The Economic Race After Iraq, the questions for November are whether jobs will stay plentiful and interest rates low. Two pros say bet on both
(MONEY Magazine) – The economy has added nearly 1.3 million jobs since the start of this year, and we're finally beginning to separate the words jobless and recovery. After a very strong second half in 2003, the economy grew by about 4% in first quarter 2004. And despite a short-term flare-up, inflation remains historically low. We're not without problems: only three months of robust job creation, a trade deficit that continues to spiral out of control and near-record-high energy prices. So just how strong will our economy be come the November presidential election?
This month I talked with two top Wall Street economists--John Lipsky of J.P. Morgan and Richard Berner of Morgan Stanley--about the health of the economy. Both are bullish on our prospects. Lipsky anticipates that growth will pick up to an annual rate of 4.5% in the second half of 2004; Berner, whose view is distinctly more positive than Lipsky's and most of Wall Street's, is looking for 5% growth in the second half. But they differ in some important respects.
WHAT'S BEHIND THE GROWTH?
Both economists feel that capital spending will drive growth for the remainder of the year. "The real story in the second half of the year is going to be the continued strength of business spending," says Lipsky. This is cyclical, he notes. Over the past few years, fiscal policies have increased disposable income and boosted consumer spending. "That's fading away," he adds, "but one result of the strength of consumer spending, of course, has been terrific profit growth on the part of businesses, which are now expanding."
Berner also predicts stronger capital spending in the second half. But another important factor, he contends, is that energy prices are peaking--which will eventually free up money for consumers to spend elsewhere. "My guess is that prices will go back to $35 a barrel for crude oil, and that gasoline prices on a nationwide basis will go back to something like $1.80 a gallon by Labor Day."
WHAT WILL THE FED DO?
We've already seen the Federal Reserve begin tightening, hiking the Fed funds rate a quarter point from its 46-year low of 1%. The questions on every investor's mind, though, are how far and how fast. Lipsky says he thinks the Fed funds rate will approach or head slightly above 4% by the end of 2005. "My suspicion," he says, "is that over the course of the coming year, we're going to see economic growth maybe a bit stronger than the consensus view, inflation that's going to be somewhat more benign than the market assumes, but a Fed that keeps tightening."
Berner, on the other hand, believes that the Federal Reserve will move more slowly. "By the end of 2005," he says, "I see the Fed funds rate somewhere in the neighborhood of 3.25%." But he agrees that high inflation will not necessarily be a problem, adding that "perhaps the markets are getting a little too complacent that the Fed will raise interest rates on something that looks like a train schedule."
WHAT'S THE OUTLOOK FOR JOBS?
Will the strong economy lead to additional hiring? Both Lipsky and Berner say that what we see now is, for better or worse, what we can expect for the remainder of the year--about 200,000 to 250,000 new jobs a month.
Where they disagree is on how much businesses can hire after that. "I still see that companies went overboard in slashing their work force in an effort to cut costs and to eliminate the hiring excesses of the 1990s," says Berner. "I think we have a shortfall of about 1.8 million jobs to make up."
Lipsky goes even further, citing a recent Boston Fed study arguing that the U.S. is 5 million jobs short of full employment. "That suggests that there's ample room to continue growing this economy and growing employment without [damaging] profitability."
DOES EVERYONE WIN?
The firming of the labor market may be good news, but is everyone truly doing better as a result? Lipsky contends that everyone has indeed benefited, but not necessarily equally. "The tax cuts, in theory, increased the progressivity of the income tax," he says, which means low-income earners should have profited more than high-income ones.
Berner disagrees--he thinks low-income earners have lagged behind. But he sees a payoff ahead. "Very importantly," he says, "consumers who are employed and who will be employed will benefit from a high-productivity economy...in the form of higher real wages and rising real wages."
Even though Berner is positive on the economy this year, he points out that it's important to look ahead to issues that could threaten our long-term prosperity, including inadequate and costly health care and education, insufficient retirement savings, the deficit and the unsustainable energy situation.
I don't think there's any doubt that our economy is as strong now as it's been at any point since the recession ended. But we still face serious challenges. Most important, we need to create more and better-paying jobs, stop selling our jobs to cheap foreign labor markets and cut both the federal budget and trade deficits. Without serious policy action on those issues, our prosperity will be severely constrained.
Lou Dobbs is the anchor and managing editor of CNN's Lou Dobbs Tonight.