For believers, favorable signs abound. Last week the International Monetary Fund forecast a global recovery. In 1999, the IMF said, the world economy will grow only a meager 2.3 percent. But in 2000, the pace will pick up to 3.4 percent and, more important, some of the hardest-hit countries will revive. South Korea is already recovering. The IMF predicts its economy will expand 2 percent in 1999 and 4.6 percent in 2000.
The IMF is not alone. Merrill Lynch regularly polls global money managers. The latest survey covered 293 financial institutions–banks, pension funds, insurance companies, mutual funds–that handle more than $8 trillion of investment funds. “Economic optimism is surging,” reports Merrill Lynch. In Europe, 74 percent of fund managers expect “a stronger economy a year from now.” Among Japanese managers, that’s 61 percent. In the United States, money managers are raising profit forecasts.
What explains the turnaround is reflation–or the perception of it. Reflation is a fancy term signifying that lower interest rates will prevent deflation (falling prices). For the last year, deflation fears have haunted financial markets. Depressed by low worldwide demand, raw-material prices (oil, grains, minerals) had declined sharply. A wider deflation might cause a downward economic spiral. Profits would drop as companies received falling prices for products but paid fixed costs, mainly wages. Some corporate debtors would default on loans. Trade would suffer. This would stymie export-led recoveries in Asia and Latin America.
But interest-rate cuts in the United States, Europe and Japan have, for the moment, defused these fears. Last fall the Federal Reserve lowered its key short-term interest rate from 5.5 to 4.75 percent in three steps. In early April, the European Central Bank reduced its key rate from 3 to 2.5 percent; earlier, European rates had been cut from about 3.3 to 3 percent. And short-term rates in Japan are almost zero. Raw-material prices have stabilized. Easier credit (it is thought) ensures expansion and precludes deflation. It promotes borrowing and spending, which prevent prices from falling.
The IMF has also helped. Its crisis management, though often chaotic, acted to prevent a simultaneous collapse of developing countries. So South Korea’s recession is ending just as Brazil’s is beginning. The staggered slumps have cushioned the adverse effect on the global economy. Fear has subsided. In a front-page story April 14, The Wall Street Journal headlined: round the globe, signs point to final days of the financial crisis.
But could the improvement be more psychological than real? The global economy is ultimately the sum of its parts. If the parts don’t work well, neither will the whole. By the IMF’s reckoning, the United States, the 15-country European Union and Japan account for almost half the world’s economic production. (The shares: United States, 21 percent; European Union, 20 percent, and Japan, 7 percent.) For each, there’s reason to worry.
The upbeat story about Europe and Japan is that they’re now copying America’s formula for economic success. Companies are “restructuring” and cutting costs. Profits and stock prices will improve. Fine. Unfortunately, these good things involve some bad things. “Restructuring” often means firing people. Who will employ the unemployed? In the United States, the economy creates new businesses and enables successful ones to expand. Europe and Japan don’t do this nearly as well. In Japan, regulations and cartels discourage new companies. In Europe, high payroll taxes and tight regulations deter hiring.
Even with low interest rates, Europe and Japan might not grow strongly. The problem in the United States is just the opposite: the economy has done so well that it may be fated to falter. Personal debt is high. The stock market may be overvalued. Strong consumer spending could weaken. And the United States has most aided other countries by buying their exports. In 1998, the U.S. current account (a broad measure of trade) registered a deficit of $233 billion. By contrast, Japan and the European Union ran surpluses of $122 billion and $78 billion. Without rich countries’ buying their products, poorer countries will struggle to revive.
The Brazils, Mexicos and Koreas of the world also face the continuing hazard of capital flight. Last week U.S. Treasury Secretary Robert Rubin outlined steps to make global lenders more prudent in extending credit to poorer countries. As Rubin noted, excessive capital inflows lead to abrupt outflows. Booms beget busts. But if new restraints frighten lenders, they may withdraw existing loans and cause the outflow that Rubin wishes to avoid. The IMF says, for example, that all “emerging market” countries have $90 billion of maturing foreign bonds in 1999 and 2000. Unless most are refinanced, countries will have to curb spending.
No one knows how all these crosscurrents will play out. Anyone who reads economic forecasts quickly discovers that even the more optimistic ones are hedged with qualifications and confessions of doubt. Global recovery could be just around the bend, but the present reality is that most economies are getting worse, not better. Growth is slowing in Europe and China; Japan’s recession is deepening; so is Latin America’s.
Economics has never been a science, and it is even less so now than a few years ago. The rising importance of global trade and finance, interacting with national economies, has created new forces that constantly change and are only dimly understood. No one is “in charge” of the world economy, and the people trying to contain its present distress have had to improvise. It would be reassuring and dramatic to declare that they had succeeded. But the duller truth is that we don’t know–and neither do they.
