TIME: Almanac 1993/TIME Almanac 1993.iso/time/caps/87/87capbus.2

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                                                                                November 16, 1987

ECONOMY & BUSINESS

Looking the Other Way


The U.S. lets its currency take a steep dive


At first the strategy was purely a matter of debate and
speculation. It was the question of the decade. What would the
Government do to prevent Black Monday from turning into Bleak
'88?  Now, less than a month after the stock-market crash, the
Reagan Administration's plan has emerged in sharp relief. The
main objective:  avoid a 1988 recession at almost any cost.
That means encouraging the Federal Reserve to pour money into
the economy and reduce interest rates. But in doing so, the
Administration has had to make a sacrifice, the U.S. dollar.
Treasury Secretary James Baker, the chief architect of the plan,
maintains that any additional attempt to prop up the dollar with
relatively high interest rates could choke the economy and
further devastate the stock market.

Yet to allow an already weak dollar to fall still further, even
though most economists agree it is inevitable, is a dangerous
move that will carry a whole new set of economic risks. In the
short run, a dollar lacking firm U.S. support could spin out of
control; over the longer haul, its eroded purchasing power could
reignite inflation. In an interview last week with the Wall
Street Journal in which he acknowledged the new policy and sent
the dollar plunging to new lows, Baker said, "I don't think
we're out of the woods yet. I think markets are still fragile."

To shore up the markets and keep the dollar from diving too far,
the Administration must achieve two other goals of its complex
strategy-- a major budget-deficit reduction and better
economic-policy coordination with West Germany and Japan. On
those two fronts came small but potentially significant
victories last week. Congressional leaders and Administration
officials reached an apparent breakthrough in their special
deficit-cutting summit, in which they have been struggling for
two weeks to compromise on a minimum of $23 billion in
reductions. For the first time, Republican leaders came up with
a proposal containing tax increases that President Reagan gave
hints he might accept. It was, declared Republican Congressman
Trent Lott of Mississippi, a "bold stroke. Fair, simple,
direct."

Meanwhile, the Administration won at least a symbolic victory
in its efforts to persuade West Germany to spur its economy.
The standoff between Baker and his West German counterpart,
Finance Minister Gerhard Stoltenberg, eased slightly, aided by
an announcement from the German central bank that it would cut
two of its less important interest rates. If Bonn were to
follow up on that step and reduce its prime interest rates,
there would be less pressure on the dollar. Reason:  the
greenback has been declining because U.S. interest rates have
lately been falling in comparison with those of West Germany
and other countries. Moreover, lower interest rates could
stimulate Germany's appetite for American products and thus help
reduce the troublesome U.S. trade deficit.

Surprisingly, the dollar's dip did not unduly upset Wall
Street, where the wild swings of recent weeks moderated
considerably. The stock market seemed relieved that the
Government would not defend the dollar with higher interest
rates. Indeed, the new accommodative posture of the Federal
Reserve enabled major banks last week to reduce their prime
lending rate by a quarter of a percentage point, to 8.75%, a
full point lower than the pre-crash level at some institutions.
 While the Dow Jones industrial stock average fell 34.48 points
during the week, to close at 1959.05, its newfound stability
seemed to give reassurance to investors.

The currency markets, by contrast, were chaotic. The dollar
plummeted as low as 134.4 yen during Tokyo trading Friday, the
U.S. currency's lowest level of the postwar era. The dollar has
now fallen more than 5% vs. the yen since mid-October and fully
48% from its peak in February 1985. Against the West German
mark, the dollar reached a historic low of 1.67, a 46% fall
during the past 2 1/2 years.

The plunge raised immediate, anxious questions:  How far would
the dollar drop?  What forces would eventually stop its fall?
 WHile most economists believe the currency must decline at
least a further 10% to help ease the trade deficit, they are
concerned that the descent may be difficult to control. Said
a former Treasury official: "Baker is playing high-stakes Texas
poker."  Says Economist Charles Schultze of the Brookings
Institution:  "We do not get a stable dollar by snapping our
fingers. We are playing a very chancy game."

It may be the only game in town. Virtually everyone concurs
that the Fed's pouring of liquidity into the marketplace is the
best short- term tonic for preventing the stock-market crash
from turning into a general economic slump. In fact, many
economists blame Fed Chairman Alan Greenspan for helping set the
stage for Black Monday by tightening up in the first place, when
he led the board in a decision in September to raise the
so-called discount rate, which the Fed charges on loans to
financial institutions, from 5.5% to 6%. At the time, the
Reserve Board was aiming to quash inflationary pressures that
it sensed were creeping up.

Once the crash occurred, however, Greenspan promptly changed
course. "He managed to turn on a dime," says Jerry Jasinowski,
chief economist for the National Association of Manufactures.

Greenspan's switch in policy may have been even more wrenching
than it appeared, because it represented an abrupt departure
from a tighter-money direction endorsed in March by his revered
predecessor as Fed chairman, Paul Volcker. Says Steven Roberts,
former assistant to Volcker and now an economist for the account
firm of Peat Marwick: "Comparing Greenspan to Volcker is natural
but misguided. Volcker had spent most of his career as a
central banker. Greenspan has to learn what it means to be a
central banker, and he is doing quite well."

Greenspan's lot may be even tougher than Volcker's was. The
new chairman must fend off a recession by keeping interest rates
low, but he will come under excruciating pressure to raise them
again if the dollar needs rescuing. Any little upward nudge in
interest rates, however, is likely to send the stock market into
a tank again. When the Fed's open market committee met last
week for the first time since the crash, some economists hoped
the group might rescind September's discount-rate increase. But
no such announcement came. One reason may be that the committee
has too little information so far about Black Monday's effect
on the economy. Without solid proof that growth is imperiled,
the Fed is probably reluctant to announce a dollar-endangering
drop in the discount rate.

One survey of 35 economists last week predicted that the economy
will expand at a humdrum 2.8% annual rate during the last half
of 1987 and a sluggish 1.4% in the first half of 1988. While
that is a definite slowdown, it is not quite a dead halt. A few
economists, however, predict a recession. Among them is Irwin
Kellner, chief economists for Manufacturers Hanover, the New
York City banking company, who thinks the U.S. economy will
shrink by 2% in the first half of 1988 before quickly
recovering.

Economists have kept a sharp eye on consumers to see whether
they have become cautious and tightfisted, but the evidence so
far is hazy. Last week domestic automakers reported a brisk
10.8% increase in passenger-vehicle sales during the last ten
days of October, compared with the same period last year. Those
customers, however, may be people who had already intended to
buy a car and went ahead with those plans in spite of Black
Monday. Many car dealers now say business is slowing by as much
as 30%. Major retailers, who released October sales figures
last week, mostly say business has proceeded at the same
sluggish pace they were experiencing before the crash. Sears,
for example, reported that October sales were up 1% from the
same month in 1986, an increase that did not keep pace with the
current 5% rate of inflation. Last week the Labor Department
reported that the unemployment rate during October inched upward
to 6% from September's 5.9%, which supported contentions that
the economy has slowed only slightly.

Polls seem to show that consumers are worried,but not enough to
change their buying behavior very much. In a telephone survey
of 800 adults conducted last week for E.F. Hutton by the polling
firm Yankelovich Clancy Shulman, 66% of consumers said they were
"more concerned about the economy" in the wake of recent
financial turbulence. But only 36% said they were more likely
to hold off making major purchases. In another survey, in which
the New York Times polled 1.549 adults from Oct. 29 through Nov.
3, fully 52% of those interviewed said they thought the economy
was in either very good or fairly good shape.

Like the rest of America, politicians in Washington seemed less
likely to change their behavior patterns as memories of Black
Monday drifted away. When congressional and Administration
leaders opened their second week of emergency budget-cutting
meetings last week, their post-crash burst of bipartisan
magnanimity was on the wane. "The worst thing for the summit is
stock-market stability. it takes the pressure off," says
Economists Schultze.

In fact, the apparent slowdown in the process started to rankle
foreign leaders, who fear that a U.S. recession would be
contagious. British Prime Minister Margaret Thatcher sent Reagan
a personal letter, urging him to take swift action in the budget
summit. A story in the London Evening Standard carried the
headline YANKEE DOODLE DITHERERS.

The budget talks seemed to trip on party lines as soon as the
15 delegates began to discuss particulars. with good reason.
 The politicians are getting no clear mandate from their
constituents. In a Los Angeles Times poll of 2,463 adults, 69%
of those interviewed agreed that the budget deficit is a serious
problem, but an almost equal number, 64%, opposed raising taxes
to close it. Moreover, they offered little guidance on how to
trim spending. Only  32% wanted to reduce defense outlays, and
just 23% approved cutbacks in domestic programs.

Each day the summiteers seemed to grow gloomier as they emerged
from their secret sessions in Room H-137 of the Capitol, where
they huddled over blue tablecloths and scribbled their estimates
on yellow legal pads. The President caught flak from Democrats
for his alleged failure to get involved in the process, but on
Friday he stepped in. Meeting at the WHite House with Republican
leaders, he lent tacit support to a proposal by House Minority
Leader Robert Michel of Illinois that would cut the deficit by
$30 billion next year and $45.5 billion in 1989.

Reagan's encouragement was notable because the plan carries
mild doses of the two things he abhors:  tax increases ($8
billion in fiscal 1988) and defense cuts ($13 billion below the
Administration's proposed budget). But those ingredients
increase the proposal's palatability for Democrats. "It's a
strong contribution. I'm optimistic," said William Gray of
Pennsylvania, chairman of the House Budget Committee. The
committee's deadline for agreeing on a plan is Nov. 20, when $23
billion in arbitrary cuts, split roughly fifty- fifty between
defense and domestic programs, would go into effect under the
Gramm-Rudman law.

The Administration achieved a different sort of cooperation
earlier in the week, when the West German central bank announced
it would, among other things, cut its so-called Lombard rate,
which it charges on loans to other German banks, from 5% to
4.5%. While mostly symbolic, that interest-rate cut is the
first tiny concession in months to increasing U.S. pressure on
the Germans to allow their economy to expand more rapidly. But
Germany will have to make much broader cuts in interest rates
to bring about a significant acceleration of growth.

Faster growth in both West Germany and JApan is essential if the
U.S. is to curb its trade deficit, which reached $156 billion
last year. But while Japan has agreed to cut taxes and interest
rates and to boost domestic spending, West Germany, which posted
a $52 billion trade surplus last year, has been less
cooperative. Says an irate European central-bank official:
"The Germans are becoming unbearably smug about their economic
performance. It's not just the Americans who are getting angry.
 I think we are al mad at them, especially the French."

The West Germans are reluctant to push their economic growth,
which is expected to be only 2% next year, because of a deeply
ingrained memory of the hyperinflation the country experienced
in the 1920s. Says West German Economist Dieter Mertens:
"Inflation is regarded by most Germans as on a par with
Communist domination and morally equivalent to the work of the
devil."  Even a rate of 3% or 4% is unacceptable high to Finance
Minister Stoltenberg, whose resistance to foreign prodding has
earned him the nickname "Ice Prince" among U.S. economic
officials. The 59-year-old, white-haired Stoltenberg, the son
of a Protestant pastor, is revered in West Germany for his
fiscal rectitude, which enabled him to reduce the country's
budget deficit by nearly a third, to $13.1 billion, in five
years. Says a West German economist, speaking for the
population at large: "Beneath everything, we are all
Stoltenbergs."

What may finally have persuaded the Finance Minister to make a
least a mild concession on interest rates was the beating that
German exporters are taking because of the rise of the mark
against the dollar, which makes their products more expensive
in the U.S. In an interview last week, Stoltenberg told a West
German newspaper, "We now want to cooperate again
constructively."  One eventual outcome could be a meeting among
the finance ministers of the seven major industrial democracies,
the so-called G-7 group, to work out a plan to support the
dollar at its new, lower level. Indeed, right now the battered
currency could use a little help from its friends.

--By Stephen Koepp.  Reported by Rosemary Byrnes/Washington and
William McWhirter/Bonn