Party Till You ...Well, Till The Rest of the World Gets Its Economic Act Together We all say we want a global economic recovery, but one of the main contributors to America's long boom has been the slowdown overseas. What happens if Asia, Europe, and Latin America really do turn themselves around?
By Anna Bernasek Reporter Associate Lenore Schiff

(FORTUNE Magazine) – At last, the world is getting back on its feet. Signs of life are emerging in Asia, Europe, Latin America, even Russia. This is what we've been hoping for--global economic recovery. As the world prospers, U.S. products will benefit, extending our eight-year-plus growth phase. Something to look forward to. Or is it?

Be careful what you wish for. A global recovery could be the U.S. economy's undoing. For the past three years, the U.S. has to a significant degree been living off the misfortune of other countries. Thanks to worldwide economic stagnation, Americans have enjoyed cheap imports, weak commodity prices, and abundant foreign investment. All that has contributed to spectacular economic growth and low inflation.

In a global recovery, that may change. "We should recognize that when the rest of the world does recover, some of the benefits we have had from their recession will go away," says Federal Reserve governor Edward Gramlich. "The fact that the world economy has developed the way it has means the U.S. has experienced a nice little investment boom financed by foreigners." Since the world economy began slowing, foreigners have parked their money here. In the past year alone, $237 billion flowed into the U.S., resulting in a strong dollar and another amazing rise of the stock market. Foreigners are contentedly buying American assets because they offer solid returns with low risk. But when--not if, when--the world economy recovers, or when the appetite for risk changes, or the outlook for the U.S. deteriorates, investors will shift their money out and in the process send the dollar and stock market down. "A day will come when U.S. assets don't provide a good enough return," says Kevin Logan, Dresdner Kleinwort Benson's chief market economist. "Depending on how quickly that happens, it could be pretty uncomfortable."

The impact might stop there, if it weren't for one major factor: a record current-account deficit, or foreign currency shortage, of $233 billion. The U.S. creates that deficit by spending more on imports than it earns on exports. To earn enough to make up for the shortfall, the U.S. must sell assets such as stocks, bonds, and real estate to foreign investors. But in a situation where foreigners have lost their enthusiasm for U.S. investments, there are only two choices: Save more and consume less to reduce the deficit, or raise interest rates to make it worthwhile for international investors to keep their money here. Either way, U.S. economic growth will slow.

Then there's the threat of inflation: As other economies recover, foreign currencies will strengthen against the dollar, increasing the price of imported cars, electronics, computers, and other goods. As demand around the world increases, prices of commodities, such as copper, aluminum, and nickel, will also pick up.

Just how the future plays out is hard to predict, of course; there are countless scenarios. The one thing we can count on is that when the world recovers, the days of low import and commodity prices and seemingly insatiable demand for U.S. assets will be over. Whenever that occurs, interest rates here will have to rise.

For now, however, most of the planet is safely stagnant, or stagnant enough, anyway, for the grand party that is the U.S. economic boom to continue. World economic growth is expected to be moderate and patchy in the near term. For next year, the IMF forecasts growth in real GDP of 4.9% for developing countries and 2.3% for developed countries. But that could change fast. In the opinion of Robert Heisterberg, chairman of the asset-allocation committee at Alliance Capital Management, this might already be occurring. "People have to reexamine the pessimism of 12 months ago, when they expected it would take several years before Asia recovered," he says. "I think now you're talking about a matter of months."

There are signs to watch, a very good one being equity markets themselves. In theory at least, stock markets anticipate economic recovery. So far this year, in U.S. dollar terms, the Nikkei index is outperforming the Dow, the Korean market is up 80%, Indonesia is up 98%, Hong Kong 36%, Argentina 28%, Chile 32%, Russia 162%, to name a few.

In the end, though, it's portfolio managers who will determine the outcome. Take Larry Fuller, who manages Merrill Lynch's $2.5 billion Global Growth fund. So far Fuller has remained tied to the U.S. market, with 50% of the fund in U.S. stocks and the remainder in the U.K., Germany, and Western Europe. He has not yet moved into Asia and is carefully watching for evidence that might change his mind. "We will change our strategy purely on the basis of changes in government policy," he says. When Fuller and others like him do alter their investment strategies, billions of dollars could flow out of the U.S. in a matter of days. "I wish I knew myself definitely when we will change," Fuller says.

So would we all. The moment that sophisticated fund managers decide foreign markets are where it's at, we may have arrived at the end of the long American boom. Maybe it's still not too late to change our wish list.

REPORTER ASSOCIATE Lenore Schiff