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Global View: All over by the second half? Friday, 13 April 2001 18:50 (ET)

By IAN CAMPBELL, UPI Economics correspondent

WASHINGTON, April 13 (UPI) -- In the fall of 1914 the "Old Contemptibles"- the British soldiers who went off to the battle lines in France and Belgium- bore a smile and the conviction that "it would all be over by Christmas." For many of those poor men it was.

Looking back we can see that their view that the war would be short was optimistic and wrong. It was wishful thinking; and yet it was not irrational. In the 19th century wars did not usually last a long time. What made the Old Contemptibles wrong was the advent of new technology in the shape of the machine gun, a weapon that gave defenders the edge. The technology that permitted the machine gun to be overcome- the tank and the fighter plane- was not yet adequately developed.

What does the First World War have to do with the global economic picture now? The U.S. economy slowed down quite suddenly last year and the ranks on Wall Street are sounding a new, optimistic refrain: It will all be over by the second half. Is that wishful thinking, or a realistic prediction?

Technology plays a role now, too, in the uncertainty. But this time its influence should be positive. Many economists argue that new computer and internet technology has permitted rapid productivity growth in the United States and therefore high non-inflationary growth.

Technology stocks have been hammered in the past year, but the evolution of new technologies and their introduction into "old economy" businesses continues apace. With high-technology growth, why can the United States not resume high GDP growth?

Those sounding the optimistic refrain also have recent history on their side. They can look back on a decade in which the belief that recovery would be swift has been vindicated.

This week, as we reported Thursday, initial jobless claims rose to their highest level not in a decade but in five years- since March 1996. In other words the economy was wobbling then; and before then, in 1994, when U.S. interest rates rose and Mexico sank; and later in 1998, when Asian economies, Long Term Capital Management and Russia and Brazil sank.

In three trading sessions at the end of August 1998 the Dow fell by 984 points, losing 11.5 percent of its value. The Fed chairman, Alan Greenspan, rushed to the rescue with three interest rate cuts. The wobbles did not lead to crash. The bicycle was swiftly righted. The expansion of the U.S. economy went on. Why should it not be the same this time?

We will come back to that central question later. Digress a little. Why did the expansion go on for so long? Why was the usual working of the business cycle interrupted?

In the second half of the 1990s a lot went wrong in the world economy. Oddly enough, it seemed to favor the world's biggest economy. Throughout the 1990s the world's second-biggest economy, Japan, struggled, reducing demand in the world economy. That ought to have hurt the United States yet appeared not to. Japanese money has flowed into U.S. stocks and bonds, strengthening the dollar and reducing the price the United States must pay for imports from Japan.

The European economies also performed sluggishly in the 1990s by comparison with the United States. But again the U.S. economy obtained a pay-off. European investors poured their money into the United States. And European companies sought to buy up U.S. companies, bringing huge direct investment flows via mergers and acquisitions. To him that hath, more shall be given.

In 1997-1998 most Southeast Asian economies collapsed and the so-called emerging markets as a whole went into crisis. The drop in demand in Asia was so acute that it caused commodity prices to tumble, spreading Asia's downturn to Latin America and Eastern Europe. But in the United States, low commodity prices were, for most people if not for oil companies, a boon. Cheap gasoline and natural gas was equivalent to a tax cut for Americans. It meant they had more money to spend on everything else. Roll on, consumer boom.

Meanwhile, another important wealth-creating phenomenon was occurring in the capital markets. All that money flowing towards the United States helped cause the stock market to soar from 1995 to 1999, a period in which the value of the Dow rose by 199.1 percent at an average annual rate of 24.5 percent, while the technology-oriented Nasdaq rose by 439 percent at an average annual rate of 40 percent. The stock market rained wealth on the United States.

So why can't it all continue? Begin with the stock market. At the end of 1999 the Dow closed at 11,497 and the Nasdaq at 4,069. After a week in which they have rallied, the Dow is still 11.9 percent down on its end-1999 level, while the Nasdaq has plummeted by 51.7 percent. The happy rain from the stock market has ceased. The wealth effect has gone and been replaced by a negative wealth effect.

Another blow: oil prices spiraled in 1999 and 2000. Natural gas prices, as California knows to its cost, have soared. Americans have less money to spend. And as unemployment begins to rise, they are beginning to curb their spending a little. For another of the extraordinary phenomena of recent years is that Americans, on average, have ceased to save any of their disposable income. They spend it all, and a little more: borrowed money, or consumed savings.

The negative savings rate, which is an all-time record, is matched by other all-time records in the trade and current account deficits. Perhaps lower growth in Japan and Europe has hurt the United States, after all. Booming alone, the United States has racked up an unsustainable position in its external accounts.

In response to the current wobbles in the economy, Greenspan is cutting interest rates and expanding the broad (M3) money supply at an extraordinary rate, by an annualized growth rate of 12.8 percent in the three months from December to March. (By comparison, the European Central Bank's favored measure of broad money growth, M2, is rising at an annual rate of 4.7 percent, and the ECB wants to get it down.)

Within the United States, Greenspan's policy wins approval. Indeed, on Wall Street more interest rate cuts are being called for, as though cheap money were the answer to every problem. But is there not a danger in encouraging Americans to borrow at a time when savings rates are at record lows and the external deficits at record highs?

Property prices have soared in many metropolises in recent years. Is this the time to be encouraging Americans to indebt themselves further and buy property at cheap interest rates? Is that not reckless and irresponsible? Is this not instead a time when Americans should be cutting back spending while the Central Bank warns of the inevitability of slowdown?

Not at all, for it will all be over soon.General Greenspan is marching forward with the ranks of Wall Street cheering behind him. It will all be over with them by the second half.

Global View is a weekly column that appears on Fridays in which our economics commentator examines questions vital to the global economic outlook.

Copyright 2001 by United Press International. All rights reserved. --

-- Swissrose (cellier3@mindspring.com), April 14, 2001