The big picture……..Part 3
San Diego Union Tribune, Sunday, December 6, 1998
DON BAUDER
The world's awash in castor oil and whiskey
December 6, 1998
You're sitting up with a sick friend, enjoying whiskey while he gags on castor oil. It's great -- if you don't catch his disease. That's America's situation today. Financially flush consumers are chug-a-lugging low-priced imports from the ailing, deflation-choked Asian economies. For the moment, the United States has the best of all worlds: inflation in financial assets (stocks and bonds), deflation in goods and services prices. Trouble is, it can end. It did this summer, temporarily. Among other things, Russia defaulted on its debts, and the Federal Reserve arranged a panicky bailout for Long Term Capital Management, a hedge fund. Investors became frightened and poured money into the safest instruments. Most stocks went into a bear market, and the world economies worsened. Then, the Federal Reserve served up gallons of whiskey in the form of three interest rate cuts, and we all got sloshed again at the bedside of our Asian brethren, who remained very ill. Now, deflation continues. Last week, oil futures prices hit a 12-year low. Copper prices fell to an 11-1/2-year low. Coffee prices were their lowest in two years. Japanese exporters are slashing prices on such items as digital video disk players and digital cameras. The Japanese must slash such prices: their own economy is sinking, their banks are wallowing in bad loans, and other countries that once constituted their best markets are also in sick bay. U.S. consumers are gobbling up DVD players and digital cameras for incredibly low prices. Meanwhile, prices of personal computers are also down. At one chain, 1,000 people were lined up last week to buy an IBM PC with printer for $599. Import prices are coming down swiftly. Therefore, prices of competing U.S.-made products are declining. California exports are falling. Silicon Valley is starting to feel it. Several San Diego companies -- Callaway, Qualcomm, Encad, to name a few -- have experienced softening in Asian markets. In some cases, layoffs have resulted.
The U.S. is not in a recession. But profits are in a recession. Third quarter earnings were down more than 6 percent from a year ago -- the biggest drop in almost a decade. Companies can't raise their prices, but labor costs are rising. Productivity gains aren't easing the squeeze. The Fed's interest rate cuts have been absorbed by the stock market and aren't easing the credit crunch very much: Interest rate spreads remain high, and more than one-third of U.S. banks are tightening -- not loosening -- lending requirements.
Around the world, there is overcapacity in many key industries, such as autos, semiconductors and chemicals. Deflation results. "The industrial sector is increasingly stressed," says Bruce Steinberg, chief economist of Merrill Lynch. The manufacturing capacity utilization rate dropped to 79.4 percent in October. "That is incredible," Steinberg says. "In an eighth year of an economic boom, the utilization rate is at levels not normally reached until the economy is well into a recession." Thus, capital spending is likely to be weak this year. There is no reason to add capacity when there is already too much of it.
This means the American consumer, two-thirds of our economy, will have to keep the U.S. economy afloat -- and also be the buyer of last resort for the world economy. Already, consumers are too deeply in debt, their spending is growing faster than their income, and their savings are dipping into the negative. But with prices declining and stock market prices rising, they still feel flush. However, with profits so anemic, "more layoffs in the name of cost reduction are likely," says Peter Donovan, president of Wright Investors' Service in Bridgeport, Conn. Indeed, Challenger Gray & Christmas, which tracks layoffs, says that job cuts this year will beat 1993, the worst year of the decade. Last week, there were plenty of Asia/deflation-related layoffs. Boeing, beset by weakness in Asian orders, will slash 48,000 jobs. Kellogg, hurt by competitors' price slashes, is whacking employment. Exxon and Mobil, merging because of low oil prices, will cut 7 percent of combined employment. Meanwhile, the world situation is deteriorating. Brazil got a $41.5 billion aid package, but its economy is contracting as interest rates soar. Russia's debt is still a cancer. "Japan remains mired in deflation," says economist Jack W. Lavery of Merrill Lynch. The Japan Center for Economic Research predicts that the Japanese economy will contract through the year 2001.
"Mexico faces weaker oil prices," says Lavery, and that won't help border areas, such as San Diego.
Nirvana: That's when stock prices inflate and goods prices deflate. But can it last? As we've seen, the deflationary ills besetting our foreign friends eventually show up here and depress the manufacturing sector, creating layoffs and reducing income. The current nirvana could continue. With incomes weakening, however, prices may drop more. Then the Fed and other world central banks will create even more liquidity. That should re-stimulate consumption unless one day -- as in Japan right now -- consumers decide they need to save for a different type of liquidity: a rainy day. Then everybody will chug-a-lug castor oil.
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