Despite trade deficit, currency value has been rising thanks to foreign capital flowing to America's tech-driven economy.

By JAMES FLANIGAN

LA Times, Sunday, April 23, 2000

If you want a clear indication of what is powering the world economy and supporting share prices on U.S. stock markets, look at the U.S. dollar.

In recent years the dollar has defied conventional thinking to rise against major foreign currencies despite growing U.S. deficits in trade and balance of payments. In the 1980s, such deficits severely reduced the dollar's value; now they don't.

In fact, when it was announced last week that the U.S. imported $29.2 billion more in goods and services than it exported in February, the dollar rose against the euro, and the Japanese yen.

What's going on? In simplest terms, the rest of the world is making a living by selling goods to the United States, which is paying them in dollars. But then, the nations receiving those dollars are investing them back in U.S. government bonds and notes and in the stocks and bonds of private companies.

As of January this year, for example, Japan held $323 billion worth of U.S. Treasury securities; China and Hong Kong combined held $103 billion; the OPEC nations, which ship oil to the U.S. and other countries, held $44 billion worth of Treasury bonds and bills.

"The demand for dollar assets from around the world has been phenomenal," says economist Stephen Roach of Morgan Stanley.

Those holdings are investments in the U.S. economy, a testament to the fact that it has grown faster in the 1990s than the economies of Japan and Europe and that the U.S. was first to move into the Information Age and come up with innovations that Japan and Europe are now adopting.

The implications are powerful. The world's money supports stock markets indirectly when it buys Treasury securities and thus keeps long-term interest rates lower than they might otherwise be. It keeps prices up directly- when it invests in stocks and bonds. And at the moment, the world's investors are saying that the recent decline of Nasdaq stocks is a correction of overenthusiastic pricing, not a repudiation of the potential of technology.

Indeed, foreign investors know the value of technology perhaps more than Americans do. The countries of Europe and Japan are now adopting information systems to restructure companies and try to achieve the productivity gains that have helped the U.S. economy grow without serious inflation while creating millions of new jobs.

In Europe, by contrast, unemployment rates of 10% and I I% are now chronic in major countries. Even Japan, which counts unemployment differently from the U.S., now sees joblessness figures rising to 5% of its work force.

So the prospect of the next few years is exciting: As enormous economies adapt to the Information Age--often with the aid of technology supplied by U.S.-based companies--global development and prosperity should ensue.

But we can't be complacent. Global prosperity could come unglued if U.S. inflation rises sharply, undermining stock, bond and currency values. In that case the Federal Reserve would slam the brakes on the U.S. economy, and the resulting slowdown would reduce imports and the international flow of investments. And worldwide recession could well ensue.

As investors and workers in the world's vast interrelated economy, we should understand what is really happening with Europe and its sinking euro. And what is the prospect for Japan, the world's second-largest economy that has been in the doldrums for a decade?

The euro, the currency of 13 European countries, came out on Jan. 1, 1999, with a foreign exchange value of $1.17 amid bold predictions that it would soon rival the dollar as the world's money and a focus of investment.

But the euro has fallen almost 20% in the last 16 months, trading now at less than 94 U.S. cents. One reason the euro has been weak is that Europe's largest economies--Germany, Italy, France--are restructuring. Banks are merging, production is being moved from one country to another, uncertainty reigns.

At such a time, a weak currency is a good thing, not a bad thing, explains Stephan-Gotz Richter, editor of the Globalist, an online economic newsletter based in Washington, D.C. "The weak euro reflects low interest rates and abundant money supplies in Europe, which help ease the strains of restructuring," Richter says. He notes that a weak dollar in the 1980s helped U.S. industrial restructuring in a similar way.

As Europe reorganizes, the strength of its companies and economies will become clearer. In wireless telephony, for example, such firms as Nokia Corp. of Finland and L.M. Ericsson of Sweden lead the world. Both are joining Motorola Inc. of the U.S. to create a software system that will allow credit card purchases over wireless telephones with Internet access.

Investment will flow to Europe as its industrial productivity rises, and then the euro will increase against the dollar, says Scott Weiner, managing partner of Payden & Rygel, a Los Angeles investment firm. That will be an adjustment to look for in the middle of this decade.

Similarly, Japan today is investing as never before in "information technology," says Osamu Watanabe, the recently retired second-in-command at the Ministry of International Trade and Industry who lectured at USC on a visit to Los Angeles last week.

Small companies are arising in Japan and older firms are adapting, reports Naoka

Kushitani, investment manager for Williams Capital Group, a New York-based investment firrn. She points to Ito Yokado Corp., which owns 7-Eleven stores in Japan (and the U.S.). It is equipping its 8,000 stores in Japan to become mini-banks, where customers who buy goods on the Internet can pick up and pay for their purchases. That way they avoid giving credit card information online, as most Japanese are reluctant to do.

All those changes spell opportunities for U.S. industry to spread technology and productivity gains to Europe, Asia and other world regions.

Spreading know-how is the essence of global commerce today, but it is not a simple matter. U.S. companies succeed not by putting computers on ships and airplanes for export but by selling knowledge--of technological systems or products and services aided by technology.

Such sales, between or within global companies, form a new pattern of world trade that is not captured by traditional statistics. That's why trade "deficits" no longer upset currency markets.

But an economy's gains in productivity and the ability of its industries to offer returns on investment do attract capital from around the world. U.S. industry's productivity gains in the 1990s are why the dollar--and stock prices--have been strong. It's a reason for confidence--but not for complacency.

James Flanigan can be reached at jim.flanigan&latimes.com.

The Powerful Buck

As profitability and growth of U.S. industry have attracted *'investments from around the world, the U.S. dollar has gained strength against the currencies of Europe in the last five years. The dollar also has gained against the Japanese yen for most years, but has been losing ground this year.

ECU/euro* per dollar

Friday: 1.07

Yen per dollar

Friday: 105.7

*The euro began to be used Jan. 1, 1999; prior to that the ECU was used as a tracking currency for 13 European nations.

Source: Federal Reserve Board

Researched by NONA YATES / Los Angeles Times