BUSINESS INSIGHTS
Interest rate hikes will curtail more than inflation ecent interest rate actions by the Federal Reserve Board raise the question of whether inflation is such a danger that growth should be sti fled. The answer may have a pro found impact on the economy in gen eral and on the chemical industry— which is only now emerging from the effects of the recession—in particular. Although inflation is a danger in an overheated economy, the 1980s showed that the U.S. can have longterm sustained growth without high inflation. In the postrecession years of 1983 through 1989, real gross domes tic product (GDP) grew at an average annual rate of 3.6%, while the annual rate of inflation averaged 3.7%, the lowest since the U.S. abandoned the gold standard for its currency in the early 1970s. During the previous and much shorter expansion between 1975 and 1979, real GDP grew at an average rate of 4.0%, but the Con sumer Price Index (CPI) averaged 7.8% annual growth. At a meeting of the Chemical Man agement & Resources Association in New York City last month, A. Nicho las Filippello, Monsanto's chief econ omist, said: "For the past several years, the Federal Reserve has made it clear that it intends to, in its words, 'eliminate inflation as a factor in busi ness and economic decisions/ That is a worthy goal and one which I be lieve keeps U.S. business' feet to the fire, forcing us to become more effi cient. But it also means, as former Fed [Federal Reserve Board (FRB)] chair man William McChesney Martin once said, that the Fed's job is to take away the punch bowl just when the party is getting good." In raising short-term interest rates in recent months—in May, for in stance, the federal funds rate shot up one-half percentage point to 4.25%— the FRB seems to be forgetting the most recent expansion and remem bering only the 1970s. However, the inflation of the 1970s was driven largely by an outside force—the in-
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Mortgage rates have moved up sharply 30-year fixed rate, % 91
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ΟΙ ι ι ι ι ι ι ι ι ι ι ι ι ι ι ι I J FMAM J J A S O N D J F M A M 1 1993 ' ^1994-^ Source: Federal National Mortgage Association
crease in energy prices brought on by oil quotas from the Organization of Petroleum Exporting Countries—and by the government itself in increasing the money supply in the later years of the decade to stave off a recession. Γη announcing the first increase in the short-term rates earlier this year, FRB chairman Alan Greenspan said he saw no reason why the rise in short-term interest should affect longterm rates, such as mortgages, but it has not worked out that way. Infla tion psychology has long dictated that a warning will bring an immedi ate reaction to counter possible eco nomic threats. Warnings of recession immediately bring antirecessionary measures; warnings of inflation bring anti-inflation tactics. Thus, when short-term rates increased, the bond market fell to increase yields, and banks raised both short- and longterm rates on loans to cover their cur rent and anticipated costs. The result: an increase in interest rates across the board. While the federal funds rate in creased from 3% at the beginning of February to 4.25% in May, a rise of almost 42%, the average rate for 30year fixed rate mortgages rose about 25% to 8.73%, according to the Fed eral National Mortgage Association. And corporate bond yields during that time also rose significantly. The upshot is that financing across
the board, from credit card purchases to mortgages for consumers and from inventory financing to plant expan sions for corporations, will cost more. And since the cost of financing will take money from the economy, de mand for goods and services and, thus, the expansion will slow. As Filippello pointed out, now that interest rates have started to climb, re financing of mortgages has dropped 85% from the peak last September. "And we are already seeing early signs that this will take some of the wind out of a few of our industry's key end-use markets/7 he said. "The punch bowl is being taken away." Two of these key end-use markets are automobiles and housing, which have helped the chemical industry fi nally begin to see increases not only in earnings but also in sales. To show just how important these two industries are to the chemical industry, one need only consider their plastics demand. According to the Society of the Plastics Industry, about 5% or 3.1 billion lb of all resins shipments went to transpor tation industries, and about 20% or 12.4 billion lb was used in building and construction in 1993. Add to these quantities the massive volume of fibers used for auto upholstery and carpets in houses—and the adhesives, sealants, paints, and other products used in both markets. Thus, the effect of a slowdown in these two interest-ratesensitive end-use markets on the chemical industry becomes massive. Reacting to rising interest rates, the National Association of Home Build ers has cut its forecast for housing construction for both 1994 and 1995. The new projections call for new housing starts to total 1.38 million units in 1994 and 1.37 million units in 1995. The previous forecast was for 1.43 million units this year and 1.48 million units next year. A survey of 35 economists by the Federal Reserve Bank in Philadelphia taken in May estimates that GDP will grow 3.6% this year and 2.7% in 1995; the CPI is predicted to rise 2.9% in 1994 and 3.2% in 1995. Again the question is, with moderate growth rates like these, should the economy be slowed even more? William Storck JUNE 6,1994 C&EN
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