Economic eruptions?

Economic eruptions?

Don L. Boroughs

Financially, this was supposed to be a week for strolls in the Mediterranean sun with dramatic views of medieval castles and Mount Vesuvius silhouetted on the horizon. President Clinton would meet with the leaders of the six other major industrial powers in Naples, Italy, for a perfectly timed photo opportunity of backslapping self-congratulation. For the first time in five years, all of the participants in the annual G-7 summit would have economies showing signs of life. The General Agreement on Tariffs and Trade would be behind them, and Clinton and his counterpart from Tokyo would arrive with another freshly completed trade pact opening up Japanese markets.

But after two weeks of financial chaos, that southern Italian sun appears dimmed by smoke, and Mount Vesuvius looks like it could blow. The dollar slid to new lows against the yen last week, closing below 100 yen for the first time since World War II; the greenback ended the week at 98.7 yen, while it wallowed against the German mark. Neither Treasury Secretary Lloyd Bentsen’s jawboning nor Tokyo’s intervention could reverse the dollar’s fall. The decline threatens Japan’s feeble recovery, helped push U.S. 30-year bonds to 7.6 percent–up from 5.78 in October–and played a role in knocking 130 points off the Dow Jones industrial average over the past fortnight.

Deficit. Political instability in Japan, which last week switched governments for the fourth time in a year, has fueled volatility in the currency markets. And hopes of a meaningful trade agreement before the Naples summit may have diminished with last week’s election of socialist Tomiichi Murayama as prime minister. With no pact to chisel away at the troublesome U.S. trade deficit, the dollar could come under further attack. If currency markets remain roiled this week, pressure could mount for the G-7 leaders to take action.

In one sense, a weak dollar with a strong yen and deutsche mark will actually benefit American workers by making U.S. exports more attractive to Japanese and German consumers. J. Paul Horne, chief international economist for Europe at Smith Barney, Paris, explains that every 100 marks earned by IBM in Germany will be worth more dollars when it is sent home. And Kurt Karl of the Pennsylvania- based WEFA Group estimates that export growth from recent declines in the dollar against a wide range of currencies could add several hundred thousand jobs to U.S. payrolls through 1996. The downside is that a debilitated currency can raise the price of imports, but that’s less likely in today’s competitive business environment, in which most companies are loath to lose customers to sticker shock. David Rolley, a senior economist at DRI/McGraw-Hill, estimates that a 10 percent drop in the dollar would add just two tenths of a percentage point to consumer price inflation. In fact, the dollar has strengthened this year against the currencies of some of the nation’s biggest trading partners, including Canada and Mexico. Says Merrill Lynch’s Bruce Steinberg: “Rather than there being a dollar crisis, there is a yen crisis.”

Soaring yen. In most instances, a strengthening currency might represent a vote of confidence in a nation’s government, but in Japan, each new round of political chaos pushes the yen to new heights. That is because only a concerted, government-led effort will bring about the increase in imports needed to shrink a trade surplus of nearly $60 billion with America. If Tokyo’s leaders cannot find a way to reduce the trade surplus, the currency markets will, by punishing Japanese exporters with the strong yen. Some of the damage is already evident: During the first three months of 1994, Japanese auto exports fell 25 percent versus a year earlier. If the yen keeps rising, “we can’t keep going,” complains Yoshifumi Tsuji, president of Nissan Motor. Japan’s recovery may not be able to withstand such a blow to exports. The nation’s economy grew a meager 0.1 percent in 1993, and the WEFA Group has predicted just over 1 percent growth for 1994.

With Tokyo unable to rein in its runaway currency, some analysts are calling on Washington to make the dollar more attractive by raising interest rates. But recent experience should give the Federal Reserve Board pause. The dollar did not appreciate against the yen after a series of rate hikes that began in February. The Fed’s short-term rate hikes did, however, push up long-term rates in both the United States and other industrialized nations. And those rates were already too high, according to a new study by C.L. Osler of the Federal Reserve Bank of New York. Osler estimates that high real interest rates in the past three years have reduced output in G-7 countries other than the United States and Italy by 2.5 to 4.5 percent per year. “There is a real risk of flattening out or sliding into recession” in America, says Lawrence Chimerine of the Economic Strategy Institute in Washington, D.C. “The Fed has to be very careful.”

Lower rates. It was not surprising, therefore, when Bentsen last week said he would prefer a strategy of lowering interest rates in Japan and Germany to raising interest rates at home. High long-term rates are already holding back Europe’s nascent recovery. Forecasters predict weak growth in the range of 1.5 to 1.7 percent for Western Europe this year. The Organization for Economic Cooperation and Development believes that Germany’s feeble rebound will not stimulate much-needed jobs and that unemployment will rise from 8.9 percent last year to 10 percent this year. Partly because of reunification costs, Germany endures long-term interest rates nearly as high as U.S. rates, despite higher unemployment and a growth rate that is half as slow. Explains Edward Graham of the Institute for International Economics in Washington, D.C.: “The feeling in Europe is that they might be just at the cusp of the recovery and, if interest rates rise abruptly, that that might cut into prospects for recovery.”

The plight of German workers and Japanese auto makers might seem distant worries for Bill Clinton as he heads to Naples this week. There are more pressing problems at home. But America’s economic expansion will increasingly depend on exports to foreign customers as domestic demand for houses, cars and other durable goods slows in the wake of the Fed’s recent interest-rate hikes. “We are undervalued, very competitive and very well positioned to take advantage of a pickup in the world’s economies,” says DRI/McGraw- Hill’s Rolley. The question facing Clinton at the summit of industrial nations is how to ensure that the pickup doesn’t lose momentum before the United States can take advantage of it.

Rising rates

The increase in long-term interest rates threatens the world’s industrial economies.

10-year yields

U.S. Govt. Bonds Foreign Bonds

June 1993 5.89 pct. 6.88 pct.

July 1993 5.89 pct. 6.71 pct.

Aug. 1993 5.51 pct. 6.40 pct.

Sept.1993 5.44 pct. 6.31 pct.

Oct. 1993 5.44 pct. 6.13 pct.

Nov. 1993 5.83 pct. 6.10 pct.

Dec. 1993 5.77 pct. 5.75 pct.

Jan. 1994 5.74 pct. 5.83 pct.

Feb. 1994 6.15 pct. 6.17 pct.

Mar. 1994 6.52 pct. 6.79 pct.

Apr. 1994 6.95 pct. 6.81 pct.

May 1994 7.14 pct. 6.89 pct.

June 1994 7.17 pct. 7.51 pct.

More trouble ahead?

The dollar has dropped against the German mark and Japanese yen but increased against the currencies of America’s other major trading partners. The greenback’s decline hurts export growth in Germany and Japan and could make it harder for these nations to escape recession.

Trade weighted dollar index (1980=100)

Jan. 1992 93.7

Feb. 1992 95.3

Mar. 1992 97.2

Apr. 1992 96.9

May 1992 96.1

June 1992 94.6

July 1992 93.0

Aug. 1992 92.4

Sept.1992 93.3

Oct. 1992 95.1

Nov. 1992 98.2

Dec. 1992 98.5

Jan. 1993 99.6

Feb. 1993 99.4

Mar. 1993 98.5

Apr. 1993 96.8

May 1993 96.6

June 1993 97.2

July 1993 98.5

Aug. 1993 98.4

Sept.1993 98.0

Oct. 1993 98.8

Nov. 1993 99.6

Dec. 1993 100.2

Jan. 1994 101.1

Feb. 1994 100.4

Mar. 1994 100.1

Apr. 1994 100.2

May 1994 99.6

Japanese motor vehicle exports, millions of units

Jan. 1993 5.9

Feb. 1993 6.2

Mar. 1993 6.4

Apr. 1993 6.3

May 1993 5.7

June 1993 5.2

July 1993 5.0

Aug. 1993 4.9

Sept.1993 5.1

Oct. 1993 4.9

Nov. 1993 4.8

Dec. 1993 4.5

Jan. 1994 4.5

Feb. 1994 4.6

Mar. 1994 4.8

Apr. 1994 4.9

Note: Foreign bond yields are averages of Canada, UK, Germany and Japan. The trade-weighted dollar index is based on 1984 bilateral trade weights for 18 currencies. Japanese car exports are based on a three-month moving sum.

USN&WR–Basic Data: C.J. Lawrence, Federal Reserve Bank of Atlanta

COPYRIGHT 1994 All rights reserved.

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