Dodging the Bullet - This Time: The Asian Crisis and U.S. Economic Growth during 1998
Hale, David, Brookings Review
One of the great surprises of the U.S. economy this year has been its capacity to withstand the trade shocks resulting from the Asian financial crisis.
At the end of 1997, most economists were revising down their forecasts of U.S. output growth by 0.5-1.0 percentage point to adjust for the impact of the crisis on both imports and exports. As the United States sends about one-third of its exports to Asia and is the major market for the exports of Asian countries whose currencies have collapsed, the U.S. trade deficit had been widely expected to increase by about $50-60 billion this year. Concern about export losses was especially great on the U.S. west coast, which depends far more heavily on Asian trade than other regions. Worries about tourism also flourished. Las Vegas baccarat tables, for example, suffered a 25 percent slump because of the loss of high rollers from the overseas Chinese communities of Southeast Asia.
During the first quarter of this year the U.S. trade deficit widened by some 2 percent of real GDP. Exports to Indonesia, Thailand, and South Korea slumped by 37 percent during January and February while exports to Japan fell by 7.6 percent. But the trade deterioration did not dampen the U.S. economy's overall growth momentum because the growth rate of domestic final sales accelerated from 1.9 percent to 6.1 percent during the fourth quarter of 1997 and thus boosted the quarterly growth rate of total output from 3.7 percent to 4.2 percent.
WHAT IS DRIVING U.S. GROWTH?
Three factors explain why U.S. domestic spending has remained so robust in the face of trade shocks resulting from the Asia slump.
The first factor is the reduced risk of Federal Reserve tightening. With the U.S. economy growing so robustly last year and unemployment in decline, the Federal Reserve would likely have raised interest rates late last year or early this year had it not been so concerned about financial stability in East Asia. The passivity of U.S. monetary policy helped produce large gains in residential construction and commercial real estate. New home sales rose to the highest level in several years while the Dun and Bradstreet survey found a sharp upturn in business confidence in the construction industry.
The second factor is the resilience of the U.S. equity market. It rose to new highs during the first five months of this year because of investor optimism about interest rates and confidence that the Asian crisis had been contained. The poor performance of Asia's economies probably also boosted foreign demand for U.S. financial assets still further after two years of unprecedented growth in foreign purchases of U.S. bonds and equities. During 1997, foreign investors bought $66 billion of U.S. equities and $184 billion of Treasury securities, as against $12.5 billion of equity and $232 billion of government securities during 1996. The buoyancy of the U.S. equity market helped bolster household wealth and sent consumer spending rising at a 5.7 percent annual rate during the first quarter of 1998.
The strong capital positions and high profitability of American banks has also helped. According to annual report footnotes, America's leading money center banks have more than $100 billion of exposure to Asia through a mixture of dollar loans, local currency loans, and security investments--nearly as much aggregate lending as went to Latin America during the debt crisis of the early 1980s. But with today's low interest rates and healthy profitability, U.S. banks are competing aggressively to make new loans despite losses in Asia.
The buoyancy of the stock market has become so great in relation to profit growth that market analysts are beginning to worry about the United States creating a "bubble economy." During 1991-97, equity market appreciation was driven equally by profit growth and appreciation of share price multiples. During the past six months, most of the gain in equity prices has come from multiple appreciation. …