May 8, 1998
Things are looking pretty good these days. The Labor Department announced this morning that unemployment was at a 28-year low. But could the first sign of bad news burst this economic exuberance like a bubble?
PHIL PONCE: The U.S. economy isn't just humming--it's singing. That, according to the U.S. labor secretary, whose department this morning announced the nation's lowest unemployment rate since 1970, an unemployment rate of just 4.3 percent in April. Today President Clinton had this to say:
A RealAudio version of this segment is available.
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Federal Reserve Board.
PRESIDENT CLINTON: No one can claim full responsibility for it. There was not a totally coordinated strategy, but it did not happen by accident. America has been on the same page from our strategy in Washington to balance the budget, invest in our people, and expand trade, to the entrepreneurs, to the scientists, technicians, to the teachers in our schools, and the people who run our businesses, and the folks who work in our factories.
Consumer confidence high, unemployment low.
PHIL PONCE: The Department of Labor said there were 262,000 new non-farm sector jobs, mainly in the service industry. Today's numbers also showed hourly wages increased by four cents an hour to $12.67. But such increases don't seem to be translating into higher inflation. In March, consumer prices were unchanged from February. And there are other healthy signs: Consumer confidence is at a 29-year high, and retailers are reporting their best sales in more than a decade.
In the first quarter of 1998, major retailers reported a six and a half percent increase from last year. And Wall Street continues to surge. The market is up 15 percent this year and 65 percent over the last two. With today's employment news, the market gained almost 80 points, again finishing above 9000. Many analysts believe these higher stock prices have helped spark a record year of mergers and acquisitions.
So far this year the Federal Reserve has left interest rates alone, and current low rates have spurred new home and car sales across the country. But Federal Reserve Chairman Alan Greenspan has reservations. He's repeatedly worried aloud that higher wages can eventually kindle inflation. And some economists have begun to refer to the economy as a bubble, which could burst on the first signs of bad economic news. President Clinton was asked about that at a news conference last week.
REPORTER: Now, do you think that this stock market bubble is going top burst?
PRESIDENT CLINTON: We have a very productive economy with high growth and low interest rates. Also, the fact that there is a downturn in many Asian economies I think has created some investment capital that normally might have gone somewhere else that may be coming back into our country. I'm encouraged by the underlying fundamentals, and what I hope will happen is that we can avoid any kind of big swings in the market one way or the other by just steady, slow--maybe not so slow, but at least steady growth.
Two experts analyze the American economy.
PHIL PONCE: Joining us now to debate the issue, Zanny Minton Beddoes covers the American economy for The Economist, the London-based magazine that recently ran a cover story called "America's Bubble Economy." And Vernon Winters, chief investment officer for Mellon Private Asset Management, the private client division of Mellon Bank. And welcome both of you.
PHIL PONCE: Mr. Winters, the lowest unemployment rate in almost three decades, what does that tell you?
H. VERNON WINTERS, Investment Strategist: Well, it tells us the economy's still doing well, and everything is on track.
PHIL PONCE: Your reaction to that, an equally rosy reaction?
ZANNY MINTON BEDDOES, The Economist: I think--actually, I think it's rather worrying, frankly because it tells us that the economy is booming. We know that because output was rising very fast at the beginning of this year, but it tells us that it's doing that because we're using more and more work. Unemployment is at these historic lows. It's way below levels that are traditionally associated with rising wage pressure. We have seen rising wage pressure. One of the other things we've found from the numbers that came this morning is that wages are, in fact, rising, and ultimately, as Chairman Greenspan says, there's a risk that that pushes through to higher inflation.
PHIL PONCE: Mr. Winters, how do you react to that, the fact that low unemployment means that employers have to pay higher wages, that could lead to higher production costs, and, therefore, inflation?
H. VERNON WINTERS, Investment Strategist: Well, so far it's not showing up in inflation because companies have been able to increase productivity such that they can afford to give workers a higher wage and not pass through the prices. In fact, they can't raise prices because of competitive conditions worldwide. So they're doing everything they can to improve productivity. And so far that's been working.
What is a bubble economy?
PHIL PONCE: Ms. Minton Beddoes, your magazine talked about the United States having a bubble economy. What is a bubble economy?
ZANNY MINTON BEDDOES: When we talk about a bubble, we talk about rising asset prices, stock prices, particularly, that are going up, further than the economic fundamentals would warrant, and they're going up because of some kind of speculative frenzy, to use a phrase, again, that Chairman Greenspan used, some kind of irrational exuberance. We're all feeling good. We're buying shares. Prices are going up not because of fundamental changes or not only because of fundamental changes, more because there's a kind of frenzied buying.
And that's what we mean by a bubble, and we worry about it for two reasons. We worry about it because bubbles tend to burst. Financial markets have had bubbles ever since finance started. But the problem is that they burst suddenly and when they burst, share prices can collapse very quickly, and that can actually have real detrimental economic consequences; it can push the economy into a recession. The other problem is that if they--if the bubble continues, then this kind of inflation in asset prices--because that's really what it is--can spill over into broader inflation. And we can begin to see--
PHIL PONCE: By inflation and asset prices, you mean inflation and stock prices and--
ZANNY MINTON BEDDOES: Yes. Stock prices rising above that which you would expect from the real corporate performance of the company. When I talk about inflation, I mean kind of unnecessarily large rises in stock prices.
PHIL PONCE: And you believe the U.S. economy is in a bubble mode?
ZANNY MINTON BEDDOES: I think there is plenty of evidence that would support that, and I think the 15 percent rise in stock prices this year, 65 percent rise over the last two years that you mentioned earlier in the program is a powerful evidence of that, particularly as now we see rising labor costs beginning to put pressure on the profitability of companies. Yet, stock prices keep on inexorably rising upward. And that's the main reason but it's not the only reason for a bubble. There are other signs. One is the merger mania that we're seeing now. It's often at the end of bull markets when we get into bubble mode, people get into merger mania, these huge, huge stock--these huge mergers of companies take place, and they are often a signal of the beginning of the end.
PHIL PONCE: Mr. Winters, that's a long list of evidence that the economy might be in bubble mode. How do you evaluate that evidence?
Will technology keep the bubble economy afloat?
H. VERNON WINTERS: I don't think what's happening to asset prices, particularly stock prices, is irrational at all. It's justified by the fundamentals. After all, if you look at our economy we've been in in 15 years of expansion interrupted only by seven months of recession since 1982, so we've been in recession in our economy four percent of the time over the last 15 years. In the prior years after World War II we were in recession 25 percent of the time. So it seems to me the stability in the economy justifies higher prices. Also, we're in a technology revolution, a revolution where productivity enhancements are coming in a rapid pace. We have the Internet, which is probably the most--the biggest development of our lifetimes, really, and it's deflationary in the nature. We have a global economy with a couple of billion people around the world now operating in the market economy and wanting to increase their standard of living and our companies have a chance to sell into those markets. I think the stock market is looking ahead. It's seeing these opportunities in terms of technology, in terms of globalization, and the prices are on a rational basis reflecting that opportunity in the future. I think it'll be--if it's a bubble--I think it'll be a balloon before long.
Do the rules of the past no longer apply?
PHIL PONCE: So you're saying that there are economic realities in place now that weren't in place in the past and therefore, what, the rules of the past don't necessarily apply now?
H. VERNON WINTERS: I think the reason economists have really been so mistaken in terms of projecting inflation and budget deficits and growth in the economy is they basically straight-lined or taken a ruler to some of the past friends and rules in the economy of the 60's and 70's. And they aren't applying now because the economy has really fundamentally changed. Now, I don't think it's going to be like this forever. The world changes, and it'll change again, but I think we still have a long way to go because these are very much structural changes. They may be interrupted from time to time by cyclical problems in the economy, but I think we're going to work our way through that.
PHIL PONCE: New structural changes, new rules?
ZANNY MINTON BEDDOES: Well, I agree that there have been changes in the world economy, and there have been changes in the U.S. economy. The question is how big have these changes been and do they justify today's prices, and I think one argument that is frequently made by the people who believe in this new economy or a new era is that we have much higher productivity. Now, the productivity figures are, indeed, were beginning to rise, but although yesterday the productivity figures came out for the first quarter this year, and they showed a marked slowdown. But I am a great believer in the traditional rules of economics. And if you look at what's happened in the last two years in the U.S. economy, we've grown far faster than the trend growth, and we--than economists normally think the economy can grow--and that is because we've used more people. Unemployment has come down. It's not that the rules have fundamentally changed. The one thing that does seem to be different is that as wages are rising, there isn't this immediate transfer into higher inflation.
Now, there are--that could be because of some new rules. It could also be because there are a lot of temporary factors which have actually influenced. One is that benefits have been rising much more slowly than they used to. The HMO revolution has meant that its employers have been able to cut costs in areas where they traditionally weren't able to cut costs. Secondly, the dollar is very strong. Now, the strength of the dollar also dampens inflation. Thirdly, commodity prices are weak. They're weak in part because of the problems in Asia, but they're not--those are not structural changes. They're temporary things that could change, and when they change, I think we'll see the old rules coming back into play.
PHIL PONCE: How about Mr. Winters' position that when there is a slowdown, that it's going to be gradual, that it's not going to be a dramatic burst?
ZANNY MINTON BEDDOES: Well, the issue is how much have today's stock prices factored in a rosy scenario forever more? And if you look at what happened in the markets today, where they rose despite the fact that we had this incredibly low unemployment figure, which might make market participants worry about a fed rise more than they did before they knew this information, so you could think these numbers would make you worry about stock prices, nothing of the sort. The market shrugged that off completely. Now, that makes me think that the market is on a bit more of an irrational binge, rather than a kind of straight laced look at the figures.
PHIL PONCE: Mr. Winters, how about the issue of what the Fed should do? The IMF said recently--the head of the IMF recently said that the Fed should do something to cool things down so that there isn't a dramatic burst?
H. VERNON WINTERS: Well, the Fed has a dilemma. World growth isn't all that great outside of this country. We're the engine of growth in the world. Our growth is needed to prop up some other economies right now. Interest rates on a short-term basis have remained steady for quite some time, while inflation has been dropping. So, in effect, the real cost of short-term money for borrowers in this country has been going up. So I think the Fed, in effect, has been doing some tightening, and it's a balancing act, and it's hard to say which way they're going to go.
PHIL PONCE: Ms. Minton Beddoes, very quickly, what is the danger sign that people should look for that things are about to change dramatically?
One guest's advice: watch the stock prices and the Federal Reserve.
ZANNY MINTON BEDDOES: I would still stick with stock prices. I think that that's the one and what the Fed does, obviously. Those are my two.
PHIL PONCE: Well, Ms. Minton Beddoes, Mr. Winters, thank you both very much.
H. VERNON WINTERS: Thank you.
ZANNY MINTON BEDDOES: Thank you.