In America, There’s Reason for Optimism
What’s going on? The stock market careens like a drunken driver while big-name bankruptcies and junk bond defaults produce a mean hangover to start 1990.
But don’t panic. It’s not the end of the world, only the end of the 1980s--a decade of easy money, big deals and rising stock prices for many companies--the Dow Jones industrial index started the decade below 1,000 and finished it above 2,600, where it remains even after Monday’s volatile price swing.
Those swings reflect confusion among big institutional investors--the pension and mutual funds, bank trust departments and international insurance companies that make up 85% of the trading on major stock exchanges. They’re worried that inflation will increase in the U.S. economy, that interest rates will rise and that company profits will decline.
But a calm look at the situation says the institutions are mistaken on two of three of their worries. And beyond the near term, the outlook for the U.S. and world economies is bright.
Inflation, which totaled 4.6% last year, is not a real concern for the U.S. economy. Business is slowing, and prices are under pressure. The car rental companies recently tried to lift rates, couldn’t do it. Energy prices went up with the cold snap in December and are now backtracking. Industrial raw material prices are down.
Interest rates aren’t falling at the moment, but they may soon because demand for credit in the United States is low. Total borrowings by households, companies and state and local governments grew only 4%--less than inflation--in last year’s fourth quarter, notes Charles Clough, chief investment strategist for Merrill Lynch.
It’s hard for interest rates to rise when loan demand is falling--although one explanation for continuing high rates is that overseas economies are growing and increasing demand for U.S. dollars and fresh capital. Still, the prospect for the year ahead is that U.S. interest rates will decline.
Which leaves lower corporate profits as a possibly valid worry. Some big companies and major banks have lately reported profit declines, and this has shaken the institutions that concentrate their investments on big companies.
But the economy has been slowing for a while. The gross national product may have grown only 0.4% in last year’s fourth quarter, virtually a standstill. Declines in small company stocks on over-the-counter markets and major exchanges already reflect this slowdown.
The point to keep in mind, though, is that the slowdown is a pause in a healthy economy, not a symptom of lingering illness--as the aftermath of the 1980s often makes it seem. Borrowings grew tremendously in the last decade--commercial and residential mortgages went from $1.5 trillion in 1982 to $3.4 trillion last year. The result is a glut of buildings in many parts of the country and, inevitably, troubled markets.
Junk bonds, at $200 billion total, make up only a fraction of the total debt buildup. But junk’s after-effects will be with us for a while. Moody’s Investors Service estimates that $20 billion in junk bonds will default this year, causing troubles for high-yield mutual funds, savings and loans and a few insurance companies that have large junk bond holdings.
But leverage is history. Individual Americans are now saving 6% of their income--up from less than 3% in 1987--and banks are making fewer loans, cleaning up their balance sheets. And companies troubled by debt are vastly outnumbered by well-capitalized firms.
Rather than looking back, institutional investors should look ahead. For individuals, it promises to be the decade of the saver not the spender. And for industry, it should be a decade of export opportunity as Europe, led by West Germany, and Asia, led by Japan, enjoy growing consumer economies that in good measure will be supplied from the United States.
Economists such as Clough of Merrill Lynch and Edward Hyman of C. J. Lawrence Morgan Grenfell see the United States as supplier to the world in the 1990s, with low capital costs and the dollar as the strongest currency. It’s a vision of a fully employed, high-export, low-inflation United States, contrasting with other countries just entering the era of personal consumption that America has completed.
And those who would question such optimism might reflect on how much the United States is capable of: After all, even in the last decade of easy money and spurious deals it managed to maintain the defense of the Western nations and lay the groundwork for world prosperity.
Sure it’s sometimes the land of the quick buck and short-term focus. But at other times it’s the land of the honest dollar and faith in the future. The 1990s could be one of those other times.
