Close Call

By GEORGE J. CHURCH

It won't be dramatic. It might not even be recognizable for a long while; turning points often stand out clearly only in retrospect. But with all those caveats, it looks as if the global financial crisis is passing a rather modest turning point. At least it has stopped getting worse, and it may be contained in Asia rather than spread to other regions of the globe. As one happy result, odds favor the U.S. economy's getting through 1999 with nothing worse than a slowdown in growth--not the recession very recently feared.

That is the consensus of TIME's Board of Economists, which gathered recently in Manhattan to assess 1999 prospects for the global and American economies--in that order, which reverses its custom. But then these are tail-wagging-the-dog days. Rather than the progress of the American economy largely determining global trends, it is the U.S. that is now under the heavy influence of events overseas--something that hasn't really happened since the oil shocks of the 1970s.

What is happening overseas is still not what you would call pretty. Many Asian economies will be slumping throughout next year, though more slowly than in 1998. Once a general upturn begins, perhaps in 2000, it will take years for those countries to regain the prosperity of 1996. And there are still pitfalls that may take intricate maneuvering to avoid.

Even so, Robert Hormats, vice chairman of Goldman Sachs International, believes that "for most of Asia, the financial situation has stabilized, but the region has not yet turned the corner." Markets are recovering, and some currencies are rising in value after a wild spiral of devaluations. Moreover, most Asian countries are beginning banking reforms, while governments are spending more to stimulate their economies. A worldwide lowering of interest rates, led by the U.S. Federal Reserve Board, has helped support an improved outlook.

True, the 1997-98 crash has left Asian countries, companies and banks with manufacturing overcapacity and huge debts, which have to be reduced. That, says Hormats, "means more bankruptcies, more unemployment and continued recession for most of 1999" as the excesses are written off. But the free fall is over: Thailand and South Korea, in his view, might begin to grow a bit by the end of 1999, while Japan will improve--though only from negative to zero growth. General recovery region-wide will not begin until 2000.

If then, cautions C. Fred Bergsten, director of the Institute for International Economics, a Washington think tank. More bearish than Hormats, he will allow that "maybe the worst of the crisis is behind us." But Bergsten emphasizes the difficulties of significant recovery--primarily that it will require "deep changes in banking systems, very fundamental changes in corporate governance systems."

A big drawback, as both Hormats and Bergsten point out, is that Asia lacks the armies of highly trained banking supervisors, regulators and portfolio managers needed to make sure that banks "make loans on the basis of credit analysis rather than who is the favored cousin," as Bergsten puts it. Given the shortage of expertise, in his opinion, it will take five years or more before Asia in general gets back to pre-crisis levels of production and income--as long as 10 years for Indonesia, currently ground zero of the disaster and torn by political and social upheaval that has drastically impeded economic reform.

There is still a danger that even as Asia slowly heals, its so-called financial flu will spread to other regions, especially vulnerable Latin America. The test case is Brazil, already battered by financial storms, which Hormats calls "the domino that the world is determined not to let fall." Bergsten thinks the odds are no better than fifty-fifty that Brazil can avoid a currency devaluation, which would trigger others in Latin America and perhaps even another round in Asia. Hormats is more hopeful, largely because the International Monetary Fund and the biggest industrial countries (led by the U.S.) have learned some lessons from earlier bungled rescues. They now realize, he says, that first, "you don't wait until things have collapsed totally to come in; second, you go in with a substantial sum of money; third, you give the money up front and don't dribble it out as in Asia." His guess: Brazil will suffer a recession in 1999, with output dropping about 2%, but will not be pushed into devaluation.

If so, the leading candidate for reappraisal becomes, of all currencies, the U.S. dollar. That, at least, is Bergsten's opinion. Right now, Bergsten notes, an outsize 60% of global trade and financial transactions are conducted in dollars, mainly because the greenback for generations has had no serious competitor as a world currency. On Jan. 4 it will get one: the euro, which becomes the unified currency of 11 European countries that together produce nearly as much as the U.S. does, account for more of world trade and have larger monetary reserves. This will make the euro an attractive unit of value for investors worldwide.

The result, Bergsten predicts, is that the euro and the dollar each will eventually finance about 40% of world trade and investment. So demand for the dollar will fall, and its price in terms of other currencies will also drop. Not by easy stages either, says Bergsten: "Sadly, the exchange markets always overshoot," meaning that the dollar's value is likely to drop further than its real worth requires, before correcting.

But Bluford Putnam, president of CDC Investment Management Corp., the U.S. subsidiary of a giant French-based money-management concern, Caisse des Depots et Consignations, strongly disagrees. His scenario: the countries of "Euroland," as the 11-nation currency bloc is being called, will focus more than ever on pumping up their domestic economies, which are suffering from slow growth and high unemployment. Though the new European Central Bank will officially be independent of any national government, political leaders of the 11 countries will be pressing the bank to lower interest rates and keep them down, in coordination with the U.S. Federal Reserve. (Early in the month, all 11 countries, for the first time, cut interest rates simultaneously.) Sharp fluctuations in exchange rates would be a very unwelcome complication to this effort. So, Putnam predicts, financial technocrats will get involved. "Instead of getting wild swings, we may end up with fixed exchange rates" between the euro and the dollar, set by tacit agreement between the Fed and the Euroland bank.

In Bergsten's view, however, another force will also press the dollar down. The U.S. current-xaccount deficit is headed for a record $300 billion in 1999. It would be even worse if gains in financial transactions and services such as advertising and insurance were not offseting part of the gargantuan deficit in exchange of goods. The trade deficit, or excess of merchandise imports over exports, will be roughly $350 billion. So the U.S. is spilling too many dollars into currency markets for the greenback to maintain its present value against most other moneys, euro or no euro.

A decline in the dollar should eventually bring down the trade and payments deficits, by making U.S. goods and services cheaper in other countries and imports more expensive here. But those effects might not be felt for three or four years--certainly not in 1999. Next year, members of the TIME board say, the worsening deficits will exert enough drag on the U.S. economy to produce, finally, the slowdown so long forecast.

But so far, notes Lynn Reaser, chief economist of NationsBank Private Client Group, a division of BankAmerica, the economy has been growing at a remarkably even clip. She believes gross-domestic-product growth in the second half of this year "will turn out to be about 3.5%, actually equal to the first half, which was in turn equal to the second half of 1997."

Manufacturing output and employment are being hurt by the rise in imports and drop in exports. But, Reaser points out, manufacturing "accounts for less than one-fifth of the total U.S. economy." Rising consumer spending has kept the other 80% growing, thanks in her opinion largely to the "wealth effect"--that is, the tendency of rising stock prices to make people feel richer and able to spend freely, even if many of their gains remain on paper. Reaser notes that retail sales rose strongly early in 1998 along with the booming market, faltered in late summer as stock prices dived but have come back with the October-November rebound in share prices.

Reaser does expect a slowdown in 1999, to a growth rate between 2% and 2.5%--probably closer to the higher figure. But she sees only a 20% chance of recession, vs. the fifty-fifty odds some economists were quoting as recently as September. She expects a leveling off in housing and a decline in nonresidential construction, as well as "a widening of the trade gap," but thinks they will be largely offset by further gains in consumer spending, business investment in information technology and "some increase in government spending." Profits of companies whose stocks are included in the Standard & Poor's 500 index will rise about 5%, she forecasts, vs. a flat performance this year but well below the double-digit gains of 1997 and earlier years. Inflation, Reaser thinks, is bottoming out this year, with the Consumer Price Index rising a trifling 1.5%. She expects about 2.4% in 1999--still no cause for deep worry.

Allen Sinai, chief global economist for Primark Decision Economics, a prominent forecasting and consulting firm, is close to Reaser on overall numbers; he predicts 1999 GDP growth of 2% to 2 1/4%. But his tone is considerably less cheery. Many economists, he notes, would consider a 2.5% increase "a trend rate of growth"--that is, roughly what the U.S. could expect to average over a long period. Sinai, however, belongs to a "new economy" school that believes rising productivity makes a 3% annual average possible. Thus he views next year's likely increase to be significantly below potential--perhaps meriting the term growth recession.

Whatever it might be called, Sinai believes, the economy's gains will be too small to prevent a rise in unemployment, from the 4.4% in November to around 5% at the end of 1999. He agrees, however, that the U.S. can fight off an outright recession, largely because, like Reaser, he expects consumer spending to continue to be strong. Some economists are worried that official statistics indicate consumers are spending more than their income, and fear this cannot continue. Sinai, however, says much of the spending is coming from sources the government does not count as "income"--specifically, money that people raise by cashing in stock-market profits or refinancing the mortgages on their homes.

A slowdown that does not turn into a recession, Bergsten warns, is still likely to lead to "a very significant increase in U.S. trade protection." Even a modest slowing of output and rise in unemployment, he fears, will be widely blamed on cheap imports. The Clinton Administration may give in to protectionism to please the AFL-CIO, which it is " beholden to" for the Democratic successes in the November elections. Hormats voiced fears that protection is all too likely to win support from the Republican right, now a stronghold of economic nationalism, as well as the Democratic left, creating a strange but potentially strong alliance.

A protectionist surge could be disastrous in the long run for the U.S. as well as the world economy, since they are now so intertwined. But that is, at worst, a long-run threat. Board members expect the economic expansion to keep rolling, even though more slowly, not only through 1999 but also on into the following year. Forecasts that far ahead, of course, are always risky, the more so given the still dicey international situation. But it is worth noting that if the expansion lasts even through the first two months of 2000, it will break the 1961-69 record and become the longest in U.S. history.

Highlights from the Board of Economists meeting will be seen on Business Day, airing on CNN and CNNfn from 6-7 a.m. (E.T.) on Wednesday, Dec. 16.