The U.S. economy may be in a blissful state for now, but Federal Reserve Chairman Alan Greenspan and Treasury Secretary Robert E. Rubin see a new threat lurking overseas. No, not another currency crisis in an emerging market. This is a more worrisome development: a slowdown in the world's only other engine of growth--Europe.
The outlook for Euroland has turned abruptly from buoyant to bearish, and that has the two titans of economic policy nervously wondering how long the U.S. expansion can keep chugging along without falling into the worldwide slump. Greenspan voiced his concerns in testimony to Congress on Feb. 23. Rubin is so worried about stagnation on the Continent that he forced a discussion of pro-growth remedies to the top of the agenda when finance ministers from the Group of Seven industrial countries met in Bonn on Feb. 20.
The distress is understandable. With Japan still a basket case eight years after its bubble burst, Rubin and Greenspan have been counting on Europe to share the burden of leading a fragile global economy back to health by sucking in imports from developing nations and providing investment capital. But growth is tapering off in Britain, Germany's economy contracted 0.4% in the fourth quarter, and industrial production in France dropped sharply in December. "Their biggest fear is that the U.S. is the last country standing," says Joseph P. Quinlan, senior international economist at Morgan Stanley Dean Witter.
That's why Rubin wants the Europeans to stimulate their economies, much as he has been pleading with Tokyo for the past two years to take bolder steps to snap out of its slump. "Private and official growth estimates for Europe have been marked down recently," he told BUSINESS WEEK on Feb. 23. "If Japan is going to be between negative growth and flat, it's extremely important that Europe be a source of strength." In return, the U.S. is willing to keep living with a strong dollar, though the resulting trade imbalance means its 1999 current-account deficit--which measures goods, services, and money flows--could top $300 billion for the first time.
Rubin's European counterparts agree with him in principle. But many are nearly as resistant as the Japanese to the kinds of major policy changes required to spur their economies. Why? "Europe is in a state of denial about the bleakness of its economic outlook," says David Malpass, chief international economist at Bear, Stearns & Co.
It's not hard to figure out why. Barely two months ago, Euro-phoria was sweeping the Continent over the launch of the 11-nation European Monetary Union and the debut of the euro, which is supposed to give the dollar a run for its money as a global reserve currency. But now economists are scaling back their forecasts for EMU growth this year, even to 1%. "I see no growth in Germany in the second half," says Deutsche Bank Securities chief economist Edward E. Yardeni, one of the more pessimistic forecasters.
Although the G-7 ministers agreed on the need to stimulate Europe's economy, the best way to accomplish that is a matter of deep dispute. Burgeoning budget deficits rule out fiscal stimulus. So German Finance Minister Oskar Lafontaine is lobbying the new European Central Bank to cut a key short-term interest rate, now 3%. But the ECB--eager to prove its independence--is resisting because it doesn't want to look like it is buckling under to political pressure. U.S. officials, noting that Rubin has refrained from publicly second-guessing Fed policy, say Lafontaine's jawboning may be counterproductive--delaying any plans by the central bank to cut rates.
For now, the ECB is showing no interest in easing. "From the monetary side, everything is prepared for sustainable growth," ECB Chief Economist Otmar Issing told BUSINESS WEEK on Feb. 19. "What is lacking is structural reforms." Issing was referring to ECB calls for U.S.-style flexibility in labor markets to combat high unemployment, as well as government cost-cutting, tax reform, and a social security overhaul.
MORE PRESSURE. Such changes, even if they can overcome stiff political opposition, won't result in immediate growth--one reason behind so much European dealmaking in the more lucrative U.S. economy. Still, Rubin applauds any potential reform: "It's been obvious for a long time that there needs to be a lot of focus on all the labor and social restraints that deter people from investing and hiring."
Despite the ECB's current stance, private forecasters are betting that short-term rates will be trimmed by at least a quarter-point--and maybe as much as 75 basis points--if the economic data for the region indicate continued deterioration. Lower rates would put more downward pressure on the euro, which has fallen 6% against the dollar since its debut.
Rubin can only hope that the Europeans prove more responsive to growth pleas than the hunkered-down Japanese. It required intense U.S. prodding to get Tokyo to finally act--albeit slowly and timidly. Japan has cut interest rates and taxes, launched massive public works programs, begun to clean up its banking system, and is keeping the yen weak with U.S. blessing to help exporters. So far, there are few signs that these measures are working. "We have to wait and see what the outcome will be," says Finance Minister Kiichi Miyazawa. Forecasters think they know: In 1999, Japan's economy will contract, just as it did in 1997 and 1998. "Japan has taken some important steps lately, but it clearly has an enormous amount to do," notes Rubin.
What more could Japan do? Rubin won't say. But U.S. officials echo economists who want Japan to print more yen and cut taxes to put cash in the hands of consumers--fast. That would send Japan's public deficit, now 10% of gross domestic product, even higher. Rubin & Co. believe it is a worthwhile trade-off if it means that the Japanese economy starts to grow again.
Can Rubin's pro-growth cheerleading win over Tokyo--or even the Europeans? In Bonn, the Europeans and Japanese seemed less concerned about the need for expansionary policies. They were more interested in new government initiatives, such as regulated exchange rates and capital controls to prevent a future financial crisis, like the currency meltdowns that have created a series of panics over the past 18 months.
Rubin blocked those moves, insisting that the group has a greater imperative right now. Without growth, the G-7 countries won't have time to worry about the next crisis--they'll be too busy coping with a current one. That, ultimately, may be the best argument to prod Europe and Japan into action.