Diane Swonk arrived in Cleveland the Monday after the mid-April Wall Street plunge that had some wondering whether the dominant bull market of the late 1990s was nearing the end of the line.
Swonk, a senior vice president for Bank One and president of the National Association for Business Economists, was in town to address the local chapter of the NABE. However, it wasn’t long before the economic forecaster, known for her frequent appearances on CNN, CNBC and PBS, was asked what she thought the April 14 dive meant for the long-term health of Wall Street.
The essence of her message was simple: The party isn’t over, it’s just moving to a different room. After several years of steady expansion, during which Wall Street reaped the rewards of a blooming economy, the expansion is entering a new phase in which the nation’s economic prosperity is now being felt by the average working American.
What does that mean in the big picture? Swonk thinks it will likely result in inflation, further belt-tightening from the Federal Reserve and a rockier road for what has so long been an investor’s Easy Street.
After that April address, Swonk sat down with SBN to share her thoughts on the current state of the national economy and what lies just beyond the horizon.
You mention the expansion of the national economy is entering a new phase. What are its characteristics?
We’ve hit a phase of expansion where wage-earners, or Main Street, are starting to get an upper hand over wealth holders, who are sort of thought of as Wall Street. The riches of the expansion that for some time seemed only concentrated on Wall Street have now spread to the masses.
That means expansion continues, but of course, if you hand off that baton, you also have some costs to the expansion. There’s no free lunch here. Inflation will begin to accelerate and the Fed will continue tightening.
One of the things that Wall Street has really fooled itself about and got a real shock on Friday (April 14) was it really thought that the Fed could not only head off inflation, but that the next move in tightening may be the last. They kept telling themselves that it would be over soon.
And I think we’re moving into a phase of expansion where it’s not going to be over soon. The expansion will continue, but it’s going to be a much rockier road for Wall Street than it has been.
What do you see as the risks of this phase?
The risk is really rooted in things being too good to be true. We’ve already seen some of that play out in stock markets in recent weeks with some of the corrections out there. This is the stage in the cycle where some self-moderation would do us good and it doesn’t look like we have any.
The risk is that inflation will accelerate faster and interest rates will rise faster than even I forecast, and that’s not a very pleasant environment. We’re talking about major movements here and the risk is it might have to get much uglier before we really deal with it.
What are the strengths of this region and how does it fit into the national economy?
This region has been the manufacturing backbone and, at one point in time, it was left for dead. I was here at that time. The 90s were really the renaissance for the Midwest.
In many ways, the Midwest is at the leading edge of the economic expansion. It was a leading edge of corporate restructuring. We developed the term and coined the phrase “downsizing.” Our heavy manufacturers were doing it.
We also saw increased productivity growth ahead of other regions of the country. Our corporations got more efficient and we had to pay the price of that, but we were more efficient sooner and our unemployment rates started to drop sooner than elsewhere.
We were export engineers, which meant we had some minor stumbling when the Asian crisis hit. But, I think the resilience of the Midwest economy — one of the most trade-sensitive economies in the country —really shows what we can reap as a nation from corporate efficiencies and more responsive corporations.
The Midwest also now is one of the tightest labor markets in the country, and there are political tensions that naturally develop. We’ve got workers who are retiring in record numbers and don’t want to pay things like real estate taxes to subsidize education.
At the same time, we need education more than ever. We have small businesses that can’t make do with the current educational system and the level of employees that are being turned out.
Where do you see the national economy 12 months from now?
We’re going to see, particularly in this region of the country, an economy with an even lower unemployment rate than we thought possible. Many people will be stunned by how many people continue to be pulled out of the woodwork to participate in this economy, and that’s wonderful.
But, the risk is we also have a greater price to that. The risk is that inflation accelerates. I expect core inflation — meaning nonfood, nonenergy — to be a little above 3 percent a year from now, but it could be much higher than that.
And once you cross that 3 percent threshold, that’s when people really start noticing it. People aren’t too upset with inflation right now. You may see it at the gas station, but beyond that, it doesn’t seem that big of a deal. When you get above 3 percent, you start feeling it a little more. Certainly, if you move it to 4 percent, you feel it even more.
The important message of the forecast, and the reality we’ve already seen, is all the productivity growth in the world can’t rescue us because it’s just not enough to completely repeal the law of supply and demand in the labor market.
Until the Internet can watch our kids and cook our food and set our tables, it’s a service-based economy, and that’s where you feel inflation first and worst.
How to reach: Bank One, Corporate Economics Group, (312) 732-3726
Jim Vickers ([email protected]) is an associate editor at SBN.