By Hillel Aron
By Joseph Tsidulko
By Patrick Range McDonald
By David Futch
By Hillel Aron
By Dennis Romero
By Jill Stewart
By Dennis Romero
The devaluation of the Thai currency in the summer of last year led to a massive flight of private Western capital from a range of Asian nations that institutional investors feared could no longer generate profits. For its part, the International Monetary Fund (IMF) required these nations to raise their interest rates with the intent of restoring investor confidence (which hasn't happened) and with the effect of inducing steep recessions or, in the case of Indonesia, a cataclysmic depression. U.S. and European companies that export heavily to Asia have seen their exports heavily reduced.
The weakening investor confidence in emerging markets also threatened to cause mass capital flight from the economies of Latin America. When Russia defaulted this summer, however, investor flight turned to investor panic. The hedge funds, mutual funds, brokerage houses and banks that daily disperse trillions of dollars into untold thousands of investments began to concentrate those dollars into a relative handful of very safe investments. The entire financial edifice that American business has erected over the past 20 years - the bond and equity markets in which corporations and real estate trusts and mortgage brokers now raise most of their money - began to sway as investors unloaded their securities and bought into the safest bond of all: United States Treasury notes. By early last week, the financial press was proclaiming a credit crunch the likes of which hadn't been seen since the early '30s: No one was buying up private-sector bonds anymore; nothing was being financed. By late last week, the papers were noting that mortgage rates, long in decline, had taken their steepest upward leap in decades.
Finally, and totally in keeping with the manic-depressive logic of a panic, a run on U.S. Treasury notes broke out last week as well. The only safe investment, apparently, was no investment at all. By week's end, all the investment community wanted was cash in the bank.
At the rate we're going, don't be surprised to learn that Goldman, Sachs and Co. has taken its money out of the bank and stuffed it under the mattress.
The sickening slide of the past year, not to mention the dizzying drops of the past week, poses three fundamental challenges for U.S. and European economic policymakers: First, how to keep the domestic credit crunch from plunging us into a domestic recession. Second, how to keep the global credit crunch from plunging us into a global depression. And third, what basic alterations should be made to global and domestic economic structures to keep this from happening again.
By a curious and gloom-inducing coincidence, as Congress was deliberating on the impeachment inquiry last week, the world's finance ministers, augmented by Messrs. Clinton and Greenspan, came to Washington for the annual meeting of the World Bank and the IMF - and to chart a course that would end the economic crisis. By week's end, it was impossible to say which group was more inadequate to its chosen task.
Consider, for instance, the nonresponse of both the administration and the Federal Reserve to the sudden credit crunch and the likelihood of domestic recession. Earlier this month, the Fed reduced its prime rate by just one-quarter of a percent: clearly, not enough to kick-start the investment community. The administration's intransigence, if anything, has been even more profound. As both Clinton and Treasury Secretary Robert E. Rubin see it, the $70 billion surplus that the federal government ran this year is the capstone of their legacy: a monument that marks the end of the three decades of deficits the government ran up while inflation either loomed or descended over the economy.
Problem is, the specter stalking the economy today isn't inflation. It's deflation, the absence of credit, and the slowing, perhaps the cessation, of growth. And the one thing the federal government could do to get growth going would be to put that $70 billion back into circulation - either through a progressive tax cut or a targeted spending program. Yesterday's monument has become today's tombstone, but the administration still seems to be fighting the last economic war.
As to averting a global depression, the administration and its newly assertive European counterparts seemed headed in opposite directions. The administration still defended the IMF last week - more particularly, the Fund's insistence on keeping capital flows unrestricted and requiring nations in distress to raise interest rates to recession-inducing levels. For their part, the Europeans - in particular, the French socialists and just-elected German social democrats who will dominate the new European Monetary Union - were increasingly critical of the IMF's bailout strategies and the general idea that money can flow in and out of nations without any regulations or restrictions. Instead, they aligned themselves with World Bank leaders who insisted that more attention must be paid to preserving the living standards of Russians and Indonesians than to repaying Wall Street creditors in bailout plans. They also called for broadening the U.S.-dominated governing structure (and thereby changing the policies) of the IMF - a proposal to which the administration was notably cool.
Finally, as to long-term solutions to global instability, there seems to be a growing gap between Bill Clinton's rhetoric and the actual policies of his administration. At a "Third Way" conference he attended with British Prime Minister Tony Blair last month in New York, and then again last week in Washington, Clinton called for a global Keynesian order: for creating social safety nets in developing nations, for creating as a monitor of global capital flows the kind of regulatory agencies that now monitor the nation's security markets. (Of course, as the saga of Long Term Capital Management makes clear, we really don't monitor many of our newer security markets at all, but that's another story.)