The long, slow march to economic disaster

Few people took much notice when Thailand devalued the baht against the US dollar in July of last year. But it started a chain of events that embraced rioting Indonesians, tearful Japanese businessmen and panic-stricken traders, before culminating last week in a financial crisis that left no corner of the globe untouched
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YOU could hear the stock market news in Marcel Cassard's voice on Thursday. As hundreds of billions of pounds were wiped off the value of shares round the world, and as the City registered its worst two-day fall since the crash of 1987, the debonair Frenchman sounded numb.

Will Russia get its act together?

"Possibly," said Mr Cassard, a Russia expert in the City for Germany's giant Deutsche Bank. But he sounded neither convinced nor convincing.

Can Russia's chaos be contained?

"There is a global flight to safety by investors," Mr Cassard replied. "Banks are trimming their balance sheets. This could lead to a self-reinforcing downward spiral."

Is there a bottom to the spiral?

"There's no real rationale for what's going on. So no one can say where the bottom is."

Mr Cassard and others in the City caught in Thursday's panic prayed Friday would be better. It was, but not much.

Global stock markets fell for a third day running as investors piled into UK gilts and US Treasury bonds - the last bastion of those trying to conserve the value of their savings. By Friday evening the City men and women stumbling into the Bank tube station looked pale with exhaustion, an army in retreat. They will need the Bank Holiday weekend to recover some perspective.

There is no shortage of questions to mull over: Can Russia's acting prime minister Viktor Chernomyrdin make a government of national reconciliation work? Will Latin America go down the tubes as the domino effect in the world's "emerging markets" gathers pace? Will there be recession in the West? How ridiculously rosy is British government's forecast that our economy will expand by 2.3 per cent in 1999?

Summed up, there was one question: How bad is it?

The answer, according to a cross-section of City traders, investors and analysts, seems to be that it is very bad, but we are unlikely to see a total collapse of the stock market or massive unemployment and breadlines as in the1930s. Most likely to come, instead, is an acceleration and deepening of the social and economic trends already in place: Misery will spread in the underclass faster and wider. There will be faster casualties, and more of them, in the middle-class as the weakest lose their grip on any claim to economic security.

The entrenched privileged class will continue to be winners in the interlocking of the world economy known as globalisation, but the end of the great bull market of the 1990s will trigger spectacular bankruptcies at both an institutional and personal level. "Russia accounts for less than 0.8 per cent of the world economy, so it is ridiculous to think that Russia will drag down the West," said Trevor Greetham, an analyst at Merrill Lynch in London. "But," he continued, "Western economies have been slowing. People have been looking for an excuse to sell shares. Russia is that excuse."

The economic mechanisms transmuting poverty on Moscow's streets into growing numbers of street people in London and Birmingham, and increasing discomfort in the suburbs, are standard. Government tax receipts will decline as the economy slows. There will be less money for Tony Blair's Third Way. There will be fewer wage rises, less money in people's pockets.

Surliness will increase, and if it's directed at the managers of the world economy it will be well founded. The treasury officials, central bankers, and IMF officials who keep a watch on the international financial system have been caught off guard by the events of August. First came the 300-point drop in the Dow Jones Industrial Average, signalling that the mood of the world's biggest investors had darkened.

There was more news of political stalemate in Japan. Then came the big one: Russia's collapse, triggered by the unsustainable run on the central bank's dollar reserves, and the decision to default on $30bn of government treasury bonds.

In the silence created by world leaders and financial officials rushing to catch up with events, the people in the markets themselves have been left to explain what is going on. Traders, investors and analysts are agreed on the narrative line which can be traced back from Friday - and Page One headlines like "Panic grips glo bal markets" and "Shares plunge round the world" - to the start of the Asian financial crisis in Thailand 13 months ago.

IT WAS the almost comically obscure devaluation of the Thai baht against the US dollar that undermined the champions of the so-called Asian economic miracle. After years of speculative boom, Thailand was confronted with a choice - trim back its standard of living or go broke. Thailand's decision to reduce its standard of living, by making imported goods more expensive, let the cat out of the bag: Asia and its teeming billions with their rising incomes might not become an engine of growth in the world ec onomy after all, but instead become a deflationary drag on it. In response to the Thai devaluation, investors scoured the region for other weak spots in the Asian economy. Conservative pension funds bailed out. Hedge funds set up plays to profit by forcing currency devaluations. The Western capital that had fuelled the Asian boom evaporated. It returned home or reinvested in East Europe or Latin America. One Asian country after another was left unable to pay its dollar bills to foreign creditors. The IMF was left to pick up the pieces: $60bn in Korea, $40bn in Indonesia. Last October, as investors everywhere woke up to the lie at the heart of the Asian economic miracle, the Hang Seng index in Hong Kong went through the floor. On Wall Street, the Dow Jones Industrial Average dropped so violently in response that the New Y ork Stock Exchange had to be closed down for an afternoon. Over the following months the consensus view of what was happening in the world economy was amended. All right, Asia might be a basket case, not a miracle. But it was too small to undermine the rosy economic outlook in Europe and North America. In the first half of this year stock markets in the US and Europe resumed their seemingly inexorable climb. There was a lot of talk about something called the New Economic Paradigm. Internet technology, job insecurity and the anti-inflationary impact of the Asian crisis were all combining to boost productivity and underpin economic growth in the West, so the story went. Japan, the world's second largest economy, was a worry. The gradual disintegration of the rule by consensus - in effect since the Second World War - meant no one could do much effectively to get the country growing again. Washington put pressure on Tokyo to clear up its billions in dud bank loans and take stimulative action. But Japan responded with fudges. It was the relentless drift downward of the Nikkei 225 stock market index in Tokyo that first prompted economists to trim their forecasts for world economic growth in 1998. Still, the stock markets in New York and Europe's capitals went up. On 21 July, the Dow peaked at 9300. On the same day, however, the IMF announced it was making $22.6bn in new loans to Russia. Although few knew it at the time, the first whack of this mo ney was earmarked simply to keep the central bank from going broke. "The euphoria lasted for a day and a half," said Arnab Das, a Russia specialist at JP Morgan's City branch. Since then Russia has come apart at the seams, and so, in response, have the w orld's stock markets which will almost certainly continue to drop this week. The question is how far and for how long. Richard Worts, a portfolio manager at Global Asset Management in London, takes a relaxed view. He notes that Wall Street is only 12 per cent off its July peak. He believes it will drift down perhaps another 5 per cent. This, he says, is healthy, given the level of company profits expected in the coming year. But the events of August signal more than the end of the great bull market of the 1990s. This bull market has been fuelled by the US, which has been governe d by a president whose personal style has been to feed his appetites. In a strange way, this style has been translated into economic policy. The worldwide panic in stock markets ripped the camoflauge off the carefully crafted disguises of US economic policy. Robert Rubin, US Treasury secretary, and the Federal Reserve Bank chairman Alan Greenspan have been presiding over one of the great let- her-rip phases of American economic history. Call it neo-laissez-faire. Since the collapse of the Soviet Union in 1991, Washington's dream has been to export its style of market-oriented economics round the world. The Clinton administration comes close to endorsing an astonishingly simplistic credo: What's good for Wall Stre et is good for the world. Now this is all up in smoke. The apostles of neo-laissez faire have been discredited by the world market panic. But expect no apologies. Instead, anticipate calls for some sort of summit of Group of Seven leaders in the coming weeks. At the end of Septem ber the IMF and World Bank hold their joint annual meetings in Washington, and this may serve as a forum for a conference roughly equivalent to the Bretton Woods gathering in New Hampshire in 1944, during which Keynes put together the architecture for th e post-war global economy. What Washington has done is let the foundations of Keynes' Bretton Woods architecture rot. A bill to provide $18bn in new funds for the IMF has languished in Congress. President Clinton has had other priorities than to get it passed. "The IMF has been stripped," said Deutsche Bank's Mr Cassard, who worked in the US capital at the Fund before moving to London. "If there is a panic in Brazil, the IMF will need a $50bn package to restore calm, and the IMF does not have $50bn." This autumn the news will be dominated by efforts to reorganise the international economy and financial system. Meanwhile, there will be little joy in the markets or on the streets. Perhaps the best advice came from one of the exhausted bankers leaving f or home on Friday. "Better make the weekend a good one," he shouted.