[Sorry, the video for this story has expired, but you can still read the transcript below. ]
RAY SUAREZ: For some explanation of what happened today on the exchanges and in the wider economy, we’re joined by Gail Fosler, senior vice president and chief economist at the Conference Board, a global business research organization that tracks economic indicators; and Richard Berner, chief United States economist at Morgan Stanley Dean Witter.
RAY SUAREZ: Well, Mr. Berner, the Dow closed at 10305. What happened?
RICHARD BERNER, Morgan Stanley Dean Witter: Ray, what happened was that investors were surprised by the inflation report that came out this morning. And I think most people had been conditioned by what we’d seen in the past to expect continued very good news on inflation apart from food and energy. And I think the inflation report did two things: It raised questions about whether or not we would see inflation rise in the future, and also very importantly, about whether the Fed would step up the pace of monetary tightening in which it has been engaged for the last nine months or so.
RAY SUAREZ: In your view, what is the connection between those two events: The announcement of the higher core rate of inflation, and that big sell-off? What does it mean to an investor to find out that inflation has been a little higher? Why should that make him or her sell?
RICHARD BERNER: I think that inflation staying low has been one of the hallmarks, the very good hallmarks of the expansion, thanks to the stewardship of Alan Greenspan and his colleagues at the Federal Reserve. And also very importantly, in the past couple or three years, because of the disinflationary or lower inflation impact of the global financial crisis that we went through in 1997 and 1998. Now the world economy is picking up steam. We think it’s growing very strongly. Inflation cyclically is rising back up again. That tends to mean that interest rates will rise. And rising interest rates and rising inflation are typically not good news for stock prices.
RAY SUAREZ: Gail Fosler, is that the way you see it?
GAIL FOSLER, The Conference Board: Well, I think there is also a very important element of risk here. There have been some underlying tones in the wage numbers and the most recent inflation numbers that kind of make investors a little bit unsettled. But really this market has been hugely volatile, and I think that it is a sense that the economy is maybe growing too fast. And maybe these very substantial increases in stock prices can’t be sustained in the year 2000, and people will want to capture gains, cut their losses and get out of the market.
RAY SUAREZ: Well, one day doesn’t happen in isolation. The markets, both exchanges have been down pretty steadily in recent weeks.
GAIL FOSLER: Right.
RAY SUAREZ: Is it in that atmosphere that something like the core inflation number has a particularly big punch? If this had been a less volatile market leading up to today, might today’s numbers have been shrugged off or had less effect?
GAIL FOSLER: Well, I think that today’s number confirmed our worst fears. The economy has been growing very fast. And, as Dick mentioned, we’ve had very little in terms of real inflation confirmation. Now we’ve got this inflation confirmation. I think the thing that’s significant about today is that the Dow and the NASDAQ fell together. We’ve had a little changing places between the two indexes over the course of the beginning of the year. This is a little bit of a revisitation of where we were earlier in the year. But now we have both indexes going down at the same time.
RAY SUAREZ: Richard Berner, a lot can hide inside the big numbers. Did everything go down at once or were there certain sectors that got hit pretty hard?
RICHARD BERNER: Ray, I assume you’re talking about the stock market.
RAY SUAREZ: Uh-huh.
RICHARD BERNER: And the answer is the selling was pretty broadly based. But as indicated by what happened with the NASDAQ, obviously the declines were most severe there. As Gail mentioned, we’ve had selling in the NASDAQ for about three weeks now. Investors have perceived that that part of the market is probably more richly valued than other parts. Indeed, the dichotomy between the evaluations in the NASDAQ and the so-called old economy stocks, has really been one of the key themes in the marketplace over the past year or so.
RAY SUAREZ: Does an event like this set off a chain of other effects in consumer spending, how people feel about their own prospects near-term, middle-term? Could we see the ripples going out from today for weeks to come?
RICHARD BERNER: Well, excuse me. That’s always a potential. We have to remember that we’ve seen stock prices rising for the past five years. In the past two years alone, we’ve had an increase in wealth that really is almost unparalleled — something like $8 trillion on a base of about $35 trillion. Those very large increases in wealth will take some time to reverse. And their effect on people’s feelings about the economy really are still working their way through into the economy itself.
GAIL FOSLER: Well, you may wonder that you have two economists that actually agree with one another, but I have to agree with what Dick has said. And I’m not sure that really the wealth effects are as important as Chairman Greenspan has made them out to be. The underlying economy is just very, very strong. We got an employment report — we’re very close to having a 4 percent unemployment rate. We got a little bit of a tick-up of wage gains but real wage gains are just the best they’ve been in a very long time. We have got a lot that’s carrying the consumer sector. People have booked a lot of wealth gain. I don’t think this… I think this kind of adjustment might be considered to be almost healthy because the market is reacting to the fundamentals that it sees. And people worry about a bubble economy. A bubble economy is really when the market moves contrary to what you would think would be underlying fundamentals. So there is an element of health in what seems to be a very bleak story.
RAY SUAREZ: Well, you talk about the employment numbers and the strength of wage gains. Does this inflation number have some threat in it for the half of the work force that doesn’t own stock, that doesn’t check to see how things went in the middle of the day and look for the close?
GAIL FOSLER: Well, yeah, I think it does — because when you look at the composition of that inflation number, part of it is in the housing sector. And we’ve actually been puzzled that we haven’t seen more inflation in the indexes in the housing sector because certainly most people have seen house prices go up in their local marketplace. Medical care costs — we’ve had almost a decade when health care costs have been — the rate of inflation in health care has been going down. Now it’s going up again. That affects a lot of people adversely, and then of course education costs and other services. So there’s not good news in these numbers for disposable income for the average person.
RAY SUAREZ: If we see in another month, in another two months, that this was a blip, Richard Berner, that today’s numbers were an aberration and really the core rate is more like it was for the past several months, very low and very steady, how do we see that work its way into the marketplace as well? Will we see some kind of correction upward?
RICHARD BERNER: Well, if indeed this did turn out to be a blip, then obviously you would see markets heave a huge sigh of relief. And then they would probably rally as you suggest. That’s really one of the key questions here, whether this does mark the beginning of a gradual up trend in inflation. And I think the answer, my own answer to that would be yes. We’ve seen a lot of signs, as Gail mentioned, that the economy is extremely strong. And we’ve seen a lot of signs of advanced warning that inflation was likely to pick up.
What this number does, however, is it creates a lot of uncertainty, not only about the question you raised, is this a blip, but could there be more to come? And history shows when we’ve seen an up tick in inflation like this one as broadly based and in the backdrop that we’re now looking at, a very hot economy, one in which a lot of the forces that were holding inflation back, have now dissipated or might even have reversed, typically we start to see an up creep in inflation. And that would be what my expectation would be.
RAY SUAREZ: Richard Berner, Gail Fosler, thank you both.
GAIL FOSLER: Thank you.