The U.S. economy should perform much better than most people expect over the next two years. Capital spending is about to spurt, which will keep economic activity going forward. And inflation and interest rates should unwind. But watch out after 1980, because a 1929-style financial crash could follow.
These are the somewhat unconventional views of A. Gary Shilling, one of Wall Street's best known economic analysts. Shilling was chief forecaster for White Weld before it got swallowed recently by Merrill Lynch.
Rather than return to Merrill Lynch - where he departed in 1970 after correctly predicting that year's mild recession and in the process provoking the ire of the brokerage giant's top management - Shilling has now set up his own consulting firm.
Among economic soothsayers, Shilling has been out on a limb for some time now with his deflationary forecast - a prediction that the long-term trend in prices is down rather than up.
He bases this on his perception that the world has moved from a period of excess demand in the late 1960s and early 1970s "to a world that is going to continue to see excess supplies of men, machines, materials and even capital."
So why does inflation seem to be a rising rather than a declining concern, at least in the United States?
Shilling conceded that U.S. price levels have been running substantially higher than the 4 percent level he predicted. But he pins the blame on federal government actions such as the increase in the minimum wage, higher social security taxes, sugar tariffs, steel trigger prices and a few others that he estimates in 1978 alone are adding $31 billion to consumer prices and 2.5 to 3 percent to the consumer price index.
"We missed this in the last three years, there's no mistaking that," he said.
"But we think there's a very strong case to be made that inflation in the private sector is really running at 3 or 4 percent," he added, noting that this represents a significant unwinding from several years ago, "but we've got an overplay of 2 or 3 percent coming from the government."
According to Shilling's analysis, business behavior since the 1974-75 recession has been extremely cautious. Rather than expand capacity through outlays for new plants or equipment, businessmen have tended to add more workers, who can be laid off again in case of a softening economic picture, rather than make the harder-to-reverse commitments involved in a new plant.
This, he said, explains the surprisingly large growth in the labor force - particularly for production workers - which has brought unemployment down faster than even the Carter administration expected, and, conversely, is a reason for the sluggish pattern in capital spending.
"Carter, when he is taking credit for reducing the unemployment rate, should really be taking credit for making businessmen so damned scared that they are using labor rather than capital, because it is a cost that can be gotten rid of much more easily," Shilling noted.
But the unusual growth in the labor force has distorted both actual increases in overall business productivity and efficiency and the costs of production, since these are usually a function of output-per-manhour, which is easily measured.
Taking into account capital, managerial talent and other factors besides labor involved in the cost of prodcution, Shilling has calculated that unit costs of production went up 7.2 percent in 1975, 3.1 percent in 1976, and 4.1 percent in 1977.
This compares with increases in unit labor costs of 16.9, 4.6 and 7.5 percent for those three years, respectively, nd actual wholesale price index increases of 9.2, 4.6 and 6.1 percent in the same years.
The gap between the offset cost of production to the private sector and actual consumer prices hikes "is government-inspired inflation," said Shilling. But he expressed some hope that the recent California vote in favor of the Jarvis Gann property tax reduction initiative will be followed up in the fall elections to send an unmistakeable message to Washington to reverse this trend.
Meanwhile, Shilling sees a capital spending boom in the offing as businessmen find it harder and more expensive to substitute labor for capital, because of tightening labor markets, as well as an increase in factory operating rates into a range that has in the past triggered a major expansion of facilities. That should continue this country's economic expansion, at least through 1980, he says.
He expects inflation to continue to unwind, with the consumer price index dipping to 4 percent by 1980.
"But what I'm concerned about is the long-run," he said, noting similarities between the last recession and the economic dip of 1920-21 which had many of the same inventory excesses of the 1974-75 decline. The next drop, he said, could repeat the 1929 financial collapse that started the great depression of the 1930s.
"It's difficult to tell your clients that the world is coming to an end," said Shilling. "And the next couple of years are probably going to turn out to be much better than we expect - better economic growth, less inflation, lower interest rates, and a more stable dollar than anyone is planning on.
"But that's what is going to suck everyone in," he added. "You'll probably get a rising stock market, a feeling the problems have been solved, strong capital spending, which will convince people that bottle-necks and productivity have been taken care of. And then you get that financial accident. And that of course fits in with the idea that financial problems, historically, don't occur when everybody expects them but rather from states of euphoria."