I believe the breaks of the last few days have driven stocks down to hard rock. I believe that we will have a ragged market for a few weeks and then the beginning of a mild bull movement that will gain momentum next year." - Irving Fisher, October 22, 1929
G7 central banks have learned from the past -- they know that they need to flood capital markets with liquidity at a time of crisis as the Fed did in October 1987 and October 1998. It has been argued , however, that Greenspan's sensitivity to the moral hazard argument surrounding his '98 rescue of LTC may have implications for the next big correction. But even if a deflationary wave like the one that has engulfed Japan is kept in abeyance by the G6 (G7-minus Japan), continuation of US household bankruptcies from the rise in US household debt may be paticularly acute if the US stock market enters into a major contraction.
During this "deflationary wave," central banks of the major world economies have successfully engineered disinflation and, for US Producer Prices, the sharpness of the disinflation following the Asian crisis (summer 1997) borders on deflation. Monetary policy of the major central banks and the IMF has not been neutral -- short term interest rates have been held up in an continuing effort to regain credibility from the inflation of the 1970s. Market rates have led interbank rates (over which monetary authorities exercise the greatest control) down as inflation subsided. In the U.S. this otherwise consistently tight policy has been relaxed several times, e.g., in the summer of 1982 in response to the Mexican debt crisis, in 1985-86 when financial intermediaries were in trouble, in 1991-92 before the presidential election, and in the fall of 1998 in response to the Russian default and LTC bankruptcy.
The reason for calling this a "deflationary wave" comes from the parallels with gold-standard deflations following World War I, the Civil War in the U.S. and the Franco-Prussian war in Europe. The current period was, as William Greider (Secrets of the Temple) argues, initiated with the October revolution in monetary policy under Paul Volcker. Within the next year commodity futures and fed-funds peaked.
Although the post-80 period is characterized as a period of disinflation, the fact that most prices have been rising rather than falling has led most observers to not recognize parallels between the post 1980 period and the post-war periods when the gold standard reigned supreme. One group of observers who have consistently emphasized the parallels between the late 20th century and the post-war long deflations of earlier periods are students of longwaves or Kondratieff waves. A primary difference between my work and the studies found in the longwave/Kondratieff literature is that I relate the timing of the down waves to post-war monetary policy. Although some writers have given a monetary interpretation of longwaves (see K. Barr, "Long Waves: A Selective Annotated Bibliography," Review, Spring, 1979), nonmonetary interpretations dominate longwave literature. The interpretation here is monetary.
In response to the influential work by Milton Friedman and Anna Schwartz, The Great Contraction, Peter Temin raised the important question, Did Monetary Forces Cause the Great Depression? If expected return on corporate earnings (that depend on continued financing) is stable relative to the swings in monetary policy, we usually think of the ensuing episodes of inflation or deflation as being largely a monetary phenomena. If monetary authorities are trying to pursue a neutral policy -- if they are trying to avoid inserting either inflationary or deflationary pressure into the system -- that proves to be especially difficult if the target is moving. It is my contention that the massive P/E ratios in the technology sector are becoming increasingly divorced from real productivity gains from the tecommunications. Intel's CEO, Andrew Grove, has repeatedly predicted a forthcoming "dislocation" of labor as new forms of commerce displace traditional labor. But the Federal Reserve, focusing on a transitional tight labor market, is pursuing tighter monetary policy -- a continuation of the tight policy begun by Volcker in the early 'eighties.
A critical player in world monetary policy is, of course, the IMF. The head of research at the Fund, Michael Mussa, has argued the Fund can not be faulted for anything like global recession since the Fund's demands for tight policies for the debtor countries under its economic reform program only constitute a small fraction of world gdp. The Fund largely supports more expansionary policy among the creditor countries that constitute the bulk of world output. But at issue is what constitutes "expansionary" monetary policy. Extensive conversation has taken place in the UK around the issue of whether the Bank of England is following a neutral or a tighter-than-neutral policy, and that same conversation could just as well take place regarding the Federal Reserve.
The bleeding edge of the post-1980 deflationary wave are the debtor countries under IMF austerity programs plus China and Japan. Critiques of the IMF are found on the Roubini site. One of the few Critiques that question the wisdom of tight macro policies is by Paul Krugman . If, as I think, the IMF austerity programs are similar in consequence to the tight monetary conditions imposed by the gold standard in earlier deflationary periods, the world will not come out of this deflation until the emerging economies throw off the yoke of IMF conditions. This could come about as result of the torrent of
| criticisms facing the IMF
a major correction in the US stock market leading to a decline in exports of developing/emerging economies and a wave of defaults . |
The waves of defaults that accompanied the late 19th century and the post-WWI deflations may have now started for the post-1980 wave with Russia in 1998. The international debt crisis of the 1980s served as a warning of the interaction of the forces of debt accumulation and tight money but policy makers, with inadequate measures of sustainable debt levels, continued to foster yet more lending to emerging economies. Although hundreds of journalist accounts of the Asian contagion are replete with stories of the difficulties of servicing emerging economy debt, the IMF has refused to recognize "overindebtedness" as an important emerging economy problem. Just as the early thirties was characterized by a wave of moratoriums and defaults, this is, I argue, a chief prospect of the future.
The IMF adjustment programs call for privatization of state owned industries but the exchange of debt for equity that privatizations yield are inadequate for genuine solution of the international debt problem. The largest privatization in Latin American history, the $19bil sale of Telebras, in July 1998 was only about 6% of Brazil's external debt. But privatizations, debt for equity swaps, were not intended to solve an "overindebtedness problem" since overindebtedness has never been recognized as a problem by the G7 or within the Washington consensus.
In Gold, Debt and the Great Depression, Lance Girton and I stressed the difference between the vulnerability of the (post WWI, gold-exchange standard) system to shocks and the particular events/shocks that led to the Great Depression. The timing of the shocks is more difficult to explain than the forces leading to the vulnerability of the system. There were scholars, such as Kondratieff and Warren and Pearson, who, in the 1920s, predicted deflation without being able to pinpoint the exact timing.
Following the Russian devaluation and default in August 1998, attention was shifted to Brazil. The market capitalization of large international banks with significant exposures in Latin American dropped in half during August and September 1998. Brazil was seen as the lynchpin for the rest of Latin America and by mid November, a $42bil loan agreement was completed. Large new loans can not be justified if original debt levels are already seen as excessive. The Latin American debt crises of the 'eighties was seen as resolved following the implementation of the Brady plan in the early 'nineties. But what in fact got resolved was the capitalization of Northern banks -- once Northern financial institutions had recapitalized the media ceased talking about the international debt problem as if demands on debtor countries had also been resolved. The accumulation of debt which had been so rapid in the 'eighties, tapered off in the early 'nineties and was then resumed in the mid-nineties.
Curiously enough western economists were more prone to talk about the "international debt crisis" in the 'eighties than in the late 'nineties despite the greater severity of the problem today. There is, I contend, a striking difference between the hundreds of news articles, the typical stories pouring out of the pressrooms and widely available on the internet, and standard mainstream macroeconomic stories that abound in the intellectual circles of the "Washington Consensus" -- the IMF and US Treasury -- a consensus which is now being attacked by traditional supporters.
