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'Fortress America'?

The financial firestorm that began in Asia is spreading around the world--and Americans assume they're safe.

June 21, 1998|Roger C. Altman | Roger C. Altman, an investment banker, served in the U.S. Treasury Department under Presidents Jimmy Carter and Bill Clinton

NEW YORK — Despite last week's tremors, an eerie calm hangs over U.S. financial markets. They reflect a seeming oblivion to the spreading international financial crisis. The U.S. stock market remains at stratospheric highs, interest rates have hit 30-year lows and Wall Street sees the U.S. economy as impregnable. It is America as a financial island.

But this isolation is increasingly untenable. There is a financial firestorm spreading across East Asia, Japan, Russia and parts of Latin America. Currencies have collapsed, capital has fled and economies have sunk into recession on an unprecedented scale. The International Monetary Fund dangerously has depleted its resources trying unsuccessfully to contain it. These events constitute the worst financial crisis since the birth of the modern, international monetary system in 1944, and they seem to be accelerating.

Our Federal Reserve and Treasury are increasingly worried about a world market meltdown. Indeed, their latest warnings were particularly ominous. Treasury Secretary Robert E. Rubin hinted that the crisis may spread to Europe. Federal Reserve Chairman Alan Greenspan said financial conditions in Asia are worsening. How would such a meltdown happen? We saw a glimpse of that last October.

At that time, the Asian financial crisis was just coming into full view. Currency and stock markets in four of the leading Asian nations had been crushed, and then the mighty Hong Kong market suddenly plunged. This triggered huge, same-day declines across Europe and a stunning 554-point drop in New York. The next morning, the financial world held its breath. Luckily, markets stabilized. But, like the blinding flash of a nuclear test, everyone saw the global linkage and the overwhelming risks in these markets.

Could the U.S. economy be damaged by such a market meltdown? Yes. Indeed, Greenspan obliquely refers to a financial shock as the one threat to continued U.S. economic strength. He means that a truly steep fall of our stock market, or the collapse of a large U.S. financial institution, could torpedo consumer and business confidence and stop our economy in its tracks. That is precisely what is happening now in Japan: Consumers and businesses are frightened and have stopped spending.

In this unstable setting, there are five reasons why the U.S. financial markets and our economy are dangerously exposed. First, our stock market is already at Himalayan levels and poised for a correction, even apart from the international crisis; it has tripled over the past six years. Most valuation measures, like price-to-earning ratios, are at record levels. It is said that the colossal amounts of available money must be invested somewhere and can only flow into stocks. But that nostrum belies any grasp of financial history.

Second, the financial crisis is threatening U.S. corporate profits, a foundation of our market strength. After eight years of domestic expansion, profit gains already are down to low single-digit rates. But, Asian demand for U.S. goods and services, is dwindling, signaled by the sharp declines in 3M and IBM shares last week. Moreover, the sliding Japanese currency is badly undermining the overall international competitiveness of U.S. products. While the evidence is just coming in, these events can only further impair corporate earnings.

Third, the international financial crisis is worse than it looks. Some of the former East Asia "tigers"--Malaysia, for example--still officially project growth for 1998, but the reality is that all their economies are contracting. The economy of Indonesia, the fourth most populous nation in the world, could shrink at the terrifying pace of 20% in one year. Hong Kong, the economic paragon, may itself be on the verge of recession.

Conditions in Japan, the world's second-largest economy, have deteriorated to alarming levels. Last week, the data signaled not just recession, but a sharp one, perhaps the worst since the oil crisis of the early '70s. The country's banking system is still laden with hundreds of billions in bad loans and thus frozen. Also, its unemployment rate, usually negligible, is about to surpass the U.S. rate. The Japanese currency, the yen, plunged to a 10-year low against the dollar.

This decline is particularly grim because Japan usually serves as the engine of growth for Asia. It has long been the biggest single market for East Asian products, but that market is now slumping. The yen's plunge also means that Japanese products will be far cheaper and more competitive compared with Asia's. It is also problematic for the United States, particularly in the auto and capital-equipment sectors, for the same reason.

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