Copyright © 1998 by James K. Galbraith. Readers may redistribute this article to other individuals for noncommercial use, provided that the text and this notice remain intact. This article may not be resold, reprinted, or redistributed for compensation of any kind without prior written permission from the author. If you have any questions about permissions, please contact The Electronic Policy Network at [EMAIL PROTECTED] The Butterfly Effect James K. Galbraith Small actions can have large consequences. The mathematics of chaos teaches that a butterfly, flapping its wings in Brazil, can set off a chain of events leading to a hurricane at Cape Fear. They call this the "butterfly effect." On March 24, 1997, the butterfly was named Alan Greenspan. That day, he flapped his wings just once, raising the interest rate by one-quarter of one percent point. Global currency instability started just about then. The Thai crisis hit three months later. After that, it wasn't just the Asian Rim currencies -- Korea, Malaysia, the Philippines and Indonesia -- that fell. So did the Yen. So did the Taiwan and Australian dollars. And so did an index representing the Euro. Indeed there was a worldwide devaluation, leaving only the British pound and the U.S. dollar flying high. Seen this way, the so-called "Asian crisis" was not restricted to Asia. Nor did the markets suddenly discover that particular countries suffered from inefficiency and corruption, the theme of President Clinton's speech in Hong Kong. Instead, Asian and non-Asian currencies have moved in striking parallel, often day by day. The differences were of degree: since March, 1997 the currencies of Europe, Japan, Australia and Taiwan have fallen about 20 percent; a cluster of the Philippines, Malaysia, Korea and Thailand fell 40 percent, and Indonesia fell 80 percent. What caused the differences? Roughly, currencies collapsed in proportion to their dependence on American capital. Those hit hardest were those that have relied most on our investments, that had the least resident wealth, that were most caught up in construction booms financed by short-term inflows. When U.S. interest rates started to rise, dollar-sensitive investors came home. The dollar went up, and its closest dependencies, like Suharto's rupiah, were the greatest victims. In short, this was a crisis of the American financial empire. It is also a crisis of the "Washington consensus," that doctrine of deregulation and open capital markets. Much nonsense has been written about the collapse of the Asian development model -- a collapse which has not taken down Taiwan, or China, two leading Asian success stories. But since this crisis was made in Washington, it cannot be ended in Seoul or Djakarta. Reforms of Asian domestic policies may be necessary. But they cannot cure a problem that was caused, most fundamentally, by our own policies that raised real and relative interest rates. Equally, the vast capital inflows into the United States in 1997 -- the portfolio investments that fueled the boom in the American stock market -- were kicked off by Greenspan's rate hike (and the expectation that more would follow). The consequences for the American productive economy are now surfacing in a vast increase in the U.S. trade deficit, as exports tumble and cheapened imports flood our markets, and as falling exports lead to slower economic growth and rising unemployment. These consequences will multiply if we fail to act quickly -- and correctly. Alan Greenspan seems aware of these dangers: he spoke of them vividly in an important speech six months ago. But there are some people, incredibly, who think U.S. interest rates should rise again. The Federal Reserve harbors a faction led by Jerry Jordan and William Poole, two refugees from monetarism who vote for higher interest rates at every meeting. (Jordan and Poole are veterans of Ronald Reagan's Council of Economic Advisers; their survival in power through the Fed's system of unaccountable appointments is the best argument yet for throwing the regional bank Presidents off the decision-making Open Market Committee.) And so the debate at the Federal Reserve's Open Market Committee is between those who say "raise rates" and those who say, "not yet." Greenspan and the "not yet" faction have held the line so far. But such a stalemate must always end, eventually, in a rate increase - never, until much too late, in a rate cut. Today, on the contrary, interest rates must come down. Indeed, interest rates should be cut sharply -- let's say two full percentage points -- to meet the global crisis. Further steps, of which the mildest would be a Tobin Tax on capital flows and speculative transactions, might help. The proposed multilateral agreement on investments (MAI) should be abandoned, and the U.S. should instead recognize the fundamental right of every state to control the immigration and emigration of capital. That loan to Japan was a good step; more may be needed later. Special measures for Russia are urgently needed, as that giant country, a security issue for the entire globe, continues its slide toward disaster. By stemming capital inflows, such actions might send stock prices downward at first; a boom based on capital inflows will not continue when they stop. But stock prices will recover if U.S. economic growth is sustained by an early recovery of the world economy, of other currencies and of our export markets. The alternative: more global instability and more of our own debt-driven bubble, followed by a prolonged collapse, could be -- chaos. James Galbraith is Professor at the LBJ School of Public Affairs, The University of Texas at Austin and author of Created Unequal: The Crisis in American Pay, to be published in August by the Free Press. He is also Senior Scholar, the Jerome Levy Economics Institute. This essay will appear in FOMC Alert. Copyright © 1998 by James K. Galbraith. Readers may redistribute this article to other individuals for noncommercial use, provided that the text and this notice remain intact. This article may not be resold, reprinted, or redistributed for compensation of any kind without prior written permission from the author. If you have any questions about permissions, please contact The Electronic Policy Network at [EMAIL PROTECTED] Regards, Tom Walker ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ #408 1035 Pacific St. Vancouver, B.C. V6E 4G7 [EMAIL PROTECTED] (604) 669-3286 ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ The TimeWork Web: http://www.vcn.bc.ca/timework/
