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World: Analysis From Washington -- Financial Crisis Presages Unstable Future

  • Paul Goble

Washington, 15 December 1997 (RFE/RL) -- The global crisis of confidence in financial markets and the underlying national economies they reflect is likely to translate quickly into an equally widespread crisis in confidence in political institutions, both domestic and international.

And that political crisis could have profound consequences on the entire world even if, as most analysts so far argue, central banks and other key institutions have sufficient knowledge and resources to prevent the global crisis in financial markets from becoming a depression like the one that engulfed the world in the 1930s.

A product of globalization -- the increasing interdependence of national markets -- this crisis in financial markets is already beginning to have three severe economic consequences not only in the countries where the problems originated but on many other states as well.

First, and especially critical for the emerging markets of the post-communist world, this crisis in confidence is leading to capital flight from these riskier markets either to cover losses at home as in South Korea or to safe havens like the United States.

Such capital flight has already put enormous pressure on the Russian ruble and the currencies of other post-Soviet states. The defenses the governments there have employed -- using foreign hard currencies to back their own and raising interest rates -- are limiting the ability of these economies to turn themselves around and begin to grow.

And that has put additional pressure on international lenders such as the International Monetary Fund, the World Bank and Western countries at precisely a time when they are having to marshal their own resources to limit the confidence crisis by supporting countries like South Korea.

Second, the crisis in confidence is putting deflationary pressures on many commodities. While most post-communist states have had experience with the ruinous consequences of high inflation, they may face new problems if the deflationary trend that has already hit many sectors elsewhere begins to touch their economies.

Deflation -- falling prices -- happens when production outstrips demand over a large portion of the economy. At present, for example, there is excess capacity in the computer chip manufacturing sector, and that is sending prices down.

For most economies not dominated by computer chip manufacturing, that appears first as a benefit rather than a problem. It means that their consumers can buy more for less. But for those economies whose fate is linked to that sector, it can lead to a reduction in incomes, spending and the standard of living.

Countries with powerful central banks and a well-disciplined banking system can usually cope with this challenge at least in its initial stages. But countries lacking those features may slip either into spiraling depression or a new bout of inflation as they try to correct the problem.

And third, over time, the economies of the major Western countries will begin to suffer as well. At first, however, they will look to be beneficiaries of this crisis: capital flowing into them from abroad will lower interest rates, and lower prices abroad will actually increase their standards of living.

But quite quickly the benefits may quickly turn into something else. The declining cost of capital will lead businesses in these countries to build up, possibly exacerbating overcapacity in some industries. And the lower incomes in other countries will reduce the ability of these states to buy Western goods and services. So serious are these economic consequences of the current global crisis in confidence that few have looked beyond them to the political impact that such changes will inevitably entail.

First, in virtually all countries affected, ever more people are likely to lose confidence both in their own governments and in international financial system. After all, and especially in recent years, these institutions have promised that they had the ability to prevent such disasters.

Second, ever more politicians are likely to respond to these attitudes and adopt a protectionist, even isolationist approach to economic and political affairs. And that too will limit the ability of states to act either separately or together to limit the impact of the current crisis.

And third, in many countries, both political leaders and their constituencies are likely to become increasingly angry at those they see as having caused the crisis, those they see as having benefited from it, and most of all at those they believe are using the crisis to impose unwelcome ideas about economics and much else on others.

None of this presages a more stable future, even if the current crisis in confidence in the economic sphere is overcome as quickly as some world leaders have confidently prophesied.