Japanese have the cheek to ask for more

Sunday Times (London)

September 26, 1999

Screeching sirens, police cars with lights flashing, security vehicles making a hash of traffic. In Washington this weekend we have to cope with all of this because the G-7 finance ministers are in town to pretend that they can take decisions that will affect exchange rates, interest rates, or any other variable that strikes their fancy. And to preen on the television talk shows, the hosts of which take them seriously.

Policy makers here are searching their dictionaries for the Japanese equivalent of "chutzpah", the great Yiddishism that means something more than unmitigated gall. It seems that Japan's government would like the assembled industrialized nations to take concerted action to drive down the yen, which has been rising in value relative to the dollar. Never mind that Japan already runs a huge trade surplus, both with America and with the world's trading nations. Or that America's trade deficit hit $25.2 billion in July, is running at record levels, and some fear is approaching 4% of GDP--a level that many international economists say is unsustainable.

Larry Summers, the economist who has succeeded Bob Rubin as treasury secretary, is not prepared to join the Japanese in pushing the yen down and dollar up. True, he repeats the Rubin mantra that a strong dollar is in America's interest. But no one has ever defined just what exchange rate qualifies for the title of "strong". And Summers has long been urging the Japanese to base their economic recovery on stimulating domestic demand, rather than attempting to get its economy on track by exporting itself out of its recession.

The Japanese case received a further wound when Martin Feldstein, a Harvard professor whose views are given great weight here, used the pages of the Wall Street Journal to urge rejection of pleas for intervention to drive down the yen. "There is no reason why the G-7 countries should participate in an exercise in yen devaluation that would inevitably raise dollar and euro interest rates and weaken its [America's] trade balance."

Which brings us to Alan Greenspan and his colleagues on the Federal Reserve Board. Greenspan is widely believed to rely on a Fed model that shows that the "right" level for the Dow Jones share price average is 8000. That is some 20% below last week's closing level--even after the recent 1000 point tumble in the averages. Although I rather doubt that Greenspan is the prisoner of any such model, or that he believes he is wise enough to pick a "right" level for share prices, my guess is that he is not unhappy at the recent drop in share prices, and would not grieve if they came down a bit more.

For the buoyant market has encouraged consumers to spend and spend. Some have benefited directly from the higher prices; other have benefited indirectly, as the run-up in share prices has led to a run-up in house prices; still others are suffused with the "feel-good factor" that comes from reading only good news about the economy.

Add to that a set of inflationary pressures that has the Fed increasingly concerned. Health care costs, recently quite tame, have turned sharply up. Higher oil prices are putting pressure on trucking and airline companies to raise rates. The recent Daimler Chrysler wage concessions to the auto workers union are the most generous that the unions have been able to wring from employers in more years than most observers can remember. And help-wanted signs are everywhere.

Add to that a dollar that has dropped some 15% against the yen since July (although it remains strong against the euro), making imports more expensive and giving domestic manufacturers room to raise prices, and you have a worried Fed. The majority view is that the Fed will live with its anxiety, and not raise interest rates soon. My own view is that it will stand pat only if the stock market continues its downward trajectory. But should prices turn up, and the dollar remain weak, the Fed will have to put rates up or risk letting inflation get out of hand.

Which brings us back to the G-7 meeting. The United States delegation is well aware of the fact that net foreign investment in this country now stands at something like $1.5 trillion. And, estimates Feldstein, is rising at an annual rate of about $250 billion, as we ship out dollars to pay for imports. At some point foreigners may say enough is enough, and start trading in their dollar assets for assets denominated in other currencies. If that happens on a massive scale, the healthy downward drift of the dollar that is making American exports more competitive might turn into a precipitous plunge.

To stem the tide Greenspan would then have to raise interest rates by more than a little. No Fed chairman would like to do that, possibly triggering a recession. And the thought that he might have to make such a move in the midst of next year's presidential election campaign must be even less attractive to Greenspan, who would like to keep the Fed above the political battle.

The Republicans, however, are not so certain that what is bad for the country is necessarily bad for them. After all, an economic downturn would make it difficult for the Democrats to continue to claim that we never had it so good. And would enable the Republicans to claim that Clinton's veto last week of their proposed tax cut was ill-timed.

All of these cross-currents should make for interesting corridor conversation among the G-7 ministers, who will talk, dine, and then scramble for the special low-priced Concorde that British Air has laid on to whisk the European ministers back to triumphant press conferences before their home constituents.