Friday August 3, 4:54 pm Eastern Time Risks of a Equity Crash High-Dresdner NEW YORK (Reuters) - U.S. productivity revisions due on Tuesday could shatter the belief in the ``new paradigm'' economy where strong growth could live with low inflation, possibly triggering a U.S. stock market crash, a leading German-based investment bank predicted. Dresdner Kleinwort Wasserstein said in a note to clients that government revisions to U.S. output made last week meant past productivity readings would also have to be revised lower when they are released next Tuesday. Stocks are vulnerable as their valuations are partly based on the idea of profit-boosting high productivity, which measures output per hour of labor, the report added. Policy-makers including Federal Reserve Chairman Alan Greenspan and U.S. Treasury Secretary Paul O'Neill have noted how high recorded productivity levels have attracted strong inflows of foreign capital into U.S. asset markets. Last week O'Neill said productivity gains justified the strength of the dollar, which hit a 15-year peak on a trade weighted basis last month. The global equity strategists at DrKW see the second-quarter reading for productivity, which measures output per hour worked, at a ``reassuring'' 1.7 percent versus a 1.2 percent fall in the first three months of 2001 But revisions to earlier readings of productivity, which underpinned a belief among investors that high growth without inflation was sustainable, will put a question mark against U.S. financial market valuations, DrKW said in the report dated Aug 1. ``The revisions to productivity next week will undoubtedly leave Mr. Greenspan looking very foolish,'' it said. ``Investing in the U.S. miracle will in retrospect be seen as a sick joke. The markets will be forced to confront this harsh reality on August 7,'' DrKW Global Equity Strategist Albert Edwards wrote. ``Make a date in your diary! The U.S. 'new paradigm' will then be officially revised away! The risks of an equity crash are high,'' he added. The term ``new paradigm'' arose to explain the fact that strong U.S. economic growth during the 1990s failed to trigger inflation. Many economists credited a rise in productivity, based on technology, which allowed businesses to produce more without raising costs. This helped drive up stock markets because investors believed corporate profits could grow at a faster pace than in the past. But Edwards predicted revisions included in the second quarter productivity data will knock a full percentage point off longer-term estimates of productivity growth. He said trend productivity growth could be closer to 1.5 percent than the 2.5 percent many now predict. Because earnings estimates are based on a 2.5 percent rate, Edwards said the equity market is vulnerable. The Commerce Department announced revisions to U.S. growth back to 1998, notably cutting 2000 growth from 5 percent to 4.1 percent. High productivity and the ``new paradigm'' economy were used by many economists to explain the strong growth and low inflation in the United States in the last few years of the 1990s. But productivity skeptics said the miracle was merely a mirage and was due to weak growth in other parts of the world that depressed prices of commodities like oil. OTHER ECONOMISTS CAUTIOUS Other investment banks take a more cautious line on the impact of the downward growth revisions. ``Despite this, we remain convinced that the ``new-paradigm'' is still alive and kicking -- just to a smaller degree than initially,'' Lehman Brothers economists wrote in a research note. Lehman estimates productivity averaged 0.3 percentage point less over the last three years than previously reported as a result of the growth revisions. Goldman Sachs wrote on Monday: ``The short-term news on productivity should become a little less dismal. Given the information currently available on output and hours, we estimate that nonfarm labor productivity grew about 1.5 percent (annualized) in the second quarter.'' But Goldman economists added: ``A lower rate of return and increased downward pressure on investment imply that the fundamental outlook for capital deepening -- which measures the contribution of investment to productivity growth -- has deteriorated further. This suggests that our below-consensus estimate of 2.25 percent for the long-term productivity trend might still be too optimistic.'' Tom Walker Bowen Island, BC 604 947 2213
