Is World Economy Stabilizing?

From Tokyo's recession-weary banking district to the thriving bourses of a unifying Europe, the world financial system is showing hints of possibly turning the corner on more than a year of turmoil.

Stock markets from Stockholm to Singapore have been pulling out of a tailspin. Currencies are strengthening across East Asia. Japan is advancing a huge bailout of its debt-drenched banks. And some European central banks have begun to mimic the US Federal Reserve and cut interest rates. Moreover, the International Monetary Fund (IMF) plans to launch a $30 billion rescue for Brazil, bolstering an economy that could otherwise tumble.

"We're at the beginning of the end" in the global financial crisis, says Allan Meltzer at Carnegie Mellon University in Pittsburgh.

Some US financial officials sing the same tune: Instability "will disappear from the radar screens of pressing policy issues as the markets settle down in due time," says William Poole, president of the St. Louis Federal Reserve Bank.

It is probably far too soon, however, to declare a sustained easing in the worst financial chaos since World War II.

The current calm is fragile, warn many economists, and the world's financial markets could easily confront another wave of frenzied selling. Among their concerns are that the Brazil initiative and other efforts are too mild to eliminate the overcapacity, cronyism, poor bank regulation, and other cracks in the world economy's foundation.

Moreover, some economists see the rebound in equities as merely a classic bear-market bounce. Eventually, overpriced assets such as American stocks, Hong Kong real estate, and Brazilian exports will resume a meltdown in value, subsiding after a long period of excessive credit, they say.

"We haven't yet seen the bottom," says Steve Hanke, professor of applied economics at Johns Hopkins University in Baltimore. "There appears to be a lot more rot in the system than meets the eye."

Still, skeptics like Mr. Hanke acknowledge there are some bright glimmers in recent political and economic trends.

In the United States, the Dow Jones Industrial Average has roughly halved its losses from its July high and, as of Oct. 26, stands about 7 percent above where it began the year. By cutting interest rates twice in the past month, the Fed has calmed a panicky bond market and headed off its leading worry - a tightening of the credit that keeps the economy chugging.

Also, Congress recently approved $18 billion in funding for the IMF, strengthening a Clinton administration effort to rally industrialized nations behind a new plan to prevent additional financial turmoil.

In currency markets, the yen has reversed a long slide and surged nearly 20 percent this month against the dollar. A stronger yen is a potent stimulant: It strengthens the buying power of Japanese consumers, makes exports of East Asian nations more competitive, and forestalls a destabilizing currency devaluation by China.

In Tokyo - ground zero in the market tumult - officials have engineered the "soft landing" of Long Term Credit Bank (LTCB), the most troubled institution in a banking sector soaked by more than $1 trillion in bad debt. The government has nationalized LTCB as part of a $500 billion banking bailout.

But all these measures may not win long-term financial stability. "The current stability is quite tentative," says economist Dan Seto at Nikko Securities International in New York. "These are ... small steps, many of them overdue."

World finance could soon shudder again as investors abandon a market suddenly deemed too risky, say some economists.

Brazil is especially vulnerable. To gain full IMF backing, President Fernando Henrique Cardoso must push through a $20 billion package in new taxes and budget cuts. Such slashing is difficult, requiring new legislation or changes in Brazil's Constitution. After budgetary sacred cows such as salaries, health care, pensions, and social security, only 10 percent of spending is discretionary, says Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis.

In East Asia, many economies remain vulnerable to huge fluctuations in capital. The current accounts in Thailand, South Korea, Indonesia, and Malaysia have swung from average deficits of minus 5.2 percent of gross domestic product in 1996 to estimated surpluses of 7.1 percent this year, according to Morgan Stanley Dean Witter in New York.

But the economies languish in recession, with rising rates of joblessness and bankruptcy. So far, they've failed to sufficiently tighten banking regulation, curtail corruption, and solve other problems.

In Japan, banks and securities firms soon will report midyear earnings and losses, testing public confidence in the government's bailout scheme. The failure of another bank could shake Japan's stock and bond markets - and throw a strengthening yen into high-speed reverse.

Although especially virulent, the recent financial turmoil is not that surprising. Credit is ebbing after flowing far too freely last decade, especially in East Asia, some analysts say.

"It is a classic boom-bust cycle," says Hanke. Easy money generated an overexpansion; inefficient or redundant businesses have faltered, badly jarring markets; investors have succumbed to panic, say the analysts.

"There is a lot of cleaning out to do in asset values in much of the world, and to suggest this will be complete in a short period is simply ludicrous," Hanke says.

Still, other economists see an end in sight. "People are getting their portfolios into shape, some of the euphoria has dissipated - to put it mildly - and investors have become much more realistic," says Carnegie Mellon's Mr. Meltzer, a professor of political economy.