If Things Are So Good, Why Is Fed Scared?
Prosperity is everywhere, but appearances may be deceiving. The Tokyo stock market is hitting new highs. New York is no slouch either, trading these days at its highest levels since the October, 1987, crash. And European stock markets are rising strongly for the first time in years.
Furthermore, the world’s economies are going great guns. The U.S. economy grew last year at a rapid 4%, and unemployment is low. Japanese government officials look forward to 4% economic growth in the new fiscal year; and growth in Europe is picking up as Common Market nations prepare for economic unity in 1992.
Confidence is high. The dollar is strong as world investors want to put money in U.S. assets.
You’d think there would be happiness all around. Yet on both Monday and Tuesday, the Federal Reserve and other central banks sold dollars in international markets in an attempt to keep the currency’s value down.
And central banks everywhere are trying to raise interest rates to slow economic growth.
That’s no distant thunder. It could mean prohibitive mortgage rates for you within the next six months. If you have a variable-rate mortgage, your payments could go up; if you plan to buy or sell a house, it could be more difficult to do so.
Has Negative Side
What’s going on? Transition in a world economy in which a growing number of newly industrialized countries, such as South Korea and Taiwan, Thailand and India, are producing more goods than they can consume and sending them to the developed countries--the United States, Canada, Japan and in Europe--that are consuming more than they could possibly produce. That situation has its advantages. American consumers and businesses get a lot of goods, from Hyundai cars to Radio Shack electronic products, at low prices.
But international monetary authorities see a negative side to the equation. The developed economies are growing faster than their capacity to produce for themselves, and that can lead to inflation, explains economist Jonathan Francis of Roh Management, a New York-based international investment firm. U.S. inflation is currently running at 4.75% a year.
Furthermore, central banks worry because global money flows are accelerating beyond their control. When the International Monetary Fund compiled records for 1988, it discovered more money sloshing around in developed-nation economies than it had thought.
The problem is that the bustling South Koreas and Taiwans, which logically should present ideal investment opportunities, are unwilling or unable to accept investment from outside, explains economist Albert M. Wojnilower, of First Boston. “So the retirement savings of the advanced countries search for outlets at home.” That has resulted in abnormally high stock prices in Japan, and leveraged buyouts and other oddities in the United States.
May Soon Change
Why haven’t retirement savings resulted in more productive investment? Because many businesses, facing a need to expand capacity in a high-cost country like the United States, look over their shoulder at the low labor rates and operating costs of a newly industrialized country such as South Korea, and get nervous. So spare cash is often invested in money markets, which turn it over in financial transactions and give us the paradox of U.S. industry lagging in capacity and productivity, while billions churn senselessly in massive buyouts.
That may be about to change, says investment strategist Charles Clough of Merrill Lynch. The Federal Reserve is sharply restricting money supplies in the U.S. economy, pushing up interest rates. So far the Fed has hit short-term rates--which increases the cost of financing inventories and affects retail businesses.
But to really slow the economy, the Fed must hike long-term interest rates for business loans and mortgages. How does it do that? It pushes up short-term rates until long-term markets have to offer higher interest to attract investors. That is, long-term government bonds will have to go to 10% to 11%, which means 12% to 13% mortgages.
The prospect is of recession in six months’ time, unless the Fed sees business activity slowing before then and eases up, explains Robert D. Laurent, an economist with the Federal Reserve Bank of Chicago.
And if recession comes? It would signal an initial failure of the world economic system to cope with prosperity. The overriding point of the changing world economy, after all, is rising living standards. But happily, say economic experts, any recession at this time will be short and much less severe than the 1981-82 downturn--and the world system will get a second chance.
New Bull Market
Even pessimists about the current economy forecast the 1990s as a golden decade, when more nations join the industrial world, and developed nations better coordinate their economies. “It’s spread the wealth,” says veteran investor John Templeton, of Templeton, Galbraith & Hansberger, a mutual fund company based in London and the Bahamas. “It’s wonderful.”
That’s why Templeton, 76, who made his mark years ago with international investing, looks past this year to a “new bull market.” He predicts the Dow Jones index hitting 4,000 a few years from now (from 2,193.21 on Tuesday), while Japan’s market stalls and marks time but doesn’t crash.
Which sounds like a world in better balance, where the appearance of widespread prosperity will also be the reality. For now, however, the Fed and other central banks are making ominous moves on interest rates.
