Bear Scare

Only a few weeks ago, economists and investors were confident, almost cocky, about the prospects for the U.S. stock market. Since inflation seemed moderate, forecasters widely assumed that interest rates would glide gently downward and bolster Wall Street. But now that assumption seems exquisitely ill timed. Interest rates around the world have suddenly surged, sending stock prices tumbling on exchanges from Tokyo to London and threatening to put the sickly U.S. economy into the intensive-care ward.

An uncertain and often bearish mood took over most of the world's stock markets last week. In a fit of gloom on Monday, Wall Street traders sent the Dow Jones average tobogganing 77 points, to 2600.45, the largest single-day drop since the 191-point minicrash last Oct. 13. The Dow closed Friday at 2559.23, down 119 points for the week and 250 points below its Jan. 2 record high of 2810.15. At week's end the Government reinforced Wall Street's fears that the U.S. economy is faltering by reporting that the economy grew just 0.5% during the fourth quarter of last year, the worst performance in more than three years. Said Allen Sinai, chief economist of the Boston Co.: "It shows that the economy ground to a virtual halt in the fourth quarter, with signs of weakness everywhere. The economy is flirting with a recession."

The Wall Street rout, which took its cue from rising interest rates and slumping stocks in Tokyo, demonstrated the extent to which global markets have become inextricably linked to one another. The U.S. is now especially vulnerable to changes in foreign markets because it depends on overseas investors to finance a large portion of its federal deficits. While the U.S. economy may need lower interest rates to stay afloat, Japanese and West German central bankers have quite conflicting needs at the moment: higher rates to prevent their surging economies from touching off a sharp rise in inflation.

The first sign of trouble emerged a month ago from the Tokyo offices of the Bank of Japan. On Christmas Day, a working day in Japan, the central bank announced that it was raising its prime lending rate from 3.75% to 4.25%, a surprising increase. The move reflected the bank's concern about a 2.5% rise in wholesale prices last year, the first increase in the Japanese index in seven years. Rising oil costs and escalating real estate values account for a good share of the upward pressure on Japan's prices.

Many Japanese moneymen thought the Bank of Japan's fears were misplaced. "I think it's mind-boggling to be worried about inflation," said a Japanese commercial banker. But the onset of higher interest rates, which have made Japanese bonds far more lucrative, took the steam out of Tokyo's once irrepressible stock market. Since the beginning of the year, the Nikkei index of 225 Japanese stocks has lost almost 5% of its value. Besides being skittish about the interest-rate rise, investors fear that Japan's Socialist Party could score an upset victory in the lower house of the Diet in the Feb. 18 general election.