WEEK OF DECEMBER 17, 2007—IS ECONOMY TOO HOT?

The holidays are bringing more Christmas cheer to the economy. Holiday shoppers are out in droves, in spite of the high gas prices. And so economists are revising fourth quarter growth estimates upward.

Year end figures show a U.S. economy that is red hot, rather than in danger of grinding to a halt. Not only are consumers spending as if there is no tomorrow, but industrial production is straining at full capacity and it is pushing up the inflation rate.

Retail sales, which account for half of all consumer purchases, surged 1.2 percent in November and are up 6.3 percent in 12 months. These are numbers reminiscent of boom times, and should raise 4^th quarter GDP growth to more than 2 percent from the 1 percent consensus forecast.

Industrial production is also growing, in part because of surging exports. Production is up 2.1 percent in one year, and operating at 0.5 percent above its 1972-2006 average capacity level, according to the Federal Reserve. ‘Real’, or after-inflation Gross Domestic Product has grown 2.8 percent in 12 months, which is close to its maximum growth potential.

This means supply bottlenecks, and bottlenecks mean higher prices. As a consequence, November wholesale (PPI) and retail (CPI) prices rose sharply, mostly due to scarcer gas and oil supplies. Producer prices are up 7.2 percent, and consumer prices have risen 4.3 percent in 12 months.

And, although home sales continue downward, the Federal Reserve reports that household wealth—the value of household assets minus liabilities—rose $625 billion in the third quarter. It is below the average $1 trillion increase of recent quarters, but still huge.

And disposable incomes and spending, a key indicator of economic health, continued upward in November. Real disposable incomes (after taxes and inflation are deducted) are actually exceeding 2006 levels.

This may explain why consumers still feel wealthy enough to continue spending, even though housing starts fell 3.7 percent in November. And though the Conference Board’s Index of Leading Economic Indicators (LEI) is down 1.2 percent in 6 months, its components are evenly balanced between strengths and weaknesses.

In addition, Martin Feldman, president of the National Bureau of Economic Research—the agency that determines the beginning and end of business cycles—recently said that the 4 indicators used to determine business cycles--employment, wholesale and retail sales, real personal income, and industrial production— indicate no oncoming recession. So, it looks like economic growth may continue to exceed everyone’s expectations!

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