U.S.: This Economy Could Shrug Off The Asia Effect Again
Once again, an ill wind from Asia is buffeting the U.S. economy. This time it's coming from Japan. The yen's persistent weakening in recent weeks finally prompted international efforts to try and prop it up, although that attempt may go for naught without fundamental market reforms in Japan. The question for the U.S. outlook is: Will Round 2 of the Asian crisis have any more impact on overall growth and inflation than Round 1, which the economy barely noticed?
As with the first squall in October, the biggest potential loser is sure to be the stock market. As the yen tumbled to an eight-year low of nearly 147 per dollar, worries over profits sent the Dow Jones industrial average down some 400 points from June 5 to June 15. That was before the June 17 currency intervention, when U.S. and Japanese central banks bought yen for dollars. That action gave stocks a boost but hit the bond market hard, reversing about half of the flight-to-quality rally in early June that saw 30-year Treasury yields fall from 5.82% to a record low 5.65%.
Financial market gyrations aside, the lesson from Round 1 was that the economic outlook will turn on domestic, not foreign, demand. On that front, the economy in the second quarter remains surprisingly strong. Certainly, growth will not match the first quarter's 4.8% pace, which was achieved despite a 3-percentage-point drag from a widening trade deficit. Still, the latest data suggest that the slowdown this quarter may not be as sharp as many forecasters had thought.
LOOK AT THE NUMBERS: First, industrial production has slowed since the third quarter of last year, but May output was stronger than expected, and production is growing faster in the second quarter than it did in the first. Second, May retail sales also rose more than expected, and consumer spending this quarter is set to post another big gain (chart). Third, while May housing starts dipped, they remain at a high level, and builders are the most upbeat in years.
Finally, the domestic economy is so strong that, despite the deflationary drafts from Asia, core consumer inflation, excluding energy and food, so far this year has picked up to an annual rate of 2.7%, up from 2.2% during all of 1997. The speedup is broad, and it is led by services, as well as some goods, which are more immune to the Asian flu.
Consumers are powering growth in the second quarter. Retail sales in May increased 0.9% from April, when they rose 0.7% from March. May buying was boosted by a surge in demand for cars and light trucks, fueled by dealer incentives. Sales in April and May averaged a 15.8 million annual rate, up from 15.1 million in the first quarter. Also, May purchases of furniture and appliances racked up a big gain, reflecting the ongoing strength in housing, and department store sales scored solid gains as well.
The retail data imply that real consumer spending this quarter is on a path to rise at an annual rate in the neighborhood of 4.5%. That would be a strong performance in its own right, but it would be stunning coming on the heels of the first quarter's 6.1% surge, which was the biggest gain in six years. Taken together, first-half consumer outlays are on their way toward the strongest two-quarter growth in 12 years.
Housing also remains strong. May housing starts dipped 0.7%, to an annual rate of 1.53 million, but demand fundamentals are supportive, and inventories of unsold homes are near-record lows. Also, the index of housing-market conditions, based on a survey of builders, hit a record-high 71 in June, as builders reported that current sales are on the rise (chart).
ROBUST DOMESTIC DEMAND continues to be a big offset to the Asia-related weakness in foreign demand. Look at it this way: Total U.S. exports are 13% of gross domestic product, but consumer spending and housing are 72%. That same math appears to be buoying second-quarter growth, similar to the way it lifted first-quarter growth.
Indeed, despite weaker exports, industrial production rose a larger-than-expected 0.5% in May. Output in manufacturing, while slowing in recent months, still grew 0.2%, the same as in April. Not surprisingly, output of consumer goods increased substantially for the third month in a row, led by home-related goods such as appliances, furniture, and electronics.
Given that domestic demand remains strong and that industrial production continued to rise in May, imports appear to have accounted for a big chunk of the large first-quarter buildup in inventories. That would mean that domestic producers would not have to absorb the full burden of cutting stock levels down to size, thus limiting the hit to U.S. output. The April ratio of inventories to sales remained at a level that does not suggest that stockpiles are excessive.
THE ASIAN CRISIS is creating a dichotomy in the U.S. economy: Output and prices in sectors that face stiff global competition tend to be far weaker than they are in sectors such as services and goods that are less sensitive to foreign influences. That is especially true for inflation. The consumer price index rose 0.3% in May, and, excluding food and energy, core prices rose 0.2%.
However, core inflation has picked up a bit. The collapse of energy prices is helping to mask the acceleration in some components of the overall CPI, specifically many services and some goods that are more shielded from foreign competition (table). Core service prices are growing at an annual rate of 3.4% so far in 1998, up from 3% for all of 1997. The pickup has been broad, from medical care to personal care to recreation.
Even inflation for goods prices is ticking higher for some items, such as pharmaceuticals and textbooks, that do not face much foreign competition. Somewhat surprisingly, core goods inflation so far this year has picked up to 1.2%, from 0.4% for all of 1997.
Nevertheless, the deflationary winds from Asia continue to blow. Import prices for nonpetroleum goods kept on declining in May and, during the past year, they have fallen 3.3%. The overall rate of decline has tapered off, but the drop-off in prices of Asian goods, down 8.3% from a year ago, continues to accelerate.
But as already seen, not all of the Asian-crisis impacts are negative. Prices of imported commodities account for most of the Asia-related drop in import prices, but that lowers production costs for many U.S. producers. In particular, crude oil prices hit a 12-year low on June 15 of less that $12 per barrel.
To be sure, Japan is the key to any further downdraft on the U.S. from Asia, particularly if a weak yen forces a devaluation of the Chinese currency, which would slam the region especially hard. Clearly, the risks have increased, but so far, domestic demand continues to keep the U.S. economy chugging along.