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July 2, 1998
Disappointing news from Japan and authentic evidence of a slowing economy here have combined to take mortgages back down to the lows of the year (around 7.00%), and T-bonds to a new low: 5.59%.
Of the two news items, Japan was the more powerful. (Note: It's easy to measure the impact of news from Japan relative to domestic reports because markets in Asia and then Europe trade on Japan news before the New York markets open. If there is a big change in T-bonds at the New York open, before domestic news releases, you know the change was due to events overseas.)
Last night, Mr. Hashimoto announced the much-hoped-for "Total Plan" to repair Japan's banks. There was a lot riding on the announcement: the Nikkei had put in an eight-day rally, back above 16,000; and the yen had strengthened from 144/$ to 136/$.
We should have known better. There will be no new money with which to close insolvent banks and settle bad loans, and there will be no tax cut to stimulate the economy.
Overnight, the yen crashed back to 142/$, the same level at which Secretary Rubin found it necessary to intervene two weeks ago. Going lower.
What does Japan intend to do? Sit tight, turtle up, and play the old game: theft-through-trade. It seems that Japan has every intention of "earning" its way out of trouble by running a $60 billion annual trade surplus with us, and another $30 billion from the rest of the world.
It is reasonable for the U.S. to tolerate an equivalent trade deficit with China, which is still a poor country relative to Japan, trying heroically to transform itself to a market economy.
But, with Japan? The world may soon object -- forcefully -- to Japanese behavior which can be regarded as a form of economic warfare. A part of the flight-to-quality buying of American Treasurys is driven by fear of trade war, the absolute last thing the world economy needs right now.
A slowdown of sorts has arrived here at last. The purchasing managers' index slid to 49.6% from 51.4%, the first time below break-even in two years, joined by factory orders, down 1.5% in May.
The slowdown may deepen, and give the Fed grounds to ease; but that's a hope, not a reliable forecast.
Manufacturing is slowing because inventories of goods were built too high in a red-hot 1st quarter. An "inventory correction", a temporary slowdown in new orders while old inventories are worked off, seldom causes a pervasive, economy-wide slowdown of the kind necessary for the Fed to reverse field.
There is little risk to the interest rate upside right now; and if a real slowdown were to develop, no bottom.
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