up under the pressure of booming demand. The forecasters expect the unemployment rate to end 2000 at a very low 4.2%. "So far, tight labor markets have not led to inflationary pressure because of offsetting shocks, such as lower commodity prices--especially for oil--a strong dollar, and a rise in productivity growth," says William C. Dudley at Goldman, Sachs & Co. But those beneficial impacts are now played out, and labor costs may pick up.
FLASHPOINT. "Wage growth slowed in 1999 as a result of a collapse in inflation expectations in 1998," says Mark Zandi of RFA/Dismal Sciences Inc. Falling oil prices lowered consumer inflation by 1 1/2 percentage points in 1998, resulting in higher real wages in 1999, even as wage growth slowed. Now, as the doubling in oil prices since the end of 1998 has pushed up inflation by a percentage point, cost-of-living adjustments have moved up, and the small pay gains of the past year look less appealing to workers. Also, companies must increasingly offer other pay, such as bonuses and stock options, in order to find and keep workers.
With labor costs at a flashpoint, cooler U.S. spending will be needed to offset a rebound in overseas demand that U.S. exporters are already feeling. Around the globe, look for emerging Asia to continue to recover, although Japan will provide little support, as it struggles with a mountain of uncollectable bank loans and weak domestic spending (table).
The best news for U.S. exporters: The upturn in Europe will kick into a higher gear. Western Europe accounts for about one-fourth of U.S. overseas business. Germany will finally join the recovery in most of the euro zone, and outside the Continent, Britain already has a full head of steam. Ulrich Ramm of Commerzbank in Frankfurt believes that low interest rates, the recovery in emerging markets, and a long-awaited pickup in household spending will lift euro-zone growth to 2.8% in 2000. Moreover, he thinks the risks are on the side of stronger-than-expected growth, especially if Europe's leaders finally tackle its structural problems, particularly its inflexible labor markets.
In the Americas, Canada continues to feed off a strong U.S. economy and a recovery in commodity prices that will boost key resource-oriented regions. Plus, Mexico may post Latin America's best growth, says Jonathan Heath at LatinSource Mexico. Heath says that while 2000 is a presidential election year, which could fuel some investor nervousness, Mexico nevertheless is expected to draw sufficient foreign direct investment to cover its expected current-account deficit.
Elsewhere in Latin America, growth will rebound, as Brazil and Argentina recover from recessions. Brazil's turnaround will be solid but unspectacular, as interest rates, now about 19%, retreat slowly. But inflation is expected to stay under control, despite the sharp currency devaluation in early 1999.
Amid the strongest world growth in three years, the biggest danger to the U.S. would be the failure of consumer and business demand to cool off, possibly provoking a sharp tightening of Fed policy. Many economists believe that the global financial crisis spawned by the 1997 Asian meltdown was a major disinflationary event that restrained U.S. inflation even as the economy grew at a 4% pace. "I believe that 2000 will prove to be a major test of the notion that the economy's speed limit is higher than 3%," says Richard B. Berner at Morgan Stanley Dean Witter. But if the forecasters are right, this record-breaking expansion will keep sailing along in the new millennium.
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