Response of the free market
By Alan Deans, New York and Sheryle Bagwell, London
Rumours of a US interest rate cut to trigger world growth have been rife for weeks. Finally that talk has gained currency with US Federal Reserve chairman Dr Alan Greenspan signalling on Wednesday that a rate cut could occur next week.
"I do think that we have to bring the existing instability to a level of stability reasonably shortly to prevent the contagion from really spilling over and creating some very significant kinds of problems for all of us," Greenspan said. "We know where we have to go."
Greenspan, it seems, is finally ready to take the lead in battling the crisis sweeping the world. A rate cut is the most powerful tool the US has at its disposal to spur world growth. It would not only stimulate the US economy, but it should also lead to a return of much needed capital to investment-starved nations.
Merrill Lynch chief economist Bruce Steinberg says a rate cut is likely after the Fed's next Open Market Committee meeting on Tuesday. "Our view is that the sooner the Fed acts the better for the health of the world economy. Monetary policy acts with a long lag and we believe that multiple easings will ultimately be necessary to stabilise both US and global growth."
Greenspan's comments follow moves by the US President Bill Clinton to kick-start the global economy to avoid deflation.
World Bank officials were recently caught on the hop when Clinton called for the international finance agency to double its support for social programs for those nations deeply in need – particularly those in Asia.
"With our support, the World Bank and the Asian Development Bank have started to deal with these challenges, but they have to expand their efforts," he said. "There is simply not enough being done." His words puzzled the organisation which has almost trebled its commitments in East Asia and the Pacific since the financial crisis began last year. Expected outlays will reach $US2 billion ($3.5 billion) in 1998-99, up from just $US790 million a year earlier. Some $US300 million of this total is to be spent in Thailand, the nation where the global crisis began, and an identical sum in Malaysia. In Indonesia, World Bank loan portfolios have been reshuffled so that more than $US440 million has been redirected to the social sector in infrastructure works, education and health. The number of new projects has jumped from five last year to 15 in the current period.
Bank officials say they "suspect he meant to urge us to redouble our commitment, not double them".
Scepticism is widespread about the ability of the US to achieve its desire to lead the world out of the recessionary trough. Not only are a number of the measures that Clinton wants enacted outside his direct control, but his motives in raising the issue belatedly when he is under intense domestic pressure about the Lewinsky scandal are being questioned.
It does not help either that details of his initiatives remain scant.
A New York Times editorial summed it up. "It is a measure of the sad state of the Clinton presidency that the President's effort to address the world's economic problems was viewed by many through a Monica prism, with commentators wondering whether Mr Clinton was trying to change the subject. The real question here is whether the American government can deal effectively with major problems at the same time Congress considers the Starr report." Apart from being out of step on the World Bank's potential role, Clinton also faces difficulties in his call for Japan to revive its economy. The US has been strident in calling for this during the past year, but it has been a painfully slow operation that was damaged again this week when banking reform stalled amid political bickering.
This was rammed home in New York on Tuesday when a summit between Clinton and Japanese Prime Minister Keizo Obuchi failed to resolve anything. Clinton has also failed to deliver $US18 billion to the International Monetary Fund after all but a small portion of the funding was knocked down in Congress.
So far, the biggest impact of Clinton's rhetoric has been to focus attention on the crisis. This has helped stiffen market resolve, most notably in recent days in Latin America where a renewed efforts by the IMF have caused a rally on currency and stockmarkets.
Brazil, in particular, is seen as being where the developed world needs to draw the line and prevent further economic collapse. If it can rebound from its current difficulties, it would give heart to other Latin American countries and deliver a much-needed PR boost for the US president and the IMF and World Bank.
• Alan Deans
Europe: it's not our problem
It's not our problem. At least not yet anyway. The economic language may not be quite so straightforward, but the clear message from Europe is that the financial turmoil in Asia, Latin America and even in neighbouring Russia has little relevance for the Western European economies. Or at least not enough, yet, to warrant any co-ordinated action with the US to combat the rising threat of a world economic slowdown.
Within 24 hours of the suggestion by President Clinton and the Group of Seven industrialised nations last week that co-ordinated action to stimulate the developing economies might be on the agenda, European central bankers knocked the idea on the head.
First, the Bundesbank governor Hans Tietmeyer, then the European Central Bank president Wim Duisenberg ruled out the possibility of a joint interest rate cut with the US in the core European countries.
Their political leaders, distracted by elections and political problems of their own, have been noticeably silent on the issue.
Only in Britain, where rates are higher and sterling remains a pillar of strength, is a rate cut on the horizon. Bank of England governor Eddie George has hinted that with inflationary targets now met, the bank may move soon. While giving a boost to the country's beleaguered manufacturing sector, a cut would also show that UK Prime Minister Tony Blair was in step with his friend Clinton.
Europe's central bankers, however, have other things on their mind – namely, the arrival of the single currency now less than 100 days away. In preparation, the 11 participating nations are expected to bring their rates in line to a level approaching that of Germany and France, the core nations – around 3.3 per cent.
The ECB does not want to take any action that might complicate that tricky convergence process, says Duisenberg, given that the French and German rates were already at historic lows – and at levels below the US.
Nor are they particularly keen to get involved in debates about capital flow controls or the role of the IMF, a subject which has captured the attention of Tony Blair who is currently spearheading calls for reform of the world's lender of last resort.
"Continental Europe is so preoccupied by the problems of bringing the euro into existence that it has become entirely inward looking," says Professor Geoffrey Wood, an economist with the City University Business School in London.
The European Central Bank, which takes over European monetary policy from January, would disagree. It claims it has surveyed the turmoil abroad and it is having little impact on Euroland growth – so far at least – despite Germany, the powerhouse of Europe, being heavily exposed to Russia.
The bank still forecasts a growth rate for 1999 only "some decimal points lower" than its original view of 3 per cent – although some economic forecasters now view even that revised forecast as optimistic.
Even so, Duisenberg and others do not believe rate cuts are necessarily the best way to solve the international crisis. After all, the recent move by the Bank of Japan to lower official interest rates did not appear to be working, Duisenberg told the European Parliament on Tuesday.
"The results are not very encouraging," he said.
Such views have much backing in Europe, although not all economists are sanguine about Europe's apparent strategy of sitting tight and letting the ill-winds of Asia and Latin America blow over them.
Writing in The Times, columnist Anatole Kaletsky said the biggest economic risk in the year ahead, if things worsened, was continued complacency on the part of the European Central Bank.
"There is an almost universal belief in financial markets and among political leaders that America is the Western economy most threatened by the emerging markets crisis . . . the reality however is that Germany is potentially more exposed than America or any other Western country," he said.
"It is therefore critical that the ECB should act as least as aggressively as the [US] Federal Reserve. If the Fed eases monetary policy but the ECB does not, the deutschemark and the euro will appreciate against the dollar . . . and the consequences for Germany would be every bit as dire as they were for Japan when the yen soared against the dollar in 1995."
Europe might still be forced to act. European stockmarkets have been volatile since the Russian rouble was devalued and foreign debt payments frozen. If the markets kept falling "2 or 3 or even 4 per cent a day over the next few weeks" interest rates may well fall in Europe by the end of the year, says Jane Edwards, senior international economist with Lehman Brothers.
But, as usual, America would probably have to lead the way.
"When have the Germans ever led anything?" asks Edwards. "This thing has to be led by the leader of the free world – which is still Clinton. The whole problem at present is that people don't perceive that anybody is in control of the situation."
• Sheryle Bagwell
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