No quick miracle cure

Robert Kuttner

March 29, 1991|By Robert Kuttner

ALL of a sudden, new gloom is displacing the predictions of an early, robust economic recovery. The immediate cause of the gloom is a double-barreled blast which shook confidence on Wall Street.

IBM announced that it would halve its anticipated dividend -- signaling soft demand throughout the computer industry. And the Labor Department reported that the core inflation rate in February had jumped to an annual rate of over 8 percent. That, in turn, meant that the Federal Reserve was unlikely to continue easing interest rates.

The economic euphoria reflected in the soaring stock market during the past several weeks was premature, to say the least. A recovery was supposed to be built on four factors: cheap oil, restored consumer confidence, falling interest rates and an export-led boom. Of these, cheaper oil is the one genuine economic gain from the decisive victory in the Persian Gulf.

But the rest of the rosy scenario is proving ephemeral:

* Consumer confidence. With unemployment continuing to rise, and take-home pay flat or falling for most income brackets, the end of the war has not unleashed a consumer boom. Retail sales are still flat and housing has begun only the weakest recovery, which will be nipped in the bud by rising mortgage costs.

In some major sectors, such as autos, imports are continuing to grab a rising share of sales. And the banking industry, desperately in need of new capital, is still unable to attract new equity investment from the public. Consumers have every reason to be wary.

* Interest rates. Until now, despite an enormous public deficit, the Federal Reserve has been able to stimulate the economy by cutting interest rates. But that was largely the result of dumb luck, thanks to an unexpectedly strong dollar.

The rise in the dollar's value against the Japanese yen and the German mark had less to do with the strength of the U.S. economy than with weaknesses overseas. The Japanese government has been struggling to contain speculative bubbles in real estate and financial markets, leading to consumer unease. The German government is facing an economic catastrophe in what used to be communist East Germany. Karl Otto Poehl, the influential chief of the German central bank, recently went public with a scathing criticism of the Kohl government's economic policy.

Thus, in both countries, the risk of higher inflation and domestic economic uncertainty makes the dollar look relatively strong. That, in turn, has allowed the Federal Reserve to cut United States interest rates more than it otherwise could, without fear that low interest rates would drive down the value of the dollar. On the contrary, the Fed would like the dollar to be a bit cheaper.

But the recent news of rising inflation puts a damper on this exercise. The Federal Reserve is suddenly far more worried about a new round of domestic inflation than about exchange rates. As a result, interest rates will begin going up.

* The export boom. Don't hold your breath. Europe and Canada, which together make up America's biggest market, are both in recession. As the European Community completes its free internal market, European nations are likely to become bigger customers for each other's products rather than for ours.

Japan, always allegedly on the verge of opening its markets to U.S. exports, has just reported another increase in its own trade surplus, which remains embedded in the structure of its economy. And the Uruguay round of trade-liberalization talks, which was to be a boon to export growth, collapsed last December in disarray.

American exports have been rising in the past year, but far too slowly to be an engine of recovery in the absence of progress on other fronts. Despite a cheaper dollar, 1990 ended with an

annual deficit in merchandise trade of $101 billion, only a trivial improvement over the 1989 deficit of $109 billion.

In a recent survey of the directors of the National Association of Manufacturers, representing major industrial companies, 68 percent said they expected exports to grow more slowly than in recent years; only 26 percent expected a more rapid increase.

In short, there will be no quick miracle cure for this recession. Instead, Congress and the president need to begin the difficult work of budget and tax reform, and to pursue a broad agenda of competitiveness and economic growth.

To stimulate the economy, the best place to begin would be a massive increase in infrastructure investment -- the roads, bridges, rails, parks, water treatment plants -- that went to ruin during the Reagan years, as well as new, productivity-enhancing outlays for energy efficiency and advanced telecommunications.

The United States may be back and standing tall militarily. But it is still in a hole economically. The sooner the false euphoria ends, the sooner we can get serious about rebuilding.

Robert Kuttner writes regularly on economic matters.

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