PATRICIA BEST November 2 1987


PATRICIA BEST November 2 1987



Ever since a landmark September, 1985, meeting of the world’s top industrial nations in New York, political leaders have depended on a loose policy of co-operation to solve the trade and debt problems wracking the global economy. Since then, the United States, Germany, Japan, Britain, France, Italy and Canada have pledged to act unselfishly and adopt domestic policies that will in turn help the economies of their fellow nations. But periodic meetings of the leaders have produced little more than vague agreements to keep currencies stable. And as stock markets collapsed around the world last week in the wake of Wall Street’s devastating Black Monday, most analysts pinned the blame in large part on a breakdown of international economic cooperation.

Last February the leaders of the group of seven leading nations, known as G-7, reached an agreement at the Louvre meeting in Paris to encourage

world economic growth. But on Oct. 14 West Germany’s central bank, the Bundesbank, boosted its prime lending rate by a tenth of a percentage point to 3.85 per cent. Higher interest rates tend to dampen growth, and the West German action prompted an irate U.S. Treasury Secretary James Baker to accuse West Germany of breaking the Paris pact. Then, Baker also speculated on the possibility of letting the U.S. dollar drift lower against other major currencies—and in doing so broke the accord himself. Four days later, in an attempt to resolve the bitter dispute, Baker flew to Frankfurt to meet with German officials, who agreed to cut back the rate.

Tailspin: But that international row, along with disappointing U.S. trade results and a spate of gloomy analyses in U.S. publications, sent the world’s stock markets into their unprecedented tailspin. Alarmed market traders and investors around the world instantly

started pulling their fluid and skittish pool of capital from the U.S. market. They were clearly worried that a hike in interest rates would slow down America’s economic growth—and even trigger a recession. As a result, they started to bail out of overvalued American stocks.

Fragile: When the enormity of the crash became apparent early last week, the U.S. government responded to the fears of higher interest rates. On Wednesday the Federal Reserve Board, the U.S. central bank, dropped its interest rate to six per cent—it had been as high as 7.5 per cent the week before. Major U.S. banks followed by dropping their lending rates by similar amounts to nine per cent. And the Bank of Canada followed suit, lowering the prime bank rate by a full 1.57 percentage points to 8.26 per cent. The rate drops flooded the financial system with liquidity, making money easier to obtain and fuelling temporary rebounds on stock exchanges.

But such a drop in rates under ordi-

nary conditions has other potential side effects. For one thing, it can set off alarms over inflationary pressure, which in turn could affect the value of the U.S. dollar as foreign capital moves out of the United States. But last week the U.S. dollar did not fall until Friday, when it declined sharply against other major currencies amid rumors, later denied, that G-7 leaders were to hold an emergency weekend session—and possibly devalue the U.S. currency. In Ottawa, finance department officials were privately worried about a steep fall in the greenback, which would take the Canadian dollar with it. However, last Friday the Canadian dollar actually improved against major currencies.

The fragile network of conflicting economic actions and consequences has world leaders hamstrung. On one side is the United States, formerly the industrial and financial engine that powered the globe, facing an array of serious, fundamental economic weaknesses. Its industries have lost their pride of place to the goods producers of other countries, notably Japan. And its consumers have developed a seemingly unquenchable thirst for foreign products, which has produced a $148-billion U.S. ($194 billion Can.) trade deficit. By contrast, in 1980 the United States had a trade

surplus of $17 billion (U.S.).

That worsening trade position had already sent the U.S. dollar into a steady decline against other major currencies since late 1985. America’s reduced purchasing ability in turn has led American business, government and consumers to take on record levels of debt in order to support the country’s 59-month-old boom. Said Patricia Mohr, senior economist with the Bank of Nova Scotia in Toronto, the U.S. economy is “on a knife’s edge.”

Crash: On the other side of the chasm that separates the United States from its economic allies are West Germany and Japan. Despite the G-7 accords, both the West Germans and the Japanese have policies designed to insulate them from global woes at the expense of the United States. Japan, plagued by an overvalued currency and a stagnant economy, has rejected pressures to increase imports. And West Germany, laboring with high unemployment and a sluggish economy, concentrates on avoiding inflation. Although Noboru Takeshita, likely Japan’s next prime minister, has promised a program of higher domestic growth, Western leaders remain convinced that the United States must fix its yawning trade and budget deficits if the economic imbalance is to right itself.

Late last week, clearly stung by criticism that he had initially reacted too mildly to the Wall Street crash, President Ronald Reagan gave the first indications that he was finally ready to adopt tougher economic policies. Reagan has conducted a long running battle with the Democrat-led Congress over the direction of next year’s U.S. budget, which is expected to fall short of revenues by $180 billion (U.S.). Despite that shortfall, Reagan has refused to raise taxes.

Fearful: Instead, Reagan is calling for greater spending cuts than those proposed by Congress in all nonmilitary programs, sales of government assets and increased user fees for government facilities and services. At his first news conference in seven months, Reagan told reporters on Oct. 22 that he would have his officials meet congressional leaders to discuss cutting the budget deficit. And while he stopped short of retracting his longheld opposition to a tax hike, he said, “I’m putting everything on the table, with the exception of Social Security.”

But stock market investors and many economists reacted with skepticism. Said Carl Beigie, chief economist at Dominion Securities Inc. in Toronto: “The President has lost any real credibility in international matters.” And C. Fred Bergsten, director of the Washington-based Institute for Inter-

national Economics, said that if White House officials “do not take these signals seriously, they court real, major disaster.” Robert Solow, the professor of economics at Massachusetts Institute of Technology who was awarded the Nobel Prize for economics last week, was equally critical. “Financing a consumption boom by borrowing from foreigners means that we’re going to be a number of years digging ourselves out of a hole that we dug for ourselves over the past six or seven years,” he said.

Still, many economists and politicians remained fearful that tough budget slicing and a tightening of borrowing would pave the way to recession. The worry is that last week’s stock market crash could have an immediate recessionary effect as newly cautious U.S. consumers and businesses curb their spending.

Many observers now say that a mild recession in 1988 is inevitable—and even welcome, because it will put a stop to overborrowing. But the clear consensus was that the world was not headed for another Great Depression. Said Irwin Kellner, chief economist at Manufacturers Hanover Ltd. of New York: “We have been predicting a recession for some time. The drop in the stock market is the last piece in the puzzle.” Added Dominik Dlouhy, vicepresident of Dean Witter Reynolds (Canada) Inc. in Montreal: “A recession was long overdue anyway. Purchasing power will drop, which will help heal the American trade deficit.”

Panic: But many analysts also drew uncomfortable parallels between the events of last week and the decline of Britain as the world’s economic leader in the 1920s, just before the Great Depression of the 1930s. Republican congressman and presidential hopeful Jack Kemp wrote in the Wall Street Journal, “The market broke, in effect, because American leadership on all these [economic] fronts appeared to be crumbling.”

Still, Kemp and a host of other observers held out hope for an end to international foot-dragging on broad world economic reform. For one thing, the Wall Street panic may have helped to reunite the leading nations to take common action on the faltering monetary system. A recent proposal by Treasury Secretary Baker to anchor the world’s monetary system to the price of a basket of commodities, including gold, gained lustre in the wake of the crash. But that was only one possible solution to one part of a global problem.

PATRICIA BEST with IAN AUSTEN in Washington and correspondents’ reports