Bears and Bulls

This week’s Buttonwood column in The Economist does a good job of summarizing the current state of the US economy, points out the signs of potential danger, and asks the right question:

[T]he economy is about to slow down… which is unlikely to be favourable to risky assets. The question is: how sharply? To a walk? A halt? In dressage, going backwards is called reining back; in economics, it is called a recession.

The Economist is quite bearish right now, and I tend to agree. In fact, with every passing week I’m more convinced than ever that raising interest rates right now poses an unnecessary risk to the economy. However, this is what Greenspan said when he raised rates yesterday by .25%:

In recent months, output growth has moderated and the pace of improvement in labor market conditions has slowed. This softness likely owes importantly to the substantial rise in energy prices. The economy nevertheless appears poised to resume a stronger pace of expansion going forward. Inflation has been somewhat elevated this year, though a portion of the rise in prices seems to reflect transitory factors.

I take this to mean that Greenspan is confident that we’ve seen a temporary reduction in economic growth over the past couple of months, mostly due to higher oil prices, that will give way to renewed strong economic growth over the last half of this year. The statement also signals that inflation is a concern. All in all, it’s a bullish statement about the economy, to go with a bullish move on interest rates.

But I’m not quite sure where Greenspan thinks the impetus for higher growth is going to come from. Consumers are tapped out, as the Buttonwood column argues convincingly. The government is tapped out, for the time being at least. So Greenspan must be putting his faith in another substantial surge in business investment. This would be on top of the non-negligible rise in business spending that we’ve already seen over the past 18 months. Does he really think that businesses believe that their sales will rise by enough over the next year or two to warrant further significant increases business spending? Maybe he does. Myself, I’m not so sure.