Disregarding Economic Danger Signs
Is the economy in a genuine recovery? William Wolman -- author, commentator, and former chief economist of BusinessWeek -- has his doubts. He thinks most forecasters, in their anxiety for an upturn, are guilty of a "serious misreading" in mistaking a defense boom for a boom in the private sector.
The reason for the strength in the second quarter was primarily a rise in government spending, particularly for the military -- in fact, as Wolman notes, the second-quarter rise in defense outlays was the biggest in percentage terms since the Korean War. Meantime, he says, the private sector continued to be weak, with the gain in private GDP closer to 1% than the 3% reported for the overall economy.
If Wolman were in Federal Reserve Chairman Alan Greenspan's shoes, he says he would lean more strongly against the risk of inflation, even at the cost in growth. He thinks the market has been underreacting to the rise in energy prices. And he also notes that the widespread popularity of gambling in such forms as state lotteries attests to how ordinary workers are being squeezed financially.
These were among the points Wolman made in an investing chat presented Sept. 2 by BusinessWeek Online and Standard & Poor's on America Online in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available on AOL at keyword: BW Talk.
Q: Bill, the market closed today with the indexes all at 15- or 16-month highs. Do you think the bulls are running? Is this rally for real? A:
Q: Bill, the market closed today with the indexes all at 15- or 16-month highs. Do you think the bulls are running? Is this rally for real?
A:It's kind of obvious that there has been a fairly strong run-up in the market in the last couple of months. But I'm still not convinced that we're on our way to anything resembling new highs, even on the Dow, which is doing well by historic standards, as compared to the other indexes.
Q: Any concern about inflation ahead, Bill? Nobody could miss the shocking rise in gasoline prices, and with energy so crucial, won't many other things be affected? A:
Q: Any concern about inflation ahead, Bill? Nobody could miss the shocking rise in gasoline prices, and with energy so crucial, won't many other things be affected?
A:There's no doubt that the price indexes, particularly for the month of August, will reflect a sharp increase in energy prices, so that there is no doubt that there will be some uptick in the price indexes.
I would like to make another point about the impact of higher energy prices, which goes way back to the famed oil embargo of the early '70s. In that period, we saw a substantial shift in profits toward energy companies and away from almost every other kind of business. I think those factors are at work this time, too. So, near as I can tell, the market has been underreacting to the rise in energy prices.
One other crucial point: Despite the celebration of the strengthening of the economy, it's overwhelmingly the case that the reason for strength in the second quarter, including the upward revisions, was a sharp increase in government spending, especially in defense. The rise in defense spending in the second quarter was the largest since the biggest quarterly gain that was recorded during the Korean War, in percentage terms. The mistake that many forecasters have been making is misreading what, in effect, is a defense boom for a boom in the private sector -- which continued weak in the second quarter.
Perspective is required here. The Bush tax cut, coupled with defense, undoubtedly gave the economy a pop, starting last quarter and possibly even more so this quarter. What's surprising to me is not how strong the pop was, but how weak it was in its effect on the private sector. My instinct is that there has been a severe misreading of what's really going on in the economy on the part of most forecasters in their anxiety to see an upturn in the economy.
The shock to me, to repeat and emphasize, is how weak the private economy has been, rather than how strong it has been. The gain in private GDP was closer to 1% than the 3% number reported for the economy as a whole because of the strength of defense. It may be that the tax-cut pop will strengthen, but there isn't serious evidence of that at this point.
Milton Friedman says money burns holes in people's pockets, and I think for that reason, people are spending their tax-cut money as quickly as they get it. And remember that for the median family, the tax cut is quite small.
Q: As a followup, what are the down concerns? You've mentioned some points already -- anything to add? A:
Q: As a followup, what are the down concerns? You've mentioned some points already -- anything to add?
A:I do have some concerns about interest rates that are perhaps not widely shared. Mr. Snow, the Secretary of the Treasury, is now in Asia talking the dollar down, or at least Asian currencies up, especially the Chinese currency. If he gets anything but cosmetic action from the Chinese, the effect would be some diminution of the size of the Chinese surplus and perhaps other Asian surpluses with the U.S. That would signal a drop in the demand for U.S. Treasury instruments in a period when the deficit is growing strongly. So I don't rule out interest-rate increases of a size that the market does not yet anticipate.
Q: Do you think the retail sector will remain strong through the holidays? A:
Q: Do you think the retail sector will remain strong through the holidays?
A:I stress my message: There will be some continuing strength resulting from the current policy brew, but what will be surprising is that the degree of momentum will fall on the low end of expectations.
Q: One audience member asks, "You have been anti-Greenspan, as have I. What would you do if you had his job?" A:
Q: One audience member asks, "You have been anti-Greenspan, as have I. What would you do if you had his job?"
A:The first thing I would do is keep my mouth shut.... The second thing I would do at this point is to lean somewhat more against the risk of inflation than Greenspan is doing, even though I recognize that the cost in growth could be relatively strong.
Another point: I get fairly uncomfortable when the Fed sits around and bases its discussion on the risk of inflation vs. the risk, virtually nonexistent, of serious deflation. I would conduct policy by the old standard of providing a framework for sustainable growth, based on moderate monetary growth, and leave the forecasting to those whose errors do not affect the average American.
Q: What's your take on the gold market? Most economists do not like gold. A:
Q: What's your take on the gold market? Most economists do not like gold.
A:Basically, I share that prejudice with most other economists. For while I don't dislike gold, I have an intense antipathy toward forecasting the price of gold, as anyone who has asked me to make that kind of forecast knows. I would say, however, that the political and economic risks in the world economy are more severe now than the markets seem to recognize. And if that assessment is correct, and if investors themselves wish to hedge by buying gold, I don't regard it as an irrational decision.
Q: How significant is job growth to an improving economy? A:
Q: How significant is job growth to an improving economy?
A:In the longer run, it's obviously extremely significant. And the truth of the matter is that the average worker not only has employment problems but is afflicted by a slow growth in income, particularly those workers who are of the same gender as I am. And I do believe that that slow growth will continue. I hate to admit this, but I actually bought something at a Wal-Mart last month for the first time in my life. The place was extremely busy, and it did strike me that the average worker is under severe pressure in terms of making his income go the distance.
The same kind of evidence is there in the enormous popularity of state lotteries and the great strength of gambling, which seem to indicate that large numbers of people despair of making it financially without taking extreme and highly unfavorable risks. So I do feel that the economic position of the median American, the guy right between the top half and the bottom half, is under severe pressure.
It strikes me that this is an economy in which there is huge vulnerability to a rise in interest rates and to the possibility that such a rise would mean much tougher times for the housing market than is yet realized.
Q: When will the markets address the incredible deficit? A:
Q: When will the markets address the incredible deficit?
A:My answer to the question is simple -- when interest rates start to rise. Beyond that, there are, of course, the demographic problems associated with an aging population, including the boomers. I've also seen some recent research that indicates that when the 50-65 population group has increased in relative size, there has been a slowdown of growth in the past.... For the moment, I would say watch interest rates and the inflation rate for signs that the deficit is really starting to have an impact.
Q: This question obviously relates to your book, The Great 401(k) Hoax. Will the 401(k) programs ever be reversed back to the traditional pension plans? A:
Q: This question obviously relates to your book, The Great 401(k) Hoax. Will the 401(k) programs ever be reversed back to the traditional pension plans?
A:I fear that the answer to that question is no, barring a basic political change in the U.S. Except in a few key areas where unions are strong and continue to be strong, the power of the corporation to scale back on both pensions and 401(k)s is very, very strong. History suggests that when private pensions become oppressive to corporate profits, they tend to be scaled back, which is a basic point of The Great 401(k) Hoax, which I co-authored with Anne Colamosca.
Q: Do you see any major withdrawal of funds from the U.S. that have accumulated because of the foreign balance of trade? A:
Q: Do you see any major withdrawal of funds from the U.S. that have accumulated because of the foreign balance of trade?
A:That is the $64 billion question. It seems to me that history suggests that something like this kind of withdrawal is inevitable. One point that should be recognized is that there has been a tendency for a certain kind of triumphalism to influence American thinking.
Don't get me wrong, I still think that the U.S. is by far the best country in the world in which to work for a living. But the facts are that we tend to overestimate our relative strength. Numbers have come out in recent weeks that suggest that the main reason why American workers are more productive than those in, say, France and Germany is that they work longer hours than do French and German workers -- rather than that they are more productive during the hours that they work.
The suggestion here is that the U.S. still faces formidable competition from around the world, even from such high-wage countries as Germany and, believe it or not, France. And, of course, low-wage countries do not have to be more productive than we are to compete effectively. If Treasury Secretary Snow didn't really think this, what is he doing in Asia anyway?
Q: Bill, I know you can't discuss specific stocks, but do you have any thoughts on what sectors or industries are best now? A:
Q: Bill, I know you can't discuss specific stocks, but do you have any thoughts on what sectors or industries are best now?
A:I would play the energy-transmission problem as best I could, although I really stress that my knowledge of specific stocks in this area is relatively limited. I include in this utilities, because they will be the regulatory beneficiaries of attempts to improve the utility grid.
Q: Any thoughts on how to allocate assets -- stocks vs. bonds vs. cash -- at the moment? A:
Q: Any thoughts on how to allocate assets -- stocks vs. bonds vs. cash -- at the moment?
A:For the next few months, I like short-term Treasuries because I'm skeptical of sustained strength in the market. I've been sounding a bit gloomy today, but the facts of the matter are that the guy who wrote the book entitled Happiness Is a Stock that Doubles Every Year had something that is worth thinking about. Difficult as the market may be, it's by far the best way to try to make a lot of money, simply because it is what we economists call a positive-sum game. That is to say that the return to investment in stocks has been positive in the long run.
Remember Jeremy Siegel's Stocks for the Long Run. The thing that has impressed me, particularly since writing the Hoax book, is that large gains in the market tend to be compressed into relatively short periods of time. And to me, although there have been substantial gains so far in the last three months, this is not one of those times. But that does not totally scrub out the relation between stocks and happiness.