Keeping the World Safe by Consuming
Every valley shall be exalted, and every mountain and hill shall be laid low. That’s how the prophet Isaiah described what would happen when the Messiah came; it also describes what’s going on in the global economy at the millennium.
Valleys first. East Asian stock markets, which lost up to 90% of their value during the 1997-98 financial crisis, are coming back. By the start of this month, Indonesia’s stock market was up 77.5% for the year; South Korea’s was up 73.7%. Every major emerging market in Asia has outperformed the Standard & Poor’s 500 in 1999. So has Russia. Devastated in August 1998, the Russian economy has done surprisingly well since; in dollar terms, its stock market is up 79% for the year.
The outlook for the euro has also changed. Two weeks ago, most analysts were predicting the euro would continue to sink, perhaps below parity with the dollar. Then it regained its footing and is now well off its lows.
Backing the euro’s new strength are signs of accelerating economic revival in the major European economies. Germany’s Chancellor Gerhard Schroeder surprised most politicians and delighted German business leaders by calling for sweeping reforms in Germany’s expensive social-safety net. The French economy has been chugging along nicely for some time, and French business is confident that the conditions for more growth remain strong.
But while the valleys rise, the mountains sink. U.S. stock markets, the wonder of the world through most of the 1990s, are losing some of their sizzle. The technology-laden Nasdaq is down about 8% from its peak. Internet stocks have been hit even harder, down more than one-third from the height of the frenzy last spring. The disappointing performances of some recent Internet IPOs and a flurry of bad news about day trading (a recent report suggested that 70% of day traders lose money and that day traders would need a 56% return on their portfolios simply to pay commissions and fees) may mean speculative fever is leaving the stock market.
This mix of good and bad news--rallies around the world, shakiness in the United States--speaks volumes about the way the global economy works now. To put it in a nutshell: The U.S. economy keeps the world economy moving; the stress of this mighty effort places strains that leave the United States and the world vulnerable to new shocks.
The United States has been keeping the world moving in two ways. First, by re-engineering its economy into a technology-based service economy, the U.S. is leading the way in the development and adoption of new technologies. That creates value and growth and leads to an investment-based boom. In fact, the U.S. has grown steadily since 1984, with only three quarters of recession in the last 15 years.
Second, the U.S. is keeping the global economy moving by serving as the world’s “consumer of last resort.” Others make, we buy. Think about what happened after Asia crashed: Asian currencies collapsed, and exports from countries like Indonesia, South Korea and Thailand became much cheaper. U.S. consumers continued to spend, and the U.S. trade deficit shot up to a record $300 billion a year. All those consumers flocking to all those Wal-Marts may have maxed out their credit cards--the U.S. household savings rate has turned negative--but they also saved the world from economic disaster. Asia recovered; Europe started to grow.
However, we are now faced with the consequences of success. Because the United States has been running such large trade deficits for so long, and because our national savings rate is so low, the U.S. needs to attract foreign savings to finance its economic expansion. The wave of Internet and high-tech start-up companies depends on access to cheap capital; start-up companies don’t usually earn large profits at the beginning, when their expenses are high. During the last two years, foreign capital flocked into the United States. With Europe stagnant, and Asia and Latin America on the brink, the stock and bond markets of the United States looked like the only smart places to put money.
Hundreds of billions flowed into the U.S., driving the dollar up and interest rates down. The economy boomed, but inflation wasn’t a problem. The strong dollar kept import prices low, while the Asian depression reduced global demand for commodities like oil, agricultural products and raw materials, including copper and nickel. Americans got richer: Those with large stock portfolios had large paper profits, and most homeowners saw the value of their houses rise sharply even as mortgage payments fell for those who refinanced.
This was terrific, and helped make the last two years the best in a generation for many Americans. Wages rose for most workers, inflation was low, unemployment was less than 5%.
But now the world seems to be heading into a new phase. Asia’s recovery and Europe’s growth mean investors can now make more money in their home markets than in the U.S. That reduces demand for the dollar, causing its value to drop against the euro and the yen. With oil prices heading back up, rising 60% in a year, inflationary pressure is building. Even before the Federal Reserve meets to talk about interest rates Aug. 24, rates are rising on open markets. Rates on the 30-year Treasury bond fell to less than 5% at the peak of the financial crisis; they are now back to 6.1%. Mortgage rates are again more than 8%.
All this is bad for stocks and house prices. If the falling dollar plus rising foreign demand for oil and other goods ignites inflation, many households will be looking at a somewhat bleaker economic future: Their houses and stock portfolios will be worth less, and the dollars they earn from work will buy less. Many consumers will have to cut back their spending; the economy will slow.
This could turn ugly fast. Rising interest rates will force stock prices down. That will lead foreigners to sell U.S. stocks and take their money home. That will drive the dollar down, leading more foreigners to liquidate their U.S. assets, driving the dollar down more. Some observers predict that a dollar crisis could lead to a drop of 40% or more in stock prices within 18 months.
Maybe so, but there’s more. The world still needs for America to max out its charge cards. If U.S. consumers cut back, we could see another round of economic crisis in Asia and in Latin America, where Mexico, Brazil and Argentina have not yet fully found their feet after the 1997-98 crisis. Japan, in particular, needs the U.S. dollar to be strong: A weak dollar prices Japanese goods out of the U.S. market, and Japan’s export-oriented economy would collapse into a depression without U.S. markets.
For now at least, the rest of the world is trapped. Since global prosperity depends on U.S. consumers going to the mall, the rest of the world must conspire to prop up the dollar--and lend us the money to keep the cycle turning.
How long this can last is anyone’s guess. It looks unstable: How can the world economy depend on the consuming power of the world’s greatest debtor for long? But the United States has been a debtor since the Reagan administration, and, so far, we haven’t suffered any of the ill effects that doomsters prophesy.
The country that suffers most has been Japan: The world’s greatest creditor nation has suffered 10 years of stagnation while we feckless debtors have gone from strength to strength.
“Sin and sin boldly!” Martin Luther wrote to one of his wavering colleagues during the Protestant Reformation. Maybe we should update that advice: U.S. consumers should spend boldly to keep the world economy on the march.*
