[PEN-L:1328] "Globalization is starting to work against us"

[Louis Proyect <lnp3@xxxxxxxxx>]

August 30, 1998

Russia's Crisis Reveals the Ugly Side of Globalization

By JOSEPH KAHN

>From the standpoint of the United States economy, Russia does not matter."

That was the line coming from American stock market optimists until late
last week. Their research reports and market comments painted a benign
picture of Russian turmoil, at least as it concerned Americans.

Of all U.S. exports, the reasoning went, less than 1 percent were to
Russia. The Russian economy was no larger than that of the Netherlands. Few
people invested their money there and those who did knew they faced high
risks.

Investors ignored that logic and panicked anyway.

Russia's financial and political crisis, however removed from the
day-to-day business of most U.S. companies and from the portfolios of most
investors, prompted the largest one-day selloff of stocks so far this year,
sending the Dow Jones industrial average down 357.36 points, or 4.19
percent, on Thursday. A further loss of 114.31 points in a volatile session
Friday left the Dow at 8,051.68, to close the week down 13.8 percent from
its peak in July. Most other stock markets also fell, and a flight of
capital to the safety of Treasury bonds drove the yield on the benchmark
30-year bond down to just 5.34 percent.

If the current correction in stock prices turns into a full-scale bear
market, meaning a retreat of more than 15 percent in the Dow, historians
will almost certainly see Russia as the trigger.

The reason, to use the buzzword of the mid-1990s, is globalization: the
ugly version.

The good version was peddled right up until the current crisis erupted. It
held that capitalism was spreading through the places where socialism once
reigned. Tapping new markets and billions of new consumers, multinationals
had already begun to earn big money abroad.

The ugly version is of more recent vintage. It goes like this: Currency
crises can zip from one changing economy to the next, spreading deflation
around the world and leaving recessions in their wake. No one, not the
United States or the International Monetary Fund, has the power, or perhaps
the will, to do much about it.

>From that perspective, Russia is the latest to succumb to a contagion that
first broke out in Thailand in July 1997 and shows no sign of slowing its
global march. South Korea has more economic heft. Thailand and Malaysia
have more foreign investment. But Russia was a vital experiment in
capitalism that until very recently was thought to be too important,
politically and militarily, to fail.

"Any one of these countries in isolation is not big potatoes in the world
economy," said Jeffrey Garten, dean of the Yale School of Management, "but
they tell a story about the downside of globalization."

When he served in the Commerce Department during the first Clinton
administration, Garten was a leading proponent of America's global push.
Today, he sees the dark side of the trend. "Nobody ever said that
globalization was just a great thing, that it only means economic progress
for everyone," he said.

Russia's fall makes clear that capitalism -- floating currencies, open
borders and free markets -- cannot exist without institutions to support
it, Garten said. The United States has a Federal Reserve Board to act as a
backstop in a bank crisis. The Securities and Exchange Commission serves as
a cop for the stock market. Bank deposits are federally insured. Global
capitalism has no such bulwarks.

"This is one reason we had a global depression in the 1930s," Garten said.
"No one took responsibility. We have been fooling ourselves that the IMF
would act as a lender of last resort. They have not. They failed, in Asia
and now in Russia."

Russia's decline also shows the power of global price trends. Some see
Russia as having aggravated an already troubling downward spiral of prices,
or deflation, that is sweeping the world through ever-cheaper manufactured
goods.

Prices for these goods began to tumble in Asia in the mid-1990s. Many
countries in that region now have full-scale deflation in consumer prices,
a phenomenon not seen on such a scale since the Depression. With the
devaluation of the ruble, prices of Russian exports like oil and metals,
which were already sagging, are likely to slump further.

Falling prices on a broad scale can be insidious because companies earn
steadily less for the products they make and because consumers tend to wait
before they buy. But while most economists recognize the evil of deflation,
little is being done to stop the spread, said Chen Zhao, a managing editor
of Bank Credit Analyst, a research and publishing concern in Montreal.

In fact, real interest rates, which take inflation into account, are at
record highs in many countries, as governments and central banks try to
defend their currencies against speculators. Shortly after Russia devalued
the ruble, for example, Canada and Mexico raised rates to defend their
currencies. High real rates slow economic growth and put fresh downward
pressure on prices.

"Russia is part of the deflation problem," Chen said. "We don't think there
are any major forces that can put a stop to it." He suggests that the U.S.
Federal Reserve should lower interest rates to reduce the relative appeal
of the dollar. But he sees few signs that the Fed is prepared to do so
unless domestic economic fundamentals take a turn for the worse. "The U.S.
does not comprehend the risk," he said.

 So far, Russia's internal problems have had only a marginal effect on
earnings of companies in the United States. Republic New York, BankAmerica
and Lehman Brothers are three financial institutions that have already
acknowledged some Russia-related losses. Several high-risk hedge funds took
serious hits and others may follow. Steel companies, paper producers,
chemical producers and others dependent on commodity prices are also made
vulnerable by Russian deflation.

But if the direct losses are relatively minor, the indirect cost, including
the toll on investor psychology, is immeasurably large. Investors have
already begun to treat "global" as a bad word.

Until recently, many of the largest companies in the Standard & Poor's
500-stock index advertised their world ties, and it was not just hype. Over
the last decade, the foreign share of sales of S&P 500 companies have risen
to 34 percent from 25 percent.

Of Exxon's total sales, 88 percent are foreign, according to IBES
International; Coca-Cola sells two-thirds of its soft drinks abroad.
Motorola is 60 percent foreign. Intel and Dow Chemical both sell more than
half of their goods overseas. Because of the turmoil in emerging markets
and the strong dollar, which reduces the dollar value of foreign sales,
IBES now projects that all of those companies' earnings will fall this
year. Merrill Lynch downgraded Coca-Cola shares last week, citing
emerging-markets woes.

After faring relatively well in the summer selloff, shares of large,
internationally oriented companies are getting slaughtered. "Globalization
is starting to work against us," said Byron Wien, chief U.S. investment
strategist at Morgan Stanley Dean Witter. "The international luster is
tarnished."

James Grant, editor of Grant's Interest Rate Observer and a longtime bear,
said Russia's woes and the poor short-term outlook for the global economy
left Wall Street bulls with little ground to stand on.

"Globalization means the knee bone is connected to the thigh bone," Grant
said. "When there were these great developments abroad, it was a whole new
world of opportunity. It could explain some extraordinary valuations of
stocks. Then when it's not working, Wall Street decides that the rest of
the world doesn't count for much."

The idea that the U.S. market alone can justify stock prices that were once
predicated on world expansion is an exercise in wishful thinking, Grant
said. "You could call it rank cynicism or hopeless optimism," he added. "I
don't think anyone will believe it."

Copyright 1998 The New York Times Company


Louis Proyect
(http://www.panix.com/~lnp3/marxism.html)