Economic Growth May Rival 1960s’ : Inflation, Dead for Now, Could Accelerate by ’87

When the Labor Department reported recently that wholesale prices had plunged a record 1.6% in February, some economists and the Reagan Administration were quick to proclaim dramatic progress in the long and difficult battle against inflation.

“For the time being, at least, there is simply no inflation in the American economy,” said one leading bank economist.

“Consumer prices are coming down, and the fears of inflation have all but abated,” added White House spokesman Larry Speakes.

With its low, single-digit rates, inflation no longer strikes many consumers and businesses as a clear and present danger. Many firms--in agriculture, energy, mining and even manufacturing--worry far more about whether prices will be high enough to cover their costs.

Careful Hedging

But as indicated by the careful hedging at the White House and among financial analysts--”for the time being,” “all but abated”--few are willing to declare the once seemingly incorrigible problem of inflation solved. And many consumers--particularly those of the baby-boom generation who grew up during the inflationary ‘60s and ‘70s--are behaving as if inflation will make a comeback in no time.

Although consumer prices are likely to fall in the coming months as lower petroleum prices work their way through the economy, many economists predict that inflation will resume in the second half of 1986 and accelerate in 1987.

Money saved on gasoline and other petroleum products, economists say, will free up funds for consumers to spend elsewhere--heating up demand and fueling price increases in other products. The dollar’s plunge on foreign-exchange markets also is expected to drive inflation higher as importers raise prices to compensate for the lower value of their sales in the United States and as domestic producers feel less pressure to keep prices down.

The falling dollar has already led to price hikes for a wide range of imported products. The current sticker price on a Japanese Honda Accord LX is $12,469, 17% higher than it was a year ago. On Jan. 1, Sony Corp. of America put into effect price hikes ranging from 2% to 12% on consumer electronic products, “and pretty much the whole industry followed suit,” spokesman Fred Wahlstrom said. Future prices “will depend on the dollar-yen relationship,” Wahlstrom said.

Steel Prices Rising

Because the dollar’s plunge has led foreign competitors to raise their prices, domestic steel prices on flat-rolled steel, used to make autos, appliances and heating ducts, are beginning to recover after two years in the doldrums. “Price hikes are beginning to stick, in large part because of the decline in the dollar,” said Georgia State University economist Donald Ratajczak.

At the beginning of the year, prices for flat-rolled products went up 5% to 10%. And earlier this month, U.S. Steel Corp. led the industry in posting another round of price hikes ranging from 2.9% to 3.7%. The increases take effect May 5. A spokesman noted that prices for tubular steel, used in oil wells and refineries, and prices for heavy structural steel remain depressed.

Beyond the immediate inflationary effects of the dollar’s slippage on international currency markets, some economists fear that developments over the longer term could fan inflation. Current record or near-record burdens of debt--government, corporate, consumer and overseas--could force the Federal Reserve Board to flood the economy with cheap money at the first sign of a financial crisis in order to forestall a depression, they say.

Some observers say the fact that Fed Chairman Paul A. Volcker, best known for his stance against inflation, was initially outvoted by his Fed colleagues on this month’s half-point cut in the discount rate to 7% also could bode poorly for future Fed vigilance on inflation.

Some Lock in at 10%

Many consumers are acting as if inflation is merely at rest before another flare-up. They are rushing to lock in fixed-rate mortgages at about 10%, and they are making major purchases to beat price increases.

“Inflation is in the wind,” said Mark Dunlop, a 31-year-old San Francisco insurance underwriter who this month installed a redwood deck on his house to beat a 10% price increase in lumber April 1. “For some products, it’s just like in the ‘70s,” he said. “Buy now or pay more later.”

“I’m convinced inflation is still with us,” said Sally Smith, a massage and hypnosis therapist in San Francisco. “Everything in the stores costs a bit more. Food is more expensive. Restaurants are more expensive. Nobody seems to be holding the line.” She, too, raised her prices this year--to $45 from $40 per 90-minute session.

Other consumers say they don’t think government inflation statistics accurately reflect the prices they pay.

“My haircuts just went up to $25 from $21,” said one young professional. “Bus fare in San Francisco went to 75 cents from 60 cents, a 25% increase. My morning coffee costs 75 cents, up from 50 cents.”

Home Buyers Bet on Inflation

The residential real estate market reflects a disbelief that inflation and interest rates will continue falling, and sometimes displays similarities to the inflationary ‘70s.

And Ramon Garcia, a Daly City, Calif., security guard, is shopping around for a fixed-rate mortgage on his home to replace the variable-rate loan he took out last year. “Ten percent is pretty good,” he said. “I don’t think it can go down much lower.”

Buyers are also sometimes bidding up for homes. “We’re seeing multiple offers on properties,” said Tony Marchese, a broker with San Francisco’s Hartford Properties. “People who’ve lost houses (to competing bidders) are offering more than the asking price if they really like a house.”

While many consumers and economists agree that inflation will return after several months of negligible price increases or even deflation, the question is how fast overall prices will once again rise. Inflation projections for this year and next are all over the lot. Blue Chip Economic Indicators, a Sedona, Ariz., firm that regularly polls 50 economists, reports a consensus forecast that the consumer price index will rise 3% in 1986 and 3.7% in 1987.

Both forecasts went down by half a percentage point in the last month--”one of the sharper drops on record,” said Robert Eggert, who conducts the survey.

The consensus masks a sharp division in the economics profession. Most people seem “to learn very slowly the evident lessons of history,” said Clopper Almon, a professor of economics at the University of Maryland and president of Inforum, an economic forecasting concern.

Money Supply Growth Watched

“There has been a tremendous surge in the growth of the money supply, and that is continuing. When that is happening, inflation cannot be far behind,” said Almon, who forecasts that 1987 inflation will be about 6%.

The basic money supply grew at a seasonally adjusted rate of 8.4% in the latest 13 weeks, once again outstripping the Fed’s target growth of 3% to 8% for non-inflationary economic growth. The growth was a record 12% last year, far above both the initial target range of 4%-7% and the revised target of 3%-8%.

Even more pessimistic is Nobel prize-winning economist Milton Friedman, dean of the monetarists, a group that believes that the economy’s direction is determined mostly by the money supply: “While there is no background to suggest double-digit inflation, I wouldn’t be surprised to see prices climbing at a 6, 7 or 8% rate before the end of 1987.”

Friedman acknowledged in an interview that his predictions of renewed inflation have been wrong before. “The timing of these things is never very precise,” he said. “But I’ve gone over my past data, and I’m convinced that lower oil prices will only temporarily interrupt my forecast of higher prices.”

A 7% rate of inflation would mean that overall prices will be double what they are today by 1996. Even a 4% annual rate would cut the dollar’s purchasing power for consumers by half in 18 years.

But other economists say the monetarists predicting resurgent inflation have missed a fundamental change in the way consumers and companies deal with cash. That’s because M-1, a commonly used measure of the money supply that used to include only cash and traditional checking accounts, has been broadened to include a new form of checking account that pays interest.

Cash Holdings Cited

“The money supply can increase without a surge in inflation because people are holding more cash these days,” argued Michael Drury, senior economist with Shilling & Co., a New York consulting company that sees 1987 inflation at just 2%.

Companies, too, he argued, are holding larger cash balances in the wake of E. F. Hutton’s scandal last year in which it was found guilty of writing checks for more than it had on deposit at banks.

Optimists about future inflation also doubt that the 30% drop in the dollar against major currencies in the last 12 months will put much upward pressure on prices. Foreign companies such as Japanese auto makers “are raising prices as little as possible in hopes of retaining market share,” Drury said.

Moreover, currencies of such newly industrialized nations as South Korea and Brazil continue to weaken against the dollar, giving low-cost exports from those nations a competitive advantage in the United States.

Some of those forecasting low inflation also point to apparent weakness in the economy. Industrial production fell 0.6% in February, and the government just revised downward its estimate of growth in last year’s fourth quarter to 0.7% from 1.2%. Such weakness or a recession, should one develop, will keep prices in check, they argue.

Many companies see no immediate turnaround in the inflation outlook and have gone through a wrenching process of adjustment amid negligible inflation or even deflation.

Scarcely a day goes by without another big oil company announcing major layoffs and cutbacks in capital spending as a result of lower oil prices.

Value of Collateral Falls

Many banks that counted on continued inflation during the late ‘70s have suffered as borrowers got into trouble and collateral such as farmland, real estate and oil rigs fell in value. Only last week, federal bank regulators said that Southwest banks are being surveyed to assess the effect of tumbling oil prices on their financial well-being. “We got big problems,” said Rep. Fernand J. St Germain (D-R.I.), chairman of the House Banking Committee.

At Bechtel Group Inc., the San Francisco engineering and construction firm that is a major beneficiary of petroleum and mineral industry capital spending, the impact has been severe. The company currently employs 25,000 professionals, compared to a mid-1982 peak of 45,000.

Fluor Corp., which purchased St. Joe Minerals for $2 billion in 1981 when mining looked like a good way to bet on inflation, has had to face up to the consequences of depressed lead, zinc and energy prices.

In a restructuring program designed to deal with lower inflation, the Irvine-based firm has decided to shed ownership of many of its mineral holdings while retaining management contracts to develop them. Last year, it disposed of its oil and gas operations, and earlier this year the company offered a 10% stake in a newly created unit, St. Joe Gold.