Capitalist Globalism in Crisis

IMF bashing, a popular sport on the left for years, has finally made it into mainstream culture. Unfortunately some new mainstream players are now playing at a higher level than many leftist veterans. Since Johnny-Come-Lately mainstream critics of the IMF do not share our progressive priorities, we can expect their views will not accord with our interests. This article explains what the IMF does and (1) how to oppose IMF policies that are no longer merely inequitable, but also ineffective from any perspective, and (2) how to respond to various proposals to reform or replace the IMF that are already being seriously debated.

In the aftermath of World War II a number of international organizations were created. Besides the United Nations, the important international economic organizations created at the conference held at Bretton Woods were the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development, now known as the World Bank. The IBRD-World Bank was established to help finance the reconstruction of war-torn Europe and the development of the poorer countries of the world. The IMF mandate was to regulate an international monetary system based on convertible currencies so as to facilitate global trade while leaving sovereign governments in charge of their own monetary, fiscal, and international investment policies. Significantly, the effort to establish the International Trade Organization (ITO) ended in failure, leaving the “minimalist” General Agreement on Tariffs and Trade (GATT) as its surviving remnant. But all that was more than 50 years ago. The IMF has now become the “point person” for efforts to “liberalize,” or deregulate the international economic system.

The IMF is usually thought of as the “manager” of the international credit system. But one could question whether the newly transformed international credit system has a manager. One could debate whether “manager” would be an accurate label in any case. The IMF would have us believe it is more like a “social worker” for international “credit addicts.” Polite IMF critics would use the word “policeman” rather than “manager” to describe the IMF's role. Angry critics see the IMF as nothing more than an “enforcer” or “rent-a-cop” in the employ of the international creditor syndicate. Here, we are concerned with what the IMF does and with the predictable effects of its policies, so readers can choose their own label.

The IMF has prescribed the same medicine for troubled third world economies for two decades now: (1) Monetary austerity: Tighten up the money supply to raise internal interest rates to whatever heights needed to stabilize the value of the local currency. (2) Fiscal austerity: Increase tax collections and reduce government spending dramatically. (3) Privatization: Sell off public enterprises to the private sector. (4) Financial liberalization: Remove restrictions on the inflow and outflow of international capital as well as restrictions on what foreign businesses and banks are allowed to buy, own, and operate. Only when governments sign this “structural adjustment agreement” does the IMF agree to: (5) Lend enough itself to prevent default on international loans that are about to come due and otherwise would be unpayable. And (6) arrange a restructuring of the country's debt among private international lenders that includes a pledge of new loans.

Since the alternative to signing an “IMF conditionality agreement” is no new international loans—even to finance export sales and essential imports—combined with threats of asset seizures abroad by international creditors; since there is no longer a Soviet bloc that might decide to “scab” on an international creditor boycott and embrace a defaulting pariah to her bosom; and since an international lending boycott would bring most third world economies to their knees within months, there have been few troubled countries in the past decade willing to stare down the IMF and say “nyet” to its “devil's deal.” The only countries able to put up any fight at all have been those who could play the “too big to fail” card. In the 1980s when Brazil owed more than 100 billion and Peru owed a little more than 10 billion, the saying in Latin America was: “If I owe you 10 billion dollars I'm in trouble. But if I owe you 100 billion dollars you're in trouble.”

In the Latin American debt crisis of the 1980s the IMF backed down in face of Brazilian threats to default and agreed to a much more lenient program—effectively allowing the Brazilian economy to continue growing. On the other hand when social democratic President Alan Garcia refused in 1985 to dedicate more than 10 percent of the value of Peruvian exports to debt repayment on grounds that paying any more would make economic development impossible, the IMF excommunicated Peru from the international economic community. Peru was denied new loans even to finance exports, and the World Bank shut down not only its development projects, but also its research projects in Peru, in solidarity with IMF policy. The greater the “exposure” of international creditors—and in particular U.S. creditors—the better the deal debtor countries have been able to extract from the IMF and the creditors it represents, because the larger the debt the more negative the consequences of default for the entire club of international creditors as well as for the country that defaults.

But what are the consequences of standard IMF policy? The predictable consequences for most residents of the troubled economy—who are not the ones who took out the international loans—have always been disastrous. Tight monetary policy and skyrocketing interest rates not only stop productive investment in its tracks, stampeding savings into short-run financial investment instead of long-term productive investment, it keeps many businesses from getting the kind of month to month loans needed to continue even ordinary operations. All of which leads to unemployment and drops in production and therefore income. Fiscal austerity—raising taxes and reducing government spending—further depresses aggregate demand, also leading to reductions in output and increases in unemployment. If any of the government spending eliminated was actually improving people's lives, then reductions in those programs eliminates those benefits. Privatization of public utilities, transport, and banks is always accompanied by layoffs. Whether productivity and efficiency is improved in the long run depends on how badly the public enterprises were run in the first place, and if private operation proves to be an improvement. One of the most glaring inefficiencies of “structural adjustment” even on its own terms has been that in its haste to reduce public sector budgets, the IMF has seldom taken the time to try and distinguish between poorly run and well run public enterprises. In its crusade to privatize, the IMF routinely lumps efficient public enterprises together with “white elephants” that do provide poor service to the public while paying bloated salaries to relatives and political supporters of ruling political parties. The IMF never considers the possibility that the private replacement might be even worse. But irrespective of whether the long run effects of privatization are positive or negative, in the short run it adds to unemployment, depresses demand, and aggravates recessionary pressures.

In the short run, hasty removal of restrictions on international capital flows makes it easier for wealthy citizens and international investors to get their wealth out of the country, i.e., removal of “capital controls” facilitates capital flight, further reducing productive investment, production, income, and employment. In the long run, removing capital controls further exposes the local economy to the vicissitudes of global capital mobility including the disease of “contagion.” No wonder IMF conditionality agreements are also known as “austerity programs.” They not only depress productive investment and thereby sacrifice economic development, they depress aggregate demand and increase the gap between actual production and the meager productive potential that exists in troubled economies.

Surprisingly, there is little disagreement about the above effects. If you did not reveal that some part of the package was part of an IMF structural adjustment program, most trained economists would predict the above consequences for each part taken separately. What is controversial is the IMF claim that in the long run these policies will rebound to the benefit of the local economy and its inhabitants. That prediction is based on the assumption that once the economy has gone through the pain necessary to right its sunken ship in the sea of international credit, the benefits of “orderly liberalization”—revived exports and new international investments, and the increased productivity they supposedly bring—will trickle down to everyone. Fortunately for those who defend IMF policies, those benefits are only predicted to materialize in the future, so whenever someone points out that they have yet to show up, the IMF and its apologists can always answer that the trickle is still working its way down.

But IMF policy is not designed to help the majority in troubled economies. It is intended to help international creditors in the short run, and increase returns on global capital in the long run. The truth is that any benefits to residents of local economies are an after thought. How are IMF policies supposed to solve the short and long-run problems of international creditors and global capital? In the short run, creditors want to be repaid by their third world borrowers. They want to be repaid on schedule, they want to be paid the high returns they were promised when the loans were made, and of course they want to be repaid in dollars. Their chances of getting repaid are better the higher the value of the local currency of their borrowers since profits in that currency must be turned into dollars to repay them. Their chances of being repaid are better the larger the surplus of exports over imports since that is one source of dollars to repay them. The only other source of dollars is new international loans, or reductions in the repatriation of earnings of current international investors. But new loans means further risk and exposure. Restrictions on international capital outflows are the last thing creditors anxious to get their money back are likely to support. So anything that boosts exports and lowers imports is in the interest of international creditors.

How do high interest rates and depressed economies—which is what IMF policies create—prop up currencies and generate trade surpluses? High local interest rates attracts international capital in the short run which increases demand for local currency and boosts its value. Lower levels of production means lower incomes, lower demand for imports, larger trade surpluses, and therefore upward pressure on the value of the local currency. Expanding the trade surplus and propping up the local currency is the only way local debtors can pay off their international creditors quickly, and that is why it is the key to every component of IMF stabilization policy. Preserving the value of local currencies is talked of as if it were a major boon to the troubled economies. But the deflationary monetary and fiscal policies used to stabilize the currency and reduce imports bring a halt to productive investment, growth, and development, and throw the local economy into a recession or worse, with dramatic drops in production, income, and employment. But the disastrous effects on the local economy are irrelevant to those who impose the policy, because protecting the local currency and expanding the trade surplus are necessary if international creditors are to get repaid.

But when the IMF intervenes in a crisis, monetary and fiscal austerity is not sufficient to get all the creditors paid back—particularly the ones whose loans are coming due immediately. That is where the second part of the IMF agreement comes in. The IMF loans the debtor country enough money to pay off what it calculates will be the unpayable portion of the outstanding loans coming due. In other words, they provide a “tide over” loan to avoid defaults, which will supposedly be repaid once the beneficial effects of the austerity measures—that is the effects beneficial to creditors—kick in. This bailout of international investors whose loans had become unpayable is designed to spare them losses from their “risky” investments, and also to prevent panic that defaults might trigger from spreading to other parts of the international credit system. The IMF also tries to convince private investors to make new loans as well, since this reduces the amount the IMF has to come up with. The easiest private investors to convince, of course, are the very ones who made the loans that are in danger of not being repaid. Essentially the IMF threatens them that if they do not participate in the debt restructuring plan and cough up new loans, the IMF will abandon the salvage operation and they will go unpaid. But a sizable commitment of IMF money is necessary to convince these lenders that the waters will now be safe for new loans and they will not be throwing good money after bad.

But where did the IMF get the money to loan $17.2 billion to Thailand, $58.2 billion to Indonesia, $22 billion to Russia, and $42.3 billion to South Korea? Where will it get the $41.5 billion it has just promised to loan Brazil? After all, the IMF is not an international central bank, like the central banks of countries, who truly are “lenders of last resort” for their national banking systems because they do have an unlimited capacity to make new loans in their national currencies. The answer is the IMF gets its budget from “assessments” of member governments—like the $18 billion supplemental assessment the Clinton administration lobbied Congress to approve in light of the Asian crisis, and well-heeled Republicans, after months of populist bluster on Capital Hill, finally signed off on in the last minute budget deal before the election recess. In other words, the IMF budget comes from the taxpayers of member nations, and any interest the IMF receives from loaning those taxpayers' money.

Notice the not so subtle shift in risk bearing buried in IMF rescue packages. International investors make loans and collect high yields in part because there is risk of default. But when danger of actual default rears its ugly head, the IMF makes the loans necessary to avoid default, at which point the creditors are paid back in full, after having enjoyed the high yields. But if the IMF can always be counted on to ride to the rescue, it turns out there is no risk for the international investors. Does this mean the risk disappears? Hardly. First of all, even when the IMF rides to the rescue, there is no guarantee the cavalry will arrive in time with enough fire power. Russia did default despite IMF attempts to shield the international credit system from such a shock. But even when an IMF intervention prevents default on loans coming due immediately, there is still a risk that despite the best efforts of the IMF to turn the troubled economy into a debt repayment machine, it may still fail to pay off all it owes farther down the line—including all it now owes to the IMF. So the IMF has arranged a full payoff for the original investors—including interest payments enlarged by riskiness—and then assumed the risk of default itself. We have re-found the risk, but who is the IMF who now bears the risk? Suddenly the IMF is the taxpayers of its member countries who pay assessments. Of course, if the IMF loans eventually get repaid, then member country taxpayers who made the loans through the IMF will also be repaid, and one can argue—as the IMF and its supporters certainly do—that the IMF bailout never actually ended up costing the taxpayers a penny. But that is hardly the point. In cases where the IMF loans themselves are not repaid, the taxpayer has paid off the international lenders by assuming their risk and getting stiffed in their stead. Even in cases where the IMF loans are repaid, taxpayers of member countries subsidize international lenders who receive a risk inflated rate of return when in fact it is the taxpayers who end up assuming the risk.

So IMF bailouts are not bailouts of debtor countries and their economies at all. That's just a popular misconception that some find convenient to let pass uncorrected. IMF bailouts are bailouts of international investors because that is who gets the money. It is the great sucker play of the wealthy in the late 20th century where international lenders enjoy the high yields while taxpayers ultimately assume the risk. Of course, in broad terms it is just one more case of privatizing the benefits of an economic activity—in this case international lending—and socializing the burdens associated with that activity—risk of international default. Through IMF bailouts taxpayers of member nations provide underwriting services to international investors, for no fee, and provide insurance for international investors, for no fee. A sweet deal when you can get it.

In the long run international capital wants to be able to invest anywhere they choose, at the highest possible rates of return, with the lowest possible risk of losses. If foreign stock markets look profitable they want to be able to invest in them without restrictions, and they want to be able to get out whenever they wish. If public utilities or state owned industries look profitable, they want to be able to buy them. If agriculture or real estate looks profitable, they want to be able to buy land in foreign countries. Whenever rising wages, business taxes, or environmental laws raise the costs of doing business in one country, they want the threat of moving to be as credible and frightening to local governments and populations as possible. That means they want to be able to go into and out of business anywhere any time. Like owners of professional sports franchises in the U.S. who play the citizens and governments of one city and state off against each other in bidding wars to subsidize franchises with new stadiums and accompanying infrastructure at taxpayers expense, international capital wants to be able to play the workers and governments of all countries off against one another, collecting promises of low wages and exemptions from taxes and environmental regulations, to keep the long run returns on international capital as high as possible. Privatization, particularly at fire sale prices, and elimination of restrictions on international capital flows and ownership, permit international investors to buy up the most attractive assets in economies that fall under IMF management, and permit them to get their profits out of the country whenever they like. That is why the IMF insists on conditions liberalizing capital flows and foreign ownership as well as fiscal and monetary austerity when it has a country over the barrel of pending default.

Anyway, that's how IMF policies were supposed to work. For the most part that's how they did work prior to the onset of the Asian crisis. So what went wrong? Why is George Soros, who made tens of billions from international investments in the 1980s and 1990s, suddenly saying things like: “International financial authorities are inadequate. The methods they used were inappropriate and unsuccessful in arresting the spread of the collapse. I'm not against the IMF but I think it should change its policies.” We can be sure it is not for the same reason others joined the Fifty Years Is Enough Campaign long ago.

IMF Failures in Asia and Russia

So the question here is not why IMF policy has failed to lead to economic recovery and development in troubled economies. They were never designed to do that. The question is why standard IMF policies suddenly failed to serve the interests of international investors who had loaned to East Asia and Russia. Why it is possible that the exact same policies and $41.5 billion loan to Brazil that has just been negotiated may prove equally ineffective.

The IMF cure for South East Asia's creditors was too little too late, and suffered from the same problem as the Asian development strategy—the fallacy of composition. Depressing the Thai economy helps Thailand's creditors get repaid—assuming the bhat can be stabilized and world aggregate demand holds steady. Depressing the Malaysian economy helps Malaysia's international creditors get their money back—assuming the ringgit can be stabilized and world demand holds steady. Depressing the Indonesian economy helps Indonesia's creditors get repaid—assuming the rupiah can be stabilized and world demand holds steady. Depressing the South Korean economy can help Korea's creditors get repaid—assuming the won can be stabilized and world demand holds steady. But that is a lot of “assuming.”

The first problem was that the IMF interventions failed to stabilize the local currencies. Instead of reversing devaluations, IMF interventions triggered capital flight and thereby aggravated depreciation of local currencies. Instead of reassuring international investors that they would be repaid, announcements of IMF agreements—pledges of billions of dollars of IMF loans to repay loans coming due, and promises from local governments to forego growth and development in order to be able to better repay their creditors—were interpreted by international investors as a sign that problems were even more serious than they had previously realized. The appearance of the fireperson did not calm guests in the house on fire, it sounded the alarm announcing to all that rule number one—DON'T PANIC—had already been broken. So of course everyone implemented rule number two—PANIC FIRST!— and headed for the exits. As you read in the evaluations of Stanley Fischer and Michel Camdessus quoted previously, the IMF would have us believe that “the market”—meaning international investors—did not find pledges of reform by troubled governments convincing. For Fischer the problem was the Russian duma. International investors did not believe they would actually collect more taxes or relax capital restrictions. For Camdessus the problem was that Indonesian and Korean promises to end crony capitalism were not credible. The more obvious explanation is that international investors did not find the IMF credible. They doubted the size of the IMF bailout was going to prove sufficient to reverse the outflow of capital given the magnitude and mobility of international capital. This wasn't Mexico in 1994 where over-exposed U.S. banks and the U.S. government had every reason to do whatever necessary to keep Mexico from going down the tubes—especially if they could get the U.S. taxpayer to assume the risk of guaranteeing the loans necessary for the bailout. International investors decided the Asian tiger economies were not too big or too important to fail—and they were right. Besides, the international investors didn't have to stay in the house and run the risk that the fireperson would fail to put out the fire. They could PANIC FIRST—dumping local currencies and withholding new loans—and wait to see what happened. If the fire got put out, they could always go back in later buying local currencies and assets at lower prices than when they dumped them, and making new loans when business conditions had actually picked up.

The second problem was that once the Thai, Malaysian, Indonesian, and Korean economies fell into recession, the assumption that world aggregate demand would hold steady was no longer valid. Just as the booming Asian economies had provided the boost in aggregate demand that sustained world economic growth in the early 1990s, depression in this region now threatens to pull the rest of the world's economies down with it. Stagnant Japan faces lost export sales to depressed Asian economies. China may devalue the yuan if Asian tiger currencies do not recover, to prevent loss of Chinese export sales to Asian competitors—in which case Japan, the U.S., and Europe would lose export sales to China. Belatedly, the danger of a world recession, or worse, due to falling aggregate demand became apparent even to IMF leaders—who have been back-peddling on their insistence that the troubled Asian economies implement fiscal and monetary austerity ever since the meetings in Washington in early October.

Now that it is apparent that IMF policies may not even solve the short-run problems of international creditors, it is natural to ask where all this might lead. The great fear of those who have yet to suffer the effects of the global crisis is summed up in the word “contagion.”

Contagion

When people speak of “contagion” they mean that problems in some part of the world economy might spread to other parts of the world economy. Since the world economy is more highly integrated than ever before, this is almost a tautology. But exactly what kinds of “contagion” must we fear? One kind of “contagion” is that falling output and incomes in a major region of the world economy depress the demand for exports from other regions, which can tip stagnant economies into recession. Just as recessions within a national economy have dangerous self-reinforcing dynamics that are harder to counter once they start to build, the same is true for the world economy. So one transmission mechanism for “contagion” is that any significant decrease in aggregate demand for goods and services can lead to further decreases in aggregate demand that spread to sectors not initially affected. This is the problem of self-aggravating, rather than self-correcting, recessionary dynamics that Keynes finally explained to the “academy” during the 1930s, and that is certainly one concern today.

Will recession in a group of Asian tigers spread to Japan because their demand for Japanese exports has dropped dramatically? Will the stagnant Japanese economy stifle recovery in the crippled East Asian economies who find it harder and harder to sell exports to Japan? The Japanese government has finally succumbed to international pressure to try and pull the Japanese economy out of recession through expansionary fiscal and monetary policy. According to the Washington Post (November 16) “Prime Minister Keizo Obuchi today unveiled public spending and tax cut plans worth $196 billion as the embattled government struggles to stop Japan's economic slide. The economic plan includes $49 billion in income and corporate tax cuts, and $147 billion in spending projects. Those projects include public works spending of $66.5 billion and vouchers to encourage consumer spending. The government plans to spend $8 billion with a goal of creating 1 million new jobs and, in particular, to promote the employment of middle aged and elderly people. Japan's banking crisis has made it difficult for companies to get bank loans. The package includes $48 billion to combat this credit crunch, by extending the scope of loans and loan guarantees by government banks such as the Japan Development Bank.” But analysts are by no means confident that the package will prove sufficient.

In an article published October 27 John Pomfret of the Washington Post worries: “Can China hold out? Surrounded on all sides by economic crisis, China's government has shifted into economic overdrive—going on a risky multibillion dollar spending spree. In an effort to save jobs, it has loosened credit standards to pump funds into moribund state-owned industries. A growing China could help ease Asia out of its economic doldrums. But stagnation could force the devaluation of the yuan [to stimulate demand for Chinese exports which are beginning to lose foreign markets to South East Asian countries whose currencies have fallen], which could in turn trigger another round of competitive devaluations around Asia and deepen recession throughout the world.” Will depression in Russian, where GDP is now less than half of what it was in 1991, spread to Germany and Europe? Whether or not the new IMF rescue plan for Brazil—which is identical to its rescue plans for Thailand, Indonesia, and South Korea—succeeds in preventing devaluation and default, it will surely create a serious recession or worse. Will a Brazilian recession drag Argentina, Uruguay, and other South American economies down with it? Would adding a recession in Japan, China, or Brazil to the depressions already raging in the Asian tigers and Russia be a sufficient blow to U.S. exports to trigger a recession here? These are all worrisome possibilities of “aggregate demand contagion.”

But when analysts talk of “contagion” they usually mean a different kind of problem. Once investors take fright of one Asian tiger, or one emerging market, they may decide that all investments in third world economies, or emerging markets, are riskier than they had previously believed, and pull out of economies that are perfectly sound. To distinguish it from the contagion of falling aggregate demand we can call this “psychological contagion.” In case it were not already apparent, international investors are not omniscient. They make assessments based on partial information—not due to lack of transparency, but because guessing is the nature of investment.

In any case, they have no choice but to make assumptions and to generalize. But being somewhat self-aware, they constantly revise their expectations. So if their assessment that the Malaysian ringgit is sound was based, in part, on their assessment that the Thai bhat was sound, when they discover that the bhat was not, indeed, as sound as they had believed, they logically revise their estimate of the reliability of the ringgit. If international investors' estimate of the reliability of Russian government bonds proves wrong, why would they not downgrade their evaluation of government bonds in other emerging markets? Some talk as if downgrading estimates of Belarussian government bonds without looking any further into Belarus is illogical. But when you discover, to your surprise, that the Yeltsin government has defaulted on GKOs and announced a 90-day moratorium on Russia's foreign debt repayment, do you wait until the 90 days is up to discover that Russian banks are only able to pay $2 billion of the $6 billion due on forward currency contracts to foreign banks before pulling out of forward currency contracts on the Belarussian as well as the Russian ruble, and before getting out of Belarussian as well as Russian government bonds? What would be illogical would be not to downgrade estimates of Belarussian bonds and currency based on new Russian evidence until one had the time to do a new investigation of Belarus.

Some would have us believe that psychological contagion is a kind of illogical and primitive reaction, and as more intelligent and rational international investors out compete those who move with the herd, the problem of contagion will recede. Then sound Latin American currencies will not be unfairly punished by investor flight to hard currencies stimulated by depreciation of Asian currencies that truly were not sound. Then reliable governments in emerging markets will not be punished by investor flight to U.S. treasury bonds when an irresponsible Russian government defaults on its bonds. Unfortunately, contagion is quite logical, and there is no reason to expect that a more liberalized global credit system will prove less prone to mistaken generalizations because the problem goes much deeper. The problem is people are making important economic decisions with precious little information and knowledge. We have permitted the world to be turned into a place where a handful of people in a handful of cities—many less than ten years out of MBA programs, who are now managers of currency, bond, and securities departments of international banks, insurance companies, and investment funds, guided only by their aging mentors—are the ones who decide what will be produced, how it will be produced, and how it will be used everywhere on the planet. Worse still, they do not even make these decisions consciously, they make them as a by-product of their guesses about how profitable and risky different investment opportunities are in different world financial markets.

The heirs of Adam Smith try to lull us to sleep crooning: “Markets make the best decisions.” But no market has ever made a decision—for good or bad. Those with power to act in markets make more and more decisions when more and more decisions are relegated to the marketplace. One can criticize the lack of democracy when so few make the economic decisions that affect so many in today's world economy. One can criticize the inequities of how those decisions distribute the burdens and benefits of world economic activity. Since those making the decisions are at the very top of the world's pyramid of wealth, or are in their employ, there is every reason to worry about the implications for economic justice. I think we should all continue to criticize the functioning of the global marketplace as anti-democratic and inequitable. But when thinking about the global crisis it is not lack of democracy or equity that is the immediate issue. It is lack of competency. Psychological contagion is the consequence of the incompetency inherent in the new world economic system that the liberalizers and deregulators have given birth to.

Finally, besides aggregate demand contagion, and psychological contagion, there is contagion spreading from the financial sector to the real sector. This can happen in two ways. Since we have wedded investment and production to the credit system, a collapse of the credit system will lead to a collapse of investment and production. Since we have wedded consumption to income and wealth, a decrease in either will lead to a decrease in consumption, which could, in turn, lead to a fall in production. As we saw in Part I, the collapse of the credit system in Thailand, Malaysia, Indonesia, and South Korea has lead to steep drops in investment and production that have already erased most of whatever economic progress had been made in the previous 15 years. The effects of the collapse of the Russian credit system this past August on production are horrifying to contemplate, since Russian production had already declined to less than half of 1991 levels. And one has to pray that the IMF intervention in Brazil will work on its own terms, because a collapse of the Brazilian credit system would trigger a far worse crisis in Brazil than the recession that is certain to result from the austerity program the Brazilian government has agreed to.

Contagion can also spread from the financial sector to the real sector through the “wealth effect.” Syndicated columnist Robert Samuelson worries in an op-ed piece in the December 30 Washington Post that “at least two aspects of the boom cannot last forever. One is the huge surge in stock prices, which are up 28% in 1998, as measured by the Standard & Poor's Index of 500 stocks. This follows gains of 34% in 1995, 20 percent in 1996, and 31% in 1997. The second thing that cannot continue indefinitely is the national shopping spree. The consumer savings rate is usually 4% to 6% of disposable income; in 1998, it was almost zero. Ominously, these two trends are connected. Americans are spending so much in part because they feel so wealthy. Economist Bruce Steinberg of Merrill Lynch notes that higher stocks have ‘added roughly $8 trillion to household net worth during the past six years.' (Net worth is what people own minus what they owe.) In turn, strong consumer spending shields production and profits from the baleful effects of foreign recessions. This props up stock prices. So there's a mutually reinforcing confidence game. High stock prices boost consumer spending; and strong consumer spending boosts stocks. If either falters, the other may follow suit.”

There is no doubt the spectacular rise in the U.S. stock market has stimulated consumption demand in the U.S. in the past few years. If the U.S. stock market suffers a significant drop, the consumption of wealthy U.S. households would decline significantly as well. Since a drop in any part of aggregate demand can lead to further decreases in aggregate demand, this could trigger a recession, or aggravate recessionary dynamics that began elsewhere. And any number of things could burst the bubble on Wall Street. Price/earnings ratios are over 30 to 1—record levels that would usually portend a correction. According to First Call, an advisory service, in early 1998 stock analysts expected operating profits for the S&P 500 companies to rise 14 percent. They have only risen 2.6 percent.” As Mark Weisbrot explained in “Neoliberalism Comes Unglued” (September Z), the U.S. stock market is significantly overvalued and a hefty “correction” is likely at some point even if there are no “contagion” effects from other stock markets. But drops in other stock markets around the world could also spread to the U.S. stock market if investors conclude that stocks in general are not as safe a way to hold their wealth as they had previously believed. “Corrections” are by no means always marginal. The Japanese stock market in 1989 was almost three times its present level. In any case, a shift by U.S. wealth holders from stocks to bonds would lead to a large drop in the U.S. stock market and create powerful recessionary dynamics in the real economy in the U.S. I see no reason to disagree with Robert Samuelson's outlook for the U.S. economy in the coming year: “What now sustains confidence is confidence. The economy has done well; so people expect it to do well. Perhaps it will. Unemployment is low, inflation is trivial. People expect interest rates to drop further. But few of the threats of 1998 have vanished. Japan's economy is still shrinking; Latin American economies are still weakening; the U.S. trade deficit is still growing; global overcapacity in many industries is still expanding. These trends imperil jobs and profits: the props of confidence. The shopping spree could end; stocks could drop; a recession could ensue.”                           Z

Next month: who is proposing to do what and why.