More prosperity, slower, in 2000

Election-year rhetoric. Higher interest rates. Y2K bugs. Can any of these derail the mighty US economy next year?

Probably not, but don't be surprised if the bullet-train economy slackens its pace a bit.

A number of factors may contribute to a slowdown, but chief among them is worry about inflation. In a preemptive strike, the Federal Reserve may crank interest rates up another notch, perhaps as soon as February - a move that could pull back breakaway economic growth to a more normal level.

"My theme is optimism tempered with realism," says David Orr, chief economist at First Union in Charlotte, N.C.

What this means for American families and workers is:

*Mortgages and other borrowing will cost more. Shoppers may think twice about big-ticket items. Home construction will slow.

*Job growth will slow, but unemployment will remain low because the pool of workers isn't growing appreciably.

*Stock prices may get shakier as corporate profits rise less briskly.

*Business will continue to invest in productivity-enhancing equipment but at a slower pace.

All of this means the nation's total economic output - the gross domestic product - is expected to grow 3.5 percent instead of the 4 to 5 percent rate of 1999.

This is not to say there won't be economic uncertainties. In fact, in some ways, next year seems to have more than the usual number of question marks.

Take the Y2K issue.

Economists are not sure how much computer glitches will take out of the world economy. Although few analysts expect a lot of mishaps in the US, computers in developing nations may fail to read the new year as 2000 (rather than 1900). Those nations, with their low-cost manufacturing, are closely tied to the American economy.

"There are studies which have found it's unlikely for the US economy to escape unfazed," says Scott Grannis, a principal at Western Asset Management, a Pasadena, Calif., bond manager.

For example, a company that manufactures parts in China may find that deliveries are delayed until computers are repaired. "Even if it's only scattered in minor events, they can cascade and present minor problems," says Mr. Grannis.

A high-tech fizzle?

The Y2K issue may also affect the US economy in another way.

Over the past two years, companies have been spending heavily on new computers to get around the problem. Mr. Orr notes that spending on technology accounted for 55 percent of economic growth in the past four quarters. Business and consumer computer-buying grew at a 40 percent annual rate.

"Even if this slows to a 25 percent annual growth rate - that is, the growth rate of 1996 - it would take one percentage point off the growth of the GDP next year," says Orr. Because of the uncertainty about Y2K, economists expect the Fed to hold off on raising interest rates until February.

Minneapolis-based economist Sung Won Sohn of Wells Fargo & Co. says the Fed will have a "narrow window" from February through April to raise rates. After April, he expects the Fed will want to remain neutral because of the November elections, "especially since Chairman [Alan] Greenspan's term is up for renewal."

Campaign promises

The elections add yet another element of uncertainty, says Mr. Sohn. "My concern is that politicians will promise goodies for everyone financed by the budget surplus, which may or may not last." The worry is that such promises could ripple onto Wall Street in the form of higher interest rates or lower stock prices.

The US economy may also start to feel the effects of changes in Japan. In the recent past, Japanese companies valued market share over profits. To keep their market share, they were willing to cut prices.

Last year, for example, Japanese auto companies cut prices so much that General Motors was forced to reduce its list prices for the first time in more than 30 years. This year, the Japanese are raising prices.

"When the Japanese raise prices, Detroit can raise prices as well," says Sohn.

Inflation may also catch hold as the rest of the world picks up after a downturn, says economist Brian Fabbri of Paribas in New York. "We were the only bidders for many of these commodities when there was excess capacity and no [worldwide] growth. The year 2000 will be different," he says.

How much will this translate into higher prices next year? Mr. Fabbri estimates inflation will climb to about 3 percent from 2.3 percent this year and 1.6 percent in 1998.

"It's not outrageous, but it does double inflation rate in the last two years," he says. The Federal Reserve is not expected to sit tight while the inflation rate increases. In February, many Fed watchers expect the central bank to raise interest rates - perhaps as much as half a percentage point.

If inflation does perk up, this would be just the start of a new round of Fed tightening. Eventually, he expects to see the 30-year Treasury bond pay 7 percent interest, up from 6.3 percent today.

This could send mortgage rates to the 8.25 to 8.50 percent level, up from 7.8 percent today. Rising interest rates will start to slow the economy. The housing industry, for example, is forecasting that builders will start about 8 percent fewer homes next year.

With the housing industry stepping back a few paces, demand will also lessen for appliances, furniture, carpets, and drapes.

"That's a significant decline but still a good year - better than anything in the 1990s except for the last two years," says David Seiders, chief economist for the National Association of Home Builders in Washington.

Richard Curtin, director of the University of Michigan Surveys of Consumers, expects retail sales will also slow next year from a 6 percent increase this year.

As interest rates have moved up, he says, so have concerns about debt levels.

"We have seen that consumers are more concerned about the pace of their spending," Mr. Curtin says. This will reduce demand for some big-ticket items, such as autos. Next year won't match 1999, he says, but "next year will be considered a very good year."

Stock slowdown

What will lower sales and profits mean for the nation's great wealth creator - the stock market?

Merrill Lynch & Co. predicts earnings for the Standard & Poor's 500 stocks will grow 12 percent in 2000, shy of this year's 15 percent pace. Stock prices are already beginning to reflect this lower growth rate. As December winds down, 57 percent of the 500 stocks are down from their highs.

Richard McCabe, chief market analyst at Merrill Lynch, predicts stock prices will begin the year with a slide.

And he would not be surprised to see a shift away from the high-tech wonders that have powered the NASDAQ average to stunning new highs. Such a decline, he says, would set the stage for a new "broader advance afterward" once investors see signs the US economy is slowing. Such slowing would reassure investors that interest rates won't rise for long.

(c) Copyright 1999. The Christian Science Publishing Society