CurrentCommentary
Global View:The bubble deflates
By Ian Campbell,
UPI Chief Economics Correspondent
It has taken longer than anyone could haveimagined. Only now, in mid-2002, is the irrational exuberanceof which U.S. Federal Reserve Chairman Alan Greenspan warned inDecember 1996, coming to an end. The bubble bubbled. Now, slowly,it is deflating. The U.S. economy and the world economy are enteringa new phase.
Two developments in the markets signal thenew phase most clearly. The first is the renewed weakness of U.S.stocks, dropping Friday, 21 June to lows last experienced in terrorism-tornSeptember 2001. The other, still more of a marker, is the fallin the dollar since May, after seven years in which it has appreciated.
Wall Street may say that these developmentsdo not mean so much, that recovery in the U.S. economy is stilltaking place, that violence in the Middle East has troubled themarkets, that rumors about corporate accounting and Brazil's economicand political worries are hurting confidence, that all this isjust "noise" which will eventually quiet down and allowthe U.S. economy and stocks to resume their recovery. We woulddisagree. The shift is important, a turning point, and investorsshould take note.
Let us take, first, the dollar's fall. Itwould be easy to dismiss it. The euro, at about 97 U.S. cents,is still twenty cents down on the level at which it was launchedin January 1999. Nonetheless the level the euro has attained isits strongest against the dollar for more than two years. Hassomething happened in Europe to justify this sudden rally? Wewould say not. It is not the euro that is reviving but the dollarthat is falling. The period of over-exuberance about the U.S.economy, its financial assets and its currency is coming to asudden, long overdue end.
The effects of a weaker dollar will be manyand varied. One of them is already evident: the drop in U.S. stocks.The prospect that the dollar could fall further makes U.S. assetsless appealing to foreign investors. That is important becausea huge inflow of foreign money into U.S. stocks, bonds and concreteassets, such as land and companies, was a feature of the periodfrom 1996 to 2001. (We detailed some of the figures in the GlobalView of May 17, "Au Revoir, Dollar!" still visible onupi.com.)
This inflow of capital not only helped todrive up stock values and drive down yields on corporate bondsand Treasuries, it financed the opening up of large U.S. deficitsin trade and current account (the broadest measure of trade, whichincludes services such as tourism and insurance, as well as dividendsand other international income.)
This week the U.S. Commerce Department reported that the tradedeficit for goods and services grew to a record $35.9 billionin April while the current-account deficit rose in the first quarterto a record $112.5 billion. Both deficits are still at recordlevels and running at annual rates equivalent to about 4 percentof gross domestic product. The reason for that is that U.S. consumershave not yet curbed spending appreciably. And that, in turn iswhy the U.S. economy has as yet escaped outright recession. Itmay not do so for much longer.
How will the current account deficit befunded if capital inflows are no longer going to pour into theUnited States? This, indeed, is one of the new trends the fallingdollar points to. U.S. exports will become cheaper; imported goodswill be more expensive. For U.S. manufacturers who export theweaker dollar comes as good news. But consumers will have to paya higher price for the goods they buy. Consumption, bastion ofAmerica's boom, is likely to go down with the dollar.
The weaker dollar is not the only reasonfor that. As we have argued in many previous articles and perhapsad nauseam, high consumption in the United States reflected thewealth effect produced by exuberant U.S. stock prices in 1995-1999.And the wealth effect has not yet entirely died. Rising houseprices, fostered by very low interest rates, are perpetuatingit. Our advice would be not to buy into this boom. House priceshave been bubbling. This, too, just like the NASDAQ at 5000, isno more than inflation in asset prices. In time house prices areall too likely to emulate the decline seen since early 2000 inthe stock market (though not as steeply as the super-bubble NASDAQ,let us add, lest readers seek to hurl themselves from sitting-roomwindows.)
The stock market will, in our view, fallfurther. This, too, will depress consumption. The blue chips arenow being chipped. Few investors seem to realize it, but manyblue chip stocks soared in the second half of the 1990s just asstaggeringly and irrationally as did the darlings of the NASDAQ.Why are FedEx and Wal-Mart and Bank of America and one stock afteranother close to all-time highs when the U.S. economy has entereda slowdown from which -- at least, in our view -- it is unlikelyto recover quickly?
Internationally, the weaker dollar willspread the U.S. pain. European and Japanese exports are goingto slacken and growth in these competitors will be hurt. Thatin turn will affect demand for U.S. exports. When the United Statesslows, there is nowhere dynamic enough to take up the slack. Thatis a vulnerability from which, through no fault of its own, theU.S. economy cannot escape.
A weak dollar is also bad news, sadly, forexporters of oil and other commodities; that is to say, mainlydeveloping economies. Oil is priced in dollars, but oil exportersimport from around the world in currencies that are now strengtheningagainst the dollar. Their purchasing power will drop.
For members of the Organization of PetroleumExporting Countries such as Saudi Arabia, Iran and Venezuela,and for other heavily oil-reliant countries such as Russia andMexico, a weaker dollar is bad news. Developing countries' dollardebt will also be affected, tending to fall in value and pushingup interest payments. It does not help either that the slowergrowth we can now expect in the world economy will dampen demandfor oil, while supply of oil has been growing because prices havebeen high for more than three years. A slide in the oil priceand other commodity prices is far from impossible later this year.
Wall Street tends to fan optimism. But tothis dismal economist the economic outlook does not look bright.
Everything comes back to the super-chargedgrowth in the U.S. stock market in the 1990s and to the vast amountof money magically created by soaring asset prices. Not just theU.S. economy but also the world economy was distorted. Americanssaved less and less and spent more and more. Capital winged towardsAmerica to join in the fun.
Now, finally, it is all over. The bubblehas burst.
Bursting bubbles are not as much fun asbubbles. But only when the distortions the bubble created areironed out can the U.S. and global economy regain its health.Health will return but it will take time.