BusinessWeek. A FEW HOME TRUTHS AMID THE GLOBAL TUMULT
What's an economic pundit to do when faced with the
challenge of writing an opinion column for business
readers in a period of such great uncertainty in global
financial markets? There are so many momentous
questions to explore. Will Japan pass a credible bank
reform? Who will lead Russia from the brink of
bankruptcy? Will China devalue? Will the hordes of new
investors in the U.S. stock market lose their cool and flee
to safer portfolios? Will the Federal Reserve lower interest
rates?
Frankly, I can't answer any of these questions with
certainty, and unlike many pundits, I'm not foolish enough to pretend I can. So
I've decided to reflect on the economic truths that have been confirmed by recent
developments.
First, greed is not enough. Without a strong rule of law, transparent financial
institutions, and legitimate corporate and political governance, greed spawns not
the marvels of the market but the mischief of crony capitalism. A working tax
system may distort market incentives. But Oliver Wendell Holmes was
right--taxes are the price for a civilized and orderly society. Strong central banks
may create large bureaucracies and regulatory headaches. But without them,
economies can be brought to their knees by the excesses of misguided,
sometimes corrupt, investors. With rules in place, privatization can promote
innovation; without them, it can amount to little more than sophisticated robbery.
DISRUPTIVE CHANGE. Second, growing economic interdependence among
nations has both benefits and drawbacks. Although freer cross-border flows of
capital facilitate the efficient allocation of investment around the world, they can
also produce disruptive changes in exchange rates and asset prices, setting off a
vicious cycle of financial collapse, deflation, and contagion. Unfortunately, what
Alan Greenspan refers to as the ''patchwork of arrangements and conventions to
govern the international financial system'' has not kept pace with its breakneck
dynamics. The world needs new multilateral governance arrangements, and
whatever its shortcomings in Asia and Russia, the International Monetary Fund
must play a key role.
Third, massive short-term borrowing in foreign currency is especially risky
business. Countries with the deepest crises over the past year attracted vast
amounts of short-term foreign capital by offering the promise of high returns and
fixed exchange rates. When the promise proved hollow, foreign lending
contracted suddenly and violently, and even creditworthy projects found
themselves starved for liquidity. By contrast, China's insulation from short-term
capital also insulated it from overnight changes in credit availability. Even some
straitlaced economists have begun to question the case for the free movement of
short-term capital into emerging-market economies. Is Prime Minister Mahathir
Mohamad of Malaysia right?
THE UNTHINKABLE. Fourth, the U.S., along with the other members of the
Group of Seven, should have put together a new Marshall Plan to ease the
transition of the former Soviet empire into the global economy. It was willing to
finance a huge cold-war military budget but not spend even a fraction of that
amount to promote Russian reform. Now, Russia has done the unthinkable. It has
unilaterally declared a debt rescheduling that has badly burned foreign private
creditors, making it even less likely that private capital flows will be sufficient to
transform Russia into a stable market democracy. The recent riots in Indonesia
were unnerving; the possibility of similar riots in Russia with its nuclear weapons is
positively chilling.
Fifth, at critical moments in the world economy, whether it's the old economy of
the 1930s or the new economy of the 1990s, human emotions can overwhelm
market fundamentals. Euphoria about the Asian economic model, about
development in Russia, about the potential of Internet and information
technologies, and about the end of the business cycle in a world of flexible
production techniques led investors to discount risk and to price equity markets
for perfection. Then, as they began to realize that their expectations were
unrealistic, panic blurred their ability to perceive meaningful differences in the
economic fundamentals of individual countries and companies. ''Irrational
exuberance'' gave way to an irrational rush for the door, and confidence, which is
essential to the smooth functioning of markets, was shattered. Which just goes to
show that no matter how sophisticated the world's technologies become, they
may never be able to control the recurrent bouts of euphoria and panic that are
part of the human psyche and an essential ingredient of the business cycle.
By LAURA D'ANDREA TYSON
Updated Sept. 10, 1998 by bwwebmaster
Copyright 1998, by The McGraw-Hill Companies Inc. All rights reserved.
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