The Knife Must Fall
By Stephen Koepp
Moneymen around the world were yearning to look on the bright side, and it was high time. After weeks of gloom and stress since the Black Monday crash of Oct. 19, the financial markets needed only to see a few rays of hope to justify a rally. But everyone was looking for encouraging signals from the one place in particular, the U.S., that lately has been unable to deliver. . Investors and foreign leaders watched with increasing impatience last week as they waited for America to come across with some evidence of progress in solving its economic problems.
In some respects, the U.S. did. President Reagan gave verbal, albeit offhand, support for the dollar, helping halt the currency's plunge, which has alarmed governments from Japan to West Germany during recent weeks. Even more upbeat was the announcement that the U.S. trade deficit, the closely watched barometer of America's global competitive woes, improved by a gratifying degree during September. But at week's end the financial world was left holding its breath for what had been promised as the most reassuring development of all: a bipartisan agreement to cut the U.S. budget deficit. After three weeks of daily meetings, the 15 congressional and Administration leaders who constitute the special budget summit adjourned without reaching a compromise on billions of dollars in new taxes and spending cuts.
The budget summiteers hoped to reach agreement this week, and waiting any longer could push the financial markets into a deep funk. But for the moment investors took consolation in the temporary halt of the dollar's worrisome slide. In a calculated strategy orchestrated by Treasury Secretary James Baker in the wake of Black Monday, the Government has been allowing the dollar to decline. Baker believed not only that a lower dollar would help ease the trade deficit by making American goods more competitive but also that propping up the currency would force the U.S. to keep interest rates too high just when a recession became possible. In the past month or so, the dollar has dropped 7% against the West German mark and 5% vs. the Japanese yen, which comes on top of an almost 40% fall during the past two years.
Besides rekindling the threat of U.S. inflation, the strategy has angered other industrial countries. West Germany and Japan, in particular, fear that their economies will be crippled by the escalation of their currencies against the dollar. Finally last week Reagan seemed determined to shore up the dollar once again. As he posed for photographs with Israeli President Chaim Herzog, the President was asked about the currency's future direction. "I don't look for a further decline," he said. "We're not doing anything to bring it down." Those words immediately acted like a parachute on the dollar's drop. "We weren't sure the President knew what he was saying, but his comments certainly helped shore up the dollar," said a London currency analyst.
The dollar got a far less ambiguous boost later in the week with the Commerce Department's announcement that the U.S. trade deficit shrank during September to $14.1 billion, down from $15.7 billion in August. The decline was sharper than expected, especially by comparison with the disappointingly small improvement in the previous month's results. The disclosure of those results on Oct. 14 helped trigger the crash five days later. Despite September's narrowing, the trade gap remains huge by any standard. At the current rate, the 1987 deficit is likely to exceed last year's record of $156 billion by some $10 billion.
But the latest figures, in which exports climbed 3.8% and imports fell 2.4% from the previous month, indicated that the dollar's two-year drop is at last beginning to have an impact on the competitiveness of U.S. products. At the same time, consumers are finally starting to turn up their noses at the rising prices of foreign imports. Last week Porsche, the West German sports-car manufacturer, announced plans to cut production because of sharply declining sales in the U.S., where the company sells fully 60% of its output. Meanwhile, the Administration is continuing its efforts to force other countries to remove trade restrictions. The White House announced plans to increase tariffs on Brazilian imports by some $105 million in retaliation for that country's barriers against U.S.-made computer software.
While watching the trade situation, Wall Street struggled to overcome its fears of the bogeyman it holds partly responsible for Black Monday. Computerized program trading, which was blamed by some experts for accelerating the Oct. 19 slide, was permitted to resume early last week. That prompted nervous traders to send the Dow Jones average falling a sharp 58.85 points on Monday. The Dow rocketed back 61.01 on Thursday, fueled by the trade-deficit improvement. The market got more good news on Friday when the Government said that wholesale prices during October fell .2%, which means that the Federal Reserve can stimulate the economy with less fear of rekindling inflation. Despite that promising sign, the Dow fell, dropping 25.20 points Friday to 1935.01, a fall of 24.04 for the week. Observers blamed the final downturn on Washington's failure to reach a budget compromise.
Wall Street and just about everyone else was exhorting Washington last week to get moving on the budget deficit. Declared West Germany's Finance Minister, Gerhard Stoltenberg: "The center is Washington. That's where the difficulties are coming from." In the U.S., a group of more than 150 business leaders, lawyers, educators and former Cabinet members, calling themselves the Bipartisan Budget Appeal, took out a two-page advertisement in the New York Times and the Washington Post to demand spending cuts of at least $30 billion to $40 billion in fiscal 1988. Said the group, which included a range of prominent liberals (Edmund Muskie) as well as conservatives (William Simon): "We recognize that the bold political action now needed is impossible unless the people allow it -- indeed, unless they demand it."
But the budget summiteers in Washington seemed to feel no such ground swell, at least not last week. The group is losing a race against the calendar for an agreement on a bipartisan package of spending reductions and revenue increases before Nov. 20, when $23 billion in arbitrary cuts will take hold under the Gramm-Rudman law. The committee began the week with optimism all around, based on a plan proposed by House Minority Leader Robert Michel of Illinois that would cut the deficit by $30 billion in fiscal 1988 and $45.5 billion in 1989. Michel's proposal was considered a breakthrough because it managed to elicit at least tentative support from the President, even though it contained the tax increases ($8 billion in 1988) that might satisfy congressional Democrats.
House and Senate Democrats then made their counterproposal, which called for a $28.5 billion deficit reduction in the first year and $58.4 billion the second. The biggest area of difference in the two proposals concerned taxes. The Republican proposal called for about $8 billion in new taxes the first year, while the Democrats wanted $12 billion. Other disputes were smaller, though numerous. In the defense budget, the Republicans proposed a $4.9 billion cut from the 1988 inflation-adjusted level, while Democrats called for slicing $5.4 billion. The priorities were reversed in domestic spending categories such as Medicare benefits and farm subsidies, which the Republicans wanted to chop by $5.1 billion and the Democrats by $4.2 billion.
Even so, some items seemed agreeable to both parties. Neither side wanted to raise revenues by increasing rates on income taxes, which the President would almost certainly veto. "They say the first things the man downtown will ask are 'What kind of taxes are there?' and 'How much are they?' " acknowledged Republican Senator Bob Packwood of Oregon. Thus any new taxes will include the closing of loopholes, the imposition of larger fees for Government services, and similarly innocuous revenue raisers. For example, under the Democratic proposal, the income tax deduction for interest on home- equity loans would be limited to the first $100,000 of principal. At the same time, neither side is pushing hard for any cuts in the cost-of-living allowance for entitlements, which would rankle too large a constituent group. Any such reduction in the growth of Social Security benefits, insists Budget Director James Miller, "is not on the table."
When the meeting adjourned Wednesday night, the summiteers broke into big smiles, predicting an early agreement. But something went wrong on Thursday. Griped William Gray of Pennsylvania, chairman of the House Budget Committee: "I think everybody in the room left last night thinking we were close." What were the sudden obstacles? "Everything," replied House Majority Leader Thomas Foley of Washington. The Democrats maintained that Howard Baker, the White House chief of staff, arrived at the meeting Thursday and under orders from Reagan retracted some concessions the Administration had made earlier. Baker denied that claim: "Anyone who tries to characterize it as the White House pulling the plug is completely and totally wrong." The Administration contended that the Democrats refused to nail down any particulars.
This week the group may feel more pressure, since the deadline arrives Friday. Congress could seek an extension of the Gramm-Rudman date, but that would be risky unless the group produces a compromise plan beforehand. Reason: the delay might send a strong signal to the financial markets that Washington is truly incapable of making tough decisions.
Most economists believe a deficit cut is necessary to prevent a loss of confidence that might bring on a recession. The contrary opinion among a few thinkers is that too large a budget reduction would sap momentum from the economy at a weak moment. But that idea seems increasingly implausible in the light of Washington's current paralysis. Says Economist Rudolph Penner of the Urban Institute: "The last thing that should keep you awake right now is the fear that Congress will do too much."
The most asked economic question since Black Monday is whether the crash * will bring a general slump, and yet few economists feel certain one way or another. Says Jerry Jasinowski, chief economist for the National Association of Manufacturers: "We're in the eye of a hurricane right now. All the usual indicators aren't very useful in telling what's going to happen next." While the consensus is that growth will slow to a laggard 1% or 2% early in 1988, there are no concrete signs so far of a drastic consumer-spending slowdown. Last week the Commerce Department reported that retail sales during October were up .7%, not including autos. Even with car purchases, which declined because of an end to rebate promotions, sales were off only a minuscule .1%.
Yet some experts remain gloomy. "The recession is here. It arrived Oct. 20, one day after the sharp plunge in world stock values," says Vincent Malanga, a Manhattan economic consultant. "That kind of market decline is bound to have an adverse effect on consumer confidence. People will borrow less, spend less and save more."
The scrutiny of consumers by economists and the press could itself be oppressive. Says George Schink, senior vice president of WEFA Group, an economic consulting firm: "U.S. consumers are nervous because they are being talked about so much. So far, they aren't doing anything." But consumers will find it hard to remain noncommittal with the arrival of Thanksgiving and the official start of the Christmas shopping season. The amount of charge-card cheer is likely to be the most closely watched economic indicator this season.
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With reporting by Richard Hornik/Washington and Wayne Svoboda/New York