councilor.org
| Source | Ian Murray |
| Date | 01/03/26/22:59 |
| Another Wall Street slide could set off worldwide deflation. And Japan shows
where that leads Special report: Japan Guardian Unlimited Money John Gray Tuesday March 27, 2001 The Guardian "We need to tame deflation and make it benign. To do so we need not just different policies but a different economic philosophy." The Japanese banker who told me this a week ago in Kyoto was not speaking only of Japan. Unlike most western observers, he understood that the world is returning to a condition it has not known since the late 19th century, when globalisation first got under way. Deflation is built into the global economy that has emerged in the wake of the cold war. The question is whether we can prevent it from spiralling out of control. While the stock market continued to defy gravity few people took seriously the idea that we may be returning to a world of steadily falling prices. Deflation might be entrenched in Japan, but there was no reason to think that it could spread. The vast destruction of wealth we have seen in stock markets over the past few weeks has shattered that complacent consensus. As in Japan, the risk is that a further collapse in the stock market will rebound on the real economy and reinforce the deflationary forces that go with globalisation. Until only a few months ago, the suggestion that the long boom on Wall Street would end in a Japanese-style crash was treated with derision. With few exceptions, western commentators insisted that it rested on sound economic fundamentals. A surprisingly large number gave credence to the idea that the US had entered a "new era" of crisis-free growth. This was, of course, sheer tosh. No doubt it owed something to gains in productivity from restructuring and new technologies, but America's millennial boom was essentially a classic speculative bubble, fuelled by loose credit and stoked up by vast inflows of foreign capital. As in the bubbles of the past, investors were assured that "This time it is different". The investment bankers who proclaimed an American economic miracle were fond of quoting Joseph Schumpeter's description of capitalism as an economic system driven by creative destruction. But in the euphoria produced by rocketing stock prices the destructive side of capitalism identified by the great Austrian economist (the decimation of obsolete industries and the recurrent booms and busts in financial markets) was rarely mentioned. Many Americans came to believe that crashes happen only in history books. As in the 1920s, the belief that the US had arrived on a plateau of permanent prosperity became the basis on which they planned their economic future. Placing their faith in the capital gains they had made in the stock market, they stopped putting money aside for retirement and borrowed as if there were no tomorrow. As could have been predicted, the sunlit upland proved to be a narrow and dangerous crevasse. Many of the capital gains on which Americans were relying for their security in retirement have now gone up in smoke. Any figure is bound to be imprecise, but the worldwide loss of wealth resulting from the decline in stock markets is estimated to be already five or six times as large as that suffered in the mini-crash of 1987. The danger to the global economy posed by this loss of wealth is significant. In order to avoid poverty in old age, millions of Americans will have to start saving again - and saving hard. If history is any guide, they cannot rely on being baled out by the markets. In 1949, the Dow Jones Index stood at less than half its top in 1929. In 1982, when the last great bull market in American stocks began, the index was still more than 20% lower than its peak in 1966 - 16 years earlier. Contrary to the claims of brokers and financial advisers, equities are risky even when they are held long-term. After a meltdown of the sort we are seeing, it can take decades for investors to recoup their losses. Many will find their standard of living reduced permanently. The danger that economic activity will contract throughout the world as Americans curtail their spending is well understood among bankers and policy makers. The deflationary impact of globalisation is less widely comprehended. But the fact is that virtually every aspect of that complex process works to drive prices down. The internet has brought about a huge transfer of value from producers to consumers. By comparison with the past, information is now virtually cost-free. An enormous variety of services can now be accessed directly, without the need for expensive intermediaries. With new technologies, production can be sliced into segments and sited in places all over the world. At the same time, the collapse of communism and the emerging economies of Asia and Latin America have injected billions of new workers into world markets. Taken together, these developments have catapulted us back in time. The world economy at the start of the 21st century bears a striking resemblance to the last quarter of the 19th century, when underwater telegraph cables started to link up markets around the world. Then, as now, new technologies and global free trade exerted a powerful downwards effect on price levels, with some parts of the world languishing in prolonged depression. The risk we face at present is that a further slide on Wall Street will tip the world economy into outright deflation. We can be sure that Alan Greenspan will do all he can at the US Federal Reserve Bank to prevent such a disaster. Interest rates will be cut aggressively in an effort to boost confidence. But the Japanese example is not reassuring. Zero interest rates there have failed to lift the country out of 1930s-style deflation. The economy is still contracting, and the stock market has retreated to a level last seen more than 15 years ago. It can be argued that the bubble economy was more extreme in Japan than in the United States, and the response of the Japanese authorities slow and indecisive. But the real lesson to be learnt from Japan is that once deflation is embedded in the economy it is fiendishly difficult to control. Japanese policy-makers have found that lowering interest rates in these circumstances is - as Keynes famously put it - "pushing on a string". That is why, partly in response to western advice, they are beginning to accept that the only way out may be to print money. As the Japanese banker observed, we need a new economic philosophy. But I'm not holding my breath. Perhaps aggressive American interest rate cuts will prevent further market slides and consequent recession in the US and throughout the world. If not, western governments and central banks are likely to follow the course they are urging on the Japanese. In that case, we may avoid late 19th-century deflation only to find ourselves back in the inflation ridden world of the 1970s. . John Gray is professor of European thought at the LSE. j.gray@lse.ac.uk |
Copyright (c) 1998, Joongpil Cho