Americans are Taking a Dive With the Rest of the World
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. 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 40% of global gross domestic product, cannot easily escape the fallout.
Given today’s prosperity, Americans are naturally disbelieving. Unemployment is 4.5%. Inflation barely exists. Exports--the sector directly affected by the global slump--are only 12% 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. The personal savings rate is less than 1%. Until recently, the jubilant stock market made Americans feel wealthier. They are spending some of their stock profits. 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% 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. The Federal Reserve should cut rates by at least 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 indicators, inflation in 1998 is somewhere between 0.9% and 1.7%. The interest rate that the Fed controls--the Fed funds rate, on overnight loans between banks--is 5.5%. This implies that “real” interest rates (adjusted for inflation) exceed 4%, 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, which 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.
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 (its Federal Reserve) recently raised interest rates by 1 percentage point to stop the Canadian dollar’s slide. Earlier, India increased rates from 5% to 8%. 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.
What is to be done? Good question. The International Monetary Fund and the U.S. Treasury have treated each ailing economy as an isolated case in need of “reform.” Larger problems--capital flight, global growth--have been ignored. 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.
