Bet Your Hip-Huggers, It's Not the Seventies

If inflation, high energy prices, and slow growth evoke the decade of stagflation, look again. These days, everything is different but the fashions

By Christopher Farrell

With a few broad strokes, it's not hard to imagine we're heading back to the 1970s. Long lines aren't forming at the gas pump yet, but it's stunning how much it costs to fill up these days. Hip-huggers and other retro-70s clothing are all the rage. Americans are fascinated by the Mob again, although we're watching The Sopranos on TV rather than The Godfather at the theater.

The comparisons with the '70s don't end there. Witness the pale version of the Cold War-style arms race playing out in Washington, with the Bush Administration's embrace of a missile-defense system. The economy is stagnant and, yes, it appears that prices are spiraling higher. The consumer price index rose at a 4% annual rate in the three months ended in March and, worse yet, my daily cup of morning java recently jumped from $1.38 to $1.44.


  Should we be worried about inflation? I think not. "Talk about pointless concerns," scoffs Bruce Steinberg, chief economist at Merrill Lynch & Co. Jim Paulson, chief investment strategist at Wells Capital Management, agrees. "I think we are heading toward zero inflation or price stability," he says.

They're right: A combination of factors will bring the inflation rate down sharply over the coming year, even as the economy regains some of its lost vigor. For one thing, inflation remains remarkably contained. The core rate of inflation (the consumer price index minus food and energy) is up a mere 2.7% year over year. The Goldman Sachs Commodity Index -- minus energy -- has fallen by a half since the Asian-led global financial crisis in the late 1990s, notes Paulson.

Most important in our info-tech economy, computer prices plunged at a stunning 40% annual rate in the first three months of the year. For instance, the handheld computer maker Palm cut prices on its low-end m100 from $149, to $129, and on its higher performance Vx model from $349, to $299. Dell Computer is slashing prices on everything from notebook computers to flat-screen monitors.


  If the economy improves in coming months -- and the signs are good -- history suggests that inflation pressures will ease. One reason is that it takes time for earlier price cuts to work their way through the system in the form of higher sales. Plus, since productivity typically picks up along with economic output, business can enjoy higher profit margins and keep prices steady during the upturn. The Federal Reserve's latest survey of the economy, released on May 2, reports that consumer prices are steady and wage pressures are easing.

The biggest factor keeping downward pressure on prices is the global economy. Of course, globalization's impact on inflation is hardly new. Yet the degree to which deflationary forces have been unleashed is still underappreciated. Prices are falling in Japan, the world's second-largest economy and a major exporter. China is adding to global price pressures as it expands into world markets.

Stephen Roach, chief economist at Morgan Stanley, and a group of executives recently visited what will become China's largest semiconductor foundry, now being built on the far outskirts of Shanghai. Overseeing the $6 billion Shanghai Grace Semiconductor project is Nasa Tsai, a Stanford PhD, Intel Corp. veteran, and Taiwanese chip entrepreneur. The complex is scheduled for initial operation in 2002, and it will be a genuine global competitor. Prices aren't about to take off in this kind of competitive environment.


  The international economy operates closer to textbook economics than before, thanks to high-tech efficiencies, deregulation, and more open borders. For instance, about one-quarter of the goods consumed by Americans come from somewhere else. "By and large, there is too much competition for companies or workers to have any pricing power," says Merrill's Steinberg. So are we locked in That 70s Show? Not by a long shot.

Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over National Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BW Online

Edited by Douglas Harbrecht

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