Economic Life

Not your typical recovery

Email|Print|Single Page| Text size + By Charles Stein
Globe Columnist / September 19, 2004

The Federal Reserve will raise interest rates Tuesday. It is a done deal. The Fed has been strongly hinting for months that it would raise short-term rates back to more normal levels. At the same time there has been an assumption in the financial markets that long-term rates -- the ones that determine mortgage rates -- would be rising as well.

''There is not a warm body on the planet that has not been expecting higher rates," said Chuck Clough of Clough Capital Partners, a local investment firm.

It turns out that all those warm bodies got it wrong. Long-term rates have been falling since June and they are now back to where they were six months ago.

I would not be shocked if those rates were stuck in the same place six months from now. What happens to rates is a big deal for investors and would-be home buyers. But it is also a big deal for the rest of us.

The bond market is telling us something. Simply put, this is not a typical economic recovery. Growth is subdued rather than robust and deflation may be just as big a threat as inflation.

In a normal recovery, the economy strengthens, the job market strengthens, business borrowing increases, and inflation and interest rates climb. The current recovery fit that pattern until the summer.

Then we hit what Federal Reserve chairman Alan Greenspan called a ''soft patch." Job gains went from solid to modest. Retail sales in June and August were disappointing. A series of companies from Coca-Cola to Intel to Alcoa have warned that their third-quarter earnings will not meet expectations.

Inflation too has been coming in below expectations. Last week the government said consumer prices rose just 0.1 percent in August following a 0.1 percent decline in July. The core rate of inflation, which excludes volatile food and energy prices, is up only 1.7 percent over the past 12 months.

There are reasons that explain the downshifting of the economy.

Stubbornly high oil prices have acted like a tax, draining money from both consumers and businesses. The stimulus provided by the government last year in the form of tax cuts and falling interest rates isn't packing the same punch this year. But John Balder thinks the economy is dealing with a bigger issue.

''We are still in the post-bubble era," said Balder, the market strategist for State Street Research in Boston.

During the bubble years of the late 1990s, the US economy created too much of everything -- too many technology companies, too many retail outlets, too much debt. Some of the excesses have been worked off but some remain. The upshot: Companies don't see a lot of attractive investment opportunities out there so they are hoarding cash, holding off on spending and hiring, and generally being cautious.

The same forces are at work on the price side. In a world with so much brutal competition, firms are finding it awfully difficult to raise prices.

Coke found that out the hard way. In its earnings warnings, the company acknowledged that its attempts to raise prices wound up depressing sales as customers went in search of cheaper alternatives. There are plenty of cheaper alternatives available -- at Wal-Mart, on a discount airline, in China, or on the Internet.

I'm not trying to peddle gloom and doom. I'm not in the camp that thinks the economy will stall out or that we are about to fall into a deflationary spiral. The gross domestic product should grow at a respectable 3 to 3.5 percent pace. The jobless rate should continue to fall, albeit slowly. Home prices won't collapse because interest rates will remain low.

But we are not about to go back to the boom years of the 1980s or 1990s either. Words like ''decent," ''respectable" and ''OK" best describe the conditions we are apt to experience. Like the analysts on Wall Street who are scaling back their estimates for earnings, we all may have to scale back our expectations of what an economic recovery should be.

Charles Stein is a Globe columnist. He can be reached at

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