BRENDA DALGLISH October 19 1992



BRENDA DALGLISH October 19 1992




Five years ago, on Oct. 19, global stock markets collapsed like balloons losing air. On that single day, which conjured up the ghosts of the 1929

market crash, shareholders lost their profits and financial wizards lost their reputations, then their jobs. And everyone's confidence in the economy began to slowly leak away. Now, the financial markets are edgy, hundreds of thousands of whiteand blue-collar workers around the world have been laid off and the economy still cannot gather enough momen tum to haul itself out of the trough. The recession, which most economists initially pre dicted would end in a so-called soft landing almost before it started in 1990, is approaching its third anniversary-and still shows no signs of loosening its grip on the economy. "I don't think this recession is over by any means," said Leon Tuey, an investment analyst with his own company in Vancouver. "There has never been another time, in my life, with a situation like this. The central bank has been stimulating [cutting interest rates] for two years and noth ing happens."

Although most analysts say that the economy will not deteriorate much further, financial markets have displayed a new nervousness and volatility in recent weeks. Lower interest rates continue to be the key factor on which economists and politicians are hanging their hopes for a recovery. Again last week, the markets waited hopefully for the U.S. Federal Reserve Board to lower the discount rate and ultimately encourage spending. But that did not happen, and by the end of the week the Canadian bank rate had climbed to 7.93 per cent, the highest level in almost a year and the fifth consecutive increase in the weekly rate. Now, a gloomy minority is harking back to the Great Depression of the 1930s, while warning that lower interest rates, on their own, may no longer be enough to get the economy moving again.

“The economy looks like it is going into a third dip,” said A. Gary Shilling, president of an economic consulting and investment firm in Springfield , NJ. He added: “We haven’t had anything like this since the 1930s.”

Even the pessimists acknowledge that the differences between the 1930s and the 1990s are numerous. Economic output in the current recession has fallen by only a fraction of what it lost during the Great Depression (page 54). But even more importantly, the international financial network that exists now is much more sophisticated. In the 1930s, the banking sys-

tem wreaked havoc on the faltering economy by raising interest rates and tightening credit in a misguided effort to correct debt problems. Until 1935, Canada did not even have a central bank to monitor the economy and regulate the money supply and interest rates.

In addition, the creation of the International Monetary Fund (IMF), as well as the growing inclination of the leaders of industrialized countries to work together in areas of global trade and finance, has increased the incidence of countries co-operating to solve financial problems. “The regulatory network is there and it

has policies, fiscal and monetary, that can be taken to prevent a global decline,” said Surinder Suri, chief economist at London Life Insurance Co. in London, Ont. “One of the clear messages from the last IMF meeting was that if push came to shove, there would be sharp reductions in short-term interest rates and a large increase in global liquidity [money supply].”

Despite such widespread confidence in the power of global financial consultation, one lead-

ing expert took a more cautious tone. He is 87year-old Edward Bernstein, a guest scholar with the Brookings Institution, an economic research agency in Washington. Bernstein, who had just completed his economics doctorate at Harvard University at the time of the 1929 stock market crash, says that he is convinced that a deep depression like that of the 1930s will not occur because global financial authorities understand better what causes such economic collapses. But Bernstein added that governments should not be complacent. “It should be emphasized that deep depressions start as moderate recessions and that they grow in severity as they are prolonged,”

Bernstein warned in a 1962 paper and still believes. “No country, particularly the United States, can afford the attitude that recessions will correct themselves.” Now, at the depth of recession with the danger of prolonged stagnation presenting itself, he said crisply: “No one is doing anything at all.”

Although Bernstein said that he does not expect the recession to turn into a deep depression, he added that governments should do much more to assist a recovery and get the unemployed back to work. Although he and fellow economist John Maynard Keynes clashed over issues at the landmark Bretton Woods economic conference in the rolling hills of New Hampshire in 1944, Bernstein is in complete agreement with Keynes over how government policy should be used during times of severe economic recession. And now, Bernstein says, it is time for authorities to shift their focus from fighting their budget deficits to stimulating the economy and creating jobs.

Indeed, even though the depth of the U.S. recession is shallow as measured by the drop in the economy’s output in terms of the gross domestic product, the duration is already more than twice as long as normal. “It is one thing for a country to have 10-percent unemployment for three months,” said Bernstein. “It is another thing to have it for three years.” Canada’s unemployment statistics for September underscore the persistence of the problem. The seasonally adjusted rate dropped to 11.4 per cent from 11.6 per cent in August. But even though the rate edged down, the actual number of people officially unemployed amounted to a staggering 1,434,000 individuals, not even including those so discouraged they had given up looking for work.

Increasingly, Canadian economists are beginning to echo Bernstein’s call for government action. Lloyd Atkinson, chief economist and executive vice-president of the Bank of Montreal in Toronto, is forecasting that the economy in 1993 will be just slightly better than it was in 1992. Even so, Atkinson says that he would welcome some strategic government intervention. “One thing that is sorely missing in the United States is investment: business investment, investment in education and training and in infrastructure,” Atkinson said. “Ultimately, if the government undertook projects that are prudent, they will more than pay for themselves.” But Atkinson cautioned that any government stimulation “must pass the competitive test.” He added: “The days of building roads to nowhere are gone—any project would have to significantly improve our productivity.” In some places in the United States, he said, truckers are rerouted by several hundred kilometres to avoid roads that have culverts or

bridges that cannot support their loads. By improving those roads, he said, the government would increase productivity.

Government intervention, however, can also have a negative impact on the economic climate. Philip Braverman, chief economist and senior vice-president of New York City-based DKB Securities, a subsidiary of Dai-Ichi Kangyo Bank Ltd., the world’s largest bank, says that he is deeply worried about the state of the economy and the government’s role in worsening it. “Things are getting worse, not better,” said Braverman. “The regulatory authorities and the Federal Reserve do not realize the desperate shape the economy is in. They do not recognize the damage that they are doing.”

Braverman said that he is especially concerned about the tight credit conditions that U.S. regulators are imposing on the financial system. “We have never had a recovery without significant credit growth,” said Braverman, but now the financial system is restricting credit.

“The regulators are tightening screws and making it more difficult for lenders to lend. The end result is that they are perverse, doing countercyclical things.” Braverman says that the problem will escalate after Dec. 19, the date set by legislation for the Federal Deposit Insurance Corp. to begin closing U.S. banks and savings-andloan companies that do not meet new minimum capital standards. The effect of that legislation will be to tighten credit even more. “It is not a pretty situation,” said Braverman. “And if you think things are bad now, wait.”

Braverman said that the deteriorating economy and the reluctance of government officials around the world to address the problem reminds him of the Great Depression, when many of the economic policies that governments pursued were the reverse of what was needed. “They are doing it again,” he said, recalling that when President Franklin D. Roosevelt first took office in 1933, he increased taxes to balance the budget. In addition to that step, the Federal Reserve raised interest rates by a percentage point to defend the dollar.

Japan is apparently the only major industrialized country taking a significantly different approach to its economic problems. In August, the Japanese government took drastic action to stimulate the economy. It promised to inject $105 billion into the economy to shore up the real estate market and to actively support the

banking system. “How successful they will be is unclear, but at least they are doing something to deal with the problem,” said Braverman. “It seems to me that we don’t even recognize that we have these problems.” He added: “To this day, the President keeps saying that we are poised for recovery. I do not agree. I see us poised for continuing stagnation at best.”

Gary Shilling shares a similarly gloomy view of the future. Shilling’s opinion may deserve special attention because of his early warnings

of an impending recession and his clear predictions about how it would unfold. In the October, 1989, issue of The Atlantic Monthly magazine, Shilling predicted a near-term global recession. At that time, he wrote: “The world’s debt load has far outrun its collateral, whether you are talking about the Third World, farmland, corporations, consumers, everything. It will take a major global recession to force a debt restructuring. But even coming out of the recession, there will be a fierce battle for exports—there is a lot of extra capacity coming on-line in the developing countries—and a protectionist scramble. Governments will not help. Military spending is dropping; Star Wars will turn into Trade Wars. It is hard to foresee a happy resolution even longer-term.”

Three years later, his opinions have changed little. “We’re unwinding all the excesses of the 1980s in terms of huge debt creation,” he said. “Historically, after we’ve had these big debt binges it takes about 10 years to work out the excesses, and during that time the economy tends to have longer-than-normal recessions and weaker-than-normal recoveries.” Indeed, by comparison with past periods, Shilling noted that so far the negative effects have been milder than he initially anticipated. “It has been unusually orderly,” he said. “Look at the whole

savings-and-loans crisis. That did not cause any generalized panic. No one went out the window. We’ve been very lucky so far. But I don’t know if our luck will continue.”

According to Shilling, a variety of imaginable events could still derail the economy. The recent upheaval in the financial markets could be a sign of things to come. “The markets go through four stages: euphoria, complacency, concern and, finally, fear and panic,” said Shilling. “As of last Friday [Oct. 2], the stock market began to get concerned.” Can fear and panic be far behind? The frightening possibilities are enough to make even the pessimists hope that they are badly mistaken.