Weak Medicine For A Raging Crisis

Remember those fearful stories your parents and grandparents told about the Depression, about how bad it was and how it scarred their lives forever? Remember thinking, how could leaders have allowed such a catastrophe to happen? Well, it's now easier to understand. Look around. A currency crisis in a small country--Thailand--triggers an unexpected global economic crisis, spreading poverty across continents with fearsome speed. A year later, well-meaning policymakers fumble their best chance to stop a tide of deflationary recession. Instead of forging a bold plan to reliquefy the global economy, they demonstrated only timidity at this year's annual International Monetary Fund conference. They failed to put a floor fast enough under a rapidly deteriorating global economy.

True, the spin out of the IMF conference is that a series of gradual steps will bring the world economy back from the abyss: a $30 billion aid package for Brazil, if Brazil can find the political will to cut its budget; a line of credit to countries with sound economies under speculative attack; a "bail-in" plan to force banks to take a haircut on loans before the IMF puts in new money; a cautious approval of capital controls on incoming short-term hot money. All positive moves, certainly.


The best news, however, comes from Tokyo, not Washington, where the government of Prime Minister Keizo Obuchi may have circumvented opposition in Parliament for legislation to finally bail out Japan's insolvent banks. If Japan pumps billions of dollars into its banking system and it starts lending again, the country's eight-year economic decline can be arrested. Package this bit of optimism with that coming out of the IMF, and the beginnings of a piecemeal effort to battle global deflation can be seen to be falling into place. Maybe. So far, though, gradualism has done little to reverse the global decline.

Confidence already is eroding in the U.S. Last spring's stock market euphoria is becoming this fall's concern. With the stock market down nearly 20% from its peak, consumers are showing signs of curbing back-to-school purchases. Banks suddenly are tightening up their lending standards. Excessive loans to a highly leveraged, secretive hedge fund raise questions about the basic health of the banking system itself. Corporate earnings are slipping, and a profits recession is setting in; layoffs are rising fast, and job growth is slowing; the yield curve is flat and suggests recession. Capital spending can turn on a dime, and if it starts to decline, the investment-led expansion of the past eight years can quickly come to a halt.

There is a palpable feeling of markets seizing up and a nation starting to hunker down. The failure of leadership is taking its toll. In the U.S., the Federal Reserve proffers a begrudging interest-rate cut and warns not to count on more anytime soon at a time when the global economy needs massive monetary easing. Congress continues its partisan wars by delaying funding for the IMF, even though the institution has capitulated to its demands for less austerity and more transparency. Europe remains obsessed with its inward-looking euro. Japan continues its economic free fall. And Asia blames hedge funds, banks, Westerners--anyone but its own cronies and corrupt practices.

The solution to the current economic crisis is clear enough: Restore demand. The world's most important source of demand growth, the Asian consumer, has been driven from global markets and forced to retreat back into local economies. Devaluations of 30%, stock market declines of 50%, and unemployment have produced a monumental case of downward mobility. Nothing like it has been seen since the Depression. Instead of buying European cars, American computers, and Japanese electronics, Thais, Indonesians, and Koreans are purchasing homegrown rice, batik shirts, and local cigarettes. In that way, Asia's poverty can impoverish the world.

To restore demand, a deal with the heft and significance of the Smithsonian Agreement in 1973 and the Plaza Accord of 1985 is needed. They were transformative events, remaking the global currency system. They showed that gradualism will not do. A global commitment by the industrial nations to stop the tide of deflationary recession is needed. The deal would involve three steps. A write-down and workout of emerging-market debt, brokered by the U.S. Treasury or the IMF, is the most important. Most of the debt is private, owed to European and American banks. Today, the money earned from trade surpluses goes to debt repayment, not domestic growth in Thailand, Indonesia, or Korea. Relief from the debt overhang would release cash for export financing and consumption.

A coordinated easing of policy by the Group of Seven is critical as well. The inability of G-7 leaders at the IMF meeting in Washington to agree to a highly publicized, coordinated interest-rate cut is a lost chance. Japan, Canada, Korea, Spain, Malaysia, China, and Thailand have made small rate cuts. Britain appears poised to do so, but Germany remains undecided. Gradualism may help some. But only a synchronized cut can send the powerful signal that is needed.


A commitment is needed to fiscal policies that stimulate demand. That means the fierce commitment to fiscal rectitude that has dominated policy over the past decade should be reexamined. Tax cuts loom increasingly important all over the world. The U.S., with its large budget surplus, must begin to think of a significant tax cut in the year ahead.

From the start, policymakers have misjudged the deflationary typhoon blowing out of Asia. It has taken leaders a year of failure to abandon old orthodoxies. The fragmented, gradualist approach taken by world leaders in Washington is unlikely to turn the tide. A grand design is needed to keep a crisis of confidence from becoming a crisis of capitalism.

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