Aug. 17, 2004 -- The U.S. and global economies will expand strongly during the rest of 2004 and into next year, according to the latest analysis by The Conference Board.
The passing of the early acceleration phase of the business cycle has led to the misperception that the U.S. and global economies are at risk, but this is not the case.
“This phase is quite normal,” says Gail D. Fosler, The Conference Board’s Executive Vice President and Chief Economist, “we will see strong growth rates return shortly and continue in 2005.”
Industrial growth has been rising at a 5.6% rate in the U.S. and a 5.2% rate globally. Growing from a near standstill in mid-2003, the sudden acceleration in economic growth rates in the past nine months has put tremendous pressure on the global supply chain, particularly in key industrial commodities like steel, copper, aluminum, and energy.
Global energy markets and the U.S. labor market are also tight, and the strength in industrial activity is likely to spur higher inflation and higher interest rates in the U.S. and elsewhere.
On the Inflation / Interest Rates Front: A Slow but Steady Increase
“Overall, there appears to be little risk of 1970s-style inflation that would cause the Federal Reserve Board to raise interest rates suddenly and substantially,” says Fosler in the latest issue of StraightTalk, her newsletter prepared exclusively for members of The Conference Board. “More likely is that both inflation and interest rates will rise slowly but persistently in the foreseeable future. The Conference Board forecast shows the core consumer price index staying close to 2.5% this year and heading toward 3.5% by the end of 2005.”
Persistent inflationary pressures means the Federal Reserve does not have the same latitude it had in the 1990s to cut rates when the U.S. or the global economies ran into trouble. Prices and wages are not nearly as rigid as in the ‘70s, but many of the structural forces – the expanding global supply chain, information and communications technology, declining inflation rates in healthcare, etc. – are probably reaching the point of diminishing returns from the perspective of price stability.
Tight labor market conditions affect inflation because higher wages tend to drive up services prices, which constitute 60% of all consumer spending. Information and communications technology is an important source of productivity gains and will keep prices low. But a low unemployment rate this early in the recovery suggests that wage pressures, which are already beginning to build, will continue.
The Conference Board’s latest forecast shows that services prices will begin to pick up this wage pressure, moving from approximately a 3% annual increase currently to over 4% by mid to late 2005. These rates, when combined with goods prices in the 3% range, point to at least a 4% overall rate by late next year – an uncomfortable position for the Fed.
The 1970s All Over Again?
The 1970s were dominated by a unique combination of oil, commodity, and import price increases that represented dramatic external shocks of unprecedented magnitude, including the tripling of oil prices and non-energy commodity prices shooting up. The surge in commodity prices was transmitted almost immediately into the U.S. price structure by a declining U.S. dollar that sent non-oil import prices up fivefold between the end of 1972 and the middle of 1974. These external shocks caused compensation increases to double.
“It is certainly not impossible that a terrorist event could cut off global oil supplies and send oil prices sky high – some say to as much as $80/barrel,” says Fosler. “Even still, if it is assumed that oil prices are rising in the long-term, statistical trends suggest that the current $40/barrel oil price is very high.”
From the viewpoint of oil producers, a sustained high oil price creates incentives for investment in oil development that will upset a delicate global demand/supply balance that, for the moment, favors them. And although the U.S. is a major source of global oil demand, energy now holds a much less important place in the U.S. economy. Also, unlike in the ‘70s, the U.S. can adjust more easily to higher oil prices because of fuel saving technologies, especially in the auto market, that were not available 30 years ago.
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