U.S. MARKETS OFFER GLIMPSE OF VOLCKER NIGHTMARE
  Today's turmoil in the U.S. Financial
  markets, with bond and stock prices tumbling in the dollar's
  wake, is evidence of a major shift in investor psychology that
  is likely to spell more turbulence ahead, economists said.
      For two years, the markets had hailed the dollar's decline
  as the cure-all for the U.S. Trade deficit. Interest rates fell
  sharply and Wall Street became a one-way street, up.
      But that confidence is now cracking as the financial
  markets suddenly believe Fed chairman Paul Volcker's
  often-repeated warnings about the risks of a dollar collapse.
      "Volcker's been saying for a long time that a dollar
  freefall would be extremely dangerous - now he's got it," said
  David Jones, economist at Aubrey G. Lanston and Co Inc.
      The dollar fell below 144 yen today for the first time in
  40 years as the Group of Seven finance ministers in Washington
  failed to convince the foreign exchange market that they have a
  credible strategy for redressing global trade imbalances, short
  of further depreciation of the dollar.
      Bonds suffered their biggest one-day drop in months amid
  worries that the dollar's slide will rekindle inflation, scare
  away foreign investors and force the Fed to tighten credit.
      The inflationary fears boosted gold bullion by more than 12
  dlrs to a 1987 high of 432.20/70 dlrs an ounce, while the spike
  in interest rates pulled the Dow Jones Industrial Average down
  by 33 points to 2339.
      Norman Robertson, Mellon Bank chief economist, called the
  markets' instability frightening. He believes economic
  fundamentals do not justify the bearishness but said that "once
  you start the ball rolling it's difficult to stop."
      "There's a stark possibility that you could get a
  destabilizing drop in the dollar that forces up interest rates
  and drives us into recession. The markets are in a panic."
      Stephen Marris of the Institute for International Economics
  in Washington, has been warning for a long time that the
  controlled decline of the dollar since peaks of 3.47 marks and
  264 yen in February 1985 could turn into a nightmare.
      "We're still more or less on track for a hard landing... But
  the agony may be fairly drawn out," Marris told Reuters.
      Marris does not expect the crisis to peak until later this
  year, but he warned that the situation is so fragile that it
  would take very little to touch off what he calls the second
  phase of the hard landing, whereby a loss of confidence in the
  dollar pushes up interest rates and leads to a recession.
      The stock market's reaction today and its sharp drop on
  March 30 shows how the loss of confidence could come about.
      The fact that it has not happened yet is consistent with
  historical experience, which teaches that domestic markets are
  not affected until a currency is in the final stages of its
  decline, Marris said. He has forecast a drop to about 125 yen.
      Marris felt that a major impetus for the dollar's latest
  weakness was the loss of credibility that central banks
  suffered when they failed to prevent the dollar from falling
  below 150 yen, the floor that the market believes was set as
  part of the G-7 Paris agreement in February.
      Robertson at Mellon, by contrast, said the loss of
  confidence was triggered last week when Washington announced
  plans to slap 300 mln dlrs of tariffs on Japanese electronic
  imports, raising the specter of a debilitating trade war.
      Many economists believe that long-run stability will not
  return to the markets until the root cause of the trade gap is
  addressed - excessive consumption in the U.S., Reflected in the
  massive budget deficit.
      But in the short term, given the failure of the G-7 and of
  central bank intervention, some feel that the Fed will have no
  choice but to tighten credit to restore faith in the dollar.
      "The only thing that will stop the dollar falling is a
  substantial increase in the discount rate and a corresponding
  cut abroad, at least by Japan," said Lanston's Jones.
      Marris expects the Fed to act quickly to raise interest
  rates, even at the risk of increasing the debt burden for
  American farmers, Latin American governments and others.
      But Robert Giordano, chief economist at Goldman Sachs and
  Co, scoffed at the notion. "It's ridiculous to think the Federal
  Reserve will raise interest rates when the dollar is weak
  against just one currency. This is yen strength, not dollar
  weakness," he said.
      Giordano said the market was ignoring the progress being
  made toward reducing the U.S. Budget deficit.
      "We're going to have one of the biggest reductions in the
  budget deficit relative to GNP in history this year, and nobody
  cares," he said, noting that only the deficit cut in 1968-69
  will have been greater.
      He said he does not expect the dollar to collapse and
  thinks interest rates are likely to fall back later this year.
      But for now, market psychology has changed so abruptly that
  a further drop in the bond market cannot be ruled out. "Put on
  your helmets," Giordano said.
  

