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Why the Doomsayers Are Mistaken : Signs of Recovery Are Evident in Reaction to German Rate Move

December 25, 1991|JAMES FLANIGAN

The world has changed.

Four years ago, the United States and Germany got into a squabble over high German interest rates and a declining U.S. dollar and helped cause the worldwide stock market crash of October, 1987.

This time it's different. In the last few days, Germany's central bank raised German interest rates, the Federal Reserve dramatically lowered U.S. rates, the dollar fell, the deutschemark rose--and the U.S. stock market has taken off, surging on Monday and Tuesday tonear record highs.

But stock markets in Germany and throughout Europe are down. Germany's 11 partners in the European Community have had to raise interest rates to keep their currency values aligned with the deutschemark, and governments are worried that their economies may fall into recession.

What does all that mean to you this Christmas morning? It's an important indicator that the coming year will be better for the U.S. economy than is being widely predicted today. It's significant that the Fed acted forthrightly to boost the U.S. economy, with scant concern for international coordination. That suggests to investment managers that government policy has shifted, that extraordinary efforts will be devoted to creating U.S. jobs and improving incomes.

Market reactions here and elsewhere signal investors' belief that the U.S. economy--and the dollar--will recover in 1992. Importantly, reaction tells you that there is no fear of inflation in the United States. If there were, letting the dollar sink would mean higher prices for imported goods and thus a hike in inflation. Now there is no such threat--not simply because a recession-bound U.S. economy imports less, but because international competition won't allow foreign suppliers to raise prices.

Also, the markets are telling you that the unity of Europe, so widely hailed coming into 1992, is no simple matter. Other European nations resent the fact that the German Bundesbank acted out of narrow national interest. Because the old West Germany is spending so much--$70 billion, or almost 5% of gross national product--to support and absorb the former East Germany, German inflation has risen to 4.5%. That may not sound like much to Americans, but Germans fear inflation. And so the Bundesbank upped key interest rates to nearly 10%, causing all of Europe to suffer.

"It was a selfish action," says Heiko Thieme, formerly of the Deutsche Bank and now head of Thieme Associates, a New York-based investment firm. And a self-defeating one. The German economy too has been slowing; trouble in Europe will hit German exporters particularly hard.

The upshot next year will be "an easing of German interest rates," says Kenneth McCarthy, a currency trader and analyst at Rinfret Associates, an investment management firm. That will prompt a revival in Europe and be especially helpful to now highly competitive U.S. exporters.

But beyond the short term, recent events may hold even more fascinating implications. Since World War II, the United States has held things together for the Western economies. It was customer of last resort, keeping open its huge market to goods of other countries, sometimes over protests from domestic business and workers. To be sure, U.S. actions were mainly in its own interest, but undeniably there were occasional sacrifices for the larger international good.

In that long protectorate period, the nations of Western Europe led a particularly charmed life. Industrial competitors to the east, such as Czechoslovakia and Hungary, were hobbled by communist rule. And, except for Britain, Europe's defense and military affairs were essentially provided and paid for by the United States.

Now a new relationship is emerging. U.S. political opinion, says one global investment manager, is concerned that "large parts of this huge market have been surrendered to foreigners." Economists note that a surge in imports stifled domestic production even as the U.S. economy struggled to emerge from recession in this year's second quarter.

And so, U.S. policy is changing. As the Fed's action indicates, primacy now will be given to helping the U.S. economy. President Bush's forthcoming business promotion trip to Asia will reflect the new thinking.

Some analysts fear a dark side to the new policy, a move back to protectionism and away from the international trading system that brought prosperity in the years since World War II.

But reform and change need not mean protectionism. The United States has some economic repair work to do; Europe, trying to unite, needs to resolve its differences; Asia, developing rapidly, must sort out new relationships.

Significantly, the global economy is unperturbed for the long term. While short-term interest rates, such as those governed by the Fed and Bundesbank, differ sharply, rates for long-term government bonds in Europe, Asia and America are converging--only 1% to 2% away from a single global interest rate. The world is changing. Merry Christmas.

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