The economic long run
When our remarkable ride ends, will it be with a bang or a whimper?
The amazing US economic expansion reached its 106th month in February, making it the longest-running, uninterrupted period of growth in US history. There's much debate over who deserves credit, but little sober discussion of how the expansion might end.Skip to next paragraph
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There is no shortage of candidates for credit, and President Clinton is first on the list. Upon election in 1993, he realized that lower interest rates borne of deficit reduction would prove a longer-lasting stimulant than the deficit-expanding spending programs he originally championed.
This act of fiscal apostasy was anointed with low interest rates by Federal Reserve Chairman Alan Greenspan, who gets a share of credit for the expansion by allowing the economy to grow at rates that would have given his predecessors vertigo. And he has helped provide stability in times of crisis - in Mexico in 1995, Asia in 1997, Russia and Long Term Capital Management in 1998.
But credit for the economy's success is due, too, to Robert Noyce and Jack Kilby, who separately, in 1959, perfected the integrated circuit, from which flowed the microprocessor, the computer, and the Internet - all of which have transformed the economy as much as any policy.
To some, giving Clinton-Greenspan credit for the expansion triggered by the Information Revolution is like giving Moses all the credit for water flowing from the rock at Hebron: Providence also had something to do with it. There's merit to this view, but absent the stage Clinton and Greenspan set, it's unlikely today's revolution would have proven so robust.
But the debate over the expansion's origin obscures the more important question: How will it end?
The economy has grown at a muscular 4 percent for four years. But as knowing Wall Streeters say, "Trees don't grow to the sky" - nothing goes on forever. When economies falter, it's usually because some delicate balance has gone out of whack.
In recent memory, this has usually meant wage-price inflation: A tight labor market leads to higher wages, which leads to higher prices, which leads Fed chairmen less fortunate than Greenspan to bring the economy back within its speed limits. Some economists - proponents of the "new economy" - think this pattern is history. After all, just about every American with an alarm clock and bus fare has a job today, but neither wages nor prices show any convincing sign of acceleration, thanks to the galloping productivity gains.
Sooner or later, something's got to give, and labor availability will constrain growth. The good news is that today's more-responsive and alert economy might modulate itself without the overshooting that's led to past recessions, which is ultimately the reason this expansion won't end the way previous ones have.
There are still other imbalances that threaten the economy's forward momentum. One is the astronomical value of stocks: I hesitate to call it a bubble, because you never really know if something's a bubble until it pops.
But were stocks to "correct" (the pinky-up word for it), the economy would feel a tremor. And not just consumers would be affected. With margin debt - the debt with which high-flying institutional and individual investors buy yet more stocks and other assets - burgeoning, a stock correction would bring many high-flyers abruptly to earth.
A second possible imbalance exists between the US and the rest of the world, principally Europe and Japan. The US is growing, they're not. As a result, the US is running massive and escalating trade deficits as it buys their goods and they don't have the means to return the favor. That's fine so long as they're willing to take the dollars they accumulate and invest them back in the US, which to date they've been willing to do. But should they lose their taste for US assets, their growing piles of unwanted dollars will become a problem. A rapidly falling dollar usually means higher prices and higher interest rates - undoing two things that have permitted this expansion to reach the outer limits of economic gerontology.
These are the real risks we face. And notice, they're on the financial side of the economy, not the real side, the side that actually produces goods and services. In the real economy, things take time - inflation gradually creeps up, demand gradually slows, unemployment gradually rises. Caught early enough, these trends can be countered.
That's why the late economist Arthur Okun once said economic downturns were like airplane crashes, not hurricanes, in that they were fundamentally preventable.
But a crisis occurs in hours, not months; in days, not quarters. Something - stocks, bonds, the dollar - lurches, investors have a financial bad-hair day, and suddenly, panic takes over. Financial institutions go bust or grind to a halt, lending stops, and economic activity implodes.
The world faced such a moment when Russia defaulted on its debt and Long Term Capital tanked in 1998.
A crisis was averted through adept management. Yet the tinderbox aspects of the economy - escalating stock prices and margin debt - have only increased since then.
That doesn't say a crisis is in the works. But it does say we're ever more vulnerable, and that's the part of the horizon we need to scan. It suggests T.S. Eliot was wrong: If our economy's remarkable ride ends, it'll be with a bang, not a whimper.
*Everett M. Ehrlich is president of the Washington-based ESC consulting firm. From 1993-1997, he was US Undersecretary of Commerce for Economic affairs.
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