Eight percent GDP growth, a housing boom, an interest rate below the inflation rate, an injection of 700 billion dollars into the economy by the federal government -- from surplus of close to 300 billion dollars early in 2001 to deficit of more than 400 billion dollars three years later-- yes, it's taken a lot, but finally they've done it, they've got inflation to budge up!
And who might "they" be? They are Federal Reserve Chairman Alan Greenspan and President George W. Bush. The former might be said really to have wanted the higher inflation that has appeared in the past three months' consumer price inflation releases whereas Bush, uncomplicated fellow as he is -- and thereby hangs a complicated tale or two -- merely wanted the good things that tend to provoke a rise in inflation: growth and higher spending and happy consumers and happy voters.
For Greenspan, a bit of inflation is a good thing because there can be little doubt that he has been concerned for three years about Japan-style deflation in the wake of the bursting of the late 1990s stock market bubble in 2000. His remedy has been to cut the short-term interest rate controlled by the Fed to 1 percent and to assure the markets that he would keep the rate low for a long time. Falls in bonds and stocks earlier this week reflected re-found fears that Greenspan won't be able to keep rates down for much longer if inflation is on the move.
But the inflation story -- and the story for the U.S. economy -- remains much more complex than the headline inflation numbers might suggest.
In March, consumer prices in the United States rose by a seasonally adjusted rate of 0.5 percent from February. That may not sound too bad but is a big rise because 12 months of 0.5 percent increases would produce an annual inflation rate of 6.2 percent. March, moreover, was the third month in which inflation has shown some life. In January the rate was 0.5 percent and in February 0.3 percent. If you annualize those three rates you get uncomfortably high inflation of 5.1 percent.
The interest rate, even the short-term one, is normally higher than the inflation rate. No wonder the stock and bond markets have been jittery this week. If current inflation were to persist interest rates would have to rise by a huge amount -- causing Treasuries and stocks and the housing market to crash. And then would we still have high growth? No, it, too would go, victim of its old enemy, inflation.
But, perhaps fortunately, headline inflation numbers often overstate the inflation case -- and do so this time. Look at the factors behind them. Gasoline prices are setting records in the United States. Take volatile energy and food prices out of the equation and the consumer price inflation rate in March was 0.4 percent, following modest rises of 0.2 percent in January and in February. The annualized increase in prices in the first quarter if you leave out food and energy was a tolerable 2.9 percent. And the current 12-month inflation rate excluding food and energy is just 1.6 percent -- and only a little more, 1.7 percent, if you do include food and energy.
Those low annual inflation rates are worth thinking about. Never mind the increase in inflation for a moment. Why is inflation not much higher?
There have been many factors in the past year that ought to have driven consumer prices up strongly -- and, by the by, created jobs for Americans. The dollar has tumbled against the euro -- notwithstanding its small recent recovery. A weaker dollar favors exports, which have done well, but also means import prices should rise, fueling inflation. But the annual inflation rate, as we point out, is still not yet up by much.
The 8 percent growth we referred to above -- 8.2 percent, to be precise -- was recorded in the third quarter last year. That is a very high rate of growth and it was followed by 4.1 percent growth in the fourth quarter and a probable higher rate of growth since. Again, these high rates of growth ought to be stimulating higher inflation -- and job creation. But in both regards the response so far is tepid.
In March the U.S. economy created 308,000 new non-farm jobs. That was a positive surprise following many months of disappointment. But the latest weekly new jobless claims figure showed a rise to 360,000, the worst number since December 2002. On balance, it seems the job market is improving, but very slowly. And all this despite -- this, to our mind, is the important thing -- the huge amount of stimulus thrown at the economy by Bush and Greenspan.
Tax cuts, high defense spending and extremely low interest rates have generated growth and a staggering and extended boom in housing construction, sales and prices. A headline from the Los Angeles Times this week told the story of the housing market in Los Angeles county: "Home Prices in L.A. Soar at Record Rate," it shouted Tuesday. "Frenetic buying activity pushed the median sale price up 29 percent, to a record $375,000," the report said, though it failed to make clear the time period over which that rise was recorded.
Los Angeles is one of many house price hotspots in the United States. Commenting on February's 6 million plus sales of so-called existing homes -- it is only the eighth time in history that monthly home sales have exceeded the 6 million mark -- National Association of Realtors President Walt McDonald said, "Last month's average mortgage interest rate was the fourth lowest on record ... Historically low mortgage interest rates are expected to dominate again this year, which will help to keep home sales very close to last year's record."
Which brings us full circle. Money and inflation: they are old cousins. There is a lot of money about, fed into the economy by Greenspan's low interest rates and Bush's tax cuts, and there is huge inflation in the United States in house prices but not, yet, in overall consumer prices. What can this lead to?
There are two alternatives. Either overall inflation does begin to pick up, in which case interest rates must rise substantially and Treasuries, stocks and house prices fall -- sending the U.S. economy back towards recession, it would seem. Or growth peters out later this year because neither Greenspan nor Bush has more stimulus to offer. That would mean interest rates would stay low and the Treasury market would have less to worry about -- other than the U.S. government's ability to pay -- while stocks and house prices would again be vulnerable because their rise reflects cheap money and speculation, not a sound economy.
Our expectation is that the second of the two alternatives will occur, the fading of growth and of inflation later this year and into 2005 and the resumption of still more marked deflationary pressures.
Neither alternative is a happy one but this is where U.S. policy-making has led the country. When a record fiscal deficit and house price inflation have become your fuel, you are simply not going to keep moving forward for long.
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(Global View is now a two-weekly column reflecting on issues of importance for the global economy. Comments to [email protected].)
