Sorry, Europe--a U.S. Crash Isn't Coming
A scary rumor is floating around European financial circles this summer: The U.S. economy is about to tank. A lot of it is schadenfreude, but the logic of the argument is worth examining. The danger is that it contains just enough truth to turn investors into believers. We're not, and here's why.
The argument is a variation on the bubble theme. It starts with one true thing: The U.S. is running a record current-account deficit in its balance of payments that will soon hit 3.7% of gross domestic product, surpassing the 1986 record of 3.6% of GDP, which triggered a major dollar crisis. Therefore, runs the argument, another dollar crisis is inevitable, and soon. This will make U.S. investments by foreigners less attractive, cause an overpriced stock market to crash, and lead to a recession by 2000. Consumers, saving nothing, running up big debts, and relying on stock market gains for spending, will fold. At the same time, faster-than-expected expansion of European and Asian economies will draw capital away from the U.S., worsening the market collapse.
There is no denying the American dependence on foreign capital to finance its yawning account deficit. Through August of this year, the U.S. sold foreign investors almost $45 billion in equities, $113 in corporate bonds, $63 billion in government-agency paper, and only $13 billion in Treasury securities. And in the first quarter alone of 1999, there was a net inflow of nearly $50 billion in direct foreign investment.
But odds are extremely low that this flow of overseas capital will cease financing the U.S. trade deficit. The current-account deficit is already poised to begin shrinking in the months ahead. U.S. exports are up dramatically, thanks to higher European, Asian, and even Latin American growth. Export volumes already rose at a 22% annualized pace over the past three months. Imports are growing fast, too, but the acceleration is likely to stop. The trade gap will probably narrow and reduce the downward pressure on the dollar. Rising exports will also sharply increase profits for U.S. corporations, making their stocks more attractive to all investors, including those overseas. Improving European and Asian economies have already led to a sharp boost in U.S. corporate profits. Earnings growth is expected to come in at 20% or more for the third quarter.
The Fed, too, is cooperating. Its small, gentle tightening measures appear to be taking the air out of the second, and perhaps more important, asset bubble in America after stocks: housing. Higher mortgage rates have cut refinancing activities, setting the stage for a cooling of home building and consumer spending. That should also help cut the trade deficit as consumers buy fewer imports.
There is always the danger that investors could make the European scenario a self-fulfilling prophecy by pulling out of U.S. markets in anticipation of a crash. Or, policymakers could sharply increase interest rates--to prevent the dollar from falling further--and wind up triggering a major market decline. But a smarter bet would be that the rebalancing going on in the world economy will prove beneficial to U.S. growth--and U.S. equity markets.