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Last Week

Signs of a Pumped-Up Economy

Sunday, March 27, 2005; Page F02

It's hard to complain about a U.S. economy that, almost alone in the industrialized world, is creating new jobs and growing at a rate of more than 4 percent, even in the face of record high energy prices.

But there is no shaking the feeling that this is an economy on steroids, pumped up by deficit spending by government and plenty of cheap money.

The telltale signs can be found in real estate markets, where home building and sales continue at record levels and a brisk trade has developed in buying and flipping houses and condos, sometimes even before they are completed. Or in financial markets, where hedge funds have been borrowing at lower short-term rates and lending out at higher long-term rates on the assumption that Alan Greenspan and the Federal Reserve have slain the inflation dragon and would do nothing precipitous to jeopardize their "carry trade." Or in corporate boardrooms, where record amounts of free cash are being used not to invest in future growth, but rather to prop up share prices through dividend increases and stock buybacks.

Last week, little cracks began to appear in the otherwise smooth facade of the economy. While the Federal Reserve announced its seventh baby-step increase in short-term interest rates, the bond market saw more ominous warnings in the language accompanying the announcement, suggesting that accelerating inflation might require the central bank to be less measured in future rate increases. It's not just rising fuel costs that are driving up prices. Increases in a wide range of commodities, along with health care and travel, have now worked their way through the supply chain, as companies find that for the first time they are able to push through price hikes.

On the bond market, where long-term interest rates are set, yields on 10-year Treasurys reached 4.6 percent -- still low by historic standards but up six-tenths of a percent in the past month. For the first time in years, holding bonds suddenly looked like a risky bet. Stocks also fell on rate jitters, for the third straight week.

And even in a real estate market that many continue to view as a one-way wager, the chatter was that some of the recent surge in activity might be the last rush to get in before rising rates cool things down.

There are those, of course, who believe markets will regain their footing in a week or two now that the speculative froth has been removed. Then again, there are those who believe in the Easter Bunny.

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