Good afternoon Henry...hope you get the weekend off.
A very good and thoughtful article by Daniel Yergin.
(C)San Jose Mercury
For Private use only
DANIEL YERGIN
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New global market faces its first real test
A world crisis of confidence
IT was what Goldilocks liked so much about the porridge -- that it was neither too hot nor too cold, but just right. And that is why, over the past few years, the remarkable American economy has come to be known as the ''Goldilocks economy.'' For it has been ''just right'' in its combination of low inflation, low unemployment, good growth and great job creation.
Unfortunately, the three bears may now be heading for the house. Much of the world's economy -- the only other exception being Western Europe -- is either engulfed in or threatened by monetary turmoil, economic collapse and contagion, with the specter or reality of political and social turmoil in close attendance. What was thought to be a hyper-speed financial crisis is now entering its 15th month, and at every stage it has proved worse than at first thought.
In the aftermath of the Russian default and devaluation, the immediate battleground has shifted to Latin America. But the past few weeks have brought the jolting recognition that Goldilocks is not invulnerable to what is happening in the rest of the world.
Perhaps the American economy is so resilient that it can shrug off the shocks. But the risk is now much greater that the United States will be affected through reduced exports, lower corporate profits, monetary instability, unanticipated exposures and losses, and the reverse wealth effect that would result from a falling stock market. Europe is likely to find that the euro arrives on Jan. 1, 1999, in the midst of unexpected stress. Downturn in the United States and Europe, in turn, would constrain export markets, making recovery in other parts of the world that much more difficult.
The heart of the matter is the misfit between global capital markets and national financial systems. It has turned out that the national systems did not have the institutional capability -- or sufficient levels of knowledge or independence -- to cope with the rapidly mounting flood of funds. Asian countries failed to comprehend the scale of debt or to properly gauge the risks. Years of high economic growth created a confidence in both borrowers and lenders that was not tempered as growth slowed. In Russia's case, a political stalemate prevented tax reform and collection.
But why are these shocks spreading around the world, hitting countries so widely divergent? After all, Latin American countries such as Brazil and Argentina are hardly in the same situation as Russia. Nor is Poland, the most successful of the transition economies. Though they have done much to strengthen and reform their economies, they are all being painted with the same broad brush.
The explanation is contagion. But this is an ailment not of countries but among investors. What it really means is a recalibration of risk, a sudden multiplying of the risk premium, with very harsh consequences for countries. Lenders and investors, originally drawn into emerging markets by the prospect of growth, now see only the downside, and they are rushing for safety.
The negative sentiment is self-reinforcing. No one wants to be the last one through the door. The result is a deliquification of national economies. Healthy companies in Asia cannot even get the letters of credit they need to stay in business. It is this new perception of risk and acute aversion to it on the part of lenders and investors that is driving the world in the direction of a global recession.
If the past two decades have been dominated by a disillusionment with government management of economies, is a new disillusion with markets themselves settling in? To some degree, yes. Russia is backing away from reform and again turning toward intervention. Malaysia has clamped on currency controls and arrested the pro-market former deputy prime minister. Even free-market Hong Kong has been buying up shares in its stock market to frustrate speculators. Capital controls to slow ''hot money'' inflows -- even if only ''temporary'' -- and protectionist measures will be on the table. And there is increasing questioning of markets themselves.
Yet the interwoven links that are creating the new global reality -- trade, direct investment, capital markets, technology, communications -- will continue to erode borders. Incremental retreat of one form or another is possible, indeed likely -- as is the search for the villains. But barring a major collapse, wholesale retreat would mean a retreat from future investment and economic growth.
Only later will we know whether the recessionary forces are already bringing the American expansion to an end. But what would be prudent now is to act to offset a global downturn.
Certain factors make it difficult. Leadership is hobbled in the three critical countries -- the United States, Germany and Japan -- though for wildly differing reasons. The international institutions that provide the means for coordinated responses are overstretched to near exhaustion, under attack and somewhat battered.
The global economic crisis is really a financial crunch, a crisis of confidence. And what are needed, beyond the emergency meetings, are concrete measures that incrementally rebuild confidence. Such measures would include reforming and repairing financial institutions (as Korea is swiftly doing, and as Japan, the world's second-largest economy, is not), improving tax systems, sharpening the distinction between government and market, and replacing intervention and manipulation with efficient regulation. Other steps involve implementing recognizable international standards, providing assurance of level playing fields to investors, facilitating direct investment, resisting protectionism, delivering clarity and transparency.
Certainly what also is required is a better understanding of how the new global financial system works. Very few knew in advance how unforgiving its new rules could be. In due course, greater transparency may be required not only of national economies but also on the part of international investors. And, at bottom, what is critically needed is honesty -- in the processes by which markets work, about the current situation and about the seriousness with which it will be met.
This is a new era. The 1990s are ending early. The ''triumph of the market'' is over. The testing of markets is here.
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