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The trade gap's crushing impact on the stock market ignited a stormy political exchange about how to solve it. The trade deficit is boosting congressional support for tougher measures that might include sheltering U.S. industries and blocking some imports. But the Reagan Administration and many economists contend that the general trend is toward improvement. Indeed, during the first eight months of 1987, exports have risen 13% over the same period last year. Says U.S. Trade Representative Clayton Yeutter: "It would be a tragic mistake to give in to protectionism at a time when the real trade deficit is declining."
With inflationary pressures (current rate: 5%) mounting and patience running out, Federal Reserve Board Chairman Alan Greenspan tried early last week to assuage inflation fears by saying that the trade deficit is "bottoming out." Not everyone is so sanguine. "Greenspan is wrong. There are plenty of signs of inflation," says Edward Yardeni, chief economist for Prudential-Bache Securities. Right now the most obvious sign is the stubborn trade deficit and fragile dollar. Martin Feldstein, President Reagan's former chief economic adviser, predicted earlier this month that the dollar will have to fall another 10% to 15% soon.
Rising prices and interest rates would be sure to act as a damper on the economy, which is still expanding at a healthy 3% pace. In corporate America, higher interest rates could force many companies to delay capital expansion projects. Steeper rates already seem to be throttling one of the economy's driving forces, consumer spending. The increases hit consumers faster than ever because of the growth in home-equity loans and adjustable-rate mortgages. The average conventional mortgage rate, one survey says, is now more than 11.4%, up from 9.1% in March. Gripes a Chicago real estate agent: "This is a dead market, deader than when we were in a real slump in 1981 and '82. I have listings that haven't been shown in a month."
But no one was hit harder by the market's fall than Wall Street's investment houses, for whom the fat-and-happy days of the long bull season may be over. "If you look at the bond market, the crash has already occurred," says a discouraged investor. As bond prices plunged, several Wall Street firms that had beefed up their bond staffs in recent years began to cut back. Salomon Brothers laid off 12% of its estimated 6,500 employees. The 800 furloughed workers earned an average annual income of $125,000, which Salomon was ill able to afford after losing $100 million in its municipal-bond unit so far this year. Kidder Peabody laid off 100 of its 280 municipal-bond traders. Said Analyst Perrin Long, who covers the investment community for Lipper Analytical Services: "This could be the beginning of the long-awaited retrenchment on Wall Street."
And this week? Many investors saw a hopeful sign in the waning minutes of Friday's bloodbath, when the market rallied and stopped what looked like a slide toward a 150-point loss. Some experts see the fall as a long-needed comedown, which took the Dow to a more rational level after an unrealistically fast climb. They believe that after a rest, Wall Street will rally again. Says Robert Prechter, the Georgia-based stock guru: "The bull market remains intact."