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January 14, 2001 Now, 3 Bears: Weak Dollar, Trade Gap and Inflation By JOSEPH KAHN

WASHINGTON -- Just two years ago, economists were still saying that America had a Goldilocks economy, the consummate combination of low inflation and low unemployment that helped the economy grow swiftly and kept interest rates under control.

Sounds like ancient history now, with the stock market plunging, economic growth slowing and the incoming Bush administration making preparations for emergency tax cuts. In fact, one of the economists who helped popularize the Goldilocks concept is using another term that has not been heard much since the 1970's.

"Stagflation," said Robert J. Gordon, an economist at Northwestern University. "I think it can, and may, come back."

That combination of high inflation and unemployment and relatively slow economic growth sounds alarmist, even in today's less-rosy economic environment. But Mr. Gordon's reasoning is that the Goldilocks economy was never about the United States economy alone: it was about global contributions to American prosperity. Stagflation, he said, could also be imported.

"So much of what supported the American economy was the perception that this country offered consistently higher rates of return on capital, especially because of our technological leadership," Mr. Gordon said. "The moment you start to see negative returns relative to what people think they can get abroad, then you have a problem."

If the United States does enter a period of economic pain, as economists predict, this country and the new economic team in Washington will most likely have to deal with an inverted set of international economic issues. A weaker dollar, more costly imports, and an outflow of capital could restrain the economy just as a strong dollar, cheap imports and a seemingly endless bounty of foreign capital once unleashed it.

In the 1990's, the alchemy worked like this: with much of the rest of the world lagging behind the United States in growth and innovation, foreign money flooded into this country as foreigners bought American companies and snapped up surging Nasdaq stocks. That helped raise the value of the dollar against other currencies, which made imports cheap without igniting inflation.

The situation has not changed much, but the warning signs are clear. Americans depend so heavily on imports that they spend $1 billion a day more buying from abroad than they earn by selling goods overseas. It's the largest trade deficit relative to the overall economy in recent history.

Global investors will sooner or later decide that they can do better by putting their money in other countries. That would undercut the value of the dollar, make imports more expensive, and fuel inflation even as the economy slows. The key indicator to watch is the value of the dollar.

The dollar has already been weakening steadily against the euro and some other major currencies. It has remained robust against the yen, however, and foreign exchange markets have shown no signs of panic. That means the readjustment could come gradually.

"The decline against the euro is clearly a trend," said Wayne Lyski, who oversees emerging-markets bond funds at Alliance Capital Management. "Our baseline case is for a controlled decline in the dollar."

It seems almost inevitable that the new administration will have to manage a falling dollar just as it grapples with a sluggish economy and a still-gaping trade deficit. No one knows for certain how much those factors will feed on one another. But President- elect George W. Bush's administration is not taking any chances, pronouncing that it favors a resilient dollar.

"The position of this administration will be the same as the Clinton administration," said Lawrence B. Lindsey, designated to be director of Mr. Bush's National Economic Council. "We favor a strong dollar."

Coleman S. Kendall, Mr. Lindsey's former consulting partner at Economic Strategies, says he will be shocked if the administration retreats from the strong-dollar stance. But favoring a strong dollar does not necessarily make it so. "I think you can also imagine that speculators are going to test them to see whether they just acquiesce," Mr. Kendall said.

Policy makers can do only so much to control such trends, especially in the multitrillion-dollar foreign exchange market. Mr. Gordon of Northwestern asserts that the Clinton administration benefited from an "extraordinary coincidence" of favorable factors that kept the dollar strong even as investment flowed in. The Bush team could also face an extraordinary coincidence.

"All of these things could go into reverse," Mr. Gordon said, "and leave them with a set of dismal choices."

http://www.nytimes.com/2001/01/14/business/14VIEW.html?printpage=yes

-- Martin Thompson (mthom1927@aol.com), January 14, 2001

Answers

All of these strictly financial analyses seem to overlook the energy crunch in California, and the U.S. in general. This is the joker in the deck that can, ultimately, bring this whole house of cards down.

-- Wellesley (wellesley@freeport.com), January 14, 2001.