BOB LEVIN November 9 1987


BOB LEVIN November 9 1987



The financial world’s attention last week focused on a small, blue-carpeted room off the U.S. Senate chamber. There, around a square table with a red floral centre-piece, 19 dark-suited men —negotiators from the White House and Congress—began to haggle over how to cut at least $30.36 billion from Washington’s $195.36-billion budget deficit. “We’re touching gloves and circling the ring,” said Senator Robert Packwood, ranking Republican on the Senate finance committee. The two sides at least agreed on the need to reduce the deficit, which has been widely blamed as a major cause of the precipitous plunge in world markets over the past two weeks. Even President Ronald Reagan—who first reacted to the market crash by offering sunny reassurances of the U.S. economy’s underlying strength—admitted that the stock turmoil “has alerted us of the potential dangers on the economic horizon.” But many analysts questioned whether the negotiations on Capitol Hill would produce a budget-cutting package strong enough—and soon enough—to calm the world’s jittery markets.

Perceptions: With market whims based as much on perceptions as on hard economic facts, the so-called budget summit had become a symbolic test of U.S. leadership at a time of crisis. The reality was that no other country could, or would, pull the world out of the financial quagmire. And the lack of immediate U.S. action last week took its toll. As officials in Washington continued to dicker, declining investor confidence drove the dollar down to a seven-year low against the West German deutsche mark and to a 40-year low against the Japanese yen, before it moved up slightly at week’s end. European and Japanese central banks bought dollars to prevent a free fall. But by week’s end, both the United States and its allies had made the decision to let the dollar remain at its new levels.

The dollar’s slide appeared to undercut a recent international accord. Meeting at the Louvre in Paris last February, leaders of the G-7 countries—the United States, Japan, West Germany, Britain, France, Italy and Canada—agreed to encourage world economic growth and stabilize exchange rates around then-current

levels. In Ottawa last week, an aide to Finance Minister Michael Wilson said that G-7 officials were ready to meet again to deal with the continuing crisis. But until Washington produces its deficit-reducing measures, the aide said, “all we can do is wait.” Just how long they would have to

wait remained unclear. For all Washington’s professed commitment to deficit-cutting, there were many hesitancies, both in political will and ideological inclination. For one thing, the figure being considered is merely what was mandated by the 1985 Gramm-Rudman-Hollings Act,

which, if no budget compromise is reached by Nov. 20, would make $23 billion in automatic across-the-board cuts. And officials remain deeply divided on how to structure the reductions. With his political power

waning, Reagan even agreed, only grudgingly, last week to consider a tax increase, which he had previously threatened to veto. Some U.S. economists, from varying shades in the political spectrum, even warned that reducing the deficit, particularly by increasing taxes, might chill the economy enough to touch off a recession—or even another 1930s-style depression. “The current debate is a repeat of talks from the 1930s,” cautioned Robert Pollin, a left-wing economist at the University of California-Riverside. “It’s almost spooky.”

Culprits: Many U.S. officials argued that the United States was not the only culprit in the market crash. For years Washington has pressured economically powerful West Germany and Japan to stimulate domestic consumer demand and, in that way, to widen the market for U.S. imports. Three weeks ago Treasury Secretary James Baker lashed out at the West German central bank, the Bundesbank, for moving in the opposite direction by raising its prime lending rate by a tenth of a percentage point to 3.85. Eventually, the bank cut back the rate, but not before U.S. threats of retaliation contributed to the pan-

ic atmosphere on the world’s exchanges. Last week both West German and Japanese finance officials said that they would consider shifts in policy, including lowering interest rates to stimulate spending, but crit-

ics doubted openly whether such moves would be significant.

For the United States, the shocks on Wall Street called attention to a problem long in the making. Since taking office in 1980 Reagan has presided over a $2.64-trillion military buildup, a peacetime record. Meanwhile, his government has reduced personal income taxes by 23 per cent on the theory that the cuts would lead to more spending and investment and, in the end, more government revenues. Instead, the budget deficit has ballooned —it is now $99 billion over its 1980 level — prompting a chorus of I-told-youso’s from Reagan’s critics and leading to the passage of the GrammRudman-Hollings Act.

As the deficit-reduction talks began last week, both Reagan and congressional leaders declared their intention to place partisan concerns aside. But the President apparently could not resist a snipe at Congress. “I set out to try and eliminate the

deficit when I first came here,” he told a group of foreign journalists. “But unfortunately the Congress has the last word about spending money, and they have been more willing to spend than I would have been.” That questionable claim aside, both parties at the closed-door sessions reported that the atmosphere was businesslike—and imbued with a strong sense of urgency. But substantial differences were evident. The administration-represented

by White House Chief of Staff Howard Baker, Treasury Secretary James Baker and Office of Management and Budget Director James Miller—reportedly favors a freeze on domestic

and military spending at current levels, with the exception of social security. Many Democrats, however, prefer an item-by-item approach to exempt certain programs that aid the poor.

Struggle: At the same time, the Democrats pressed for $15.8 billion in new taxes. That proposal has created divisions within the White House itself, setting off a struggle for the mind of the President. Miller and other hard-liners remain unalterably opposed to any new taxes. The two Bakers, on the other hand, favor the more pragmatic path of compromise, and it was they who apparently persuaded Reagan to open the door, if only a crack, to the tax-hike possibility-alienating many staunch conservatives. “It was a very unwise move,” said Stuart Butler of the Heritage Foundation, a right-wing think-tank. “There have been jokes going around that this would not have happened if Reagan was still the President. That, to me, says it all.”

Still, Butler asserts that the White House’s intent seems mostly symbolic. He dubbed the present time “a sort of phoney policymaking period, where gestures are the currency”— and plainly hoped that Reagan would soon revert to his antitax stance. That prospect would anger the Democrats. Discussing the $15.8-billion tax proposal, House Speaker Jim Wright said of administration officials, “Surely if they are not willing to accept that much, they are not really serious.” Wright tried to drum home his message by championing a $19.1billion deficit-reduction bill that included the tax increase. But the

House initially rejected the bill last week. And only after supporters stripped it of a controversial welfare-reform provision did it win passage—and then by only one vote, evidence of strong antitax sentiment among legislators.

Allies: That sentiment has also created some strange allies among outside experts.

Both the left-leaning Pollin and the conser-

vative Paul Craig Roberts, an economist with

the Washington-based Center for Strategic

and International Studies, argue that the deficit is a secondary problem. Said Roberts: “It’s as if you’ve got the flu and you’ve had a heart attack. But your doctor only wants to treat

the flu. It’s madness.” Added Pollin: “There are these clichés that the party’s over, and we now have to pull in our belts. But most people in America haven’t been at any party. Median incomes still remain below the 1971 peak. We never fully recovered from the ’82 recession.” Both Roberts and Pollin maintain that, in the short term, instead of cutting the deficit, which tends to contract economic growth, the government should expand the economy by dropping interest rates.

While Americans debated their troubles, the rest of the world was left to cope with the ripple effects from the U.S. crash. In Japan, where economic policies are designed to shield the country from global woes, the Tokyo stock market seesawed less wildly than others. But if a recession hit the United States, it would undoubtedly spread to the rest of the world, including Japan. In an effort to head off that prospect, Economic Planning Minister Tetsuo Kondo said last week that Japan should be prepared to stimulate its own economy further—which is exactly what Washington has been urging for years. In fact, over the past six months Japan has taken some modest steps to stimulate its economy, including a $56.7-billion package of public-works projects. And Noboru Takeshita, expected to be Japan’s next prime minister, has pledged to inaugurate a program of greater domestic growth.

Damaging: On the Hong Kong Stock Exchange, the Wall Street quake caused more damaging aftershocks. After Black Monday, Oct. 19, the market plunged 421 points, prompting its chairman, Ronald Li, to close it for four days. When an Australian reporter asked Li after the market reopened last week if the closure had broken the exchange’s rules, Li, showing the postcrash strain, launched into a tirade. “This is slanderous,” he shouted. “Charge him. Take him to the police station.” The Hong Kong market continued to fluctuate last week. But interestingly, among those helping to stabilize it— by pumping in cash and buying stock—was the government of Communist China, which will begin ruling the British colony in 1997.

In West Germany last week, finance officials were preoccupied with the drop in the U.S. dollar, which was sure to affect Bonn’s export-heavy economy. The Bundesbank made massive purchases of the declining greenback, but the dollar still ended the week worth 1.73 deutsche marks, compared with 1.80 two

weeks ago. West Germany was also under increasing pressure from its European allies to lower its interest rates and expand its economy. West German Finance Minister Gerhard Stoltenberg said that once Washington adopted its budget cuts, Bonn would reconsider its interest rate policy. But the government of Chancellor Helmut Kohl is clearly reluctant to go further in that direction because of concerns about igniting inflation. And that caution can only win approval from a conservative population that still bears the psychological scars from Germany’s

hyperinflation of the 1920s.

Battering: Although the Bonn government remained largely untouched by the financial storm, France’s conservative administration came in for a partisan battering. Finance Minister Edouard Balladur declared that despite the market turmoil, the government might delay—but would not scrap—its privatization program, a central plank in Premier Jacques Chirac’s platform. “We will press ahead the moment economic conditions permit it,” declared Balladur. In Parliament, opposition Socialist party stalwart Pierre Joxe charged that the government was sticking to its privatization project out of “stubborn commitment to a discredited, Reagan-type ideology.” Balladur countered that the opposition was cynically “exploiting an international crisis.” It remained to be seen whether either side would benefit

from the controversy in the presidential elections that are to be held next May.

In Britain, much as in France, the slide in share values posed a problem for Prime Minister Margaret Thatcher’s Conservative government. Under Thatcher’s own privatization program, the number of Britons who own stock in publicly traded companies has increased to nine million from three million in 1979. As long as share prices continued to rise, Thatcher’s policy of popular capitalism was a vote-winner. But the recent collapse of prices on the London Stock Exchange has, at least

on paper, wiped out billions of pounds worth of shareholders’ savings. It also caused the government to consider delaying the planned sale of its remaining 31.5-percent stake in British Petroleum PLC—before deciding to proceed at week’s end (page 45). Critics seized upon the market collapse as evidence that Thatcher’s private-enterprise policies were misguided. “Finally,” Labor party finance spokesman John Smith said in Parliament, “the free-market chickens have come home to roost.” But most analysts doubted that the market woes would undermine Thatcher’s popularity.

Critical: Meanwhile, even Thatcher’s government, a staunch Reagan ally on most matters, was critical of Washing-

ton’s monstrous budget deficit. In the House of Commons last week, Nigel Lawson, the chancellor of the exchequer, said that it was important “to keep up the pressure on the United States” to reduce the red ink—even if it took a tax increase to do it. Under

such pressure, Washington seemed

compelled to make some budget-cutting moves, at least enough to calm the crisis of confidence. The Reagan administration must also decide at what levels to try to sustain the dollar, an effort that could be co-ordinated with G-7 countries. Wounded though it may be, the U.S. economy remains that proverbial elephant, and the havoc it wreaks by rolling over demands attention around the world.