It’s Not <i> That </i> Bad : Market’s Neurosis Doesn’t Herald Economy’s Breakdown

Just one week ago Alan. S. Greenspan, the new chairman of the Federal Reserve Board, said that the nervousness already evident in the financial markets was uncalled for. The U.S. economy is doing better than many economists had expected, he pointed out. The huge trade deficit appears to be “bottoming out,” and fears of resurgent inflation rates lack “underlying statistical support.”

Two days later the U.S. Commerce Department reported that this country’s trade deficit fell from $16.5 billion in July to $15.7 billion in August. Instead of interpreting this as good news, the people who control large movements of money began hitting the panic button.

The value of the dollar relative to other currencies slipped. By the close of business on Friday, stock prices had suffered the largest weekly loss since World War II. The drop on Friday alone wiped out $145 billion in stock values.

When stock prices fell a calamitous 500-plus points on Monday, financial analysts began openly using the word “panic,” and the head of the U.S. Securities and Exchange Commission discussed the possibility of emergency action to stabilize the market.

Yet, as Greenspan said, nothing that is going on in the “real economy” justifies what is happening in the financial markets.

Granted, 59 straight months of economic growth, declining unemployment and the growing competitiveness of U.S. industry cannot obscure the long-term threat posed by the persistence of massive deficits in the federal budget and in this country’s balance of trade. But why did financial people choose now as the time to go berserk?

As the folks on Wall Street tell it, the tailspin in the market reflected worry that a resurgence of inflation is just around the corner, and disappointment that the monthly trade figures didn’t show an even greater improvement.

For weeks, however, economists have been pointing out that the trade picture is better than it looks.

From 1980 through 1985 imports grew an average of 11% a year while exports declined an average of 1.1% annually. During the last 12 months, imports increased by only 4 1/2% and exports rose by 14%. Employment in export-oriented manufacturing is growing, and the competitiveness of U.S. producers is on the rise.

We are still buying far more from Japan and Western Europe than we are selling to them--and will be for some time to come. But the trend is in the right direction.

As for fears of inflation, which is being used to help justify the upward march of interest rates, the reality hardly fits the notion of a tiger straining at the leash.

Consumer prices have indeed been rising at a faster clip. The inflation rate, a minuscule 1.3% in 1986, is expected to be close to 5% this year. Leaving aside the potentially self-fulfilling effects of inflationary expectations in the financial markets, however, there is little reason to expect it to go much if any higher in 1988.

The nation’s factories are still operating at only 81% of capacity--well below the level historically associated with inflationary pressures.

Prices of raw materials and components used by U.S. producers are on the rise. But wholesale prices in general increased a moderate 0.3% in September. With unemployment dipping below 6%, the labor market has tightened a bit--but economists have noted that wages are rising only modestly, even in labor-short areas.

To quote economist David Wyss of Data Resources, “We are seeing stable inflation, but the markets are in a bearish mood so they ignore good news.”

No, if there is any real reason for the rise in interest rates, it is concern that the dollar will go lower as a result of the U.S. trade and budget deficits--and that we must pay higher interest to compensate Japanese and other foreign investors for the risk that they run in continuing to lend us the money to finance these deficits.

However, the market is ignoring the improved outlook here, too.

It is true that neither Congress nor President Reagan has dealt responsibly with the budget deficit through some combination of spending cuts and higher taxes. The official goal of balancing the budget by fiscal 1991 has slipped to 1993. On the whole, the presidential candidates in both parties are ducking the issue, too.

The deficit picture is nonetheless growing better instead of worse. Federal spending is now expected to outrun revenues by $157 billion in the current year, down from $221 billion in fiscal 1986. Under terms of the revised Gramm-Rudman law, the deficit should sink to $144 billion in fiscal 1988.

Obviously Americans need to accept the fact that we can’t live forever off money borrowed from foreigners, that we must go back to paying our own way. The chaos of recent days says at least as much about the institutional shortcomings of the financial markets, however, as it says about deficits and the strain on the dollar.

Stock analysts do not base their buy-or-sell decisions so much on a company’s earnings potential, or even on economic trends, as on their anticipation of how other investors will act. Psychoanalysis merges with economic analysis.

The prophecies of the market operators tend to become self-fulfilling. As Greenspan said the other day, “If everybody gets it into his head that inflation is inevitable, they will start taking actions which will create” higher inflation--which in turn produces higher interest rates and, ultimately, recession.

Furthermore, stock values tend to swing in larger arcs these days because of the major role played by mutual funds and pension funds, which deal in large blocks of stock. The volatility has been enhanced further by the emergence of buy-and-sell decisions generated mechanically by computer programs.

As one disgruntled federal official commented, “This is a computer-generated drop, caused by 29-year-old technicians with three years of market experience.”

That may be an oversimplification. But so are the pretensions of the gloom-peddlers that their nervous breakdown of the past week had a rational basis.