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THE IN TER NA TIO NA L ECONOMIC OUTLOOK FOR 1989
Remarks by Robert P. Forrestal, President
Federal Reserve Bank of Atlanta
To The Program in International Banking and Finance
Georgia State University
June 16, 1989
Good afternoon! I am pleased and honored to have been asked to participate in the
Program in International Banking and Finance once again. I think it is vital for students
o f any aspect of business today to be tuning into international developments, and you
have certainly chosen an exciting way to go about it.
Your field trips will take you to
Europe’s great financial centers and give you first-hand exposure to the ways in which
the financial services industry is becoming global in scope.
In particular, Europe is the
setting for one o f the most important transformations in the overall globalization of
markets.
The nations o f the European Community (EC) are working toward greater
economic integration among themselves and have targeted 1992 as the year in which
many changes in business procedures will go into e ffe c t. I would like to talk about a few
implications o f 1992 for the American financial services industry this afternoon. Before
I do that, however, I shall begin with a summary o f the national and international
economic outlook for the remainder of the year to provide some context for your study
o f international banking and finance today and as we move toward 1992.
The National Outlook
In the year ahead, I see a continuation of expansion in the U.S. economy, but at a
somewhat slower pace. On a year-over-year basis, reported G N P growth will probably be
just over 3 percent.
Factoring out last year’s drought effects, our growth should be a
little over 2 1/2 percent.
decelerate.
By either measure, the rate of expansion seems likely to
As a result, unemployment will probably decline less dramatically than in
the last two years. Inflation, however, may accelerate to over 5 percent on average for
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1989, especially in light o f the price pressures w e've already experienced.
While I welcome this deceleration in overall business activities, I want to
emphasize that I am not at all com fortable with this level o f inflation, and I am
becoming increasingly concerned that some people are becoming complacent with the
present inflation rate.
I would remind those who fe e l we can live with, say, 5 percent
inflation that at this rate, prices would double in 14 years. What's more, it is a mistake
to believe that inflation can somehow be stabilized in this range. We have never in the
past been successful in capping inflation at 5 percent; instead, it has always accelerated
beyond that level. In the past few years, measures o f inflation have appeared moderate,
but this can be explained to a large extent by weakness in energy prices.
Meanwhile,
underlying inflationary tendencies have actually been somewhat higher. For example, in
the near term , we are likely to fe e l pressures from the drought's delayed effects on food
prices and perhaps from higher oil prices.
In addition, we are running up against
problems o f capacity constraints that I w ill discuss in a moment.
Therefore, we must
treat current inflationary pressures as a serious threat to our nation's economic w ell
being.
The continuing expansion in 1989 w ill again be fueled by manufacturing.
Exports
are likely to bring the trade deficit low er {g a in this year, and manufacturers w ill turn
out more goods to meet foreign demand.
Although in recent weeks the dollar has risen
above its levels o f mid-1988, it is still about 30 percent below the peak o f early 1985 vis
a-vis the currencies o f our major trading partners. U.S. goods should remain attractive
to foreigners in terms o f their prices, especially since currency realignments a ffect trade
flow s with a considerable lag.
A t the same time, past dollar declines w ill no doubt
translate into higher prices fo r imports.
Thus, consumers here can be expected to
continue shifting their purchases to dom estically produced items.
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By adding jobs to factory payrolls, strength in manufacturing should help purchasing
power and keep consumption going at a reasonable rate. Business investment in capital
goods and plants should also post respectable gains as factories are expanded and
equipment is upgraded to accommodate increased industrial production.
The weak sectors in the economy will probably be construction and government. I
expect modest growth in commercial building led by warehouses and other industrial
structures. However, residential building shows few signs o f strengthening. The housing
cycle remains in a downturn and is not necessarily at its lowest point.
Demographic
trends, especially the passage o f the baby-boom generation from its period o f peak
household formation, also contribute to a soft housing market.
Government spending,
too, will have to remain on a downward slope if we are to meet Gramm-Rudman-HoUings
requirements without raising taxes.
As I mentioned, inflationary pressures are the most worrisome aspect o f the
outlook.
The U.S. economy's capacity to grow is realistically about 2 1/2 percent per
year.
Except fo r the farm sector, growth has been above that level fo r well over a
year.
Meanwhile, now that the baby-boom generation has been absorbed into the work
force and the number o f new workers is diminishing, labor markets have begun to show
signs o f tightening.
If growth were to continue at last year's pace while the number o f
new workers declines, labor costs would tend to rise in the absence o f stronger advances
in productivity.
Capacity utilization is also quite high, above 90 percent in certain
industries. This combination o f developments suggests that bottlenecks and shortages o f
materials may occur that could lead to general price increases.
In sum, the U.S. economy appears headed for a good performance in 1989, although
this year's growth should decelerate somewhat from last year's. I think it is important to
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remember that there Is a considerable difference between a slowing economy and a slow
economy. We need to become com fortable with a pace o f 2 1/2 percent as a goal and not
regard it as weak. Instead, it is a rate o f growth more in line with an economy that is at
or very near fu ll capacity.
Thus, the anticipated slowdown should be viewed as a
necessary and welcome adjustment. On the other hand, inflation presents very real risks
to the continued health o f the economy.
International Outlook
In general, the outlook for the world's other industrialized nations is similar to that
for the United States. They tended to have better-than-anticipated expansion in the year
just ended, and they will likely continue to grow in 1989, but at a more moderate pace.
Last year unemployment fell slightly among the major free-market economies and should
hold at just over 8 percent overall in the year ahead. In Europe the percentage of jobless
workers could hover near 10 percent.
Even though those rates seem quite high--
especially in Europe, there appear to be a substantial number of Europeans who have
become more or less permanent members of state welfare rolls. Thus, the current levels
of joblessness, in combination with shrinking amounts of unused capacity in many
countries, may be sufficient to add to inflationary pressures.
Turning to highlights in the outlooks for specific countries, I think 1989 will find
West Germany dropping back to the vicinity of 2 1/2 percent G NP growth after a year of
nearly 3 1/2 percent expansion.
A slowing of consumer demand due to higher indirect
taxes will probably lead toward this lower growth rate.
On the other hand, exports,
particularly of capital machinery, will remain a source of strength. Thus all signs point
toward a further increase in that country's substantial trade surplus in the year ahead.
Japan, too, will have another year of huge trade surpluses.
Despite increases in
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imports, exports may grow even more. Personal consumption should moderate in 1989, in
part due to recent tax reforms.
Thus Japan should continue its robust growth, but at a
pace closer to 4 percent as opposed to the past year's 5.7 percent.
Rapid growth should
be the norm throughout the Pacific Basin, in fact, as the export-oriented newly
industrialized countries—Taiwan, South Korea, Singapore, and Hong Kong—gain between
6 and 7 percent in real GNP.
As trade surpluses were growing in Germany and the Pacific, Great Britain spent
last year at the other end of the spectrum with a record deficit.
Imports were up 14
percent over the previous year due largely to high domestic demand in the face of
capacity constraints and rising values for the pound sterling. Economic growth was quite
brisk over the period, however. Boosted by consumer spending, G N P growth was close to
4 1/2 percent.
A t the same time, inflation heated up to around 6 percent, and it could
surpass this level in 1989. In an effort to cool o ff the overheated economy, the Bank of
England raised interest rates several times, bringing the base rate to 14 percent. Thus
growth in England will probably back o ff to around 3 percent this year.
In this hemisphere, Canada should grow about 3 percent in 1989.
High capacity
utilization is likely to mean that business investment will provide a major push to the
Canadian economy.
I expect direct tax cuts and more rapid growth in wage income to
support private consumption as well.
The U.S.-Canadian free trade agreement is likely
to boost both imports and exports and provide an additional benefit to the economy over
the next few years.
America.
Unfortunately, similar good news cannot be reported for Latin
Most countries to the south are showing major signs of stress.
Though a
firming of oil prices has helped a bit, chronic debt and inflation problems reduce the
prospects of improvement.
Mexico, which is our biggest trading partner in Latin
America, is still adjusting to the opportunities created by its reduction of trade
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barriers.
Over time, though, this shift to a more market-oriented trade policy should
boost both exports and imports in that country.
Taking all of this into account, the year ahead looks to be a good one for the major
industrialized nations and many newly industrialized countries also.
Some potential
dangers emerge from the outlook, however. One consistent theme in looking toward the
year ahead is the possibility of growing inflation throughout the industrialized world.
Policymakers here and abroad need to keep a wary eye on prices so that the positive
benefits of worldwide expansion are not eroded by price increases.
A second theme is
the persistence of large external imbalances—the continuing surpluses in Germany and
Japan in contrast to the deficits of Great Britain and the United States.
It does not
appear that we will see dramatic progress in reducing these imbalances in the near term,
and the potential adverse effects on capital flows is always of concern when trade
balances are as misaligned as they are now.
Imbalances can also inspire the advocates of protectionism to agitate against free
trade.
Indeed, I feel protectionist sentiment is very much a danger here in spite of
advances like the U.S.-Canadian free trade agreement.
As the Omnibus Trade Act that
became law last year begins to be implemented, there will undoubtedly be attempts by
particular industires to use its provisions in a protectionist manner.
The effect of this
would be to close o ff our markets to foreign competition instead of opening foreign
markets to our exports.
1992 in Europe
I would like to round out my remarks this afternoon by discussing some of the
implications I see arising out of developments there that will coalesce in 1992.
A fter
several visits to Europe last year and numerous discussions with financial leaders there, I
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am convinced that the long-standing dream of a truly common market will be realized in
the next decade. An economically united Europe would create a formidable new force in
the world’s economy.
The 12 members of the European Community together have a
population one-third larger than the United States and a combined G N P about equal to
ours.
The move toward unifying that large market is underway as the nearly 300 separate
trade barriers maintained by individual nations are being dismantled.
Simply reducing
the additional costs imposed by such barriers will raise the EC's economic growth, cut
consumer prices, and create millions of new jobs.
Beyond that, easing restrictions on
business scan allow firms to combine in ways that would increase their strength and
anticipation of 1992. Pechiney, a French company, became the world's largest packaging
company when it acquired Triangle Industries recently. By purchasing Pillsbury, Britain's
Grand Metropolitan stands to become one of the world's biggest food and drink
businesses.
Such giant European companies will become increasingly powerful rivals for
American producers in the post-1992 environment.
I am particularly interested in the impact 1992 could have on the American
financial services industry.
These could take place in at least two major ways. One is
that the current size advantage foreign banks enjoy could be amplified, hobbling U.S.
banks" efforts to win the business of larger firms.
The second is the potential effects
European banking practices could have on the U.S. regulatory framework.
In terms of
asset size, 22 of the world's 50 largest banking institutions at the end of 1987 were
housed in EC countries. Only 4 of the top 50 were American-based; 20 were Japanese, by
the way.
The further deregulation built into plans for 1992 in Europe could lead to the
formation of more large banks there, and such a development could have important
implications for the competitiveness of American banks.
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Commercial entities of the magnitude of Pechiney and Grand Met look for banks
that can offer one-stop convenience in meeting their requirements.
As international
trade grows, this demand requires financial industries to maintain a presence in all the
important economic centers and the capacity to handle sizable transactions.
banks can meet these demands.
Only large
U.S. banks are presently underrepresented among the
world's top banking institutions in part because of interstate banking restrictions and
limitations on the types of businesses in which banks can engage.
Specifically, banks
cannot expand across state lines in the United States unless they are permitted to
purchase an organization in a state that allows such acquisitions. Here in the Southeast,
for example, several states have allowed each others' banks to set up regional institutions
in this way, but do not allow banks from, say, New York or California to enter their
markets.
In addition, the Glass-Steagall Act makes it illegal for banks to hold equity
positions in commercial firms, something that many European banks are permitted to
do.
Thus, it is quite possible that American banking regulations will have to be
restructured in order to allow U.S. institutions to be competitive in the post-1992
environment.
The manner in which Europeans treat American banks seeking to do business in
their market after 1992 may provide a second reason for reevaluating the way we
regulate banks here.
Many statements regarding the future shape of business in the EC
are couched in terms of "reciprocity." That is, American firms' entry into Europe will be
conditioned by the treatment European firms receive in America. It is not yet clear how
reciprocity might be applied to banking. Were total reciprocity demanded today, though,
we would be a long way from matching European standards.
Look ahead to 1992, one
possible scenario is that banks in Europe will be allowed to branch across borders. The
debate there has revolved around whether the home-country rules of the branching bank
or those of the host country will govern its actions when it sets up shop in another
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country.
Recently home-country rule has gained in favor. If this arrangement triumphs,
it will mean that, in fairly short order, bank regulations within the EC would tend to be
standardized around the most liberal framework. Bankers facing competition from banks
headquartered in a country with less stringent regulations would naturally pressure their
legislators to give them equal powers.
It is possible that negotiations will lead to something less than full reciprocity.
Europeans might accept a core set of powers as parameters for their activities in this
country.
Nevertheless, Congress may still have to decide whether our system should be
revamped in a way that permits unrestricted nationwide banking and even interstate
branching.
In addition, if action to alter Glass-Steagall restrictions has not yet been
taken, the continued separation of banking and commerce will obviously pose another
obstacle to our ability to reciprocate.
In my opinion, Europeans would probably do better not to go the route of
reciprocity.
They could decide instead to do business with any country that provides
equal regulatory treatment—whatever those regulations might be—to domestic and
foreign institutions alike.
In that way, the EC could accept American banks and extend
the benefits of greater competition to its own residents even if we persist in clinging to
broker powers for banks and nationwide interstate banking for some time. The potential
improvements in service and costs for our own customers are good enough reasons to
take quick action on such banking reforms at the national level. If in addition our banks
might be kept out of Europe after 1992 because we are unable to stand the test of
reciprocity, it is even more difficult to justify delaying our decisions. Now is the time to
modernize our banking laws and set the stage for a more competitive international
banking market in the 1990s, one in which American banks can be leading players.
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Condusion
In conclusion, we have seen that the year ahead promises continued growth both
here and in most important economies abroad. Indeed, the fundamentals look positive for
the longer term as we move toward one of the signal events of the twentieth century, the
melding of European markets in 1992.
The economic unification of the European
Community has the potential to bring greater competition to the global marketplace and
to hasten the arrival of a truly international economic order.
At this watershed, it is
more important than ever than in Europe, the United States, and throughout the world all
of us accept the challenge of competition and leave our markets free to do the work of
serving consumers with the best products at the most efficient prices.
@FedFRASER