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1996 | 06 | 07 | Articles | The Wall Street Journal | Business | Economics
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The Wall Street Journal
June 7, 1996
People Are Spending Briskly, But Inflation Remains Low

Alan Helfman has no doubts about the strength of the economy. He owns Ford and Chrysler dealerships in the affluent Houston suburb of River Oaks, Texas, and is selling vans, Jeeps and Ford Explorers like "gangbusters."

"We’re hot as fire down here," he drawls. "It’s not the best it’s ever been, but it’s pretty dang close."

Defying predictions, American consumers continue to open their wallets — and fuel economic growth. Economists say businesses let their inventories dwindle early this year and then were surprised by consumers’ resilience. But now, as they rush to restock their shelves, economic growth could pick up in the current quarter — with much of the spending coming from affluent Americans enjoying the dual benefits of rising incomes and gains in mutual-fund investments.

A Stream of Cars

You can see evidence of economic growth in the cars streaming into Mr. Helfman’s dealership from Chrysler Corp.’s Sterling Heights plant, near Detroit. The plant recently added Saturdays to its production schedule "to keep up with demand," says Dick Entenmann, its manager. Even hotter is Chrysler’s minivan plant in nearby Windsor, Ontario, now up to three shifts and turning out 1,450 units a day. "The lights never go out around here," says manager Adrian Vido, though he has to allow half an hour between shifts for workers to get in and out of parking lots.

Chrysler’s growth is leading the industry at the moment; its May sales were up 17% from a year earlier. For the industry as a whole, auto sales by domestic producers rose 7% from May 1995. Chrysler economist Van Bussmann says the industry, long prone to boom-and-bust cycles, will rack up its third year of strong sales this year. "We haven’t had three years of back-to-back steady sales for at least 50 years," he says.

All this activity on Main Street, of course, is making Wall Street nervous. Bond-market experts fear that when the economy gets hot, inflation heats up, too. So, they are watching closely for any hints of excessive strength in the government’s employment report coming out Friday. Strong job growth, they fear, could lead the Federal Reserve to raise interest rates in an effort to head off inflation, and fixed-income securities would suffer.

Little Hint of Inflation

Right now, there is little evidence of strong growth fueling inflation. Materials costs are stable, and businesses say they have little pricing power. "It is becoming increasingly difficult to pass on higher prices," says Nolan Archibald, chief executive of Black & Decker Corp., the Towson, Md., toolmaker. With foreign competition intense, "you just have to absorb any price increases on the raw-material side."

Wage increases remain modest as well. In 26 states, unemployment is below 5% — a level that in the past has pushed wages higher. Yet even in those states, employers seem to find creative ways of hiring enough workers without raising wages. In Minnesota, with a 3.1% unemployment rate, for example, the Minneapolis bus authority cut its drivers’ minimum age to 19 from 21 to fill jobs. The first to be hired, 19-year-old Kari Kuntz, seems a little out of place among the burly men in the drivers’ lounge of the bus garage. She says most passengers don’t ask about her age, though some inquire about her long, purple-tinted hair.

William J. Hudson, chief executive of AMP Inc., a $5.5 billion maker of electronic components with 40 factories in the U.S., says he isn’t having any trouble filling jobs. He is raising wages by a moderate 3.5% this year, "but we are more than making up for that in higher productivity." Meanwhile, his prices are falling an average of 4% a year, largely because of foreign competition.

The View From the Fed

The Fed isn’t at all likely to raise interest rates at its July 3 meeting despite the bond market’s fears. In interviews, some Fed officials express concern about a first-quarter uptick in wages, but they note that that rise was offset by lower employee benefits. And they see scant other signs of strain in the economy; they note, for instance, few worrisome shortages of materials. One of Chairman Alan Greenspan’s favorite indicators, lead times for parts and materials deliveries, has been little changed for a few months, giving no hint of the bottlenecks that could force up inflation.

"We are in a strong quarter," a fact that will require the central bank to be especially vigilant for inflationary signs, says Fed Governor Janet Yellen. But she adds, "The underlying trend is for balanced growth" and expects the second half to slow a bit from the current pace.

For President Clinton, the economy could hardly be better; in some ways, it is in its best shape in a generation. Although a flare-up in inflation or surge in interest rates could change things quickly, the economy’s current resilience is helping fuel Mr. Clinton’s popularity in the opinion polls. The so-called misery index — the combination of inflation and unemployment that helped sink President Carter’s bid for re-election — is at its lowest level in decades. Inflation has stayed below 3% for more than three years, and unemployment below 6% for nearly two years. However, wage stagnation remains a serious and confounding problem for people who lack a college education.

What could go wrong? For one thing, the economy’s moderate strength isn’t uniform. California is finally emerging from a long slump, which lingered on well after the national recession lifted in 1991. But unemployment there remains at a painful 7.5%, second only to West Virginia’s. New York and New Jersey, too, are lagging behind in economic growth.

There’s also the possibility that inflation will pop up, forcing the Fed to act later this summer. A single strong quarter isn’t likely to cause policy makers to slam on the brakes; nor is it likely that a small rise in rates would sharply slow the economy. But if there are signs of an inflationary spike, the outlook could change.

And the stock market might drop. Economists think one explanation for the strength of housing and auto sales might be the "wealth effect": Households flush with gains on stocks or mutual funds are more likely to buy big-ticket items. But if those gains in wealth evaporate in a sudden slump in the market, it could affect consumer spending in a way that it never has before, says economist Henry Kaufman. A bigger slice of household assets is in the stock market now than before the 1987 crash; so, a plunge could hit consumer sentiment far harder. "There’s no precedent for this," Mr. Kaufman says.

Steady Progress

But for now, it’s steady as she goes. "It’s not too hot, and it’s not too cold," Chrysler’s Mr. Bussmann says.

Mr. Bussmann’s favorite consumer-spending barometer is a measure of real disposable income per household — income after taxes and inflation, divided by the number of households. In March, disposable household income was 1.8% above a year earlier. "It’s been running in that range for a couple of years," he says. "Steady, sustained growth — nothing that would lead to a buying binge," but enough to keep people buying plenty of Chryslers.

The consumer’s strength is evident in government statistics that show overall consumer spending soared in the first quarter to a two-year high. Retailing, after suffering during the winter, is picking up, with high-end merchants doing especially well. At Neiman-Marcus Group Inc., for example, $1,000 suits are flying off the racks, says Kelly Patrick, a spokeswoman. Among even bigger-ticket items, luxury-yacht sales are booming: Kadey Krogen Yachts Inc., a Miami maker of boats that start at $350,000, says business is so good that its production is sold out for a year.

Even the limousine business is rolling along. "Compared to last year, our business is booming," says Ari Kazmi, manager of All City Limousine in Burlingame, Calif. But he says competition is fierce, keeping prices down. The wedding season is just getting under way, he says, and he has been booking more bachelor and bachelorette parties this year.

Consumers are snapping up outdoor products, despite bad weather in much of the country. Black & Decker’s Mr. Archibald reports strong sales for every product category in his outdoor division, led by the Hedge Hog, a cordless hedge trimmer. Cordless lawn mowers, which, at $350 or more, cost far more than conventional models, are roaring, he adds.

In manufacturing, a slow first quarter is giving way to hopes of a stronger year ahead. AMP’s Mr. Hudson says the economy "isn’t exactly ebullient, but it’s not sick." His company, which makes parts for scores of industries ranging from computers to cars, is budgeting for a stronger second half now that inventories, which were too big last year, are down and demand has steadied.

The Housing Market

The rise in interest rates over the past three months may slow parts of the economy later this year, of course. But right now, housing sales are still showing unexpected strength. In the latest report, for April, new-home sales shot up 28% from the slow pace a year earlier. But many in the business say the second half will slow, reflecting higher mortgage rates, which now stand at 8.3%.

The slowing trend is clear in northern Montgomery County, Md., outside Washington. Its rolling hills are full of new homes for sale, mostly priced above $250,000. Rob Bolton, a salesman for Virginia-based Ryan Homes Inc., recalls that in some weeks earlier this year he would have one customer in the office and three more waiting to talk to him in the model home nearby. Now, things are starting to slow.

"Sales are pretty steady, but they are way down from February, March and April," he says. "It’s been a pretty successful year so far, but the amount of traffic I see up here is really directly affected by higher interest rates." Indeed, some large builders are beginning to talk about slippage in building contracts and even some outright cancellations.

Moreover, many Americans, in spite of the favorable macroeconomic trends, still feel discouraged by the stagnation of wages that affects many less-educated workers, and by continued corporate layoffs. "In the face of all this seemingly good news, a sense persists that something is fundamentally wrong," Mr. Greenspan said Wednesday at an economic conference on Cape Cod, Mass. "I refer to the pervasiveness of job insecurity in the context of an economic recovery that has been running for more than five years, inflation that has been contained, and a layoff rate that is historically quite low."

The Fed chairman also suggested Wednesday that this insecurity is rooted in a "rare, perhaps once-in-a-century event — a structural technological advance." The rapid changes in technology, he said, have created a world in which ideas and education are now the dominant element in creating economic value. This, in turn, can be threatening to people unready or unwilling to embrace it. "A new world is emerging," he said.

– Stewart Ugelow contributed to this article.