Leadership Is a Crucial Need of Shaken System

October 25, 1987|JAMES FLANIGAN

What's the story? Can the government calm the stock markets? Possibly it can, but it's far from a simple matter.

The markets last week seemed both reassured by President Reagan's pledge to discuss budget cutting with Congress and unimpressed with his confident assertions about the economy. Stocks bounced and plunged.

The President happens to be right about the economy, but he doesn't rule the financial markets. They, in a sense, rule him. How the markets view Reagan and others in the next weeks and months will be crucial to whether the U.S. economy falls into recession in the wake of last Monday's collapse of stock prices or gets by with a chastened but functioning prosperity.

The budget deficit that everybody talks about is not, in itself, the problem. At $150 billion, it is less than 2% of the developed world's combined output of goods and services, or gross national product.

But it has become a symbol of political will. Can the American government deal with the deficit firmly, accepting the restraints on its actions--and the reduction in the U.S. standard of living--that deficit elimination could bring?

No simple answer. Raising taxes would cut the deficit, but that's not like taking aspirin for a headache. If new taxes slowed the U.S. economy and caused it to take fewer imports from Japan and Europe before they got their economies growing enough to absorb more of their own goods, the world might quickly fall into the recession that already threatens it.

And yet the President and Congress must take some firm action to renew the confidence of international markets, which see the strains in world economies and suspect that leaner times are coming. That's a big reason stocks reeled last week.

Big Questions

Big questions. What strains? And who's behind these markets?

Strains first. The industrial countries are straining to keep prosperity going with a system that enjoys little new business from the eager but debt-ridden economies of the developing world. It's getting harder to achieve economic growth in an incomplete world economy.

Do we need growth? Weren't societies better off for thousands of years before the ordinary person heard of economics? No, they weren't. What they had they rationed out strictly, according to class and caste, and "the life of man," as the philosopher Thomas Hobbes put it, was "solitary, poor, nasty, brutish and short."

But the Industrial Revolution raised human productivity and allowed some countries to achieve a better life. Then billions of people in Asia, Latin America and Africa reached for that better life in the 1970s, but most fell short. And now the incomplete world economy is troubling international markets.

Those markets are not impersonal forces. They are a vast river of funds from Japanese savers, U.S. corporate treasuries, retirement accounts on every continent, invested everywhere. If you have a bank account, you are part of them.

But they are powerful forces. "With currency transactions of $300 billion a day," says investment banker John Wadsworth of Morgan Stanley, "world markets and not the Federal Reserve or Bank of Japan determine interest rates and currency values."

What's that got to do with the sinking stock market? Only this: The markets were in charge in 1929, too, and mistakes made after the stock market crash--and not the Crash itself--caused the Great Depression. The Federal Reserve at that time took what it thought was the rational action of holding back money supply to reduce credit to the stock market. But the lack of money helped tip the economy into a decade of misery.

Today, the Federal Reserve, pumping money into the economy to prevent bankruptcies, is not making that mistake. But it can't keep printing money without unduly cheapening the dollar.

So pretty clearly tighter credit is coming next year as steps are taken to rein in money, reduce the deficit and keep the economy growing.

But if the President, Congress, Fed, the whole bunch can perform that balancing act without scaring the markets, last week's collapse of stock prices will be remembered as a bad day on Wall Street but not the beginning of years of misery.

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