Overseas Revival Could Threaten U.S. Economy

The U.S. economy, which has boomed in a world of financial woe, now faces the oddest of challenges: An accelerating pace of recovery overseas is altering the outlook at home, posing a new series of dangers, including higher inflation, rising interest rates and a weaker stock market.

For now, most forecasters believe the pressures will not flare out of control. But the dawning view that Europe, Asia and South America are resuming paths of growth reflects a sweeping change in the global outlook, and the apparent fading of forces that worked dramatically to the U.S.’ advantage in 1998 and early 1999.

“Every passing day suggests the United States is still going strong, and the rest of the world is picking up,” said Nariman Behravesh, chief international economist at Standard & Poor’s DRI in Lexington, Mass. “This is what we’re worrying about.”

The most obvious danger is inflation, as a revived global economy gobbles up more resources, enables firms to hike prices and, ultimately, creates shortages if economic growth is strong and sustained.

Beyond that, some economists now worry that America’s gigantic trade deficit, whose July figures are to be reported today, has become a ticking bomb.

In recent years, the trade gap has been evidence of the nation’s economic strength because it reflected a U.S. appetite for goods from all over the globe. But now, as the rest of the world begins to grow, the deficit stands to drive down the value of the dollar and drive up interest rates and the price of imports. The reason: The trade deficit has oversupplied the world with dollars, and now that other nations’ currencies are attracting buyers, those dollars have begun to lose their value. So far this year, for example, the greenback has shed about 20% of its value against the Japanese yen; on Wednesday it hit a six-month low as more capital rushed into Japan.

“Investors swamped with the dollar are moving on to greener pastures,” cautions Sung Won Sohn, chief economist at Wells Fargo Bank. “The United States has to attract foreign capital by raising interest rates.”

This also makes the booming U.S. stock market vulnerable as growth in Asia, Europe and elsewhere creates other options for people’s money. A serious stock sell-off would weaken another strut that has supported the nation’s near-record expansion.

“Much of the prosperity that we have come to take for granted is directly or indirectly linked to the rousing performance of equity prices in recent years,” Henry Kaufman, a veteran Wall Street economist, wrote recently in the Washington Post. “Thus anything that could cast a pall over this favorable set of circumstances has to be scrutinized with great care.”

While she doesn’t see any sort of disaster ahead, Karen E. Parker, managing director for currency research at Chase Securities in New York, says, “It’s natural to expect that we’re in for a weaker dollar, higher interest rates and somewhat lower equity prices.”

To understand how overseas recoveries are creating new risks for the United States, it helps first to consider how overseas economic crises boomeranged in this country’s favor last year--a paradox that took most economists and political leaders by surprise.

Starting in July 1997, when financial panic broke out in Thailand, America became the world harbor for investment capital. U.S. stock and bond markets thrived as investors pulled their cash out of shaky, emerging nations and parked it in Wall Street stocks and U.S. Treasury securities.

Factories in these same beleaguered countries, particularly in Asia and Latin America, flooded the United States with cheap imports as a way to generate desperately needed income. At the same time, global markets for oil and other commodities plunged, reflecting the pervasive hard times.

There were domestic losers, to be sure: U.S. exporters, including many manufacturers, were hammered as their foreign customers slashed orders. More broadly, however, Americans benefited from low prices, falling interest rates and a skyrocketing stock market.

A key indicator of how much they benefited can be found in the trade deficit, which climbed from a mere $4.3 billion in 1991 to more than $220 billion last year and is headed still higher this year.

Inevitably, an economic revival overseas would transform the picture, and that may be starting to occur. Behravesh, for instance, believes that much of Asia is moving toward growth rates of 5% or even more, with Japan still highly uncertain; Brazil, Latin America’s biggest economy, is emerging from recession; and parts of Western Europe are edging close to 3% growth next year.

Overseas growth not only prompts global investors to send their money someplace besides Wall Street, but also creates new competition for basic commodities, which Americans could until recently snap up for a song because almost nobody else was buying.

The new appetite for commodities is most apparent in the price and supply of oil. Fed in part by the rising demand of recovering Asian nations and in part by an unexpectedly successful production cutback by OPEC, the price of benchmark West Texas Intermediate crude oil has doubled since February from $10 to more than $20 a barrel and is likely to go higher.

According to the economic textbooks, the balance between the U.S. and other countries should adjust naturally. For example, Americans should now be able to sell more goods abroad to their strengthened trade partners while the price of imports to this country rises to reflect the greater strength of foreign currencies against the dollar. Those trends should bring down the trade deficit.

But some analysts worry that the adjustment process may not be as smooth as the textbooks promise, citing the 1980s to justify their concerns.

Like today, the nation’s trade deficit ballooned then, setting the stage for a sharp decline in the dollar, which was widely seen as contributing to the 1987 stock market crash. Although that crash ultimately proved to be of minor consequence to the U.S. economy, it was only because of some fast action by the Federal Reserve and other policymakers.

“It’s a question whether the dollar can float down gradually” without triggering a collapse in the stock market, said Gary Hufbauer, a senior economist with the Institute for International Economics.

Times staff writer Peter G. Gosselin in Washington contributed to this report.