America spends its way to Rolls Royce economy

Last month, Hannay Reels Inc., which makes metal reels used in fire trucks and refueling tankers, had its best month in its 66-year history.

"We're not running at capacity but no one is standing around idle," says Roger Hannay, the president of the Westerlo, N.Y., firm.

Hannay's experience is typical of what's happening in the US economy. Driven by strong consumer demand and business investment, the US economy continues to operate better than anyone expects. The Dow Jones Industrial Average is close to its all-time high. And, with inflation remaining quiescent, the Federal Reserve is expected to sit back, keep interest rates steady, and just enjoy the prosperity.

Last week, these trends were highlighted when the US Commerce Department released its preliminary snapshot of the nation's first-quarter gross domestic product (GDP). The latest report shows an economy that is slowing down from its warp speed pace at year-end but still performing beyond expectations.

According to the government, the US economy grew at a 4.5 percent annual rate for the first three months of the year, down from 6 percent in the fourth quarter last year. And inflation, the reports indicate, remains dormant.

"It continues to be a Rolls Royce economy," says Robert Dederick, a consulting economist at Northern Trust Co. in Chicago.

The main driving force behind the good news is the consumer.

Spending that refund

Boosted by record tax refunds, consumers have been hitting the malls and automobile showrooms. Auto analysts believe vehicle sales were up 4 percent in April - with cars moving off the lots at a record pace.

Credit-card debt is also hitting record levels. As a result, the savings rate in the first quarter actually showed a negative 0.5 percent. "With tax refunds over, consumption patterns are not going to be this robust going forward," predicts Kevin Flanagan, a money market economist at Morgan Stanley Dean Witter.

But economists don't expect the consumer to stop spending. In a survey of consumers released today, the University of Michigan concluded, "Overall, consumers have never been more confident for a longer period of time than at present."

Among the reasons for the confidence: an unemployment rate of 4.2 percent - indicating that jobs are plentiful. At the same time, more consumers reported income gains in the April survey than at any time since the 1960s.

Wall Street pumps up wallets

Economists believe many of these gains are in the stock market, since an important government index, the Employment Cost Index, showed virtually no increase.

"People are making so much money in other venues, such as the stock market, that they are not holding their employers accountable," says John Burgess, a managing director at Bankers Trust Co. in New York.

The stock craze is spreading, he says. Recently, he was taking a cab at 6 a.m. "The driver wanted to know how to trade Internet stocks," he recalls.

Last week, the Dow closed at 10,788.75, up 99.37 for the week.

Merrill Lynch estimates capital gains have added about 7 percent to consumers' income so far this year. As a result, says Merrill economist Bruce Steinberg, "We expect consumer spending to rise at least 4 to 4.5 percent during 1999."

Spending has spread to the business community as well. In the first quarter, business spending rose at an 11 percent annual rate. This is a slowdown from the 17 percent rate last year. A good portion of the spending went to technical equipment, such as new computers designed to overcome the Y2K problem.

Hannay is a beneficiary of some of this capital spending since most of its sales are to other businesses.

Like many other manufacturers, Mr. Hannay has competition from Japan, but so far, he says imports have not significantly eaten into his order book.

Weak markets abroad are definitely cutting into exporters' order books. According to the US Commerce Department report, the trade deficit took 2.4 percent out of the GDP numbers.

With the US economy so strong, economists are viewing this positively. "The trade sector is a safety valve," says Mr. Dederick.

Without the slowdown in exports, economists believe the Federal Reserve would raise interest rates when it next meets on May 18. Last week, the head of the International Monetary Fund suggested the Fed should be tightening rates.

Not so, says Scott Grannis, head of Western Asset Management, which manages $53 billion in fixed income assets. He says there is no sign of inflation. Instead, he points to commodity prices that are at 50-year lows. "If they raise rates they are crazy," says Mr. Grannis, whose firm is in Pasadena, Calif.

Balkans conflict

Even the war in the Balkans is not likely to make much of an impact on the US economy, say economists. Past wars, such as in Vietnam, have often had an inflationary impact. However, the bombing war over Serbia and Kosovo is considered too small to impact the US economy.

Last week, President Clinton asked Congress for $6 billion to help fund the NATO campaign.

"It will have a marginal impact on the economy," predicts Grannis.

If the Fed does not act, most economists expect the economy to continue to slowly wind down as the consumer tires. The consensus is for a more sustainable 3 to 3.5 percent annual growth rate. Asks Dederick, "What will cause the consumer to stop spending?"