The U.S. Will Have to Be the World's Lifeline

By forging a recovery at home, the Fed will also shore up global growth

Is the rest of the world slipping into recession? If so, will a global slump drag the U.S. down as well? It's a worrisome premise, but let's make sure we put the horse in front of the cart.

Clearly, weaker foreign demand is one more problem for the beleaguered U.S. expansion, especially for manufacturers that have borne the brunt of this slowdown. However, the economy's problems are all made in the U.S.A.--the result of booms in consumer spending, stock prices, and business investment that went bust. Moreover, it is weakness in the U.S. that is most responsible for the slowdown in the rest of the world. That's because the U.S.'s global influence goes far beyond its 23% share of world gross domestic product. It has significantly greater impact in the areas of tradeable goods and financial flows.

Global concerns were one of the reasons the Federal Reserve kept up its efforts to assure a pickup in U.S. growth when it cut interest rates on June 27. The Fed knows that the quickest path to a healthy world economy is via a U.S. recovery. Moreover, the Fed now appears to believe that the hardest work toward achieving that goal is already completed. After five half-point cuts in as many months, the Fed opted for only a quarter-point cut, lowering the federal funds target rate to 3.75% (chart).

THE ACCOMPANYING STATEMENT did not contain the urgency of the communiques that came with the April and May cuts. The perfunctory wording suggests a divide among policymakers, and the smaller cut may reflect a compromise between those fearing future inflation and those who still see significant risks to growth.

The statement listed "slowing growth abroad" along with "declining profitability and business capital spending" and "weak expansion of consumption" as factors that continue to weigh on the economy. Consequently, the Fed continues to believe that the risks in the outlook are still slanted toward economic weakness, which leaves the door open for further cuts.

The Fed is well aware that the U.S. economy has been dodging bullets, first from auto-industry cutbacks, then from tech-driven problems in capital spending. Now, with exports slumping badly, the U.S. is suffering new fallout from its own weakness, which is yet another blow to the already punch-drunk factory sector. The steady appreciation in the dollar during the past year only compounds the hurt.

News from around the globe has been almost uniformly bad. An unexpected fall in first-quarter real GDP suggests that Japan has dropped yet again into recession. And a dip in Germany's business-climate index hints that the euro zone's largest economy may not have grown in the second quarter. Other trouble spots: Southeast Asia's rising tech problems and Argentina's debt-and-devaluation woes. In fact, almost all economies are expected to grow more slowly in 2001 than they did in 2000 (table).

What may rankle U.S. policymakers is that the Fed's easing has not been matched by other major central banks. The Bank of Japan can't lower rates because they're already effectively zero. Besides, many of Japan's problems are structural, not cyclical. And the European Central Bank has held firm to its mandate to fight inflation, so it has been extremely reluctant to cut rates even in the face of bad economic news. The ECB held rates steady at its June 21 meeting, though the betting now is that the bank will ease in July.

But a July cut will be too little, too late to help the euro zone out of its morass. And in an increasingly global world, sniffles in one part of the world can quickly become a cold elsewhere. For the U.S., most of the chills are being felt in exports. Foreign shipments fell 1.9% in March and 2% more in April, with additional declines likely in coming months.

EXPORTS OF TECH EQUIPMENT have fallen off sharply. Shipments of computers, peripherals, telecom gear, and semiconductors have declined in six of the past seven months, and over the past half year, they have accounted for two-thirds of the drop in overall exports, even though tech is only 12% of the total.

But even with increasing weakness in exports, the trade gap has narrowed since last autumn. That's because imports are also declining in response to softer U.S. demand. Imports fell 2.2% in April, allowing the trade deficit for goods and services to narrow slightly, to $32.2 billion, from $33.1 billion in March. Since last September, exports have fallen 4.7%, but imports, which are a third greater, have declined 5.2%.

A smaller trade gap provided a plus for first-quarter GDP growth, but the intensifying weakness in exports means the deficit widened in the second quarter. The trade gap is on track to subtract nearly a percentage point from the quarter's GDP growth.

WEAKER FOREIGN DEMAND is only the latest of manufacturers' woes, on top of flagging demand in the U.S., especially for capital equipment. New orders for durable goods stayed above water in May, as bookings rose 2.9%, but they had plunged 5.5% in April. Through May, second-quarter orders are still down from their first-quarter level, though they are not falling nearly as fast as they did in that quarter.

Not surprisingly, one area in which bookings are falling faster this quarter is tech equipment. Orders for technology gear dropped at a 36.1% annual rate in the first quarter, and through May, they're down 44.5%. And shipments of technology equipment are dropping like a stone, indicating that outlays for information-processing gear will subtract a sizable chunk from second-quarter GDP (chart). Moreover, falling orders suggest more weakness to come in the third quarter.

Throughout all of the bad news of recent months, consumers have remained a beacon of hope. And they still are, based on their willingness to commit themselves to the purchase of a home. Sales of both new and existing homes rose in May, and both levels are well above their year-ago readings. Buoyant housing demand says volumes about consumers' confidence in the future. As if to corroborate that, the Conference Board's June confidence index rose for the second consecutive month as households felt the most upbeat about prospects for the future since December.

No doubt, the promise of tax cuts is playing a role in consumers' outlooks, and the Fed's cuts in interest rates, now totaling 275 basis points, are sure to provide further economic support in coming months. In fact, one of the key factors that has elevated the U.S. economy's stature in the world during the past decade has been sound and timely economic policy. That suggests that the question is not will the rest of the world drag the U.S. into a recession, but how fast will the U.S. lead a global upturn?

By James C. Cooper & Kathleen Madigan

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