Samuelson on Crisis

James Devine jdevine at popmail.lmu.edu
Tue Sep 1 11:19:30 PDT 1998


Tuesday, September 1, 1998

PERSPECTIVES ON THE WORLD ECONOMY

Americans are Taking a Dive With the Rest of the World

By ROBERT J. SAMUELSON [no relation to Paul]

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

Copyright 1998 Los Angeles Times. All Rights Reserved

Jim Devine jdevine at popmail.lmu.edu & http://clawww.lmu.edu/Departments/ECON/jdevine.html



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