Just Keeps Truckin'

What Slowdown? February 1, 2007; Page A16

If the U.S. economy keeps growing like it is, Rodney Dangerfield is going to have to rise from the dead and file a patent claim. The expansion that gets no respect keeps cruising along -- past $70 oil, above rising interest rates, and now apparently around even the housing and auto slumps.

Yesterday's report that fourth quarter GDP rose a healthy 3.5% was merely the most recent repudiation of the media and Beltway bears who have predicted a recession in each of the past four years. The latest scare came last fall, as the decline in housing accelerated and many of Wall Street's Keynesian forecasters predicted the consumer would slump along with it. (We hope someone offered smelling salts to the economists at Goldman Sachs yesterday.)

To the contrary, the consumer remains confident, clocking in with a strong 4.4% spending growth rate in the quarter. Clearly the strong job market and rising wage levels are offsetting any fear among consumers that their home values have flattened or fallen. Without housing and autos, real GDP rose 5.8%.

At the same time, U.S. exports are booming, as growth elsewhere accelerates. Exports rose 10% in the quarter and a very robust 9.2% for the year, adding 1.64 percentage points to GDP growth. By the way, exports to China alone rose by more than 30% in the first 11 months of last year, even without a major change in China's policy to peg the yuan closely to the U.S. dollar. Members of Congress pounded Treasury Secretary Hank Paulson yesterday for not doing enough to get China to revalue the yuan, but maybe China's growing economy is more important for American exporters than devaluing the greenback. Just a thought.

The most bullish economists yesterday also hailed the GDP report's inflation signals, which were muted. But we're not convinced the current inflation cycle has played itself out -- not with gold back near $650 an ounce, commodities in general rising again and the dollar weak. For its part, the Federal Reserve held its target fed funds rate at 5.25% yesterday, but played inflation down the middle. "Inflation pressures seem likely to moderate over time, its statement said, but "some inflation risks remain." In other words, they have no idea.

Our own view -- which we noted at the time -- is that the Fed would have done better to keep raising rates last year. It's clear today that the economy was fundamentally healthy, and the question now is whether the Fed will decide it has no choice but to raise rates again later this year if inflation reaccelerates. We'd note that even yesterday's benign price data showed that so-called "core inflation," less food and energy, was up 2.1%. The core rate has risen by at least 2% for more than two years. Chairman Ben Bernanke may end up regretting that he hasn't run a tighter policy.

For now, though, the economy remains healthy, defying its many critics at home and abroad. As the chart above shows, growth since the Bush tax cuts passed in mid-2003 has averaged more than 3.6%, helping to drive prosperity around the world but without the U.S. getting any credit for this remarkable performance. By comparison, whenever growth reaches even 2% in Europe these days, they throw a party.

The biggest threats to this expansion aren't the trade deficit, or "global imbalances," or the savings rate, or the yuan-dollar peg, or any of the other bugbears we hear so much about. The threats are policy mistakes -- such as a tax increase or protectionism from the new Democratic Congress, or the discovery by the Fed that it still hasn't lassoed inflation expectations. Let's hope Democrats don't mess with a good thing.

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