Toward a safer world (minor blips allowed)

It's not hard to paint a scary picture of the world economy. In the United States, the picture includes a falling dollar, rising oil prices, and a possible housing bubble.

Overseas, the European Union faces new perils. Russia is moving away from free-market capitalism. And China is growing so fast that it threatens to ignite inflation or deflation (take your pick).

Yes, financial crises seem to come and go more frequently than in the past.

So it comes as something of a surprise to hear that, on average, the world economy has become less risky than it was a few years - or even a few decades - ago. It's "rather a peaceful period," says Nick Crafts, an economic historian at the London School of Economics, who has compared this era to previous ones.

It's volatile politics - not economics - that should make people uneasy, concludes Ian Bremmer, president of Eurasia Group, the world's largest political-risk consultancy. Messrs. Crafts and Bremmer spoke at a recent Merrill Lynch seminar in London.

First, the economics.

Can anyone really say the world is more stable when people are worried about job losses, stock-market declines, and foreign competition?

It depends on the context. In the big economic picture, the world is safer than it was, for instance, when President Nixon loosed the dollar from the last vestiges of the gold standard in the early 1970s. Or during the Asian financial crisis starting in 1997. Or, if you want to choose a really frightening period, the Great Depression of the 1930s.

In the first four years of that decade, output fell in advanced countries by about 17 percent. In the worst slumps since World War II, the US has seen nothing worse than a 2 or 3 percent decline. In the early '30s, the price of tradable goods fell 40 percent - a drop that makes the worries about deflation a year or two ago seem almost silly. And some 9,000 US banks failed in that Depression.

Of course, that doesn't mean the world economy doesn't have problems today. One relatively new challenge is that money - portfolio capital - can slosh around the world rapidly. At the first sign of such trouble in 1997 in Thailand, billions of dollars rushed out of Asia, pushing, for instance, Indonesia, South Korea, and the Philippines into the economic dumps. That risk is bigger if a developing nation has banks and other financial institutions that cannot handle sharp outflows.

Developing nations should get their financial houses in order before jumping into the world's pool of capital with both feet, Crafts says.

Another risk is today's massive deficit in the US current account - its international payments. When the pound was the world's prime reserve currency, held by other nations in something like savings accounts, Britain had a big surplus in its current account. But not the US.

"This needs correction eventually," says Crafts. Perhaps it will take a 30 percent devaluation of the dollar, he adds. A key danger is that Asian central banks - Japan, China, South Korea, Taiwan - will decide to dump some of the hundreds of billions of US Treasury securities in their reserves, depressing prices and raising interest rates. Crafts likens it to France and Germany reneging on commitments not to buy gold with surplus dollars in the late 1960s - which led to the dollar's devaluation.

On the positive side, Crafts finds that most industrial nations in recent years have adapted policies better able to sustain economic stability than in the past. Central banks more often adjust their monetary policy according to rules taking account of inflation, inflation targets, actual unemployment, and a theoretical unemployment rate assumed to be inflationary if the rate drops lower.

On the fiscal side, governments are quicker to cut taxes or step up spending if their economies show signs of sliding. After the US economy weakened in 2000, for example, the Fed cut interest rates to a record low. Congress cut taxes by huge amounts. Eventually, the stock market - and the economy - recovered.

So you could almost breathe a sigh of relief - over the housing bubble and everything else - if it weren't for politics.

"It's virtually guaranteed that the world will become a riskier place over time," says Bremmer, the political-risk analyst. That's because politics often trumps economics. So adding political elements into the economic mix raises instability.

One problem, for example, is the diffusion of dangerous technology - for example, how to make atomic bombs. Another is the porous nature of borders. Terrorists can go from country to country relatively easily, as can weapons of mass destruction.

Such threats carry a cost - not only in increased security measures taken by governments and corporations, but also in the opportunities not taken by businesses that must continually assess the risks in a world being "globalized."

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