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To: Enigma who wrote (17208)	9/2/1998 12:15:00 PM
From: Alex	Respond to of 116779

The Crisis Is Global By Robert J. Samuelson Wednesday, September 2, 1998; Page A23 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. "Mexico's economy -- which had been growing 4 to 5 percent -- will be lucky to grow 2 percent next year," says economist Desmond Lachman of Salomon Smith Barney. 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 another 40 percent of global gross domestic product (GDP), cannot easily escape the fallout. Given today's prosperity, Americans are naturally disbelieving. Unemployment is 4.5 percent. Inflation barely exists. Exports -- the sector directly affected by the global slump -- are only 12 percent 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. In the first half of 1998, the personal savings rate was less than one percent. Until recently, the jubilant stock market made Americans feel wealthier. They are spending some of their stock profits; since 1992, annual realized "capital gains" have roughly tripled. 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 percent 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. Economist Gary Hufbauer of the Council on Foreign Relations rightly says that the Federal Reserve and Germany's Bundesbank should cut rates by 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 measures, inflation in 1998 is somewhere between 0.9 percent and 1.7 percent. The interest rate that the Fed controls -- the Fed Funds rate, on overnight loans between banks -- is 5.5 percent. This implies that "real" interest rates (adjusted for inflation) approach or exceed 4 percent, 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; this 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. Foreign investors often lead capital flight. Mutual funds or banks that invested in "emerging markets" pull out. They sell local stocks or withdraw bank deposits and sell the currency for dollars. But capital flight also occurs among a nation's citizens if they lose confidence. In Russia, business tycoons ("the local oligarchs," Lachman calls them) switched rubles into dollars by the billions. And 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 recently raised interest rates by one percentage point to stop the Canadian dollar's slide. Earlier, India increased rates from 5 percent to 8 percent. In Mexico, short-term rates have risen from about 20 percent to 36 percent in recent weeks to defend the peso. 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. Consider Russia. A drop of about a third in oil prices has compounded its problems, because oil is its largest export. Russia needs higher oil prices; and higher oil prices depend on a stronger world economy. What is to be done? Good question. The International Monetary Fund and the U.S. Treasury have taken the lead in dealing with economic collapses in Asia and elsewhere. They have treated each ailing economy as an isolated case in need of "reform." Larger problems -- capital flight, global growth -- have been ignored. There are ways to deal with capital flight (exchange controls or debt relief, for example); but all are complex and none guarantees success. 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. c Copyright 1998 The Washington Post Company washingtonpost.com