Smith Faculty Opinion Article	September 28, 2007
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

Personal Income up $40.2 Billion in August
Inflation falls, Stocks Should Rise

Today, the Commerce Department reported in August personal income increased $40.2 billion or 0.3 percent, disposable personal income increased $37.2 billion or 0.4 percent, and personal consumption expenditures increased $54.8 billion or 0.6 percent.

Consumer spending continues to support economic growth, and for July and August, consumer spending outpaced second quarter growth.

Gasoline fell 5.9 percent in August, freeing up money for other purposes, and that helped boost inflation adjusted consumer spending 0.6 percent. That is good news for those worried about a recession.

Second quarter growth was 3.8 percent, and that strong showing was helped a lot by an upswing in government spending, nonresidential construction, and an improving real trade deficit--rapid growth in exports and fewer imports--as the weaker dollar began to bite on consumer choices.

In the third quarter, GDP growth in the range of 2.5 percent is likely, but the risk of a recession is still significant.

Slumping housing prices and sales are negatively impacting local government budgets, and this will curtail both current spending and construction projects. Taxes will be increased in some states and that is hardly ever good for growth.

The trade deficit is not likely to improve much further, because petroleum and trade with China account for 80 percent of the deficit. Oil is priced in dollars, and the Chinese yuan has fallen little against the dollar; therefore, a weaker dollar will not much affect 80 percent of the U.S. trade deficit.

A lot depends on whether the slowdown in housing and fall in home values will ultimately slow consumer spending. Despite the recent adjustment in home prices, homeowners still have lots of appreciation borrow against, and much depends on consumer expectations about job security and recovery in the housing market.

Although inflation remains worrisome, the risk of a recession is substantial. The high risk of recession will likely prompt the Federal Reserve to cut interest rates further.

Inflation and Federal Reserve Policy

The price index for personal consumption expenditures, including food and energy, fell 0.1 percent in August, and was up 1.8 percent from August 2006.

The Federal Reserve closely watches the price index for personal consumption expenditures, less food and energy. This core price index was up 0.1 percent in August, after rising 0.1 and 0.1 percent in June and July. In August, the index was up 1.8 percent from August 2006.

As important to the Federal Reserve, the market-based core inflation index, which excludes food, energy and imputed prices like rent on owner occupied homes, was up 0.1 percent in August, after rising 0.1 and 0.1 percent in June and July. That index has increased 1.6 percent since August 2006.

Oil and other commodity prices continue to surge on international markets, and this is likely to feed U.S. inflation. The Federal Reserve, by constraining U.S. economic activity, can do little to slow rising commodity prices, and will likely continue to focus on stabilizing credit markets and avoiding recession.

With the housing market continuing to deliver discouraging news, and structural problems in the mortgage market and bond rating systems continuing to handicap credit markets, financial and economic stability will remain the Federal Reserves primary objectives through the end of 2007.

Look for another interest rate cut when the Federal Reserve Open Market Committee meets on October 30 and 31.

Outlook for Stock Prices Remains Bullish

The stock market came through the subprime crisis reasonably well. Despite wide fluctuations, the Dow Jones average rose 146 points in August after falling 197 points in July. As of September 27, the Dow Jones was up 691 points from July 31, and 2837 points from its August 2006 low.

Global economic uncertainty, precipitated by the U.S. subprime crisis, rising global oil prices and surging Chinese trade surpluses, is causing foreign investors to seek safe harbor in U.S. real estate and equities but not bonds.

Skepticism about the quality of U.S. bond ratings will continue, thanks to the denial and stone walling at Standard and Poor, Moodys and other rating agencies. Coupled with lower short-term interest rates, pessimism about the security of U.S. bonds should be good for U.S. equities.

With U.S. companies earning large profits from robust growth in Asia and uncertainty in credit markets driving foreign money into U.S. stocks, steady or falling U.S. interest rates create a great incubator for an end of year stock market rally.

The bull market will continue, and the Dow should breach 14000 again soon, and pierce 15,000 in early 2008.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.