JACKSON HOLE, Wyo. -- This just keeps getting better.
When the yield on the 30-year
dipped as low as 4.7% last October, all kinds of New Era types promised you that yields would fall further still. From slimy, nose-wiping forecasters filling in for
on television (a hundred bucks says you never thought you would be wishing him back) to pathetic, just-plain-stupid (non)economists writing on the Web, the message was the same: At worst, yields are capped right here, and at best they're headed to 4% and lower.
Such forecasts, remember, came as a result of It's-The-End-Of-The-World-As-We-Know-It thinking. Growth would plunge; deflation would ensue; yields would know no lower bound.
Well, here we are, seven months later.
The world did not end.
Growth did not plunge.
Deflation did not ensue.
And the yield on the bond did not fall.
Not only were Those People wrong, they were dead wrong. They could not possibly have been more wrong. Growth ended up nearly doubling between the third quarter of 1998 and the fourth; data to be released Friday will show that the absolutely phenomenal pace of domestic demand that set in during the third quarter of 1997 showed no sign of letting up as March ended. The broad price measures, meantime, are still rising, just like they've been doing every year, without interruption, since 1939.
And the yield on the bond sits a percentage point higher.
And you know what the funny thing is?
None of that has done anything to dampen the enthusiasm of Those People for promising lower yields.
Their reasoning changed, of course. It had to. When you go from forecasting 1.5% first-quarter growth last autumn to accepting that it's closer to 4% now, and when you hike your growth forecast for all of 1999 to something closer to 4% from something closer to 2%, you've got to come up with a new reason as to why yields will fall.
And you know what that reason is?
The bond market is stupid.
Is there really any other conclusion to be drawn? The 1996-1998 economic experience, which delivered faster and faster economic growth alongside kinder and kinder price increases, serves as unambiguous proof that big growth need not be feared. The old rules no longer apply; a set of new, free-lunch ones have taken their place. And they are here to stay.
And yet there's the 30-year Treasury, fearing big growth enough to keep its yield above 5.6%.
Silly bond market.
Look. You have two choices. One is to believe (and act on the advice of) Those People, which boils down to waiting for the idiotic bond market to finally embrace "wise" thinking. There is absolutely no reason to fear big growth, they promise; one day the market will finally realize it, and yields will then come down materially and stay there. (Your longs getting whacked until that day comes, of course, is your own problem.)
The alternative choice is to try and figure out what's going on.
And this is what's going on: The old rules have not been broken. There is nothing at all broken about them.
The old rules say (in a nutshell) that excess demand in the product market produces excess demand in the labor market, which produces upward pressure on compensation, which produces upward pressure on prices.
We certainly got the excess-demand-in-the-product-market (big growth) part. And excess demand in the product market has indeed produced excess demand in the labor market (a lower unemployment rate). And excess demand in the labor market has indeed produced upward pressure on compensation (either Those People know this and choose to ignore it, or they really are too dim to know it).
That much is painfully clear from the table above. And, though your narrator is rarely one to appeal to authority to support a point, here he will mention the work of two of the best forecasting units around. One concludes that "we find no evidence that the traditional link between inflation in hourly compensation and the unemployment rate has broken down." The other recently noted that "our forecasts of wage inflation were right on the money in 1998. We are not inclined to think there has been some major change in the relationship that goes from labor-market tightening to wage inflation."
That leaves prices.
And yes, they have proven kinder than anyone guessed -- not because we can now buy books on the Internet, but because of a host of supply-shock reasons explained again and again in this column. (On that score, you really ought to read and understand the Is Inflation Dead?
Friday. It's essential to understanding what's gone on on the price front over the past few years.) And do note that some of the better price measures, like the
median consumer price
index shown in the last column of the table above, suggest that price increases have proven less kind than the New Era crowd advertises.
Look. It may not be entirely clear to everyone at the moment, but what we have seen in this country over the past few years will go down as just about the most favorable set of inflation circumstances to ever hit any economy anywhere.
Now that good luck is slowly unwinding.
Unwinding doesn't necessarily mean that prices will surge (although they are likely to accelerate moderately from a very low base), it doesn't necessarily mean that rates will soar (although those looking for a return to 4.7% are delusional), it doesn't necessarily mean that shares will crash (although it stands to reason that rates will act as a depressant).
But it does mean that The Best of All Possible Worlds is a thing of the past.
You can listen to hopeful New Era types, or you can listen to what makes sense.