TIME: Almanac of the 20th Century

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<text> <title> (Feb. 05, 1990) Financial Markets:Bear Scare </title> <history> TIME--The Weekly Newsmagazine--1990 Feb. 05, 1990 Mandela:Free At Last? The American Economy </history> <link 04823> <link 01540> <link 00394> <link 00061> <link -0001> <article> <source>Time Magazine</source> <hdr> BUSINESS, Page 48 Bear Scare </hdr> <body> Rising global interest rates spook Wall Street and squeeze the U.S. economy By Barbara Rudolph--Reported by Barry Hillenbrand/Tokyo, Frederick Ungeheuer/New York and Adam Zagorin/Brussels Only a few weeks ago, economists and investors were confident, almost cocky, about the prospects for the U.S. stock market. Since inflation seemed moderate, forecasters widely assumed that interest rates would glide gently downward and bolster Wall Street. But now that assumption seems exquisitely ill timed. Interest rates around the world have suddenly surged, sending stock prices tumbling on exchanges from Tokyo to London and threatening to put the sickly U.S. economy into the intensive-care ward. An uncertain and often bearish mood took over most of the world's stock markets last week. In a fit of gloom on Monday, Wall Street traders sent the Dow Jones average tobogganing 77 points, to 2600.45, the largest single-day drop since the 191-point minicrash last Oct. 13. The Dow closed Friday at 2559.23, down 119 points for the week and 250 points below its Jan. 2 record high of 2810.15. At week's end the Government reinforced Wall Street's fears that the U.S. economy is faltering by reporting that the economy grew just 0.5% during the fourth quarter of last year, the worst performance in more than three years. Said Allen Sinai, chief economist of the Boston Co.: "It shows that the economy ground to a virtual halt in the fourth quarter, with signs of weakness everywhere. The economy is flirting with a recession." The Wall Street rout, which took its cue from rising interest rates and slumping stocks in Tokyo, demonstrated the extent to which global markets have become inextricably linked to one another. The U.S. is now especially vulnerable to changes in foreign markets because it depends on overseas investors to finance a large portion of its federal deficits. While the U.S. economy may need lower interest rates to stay afloat, Japanese and West German central bankers have quite conflicting needs at the moment: higher rates to prevent their surging economies from touching off a sharp rise in inflation. The first sign of trouble emerged a month ago from the Tokyo offices of the Bank of Japan. On Christmas Day, a working day in Japan, the central bank announced that it was raising its prime lending rate from 3.75% to 4.25%, a surprising increase. The move reflected the bank's concern about a 2.5% rise in wholesale prices last year, the first increase in the Japanese index in seven years. Rising oil costs and escalating real estate values account for a good share of the upward pressure on Japan's prices. Many Japanese moneymen thought the Bank of Japan's fears were misplaced. "I think it's mind-boggling to be worried about inflation," said a Japanese commercial banker. But the onset of higher interest rates, which have made Japanese bonds far more lucrative, took the steam out of Tokyo's once irrepressible stock market. Since the beginning of the year, the Nikkei index of 225 Japanese stocks has lost almost 5% of its value. Besides being skittish about the interest-rate rise, investors fear that Japan's Socialist Party could score an upset victory in the lower house of the Diet in the Feb. 18 general election. Since U.S. borrowers draw from the same pool of global funds, the Japanese rate increase proved to be contagious. Rates on ten-year Treasury bonds have climbed from 7.84% to 8.4% during the past month. Money-market speculators sent rates higher because they know that the Japanese, who typically buy as much as 40% of U.S. long-term bond offerings, will be disinclined to invest in U.S. Treasury securities unless American bonds offer significantly higher yields than equivalent Japanese or West German paper. Because of Tokyo's rising interest rates, the premium that the U.S. offers in comparison with Japanese bonds has narrowed to a ten-year low. Says Robert DiClemente, an analyst at Salomon Brothers: "There is very little incentive for any investor to come to our shores these days." A year ago, Japan's ten-year government securities carried a yield of 4.9%, 4 percentage points lower than in the U.S. Last week those bonds posted a yield of almost 6.6%, less than 2 percentage points below the U.S. yield. While American borrowers could afford to pay a hefty premium to finance the U.S. deficit during good times, the country will have a difficult time supporting its debt habit during a slowdown. Says Karin Lissakers, a professor of international affairs at Columbia University: "Let's face it, like any country that has gone deeply into debt, the U.S. has lost its autonomy in economic affairs." The slowing economy worries Wall Street because corporate profits, which are already growing faint, would evaporate during a recession. Of 795 firms surveyed by Zacks Investment Research that have released fourth-quarter results, 51% had worse-than-expected earnings. Another factor depressing Wall Street is the pervasive feeling that the 1980s gold rush of takeovers and leveraged buyouts has finally subsided, largely because the junk-bond market is moribund and banks have grown leery of financing major new deals. Wall Street's pessimism has helped push down London's stock market, where average share prices have fallen 8.5% in the past three weeks. London's market has been buffeted by high domestic interest costs as well, with short-term rates hitting 15%. The Bank of England has been boosting rates to combat an 8% inflation spiral, which has been aggravated by double-digit increases in recent labor contracts. Case in point: last week Ford's British subsidiary agreed to a 10% wage increase for its unionized workers. Even more influential than London's mounting rates, however, are West Germany's. Some economists blame the Bundesbank's late-December increase in its key interest rate, rather than the Bank of Japan's boost, for triggering January's wave of increases. The Frankfurt central bank is concerned about inflation because of West Germany's supercharged economy. In spite of the Bundesbank's credit tightening, the Frankfurt stock exchange is up 1% so far this year. The main reason: investors feel confident that West German companies will realize tremendous gains in the opening of East European markets. With both Japan and West Germany trying to dampen their growth, the risk is that their measures will completely choke it off in the U.S. The situation once again puts the Federal Reserve in a precarious position. If the Fed leaves interest rates where they are, the economy might slide into a recession. But if it eases rates, the already flagging U.S. dollar might slump even more, which could readily spark inflation because Americans would have to pay more for imports. Even so, the Bush Administration hopes that the Fed will ease its grip on credit. Bush publicly called for lower rates when he addressed a group of homebuilders in Atlanta two weeks ago. Said Bush: "I want to see them come down even more." For all the gloomy signals, many U.S. business leaders think that the economy's so-called soft landing has already occurred and that the economy will soon be ready for takeoff again. A survey of executives published last week by Dun & Bradstreet concluded that "business optimism has reached a turning point and businesses are regathering strength for the second half of 1990." Consumers are not so sure. Their cutback in spending during the October-December quarter was largely responsible for the economy's poor performance. For clues to the future, Wall Street investors now look to Tokyo almost as much as to Washington. The biggest topic of speculation on Wall Street is the possibility that Japan's tighter credit will trigger a major slide in the Tokyo market, which stands at 36,874, up from 13,000 in late 1985. Some Wall Street brokerage firms recently began selling a new product: warrants that allow investors to profit if the Tokyo market falls. But most investors do not fear a crash so much as a long, stubborn decline. If the January mood persists, the long-running bull market will go out not with a bang but with a long, drawn-out whimper. </body> </article> </text>