Fed Urged to Ease Interest Rates to Cure World Overproduction, Deflationary Ills
Matthews, Gordon, American Banker
With stock prices suddenly in reverse on gloomy reports from abroad, many investors are asking: How did the global economy get into such a jam? More importantly, what can be done?
Simply put, post-Cold War exuberance and other global developments sparked an explosion of investment in underdeveloped countries-which were popularly designated "emerging markets."
Most such nations pegged their currencies to the dollar but also made them convertible in accordance with free market convention. Capital flows and international trade were expedited, but overproduction and the threat of deflation resulted.
Meanwhile, by adopting a "dollar standard" these countries effectively tethered themselves to policies of the Federal Reserve-which concerns itself foremost with business and economic conditions in the United States.
"What the world built in the 1990s was an 'exchange rate condominium' with open capital accounts, linked to the dollar, but without the custodian of the dollar, the Fed, committed to fighting deflation in the dollar price of globally traded commodities and manufactured goods," said economist Paul A. McCulley of Warburg Dillon Read.
"The underlying cause" of today's turmoil "is that the world created too much excess capacity on too many borrowed funds," said economist Lacy Hunt, a partner in Hoisington Investment Management Co., Austin, Tex. "There is now a great glut in the world's ability to produce goods."
"The capacity is so great that a price war is undermining the ability of those who built the capacity to service their debt," he said, "and that is beginning to adversely affect the world's banking system."
Deflationary price trends are even growing in the United States. Friday, the Labor Department reported that the producer price index, an indicator of future inflation or deflation, fell 0.4% and was down 0.8% from a year earlier. "Inflation is dead, and deflationary pressures intensify," said economist Cheryl R. Katz of Merrill Lynch & Co.
What can be done? Several economists said the Fed should start cutting rates soon, and at the same time, they said, new means of dealing with global financial problems need to be devised.
Mr. McCulley said the Fed should "go global," publicly committing itself to ease rates enough to stop and partly reverse the deflation in globally traded commodities and goods prices. …