What a difference a few months can make in currency markets. As recently as early February, the consensus among observers was that the sagging dollar would remain weak through most of this year. America's recession, declining interest rates, and stubbornly high core inflation all argued for a shaky dollar. So did Germany's and Japan's strong economies, tight monetary policies, and relatively modest inflation rates.
Then suddenly in February, the dollar turned around and mounted a spectacular rally. By early April, when it paused for breath, the dollar had recouped most of the 17% it had lost against European currencies over the past year and had retraced all of its decline against the Japanese yen since last August.
What lies behind the turnaround? One clear factor has been the gulf victory, which has not only shored up the prestige of the U. S. and the Bush Administration but has also banished fears that a protracted war would continue to undermine consumer and business confidence. Observers note, too, that the billions that America's allies are chipping in to pay for the war should make a substantial dent in the U. S. current-account deficit this year, as should orders for the reconstruction of Kuwait.
That's not all. Economist David Hale of Kemper Financial Services Inc. thinks that overseas investors, who shunned U. S. markets in 1990, are getting back into the act. He notes, for example, that foreigners sold a record $15.5 billion of U. S. equities last year, 12 times the previous net sales high posted in 1984. "Many foreign investors entered 1991 uith record low shares of U. S. securities in their portfolios," says Hale, "but the dollar and stock market rallies have made them believers again."
Several long-run trends also seem to favor a stronger dollar. The greenback's sharp depreciation since 1985 and gains in manufacturing productivity, note economists at Merrill Lynch & Co., "have made U. S. goods highly competitive internationally." And the dollar now appears significantly undervalued in terms of the relative purchasing power of different currencies.
But the biggest reasons for dollar strength are cyclical. The currency markets are anticipating both a near-term U. S. recovery and a sharp slowdown in German and Japanese economic growth. Such developments, expected later this year, would shift interest-rate differentials and economic fundamentals more decisively in the dollar's favor.
The catch, of course, is that the U. S. still seems mired in recession while the slowdowns overseas have not yet fully materialized. And foreign central banks remain fearful of the impact of a stronger dollar on their inflation rates. Thus, at least for a while, further dollar appreciation may hinge less on anticipated future cyclical changes in U. S. and foreign economies than on hard evidence that those changes are actually unfolding.
Aside from the clear symptoms of economic malaise, there are some good statistical reasons to believe that the Commerce Dept. will report an outsize drop in gross national product in the first quarter--perhaps as much as 4%. Economist Philip Braverman at DKB Securities Corp. points out that the fourth-quarter drop in GNP was recently reduced to 1.6% from the 2% decline reported earlier because of a surge in foreign earnings of U. S. companies. Buoyed by the appreciation of foreign currencies relative to the dollar, such earnings climbed at a $10.4 billion annual rate during the quarter.
This positive effect, however, will be reversed in the first quarter of this year, he predicts, as the soaring greenback lowers the value of foreign earnings as they are translated into dollars. Indeed, the drop should be even greater because slowing economies overseas are also dampening foreign earnings in local-currency terms. "This will not only affect GNP," says Braverman, "but will reinforce the continued deterioration in overall U. S. corporate earnings."
Another reason to expect a big drop in GNP for the first quarter is the sharp swing in imported oil prices. Economists writing in Citibank's Economic Week point out that surging oil prices in the fourth quarter of last year actually moderated the reported decline in GNP. That's because of their impact on the change in real (inflation-adjusted) imports during the quarter.
The Commerce Dept. subtracts real imports from real GNP when it calculates the pace of economic activity, just as it adds the inflation-adjusted value of exports, Citibank explains. And by boosting the measure of import inflation in the fourth quarter, the 45% surge in oil prices in effect lowered the estimated level of real imports.
In sum, there were fewer imports to subtract from real GNP, so the economy looked a lot stronger than it would otherwise have appeared. Indeed, without the oil-price effect, economists estimate that the economy would have declined at close to a 4% annual rate rather than the 1.6% officially reported.
The same logic, however, suggests that the economy may look exceedingly weak in the first quarter because oil prices not only stopped rising, but actually plunged significantly. Falling import inflation will magnify the level of real imports and thus drag down GNP. The upshot, says Citibank, "is that real GNP will probably take a big dive."
Although joblessness is rising, there may still be some light at the end of the unemployment tunnel. Dun & Bradstreet Corp. reports that a nationwide survey of 5,000 employers projects a net increase of 850,000 jobs in 1991, up from an actual rise of 621,000 in 1990. The survey, conducted earlier this year, indicates that hiring will be strongest among smaller businesses. Employers with less than 20 workers account for over half of the anticipated job growth, while companies with payrolls above 25,000 still expect to pare jobs a bit.