America Loses Out As World Economy Comes Back To L

The Sunday Times (London)

25 July 1999

The good news is that many of the world's economies are starting to show signs of life. Although Japan is certainly not growing at the incredible 8% annual rate that the latest figures suggest, there are signs that its economy has stopped contracting. Korea is growing again. Brazil has pulled back from the brink. Even sclerotic France reported that output rose in May.

The bad news, at least for America, is that many of the world's economies are starting to show signs of life. After complaining about being forced to become the world's consumer of first and last resort, and urging its trading partners to rev up their economies, America is contemplating life in a world in which other economies may be doing just that. And it finds the prospect not a little worrying. Here's why.

America has been able to enjoy an annual growth rate of 4% and more in part because its fully employed work force, aided by massive capital investment in communications, computer and other technologies, is turning out more goods and services per man-hour worked. But this rapid rate of growth has not unleashed inflation for still another reason: the world's pain has been America's gain.

Because of Asia's economic difficulties, and nil or at best sluggish growth in other economies, the world is awash in excess productive capacity. Commodities are cheap because producers have more to sell than the world wants to buy. So, too, with manufactured goods. Everything from t-shirts to trainers to steel is available to American businesses and consumers at low prices. So America grows, relying increasingly on the anti-inflationary effect of low-priced imports from countries in which domestic demand has shriveled. That's why the nation's trade deficit is running at an annual rate of $224 billion, 37% higher than last year's record.

Foreigners, piling up the dollars that they have been getting for their goods, have been happy to invest those dollars in American shares, bonds, real estate and other assets, to the tune of $237 billion in the past year alone. Morgan Stanley economist Joseph Quinlan says that Europeans are the biggest buyers of US shares, having bought $72 billion last year and $30 billion in the first four months of this year. After all, most of the other world economies haven't looked exactly like safe havens for investors. This demand for dollars with which to purchase US assets has kept the value of the dollar high. And a high dollar means that foreign goods can be bought more cheaply.

Now the other economies are making something of a comeback. This means that they will be bidding for the commodities and goods that until now have been reserved for US consumers. That new demand, if large enough, might put some upward pressure on the prices of those products.

Moreover, as the world's economies recover, they become more competitive with the US for investors' favour. Investors will, therefore, demand a somewhat higher return on their American assets than they have thus far been getting, which means that they will sell shares until prices are low enough to drive those returns up. Or they will sell bonds, driving up interest rates.

With securities prices down, foreign recovery and the weaker dollar driving up the price of imports, and interest rates rising as an inducement to foreigners to keep their money here, the American economy will slow. If it slows only a bit, fine. But if it turns out that American interest rates must rise substantially in order to attract sufficient foreign investment to offset the massive US trade deficit, the slowdown might become stagnation. And if share prices drop sharply, causing American consumers to retreat from the malls, stagnation might well become recession.

That's the scenario that has policy makers worried. They see the stock markets of Japan, Korea, Indonesia, Hong Kong, Chile, Brazil and other countries rising, and fear that those rebounds will increasingly lure investors away from American markets. And not gradually. At the moment, most fund managers are retaining their preference for America. If they change their mind, the outflow could be sudden and massive.

Fortunately, this fearsome prospect remains remote, at least for now. Despite signs of life in Europe's economies, the main possible locomotive, Germany, remains stalled in the station. Fortune magazine reports that a new breed of "hypercool entrepreneurs and hardheaded moguls" has appeared on the German scene, and that venture capital is more available than ever.

But what the private sector giveth, the German government taketh away. New taxes on entrepreneurs and on part-time workers are taking their toll: in the month following their enactment, 106,000 part-time jobs in German retailing, wholesaling and catering businesses disappeared. That's 6% of the total.

Meanwhile, the European Central Bank is publicly musing about raising interest rates to defend the Euro, even though such a move might abort French and German recovery, and exacerbate Italy's problems. In short, Europe cannot match the US as a magnet for investors' cash. Quinlan estimates that US investors unloaded $25 billion in European shares in the first four months of 1999, almost equaling the total they dumped in all of 1998.

Nor is the Asian recovery yet so robust and firmly established as to threaten a massive shift of funds to that region from America. Especially since the American economy seems to surprise the this-just-can't-go-on crowd with continued good news. Consumers keep spending, inflation remains indiscernible, the federal government is in surplus, everyone is working, and corporate profits remain satisfactory. Federal Reserve Board Chariman Alan Greenspan late last week raised his forecast of economic growth in America, worried aloud a bit about tight labour markets, but in the end predicted that rising productivity would continue to contain the inflation rate.

True, consumer debt is rising, corporations are becoming more dependent on debt as they buy back equity, and the trade deficit makes Americans highly dependent on continued foreign investment. But those are problems for another day. Right now, the good times continue to roll.