[Austin-ghetto-list] Pessimist's outlook brightens

[Roger Baker]

World  >  Global Issues 
from the September 26, 2001 edition 

Global economy just got weaker

Economic forecasts through 2002 are slashed.
 
Central banks unleash new money.

By David R. Francis | Staff writer of The Christian Science Monitor
 
Central banks around the world are racing to stave off a global slump
that some economists now warn could become one of the sharpest slowdowns
of the post-war era. 
Before the terrorist attacks on the United States, the major
industrialized nations of the world already appeared headed for a rare
synchronized downturn. Now, in the aftermath of the tragedy, the US
economy is plunging further toward recession - and the effects are
starting to ripple around the world.

In just the past few days, several prominent economists have added a
darker hue to their forecasts for the world economy. While most don't
foresee a slump as long or as deep as the "oil shock" of the early
1970s, others believe it could be more than a short-lived blip.

Almost everything, of course, will turn on how quickly the US economy -
which represents about one-quarter of global output - rebounds. A widely
watched gauge of consumer sentiment released yesterday did little to
instill optimism. The consumer confidence index dropped 16 points last
month - the biggest one-month decline since 1990, at the start of the
Gulf War.

The numbers, from the Conference Board, a business group in New York,
are perhaps skewed by early, post-attack emotions. But they are
nonetheless considered significant, since consumer spending has been the
main girder holding the US above an official recession.

"The attacks of Sept. 11 are likely to provoke a sharp slowdown in world
growth, if not recession," warns Italy's leading industrial group, Confindustria.

To prevent a further downturn, the world's major financial czars have
been taking some of the most coordinated - and aggressive - actions
since 1985 efforts to deflate the dollar. Central banks in the US,
Europe, Japan, Canada, Mexico, and elsewhere have slashed interest rates
sharply and pumped liquidity into the financial system in just the past
few weeks. Their big hope is that the influential US economy will emerge
from recession early in 2002.

When central banks do coordinate policy, it is "more effective" than
stand-alone actions, says Tom Schlesinger, director of the Financial
Markets Center in Philomont, Va.

The latest monetary decision occurred Monday. The Swiss National Bank,
concerned that the Swiss franc was being driven up by investors seeking
a supersafe currency, cut short-term interest rates by half a percentage point.

It was only 16 months ago when Federal Reserve policymakers hiked
short-term interest rates half a percentage point. They wanted to dampen
inflation pressures in the US, and they expected rising prosperity in
Europe and elsewhere.

Falling forecasts

But in the past year, the pace of global growth has been slowing, and
now economists are rapidly revising forecasts.

Stephen Saywell, a currency strategist in London for Citigroup, is
typical. He had forecast a "fairly strong recovery" in the United States
in the fourth quarter of this year. Now he expects the economy to shrink.

He and other economists have also scaled down expectations for growth in
Europe and remain gloomy for Japan's economy.

On Monday, UBS Warburg in London cut its growth forecasts as well for
emerging Europe (Poland, Hungary, Bulgaria, etc.), the Middle East, and Africa.

"If the verdict ... falls at the lower end of our new risk range, it
would qualify as the worst global recession of the post-World War II
era," Stephen Roach, chief economist of Morgan Stanley & Co., wrote this week.

If so, it would beat the severe downturn in 1974, related to massive
hikes in oil prices by OPEC, or that of 1980-81, after Federal Reserve
Chairman Paul Volcker jammed on the monetary brakes to halt double-digit
inflation in the US.

Morgan Stanley now sees world GDP growing a mere 1.8 percent this year
and 2.1 percent next year. Any growth below 2.5 percent for the world is
often defined as a global recession. That's because economic growth must
keep pace with population for living standards to improve.

Allan Meltzer, an economics professor at Carnegie-Mellon University in
Pittsburgh, also suspects that Morgan Stanley is too pessimistic,
considering the stimulative moves of key governments and their central
banks and the reduction in inventories already achieved by American business.

"It is too early to come to a conclusion that we are in for a savage
reduction in the economy," Meltzer says. "Unless we have another
terrorist attack, life will get back to normal in a matter of weeks -
not months."

'The Fed leads, others follow'

Economists agree that in the current crisis of confidence, the actions
of the US Federal Reserve are central.

"The Fed leads, and others follow along," says Ronald McKinnon, an
international economist at Stanford University in California. "That's
the way the world works. The world is actually on a dollar standard."

Europe, with its huge market, is somewhat of an exception. To its
disappointment, though, the European Central Bank saw its 12-nation
market weaken along with the US economy this year, far more than it had expected.

Most nations, of course, have their own currencies. But almost all
commodity pricing and trade are conducted mostly in dollars. And central
banks hold most reserves in dollar investments.

So when the Fed acts, other central bankers watch carefully - and try to
keep their nations' currencies stable against the dollar.

Japan, already in a deep recession, saw its yen strengthen against the
dollar in the present crisis. Since the shift could hurt Japanese
exports, the government bought dollars to weaken the yen. This also
creates more yen that can be spent by consumers or businesses.

Central banks have occasionally coordinated their actions in the past,
but generally to deal with an out-of-whack foreign exchange rate - not a recession.
In 1985, the Group of Ten industrial nations met at the Plaza Hotel in
New York and agreed to weaken the dollar.

In 1988, the US and Japanese central banks worked together to weaken the
overly strong yen.

During the 1998 financial crisis in Russia, the Fed pumped extra
liquidity into the financial system. There was some unhappiness in
Washington that more was not done abroad.

Since Sept. 11, the Fed has not only cut interest rates by half a
percentage point, but also injected an extra $100 billion into the
economy to avoid any freeze-up in financial institutions.

The Fed "performed well" last week, says Mr. Schlesinger. Since then,
the system in the US has been returning closer to normal, with less
emergency cash needed.