The current expansion is now four years old, making it the fourth- longest in the postwar period. Moreover, there are no signs of deterioration.
On the contrary, we expect the expansion to continue at least through 1996. The endgame of expansions always includes accelerating inflation, rising interest rates, and scarce money. None of those forces are present.
This expansion has been driven by several special strengths. Corporate profits have done very well. Indeed, over the first 15 quarters (latest data available) corporate profits have grown by more than in all but one of the earlier expansions. Furthermore, company reports for the first quarter of 1995 strongly suggest that profits are continuing to mount.
Related to profits has been the improvement in productivity. Over the first 15 quarters of the current expansion, productivity has risen by more than in all the postwar expansions but one.
The most extraordinary characteristic in the current expansion has been spending on fixed investment. That spending has increased more than in any earlier four-year period since World War II.
Most of that increase has been for equipment. This spending surge is being driven by corporate profits and the high-technology revolution - computers, telecommunications, and the merging of these technologies. Since the high-technology revolution and corporate profits are likely to continue, we can expect continuing growth in capital spending.
Another unique characteristic of this expansion has been the sharp decline in federal government spending, especially for defense. In 1992, 1993, and 1994 defense spending went down by progressively larger amounts and percentages, gross domestic product grew by larger amounts and percentages, and the GDP deflator rose by progressively smaller amounts.
These are related phenomena. The reallocation of resources from defense spending to the private sector has contributed to more efficient resource utilization, higher productivity, and greater competitive pressures on prices.
With the economy fully employing its productive resources - labor and capacity - this transfer of resources has been an important contributor to the vigor, duration, and balance of the expansion.
Inflation has been remarkably subdued. In fact, the inflation rate for the first 16 quarters of the expansion has been lower than all but one of the earlier prolonged upswings. An important suppressant to the inflation rate has been the low and diminishing rates of increase in employment costs.
That, in turn, can be accounted for by the much lower rates of increase in benefits, especially health care, and a shift to greater reliance on incentive compensation by employers. A growing number and percentage of workers across the chain of command, from factory line and staff levels upward, are now receiving various forms of incentive compensation based on their performance and on company profitability.
This has sharpened focus and improved motivation. As a result, real private-sector wages and salaries per worker have risen sharply for a prolonged period. This phenomenon helps to explain the improvement in the savings rate and high level of consumer confidence.
In our view, the U.S. economy has become far more entrepreneurial than at any time in the past 50 years. While that is difficult to measure, the benefits are palpable: rising profits, rising productivity, rising personal income, and a strong, sustained expansion.
The last special strength that should prolong this expansion has been the decline in the dollar. The trade weighted index has fallen 13% to 14% since the second half of 1993. That is meaningful and prolonged, enough to have economic repercussions.
With the United States now the low-cost producer among industrialized countries, we are likely to see more investment in plant and equipment within the U.S. by both domestic and foreign producers.
We will also see further increases in U.S. exports and in U.S. share of world trade. Owing to the lags, these phenomena should manifest themselves in the second half of 1995 and throughout 1996. However, there are drawbacks. In economic terms, the United States is becoming poorer. We are suffering a worsening in terms of trade.
That is to say, it will take increasing amounts of American exports to pay for a given amount of imports. The U.S. also runs the risk of an erosion of the dollar's status as a reserve unit. Eventually, there will have to be a payback.
There is also a monetary policy impact. The dollar has been declining while the Federal Reserve has been engaging in progressive tightening. By providing a stimulus, the dollar's decline partially, perhaps even largely, nullified the Fed's intent of restraint through interest rate increases.
Also, sterilized foreign exchange intervention has resulted in a transfer of ownership of dollar balances from private holders abroad to private holders domestically. Thus, even though there has been no quantitative increase in reserves or money supply as a result of foreign exchange intervention, there has been a qualitative shift leading to an increase in domestically controlled liquidity.
This, too, is partially nullifying the Fed's intent at restraint. In my view, a year from now the Federal Reserve will look back and acknowledge that currency market developments had the effect of providing more stimulus than it, the Fed, had intended. All of this makes me believe that the economy will continue along a 3.0% to 3.5% growth track through the first half of 1996. By the second half of that year, growth should slow below 3%, but not much below.
Meanwhile, inflation is likely to accelerate through the 3% range in the second half of 1995 to over 4.5% in the second half of 1996. By that time, the unemployment rate should be below 4.5%.
The Federal Reserve will respond to all of this by repeated rounds of tightening at about three-month intervals in 50-basis-point increments. That means that by yearend 1995, the federal funds rate is likely to be 7.0 to 7.5%; by yearend 1996 it should be 8.0 to 8.5%.
Treasury bond rates should rise well above 8%, perhaps reaching, or even piercing, 8.5% in 1996.
Mr. Sherman is director of research at M.A. Schapiro & Co., in New York. This article summarizes a speech he was scheduled to make Tuesday at the midyear senior management conference of the Community Bankers Association
