U.S. Is Globe’s Last Hope to Halt Recession

It is a doomsday scenario too real for Hollywood: The financial meltdown of a little-noticed Southeast Asian country pushes Japan to the edge of collapse, bringing the rest of the industrial world down with it.

To most economists, this notion of a global recession still seems highly unlikely. If minuscule unemployment and soaring consumer confidence mean anything, the U.S. economy seems a bulwark against global havoc.

But Friday’s report confirming an abrupt slowdown in the U.S. economy, amid the drumbeat of bleak news from Japan--the two giants of the global trading system--has economists asking if the pace of globalization has surpassed their ability to assess the world’s fiscal health.

What seems clear is that an exceedingly thin line exists between prosperity and stagnation in a world where jittery currency traders in London affect rice farmers in Indonesia, cost-conscious Tokyo homemakers influence beef prices in the Midwest, and the fate of the Silicon Valley’s biggest players could be determined by a cadre of Communist officials in Beijing.

“At the end of the day, do I think we’re going to have a global depression or recession?” asked Marcus Noland, a senior fellow at the Washington-based Institute for International Economics. “No. But do I think there is some real possibility? Yes.”

For Noland and others responsible for monitoring the health of the global economy, the last year has been a tsunami ride through uncharted waters.

In many ways, the pressures facing the global financial system--triggered by the July 1997 devaluation of Thailand’s little-known currency, the baht, and the regional currency falloffs that followed--are unprecedented because of the size and complexity of today’s global economy.

New Fiscal Interplay Means Greater Risks

The ease with which people, goods and capital flow across borders has made it impossible to predict the interplay between Asia’s pain and the countless strands of world commerce. Even more challenging is the unfathomable mix of psychological factors--the confidence issue--that ultimately determine where and how money is spent from one moment to the next, one country to another.

It all points to greater risk.

“It’s really bizarre,” said Clyde Prestowitz, president of the Washington-based Economic Strategy Institute. “I’m writing an Op-Ed piece about the meltdown of Asia, and my broker calls and tells me it’s time to buy another Internet stock. It’s the Goldilocks economy.”

Although globalization has provided real economic gains for tens of millions, its intricacies are “almost beyond human comprehension,” said Jeffrey Garten, dean of the Yale School of Management and a former U.S. Commerce Department official, in a recent Harper’s magazine article.

In this environment, any event that seriously rattles the global financial markets could conceivably push the economy over the edge: war in the Middle East, stepped-up nuclear tensions between India and Pakistan, the impeachment of the president--perhaps even the predicted 2000 computer failures.

Destabilizing shifts already are taking place across the globe as a result of the Asian fallout--unremarkable in themselves, but potentially dangerous in concert.

In recent weeks, nervous economists have begun slashing growth estimates as the Asian financial crisis widened its reach: depressing commodity and oil prices in Mexico and Canada, cutting into American exports, sparking capital flight in Russia and South Africa, and robbing manufacturers in China and elsewhere of overseas business as lower-cost, desperate Asian competitors turn their sights on customers in the U.S. and Europe.

A newly released Institute of International Finance study estimates that the trade balances of the seven hardest-hit Asian countries will swing by a shocking $100 billion to $150 billion this year as a result of their reduced appetite for imports and stepped-up exports.

The latest predictions are that the worsening situation in Asia and its drag on growth in other parts of the world will slow global gross domestic product growth by one-third this year to 2.1%--a decline in economic activity on the order of $300 billion.

The ripple effect could move something like this:

The collapse of buying power in what was once the world’s fastest-growing market--Asia represents about one-third of global GDP--causes slower growth in Latin America, Canada and Europe, spelling trouble and falling profits for corporate America and its workers.

Sliding Stock Prices Threaten Stability

Declining profits translate into falling prices on Wall Street--as occurred last week. And that could mean tumbling confidence among both American consumers and the legions of foreign investors who have parked record volumes of their money in U.S. stocks in search of a safe haven from Asia’s shocks.

“We don’t have the margins at the moment to absorb any more shocks,” said Kenneth Courtis, the Tokyo-based chief economist of the Deutsche Bank Group, one of Europe’s most aggressive global players.

It is Japan, the Asian giant whose beleaguered banking system is sinking under as much as $1 trillion in bad loans, that many experts fear could be the trigger for a global contraction.

If Japan’s new government does not move quickly to restore consumer confidence, stimulate domestic spending and clean up the banking mess, the world’s second-largest economy is in danger of sliding much deeper into recession.

That could lead to the failure of several large banks, which would spark a panicked outflow of money, a further collapse of the yen and widespread bankruptcies and job loss.

Japan has dramatically retreated from the rest of Asia, which relies heavily on Japanese investment, trade and aid. This is subverting the recovery efforts of Asia’s hardest-hit countries.

South Korea, already shrinking at a rate of 5% annually, is particularly vulnerable because about 17% of its trade is with Japan and about one-third of its exports--notably automobiles--compete directly with Japanese products freshly cheapened by the tumbling yen. The same is true of Singapore and Taiwan.

“Rather than being the locomotive to rebuild the Asian economy, Japan will be the Titanic that pulls the rest of Asia under,” Courtis warned.

Since these hard-hit Asian countries can’t sell to Japan, they’ve got to look elsewhere. In a slowing global economy, that means they are already stealing markets from other regions such as China and Latin America.

China Faces Challenge From Asian Rivals

China is one of the most vulnerable targets, though it initially escaped the worst of the Asian fallout thanks to its relatively insulated economy.

In recent months, the stepped-up pressure from Asian competitors has started to hurt China’s manufacturers, particularly in areas such as steel and apparel, where low-cost South Korean imports are finding their way into the mainland market.

Chinese and Hong Kong exporters could lose as much as $18 billion in sales to Asian competitors, according to the Institute of International Finance, a think tank created by global banks.

For China, the Asian crisis has turned off the spigot from the thousands of overseas Chinese who have been the main source of direct foreign investment into the mainland. Now that flow has been reversed: These overseas Chinese are pulling as much as $200 million a day out of mainland China to replenish their coffers back home, according to Courtis.

Although China still has huge foreign reserves, this erosion in revenue is making it harder to pay for the ambitious reforms of its debt-laden state-owned companies and banks.

China’s top leaders have repeatedly promised not to devalue the yuan, but each competing shipment of cheap steel, apparel and computer parts undermines that resolve.

The devaluation of the yuan, a bastion of stability in Asia, could set off a disastrous further round of competitive devaluations as Asia’s exporters scramble to underprice each other’s products.

The psychological impact would be enormous, undermining confidence in the Chinese leadership and deepening international uncertainty about the direction the huge nation is headed.

Meanwhile, each new disruption in Asia ripples further around the world.

The seven major Latin American countries--Brazil, Argentina, Chile, Colombia, Mexico, Peru and Venezuela, whose manufacturers have enjoyed a booming export business--could see a deterioration of $11.4 billion in their trade figures this year because of lost sales and increased competition from Asia, according to the Institute of International Finance study.

Although Mexico’s revitalized economy is expected to weather these new pressures, they are taking a toll. Apparel and textile manufacturers are shifting operations--and jobs--to Asia to exploit those cheapened currencies. And last week, Altos Hornos de Mexico, Mexico’s largest steelmaker, blamed cheap steel from Asia and slumping global demand for the elimination of 3,000 jobs.

Mexico, the United States’ No. 2 trading partner, is projected to lose $5.4 billion in exports to cheap Asian competition, most of that in U.S. markets.

Meanwhile, Asia’s demand for oil has plummeted along with its economies, pushing crude oil prices to 12-year lows and creating such a serious glut that some producers are being forced to store their excess oil on tanker ships.

That’s good for the world’s inflation outlook but bad for oil exporters such as Mexico, Venezuela and Colombia.

Mexico and Venezuela have repeatedly slashed their budgets. Mexico has suffered a shortfall of nearly $4 billion in oil revenue, and its oil-dependent stock market has plummeted.

The oil slide, combined with the loss of export business to Asia, will cut a percentage point off GDP growth, the Institute of International Finance predicts.

High-Risk Areas Feeling Pressure

The collapse of the world’s most vibrant economic region also has given investors second thoughts about other high-risk areas. One result: They pulled capital out of Russia, pushing that heavily indebted country dangerously close to default in July before the IMF stepped in with a $22.6-billion rescue.

Among its many implications, the deterioration of Russia’s economy sparked fears that its government would step up its export of gold, wreaking havoc in other gold-producing countries, including South Africa.

Over a five-week period this year, the South African currency, the rand, fell nearly 27% because of investor concerns over the interplay of the Asian crisis, the gold market and problems in Russia.

In South Africa, like Russia and other nations in transition, the potential political damage is as great a concern, or greater, than the financial troubles that often cause it.

“Politically, South Africa is in a desperate situation,” said Barry P. Bosworth, an economist at the Washington-based Brookings Institution. “This is a country trying to come out of apartheid. Economic problems could worsen the racial tension.”

Until now, the global shock absorber has been North America and to a lesser degree Europe, whose combined economies represent about two-thirds of the world’s output.

Some of Europe’s largest banks, which had expanded more aggressively in Asia than their U.S. counterparts, have taken an earnings hit in recent weeks because of Asia’s downturn.

But for all its overseas expansion, most of Western Europe’s trade and investment remains intra-regional.

In the coming year, the region will be preoccupied with establishing a common 11-nation currency. With Britain’s economy slowing significantly, there is little expectation that Europe will be of much help absorbing the world’s excess production of automobiles, computer chips and T-shirts.

In the end, it is the United States--the sole superpower and the largest and most dynamic economy--that will provide the answer to whether the world merely slows its economic expansion or falls into a slump.

The U.S. role and that of the Federal Reserve Bank have become even more critical amid complaints that the world’s post-World War II fiscal support institutions, most notably the International Monetary Fund, are not up to the task of managing today’s international economic crises.

And so far the United States appears in pretty good shape to act as a fiscal firewall in the coming months. Federal Reserve Chairman Alan Greenspan and U.S. Treasury Secretary Robert E. Rubin have made it clear they intend to prevent an economic disaster by moving to prop up the Japanese yen and factoring Asia into monetary policy.

Asian Economic Crisis Casts a Long Shadow

On balance, the Asian crisis has so far been a boon to a slightly overheated U.S. economy, putting a lid on interest rates and prices. That has bolstered consumer confidence and domestic expansion, which has helped offset the dramatic slump felt by the nation’s exporters.

But volatile forces will encroach for as long as Asia deteriorates.

“The risk is that Asia could remain stagnant or go into a deep recession . . . and the U.S. starts to slow down before Asia starts to recover,” explained Karen Parker, currency strategist for Chase Manhattan Bank. “Will the Fed recognize that this is a big risk for the global economy? And how will they act?”

Politics is another wild card. The falloff in exports and rise in imports is expected to push the U.S. trade deficit to at least $160 billion this year and as high as $200 billion in 1999. Given the domestic priorities of Congress, that could fuel cries for a withdrawal from international commerce and spark a protectionist backlash.

That recalls another precarious moment in history, when the passage of a series of steep tariffs designed to protect the U.S. economy precipitated the collapse of a fragile world economy.

“With our absolutely skyrocketing trade deficit, I don’t even want to think about the repercussions in Congress,” said Richard Ellings, executive director of the Seattle-based National Bureau of Asian Research. “If China devalues or the Japanese are belligerent or recalcitrant, Congress could say, ‘To heck with it,’ and we could be revisiting the 1930s.”