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Differing economic prospects for the Group of Three industrial powers raise questions about the global recovery's health. Just how the G-3 nations tackle their own problems -- and coordinate their policy efforts -- will dictate how durable or frail the recovery in global growth will be.
The problem is that the three main engines of global economic growth can't seem to get their timetables in sync. Even as the Superchief, the U.S. economy, is finally pulling out of the station (a little behind schedule), the Trans-Europe Express can't seem to build up enough steam to get moving. And Japan, which for the last decade has looked like The Little Engine that Can't, has changed conductors in its latest effort to get back on track.
In the U.S., most of the recent rhetoric from the Federal Reserve suggests that the majority of voters on the Federal Open Market Committee, the Fed's policy-setting arm, believe the Fed has done enough to stimulate economic growth (it sees its current policy as "accommodative") and deem the economy's long-term prospects as healthy. U.S. financial markets appear to have come around to that view in mid-October. Equity prices have recovered some 15% from their recent lows, and the yield on the benchmark 10-year Treasury note has shot up nearly 40 basis points, to 4.11%.
MUDDY WATERS. Recent U.S. data reports certainly support that view. One leading example: the 13.3% surge in September housing starts. But while homebuyers remain resolute, caution persists elsewhere, especially in Corporate America. Take a look at one business sentiment indicator, the Philadelphia Fed index. This widely followed gauge of regional business conditions fell to -13.1 in September from 2.3 in the previous month, reflecting still-sour corporate sentiment.
The bottom line: While the Fed could still have another rate cut up its sleeve if conditions deteriorate, our view at MMS International is that Alan Greenspan & Co. will bide its time until the business sector catches up with consumers.
As for Europe, the recovery waters there have muddied a bit, fostering speculation that the next move by the European Central Bank (ECB) will be an easing in interest rates. A brewing fiscal storm for the three largest EU economies (Germany, France, and Italy) -- brought about by declining tax revenues from slowing business activity, rising expenditures, and weak capital markets -- is indicative of the toll taken by Europe's economic downturn.
Germany will likely join Portugal in breaching the formerly sacrosanct 3% debt-to-gross domestic product limit established at the dawn of European monetary union to ensure a level fiscal playing field for the region's economies. This, in turn, has engendered talk that the ECB is being pressured to relax monetary policy, though any perception of lobbying by the likes of Germany could easily backfire on the banking body, which is keen to protect its independence.
GOOD SIGNS IN JAPAN. Nevertheless, with inflation and growth subsiding in Europe, and with inflation-adjusted growth rates falling well short of their potential, the ECB has room to maneuver. MMS sees up to a half-point easing by yearend, which would bring the benchmark repurchase rate, a closely watched short-term rate, down to 2.75%.
Japan, the world's third-largest economy (China is the second), finds itself at yet another crossroads in its effort to snap its deflationary cycle. Its GDP growth is expected to recover from deeply negative territory to roughly zero percent in 2002. That would put the growth rate even with its monetary policy target.
Japan has kicked off an extraordinary parliamentary session, set to extend through Dec. 13, that will focus on ways to shore up its beleaguered banking system and economy. Such opportunities have been squandered in the past, condemned to futility by political expediency and cynicism.
Yet, indications are that the government could be finally be facing up to its problems. Prime Minister Koizumi announced social safety net and anti-deflation measures to help insulate the economy from the harsh remedial action deemed necessary to fix the ailing banking sector (i.e., writing off the monumental amount of bad debt now on the books). The Bank of Japan's recently announced scheme to buy stocks owned by banks to help them shore up their balance sheets is another such omen.
GLOBAL DRIVERS. One other sign that Japan is getting serious: the installation of the hard-nosed Heizo Takenaka as Financial Services Minister. Takenaka favors aggressive write-offs of nonperforming loans and consolidation of ailing players in banking. Still in denial as to the extent of their troubles, banks have resisted any government initiative to clean up their loan portfolios as a threat to their independence.
Takenaka is scheduled to meet with the head of the Resolution & Collection Corp. (Japan's counterpart of the Resolution Trust Corp. of the U.S. savings and loan crisis fame) to discuss tactics in winding up bad loans. Takenaka's task force should then have a final report on the banking sector by October's end.
The bottom line: It may take some time before the global economy can reach full steam once again, but it would be especially well served if Europe eases up on interest rates -- and Japan finally takes the painful and necessary steps to fix its banking system. And the engineers of the G-3 economies may just decide to hitch together and coordinate policy globally, which could provide a powerful signal to bolster confidence -- for businesses and investors alike. All aboard.
Wallace is a senior market strategist for MMS International
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