The Sky Isn't Falling!

MARK MEADOR and STEVE WALTERS

November 12, 1991|By MARK MEADOR and STEVE WALTERS

Finally, after a generation of foundering aimlessly as the party of no ideas, the Democrats have found a philosophical guiding light, an inspirational leader for the '90s: Chicken Little.

Never mind that their sky-is-falling rhetoric, talk of body bags and cries of ''no more Vietnams'' backfired miserably during the Persian Gulf War. They're back at it, more pessimistic than ever, prophesying economic doom from every campaign stump.

It's a simple strategy, really. Scare folks, make 'em think that America is poised on the brink of another Great Depression with repeated allusions to George Herbert Walker Hoover, and voters might confuse somebody named Brown, Clinton, Harkin, Kerrey, Tsongas or Wilder for a new Roosevelt.

At first blush, it looks like this might play in Peoria -- or, more, important, in New Hampshire and Iowa. Though the economy grew 2.4 percent (in real, inflation-adjusted terms) last quarter, clearly signaling the end of the recession, the unemployment rate is still stuck around 6.7 percent, and consumer confidence remains low.

There's just one problem with such data: They tell only where the economy has been, not where it will go. The gloom-and-doomers are like children staring out the rear window of a car, expecting a rough ride ahead because they see some potholes receding into the distance.

Whats the view through the windshield? Pretty good, actually. Four reliable leading indicators suggest the economy will accelerate sharply in '92.

* Consumer spending. The pollsters keep telling us that consumers are anxious about the future and reluctant to spend, but that's not what the data show. Real consumption grew 2.8 percent in the second quarter of this year, and even faster -- 3.8 percent -- in the third quarter. Thus, consumer spending led the turnaround, and presages even stronger future growth. This is typical of all economic rebounds: Consumption growth not only provides a direct stimulus to the economy, but signals that households expect future income to be higher.

* Bond Markets. An especially strong leading indicator is the ''yield spread,'' the difference between the interest rate on long-term government bonds and the current short-term rate. Every recession since 1968 has been preceded by a negative yield spread, and every subsequent recovery has been preceded by a positive spread. Why? Long-term rates represent the average of today's short-term rate and expected future short-term rates. A positive yield spread (i.e., long-term rates far in excess of short-term rates) indicates that bond traders believe that an acceleration in economic activity will cause future short-term rates to rise above their current levels.

These traders' beliefs should be accorded great weight. They have trillions of dollars invested in the bond market, and -- unlike the so-called ''experts'' whose opinions are often quoted in the media -- they have a lot to lose if their forecasts are wrong. Right now, the yield spread is about as high as it has ever been. Clearly, bond traders are betting on a robust expansion.

* Stock Markets. People buy stocks because they expect to cash healthy dividend checks or see the value of their shares appreciate or both. For these events to occur, corporate earnings need to be healthy. And though some corporations (notably U.S. auto makers) reported lackluster earnings in the third quarter, most stock-price indexes have remained at or near record highs. Thus, investors are anticipating increased corporate earnings driven by economic recovery; like bond traders, they're putting their money where their mouths are.

* Money growth and the mythical ''credit crunch.'' The Federal Reserve's monetary policy has been strongly expansionary this year. The monetary base has grown at an annual rate of 8.4 percent, pushing the much-watched federal funds rate down from 8 percent to about 5 percent, its lowest level since 1977. Such monetary ease is normally sufficient to fuel a strong recovery. But today, say various self-anointed experts, tightened regulation has made banks reluctant to lend, defeating Fed policy by creating an artificial shortage of credit.

Not to worry, however: the ''credit crunch'' is a myth. It's true that bank lending has grown slowly, but focusing on banks misses the big picture. In the last few years, new financial intermediaries offering alternatives to bank loans have been popping up all over; when these innovations are considered, credit is not nearly as tight as a scan of banks' balance sheets implies.

Does all this guarantee a rosy 1992? Hardly. Maybe all the Chicken Little prophecy will be self-fulfilling, persuading consumers and investors to reduce their spending so that the recovery is delayed or weakened. Or maybe we'll push the panic button and create so much market turmoil that we create a ''double dip'' recession.

More likely, though, we're in for a period of steadily improving economic news. With each additional piece of data, the limb onto which the Democratic presidential candidates have crawled will bend and creak. By primary time next spring, they -- not the sky -- should be in a free fall.

The authors teach economics at Loyola College.

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