Almost unnoticed, the industrial world has slid up to the edge of a recession. In the first quarter of 1986, the gross national product of Japan (the world's second-largest economy) was falling at a 2% annual rate after correcting for inflation.
Meanwhile, in West Germany (the third-largest economy in the non-communist world) the real GNP was falling twice that fast at a 4% annual rate.
Little worldwide attention has been paid to the falling German and Japanese economies since on the surface the world's largest economy, the United States, seemed to be growing at a healthy, if not booming, 3% rate in the first quarter of 1986. With strong American growth, the industrial world simply could not fall into a recession.
But if one looks at the details of American growth, it is clear that the U.S. economy is also at the edge of a recession.
After correcting for inflation, final sales to consumers, business, and government were falling at a 1.7% annual rate.
All of that seemingly healthy growth was in fact an unwanted accumulation of inventories. Unwanted inventories of finished goods, goods in the process of production, and raw materials rose by $40 billion and offset the negative growth that would otherwise have been occurring in the United States.
Inventory growth, however, is not sustainable economic growth. No business for long buys raw materials to make goods, only to pile those goods up in their warehouses.
When the economies of the first-, second- and third-largest economies start slipping, one has to take the prospects of a recession very seriously because of the interactions set in motion between these economies.
Japanese and German exports into the American market sag because final sales are falling in America, and because the German mark and Japanese yen are rising in value relative to the dollar.
In response, the German and Japanese economies start to decline. But with declining German and Japanese economies, exports from the United States to these countries do not pick up, even though the dollar has declined in value relative to the mark and the yen.
This stalls one of the expected engines of American growth. Initially inventories pile up, but rather quickly production is cut back and the American GNP starts falling.
Made in Washington
Recessions are not foreordained by the stars, however. They are made in Washington, Bonn, and Tokyo. When signs of recession begin to appear, the appropriate response is for economic policy-makers to press down on their monetary and fiscal accelerators.
Money supplies are pushed up and interest rates are pushed down. Taxes are cut or expenditures increase. Systematic efforts should be made to expand aggregate demand.
In the last 25 years, recessions have occurred not by accident but by design. America has had four recessions (1969-70, 1974-75, 1979-80, 1981-83) in that period of time, but each and every one of them was deliberately caused by government economic policy-makers.
Step on Brakes
Inflation would break out and policy-makers would step on their fiscal and monetary brakes to produce a recession to force unemployment up to prevent wages and prices from rising.
But this is not a period of time with inflation on the horizon. Consumer prices are rising at a very modest rate in the United States, Japan, and West Germany, and producer's prices are actually falling at substantial rates.
If there was ever a time where the fundamentals would seem to be consistent with concerted action to stimulate aggregate demand and prevent an incipient recession, this would seem to be it.
In the United States, however, the large federal deficit means that all of the talk is about cutting expenditures or raising taxes. To do either would be to contract aggregate demand and make recessionary pressures stronger.
But whatever happens on the balance-the-budget front, the U.S. government is unlikely to take vigorous fiscal actions to stimulate demand.
On the monetary side, the Federal Reserve Board is afraid to lower real interest rates for fear that it will cause a run on the dollar and deprive the United States of the foreign lending on which it is now dependent for its investment funds.
If those funds were to disappear, the effort to produce lower interest rates might well produce higher interest rates or require the Fed to print massive amounts of money.
This leaves the stimulus burdens on West Germany and Japan, but neither is willing to act. Both countries are reluctant to cut taxes or raise expenditures, since they both have just succeeded in sharply cutting their budget deficits.
There is room to cut interest rates in both countries. Real rates are high by historical standards--especially if one uses those falling wholesale price indexes to calculate the real rate of interest. But so far neither country has moved vigorously to stimulate demand.
Sitting and Waiting