There is a simple lesson in the turmoil roiling the markets this August. "Even the world's largest, most perfect economy is not insulated from external shocks," says David M. Jones, chief economist for New York securities trader Aubrey G. Lanston & Co. "We will pay a price."
The only question is how steep. Asia's depression helped clip second-quarter growth to 1.4% and dimmed the outlook for earnings. Now, with the Japanese economy showing no sign of near-term recovery, the yen is racing toward new lows, threatening devaluations of currencies from Beijing to Brasilia. Already, the plunge in commodity prices set off by Asia's problems has reached North America, dampening the economies of Mexico and Canada, whose currencies have dropped sharply against the dollar. With this rising tide of woe, analysts are scaling back earnings estimates for the rest of 1998, markets are "correcting," and economists are assigning a higher probability--though still low--to a mild recession within a year.
NO SIGN. So while the U.S. remains on the road to healthy, long-term growth, it could be a bumpy ride. Joshua Mendelsohn, chief economist at Canadian Imperial Bank, predicts that the Asian crisis will slow global output to 2% this year, down from a forecast in December of 2.2%. If China devalues its currency, the world outlook will be grimmer, he warns: "The situation has deteriorated, and there is no sign of Japan getting out of this in the near term."
As each new convulsion from Asia makes clearer, the old institutions are ill-equipped to handle the problems of the global economy. The International Monetary Fund and its principal patron--the U.S. Treasury--were slow to grasp the gravity of Asia's problems. And they have been largely ineffective in spurring reforms in countries such as Korea. In Tokyo, not even the fall of a government has persuaded Japan to clean up its banks and restore its economic health--which would be the best hope for reviving its neighbors' economies.
So what can policymakers do? At the very least, Treasury Secretary Robert E. Rubin and his counterparts from the major industrial countries--the Group of Seven--should keep the heat on co-member Japan to cut taxes and interest rates, sell bad loans to foreigners, and close insolvent banks. Rubin is sure to make his case when he meets new Japanese Finance Minister Kiichi Miyazawa on Sept. 4 in San Francisco. But the jawboning should not stop there. "The G-7 should exert as much pressure as it can on Japan," says Allen L. Sinai, CEO of Primark Decision Economics Inc.
What the U.S. should not do is volunteer for another yen rescue. Just eight weeks after a joint intervention by the U.S. and Japan that briefly drove the yen up to 136 to the dollar, Japan's failure to follow through on promised reforms sent the currency back to an eight-year low of 147 on Aug. 11.
The IMF, which was never intended to manage crises on Asia's scale, should get back to its original mission of providing short-term loans and leave negotiations on internal reforms--such as setting monetary policies--to political leaders. The rich countries provide the IMF money in the first place, so they should set the rules for how it is spent and be accountable for the social unrest their policies may cause.
The Federal Reserve has already played a vital role by considering the state of the global economy--not just the U.S.--in setting monetary policy. The turmoil in Asia is the main reason Fed Chairman Alan Greenspan has resisted calls to hike rates. With the Dow Jones industrial average on Aug. 12 down 8.4% from its July high, Greenspan should breathe a little easier about overvalued stocks. In fact, many economists think a rate cut might be the next move--to keep the U.S. expansion going and buoy Asia's currencies by making dollars less attractive. "The Fed has to be careful not to fight the last war," cautions former Fed Vice-Chairman Manuel H. Johnson Jr. "It should lean toward easing."
FREE FLOW. But these are stopgap measures. If the U.S. and other nations are to reap the full rewards of the global economy, they'll need better safeguards to make sure one country doesn't pay a heavy price for another's mistakes in the future. That will require the G-7 to take on a new role as an advance warning system for financial trouble. Nations that want to benefit from the free flow of capital or need financial help from the G-7 should be required to open their books. The G-7 should also develop clear guidelines for conditions on IMF loans.
If there is a lesson as we move into the 21st century, it's that no economy is an island unto itself. If nations are to prosper together, they're going to have to pull together.