World stock markets crashed to record lows today, setting off what economists are calling "the Millennium Depression." The meltdown was triggered by the collapse of the Brazilian, Argentine, Russian, Indonesian, Mexican and Czech stock markets.
These peripheral markets were dragged down after another devaluation by China made Chinese products so cheap that everyone else in Asia had to devalue again, and other emerging markets could no longer compete. In Tokyo, the entire senior staff of the ministry of finance was arrested and charged with incompetence. Their failure to stimulate growth, so Japan could absorb more of Asia's exports, resulted in all these goods flooding the United States instead, creating a record U.S. trade deficit and prompting Congress to pass the Smoot-Hawley-Gephardt Protectionist Act.Far-fetched, I know, particularly when Asian markets seem to be bouncing back. But be careful. In the next few months China, Japan and the United States, the three main engines of the global economy, will still need to make some extremely tough decisions. How well they do will determine whether the Asian flu is really over or becomes a ragin' contagion.
Let's start with China - a key factor in unintentionally triggering the Asian meltdown. China devalued its currency in 1993 and 1994. As a result, countries like Thailand, Korea and Indonesia, whose currencies were pegged around the rising dollar, became much less competitive. Any of their companies whose cost structure got out of line with that of China got hammered, making it hard for them to repay loans. Since the crash of the Asian currencies, the Thais, Koreans and Indonesians are again much more competitive with China. They are all hoping to export their way out of this crisis.
Memo to China: Your economy is slowing, the Shanghai real estate market is slumping, and overseas Chinese are not pouring money in as before. But don't devalue. Instead, cut your interest rates and speed up plans for major infrastructure projects. It will keep your economy growing, maybe with a bit of inflation, but it's better than undercutting your neighbors' chances for recovery.
As for Japan, it's the world's second-largest economy, but it is currently being run by Herbert Hoover Hashimoto. Japan has huge reserves it could use to absorb imports from the Asian tigers, all of whom are on export-or-die strategies. But Japan's brain-dead leadership has failed to stimulate the Japanese economy.
Memo to Japan: Cut taxes deeply, enough to really put some money in the pockets of your consumers. Get your Parliament to pass the proposed $225 billion package to clean up and restructure your banking system, which is like a walking skeleton spooking everyone in Asia, and open your markets more to Asian exports - now, not in 2005.
As for the United States, the president needs to use his soaring job approval rating to persuade Congress to make its promised $17.9 billion deposit to the IMF and to revive the fast-track free-trade legislation. This is no time for America to turn inward. Congress is right to be wary of IMF bailouts, but both J.P. Morgan and Deutsche Bank have just announced huge losses on their Asian loans, so the banks are taking a hit.
In the late 1920s, it was competitive devaluations among the producers of that early industrial era, and the protectionist responses to them, that made the Great Depression great. Today we are seeing the start of a similar cycle, leading already to a deterioration in the competitive situation of Latin America and Eastern Europe.
"If the U.S., Japan and China do the right thing now, this Asian deflation can be contained, Latin America and Eastern Europe won't be dragged into it and we can have lower global interest rates and higher growth," says Ken Courtis, an Asian economist for Deutsche Bank. "But if they do the wrong thing, there could be real trouble."