First Step: Send Clear Economic Signals

ARE world stock markets gyrating because Bill Clinton may become president? Not yet, but the markets may be emitting alarm signals soon. They are currently attempting to wake up complacent central bankers, who, like blind men touching an elephant, are dealing with domestic economic slowdowns as though each were separate and strictly their own business. In fact, say worried experts, these are all part of the same global deflationary trend that could lead to a severe worldwide recession - or worse.

Assuming that Mr. Clinton is elected president and is prepared to turn to fiscal stimulus - and larger federal budget deficits - to kick-start the economy, what will be the reaction of the United States' major overseas allies, trading partners, and, most important, wary creditors and financial markets? It should be remembered that the markets control vastly more liquidity than the world's central banks and can veto any policy shift seen as potentially inflationary - or even one that takes them by surpris e - by dumping dollars and long-term US Treasury bonds.

The three months between the election and the inaugural are a time of intense scrutiny of the newcomer as financial markets and foreign governments try to discover and discount likely policy moves. If a new president is elected, he should deliberately signal his intentions after the election.

The emerging world economic crisis calls for policy coordination among the leading industrial nations, the G-7, without delay. But with the possibility of a lame duck in office and with the bankers and political leaders scarcely talking to each other, much less acting in concert, the president-elect may have to take the first step - if only to preserve his own policy options for the next four years.

There is another compelling reason for tomorrow's victor to disclose his economic-policy intentions early. The US is the world's largest debtor and requires a continual flow of borrowed funds to finance our government's deficits. Much of the money comes from overseas, and these creditors have a voice in our affairs. In an interdependent world, the US has become, of necessity, dependent on foreigners.

Fortunately, many people overseas are becoming as worried as Americans, and they are reconsidering their own fiscal as well as monetary options to fight recession. Most of us are probably too preoccupied with our own troubles to notice, but the bleak economic environment - shallow recession and failed recovery, adding up to stagnation - is spreading to the rest of the leading industrial nations. Germany is slipping into recession, taking Europe with it. The same is true of Japan; much of Asia, after a lu ll, probably will follow. Indeed, the US economy, weak as it is, is holding up better than the rest of the G-7.

A simultaneous worldwide recession is a rare and troubling phenomenon. This time, unlike the mid-1970s, no single dramatic event, such as an oil price shock, can explain it. The historical triumph of the West in the cold war and demobilization of defense establishments is part of the trend we are experiencing, but its roots go deeper, back to the oil-driven inflation of the 1970s and the debt-financed boom of the 1980s.

In a nutshell, the emerging global slump stems from too much of a good thing - disinflation - now threatening to turn into a bad thing, deflation. A gradual worldwide cooling of inflation could run out of control and become the economic equivalent of a new Ice Age. Asset values, once gently declining, are now falling faster and could conceivably collapse, endangering fragile household and business debt structures, shaky banks, and perhaps the entire global financial system. This system is vulnerable beca use markets are electronically tied together and computerized traders can spread panic literally in the blink of an eye, while national governments are fragmented and often squabbling.

The symbol of present-day economic nationalism and the focus of much squabbling is Germany's Bundesbank. Universally respected for its tough anti-inflation stance and jealously guarded independence from politics, the Bundesbank takes very seriously its statutory mandate to maintain a sound German monetary system with the lowest possible rate of inflation. But the parochial German authorities, by rigidly obeying German law, are ignoring their clear international responsibilities. By financing the takeover

of eastern Germany with mountains of potentially inflationary debt and pursuing a high interest-rate anti-inflation policy, the German authorities are forcing the rest of Europe and perhaps the entire world to the wall. Other Europeans see the danger clearly. "Inflation is not the No. 1 enemy," says Alois Bischofsberger, chief economist at Credit Suisse. "It's deflation, recession, even depression."

The Bundesbank, slowly reacting to intense domestic and foreign pressures, has begun easing some short-term rates. But even optimistic German observers say it probably will delay significant easing moves until the end of the year or early 1993. The crisis may force earlier action.

Japan is also moving very cautiously. Tokyo is given higher marks than Frankfurt for adjusting pragmatically to rapidly changing economic circumstances. Tokyo's inflated stock market has crashed, losing more than half its value. Phenomenal Japanese land values are falling rapidly - no one knows by how much because there are few transactions. Corporations that borrowed heavily to expand capacity during the 1980s boom are laying off workers and closing factories.

Recognizing the deflationary potential in Japan's "post-bubble" economy, the Bank of Japan and the Ministry of Finance are beginning to face up to the need for substantial fiscal stimulus to fight what threatens to be the worst recession of the post-war era. But Tokyo's fiscal stimulus package unveiled in August is estimated to be equal to about 2.5 percent of Japan's gross domestic product, which financial observers in Washington and New York believe is insufficient to stem the deflationary crisis.

In the US, the Federal Reserve has reduced short-term interest rates 24 times since 1989, but cheaper money has failed to stimulate a sustained recovery. If the Fed's low-interest, cheap-dollar strategy has failed in today's deflationary environment, what remains? Obviously, fiscal policy, in the form of public-works (infrastructure) spending, business tax cuts, and targeted incentives for investment, perhaps even some relief for middle-income families. But what about the budget deficit, estimated at clo se to $400 billion when the deferred S&L and bank bailouts are included? And what about the reaction overseas to more deficit spending?

The danger is quite real that a new president could face a stern veto from the markets and foreign creditors and thus effectively lose control of his policy choices. Officials and bankers in Europe and Japan have only recently faced the reality that President Bush could lose and that after January they may have to deal with a virtually unknown Southern governor and a new supporting cast.

In 1979, behind-the-scenes pressure from the Bundesbank forced then-President Jimmy Carter to appoint then-New York Fed President Paul Volcker as Fed chairman to adopt a tight-money policy, fight soaring inflation, and defend the dollar. That policy switch influenced the election that Carter lost a year later.

Thus, if the crisis quickens, Clinton could face an extraordinary test of his leadership at the very outset of his presidency, possibly even before his inauguration. He should meet it squarely and deal with concerns at home and overseas by answering two fundamentally important questions:

* Is he an internationalist who accepts the established US leading role and responsibilities in the world economic and financial system, or is he a neo-protectionist believer in "managed trade" who will give priority to domestic politics? His hedged endorsement of the North American Free Trade Agreement is encouraging but scarcely definitive.

* Will he use fiscal policy responsibly in an attempt to stimulate the economy, or will he and his advisers opt for radically increased spending to boost his popularity and tolerate rising inflation in the hope that it will lighten the burdens of the deficit and the $4 trillion national debt?

A former colleague of Mr. Bush says privately: "He turned out to be weak and indecisive on the important money issues and that hurt him badly at home and overseas. Clinton is completely unknown and therefore has a one-time opportunity to make a favorable first impression. For our sake, I hope he makes the most of it."

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