The "New Economy" of the 1990s was less than meets the eye. The capital stock of America is depreciating at its fastest pace in 72 years - faster than at the depth of the Great Depression. Going forward, we will be devoting a larger proportion of our economic resources to national defense, including homeland defense. Unless the rest of the world advances us even relatively more resources than it has, our private capital stock will grow slower. All else the same, our productivity growth will slow. This increases the odds of stagflation in America. For all the hype about the "New Economy" of the 1990s, both growth in the capital-to-labor ratio - so-called capital deepening - and growth in business productivity were clearly sub-par in a post-WWII historical context. Chart 1 shows that although the trend rate of growth in the capital-to-labor ratio picked up in the 1990s, this growth still paled in comparison to most of what preceded it. Not surprisingly, then, the same can be said for business sector productivity growth, as shown in Chart 2.

A business capital-spending boom similar to the one we experienced in the 1990s is unlikely. As shown above in Charts 1 and 2, even the business capital-spending boom of the 1990s did not result in spectacular growth in capital deepening or productivity growth. What can we expect in terms of productivity growth going forward if capital-spending growth is tepid? State and local governments are financially strapped. This is going to severely limit their infrastructure spending. The federal government will continue to increase its spending on military capital equipment. But because of budget constraints, nondefense federal infrastructure spending will necessarily be constrained. All of this augurs poorly for the economy's potential growth rate. Thus, the tradeoff between real economic growth and inflation is likely to worsen.