Samuelson on Crisis (fwd)

[Robert Weissman <rob@essential.org>]

One of the most conservative of economic writers acknowledges problems
related to capital mobility ...

Robert Weissman
Essential Information			|   Internet:	rob@essential.org

Tuesday, September 1, 1998 

 PERSPECTIVES ON THE WORLD ECONOMY 
 Americans are Taking a Dive With the Rest of the World 
 By ROBERT J. SAMUELSON 

 We should not fool ourselves that the recent sell-offs in world
 stock markets simply reflect a nervous reaction to Russia's
 turmoil or a long-overdue "correction." They signify instead a
 gathering fear that the global economy is drifting toward a dangerous
 slump, driven by forces that world leaders only vaguely understand
 and seem powerless to affect. Even those supposed titans of global
 finance--Treasury Secretary Robert Rubin and Federal Reserve
 Chairman Alan Greenspan--give little hint publicly that they grasp the
 threat or know what to do about it. 

 This is no longer a minor "Asian" crisis. Japan's recession is its worst
 since World War II. Latin America's economies are slowing.
 Russia's depression hurts its Eastern European trading partners.
 China is slowing. Together, these areas represent almost half the
 world economy's output. The United States and Europe, with 40% of
 global gross domestic product, cannot easily escape the fallout. 
 Given today's prosperity, Americans are naturally disbelieving.
 Unemployment is 4.5%. Inflation barely exists. Exports--the sector
 directly affected by the global slump--are only 12% of U.S. GDP.
 But economists (and others) often blunder by projecting the present
 into the future. America's prosperity is precarious precisely because
 things can't get better; they could easily get worse. 

 How? The economic expansion began in 1991. Americans have
 already bought lots of cars, computers and clothes. Consumer debt
 (including home loans) is high. The personal savings rate is less than
 1%. Until recently, the jubilant stock market made Americans feel
 wealthier. They are spending some of their stock profits. Now, lower
 stock prices could dampen confidence and consumer spending, which
 is two-thirds of GDP. Exports are already weakening; rising imports
 further imperil domestic production. Why, then, would companies
 continue to increase investment (11% of GDP)? A recession is
 clearly possible. 

 And a U.S. slump would compound everyone else's problems. The
 United States is the world's largest importer, and other
 countries--from South Korea to Brazil--need to export to recover.
 Lower interest rates would improve the outlook. The Federal
 Reserve should cut rates by at least half a percentage point. Lower
 rates would ease debt burdens and help sustain consumer spending
 and home buying. 

 The Fed's refusal so far to cut rates seems less and less defensible.
 The inflation that an economic boom normally produces has been
 largely stifled by global deflation and competitive markets. By various
 indicators, inflation in 1998 is somewhere between 0.9% and 1.7%.
 The interest rate that the Fed controls--the Fed funds rate, on
 overnight loans between banks--is 5.5%. This implies that "real"
 interest rates (adjusted for inflation) exceed 4%, which is high
 historically. 

 The reason to lower rates is not simply to give the U.S. economy a
 shove. It is also to counteract capital flight out of other countries,
 which is now spreading economic distress around the globe. Capital
 flight involves moving funds out of local currencies (say, the Russian
 ruble or Mexican peso) into "hard" currencies, such as the dollar or
 the German mark. When this happens, countries lose foreign
 exchange reserves (again, mainly dollars) or suffer sharp currency
 depreciations, as their currencies are dumped. Or both. 

 Capital flight imposes austerity. Countries raise interest rates to
 entice investors to keep funds in local deposits--or to dampen
 economic growth. A slumping economy cuts imports and saves
 scarce foreign exchange reserves. Many countries are now
 succumbing to this cycle. Canada's central bank (its Federal
 Reserve) recently raised interest rates by 1 percentage point to
 stop the Canadian dollar's slide. Earlier, India increased rates from
 5% to 8%. What makes sense for one country can, if done by too
 many, cause calamity. If all squeeze their economies, their slumps
 feed on each other through less trade. This is now an obvious danger.

 Lower U.S. interest rates would relax these pressures. It would be
 easier to earn dollars by exporting. Dollar investments would become
 slightly less attractive for those fleeing local currencies. But lower
 U.S. rates, by themselves, probably can't stop capital flight and its
 fallout. And this creates a Catch-22: Individual countries can't
 recover until the world economy improves; and the world economy
 won't improve unless many individual economies do. 

 What is to be done? Good question. The International Monetary Fund
 and the U.S. Treasury have treated each ailing economy as an
 isolated case in need of "reform." Larger problems--capital flight,
 global growth--have been ignored. Meanwhile, political leaders in the
 world's three largest economies (the United States, Japan and
 Germany) are weak. The result is an intellectual and political
 vacuum. Why shouldn't the world's stock markets be nervous? The
 wonder is that it took them so long to get that way. 
 - - -

 Robert J. Samuelson Writes About Economic Issues From
 Washington

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