Dollar Dip May Prevent Recession
As the U.S. economy prepares to round the midyear turn, some clouds have begun to appear on the horizon. They do not augur an imminent change in our economic climate--but they are ominous enough to suggest that our prolonged economic expansion is likely to encounter choppy waters next year.
What’s more, there are some shoals in our immediate path. Indeed, the current economic scene is laced with uncertainties:
- May marked the conclusion of the 54th month of economic growth--20 months longer than the average peacetime upswing and just four months shy of the record set in the late 1970s.
- The trade deficit continues to drain strength from the goods-producing sector of the economy.
- Tax reform has depressed business outlays on capital goods and has distorted consumer spending, making it more difficult to interpret the underlying trend of the economy.
- The Gramm-Rudman Deficit Reduction Act, whose passage fired up hopes that a balanced federal budget eventually would be achieved, has not been adhered to--yet it still is a factor that Washington and the financial markets must contend with.
To add to the fog enveloping the outlook, a number of signs have appeared that in the past have signaled the onset of recession:
- An acceleration of inflation. After falling at a 1.5% annual rate in 1986’s second quarter, prices at the consumer level shot up at a 6% clip in the first four months of this year. What’s more, industrial raw materials prices have jumped 30% since last August.
- Rising interest rates. Short-term rates have gone up by about one percentage point over the past seven months, while long-term rates have advanced even more.
- Declining stock prices. Since peaking in early April, prices of most stocks traded on the major exchanges have drifted lower.
- Lower domestic car sales. New auto purchases so far this year are down 10% from year-ago levels and are 15% lower than they were in the same period of 1985.
- Less residential construction. Housing starts fell 3% in April, on top of a 5% drop in March, putting the total so far this year nearly 9% below the first four months of 1986. And this was before the recent climb in mortgage interest rates.
Having said all this, I remain hopeful that the U.S. economy can avoid a recession this year. The key to this cautious optimism lies in what already has taken place in the foreign exchange markets and its impact on our trade deficit.
The dollar has fallen sharply against a number of key currencies since reaching a peak in February, 1985. It is down by about 46% against the Japanese yen and West German mark, more than 42% against the French and Belgian francs and the Dutch guilder, and more than 35% against the British pound and the Italian lira.
This already has begun to turn the tide on our trade deficit. In real terms, our trade imbalance has been shrinking since the third quarter of 1986. This means that the demand for U.S.-made goods is once more climbing after nearly three years of flatness.
In addition, employment remains high. This translates into at least a sustained level of spending by consumers. And inventories, for the most part, seem to be in good shape relative to sales.
Outlook for 1988 Uncertain
While the U.S. economy should log another year of growth in 1987, there are no guarantees for 1988. Our trade deficit should continue to decline, but its positive impact on U.S. goods producers eventually may be overwhelmed by the negative effects on domestic spending arising from more inflation (less buying power), higher interest rates (less borrowing power), and lower stock prices (less confidence).
It is too early to determine the dimensions of the next recession, but past downturns have averaged about one year in length and have seen the gross national product fall by about 2%. Needless to say, unemployment can be expected to rise while business profits fall.
Keep in mind that 1988 is a presidential election year, and the record shows that when we have a recession during such years, the party occupying the White House usually is forced to vacate.
The selection of Alan Greenspan to replace Paul A. Volcker as chairman of the Federal Reserve Board has been interpreted by some as a way to ensure continuity of Republicans in the White House after the 1988 elections. In fact, it may do just the opposite: To establish the credibility his predecessor already has, Greenspan may have to push up interest rates faster than Volcker would have to keep the dollar stable and fight the developing inflation psychology.
