(FORTUNE Magazine) – THE ECONOMIC OUTLOOK for two of the U.S.'s biggest trading partners, West Germany and Japan, annoys Treasury Secretary James Baker and will fuel the fire under protectionist legislation now before Congress. In Japan the government is terribly concerned because the inflation rate is about to go up -- can you believe this? -- from close to zero to 2%. West Germany faces a slightly less terrifying rate of 1.5%. Both countries expect respectable growth next year partly because their exports will climb, and both are moving toward tighter money. To paraphrase William Jennings Bryan: How long, O trading partners, do you expect American politicians, even the free-traders among them, to keep getting crucified upon the docks where the Mercedes and Toyotas arrive? Well, listen to a rebuttal from the Germans and the Japanese. Until recently they had been goosing their money supplies, using a cornucopia of D-marks and yen to support the dollar, whose weakness they ascribe to American profligacy. They are worried that at some point all this liquidity will burst through into higher prices -- as big a bugaboo to them as the trade deficit is to the U.S. Considering the balancing role they must play, perhaps they are entitled to a little respect. There's no question that the lopsided accounts of the world's biggest traders require a role reversal of historic proportions. To keep the world economy humming -- and the dollar from falling dangerously fast -- the U.S. has to rein in domestic demand relative to GNP while boosting exports. The trade partners have to do pretty much the opposite. Whether their nascent expansions continue next year depends mostly on robust domestic demand, and that is up to German and Japanese policymakers. Both countries are taking modest shots at fiscal stimulus. Says Lars Pedersen, an international economist at Merrill Lynch Economics: ''They got quite a bounce in 1987. The question is, what's the follow-through for 1988?'' Consider the German case. GNP grew at about a 6% annual rate last spring, after declining in the two previous quarters. Though business investment fell, consumers boosted their spending smartly and construction activity took off. All in all, domestic demand grew about a percentage point faster than output. The biggest surprise, says Pederson, was unexpectedly strong export performance. After the D-mark rose against the dollar in January, the Frankfurt stock market fell because investors assumed that exporters would take a beating. Instead export orders have been rising since March -- especially for top German competitors like chemicals, machinery, and trucks -- and export volume is up a couple of percentage points over a year ago. The goods will keep flowing out unless the mark strengthens sharply. Exporters are learning to live with lower profit margins in order to hang on to market share. Moreover, several favorite German markets, including OPEC and other European countries, will be expanding. James Baker's worry is that Germany's recent tilt to tighter money will derail the expansion. The Deutsche Bundesbank, the central bank, has been nudging up interest rates since July. This move, said Baker, ''is not of course a trend which we favor, and we do not think that this rise is reflective of the spirit of our recent consultations.'' He hinted that in reprisal the U.S. might let the dollar fall further against the mark. But the American fears are overblown, says William C. Dudley, a senior economist at Goldman Sachs. The Bundesbank has had legitimate reason to worry about excessive monetary growth. The monetary base -- currency and bank reserves -- has been outpacing its target range of 3% to 6% this year, in part because of massive intervention to support the dollar last spring. And short-term interest rates have been near postwar lows -- between 3% and 5%. In any case the mark's renewed strength is likely to discourage further restraint. Profit margins of German exporters are wafer-thin, and the strong currency is keeping a lid on inflation. Chances are that rates will stay about where they are into next year. Though public works spending won't increase much, fiscal policy as a whole should turn mildly expansionary. The federal government plans income tax cuts of $8 billion in 1988. These should boost household income growth by more than a percentage point and GNP by half as much, according to Dudley, even if the government finances part of the tax cut by trimming its budget or raising sales taxes. If all goes well, the economy should grow about 2% to 2.5% next year. For all the grousing, that is not much slower than what the U.S. is likely to get -- and domestic demand will rise faster, picking up to a rate of 3% to 3.5%. Consumer spending will be especially buoyant. Capital spending should grow at least as fast as last year, about 2.5% . Still, the economy will be performing below par, with unemployment hovering around its current rate of 8.4%. And even this modest recovery could shrivel ! if the mark takes off again or if consumers increase their savings rate. It is already extraordinarily high at 13.6%, but some forecasters think that consumer confidence is fragile and that a shock or spate of bad news could scare the thrifty Germans into saving still more. Japan, the U.S.'s second-biggest trading partner, has adapted astonishingly well to the stronger yen. Exports have weakened, but domestic demand is increasing briskly. Profits are up, and unemployment has edged down. Business and consumers are turning confident again. A vast pent-up demand for living space has driven housing starts up some 30% in the summer, and consumers are buying furniture and appliances like mad. Consumer spending will probably grow about as fast in 1988 as it has this year, at a 3.5% to 4% rate, though more of the yen will be going on goods from abroad. Investment is reviving too. Machinery orders have risen handsomely. Service industries -- finance, real estate, and utilities -- will be the big spenders. In 1988 domestic demand should increase at a 4% to 4.5% rate. Could the U.S. wish for more? GNP should grow as fast as this year, about 3%. It could rise more if exports continue to perform better than expected. Look for a mild tightening of monetary policy by early 1988, when many observers expect the Bank of Japan to raise its discount rate by half a point. But money growth has been soaring, partly because of intervention on behalf of the dollar, and interest rates have fallen to postwar record lows of around 2.5%. So the expected rise in rates is not likely to slow the economy. Inflation should stay below 3%, and the Japanese central bank is not eager to drive the yen still higher. Fiscal policy is apt to spur consumption. Income taxes will be cut again next year, and most economists don't expect Japan's central government deficit to shrink. So how bad is it that the German recovery is far from rip-roaring, and both Germany and Japan will continue to excel at exporting? The strong revival of domestic demand in Japan will help U.S. exports. American-made food, paper, pulp, chemicals, steel -- even some car parts -- are now cheaper for Japan to import than to make at home. From the U.S.'s point of view, the faster growth abroad at least adds up to half a loaf.

CHART: NOT AVAILABLE CREDIT:NO CREDIT CAPTION:NO CAPTION DESCRIPTION: Chart of GNP for Japan and West Germany, 1984-1987, with forecast for 1988.

CHART: NOT AVAILABLE CREDIT:NO CREDIT CAPTION:Read It and Envy A consensus of forecasters expects only 2.2% inflation in Japan and 1.5% inflation in Germany for 1988. DESCRIPTION: Chart of change in consumer prices for Japan and West Germany, 1984-1987, with forecast for 1988.