Hurricane warning that Germany should heed

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The Independent Online
Hurricane Andrew is a good symbol for what is happening to the world economy. Much reporting of the economic crisis has naturally concentrated on the local damage: for instance, the Sunday Times yesterday listed 50 British businessmen who between them have lost pounds 2.4bn since 1989. That is very damaging to them, but it is rather like listing 50 families in Florida which have seen the roofs blow off their houses. The important thing is the power of the hurricane itself, not just the local effects.

This is the greatest world economic crisis since the Thirties. It is now wholly out of the Government's control; some countries, including our own, have adopted policies that actually make things worse, but none can control events or assure its people a stable and prosperous economic future. We have so far seen economic damage in almost all countries, and political damage in the former Communist countries of eastern Europe.

As the pressures become worse in Europe and North America, we can expect to see political changes, with public support flowing towards politicians who promise to protect national interests and take action to restore better economic conditions. Inaction is death, as John Smith will find. The first beneficiary of this mood could well be Bill Clinton, who seems increasingly likely to be elected President of the United States in November.

Britain has already been hit hard, but we are only on the edge of the storm; whatever we do will make little difference to its severity in the rest of the world. Our Maastricht and exchange rate mechanism policies, which have caused penally high interest rates and the absurd dollars 2: pounds 1 exchange rate, seem likely to be tested to destruction in terms of public support and the exchange markets.

Between 1979 and 1986, British unemployment rose for seven successive years, and was three times as high at the end as it had been at the beginning. The squeeze on business this time is much more acute than in the early Eighties. A similar pattern would result in unemployment peaking at 4.5 million in 1997. UBS Phillips and Drew is forecasting an earlier peak of just under four million in 1994, and even that assumes a 10 per cent devaluation.

So our purely British crisis is acute, and the main parties will have difficulty in sticking by their policies. John Major and John Smith are already threatened with loss of support inside their own parties; there is a possibility that neither will lead his party into the next election, and a remoter possibility that the economic crisis - as in 1931 - will produce a coalition. A reduction in inflation by no means guarantees recovery; falling retail price inflation has unfortunately been accompanied by a virtual collapse in many asset values. The meeting of European Finance Ministers at Bath has shown that they, and indeed their governments, do not know what to do. Eleven of the 12 pressed the Germans for lower interest rates in the ERM. The Germans refused, though they admit to similar pressures inside Germany. The fact that 11 of the 12 cannot get the lower interest rates they want proves how badly the ERM is working.

Germany's own economic position is now deteriorating rapidly; the highest unemployment in the European Community is in what was East Germany. The Rostock and other riots should be regarded as protests against non-German workers rather than symptoms of neo-Nazism. If you have high enough unemployment, some people will become extremists.

Western Germany's economy in recent months has fallen sharply from boom to recession. In export markets, German costs are not competitive with those of the US or Japan. The mark is almost as over-valued as the pound; that has made the whole of Europe, and Germany in particular, a very high-cost producer. So long as this false dollar-mark rate continues, German and European unemployment can only rise. Indeed, we can talk of a separate German econonic crisis.

Italy is the weakest major economy in Europe. Last week the Italians raised their base rate to 15 per cent, thereby dramatically increasing their budget deficit. The convergence programme agreed at Maastricht - if it were believable - might have provided a faintly plausible route out of Italy's intolerable financial situation. A large devaluation of the lira is clearly necessary, but that will put renewed - and entirely rational - pressure on the overvalued pound.

The French economy is also weak but, of the larger European economies, it is probably in the least critical state. Opinion polls now suggest that the French referendum may narrowly support the Maastricht Treaty. That would resolve nothing; it might postpone the ERM crisis, but not necessarily for long. Maastricht may be ratified in every country except Denmark, though British ratification without a referendum is still uncertain. In any case, the Maastricht convergence proposals are wholly unattainable, and a single currency is almost impossible to achieve. With the European economy in its present or likely future states, Germany will not destroy the mark; nor should we ask it to do so.

The best Europe can hope for is that the Bundesbank will take fright at the decline of the German economy and start to reduce interest rates. A thorough-going German panic is what Europe needs. When that happens, European bond markets will make a strong recovery, and that will help to stabilise confidence. Even then, however, it will take the better part of two years before unemployment stops rising; even a rapid reduction of German interest rates would not bring significant recovery before the second half of 1994.

The US has avoided some of the damage because the Federal Reserve has made 24 successive cuts in interest rates. But even these have not produced the recovery expected. (August unemployment figures are up 84,000 when they were expected to fall.)

Japan, the world's strongest economy, has a balance of trade surplus running at about dollars 10bn a month, which shows how much world trade is out of balance. It can well afford its new reflationary policy, but the crash of its asset values has weakened its banking system, and the country faces low growth.

A world economic crisis is a type of world revolution. It destroys old structures, economic and political. The Soviet Union, with its rigid inability to adapt, was the first to fall before the full force of the storm. But while the crisis clears the ground for new businesses, new governments and new regimes, it leaves behind a new class of dispossessed - those who have lost their assets, their jobs or their homes - and that class is always dangerous.

Such a crisis speeds up transfers of economic power between individuals and states, as it is now speeding up the transfer of advantage from the US to Japan. It destroys well-meaning politicians and promotes men of power. It makes nations fearful, selfish and protectionist.

It causes terrible human suffering, which is already happening. It destroys respect for government, as people discover that their leaders cannot control such events. It would have made little difference to the outcome at Bath if the European nations had been represented not by their finance ministers but by their football managers. Even the new sceptical attitude to the British monarchy owes something to the world's mood of disillusion.

In the end, the crisis will blow itself out and we will be reporting a tropical storm. But at present it still seems to be approaching a climax.