Global economy just got weaker

Economic forecasts through 2002 are slashed. Central banks unleash new money.

Central banks around the world are racing to stave off a global slump that some economists now warn could become one of the sharpest slowdowns of the post-war era.

Before the terrorist attacks on the United States, the major industrialized nations of the world already appeared headed for a rare synchronized downturn. Now, in the aftermath of the tragedy, the US economy is plunging further toward recession - and the effects are starting to ripple around the world.

In just the past few days, several prominent economists have added a darker hue to their forecasts for the world economy. While most don't foresee a slump as long or as deep as the "oil shock" of the early 1970s, others believe it could be more than a short-lived blip.

Almost everything, of course, will turn on how quickly the US economy - which represents about one-quarter of global output - rebounds. A widely watched gauge of consumer sentiment released yesterday did little to instill optimism. The consumer confidence index dropped 16 points last month - the biggest one-month decline since 1990, at the start of the Gulf War.

The numbers, from the Conference Board, a business group in New York, are perhaps skewed by early, post-attack emotions. But they are nonetheless considered significant, since consumer spending has been the main girder holding the US above an official recession.

"The attacks of Sept. 11 are likely to provoke a sharp slowdown in world growth, if not recession," warns Italy's leading industrial group, Confindustria.

To prevent a further downturn, the world's major financial czars have been taking some of the most coordinated - and aggressive - actions since 1985 efforts to deflate the dollar. Central banks in the US, Europe, Japan, Canada, Mexico, and elsewhere have slashed interest rates sharply and pumped liquidity into the financial system in just the past few weeks. Their big hope is that the influential US economy will emerge from recession early in 2002.

When central banks do coordinate policy, it is "more effective" than stand-alone actions, says Tom Schlesinger, director of the Financial Markets Center in Philomont, Va.

The latest monetary decision occurred Monday. The Swiss National Bank, concerned that the Swiss franc was being driven up by investors seeking a supersafe currency, cut short-term interest rates by half a percentage point.

It was only 16 months ago when Federal Reserve policymakers hiked short-term interest rates half a percentage point. They wanted to dampen inflation pressures in the US, and they expected rising prosperity in Europe and elsewhere.

Falling forecasts

But in the past year, the pace of global growth has been slowing, and now economists are rapidly revising forecasts.

Stephen Saywell, a currency strategist in London for Citigroup, is typical. He had forecast a "fairly strong recovery" in the United States in the fourth quarter of this year. Now he expects the economy to shrink.

He and other economists have also scaled down expectations for growth in Europe and remain gloomy for Japan's economy.

On Monday, UBS Warburg in London cut its growth forecasts as well for emerging Europe (Poland, Hungary, Bulgaria, etc.), the Middle East, and Africa.

"If the verdict ... falls at the lower end of our new risk range, it would qualify as the worst global recession of the post-World War II era," Stephen Roach, chief economist of Morgan Stanley & Co., wrote this week.

If so, it would beat the severe downturn in 1974, related to massive hikes in oil prices by OPEC, or that of 1980-81, after Federal Reserve Chairman Paul Volcker jammed on the monetary brakes to halt double-digit inflation in the US.

Morgan Stanley now sees world GDP growing a mere 1.8 percent this year and 2.1 percent next year. Any growth below 2.5 percent for the world is often defined as a global recession. That's because economic growth must keep pace with population for living standards to improve.

Allan Meltzer, an economics professor at Carnegie-Mellon University in Pittsburgh, also suspects that Morgan Stanley is too pessimistic, considering the stimulative moves of key governments and their central banks and the reduction in inventories already achieved by American business.

"It is too early to come to a conclusion that we are in for a savage reduction in the economy," Meltzer says. "Unless we have another terrorist attack, life will get back to normal in a matter of weeks - not months."

'The Fed leads, others follow'

Economists agree that in the current crisis of confidence, the actions of the US Federal Reserve are central.

"The Fed leads, and others follow along," says Ronald McKinnon, an international economist at Stanford University in California. "That's the way the world works. The world is actually on a dollar standard."

Europe, with its huge market, is somewhat of an exception. To its disappointment, though, the European Central Bank saw its 12-nation market weaken along with the US economy this year, far more than it had expected.

Most nations, of course, have their own currencies. But almost all commodity pricing and trade are conducted mostly in dollars. And central banks hold most reserves in dollar investments.

So when the Fed acts, other central bankers watch carefully - and try to keep their nations' currencies stable against the dollar.

Japan, already in a deep recession, saw its yen strengthen against the dollar in the present crisis. Since the shift could hurt Japanese exports, the government bought dollars to weaken the yen. This also creates more yen that can be spent by consumers or businesses.

Central banks have occasionally coordinated their actions in the past, but generally to deal with an out-of-whack foreign exchange rate - not a recession.

In 1985, the Group of Ten industrial nations met at the Plaza Hotel in New York and agreed to weaken the dollar.

In 1988, the US and Japanese central banks worked together to weaken the overly strong yen.

During the 1998 financial crisis in Russia, the Fed pumped extra liquidity into the financial system. There was some unhappiness in Washington that more was not done abroad.

Since Sept. 11, the Fed has not only cut interest rates by half a percentage point, but also injected an extra $100 billion into the economy to avoid any freeze-up in financial institutions.

The Fed "performed well" last week, says Mr. Schlesinger. Since then, the system in the US has been returning closer to normal, with less emergency cash needed.

You've read  of  free articles. Subscribe to continue.
QR Code to Global economy just got weaker
Read this article in
https://www.csmonitor.com/2001/0926/p1s1-wogi.html
QR Code to Subscription page
Start your subscription today
https://www.csmonitor.com/subscribe