Behind Global Turmoil, the Opportunity of Low Inflation

With so much turmoil in the world’s economies, predictions come easy but understanding that the underlying trends are mostly positive takes more explanation.

So here are a few predictions about what lies ahead in the next three-to-six months for the U.S. and other economies. And some observations on what’s really going on.

* The Federal Reserve may well cut short term interest rates again this week, after the September employment figures are released on Friday. Unemployment nationally is expected to be above last month’s 7.6% rate.

* Long-term U.S. interest rates rose last week because a new concern hit the markets--”a fear that Clinton will be elected and will increase government spending, pushing up inflation,” says an international banker.

But whatever the concerns about spending, fear of inflation is unfounded, adds the banker. U.S. inflation may be as low as 2% now.

* Germany, however, has inflation and growing consumer borrowing in what used to be East Germany. So the Bundesbank probably won’t lower interest rates this week--although it will do so before the end of the year because the German economy is in recession.

* The French franc’s value will hold up thanks to support from Germany. But as soon as world markets allow it to do so, France will lower its 13% interest rates, which are throttling the French economy.

Now, to link those predictions, think of them as reflecting one of the biggest changes in the world economy in 40 to 50 years--disinflation.

U.S. inflation is not low merely because of the recession--when business picks up, prices will not shoot up.

On the contrary, powerful trends in finance and technology have combined to produce different patterns. The asset you hold today, be it a house, an office building or business inventory, does not necessarily rise in value tomorrow.

Inventory has been reduced by communications. At giant factories these days, parts for cars arrive on half-hourly delivery schedules, just in time to be put on the vehicle. In retailing, merchandise goes directly from manufacturer to Wal-Mart or Home Depot stores. Wholesaling and warehousing are bypassed, which explains why employment in retail and wholesale trade is shrinking nationwide.

With less need to finance inventory, business borrowing is down, notes Charles Clough, chief investment strategist for Merrill Lynch. “So there is excess capacity in banking. And just as with steel plants in the early ‘80s, banks are closing or merging.” Employment in banking and finance, a growth field in the ‘80s, is now declining.

Growing service industry unemployment, along with workers made jobless by Hurricanes Andrew and Iniki or the General Motors Lordstown strike in early September, promise higher unemployment numbers on Friday.

And that will lead the Fed to cut interest rates. Wayne Angell, a Federal Reserve Board governor, noted last week that there’s room to lower rates because U.S. inflation is down to 2% annually.

But given the changed economics of the ‘90s, lower short-term rates are unlikely to spur lending, borrowing or hiring.

For jobs with a future, new opportunities will have to be created, perhaps in whole new industries.

Which brings up Clinton’s proposals to spend $200 billion-plus on roads, bridges, telecommunications lines, data highways and high speed trains. Depending on the details, and how such plans are carried out, such spending could be a non-inflationary boon, increasing productivity and opportunities in America.

Or, as with anything political, such plans could yield enormous pork barrels.

Right now, global investors are skeptical. That’s why interest on 30-year U.S. Treasury bonds are at 7.4%, more than five percentage points over inflation, a much higher-than-normal spread.

High rates make five-year Treasuries a good investment at 5.54%, and seven-year Treasury notes an even better one at 6.47%. But such interest rates will have to come down if the recovery is to pick up speed, and new business is to be financed.

So whoever is elected in November will have to persuade investors in world markets--where $1 trillion in currencies, stocks and bonds are traded every day--that his policies are intelligent, useful and non-inflationary.

In other words, to win election candidates must please voters, but to govern they must please world markets.

That’s a trend--and a mostly positive one. Yet there were frightened suggestions last week, from Treasury Secretary Nicholas Brady and others, about world markets being out of control and dictating to governments.

But such talk is naive. Markets have influenced governments for years, if not centuries. And governments use markets too.

Germany, for example, used high interest rates to attract global investment to finance the reunification with East Germany. But it misused the investments to pay lavish subsidies to the East, practically ensuring a surge of inflation.

Now the German economy is distorted and the Bundesbank, which has been holding the line against inflation, will soon lower interest rates to try to end a recession. France will do likewise.

Meanwhile, world investment flows will move on, to China and Russia in coming years, promising productivity increases in societies that didn’t see much money in previous ages. And perhaps next year the money will flow to U.S. infrastructure projects, if they are intelligent, useful and non-inflationary.