Stephen Roach: "Is Global Collapse at Hand?"
By STEPHEN S. ROACH -- September 1, 1998
There can be little doubt that world financial
markets are now in full-blown crisis. With yet
another black Monday
taking the Dow down 513 points yesterday, a sense of
despair and desperation has set in. Global currency
contagion has run rampant, from Thailand to Russia and
all too many points in between. The International
Monetary Fund seems to be out of bullets. Investors are
stripping risk from their portfolios.
Is there a way out? Resolving the crisis depends on why
the market started to plunge in the first place. Did
inherent flaws in the world economy cause the crisis?
If so, a collapse of global activity could certainly be
in the offing, leading to an outbreak of global
deflation. Or was this crisis simply caused by a panic
among investors and the inherent instability of
financial markets? Put another way, are countries now
completely insolvent, or are they just suffering from a
temporary lack of funds?
Worldwide deflation can't happen without a collapse in
worldwide demand. For example, in the early 1930's
world production and trade fell by 5 percent to 10
percent annually.
Such a collapse is highly unlikely today. World gross
domestic product is likely to increase by 2.3 percent
in 1998, even with the crises in Asia and Russia. In
the full-blown global recessions of the past, gross
domestic product usually increased only about 1.5
percent a year. In other words, markets around the
world may be crashing, but the global economy is
probably not. That suggests that the market's reaction
to fears of global depression and deflation are
overblown.
Indeed, before the steep market declines of the last
several days, there were signs of healing in Asia.
International financing positions as measured through
the balance of payments went from deficit to surplus --
having the effect of transforming these countries from
borrowers to lenders in world financial markers.
Foreign companies were beginning to buy Asian
enterprises at significantly reduced prices, thereby
providing capital to previously bankrupt businesses.
But given the events of the past several days, these
market-driven solutions are no longer enough. Fear and
panic in financial markets sometimes take on lives of
their own, and that is now the risk. Under these
circumstances, the United States and other leading
industrial countries, as well as the International
Monetary Fund and the World Bank, should take action
that restores investor confidence.
The time for a coordinated international response may
now be at hand. Such an effort will need to include two
important ingredients.
First, all major central banks except Japan's must
reduce interest rates. In return for being relieved of
this responsibility, Japan would have to accelerate its
financial reforms.
Second, the I.M.F. must rethink its "rescue tactics."
Specifically, it must relax its fiscal austerity
requirements -- for instance, the mandate that
governments cut spending -- and recognize that it is
time to put banking reform on hold because it denies
the expansion of credit to borrowers at precisely the
time they need it.
In short, central banks and the I.M.F. both need to
focus squarely on crisis containment and put tangential
considerations aside.
Financial markets would probably respond quite
favorably. In Japan and Russia, however, the impact on
the financial markets would be more limited. That's
because both countries suffer from more fundamental
structural problems -- Japan's credit crunch and
Russia's inability to collect tax revenue -- and thus
require more radical solutions.
Indeed, a world in crisis requires many of us to think
the unthinkable. For example, I had long felt that the
Federal Reserve's next move should be to raise interest
rates; now I believe it should reduce rates to stem the
crisis. But the Fed cannot be expected to do the job
alone. This must truly be an international effort.
There are risks in this approach. Lower interest rates
would only boost domestic demand in an already rapidly
growing and fully employed American economy, thereby
setting the stage for a prompt policy reversal once the
crisis subsides.
Such an outcome, of course, is strikingly reminiscent
of the Fed's policy whipsaw in the aftermath of the
crash of 1987, when interest rates were reduced by
three-quarters of a point and then raised by three
points the following year. It certainly wouldn't be the
first time history repeated itself.
Stephen S. Roach is chief economist and director of
global economics for Morgan Stanley Dean Witter.
Copyright 1998 The New York Times Company |
