THE ECONOMY WILL ROLL WITH THE PUNCHES THE DOLLAR IS TAKING
It's not enough these days that inflation fears can grip U.S. financial markets. Now, those anxieties can zip around the world as global investors move millions in and out of markets with lightning speed.
That's exactly what's happening now, especially in European bond markets. Yields on everything from British gilts to German bunds are soaring, even though inflation is far less of a threat in those countries than in the U.S.
The victim in all this is the U.S. dollar (page 30). That's because global investors are fearful that rising U.S. inflation could erode the rate of return on dollar-denominated securities. And except for Japan, dollar-based yields are already among the lowest in the world. As investors search for the highest return, many of them are unloading U.S. assets, which is tantamount to selling the greenback, thus weakening its value.
The world financial markets became fixated on U.S. inflation prospects after the Federal Reserve began hiking interest rates on Feb. 4. Since then, the dollar has lost 8% of its value against the German mark and 9% vs. the Japanese yen, hitting a postwar low on June 21.
Federal Reserve Board Chairman Alan Greenspan would not discuss the dollar in his June 22 congressional testimony, but he did say that the Fed could not be "indifferent" to its fluctuations. And Greenspan seemed to point to two solid supports that should be bolstering the U.S. currency: He said that the U.S. outlook was the "brightest in decades" and that inflation prospects were "quite reasonable."
The key question now: Does all this dollar shuffling cloud that bright outlook? The short answer is, not by much. On the plus side, a weaker dollar will help a little in curbing the yawning U.S. trade deficit by making exports cheaper and imports costlier. A minus, though, is that the ailing greenback further fuels inflation fears.
Those worries seem minimal, however. To begin with, the decline of the dollar vs. the mark and the yen exaggerates the sagging greenback's inflation impact, compared with the broader picture of U.S. trade.
Since January, the trade-weighted value of the dollar against the currencies of 10 of America's largest trading partners is down only 3% (chart). The U.S. unit is higher than its year-ago level, and that doesn't include the currencies of developing nations such as Argentina, Brazil, and China, which effectively peg their currencies to the dollar, negating the weaker dollar's inflation impact.
Still, there is an undeniable correlation between the dollar and import prices. And since imports now fill a record 25% of U.S. demand for nonoil goods, some inflation impact is inescapable. During the past year, the inflation rate for nonpetroleum imports has risen to about 2%, about double its pace of a year ago. That's not very much, though, and there is no sign that the speedup is affecting the producer prices of finished goods (chart).
In fact, the overall argument that U.S. inflationary pressures are rising remains difficult to make--in the face of tame producer and consumer prices and of signs that growth is cooling off. The Fed's June 22 report on regional economic activity stated that "growth has moderated recently" in some areas. In addition, foreign trade is shaping up to be a drag on growth during the second quarter, at a time when consumer spending and industrial output are also slowing.
Indeed, if there is one reason to be bearish on the dollar, it is America's deteriorating trade deficit and its difficulty attracting the foreign capital needed to finance that gap. In the first quarter, the U.S. current-account deficit, which includes trade in goods and services as well as certain financial flows, swelled to its largest in more than five years.
And in April, the trade deficit in goods and services widened to $8.4 billion, up from $6.9 billion in March. Exports slid 3.3%, to $56.2 billion, while imports edged down by 0.6%, to $64.6 billion. For merchandise alone, the April deficit ballooned to $13.3 billion, up from $11.5 billion. After adjusting for prices, the overall April gap appears to be larger than the first-quarter average. The problem is imported goods, which hit a record for the second month in a row.
In addition to America's ever-growing appetite for imports, another impediment to the trade outlook--and the inflation picture--is the rise in oil prices. Crude oil is 30% more expensive now than in January, and it may increase even more before the year is over (page 32).
At their June 15-17 meeting, OPEC members agreed to hold their production quota steady at 24.5 million barrels per day for the rest of the year. By holding output flat, OPEC is hoping that rising demand will help boost oil prices to $21--a price not seen since 1985. The International Energy Agency forecasts that world demand for OPEC oil will rise to 25.7 million barrels a day by the fourth quarter, as stronger growth takes hold in Japan and Europe. In the U.S. alone, oil demand in May was 4.4% above its year-ago level.
Rising oil prices will clearly increase America's import bill, but oil may be less of an inflation problem than in the past. The economy's greater fuel efficiency and the stellar gains in factory productivity mean that the U.S. can produce more with less imported oil.
Of course, OPEC is not the only one betting on the global upturn. U.S. exporters are also counting on foreign demand to keep production lines humming even as the weaker dollar enhances their global pricing.
Total merchandise exports slipped 4.2% in April, to $41 billion, after jumping 12.3% in March, to a record $42.8 billion. Almost all major goods categories fell, after rising strongly in March. After adjusting for price changes, exports are growing at the same 6.8% yearly pace as in the first four months of 1993, buoyed by capital goods.
The customers are changing, however. Shipments to other G-7 nations continue to be dwarfed by exports to the rest of the world. Just three years ago, Britain, Canada, France, Germany, Italy, and Japan purchased half of all U.S. exports. Now, that share has drifted to 46%, while demand from such nations as Mexico, Brazil, and South Korea has soared (chart).
Export figures will begin to pick up even more when other major economies return to stronger growth. Stirrings of an upturn are evident in Germany as well as in the rest of Continental Europe. True, those signs are one cause of the dollar's weakness, but U.S. exporters need an expanding Europe.
So, too, the latest data show that the worst may be over for Japan. The Economic Planning Agency reported on June 21 that Japan's real gross domestic product grew at an annual rate of 3.9% in the first quarter (chart). That was the strongest pace in three years.
Faster growth and the soaring yen are beginning to draw in more imports already. Lost in this year's trade rhetoric is the 10% surge in U.S. exports to Japan so far this year.
The deterioration in the bilateral trade deficit--$20.5 billion so far in 1994, up from $18.9 billion in 1993--can be traced entirely to the 9.4% rise in U.S. purchases of Japanese goods--which outpace U.S. exports 2 to 1. This huge imbalance means that the downward pressure on the dollar vis-a-vis the yen will not dissipate any time soon.
For decades, of course, the domestic priority of balancing growth and inflation took precedence over any foreign considerations. That is still the case today: The Fed will not sacrifice this expansion in order to shore up the dollar. But in the new world order of financial trading, U.S. monetary policymakers as well as borrowers may no longer be able to ignore the powerful influence of international markets.JAMES C. COOPER AND KATHLEEN MADIGAN