Global: Two Jolts
Stephen Roach (New York)
The world rarely turns on a dime. But this could well be one of those times. Suddenly, activity in the industrial world is starting to take on a different tone. Two key data points hint at this metamorphosis -- a surprising upsurge of business sentiment in Germany and a record trade deficit in the United States. In response, the glow is off the once sparkling US dollar and ever-fickle foreign exchange markets are suddenly enamored of the new euro. Is this the summer thunderclap that might bring an overvalued US equity market to its knees?
The news from Germany came as welcome relief to our euro team, which has long been out on a limb with an above-consensus forecast of Euroland growth in the second half of 1999 and the year 2000. Germany, of course, has been labeled as the "sick man" of Europe -- hardly comforting to a nation that accounts for fully 33% of total Euroland GDP. Particularly disconcerting has been a surprising deterioration in business confidence in early 1999 that persisted through May. The June Ifo survey changes all that, with the overall gauge rising much sharper than expected back to levels prevailing last fall. Gains were broadly based, reflecting improved sentiment in both manufacturing and retailing. While the June surge comes too late to rescue a weak 2Q99, it points to considerable momentum heading into the second half of this year -- consistent with our prognosis of 3% German and Euroland GDP growth over that interval. At the same time, we shouldn't get too carried away with the June Ifo surprise; at 92.9, the headline index is still well below the 100+ readings that were hit in mid-1994 and again in late 1997.
Juxtaposed against the positive news coming out of Europe was a dramatic, further deterioration in America's already gaping trade deficit. With the deficit surging to a record -$21.4 billion in May, we now estimate this "external leakage" is knocking slightly more than one percentage point off 2Q99 real GDP growth. The US trade balance is now closing in on -2.5% of GDP, within shouting distance of the record -3.0% shortfall that prevailed in the 1986-87 interval when the dollar was falling like a stone. To be sure, the bulk of May's trade disappointment reflected an outsized surge of imports (+2.2%), underscoring the ongoing vigor of domestic demand. But there was a disturbing further slippage on the export front (-0.8%) -- the sixth such decline in the past seven months; in a climate of global healing, such persistent export weakness was not supposed to be in the cards, especially in the face of improved foreign orders sentiment showing up in recent purchasing managers' surveys. But the facts speak for themselves -- America's external imbalance is quickly emerging as the dark side of an otherwise spectacular recovery.
The bear case for the dollar -- predicated on a looming balance of payments crisis -- has long been well understood. Significantly, however, the bear case for the euro has been better understood in the first half of 1999. That could now be changing. Relative growth expectations have mattered a lot in the relative pricing game that has driven currency markets recently. The case for an upside surprise in Euroland economic growth has -- until now -- been nothing more than a forecast; the June Ifo data, however, begin to put some meat on the skeleton of our above-consensus Euroland growth call. They also reinforce the notion that the weakness of the euro has been more cyclical than structural -- consistent with an exaggerated cyclical downshift in the pace of Euroland activity in the first half of 1999. As the pendulum of growth expectations shifts back in favor of Europe, suddenly the relationship between a deteriorating US trade picture and an unexpected weakening in the dollar appears quite robust.
All this, of course, is strikingly reminiscent of the pyrotechnics of a hot summer some 12 years ago. As the trade deficit widened in 1987 and the dollar continued to fall, Fed tightening became the only answer. Such an outcome could be all the more essential in the months ahead. The US central bank has benefited over recent years from the fortuitous combination of skill and good luck. A big change may be afoot on the latter count. With the commodity cycle turning, the US labor market at full employment, and nothing but upside to long dormant wage pressures, a depreciation of the dollar could well be the straw that breaks the proverbial camel's back. For the record, the US stock market is today just about as richly valued as it was in that nasty summer of 1987. History has strange ways of repeating itself -- just when you least suspect it. |
