How Bad Can the World Economy Get?

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How Bad Can the World Economy Get?

One spark could ignite a global economic crisis

Monday, Aug. 27, 2001 Think of yourself flying across the country. an engine starts sputtering; cause for alarm, sure, but the pilot does that folksy number--"Aw, shucks, little problem here"--and assures you the others can take the strain. Then a second engine goes out; the sweat trickles down your neck, but you reckon you'll make it to the ground safely. But if the third, and then the fourth, flame out...

The global economy hasn't crashed just yet. But a worldwide slowdown is giving analysts everywhere a bad case of the jitters. The key reason: this, says Robert Hormats, vice chairman of Goldman Sachs International, is "the first synchronized downturn since the 1980s," when high interest rates squeezed the world economy like an orange. During the last U.S. recession, 10 years ago, Europe was in its post-cold war euphoria, while the Asian economies were the stuff of miracle. By the time a financial crisis declawed the Asian tigers in 1997-98, the U.S. economy was in the middle of its technology boom.

This time around, both the U.S. and German economies are flatlining, while that of Japan continues its slow, downward spiral. The Japanese unemployment rate has risen to 5%, while the Nikkei stock market index last week touched lows not seen since 1984. The world's three most powerful engines are out of juice. Worry.

Why are this year's economic woes so widespread? Blame globalization, the increase in cross-border trade and investment, that has bound the world economy closer together than ever before. In good times, globalization spreads the wealth. The astonishing growth of the the U.S. economy in the late 1990s spilled over into countries from Taiwan (which makes the microchips that power your computer) to Ireland (a prime destination for U.S. firms outsourcing manufacturing). But globalization, it turns out, has a reverse gear. Once it was plain--by last winter--that technology firms had vastly overestimated demand, the consequent retrenchment spread far beyond the Bay Area. Last week, for example, Baltimore Technologies, the jewel in Ireland's high-tech sector, slashed jobs in an effort to achieve profitability.

Signs of a global recession inevitably conjure up thoughts of the last time the whole world went to hell in a handbasket: the Great Depression of the 1930s. In truth, we're a long way from breadlines, and policymakers understand the forces that move the economy today much better than they did then. But one lesson of the 1930s is worth remembering. In an interconnected world, points out Jeffrey Garten, dean of the Yale school of management, a small spark can start a huge conflagration. In 1930 it looked as if the consequences of the 1929 market crash might be contained; it was the collapse in 1931 of the Austrian bank Creditanstalt that turned a market correction into a worldwide slump. Similarly, the global financial crisis of 1997-98 started with the devaluation of the Thai baht--though Thailand's whole economy is about the size of Kentucky's.

That's one reason why, after much dickering, the Administration last week signed off on an $8 billion international rescue package for Argentina (an economy about the size of North Carolina's). Treasury Secretary Paul O'Neill had spent weeks making plain his distaste for lending tax dollars paid by American plumbers and retail clerks to a country that careens from one debt crisis to the next. But in the end, as Goldman Sachs' Hormats puts it, "pragmatism triumphed over ideology." If Argentina had defaulted on its debt, investors might have pulled out of other emerging markets, triggering a real crash. In a nervous world, it's best to avoid anything that leads to a loss of confidence.

Might anything else tip the mood from mere gloom to catastrophe? Watch the reaction to this week's meeting of the European Central Bank, which, unlike the Federal Reserve, has kept interest rates relatively high, thus choking off domestic demand. Otherwise, keep putting your faith in your own wallet as well as all those plumbers and clerks. They're still the best hope for pumping demand into a slowing economy. "A huge amount," says Yale's Garten, "is hinging on the American consumer." In today's planes, one really strong engine can get you safely to your destination. But expect a bumpy ride.

http://www.time.com/time/searchresults?venue=time&summaries=yes&search_type=simple&query=mideast

-- Martin Thompson (mthom1927@aol.com), August 29, 2001

Answers

I can't understand the European Central Bank. The alarm should be loud and clear. Germany, Europe's economic engine, is fast going into the tank, and still the Central Bankers will not cut interest rates. Japan, with rates already bumping off zero, can't cut anymore. And, here in the U.S. the Federal Reserve has been aggressively cutting rates since the first of the year.

With all those massive U.S. rate cuts doing so little good so far, a case can be made for a coming world-wide economic crack-up.

-- Billiver (billiver@aol.com), August 29, 2001.


Apparently the European Central Bank has not looked at the CRB lately. It is bleeding. There's so much over-capacity out there, around the world, that it's deflation that is the great danger, not inflation.

-- Wellesley (wellesley@freeport.net), August 29, 2001.

To top it all off, with hi-tech down, world productivity is going to take a drubbing. That won't help either.

-- Big Cheese (bigcheese@mulimax.net), August 29, 2001.

If you lived in Germany during the 20's you would understand their reaction to any inflationary sign

-- Steve (ke6bjd@yahoo.com), August 29, 2001.

This economic downturn is similar to 1990 - 1994, a deflationary type mild (?) depression, rather than a classic high interest rate inflation wringout recession like 1981 - 1982, EXCEPT: This time there is no long-term offsetting "Peace Dividend", which naturally helped to end the 1992 deflationary mild depression. Quite the contrary, war appears imminent, in the Middle East, and possibly Macedonia and China/Taiwan also. The "Peace Dividend" this time around will thus be negative, thus augmenting rather than cushioning the economic downturn. It looks VERY bad!

-- Robert Riggs (rxr.999@worldnet.att.net), August 30, 2001.


ECB is keeping rates higher in Europe to give the euro a competitve advantage against the greenback, especially during the complicated 2002 euro transition.

-- number six (!@!.com), August 30, 2001.

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