US Economy to Remain Hot

June 1, 1998
A HOT US economy that shows no signs of cooling was the topic probed by Dr Lawrence Chimerine, managing director and chief economist for the Economic

A HOT US economy that shows no signs of cooling was the topic probed by Dr Lawrence Chimerine, managing director and chief economist for the Economic Strategy Institute. Chimerine presented "The New Global Realities" at the 56th annual Truck Trailer Manufacturers Association convention in Aventura, Florida.

"We just celebrated the seventh anniversary of this economic expansion in the United States," said Chimerine. "It is already the second longest expansion in US history. If it continues to the end of this year, it will be the longest period of economic expansion without a downturn or recession.

"Obviously the number one question on your mind must be: Is this going to continue? Or are we living on borrowed time? Since World War II, the average expansion period has been about five years. We are two years beyond the average."

Chimerine predicted that economic expansion will continue until the end of this decade and beyond, and offered several reasons for continued growth.

"The economy's slow growth to this point is reason for optimism," he said. "There is a direct correlation between the speed of economic growth during an expansion and how long the expansion lasts. Rapid economic growth leads to capacity restraints in a number of industries. Bottlenecks and imbalances will occur, causing the economy to peak out. Shortages, high prices, and erratic delivery schedules are other problems that come with a hard-charging economy. All these problems combined can plant the seeds for an eventual recession."

Chimerine believes that with a more moderate and consistent economic growth, these issues don't come into play. "With the exception of some shortages in skilled labor, there are no real shortages in this economy. No sectors have gotten way ahead of the rest of the economy. Also absent are the traditional warning signs that usually surface in a full capacity economy, limiting our ability to grow further."

Investment-Led Economy. An investment-led economy is another reason to expect continued economic growth, according to Chimerine. "We have had five years of extraordinary growth in business spending for new equipment. Computers, information processing equipment, and advanced technology spending have all combined to give the economy more room to grow."

Increased business spending on productivity-enhancing equipment has had two effects, said Chimerine. "It has increased capacity for many industries, allowing more room for growth, and raised efficiency throughout the economy without the traditional kinds of inflationary pressures normally expected this late in a business cycle."

Chimerine called investment-led growth the most unpublicized and underappreciated aspect of this economic expansion. Investment-led growth allows the economy to grow more than would otherwise be expected.

"The old rules are no longer relevant," Chimerine said. "Twenty or 30 years ago, the average expansion lasted five years followed by a recession. That doesn't apply today. Structural changes in the economy, which dampen the business cycle, lengthen the expansions and reduce the severity of recessions. Growth in the service sector and new inventory controls are other positive factors. The inventory excesses of the past led to order reductions and production decreases, which resulted in a sizable downward pressure on the economy."

Market Stabilizes Economy Chimerine cited the bond market as an automatic stabilizing device for the US economy. "It senses that the economy is starting to pick up too strongly, causing imbalances and inflation, which in turn cause the Federal Reserve Board to raise interest rates to slow things down. Long-term interest rates rise in anticipation of higher short-term interest rates. The increase in long-term interest rates tends to slow the economy down. It makes housing and consumer products and anything purchased on credit less affordable. It also slows down the refinancing of mortgages, which lessens discretionary purchasing power."

When the economy slows, the bond market tends to rally, said Chimerine. Long-term interest rates come down, sparking the economy. Housing becomes more affordable and other industries are stimulated. The economy begins to perk up. This has become a sort of automatic regulating device, which helps to extend the expansion.

The three longest economic expansions have occurred within the past 25 years, the present expansion being the second longest ever, he said. This clearly represents a trend brought about by structural changes in the dynamics of the business cycle in the United States.

No Weakness Showing Chimerine said that none of the 15 economic indicators he follows are showing any signs of weakness. Most of these indicators are accurate for at least six months to a year, and suggest the probability for a recession is very low.

"The fundamentals are extraordinarily favorable," he said. "Interest rates are trending down, wages are accelerating for the first time in a couple of decades, and most workers are seeing increases in their real earnings and purchasing power. Inflation is very low, particularly for basic necessities, which means discretionary purchasing power is rising quite rapidly. Low interest rates have led to a refinancing boom, jobs are plentiful, and the financial condition of American families is the best it has been in at least 25 years."

"Some businesses will be hit by the Asian crisis," Chimerine said. "It has been reported that the Asian economic crisis was caused by poor banking practices, such as bad loans brought about by inappropriate lending risk and credit analysis."

But the big picture has been missed, Chimerine said. "All these factors are only parts of a broader issue. The real cause of the Asian crisis is that every country in Asia has adopted export-led growth strategies, which the Japanese have used for the past 25 years."

Japan was successful because it was the only country using this method before others followed, Chimerine said. The only open market was in the US, which led to a glut of exports. That was the starting point of the Asian crisis.

"Problems intensified three years ago when China devalued its currency, giving it a huge advantage in export markets relative to its Asian neighbors," he said.

Chimerine believes these crises have peaked and may bottom out in a few months, leading to a gradual recovery in a couple of years.

US Economy Not Affected Chimerine believes the Asian crisis will have little or no effect on the US economy. "Exports to the entire Asian region amount to about 25 percent of our total exports, or about three percent of Gross Domestic Product (GDP). A one-third decline in our exports to Asia would result in about a one-percent decline in GDP. With our economy growing at more than three percent, we would see economic growth reduced to only about 2 to 21/2 %. Even if our exports dried up completely, we would have a flat GDP, with no loss."

Inflation Process Changing Perhaps the most significant change in the economy, in addition to the dampening business cycle, is inflation in the United States, Chimerine said. "The advent of global competition, domestic deregulation in many industries, the growth of discount chains, massive buying power, the excess capacity of retailing, and new technology are all factors that have dramatically changed the inflation process," he said. "In most industries, it has become almost impossible to raise prices. Companies I work with assume they will not be able to raise prices. They must improve profitability by keeping costs under control and increasing productivity."

The key issue for the US is to minimize any spillover from the Asian crisis into the US economy, and to adopt trade policies that will encourage the US economic expansion, Chimerine said. He offered a six-point package of economic policies.

"First, we should support the IMF (International Monetary Fund) as long as the IMF structures its bailout of Asian economies in a way that is in the best interest of the US," he said. "The crisis in Asia is different than it was in Mexico, Latin America, Russia, or other countries. Generally, a country gets into a financial crisis because of high inflation, bad monetary policies, big budget deficits, or big trade deficits.

"The Asian countries in crisis are just the opposite. They underspend. In accordance, the IMF should structure their bailout in a manner that does not force the same austerity on these Asian countries as it does on other countries. If there is any austerity, it should be producer-austerity to stop the preferential lending that creates the overcapacity. Countries should stop depending on exports for growth in the long term, reform their banking systems, and open their markets. This is the best opportunity to force these countries to open their markets to US companies and stimulate domestic demand, which in the long run will help the US economy."

Secondly, Chimerine said, the US administration is wrong to urge Japan to cut taxes to stimulate the economy. Japanese save too much and spend too little money. After seven years of economic stagnation, they can no longer export their way to prosperity. Spending internally and opening their markets to competition will reduce their high domestic prices.

Thirdly, the Federal Reserve should not raise interest rates during the Asian economic crisis. The dollar is already grossly overvalued.

"Fourth," continued Chimerine, "we should tell China that if it continues to devalue its currency, we will not support Chinese entry into the World Trade Organization, something they badly want. China has lost its competitiveness because competing currencies have dropped sharply."

Chimerine warned industry officials not to support huge tax cuts just because the US has a budget surplus. "A budget surplus is healthy. It keeps interest rates down and frees up our savings for private investment. Tax cuts should be used selectively toward things that improve our competitiveness in world markets-investment oriented tax cuts, and export promotion and financing programs."

Finally, Chimerine emphasized that Washington officials should not weaken US trade laws when our trade deficit is already high. "Overcapacity on a global basis breeds dumping. Many of our industries have been wiped out in the past from dumping and it should not happen again," he said.

Chimerine also warned against global warming hysteria that could lead to a significant energy consumption reduction. If energy consumption is reduced too quickly, industry will suffer and that could lead to a harmful recession.