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Threats to Economy Lurking on Home Front

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TIMES STAFF WRITER

Crashing currencies. National depressions. Yet the U.S. economy cruises forward with barely a shudder.

That was last year. In 1999, the United States’ long-running economic expansion is expected to finally slow down. And unlike in the year just ended, there might be as many risks lurking within U.S. borders as beyond them. From political uncertainty in Washington to a stock market hovering in uncharted territory to a squeeze on corporate profits, the U.S. economy is hauling a load of baggage into the new year.

Indeed, the possibility of a steep decline on Wall Street is considered a risk to the global economy--a noteworthy turnabout from last year, when the focus was on perils from overseas that could endanger prosperity at home.

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“There’s an awful lot going on [within] the U.S. economy that is more challenging to policymakers than what is happening abroad,” contends Catherine Mann, a senior fellow at the Institute for International Economics in Washington and former economist at the Federal Reserve.

To be sure, any tour of the global economy features plenty of possible flash points that could cause trouble in the United States. Few experts are prepared to write an epitaph for the recent chapter of financial turmoil overseas, despite the return of apparent calm in global markets.

Brazil remains in danger of financial combustion until investors become fully convinced that the South American giant will stick to its pledge of budgetary austerity. A run on Brazil’s currency would put serious pressure on the economies of Argentina, Mexico and other Latin American nations, threatening a broader downturn throughout Latin America.

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“If Brazil goes, Mexico would be the next country under attack,” says Kurt E. Karl, chief international economist at the WEFA Group, a Philadelphia economic forecasting firm.

Even if it avoids a meltdown, Brazil is expected to slip into recession, possibly taking Argentina with it in 1999. On top of that, Mexico’s outlook has worsened as the global collapse in oil prices has forced belt-tightening throughout its economy. Unlike Brazil, however, Mexico is still expected to avoid recession.

In any case, American exporters would suffer greatly from any sharp decline in Latin America, which would only add to the effect of the collapse in Asian markets that hurt the United States in 1998. Consider: Hard-hit Asia takes in about 25% of U.S. exports, and Latin America buys an additional 20%.

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“Who would buy our stuff?” Karl asks, if a downturn in Latin America comes on the heels of Asia’s. “There wouldn’t be many countries left.”

That scenario is of particular concern to the West Coast.

“You could argue that the economy between Seattle and San Diego was really the strongest in the country” before the Asia crisis, says Mark Zandi, an economist at the Regional Financial Associates forecasting firm in West Chester, Pa. “It’s weathered the [global] storm quite well, but it has slowed considerably.

“If there were another shoe to drop in Asia, I think the West Coast might experience a period of declining jobs and rising unemployment. I think it’s the [nation’s] most vulnerable economy.”

Japanese Economy Is Biggest Single Concern

Japan’s bedridden economy remains the biggest single concern for the United States and for Japan’s neighbors in Asia. Despite some official attempts to revive its banking system, Japan remains threatened by a banking crisis that in relative terms is 10 times worse than the U.S. savings and loan fiasco of the 1980s.

Analysts say Japan’s huge economy, which represents two-thirds of Asia’s economic activity, remains in danger of a precipitous slide that would further harm its neighbors as they make their first tentative attempts to recover from financial calamity.

Nariman Behravesh, chief international economist at Standard & Poor’s DRI consulting firm, calls this the “Japan Armageddon” scenario. If Japan fell further, “Asia would take another dip, and that could come back to haunt the U.S. It’s definitely a possibility.”

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Although Japan has the weakest economy among the world’s richest countries, none expect boom times in 1999. Western Europe, where the outlook for most countries is only modest growth, has had to resort to interest-rate cuts to stay out of the doldrums.

A recent analysis by Wells Fargo Co. projected that global economic growth will slow this year to a meager 1.2%, with various regions suffering downturns. And that assumes no calamitous events, such as a currency devaluation in Brazil or China (which would hammer foreign investors), a U.S. stock market crash or war in the Middle East.

Other millstones burdening the global economy include “too much excess capacity, too little investment in emerging markets, too many bad loans on the books and too many lengthy reforms that are needed,” maintains Wells Fargo economist Don Hilber.

Domestic Issues Put U.S. and World at Risk

Experts also emphasize that, unlike in 1998, when spectacular financial gyrations around the world threatened the United States, now an array of home-grown concerns could put a distinct drag on the U.S. economy--and the world’s.

Some of these concerns are quite novel. A lengthy impeachment trial in the Senate would add political uncertainty to financial calculations and possibly take an economic toll. And the year 2000 computer bug, which threatens costly disruptions of computer systems and the machinery of ordinary commerce, could exert some drag on the economy, although forecasts of the magnitude differ.

Perhaps the key U.S. vulnerability is the unusual combination of a zero rate of household savings and a sky-high stock market that has served as a pain-free savings plan for many American households.

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If the markets take a dive, which would be consistent with the weak outlook for corporate profits, consumer spending could screech to a halt after providing the economy with a far greater boost than most analysts had expected in the year just ended. And consumer spending fuels two-thirds of the economy.

“What happens if consumers return to a more realistic path and business doesn’t pick up the slack?” asks Mann of the Institute for International Economics. “The U.S. economy will have a significant slowdown.”

The International Monetary Fund cited this as one of the major risks for the global economy in 1999, alongside a new debt crisis in emerging nations and a further tailspin in Japan.

“We continue to see significant risks . . . for the world economy,” Flemming Larsen, the IMF’s deputy research director, told reporters.

Add to such concerns the prospect of lackluster corporate profits in the United States and a lower level of business investment in new technology and facilities, and forecasters generally conclude that the hard-charging U.S. economy is destined to cool off in 1999.

A recent survey of 52 economists by the newsletter Blue Chip Economic Indicators, for example, found an average prediction of 2.2% economic growth this year. Although that rate would be comfortably above recession levels, it would still represent a sharp slowdown from last year’s bubbly pace, expected to be about 3.6%.

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In 1999, Fed Has Work ‘Cut Out for It’

For U.S. policymakers, the path away from a slowdown is not easy to see. Further interest-rate cuts, if called for, bring risks of their own. When the Federal Reserve began cutting rates this fall, it succeeded in defusing a potential global credit crunch and keeping the U.S. economy churning. Yet the rate cuts also had the unintended effect of setting off a new round of euphoria on Wall Street, which is viewed as a major vulnerability of the economy.

The Fed has in some respects played central banker to the world in the last year, juggling the intertwined interests of the United States and those of key foreign nations. Yet no Fed policy can guarantee protection against such dangers as a new financial debacle overseas that would harm the United States, or a U.S. stock market plunge that would reverberate throughout the world.

In 1999, says Bruce Steinberg, chief economist at the Merrill Lynch & Co. investment firm in New York, “the Fed has its work cut out for it.”

Times staff writer James F. Smith in Mexico City contributed to this story.

* SPECIAL BUSINESS SECTION: Investing ‘99, an annual guide to making financial decisions, includes columns, comprehensive tables and articles to help readers sort out what’s in store for the markets this year. Section C

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