Time to pop the party
A strong economy unnerves the Fed
By BERNARD BAUMOHL
January 31, 2000
Web posted at: 3:47 p.m. EST (2047 GMT)
The U.S. economy roared into the 21st century like a bullet
train last quarter, and the vibrations it created were rattling
the china on Wall Street last week. Stock prices plunged on
fears of higher inflation and rising interest rates, but neither
of these variables seems likely to derail the economy this year
or possibly even next.
The Commerce Department report released on Friday amounts to an
impressive display of resilience. Business activity grew at a
breakneck rate of 5.8% in the final three months of the year,
faster than most experts had predicted. The surge in output
lifted 1999's total gross domestic product 4%. That's the third
year in a row the economy grew at that rate or better, a feat
last accomplished in the late 1970s. When this expansion passes
the February milepost, it will become the longest in American
history--107 months.
The force sustaining the economy's extraordinary performance is
you. Consumer spending accounts for two-thirds of all business
activity, and with record low unemployment, better pay and the
effervescent stock market, Americans spent 5.3% more in 1999 than
they did the year before, the largest gain in 15 years. Business
spending jumped 8.3% as companies not only sought to protect
themselves from phantom Y2K problems but also stocked up on goods
to keep holiday customers happy. The Y2K fizzle will permit
companies to redirect their investments to capital spending,
which serves to increase corporate productivity and boost
profits.
With such good news, why did Wall Street freak? In a word:
inflation. A report by the University of Michigan showed that
consumer confidence soared in January to an all-time high,
suggesting that the consumer spending binge is far from over.
Other fresh signs emerged showing that the scarcity of workers is
driving up labor costs, as Federal Reserve chairman Alan
Greenspan has long warned it would. The Labor Department said the
employment cost index, which measures how much worker pay and
benefits are rising, surged 1.1% in the fourth quarter--the
biggest increase in nearly six years--and rose 3.4% for the year
as a whole, much higher than expected.
That's pretty manageable in the big picture but is nevertheless a
warning light flashing that inflation may accelerate as the
economic expansion picks up speed. Investors feel certain that
when the Federal Reserve meets this week, it will raise interest
rates at least a quarter of a percentage point--25 basis points in
the Street's calibration (1 percentage point equals 100 basis
points)--and they fear more increases are on the horizon. Money
flows out of stocks when rates rise or seem likely to, and did it
ever last week. The Dow Jones industrial average dropped 513
points, to 10,738.87, its lowest level since Nov. 11. The
tech-driven NASDAQ shed 8% to 3,887.07.
Many "new era" investors, who believe the use of computers has
solidly lifted the nation's productivity, think the inflation
threat is still way overblown. That may be true. But as long as
the Fed believes the threat is real, the financial markets will
react accordingly.
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