After '94, U.S. exports will strengthen.

The United States has much at stake in the health of the world's economy. The importance to our economy of American exports of goods and services has grown steadily over the years to the point where they now represent nearly 11% of the nation's economic output.

Recently, however, weak

economic conditions in our largest trading partners have temporarily dampened U.S. export growth. Between 1988 and 1992, U.S. exports of goods and services grew at more than a 10% annual rate, slowing to less than 5% in 1993 after a recession hit key markets in Europe and Japan. After another weak increase of 3% to 5% in 1994, the growth of U.S. exports should accelerate as the economies of its trading partners fully recover. This should boost export sales of American goods and services to over $700 billion in 1995.

Generally, those economies that entered the most recent international recession first--the U.S., Canada and the United Kingdom--also began their recoveries first. The U.S. economy is now in a solid expansionary phase, with Canada and the U.K. close behind. All three economies posted real GDP growth rates of 2% to 3% in 1993 while, at the same time, Japan, Germany and France struggled to reverse their economic slide. In the latter three nations, a variety of economic problems have complicated attempts to resuscitate stagnant consumer spending and corporate investment. In 1994, all the major industrialized economies should move in the same positive direction for the first time since 1989. Japan followed its economic doom of the late 1980s and early 1990s not with the "soft landing" most policymakers hoped for and expected, but with the thud of a tired and overextended economy. The apparent end to lifetime employment brought about through corporate restructurings spooked consumer confidence, resulting in weak consumer spending, cutbacks in capital investment, and a deepening of the economic decline. At the same time, the expanding U.S. economy and the economic growth in many of East Asia's newly industrializing economies enabled Japan to run a record current account surplus in 1993 of over $130 billion. But this helped only in part to offset the domestic contraction. The contraction will likely extend well into 1994 and result in virtually no growth for this year, while the Nikkei stock index struggles to maintain a level of 20,000--barely half its 1989 peak. The failure to reach a trade a greement to boost Japanese imports during the Clinton-Hosokawa meeting in February was inevitable. The Japanese government is increasingly less able to dictate the import strategies of Japanese industry even as it accepts the U.S. position that more imports would help the bilateral relationship and provide benefits to the Japanese consumer. But the Japanese Government also argues, correctly, that to introduce numerical sales targets for U.S. goods in Japan (a U.S. objective) would run counter to their efforts to deregulate and reform the Japanese economy.

The rise in the value of the yen to close to 100 yen/S1 is unsustainable and an overreaction to the trade problems that exist. Economic fundamentals should eventually push the exchange rate back into the 110 to 120 yen/S1 range, where it was just before the recent trade friction developed.

Germany's recession has

resulted in soaring

unemployment, stagnant industrial production and relatively high inflation. With more than four million people unemployed in the western half of Germany alone--an unemployment rate close to 9%many pohticians are looking for quick relief from the Bundesbank, hoping that it will lower interest rates more rapidly to help jump-start the economy. Over the past year, the Bundesbank lowered its key official discount rate in several small steps to 5.25% at mid-February 1994. Despite signs of a more relaxed monetary policy, reflecting in large part recent improvements in the inflation outlook, the Bundesbank is unlikely to abandon its policy of "cautious" easing.

A continued gradual reduction in interest rates will ultimately contribute to the slow recovery we expect in 1994 in Germany. This recovery, because of its impact on Germany's propensity to import, will help other European Union member states resume modest growth this year--especially France and Italy. The German mark should also continue to depreciate during 1994 not only against the U.S. dollar (we expect it to rise slowly through the 1.70-1.80 DM/$1 range) but also against some of its counterpart currencies in the European Monetary System. Against the French franc, the D-mark has already lost most of its 1993 gains, and the German economy will likely underperform the French economy in a number of areas, including inflation and real economic growth this year.

Canada and the United Kingdom both had deep recessions in the early 1990s that drove up unemployment and drove down inflation. The Canadian dollar, after several years at very high levels (close to C$1.13/$1), finally began to depreciate in 1992--two years after the recession began and as interest rates fell. With only a slight depreciation expected for the Canadian dollar during the next twelve months (to about C$1.35/$1), Canadian exports should continue to rise.

The British pound sterling has and should continue to remain relatively stable near $1.50/1 following its sharp depreciation in late 1992.

Prospects for U.S. exports for the remainder of the decade look good. The reason: passage last year of the North American Free Trade Agreement and the signing of a new GATT tariff agreement that will reduce tariffs on goods around the world. The United States, with its revitalized and competitive export sector, will be one of the principal beneficiaries of the world's continued growth in trade.

And while Europe and Japan will remain the key trading partners for the foreseeable future, much of our export growth will flow to East Asia, Latin America, and elsewhere in the developing world. Market-oriented reforms in many developing countries have generated rapid economic growth and an almost insatiable demand for western products.