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The Problem of Global Cooling

The Bush Administration is showing signs of complacency toward a growing storm of global financial instability. Treasury Secretary Paul H. O'Neill may be right in expressing little worry about Argentina's slide toward default, Brazil's falling cruzeiro, Turkey's soaring interest rates, or Asia's nasty game of beggar-thy-neighbor devaluations. After all, the U.S. dodged the bullet in the last international financial crisis in 1997-98. Why wouldn't it dodge the bullet again?

For one very good reason. Last time, the financial crisis struck when the U.S. was in an economic boom. Capital spending by corporations on information technologies was generating huge sales and profits, which more than compensated for the decline overseas. Indeed, falling currencies meant lower prices for high-tech and consumer-product imports, and served to combat inflation and fuel the boom.

The crisis brewing this time around comes when the world is in a synchronous slump, with the U.S. bouncing along the bottom of a severe slowdown. Weak overseas economies and falling currencies are translating into lower profits at a time when corporations are desperate for earnings. Compared with past recoveries, stocks are not responding nearly as well to Fed easing. In the recession of 1990, the Standard & Poor's 500-stock index was up 21.6% 17 weeks after the market trough. In 1982, it was up 36.3%. Today, the S&P is up only about 9% from its low. A profits drought is already hurting stocks. A currency crisis could make this much worse.

O'Neill's predecessors at Treasury, Lawrence H. Summers and Robert E. Rubin, focused on short-term solutions to global financial crises and neglected the long-term impact of their actions. O'Neill wants to do the opposite. He says that previous bailouts encouraged banks to think the government would always save them, and argues that doing nothing to stave off a crisis would do little harm to the U.S.

Maybe, but the risks are asymmetrical. The U.S. economy is very fragile at the moment. A serious global financial crisis in the weeks ahead could hurt the prospects for a U.S. recovery. This isn't the time to experiment or debate the role of government and the purpose of intervention. The Treasury Secretary, a pragmatic man, should be prepared to act pragmatically in the days ahead.

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