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U.S, Japan Put Economies On Line In Trade Feud At Worst, Unresolved Dispute Could Trigger A Worldwide Recession

With a deadline only two days away and both sides still far apart, some are beginning to think the unthinkable - that the world’s two largest economies could really be headed for an all-out trade war and all the woes that could bring to the global economy.

Under the gloomiest scenarios, the fight between two economic giants would get so nasty that it would destabilize financial markets, kick the props out from under the already shaky dollar and trigger a worldwide recession.

Even the most optimistic economists believe the trade dispute will lead to slower economic growth. Most believe that Japan, which is already threatening to dip back into recession, will be hurt more severely than the United States.

“Both countries are playing with fire,” said Robert Hormats, a vice president at Goldman Sachs in New York. “You can’t have a trade dispute of this magnitude between the two biggest financial powers in the world without an impact on other areas.”

Of course, last-ditch talks that began Monday between U.S. Trade Representative Mickey Kantor and Japanese Trade Minister Ryutaro Hashimoto could yet produce an agreement before U.S. sanctions on Japanese luxury cars take effect at 12:01 a.m. Thursday.

But if those discussions don’t succeed - and prospects are cloudy at best - then analysts said U.S. policymakers should start making contingency plans to deal with the fallout from what threatens to become the biggest trade dispute since the 1930s.

The first shoe to drop could well be counter-retaliation by Japan, where officials met last week to discuss imposing their own punitive tariffs. High on the hit list are two of America’s biggest sellers in the Japanese market - food and aircraft.

If Japan does retaliate, that would fit the classic definition of a trade war in which sanctions by one country are met by counter-retaliation by the other nation.

The Japanese, however, might choose to retaliate in another way. Some believe that Japan’s recent rejection of President Clinton’s call for a tougher economic embargo against Iran was just such a retaliation. And they suspect that Japan’s hard-line stance in a fight with Federal Express over expanded landing rights could be another spill-over from the bitter auto dispute.

There also has been a rumor roiling U.S. financial markets that the Japanese might stop buying U.S. Treasury bonds. That would put upward pressure on American interest rates as the government was forced to pay more to sell its debt.

Even if Japan doesn’t seek retribution in bond markets, economists warn that markets are likely to remain jittery if the U.S. sanctions go into effect because markets would be fearful of further hostilities.

The economists believe the biggest threat to the U.S. economy will come from any further weakness in the dollar, which could make inflation worse in this country by making imports more expensive. That could keep the Federal Reserve from cutting interest rates to fight off a potential U.S. recession.

The economic fallout in Japan would be even worse. The Japanese economy is already teetering on the brink of another recession, with its exporters hurt by a yen that has gained 15 percent in value against the dollar just since the first of this year.

Weakness in the world’s second biggest economy would be coming at a time when there are growing signs of a slowdown in the United States and Europe. It would not take much, analysts warns, for such a slowdown to spiral into a global recession.

Another victim in an all-out trade war will be the World Trade Organization. The United States, which fought hard to create the new global referee for global trade disputes with expanded powers, is now being universally condemned for bypassing the WTO with its threat of unilateral sanctions.

“As is often the case when you have these kinds of fights, there are no winners,” said Allen Sinai, chief economist at Lehman Brothers in New York.

Given the bleak prospects, the pressure should be growing for both countries to compromise and reach an 11th-hour agreement as they have done so often in the past. But many analysts fear that entrenched positions on both sides make such an outcome less likely this time.

“On any grounds of economic rationality, the wisest course would be for a settlement. But this fight has more to do with politics than economic rationality,” said David Wyss, an economist at DRI-McGraw Hill.