Now's the time to prepare for economic catastrophes

Published March 23, 2007

Now's the time to prepare for economic catastrophes

By PAUL SAMUELSON


SPRING 2007 is a time of considerable economic uncertainty. Quite by surprise, talk in China of new taxing and restraints on credit sent its stock prices falling 9 per cent in one day. In today's wired-together global system, Asian markets everywhere followed China's downward lead with the speed of light. When dawn came to Europe and America, markets there joined in the sell-off.

At the same time that China pulled the plug on its markets, the US housing bubble burst. This curtailed building jobs and revenues. Sub-prime lenders to credit-unworthy homeowners began to go bankrupt in droves.

It did not help that simultaneously, Alan Greenspan, the respected retiree from the US Federal Reserve Board, warned a European audience publicly that America's boom 2003-2007 was becoming old. He even used the 'R' word - a 'possible' 2007 recession just ahead! Ben Bernanke, the Federal Reserve's new chieftain, rushed to reassure one and all that a soft landing for the global economy was still the most likely future. That did reassure some. But Mr Bernanke refused to say the words that Wall Street wants to hear, 'soon, the Fed will be lowering its interest rate', and traders can then earn new capital gains.

Economic history teaches us that inevitably, catastrophes will strike. As an example, a huge asteroid once hit the earth unexpectedly; that killed off all the dinosaurs.

New Orleans on the Louisiana Gulf coast, being below sea level and lacking the kind of proper sea dykes that the Netherlands has, was always in danger of the kind of hurricane that Katrina finally brought in 2005.

No scientist doubts that, at some unknowable future date, much of California will be devastated by a super earthquake.

Normal, rational people have to carry on with ordinary life without losing sleep over future dire contingencies. But, if we are rational, we do our best in the here and now to map out in advance how to ameliorate the evils that will surely come.

Let me stick to economics. In October 1929, the stock market crashed. Non-economists think that the great world depression of 1929-1939 was the inevitable consequence. Not so. If then-president Herbert Hoover and then-secretary of the US Treasury Andrew Mellon, and Montague Norman at the Bank of England, had known then what experts everywhere do know now, there could have been only a minor 1930-31 recession.

And in such a case, Adolph Hitler's 1939 war of revenge need never have occurred.

We cannot rerun economic history. But we can learn something from it. Here are a few useful considerations:

1. Ben Bernanke in Washington, Alwyn King at the Bank of England and Jean-Claude Trichet at the European Central Bank in Frankfurt have the knowledge, the powers and the will to act stridently against strong deflationary forces, if such were to develop in 2007-2008.

2. Mr Greenspan's 'possibility' of an impending recession translates into 'at most a one-third probability of a minor recession'. Two-thirds is twice one-third, and that backs the best guess about a modest slowdown ahead.

As a realist, I see in my crystal ball some extreme global economic trials. Here is a thumbnail sketch of them:

A. China's GDP now outpaces Japan's and is second only to that of the US. If it continues to enjoy 9 or 10 per cent annual real growth, then at some nearby date China's total GDP will equal the US. Combining India's billion-plus people with China's, their sum will soon equal America's.

B. The hedge fund craze is spreading to all the global markets. These escape regulation. In normal times, hedge funds may help to spread and reduce risks. Nonetheless, in the eye of the future storm, I fear that hedge funds everywhere will pile on to - and exacerbate - a future disorderly massive run away from the American dollar. Could that occur without a major global crisis? By then, President George W Bush will be on his Texas ranch. But the Middle East will still be in chaos and civil war.

Alas, we reap what we sow. America's perverse post-2000 fiscal follies, combined with our electorate's thriftlessness on Main Street, will test the fragility of our new worldwide financial system.

In today's geographically mobile world, rational regulation of corporate governance misbehaviour seems to be almost impossible. If you forbid Enron and WorldCom shenanigans, you move finance activities out of America and out of London and out of Brussels to tax and regulation havens in the Bahamas or the Channel Islands.

Those places are like America's legendary Wild West: an ethical race to the bottom, where the fastest gunslinger grabs whatever is left.

More than the wisdom of King Solomon will be needed to find the elusive feasible golden mean between freedom and regulation. - Tribune Media Services

Paul A Samuelson is considered one of the founders of modern neoclassical economics and was awarded the Nobel Prize for Economics in 1970