Global Financial Crosscurrents Alter US Outlook

THE Pushmi-Pullu pattern among the world's three largest economies accounts for much of the tension in world financial markets today. As the United States struggles out of its recessionary hole, Japan and Germany are still roaring ahead - temporarily decoupled from the global economy.Meanwhile, the dollar has surged despite a sharp decline in US short-term rates relative to rates in Japan and Germany. Federal Reserve actions have led to a sustained acceleration in US monetary growth. Officials in Tokyo and Frankfurt are still trying to slow things down. Against this background, finance ministers of the seven largest industrial democracies met in London in late June. Double-talk aside, their aim was clearly to cap the dollar's rise. As French Finance Minister Pierre Beregovoy put it, the present level of the dollar "is appropriate.... It should not go any further." He added that the meeting provided an opportunity "to give an indication to the market" on the dollar and interest rates. These crosscurrents in global finance have distorted world financial markets. Prices of high-grade US dollar bonds have dropped in recent weeks, notwithstanding an exceptionally favorable domestic environment. Private credit demand is at a postwar low. Underlying inflationary forces are receding. The problem is overseas. The perception of high real returns on German bonds has acted like a magnet, pulling US rates up and pushing US bond prices down. However, this may soon change. Karl Otto Pohl, the outgoing president of the German Bundesbank, said recently that inflation in Germany would accelerate in the months ahead. Investors should heed Mr. Pohl's warning. The deutsche mark is down, capacity use is high, and wage increases are running 5 to 7 percent in western Germany and 20 to 30 percent in the new east German states. As prices in Germany pick up, the perceived real return on German debt may fall. That could clear the way for higher prices for US Treasuries. On a more fundamental level, persistent strength in the Japanese and German economies should mitigate the global recession. This bodes well for US exports, especially of capital goods. The 1992 investment boom will likely be powered by a big improvement in domestic profits and cash flow. Break-even points in American industry have declined materially as a result of brutal cost-cutting over the past 2-1/2 years. As operating rates improve, investors should get their first glimpse of cash flooding down to the bottom line. In part, the gains in corporate liquidity will go to repay debt. However, the larger portion, by far, should go to investment in equipment to improve productivity. The coming surge in investment should offset a portion of the long-term erosion in the rate of return on the assets of domestic nonfinancial corporations in the US. In the long run, the only way to reverse this decline is through improved productivity. The sharp rise in stock prices in relation to true, or "economic," profits means that the cost of equity financing declined dramatically. Corporate strategists have finally wakened to this fact. This is why we have had such a flood of equity financing - whether initial public offerings, leveraged buyouts going back to public ownership, or just plain-vanilla sales of additional shares. According to the Federal Reserve, in the first quarter of 1991, nonfinancial companies were still redeeming common stock on balance. However, the net buyback came to only $4.3 billion, the smallest since 1983. Chances are, companies sold stock on balance this spring. The madness of the 80s, which stripped more than $600 billion of equity out of American companies, may finally to be ending. If true, this is exceptionally good news - for the economy in general and especially for capital-goods companies.

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