Inside the Fed's head: Alan Greenspan's economic policies are meant to encourage productivity and deter inflation. Will the industry buckle under his rising interest rates?

Pool & Spa News, Nov 19, 2004 by Shabnam Mogharabi

Alan Greenspan is intent on taking things slowly. Since June 30, when the Federal Reserve Bank implemented the first of a series of interest rate hikes, its 78-year-old chairman has said he's committed to gradually tightening the economy.

For many, that means saying goodbye to historically low financing rates.

Appointed in 1987 by Ronald Reagan, Greenspan guided the economy through the recession of the early 1990s and the '97 Asian financial crisis. He now now has to weather today's ups and downs, which include terrorist attacks, widespread corporate scandal and war in the Middle East.

When interest rates were slashed in 2001 and 2002, consumers responded by pulling equity out of their homes and investing in room additions and elaborate backyards. Home building and remodeling activity soared. However, in the long run, an increase in interest rates--and the possible threat of inflation--may cut into pool construction volumes and profits.

The Greenspan standard

Since Sept. 11, 2001, Greenspan has followed a consistent course of action. In spring 2004, when consumer prices crept upward, he ignored national demand to raise rates. Now that inflationary activity has slowed, Greenspan has implemented a series of rate hikes to stimulate the economy.

As of press time, he had upped the federal prime rate (the interest rate at which banks lend money to other banks) to 1.75 percent from a 46-year low of 1 percent. Analysts expect the rate to reach 2.3 percent by February 2005. That's still well below the 4 percent rate that many economists feel is a stable equilibrium, in general, this median figure translates into consumer financing rates ranging from 7- to 10 percent.

"The economy is growing in a solid fashion," Greenspan said in July. A month later, he called the economic recovery "self-sustaining." In the flail, he then told Congress that "the expansion has regained some traction."

Over the past year, almost all of the price indexes--from raw' commodities to retail sales--have risen. Gas has averaged around $2 a gallon nationally; milk costs roughly $4 a gallon. Through July, the average annual rate of inflation was 5.5 percent, due mostly to energy prices. Core inflation, which doesn't include energy or food, is at 1.7 percent.

"Inflation always concerns me," says Thomas Brown, vice president of sales and marketing at Aquatech Society in Huntington Beach, Calif. "We've seen a lot of in creases in supply costs. Alan, in his wisdom, is doing a fairly decent job for the economy.

"What we may see is that pool builders [are] not making as much profit on a particular project," Brown says. "Luckily for us, our industry is made of intelligent, mom-and-pop shops that can react quickly to the marketplace."

Brown's worries are exactly what Greenspan is trying to avoid. Inflation is a self-feeding process, so if companies and workers are convinced it will remain under control, as Greenspan believes the central bank can then afford to move at a much more measured pace to increase rates.

But once companies and workers start anticipating higher costs, they may act in ways that feed the inflationary spiral. For example, companies will be quicker to increase prices, and workers will aggressively press for higher wages to make sure they don't fall behind.

"If you don't raise rates, you may see inflation," says Nicholas Buss, Ph.D., vice president of market research at PNC Real Estate Finance in Pittsburgh. "But in looking at the numbers, long-term inflation has been relatively stable."

"Now, it's been more pronounced of a difference over the last year," Buss adds. "But I don't see inflation as a problem unless there's another terrorist attack or issues in the Middle East escalate again."

Is the pool party over?

In many ways, higher interest rates can stimulate the economy. Companies with financial investments earn higher returns, leading them to increase productivity and invest in new hires. At the same time, the continuing rise in home prices has some comparing the real estate market with that of the late '80s. If a housing bubble exists, any tumult could cause widespread harm, especially for sectors such as the pool and spa industry, which bank on low financing rates and home improvement expenditures. (See "Is there a housing bubble?" sidebar on page 126.)

This speculation hasn't fazed most builders, says Aquatech's Brown. "I don't think interest rates will be an issue," he says. "If we look back just three or four years ago, rates were high and we still saw movement in our industry. The desire to have a swimming pool will outweigh concerns about interest rates."

In contrast, many builders think that the perception of rising rates well influence consumers to install pools as soon as possible to avoid the hikes. "They're so low now that even if they go up a little bit, it's not going to make a big impact on the industry," says Matthew Gohlke, president of Gohlke Custom Pools in Denton, Texas.

"If consumers can fit the monthly payments in their budgets, they'll do it," he says. "They may pass on an option or additional custom part if they can, but that's about it."