The betting was that as the German and Japanese economies gathered momentum in 1995, they too would have to follow the example of the Anglo Saxon economies and raise interest rates in an effort to prevent unsustainable growth.
Much of this analysis now turns out to be wrong. If anything, the balance of probabilities more than half way through 1995 has shifted from boom conditions to slow down. Indeed, there is even some concern that economies like the US, which have now been on the upswing of the economic cycle for more than three years, may not achieve the soft landing - the policymaker's dream - and will come down harder.
In the German and Japanese economies, expected to move towards full capacity this year bringing down the high levels of structural unemployment left from the recession, there is concern that the upturn will be little more than anaemic.
The best evidence that the industrial economies are now moving towards a far more dreary period than had been expected, is provided by the very same bond yields which climbed so high a year ago. In some cases they have drifted down a full point suggesting that the squeeze on global liquidity so widely predicted - as industrial and developing countries sought large sums for investment, and to address budget deficit problems - never materialised.
A major factor turning expectations on their head has been the foreign currency markets, generally regarded as the most capricious of all capital markets.
The consensus of many economic forecasters at the end of 1994, was that by mid year the dollar would stand at 108 against the Japanese yen. Instead, it has been hovering in the 80-85 yen range reflecting a 15 per cent devaluation so far this year, and 30 per cent down over the last three years.
This has been the most significant currency movement since the upward surge of the dollar in the early 1980s, far outstripping the effects of the turbulence in the European exchange rate mechanism seen in 1992 and 1993.
The sinking dollar has not been confined to its relationships with Japan, although that is the most significant because of trade flows between the world's two largest economies. It has also sunk to historic lows against the German mark and other currencies in the exchange rate mechanism. A climbing currency has the same impact on an economy as a rise in domestic interest rates: it acts as a barrier against imported inflation through commodity prices and semi finished goods.
But for large exporting economies like those of Japan and Germany, so dependent on overseas markets, it slows exports, growth, investment, and eventually unemployment. Hence the unthinkable has happened. Both Germany and Japan have been required to cut domestic interest rates in a bid to mitigate the effects of their rising currencies.
In Germany already, there has been one half point cut in official rates and another is being discussed. In Japan, domestic interest rates have sunk to just one per cent and there is now speculation that if activity does not pick up, the Bank of Japan will have to bring them down to half a per cent some time this summer.
An indication that the turbulence on the foreign exchange markets, exacerbated by the worsening trade relations between the US and Japan, could start to impact on growth is provided by forecasts from the Organisation for Economic Cooperation and Development.
These show downward revisions for growth in each of the three largest economies this year. In the US, OECD now expects growth to be around 3.1 per cent this year, slightly down on the end of 1994 projections, and a full point lower than a year ago.
Recent economic data from the US suggests that OECD data may be out of date already. Manufacturers are responding to declining demand for expensive items such as automobiles by cutting back on investment plans which have shrunk to their lowest in three years. Forecasts are that despite the weak dollar, the next move in interest rates could be down as the Federal Reserve seeks to keep the recovery alive.
The most serious indication that currency instability is causing genuine problems for recovery and growth, comes from Japan. At the start of the year OECD was projecting growth of up to 2.5 per cent for 1995. It has now cut that forecast to 1.3 per cent amid signs that Japan's most important export - automobiles - is being priced out of world markets.
Germany also is feeling the bite of the uncompetitive exchange rate. Goods flooding in from Italy are threatening the upturn of consumer goods industries including automobiles, electronics, furnishing and clothing. Even the capital goods sector, in which Germany has such a dominant role, is finding times tougher than expected with smaller but cheaper rivals like Britain starting to benefit. As a result, OECD has trimmed the German forecast for 1995, although lower than expected Bundesbank interest rates could help to keep the domestic German economy moving.
The most positive countervailing force is the inexorable rise in world trade, particularly in fast growing regions like Asia-Pacific and Latin America, which should help keep the global economy buoyant.
Source: Airline Business
