NEWS ANALYSIS : Turbulent Markets Seen Masking Healthy Economy

For millions of Americans, something scary is happening. For three years, they have poured record amounts of their savings into stock and bond mutual funds, in effect betting on a healthy U.S economy.

But now that the economy is finally rolling along, they are seeing sudden and serious declines in the value of the investments they have made for retirement, college tuition and other long-term goals.

At the same time, rising interest rates have made mortgages more expensive, cutting into one of the great benefits for U.S. homeowners and buyers.

What is going on? Markets in part are responding to fears that things are too good, analysts say. The fear is that economic growth will surge at such a pace that it brings back the corrosive inflation of the 1970s.

But there are new and different forces at work. High-rolling global speculators, who also have pumped vast amounts of money into stocks and bonds worldwide over the past year, have been forced by sudden turns in the markets to stampede for the exits.

The situation may look perilous, but many financial and economic experts say the markets’ reaction in recent weeks is overblown and does not threaten the healthy long-term outlook for the economy, inflation and investments. They advise ordinary investors and mortgage holders to keep an eye on the underlying strength of the U.S. economy and not be diverted by short-term swings.

“There’s way too much concern,” says Charles Clough, chief investment strategist for the giant brokerage Merrill Lynch. “The story remains that U.S. industry is increasingly efficient and competitive worldwide.”

Federal Reserve Chairman Alan Greenspan said as much last month when he surprised Wall Street by raising short-term interest rates slightly, the first official hike in five years.

Greenspan, who described the U.S. economy as being in its best shape in 30 years, made clear that his intention was to keep a moderating hand on the expansion while countering speculative excesses--two goals that Wall Street normally would cheer. But the Fed’s action has had dramatic unintended consequences, sending mortgage rates surging and stock prices tumbling worldwide.

One reason for those consequences was the extent of speculation in global markets, where mega-investors like London-based George Soros have placed massive amounts of borrowed capital in international securities and currency markets. These so-called “hedge funds” made huge bets early this year in Europe and Japan. But their investments, more than $300 billion by some estimates, have gone sour as a result of Greenspan’s action to raise interest rates and defuse the speculative threat.

This selloff has been a major cause of the market gyrations and led to fears that the U.S. economy and financial markets are now on the brink of a long decline, reminiscent of the crash of 1987 and the bear market of 1973.

But most financial experts say the current environment is not at all like those earlier times. On the contrary, the U.S. economy has turned the corner from recovery to expansion. Economists now predict growth of 3.6% this year, or an additional $216 billion worth of economic activity. California may not join fully in such good times until early next year, although a better national economy could quicken the pace here.

That kind of economic growth creates jobs. In the latest surveys, companies throughout the economy say they plan to hire more people in the second quarter of 1994. Corporate profits are rising, especially for companies that supply machinery and services to industry overseas, such as Caterpillar Inc. and General Electric.

This is the basis for sustained economic growth that will produce rising profits and ultimately a return of rising stock prices.

Meanwhile, increased inflation is not seen as a real threat because productivity--output per hour of labor or dollar of investment--is rising more than it has in years. It is increasing across the board, in both manufacturing and service industries. And that means low or decreasing inflation.

At the same time, the economies of Europe and Asia are adjusting to the post-Cold War period, as the U.S. economy has been doing since 1990. Though the effort to change Japan’s has led to a very public dispute, it is not likely to upset an increasingly interdependent and growing world economy, most economists agree.

The contrast with earlier periods of economic change and market swings is dramatic. In 1973, the start of a major market downturn saw a quadrupling in the price of oil and the instability of Watergate in the U.S. government.

In 1980, then Federal Reserve Chairman Paul A. Volcker was forced to bail out U.S. and international banks that had become overextended in the inflation-driven speculations in silver, oil and other commodities. He also had to take stern action, and trigger a recession, to break the back of double-digit inflation.

Greenspan, who acted quickly to curb the market slide in 1987, may have made a timely move again. He stepped in to curb the threat of inflation and speculation before the system was pushed to the brink.

Still, even the fact that the nest eggs of the average American investor could be threatened by excesses of esoteric financial concepts like “interest rate swaps” and “currency futures” will infuriate and puzzle most people. If such things are a threat, why are they allowed at all?

The answer is that hedge funds and other financial exotica are part of a new and still-emerging global financial system in which more than $1 trillion of securities, currencies and all manner of financial instruments are traded every day, with many benefits.

“The trading is maximizing the efficiency of capital movements, bringing together money that is available in one spot but required in another,” says Dennis Weatherstone, chairman of J.P. Morgan & Co., one of the world’s leading banks and a leader in these markets.

For example, he notes that such markets make loans and other capital much more available for building factories and power plants in countries like Mexico, China and Indonesia--developments that bring profits and jobs to American companies.

In fact, these markets are a reflection of how American money has become so tightly linked to other countries and economies around the world. And this is why average mutual fund holders in the United States find their savings affected by hedge fund investments gone awry.

There are dangers in this system and the consequence of bad investment decisions could mean the failure of a developing country’s loan or the bankruptcy of a speculative fund.

But most experts accept such risks for the benefits that a global market brings, so long as the bankruptcies don’t get too large and their consequences spread too far.

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