Steering Out of Global Economic Gridlock: Road Is Long and Narrow
As we turn the calendar and contemplate what may lie ahead for the United States and the world, the word uncertainty , overworked though it may be, is the only one that fits the current scene. Struggling with the current mess in the world economy is akin to punching marshmallows. What we don’t know is potentially more damaging than what we do, and that can do damage enough.
Unfortunately, even though the global economy has become inextricably intertwined in financial terms, the requisite global understanding of economic, monetary and political matters has not developed apace. And that’s as true for economists as for anyone else. We know a fair amount about our own economic system and monetary situation but precious little about the other guy’s. We know even less about what is happening in the no-man’s land between our borders; that is, in the truly global financial markets that are beyond the purview or control of any single country.
It is said that now the sun never sets on stock, bond, commodity or currency markets; somewhere in the world something is trading 24 hours a day. Of course, in a floating exchange rate regime, there is less need for international policy coordination and that may explain why the markets have linked during the past 15 years while the policies have not.
We woke up in a hurry to these global market interconnects when they all went crazy in late October and early November. We found that a problem in one market can and will be transmitted to markets in other countries with the speed of light and that, on occasion, these separate markets literally can be flash-welded together.
There were two key messages from the recent global financial earthquake: First, it is no longer possible for any free country to isolate its markets or its policies from what’s happening elsewhere in the world, floating exchange rates or no; second, the United States is no longer the undisputed master of the world economy and financial markets or even of its own destiny. Increasingly, as the nation becomes a net debtor, terms are being dictated to us, terms we increasingly may not like.
In truth, however, the global markets have already foreclosed most of the world’s options. And the few remaining are about as narrowly constrained as I’ve ever seen them, especially for the United States. It’s very close to what one might call “economic gridlock.” For example, we know we must do something to reduce the federal budget deficit, but if we take major short-term steps, such as boosting income taxes, we might pitch an already weak economy into recession. Severe recession here would be a disaster for others, particularly the lesser developed countries. Any hopes that they might repay their loans to U.S. banks would be dashed. Remove the “repayments someday” illusion and what would happen to the banks that hold those loans? And so on around the loop.
When I hear about a pending new meeting of the Group of Seven nations and ponder what it might accomplish, the reality couldn’t possibly match the world’s expectations. Another round of exchange rate stabilization? If the markets aren’t ready for it--that is, if the dollar hasn’t found its own bottom--it won’t (repeat won’t) work. Further coordination of economic policies? Such as what? A U.S. pledge for further reductions in the federal budget deficit? Forget it! There’s an election here next November. The pittance the politicians produced last month is all you’re going to get until 1989. More steps to reduce the trade deficit? Aside from letting the dollar drop some more, there’s nothing to be done short of inducing a recession and that would make the U.S. electorate think unkindly toward the party in power.
More stimulation from Japan? They will trot out their gigantic 8% increase in real GNP in the third quarter, their strong money supply growth, extremely low interest rates and shrinking trade surplus as proof positive that they’re doing all they dare, and at some risk of potential inflation. Additional steps by West Germany? I’m sure they think they’ve done all they should to accommodate the bad-boy economy of the Western world in its spendthrift, inflationary habits. In short, other than showing that the G-7 nations are still on speaking terms, I can’t imagine what such a meeting could achieve.
The problems are obvious; the solutions are not. They are as much matters of philosophy as they are economics. The United States, in the pursuit of growth, is borrowing and consuming too much in imported goods and capital and saving too little. Consequently, it has excessive budget, trade and current account deficits.
Japan, with an underdeveloped domestic economy, is saving too much and consuming too little and running excessive trade and capital account surpluses. Europe, particularly West Germany, has such a rigid cost and social welfare structure that it appears almost afraid of growth and strangely oblivious to high unemployment. A dozen G-7 meetings couldn’t fix this gridlock in a short period of time.
When into this shaky environment we mix the huge amounts of indebtedness in this and many other countries, at all levels and relative to anything or any time you might choose, the potential for gridlock becomes even greater. In short, the risk level in the world economy stands greater today than at any time in postwar history.
If we’re lucky, the United States soon will enter a period of slowdown, characterized by very weak consumer demand partially offset by expanding exports to other countries whose economies, it is hoped, will remain more buoyant than ours. That will permit a wave of import price increases to pass through the U.S. system without causing our hard-won battle against inflation to be lost. It will also help the trade deficit to shrink more rapidly and reduce our call on global savings flows.
Finally, it will allow interest rates to remain relatively low, although they will likely continue high in real terms. This is a very narrow channel through which we must pass, and success requires all kinds of hefty assumptions about global interactions and internal politics, to say nothing of pure luck. We will just have to wait and see for the next several months.
