Inflation Fears Mount as Doom Gathers Steam

The Sunday Times (London)

10 October 1999

The business community heaved a sigh of relief when the Federal Reserve Board's monetary policy committee decided not to raise interest rates last week. True, the Fed did say that it would be "especially alert in the months ahead" to any signs of resurgent inflation. This so-called bias towards a rate rise in November spooked the stock market a bit, but is of little consequence: the Fed often fails to follow its announced biases towards raising or lowering rates with commensurate action.

The Fed's restraint reflected the fact that, so far, the traditional inflation indexes have failed to register any consistent upward pressure on prices. Some put this down to a new paradigm-a steady and continuing increase in productivity that offsets any wage increases. Others claim that the Internet is now a force that traditional retailers have to reckon with when setting prices. Economists Ethan Harris and Joseph Abate of Lehman Brothers point out that although e-commerce accounted for only some 1% of retail sales last year, every item available in stores and shops is also available on the Web, and therefore subject to its competition.

The Lehman Brothers economists estimate that prices on the Web average 13% less than those in traditional retail outlets, even including shipping costs on Web orders. Prescription drugs are 28% cheaper, apparel 38% cheaper, and alcohol and cigarettes 28% cheaper.

But the fact that prices have not gone up does not mean that inflationary pressures are not building, perhaps to a point where even competition from the Web can't offset them. After a brief pause in the second quarter, when the annual growth rate fell to 1.6% (its lowest level in four years) from the first quarter rate of 4.3%, the economy seems to be picking up steam. Most economists think that it grew at an annual rate of around 4% in the third quarter, and many expect that expenditures on Y2K adjustments will take the rate to 5% in the final quarter.

They could be right. Jobs are easy to come by, and personal incomes are at record levels. The Census Bureau reports that median household income reached $38,900 last year, breaking the record set in 1989 (all figures are adjusted for inflation). The University of Michigan finds that consumer optimism is at its highest level since the 1960s. Little wonder that consumers continue to snap up all of the goods that America's factories, and those of its trading partners, can turn out.

Or that factories and are humming and construction sites ubiquitous. Factory output rose smartly during the past summer, and is continuing to barrel ahead. The National Association of Purchasing Managers says that the manufacturing sector has now recovered the ground it lost when the Asian economies collapsed last year. By the time the year is out, auto makers will have sold some 17.5 million units, breaking the 1986 record of 16 million. Pick-up trucks and sports utility vehicles continue to lead the way. Sales of new homes registered their third straight advance in August, and housing starts continue to rise, despite recent increases in mortgage rates.

All of this adds up to severe tightness in the labor market, and to an incipient bidding up of wages. Help-wanted signs are everywhere. Fast-food shops, long dependent on low-wage student labour, are now offering health-care coverage and other benefits usually bestowed only on more mature and permanent employees. And the Wall Street Journal reports that even tiny businesses, such as Ohio-based Shared Resources (53 employees), are recruiting workers from as far away as India. And not at low wages: the computer programmers will be paid the same $41,000-$53,000 salaries that U.S. workers get.

If all of that is not enough to raise the spectre of an inflationary outburst, consider this. The American current-account deficit, which includes trade in goods and services and payments to foreigners to cover interest and dividends due them, is headed towards 4% of GDP, a level that many economists say cannot be sustained. Business Week, not generally given to panic, says that "the U.S. is now in an unsustainable international position that will only get worse over the coming year."

That means that the already weakening dollar will sink further, making imports more expensive and adding to the inflationary pressures created by a fully employed economy. Meanwhile, continued growth in fringe European economies such as Spain and the Netherlands, combined with economic recoveries in France and in Asia, will increase the demand for commodities, driving up their prices. Indeed, thanks in part to a cartel that has found new cohesion, oil prices have already soared. This is putting pressure on airlines and truckers to raise their rates.

To add to inflationary pressures we have a rapid growth in the money supply and what The Economist terms a "borrowing spree" by both households and businesses, encouraged by the inflation in the value of the shares and other assets that they hold.

All of this, of course, Greenspan and his colleagues know. But they also know that many of the old relationships in the pre-Internet economy may no longer hold. It may indeed by the case that rising productivity will keep costs down, and that the increased competition stemming from the globalisation of many markets and from efficient Web-based delivery systems will persuade producers that they cannot raise prices. And the end of daily increases in share prices may persuade consumers to begin putting a bit aside for a rainy day, or for their so-called golden years, rather than outspending their income, as has become the fashion in recent years.

That's what the Fed is hoping. If that hope is not realized by the time the policy makers gather again in November, look for a rate rise before the year is out.