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U.S.: The Dollar's Coming U Turn

Business Outlook: U.S. ECONOMY


With the current-account deficit starting to balloon, it's bound to happen

When the pall from the Asian crisis eventually lifts, currency traders are going to take a hard look at the damage Asia has done to the U.S. trade deficit. When they do, they will very likely come to the same market-jarring conclusion: "Sell the dollar!" The resulting flight to another currency--such as the new euro--could crimp stock prices, lift interest rates, and push up inflation.

It won't happen overnight, mind you. Japan is now the focal point of the foreign-exchange markets. Until Japan enacts real economic reform--or at least fixes its house-of-cards banking system--Asia will not turn around, and the U.S. dollar will continue to be the global currency of choice. And no amount of currency intervention will change that, which is clear from the dollar's renewed gains against the yen in late June. So for at least a while longer, the U.S. will continue to enjoy the benefits of its muscular greenback, including a flood of foreign capital, falling import prices, and low inflation and interest rates.

But the dollar's U-turn will happen. Why? Because the current-account deficit--a kind of cash-flow statement of U.S. international business that includes trade in goods and services, net investment income, and foreign transfers--is ballooning (chart). This deficit totaled a record $47.2 billion in the first quarter. At an annual rate, that was 2.3% of gross domestic product, and the second-quarter gap is on track to hit 2.5%.

As a percentage of GDP, the current-account deficit is already the largest of the Group of Eight industrialized nations, and it is headed toward 3%. That is typically the level at which the currency markets begin to speculate about a country's ability to continue to finance its international obligations at an existing exchange rate. Put simply, as a country's debts mount, its currency starts to look too lofty.

HOW DID THE U.S. get into such a hole? It has been digging for some time. The trade-deficit portion of the current account, for example, has been widening during this entire expansion. But the Asian financial crisis is speeding up the deterioration in the current account. First, the sharp falloff in exports to Asia is a big reason why the April trade data show that the trade gap is on its way to surpassing the chasm that opened up as a result of the superdollar in the mid-1980s.

Second, Asia is behind another growing concern for the 1998 current account: U.S. net investment income. This component of the current account is what U.S. investors earn in interest and dividends on overseas investments minus what the U.S. pays out to foreign investors. By mid-1997, this balance had swung decidedly into negative territory for the first time since World War II, and the drag is set to worsen.

That shift reflects the jump in U.S. payouts resulting from the huge inflow of foreign capital needed by the U.S. to finance its growing trade gap. The drain will continue well into 1999 because of the new money coming in as a result of the Asian crisis. Through the first quarter, net capital inflows to the U.S. totaled a record $264 billion during the past year. That includes $643 billion in foreign assets in the U.S. less $378 billion in U.S. assets abroad. The net capital inflow has slightly more than doubled in only the past two years.

That inflow has provided a major lift for U.S. stocks and bonds. In the first quarter, net foreign purchases of stocks jumped to a record $29.4 billion, triple the $9.8 billion bought in the fourth quarter. Also, demand for U.S. bonds surged to a record $47.3 billion, nearly double total fourth-quarter purchases of $26.9 billion. The resulting gain in stock prices and downward push on interest rates has buoyed demand in the U.S.

THAT STRONG DEMAND has already bloated the import side of the U.S. trade ledger. And now, significantly weaker exports to Asia are swelling the trade deficit even further (chart). The April gap for goods and services soared to a record $14.5 billion, reflecting a steep 2.6% drop in exports and a 0.9% dip in imports.

April marked the third month in a row that the deficit has widened sharply, and the trend is eye-popping. April's level is up from a monthly gap averaging $11.6 billion in the first quarter, and from $9.5 billion in the fourth quarter. So far this year, the trade deficit has totaled $49.3 billion, up from $37.1 billion in the first four months of last year. The overall downtrend in trade is mainly for goods, but services are also feeling the chill. The service surplus is shrinking, due to falling exports.

A widening gap with all Pacific Rim countries, including Japan and China, has more than accounted for the increase in the total deficit, and the deficit with Asia's newly industrializing countries alone has accounted for half. Trade with the NICs has gone from near balance to a deficit of $6.4 billion. What's more, the entire Asian impact on U.S. trade so far shows up only on the export side. That's why durable-goods orders have weakened this year (chart). In May, bookings dropped 2.6%, to the lowest level since July, 1997.

Any new wave of imports has yet to be felt. Asian goods continue to come in at a rapid clip, but the growth trend is no different now than it was before the crisis. That will change when Asian exporters start to find the financing they need to get back on their feet, adding to U.S. trade woes in the second half.

THE APRIL TRADE REPORT makes it clear that the Asian crisis is hitting the U.S. far harder than expected. The widening in the trade deficit subtracted three percentage points from first-quarter GDP growth. And if the deficit in May and June only stabilizes at the April level, a further swelling would take away an additional three points from second-quarter growth--a much bigger drag than nearly all economists had anticipated.

The United Auto Workers' strike at General Motors Corp. will be another, but smaller, drag on the second quarter. By June 23, the three-week stoppage had idled 93% of GM's production and 142,000 workers. The strike is already lifting new claims for jobless benefits, and it will depress June reports on jobs, hours worked, and industrial production.

Moreover, if the strike lasts into August, as GM is suggesting, July data will show an even larger hit, and the strike will cause significant secondary impacts in auto-related industries. With the dollar so strong, the strike could give foreign carmakers an opportunity to grab more market share in the U.S. That would be yet another factor pushing up the trade deficit.

But at some point, the trade gap will grab the attention of the foreign-exchange markets. That's what happened in 1985, when the current-account deficit soared and the real trade-weighted dollar began to plunge. And when the markets finally say enough is enough, all the benefits of a strong greenback will once again start to fade away.BY JAMES C. COOPER & KATHLEEN MADIGANReturn to top

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