It's The Worst Of Times To Tighten The Rate Screws
Should the world's Big Three central bankers, Germany's Hans Tietmeyer, America's Alan Greenspan, and Japan's Yasuo Matsushita, succumb to pressure from inflation-obsessed bond investors or fixed-income-dependent retirees and raise interest rates? BUSINESS WEEK's rate watchers say no. All the elements are in place for a long-awaited global expansion in the second half of 1996: The U.S. is posting strong growth with moderate inflation, Germany's economy is forecast to climb into positive territory, and Japan is in recovery. These countries are so dependent on each other's trade and capital that synchronous growth would be a boon for all. Our point: The Big Three shouldn't fix what ain't broke.
THE U.S.: WHAT INFLATION?
The news hit Wall Street like a wrecking ball. The June 7 employment report revealed that the U.S. economy created 348,000 new jobs in May--more than twice as many as private forecasters had expected. Bond traders began dumping their U.S. Treasury holdings, convinced that the Federal Reserve will raise rates at its July 2 meeting to brake an economy surging forward at 3% or more.
But unless the Fed wants to stall the engine of global growth, it shouldn't take Wall Street's bait. The employment report is only part of the growth spurt that followed a winter of government shutdowns. "The U.S. economy is not going to persist at this growth rate for much longer," says Donald H. Straszheim, chief economist for Merrill Lynch & Co. Partly because bond investors have already driven up long-term rates, Straszheim predicts growth will dip to 1.3% by the fourth quarter.
Fed Chairman Alan Greenspan has long insisted that the central bank doesn't try to restrain growth--just inflation. Now, the Fed can prove this is not just rhetoric. Corporate America's heavy spending on computers and other capital equipment has raised industrial capacity by better than 4% over the past year. That means the economy can absorb higher-than-normal growth, at least for a while. Meanwhile, inflation is nowhere to be found. Excluding the volatile food and energy sectors, May consumer prices rose just 0.2%, while producer prices were unchanged.
Even the May employment report isn't as worrisome as it seemed at first glance. True, wage growth has surged by 3.4% in the last 12 months, the highest rate in five years. But Deutsche Morgan Grenfell/C.J. Lawrence Inc. chief economist Edward E. Yardeni notes that much of the increase occurred in two areas: manufacturing and retail, which includes restaurants. The 3.5% hike in factory wages should be viewed as a reward for workers who are showing better than 4% productivity growth. And given the glut of malls and eateries dotting the U.S. landscape, there's little reason to think wage hikes in these sectors will boost retail prices.
HIGH DEBT. In addition, the bond market has already done the Fed's dirty work. Yields on 30-year Treasuries are up more than a point this year, to above 7%. These higher rates are pinching borrowers: Credit-card delinquencies are approaching a 15-year high, and more homeowners are falling behind on mortgage payments. Such trends should trigger a slowdown in consumer spending.
A Fed hike in interest rates would send the wrong signal. Wall Street would figure the economy is overheating and send long-term interest rates soaring. Besides choking off U.S. growth, higher rates here could kill the global economic recovery just as it takes hold.
By Dean Foust in Washington
GERMANY: TAKE THE LONG VIEW
As the world's central bankers filed in to lunch at a Basel restaurant during the Bank for International Settlements annual meeting on June 10, German Bundesbank President Hans Tietmeyer spotted a European bank staffer whose suit-coat collar was turned up. Tietmeyer moved briskly to catch up with the banker and graciously smoothed out his appearance.
Will Tietmeyer, Europe's dominant money man, be equally kind over the next couple of months as the Buba mulls its next rate move? In response to a severe growth slump, Germany's central bank has pushed the discount rate down to 2.5%, a postwar low, from 6.75% in July, 1993. Now, as the German economy shows signs of a rebound, pressure will grow on Tietmeyer to reverse course. He shouldn't. Germany and Europe need easier money, and soon. Without it, recovery on the Continent could be derailed, and hopes for a historic monetary union could crumble.
It will take courage for Tietmeyer to justify easier money. Annual growth in Germany's M3 money supply, the Bundesbank's key guide in setting monetary policy, has been running around 11%, well above the Buba's 4% to 7% target range. And although gross domestic product has declined for two consecutive quarters, German industrial production bounced back strongly in April. James Lister-Cheese, an analyst at London's Independent Strategy, predicts a rebound in export-led German growth in the second half, aided by economic strength in the U.S. and revived Japanese demand. The global money clique wants the party to end.
Tietmeyer's maneuvering room is also limited by uncertainty over monetary union. Investors fear that France, with its swelling social security deficits, and Germany, with its high public debt, will try to meet the criteria for EMU by the end of 1997 by fudging their numbers. If they do, holders of mark-denominated assets will find their value eroded, because Europe's new single currency won't have the credibility of the mark. Already, such fears keep German long rates excessively high, and if Tietmeyer cuts short-term interest rates to boost EMU's chances, long rates could jump.
But Chancellor Helmut Kohl has a good chance of cutting spending by more than 1% of GDP next year. Tietmeyer should bet on Kohl's success and lower the key repo rate within the next two months. Then, he should hold rates down through the crucial EMU deadline at the end of 1997. This would boost growth among Germany's neighbors and provide the best chance to forge a credible single currency on schedule.
For Tietmeyer to put Europe's long-term goals over Buba's inflation-fighting role is a tall order. The job will be even tougher if signs of a global upturn continue. But if Tietmeyer's goodwill toward Europe prevails, he will go down in history as the moneyman who helped turn the EMU dream into reality.
By Bill Javetski in Basel
JAPAN: DON'T PLAY WITH FIRE
Japan's near-zero interest rates are a lifeline for its fragile banks. But they're murder on Japan's graying masses, who rely on yen deposits earning less than 1%. As Prime Minister Ryutaro Hashimoto's Liberal Democratic Party-led coalition faces a general election, the Bank of Japan's ultraloose monetary policy isn't the stuff of landslide victories.
Small wonder that jittery LDP politicians have been urging Bank of Japan Governor Yasuo Matsushita to turn off the cash spigot. Yet though Japan has clearly emerged from its postbubble free fall, now is scarcely the time to touch the benchmark discount rate, which stands at an all-time low of 0.5%. If Matsushita were to raise the discount rate, "the yen would rally, and it wouldn't be good news for the markets," deadpans Salomon Brothers Inc. economist Jeffrey D. Young in an obvious understatement.
Besides the pain that retirees are feeling, a strong case can be made for higher rates. Business investment is expected to advance 4.1% this year, April machinery orders vaulted 26% over March, and the Nikkei stock average has rebounded 52% from its 1995 low. Consumer spending is up, and corporate sentiment is at a 4 1/2-year high. What's more, Salomon expects first-quarter GDP figures, due out later this month, to show annualized growth of 5.6%.
LONG-AWAITED. Yet it's hardly time to throttle back. Inflation isn't a worry as Japan finally begins to feel pressure from the global economy. Cheap imports continue to drive down wholesale prices, and consumer prices should advance all of 0.5% in the fiscal year ending March, 1997. Then there's the yen, which has weakened 36% against the dollar over the last 14 months. A significant rate hike could enhance the value of yen-based assets, send the currency soaring again, and cut short Japan Inc.'s earnings rally.
On May 30, Matsushita sympathized "with people who largely depend on interest as a means of earning their bread." Yet if the Bank of Japan moves too soon and Japan's long-awaited recovery stumbles, pensioners won't be the only ones screaming.
By Brian Bremner in Tokyo