Era of Good Feeling

On February 24, 1998, Alan Greenspan, Chairman of the Federal 
Reserve Board, gave an annual report to Congress on the nation's 
monetary situation.

The U.S. Economy in 1997 expanded close to 4 percent, Greenspan 
reported, its fastest annual increase since the end of the Reagan
Administration in 1988. An additional 3 million people joined 
the nation's payrolls, bringing down the unemployment rate to 
4_ percent, its lowest sustained level since the late 1960s. 
Industrial production increased 5-3/4 percent last year. Consumer 
price inflation came in at 1-3/4 percent over the twelve months 
of 1997, down about 1-1/2 percentage points from the pace of the 
prior year.

It was the booming economy that created the conditions needed for
the Congress and the Administration to finally agree on a program 
that would balance the federal budget. Greenspan observed in his 
report: "As I have indicated to the Congress on numerous 
occasions, moving beyond this point and putting the budget in 
significant surplus would be the surest and most direct way of
increasing national saving. In turn, higher national saving, by 
promoting lower real long-term interest rates, helps spur 
spending to outfit American firms and their workers with the 
modern equipment they need to compete successfully on world 
markets. We have seen a partial down payment of the benefits of 
better budget balance already: It seems reasonable to assume that
the decline in longer-term Treasury yields last year owed, in 
part, to reduced competition-current and prospective-from the 
federal government for scarce private saving. However, additional
effort remains to be exerted to address the effects on federal 
entitlement spending of the looming shift within the next decade 
in the nation's retirement demographics."

However, it was the "dramatic improvements in computing power 
and communication and information technology appear to have been 
a major force" behind the booming economy, according to Greenspan.

Those innovations, together with fierce competitive pressures in
our high-tech industries to make them available to as many homes, 
offices, stores, and shop floors as possible, have produced
double-digit annual reductions in prices of capital goods 
embodying new technologies. Indeed, many products considered to 
be at the cutting edge of technology as recently as two to three
years ago have become so standardized and inexpensive that they 
have achieved near 'commodity' status, a development that has 
allowed businesses to accelerate their accumulation of more and 
better capital.

"Critical to this process has been the rapidly increasing 
efficiency of our financial markets-itself a product of the new 
technologies and of significant market deregulation over the years. 
Capital now flows with relatively little friction to projects 
embodying new ideas. Silicon Valley is a tribute both to
American ingenuity and to the financial system's ever-increasing
ability to supply venture capital to the entrepreneurs who are 
such a dynamic force in our economy."

However, Greenspan's outlook for 1998 warned of storm clouds 
ahead due to the Asian crisis.

"With the crisis curtailing the financing available in foreign 
currencies," he said, "many Asian economies have had no choice 
but to cut back their imports sharply. Disruptions to their 
financial systems and economies more generally will further 
damp demands for our exports of goods and services. American 
exports should be held down as well by the appreciation of the 
dollar, which will make the prices of competing goods produced 
abroad more attractive, just as foreign-produced goods will be 
relatively more attractive to buyers here at home. As a result, 
we can expect a worsening net export position to exert a 
discernible drag on total output in the United States. For a
time, such restraint might be reinforced by a reduced willingness
of U.S. firms to accumulate
inventories as they foresee weaker 
demand ahead."

The outlook for 1998, Greenspan warned is "uncertain" with the 
"current situation reflecting a balance of strong countervailing
forces, events in the months ahead are not likely to unfold 
smoothly.

In that regard, I would like to flag a few areas of concern about 
the economy beyond those mentioned already regarding Asian 
developments. Approaching the eighth year of the economic
expansion, this is understandable in an economic environment 
that, contrary to historical experience, has become increasingly 
benign. Businesses have been meeting obligations readily and 
generating high profits, putting them in outstanding financial 
health.  

"But we must be concerned about becoming too complacent about 
evaluating repayment risks. All too often at this stage of the 
business cycle, the loans that banks extend later make up a
disproportionate share of total nonperforming loans. In addition,
quite possibly, twelve or eighteen months hence, some of the 
securities purchased on the market could be looked upon with 
some regret by investors. As one of the nation's bank 
supervisors, the Federal Reserve will make every effort to 
encourage banks to apply sound underwriting standards in their 
lending. Prudent lenders should consider a wide range of economic
situations in evaluating credit; to do otherwise would risk
contributing to potentially disruptive financial problems down 
the road.

"A second area of concern involves our nation's continuing role 
in the new high-tech international financial system. By joining 
with our major trading partners and international financial 
institutions in helping to stabilize the economies of Asia and 
promoting needed structural changes, we are also encouraging the
continued expansion of world trade and global economic and 
financial stability on which the ongoing increase of our own 
standards of living depends. If we were to cede our role as a
world leader, or backslide into protectionist policies, we would
threaten the source of much of our own sustained economic growth.

"A third risk is complacency about inflation prospects. The 
combination and interaction of significant increases in 
productivity-improving technologies, sharp declines in budget 
deficits, and disciplined monetary policy has damped product 
price changes, bringing them to near stability. While part of 
this result owes to good policy, part is the product of the 
fortuitous emergence of new technologies and of some favorable 
price developments in imported goods. However, as history 
counsels, it is unwise to count on any string of good fortune 
to continue indefinitely. At the same time, though, it is also
instructive to remember the words of an old sage that "luck is 
the residue of design." He meant that to some degree we can 
deliberately put ourselves in position to experience good 
fortune and be better prepared when misfortune strikes. For 
example, the 1970s were marked by two major oil-price shocks 
and a significant depreciation in the exchange value of the 
dollar. But those misfortunes were, in part, the result of 
allowing imbalances to build over the decade as policymakers
lost hold of the anchor provided by price stability. Some of 
what we now see helping rein in inflation pressures is more 
likely to occur in an environment of stable prices and price 
expectations that thwarts producers from indiscriminately 
passing on higher costs, puts a premium on productivity
enhancement, and rewards more effectively investment in 
physical and human capital.

"Simply put, while the pursuit of price stability does not rule 
out misfortune, it lowers its probability. If firms are convinced 
that the general price level will remain stable, they will 
reserve increases in their sales prices of goods and services 
as a last resort, for fear that such increases could mean loss 
of market share. Similarly, if households are convinced of price
stability, they will not see variations in relative prices as 
reasons to change their long-run inflation expectations. Thus, 
continuing to make progress toward this legislated objective 
will make future supply shocks less likely and our nation's
economy less vulnerable to those that occur."

As we go to press, announcements of evaporating earnings 
experienced by Intel and other high-tech companies, the fact 
that the economic debacle in Asia is causing the loss of millions
of jobs and a drop in the values of its currencies, is making 
Wall Street nervous. Growth for 1998, which as recently as the 
last week of February was estimated at 10%, had been cut back a 
week later, after announcements of dwindling profits in major 
high-tech companies, to a sobering 2% growth projection.

What's going to happen in the economy for 1998? Actually, not 
even Alan Greenspan can figure out what is happening. However, 
one prediction can be made. If the upward march of the American
economy suddenly comes to a screeching halt, the Gallup Poll 
Question, "How do you think the President is handling his job" 
will show a precipitous drop. When people start hurting 
financially, whether or not the President is at fault, the 
president will get blamed, as Herbert Hoover painfully discovered.

Shanghai's Empty Skyscrapers

By: Mary Mostert, Editor

For years Shanghai's financial center was a symbol of booming 
capitalism in the midst of a communist society, where a fifth 
of the world's construction cranes were at work transforming the
skyline. Today, many of the new office buildings sit empty as 
Chinese officials try to figure out how to avoid the economic 
troubles plaguing the rest of Asia.

Thailand, Indonesia and South Korea turned overnight from 
booming economies that Americans were encouraged to mimic, 
to paupers begging for help from the International Monetary Fund,
victims of plunging currencies and stock markets.

Since last summer former "miracle" economies have been propped 
up by the IMF. 

Since the crisis began last summer, the IMF has poured over 
$100 billion in emergency bailout funds into the three nations. 
If China is the next to falter financially, the drop in stock 
market points from a high of 16,820 on August 7, 1997, to a low 
of 8,660 on January 16, 1998, is significant. The worry is that 
China could be the next country hit and if that happens, nagging
fears of a developing global recession would intensify.

Chinese officials are depending largely upon their faith in their 
Communist system. They give two reasons why they think they will
avoid financial stress.

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