Beware of revival abroad

The Economy

Financial health there could bring ills here

August 08, 1999|By William Patalon III

HERE'S a paradox to ponder: The U.S. economy flourishes in the face of the global financial meltdown that reached the crisis stage last year, only to see growth squeezed when the once-brutalized markets abroad regain their health.

While some economists say this won't happen soon, others say it's possible with the worst of the Asian contagion apparently history and with countries like South Korea, Japan and Germany showing signs of revival.

"Their bad luck has been our good luck," says Ira Silver, chief economist for retailer J. C. Penney & Co. Inc.

For the United States, that good luck has translated into good fortune. Thanks to the somnambulant economies overseas, worldwide demand for commodities has been low, making them cheap. As key ingredients of other products, low prices for materials such as crude oil or aluminum have held down the sticker price on the final wares in many industries.

In some businesses, like steel, product prices were actually slashed as cheap materials, a worldwide glut of factories and nearly no demand outside U.S. borders combined to make it a buyer's market.

If cheap commodities and priced-to-sell imports helped fuel the U.S. economic growth engine the past few years, the strong dollar, low interest rates and low inflation supercharged it.

Torrid consumer spending -- 70 percent of the economy -- coupled with the lack of demand elsewhere made the United States the buyer of last resort. And buy it did. The United States is a huge net importer anyway, and the need for foreigners to do business here translated into a demand for dollars. That helped boost the dollar against other currencies, allowing companies and consumers here to buy even more already cheap imports.

Credit, too, was inexpensive and plentiful. Since the United States had the world's strongest and most-stable economy, foreigners invested their money here, creating a huge pool of capital.

"In a way," muses William Cheney, chief economist for insurer John Hancock, "it was the best of all worlds."

A rebound abroad would change these dynamics. Competition for capital would escalate, pushing up interest rates. That would hit consumers the hardest. Loans for cars and houses would become more expensive. Monthly payments on existing consumer debt that carries floating interest rates would rise. And for consumers seeking refuge from a wallet full of maxed-out credit cards, home equity loans would become more expensive and perhaps a bit more difficult to get.

Companies, too, would find borrowing more expensive, forcing them to trim expansion plans and, through that, opportunities for growth.

"We've been the big hog at the trough," says Maureen Allyn, chief economist for Scudder, Stevens & Clark Inc. "If the other piglets join in, there won't be as much left over for us and we'll pay more."

More expensive credit would cause spending to fall, diminishing demand for imports, which would cause the dollar to weaken.

As foreign economies revive, demand for commodities like oil and copper would escalate, driving up prices. Higher-priced commod- ities would become even more dear because of the weakened dollar. That's inflationary, which is bad for the stock market -- hence the maxim: "All bull markets have a copper ceiling."

Economists disagree on whether foreign economies will show enough strength for this scenario to become reality. Japan still has major problems in its banking system. China, an economic keystone for Southeast Asia, is expected to devalue its currency. And financial troubles linger in some Latin American countries.

Hoisington Investment Management economist Lacy Hunt, for one, says "the international recovery is overblown." Indeed, he says any weakness in the dollar against the Japanese yen and the European Monetary Union's euro reflects more the concern about the U.S. economy than it does optimism about Japan or Europe.

Indeed, some fear a big rise in U.S. interest rates could send another financial tsunami through Asia.

But other indicators hint at recovery, though brittle it may be. In Japan, long-absent consumer spending is increasing and the stock market is up about 25 percent so far this year, reflecting expectations about how much money companies will make in the future.

In Germany -- one-third of the EMU's economy -- manufacturing orders are surging though unemployment remains higher than healthy. Germany's Ifo economic research institute forecast last week that Germany's economy should grow 1.6 percent this year and 2.4 percent next.

"We've had a good run, and a lot of that run has been facilitated by the rest of the world being in bad shape," says J. C. Penney's Silver. "It looks like the party is getting near the end -- and that we'll have to go home soon."

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