Copyright 2001 The New York Times Company
January 7, 2001

Slowdown at Home Spells Risks Abroad for Bush

By DAVID E. SANGER

WASHINGTON, Jan. 6 ó The last time the Federal Reserve was forced to cut interest rates in a hurry ó in October 1998 ó it was to protect the United States from a fast-spreading currency crisis in Russia, after more than a year of economic turmoil in Asia. It was called the "contagion effect," and the strategy was to stop it before it infected a booming American economy that had become the predominant force for growth around the world.

Little more than two years later there is now fear of a different kind of contagion effect, this one radiating from the United States. The sharp slowdown here alarmed the Fed so much that it took the highly unusual step on Wednesday of acting between scheduled meetings, slashing short-term interest rates by a half a percentage point.

And what is already clear is that the faltering American economy is not just a domestic problem for the Fed chairman, Alan Greenspan, and for President-elect George W. Bush when he takes over the White House in two weeks. In the last few days it has also become evident that it could rank among Mr. Bush's early international troubles, along with the violence and fragile negotiations in the Middle East, a difficult relationship with Russia, collapsing sanctions on Iraq and lingering questions about the nature of Washington's engagement with China.

For nearly seven years, the United States has so dominated the world economy that other nations have come to depend, more than ever, on constantly rising demand from the United States for products of all kinds. America's role as the main engine of global growth has been all the more vital because the world's second-largest economy, Japan, has been stagnant for nearly a decade ó and now appears headed into yet another recession.

Suddenly, officials around the world are afraid that as America's engine sputters, they could become the first to suffer. "There is no safety net," one senior Japanese official said Friday from Tokyo. During the Asian crisis, he noted, it was the United States that sucked in manufactured goods from around the world, helping stabilize the world economy.

That is unlikely in 2001, and Mr. Bush may discover, as Mr. Clinton did time and again ó from Mexico City and Jakarta to Tokyo and Moscow ó that as financial troubles spin around the world, diplomatic troubles follow.

Mr. Greenspan, by all accounts, was far more worried about problems at home than problems elsewhere when he sprang his interest rate cut on the world's markets. But he was a central player in each of the global financial crises of the last decade, and understands better than most in Washington how a more tightly linked world economy means that problems resound more quickly than ever.

Here in Washington, though, there are questions about whether Mr. Bush's team, still trying to get organized, is ready for the kind of side-effects the American slowdown could generate around the globe. Mr. Bush's foreign policy advisers are experienced in handling Russia and defiant states like Iraq, but many of the new challenges of managing financial instability that leaps national boundaries came largely after most of them left when Mr. Bush's father lost the White House in 1992.

The Treasury Secretary-designate, Paul H. O'Neill, formerly served as chief executive of Alcoa, the huge aluminum manufacturer, and knows both the world and Mr. Greenspan very well. (Mr. Greenspan, once a member of the Alcoa board, recruited Mr. O'Neill for his corporate job.) But Mr. O'Neill has never managed the kind of rolling financial turmoil that has beset various parts of the world off and on since the most recent Mexican currency crisis began in 1995.

And, like Colin L. Powell at the State Department and Donald H. Rumsfeld at the Pentagon, Mr. O'Neill is still scouting for his deputies, who will have the day-to-day responsibility for managing the slowdown at home, and containing its effects abroad.

"The highest priority is to get your team together in the Treasury, and that may be more important in the globalized world than putting together the traditional teams in State and Defense," said Jeffrey R. Shafer, the vice chairman of Salomon Smith Barney International and a former undersecretary of Treasury for international affairs in the Clinton administration. "The crises that hurt the most are the ones you don't see coming."

During his campaign, Mr. Bush repeatedly expressed doubts about using the International Monetary Fund to bail countries out of trouble, saying it created a "moral hazard" by sending a signal to investors that Washington would help them out of trouble. But it is unclear whether his view might change if declines elsewhere in the world worsen America's own financial picture by cutting into American exports ó one of the keys to growth in the United States.

"This is a case," said one former senior member of Mr. Clinton's economic team, "where something that sounds pretty simple on the campaign trail can look a lot more complex once you get into the Oval Office."

In interviews with finance ministers, business executives and analysts around the world late this week ó all conducted after the Fed's interest rate cut sent a message that the American economy was deteriorating much faster than anticipated a few months ago ó it became clear that the wrench thrown into the gears of the world's dominant economy is sending sparks flying everywhere.

Most countries are not yet feeling the effects. But with the International Monetary Fund declaring on Thursday that it would dramatically revise the optimistic projections for world economic growth that it published just a month ago, few doubt that they are in for a rough year ó perhaps rougher than the United States' own.

The United States absorbs about 20 percent of all of Asia's exports, and its insatiable demand for more was the key to the quick recovery in Southeast Asia and South Korea.

"Telecommunications equipment, semiconductors, computers and peripherals are all things that the U.S. and the rest of the world couldn't get enough of in the past few years," said David G. Fernandez, an economist at J. P. Morgan in Singapore. "The same factors that allowed them to have the V-shaped recovery" ó one where the plunge down is followed by a sharp bounce up ó "have turned fully against them."

Government officials around Asia say that they doubt America's problems will plunge them into the kind of crisis that struck in the summer of 1997. That was when many of them discovered that linking their own currencies to the fast-rising dollar meant they could neither sell their goods nor repay enormous loans from Western banks and investors.

Chatumongkol Sonakul, governor of the Bank of Thailand, where the Asian crisis began, insisted this week that his country was no longer as vulnerable as it once was.

"We're not too worried like last time when we were really unstable," he said in an interview. Thailand's foreign debt has fallen dramatically, he said. "We're still overborrowed. But these are reasonable numbers coming from where we were."

Masahiro Kawai, the World Bank's chief economist for East Asia and the Pacific, noted that many of the countries that were in such dire straits two years ago have in the meantime accumulated "large foreign exchange reserves" that should help see them through a brief downturn.

But a lengthy recession could well trigger new resentments against Washington. When Thailand hit turbulent times, there was a sharp adverse reaction against the United States ó which did not immediately come to the country's aid. Indonesia is already in the throes of an anti-American mood ó sparked in part by Islamic fundamentalists ó and across Asia a prolonged slowdown now could rekindle suspicions that the United States turns the trade spigot on and off for its own advantage.

The effects may also be felt acutely in Mexico, which sends more than 80 percent of its exports to the United States ó accounting for 21 percent of Mexico's gross domestic product. Goldman, Sachs is already predicting a sharp economic slowdown in Mexico this year. That could greatly complicate the task of the country's new president, Vicente Fox Quesada, the world leader Mr. Bush talks about most frequently.

There are other, more complex, troubles anticipated in Latin America. The same oil price increases that have vexed American consumers have helped bolster Russia, Mexico, Venezuela, Colombia and Ecuador. Now the slowing American economy seems likely to reduce oil demand, and with it prices. Consumers here will be relieved; much of Latin America may be back in trouble.

Similarly, there is a fear that investors, pulling back from risk around the world, will make it far harder for developing nations to borrow. "We think that because of this uncertain investment environment, more liquidity will not go to Latin America," said Paulo Leme, who studies emerging markets for Goldman, Sachs. The stakes are particularly high for Argentina, which needs $21.8 billion in loans this year and is already on the I.M.F.'s list of potential trouble spots.

Europe seems less vulnerable. It is less dependent on the rest of the world, and its new currency, the euro, has recovered somewhat in recent weeks as America has weakened. But because the Europeans are hardly major importers of goods from America or the developing world, they are not a solution to problems emanating from the United States.

Perhaps the biggest risks ó and the most immediate diplomatic challenge for Mr. Bush ó involve Japan. Three times in the last decade Japanese officials have declared that their long economic decline was over, and three times they have been wrong. What little growth the country is experiencing comes in large part from massive deficit spending by the government, some of it urged on by American officials, which has created an unsustainable national debt.

Just before the presidential election, Lawrence B. Lindsey, Mr. Bush's chief economic adviser, gave a speech in Washington sharply critical of how the Clinton administration has dealt with Japan. He argued that it was time to lecture the Japanese far less about how to reform their economy and spend more time working to introduce competition. Suggestions, he said, should be offered in private ó and more modestly.

But if the American economy declines, pressure will almost certainly build in Washington to get Japan jump-started, in hopes that it can buy more American goods and help the United States out of its problems ó just as the United States, in recent years, has aided Japan.

"Japan is probably the most fragile country in Asia right now, and the one where a recession could create the most problems elsewhere," Daniel Tarullo, a professor at Georgetown University and previously one of Mr. Clinton's top international economic advisers, said Friday. "It has to be the No. 1 worry."

The Japanese, however, are hardly in a mood right now to think about boosting their imports of American goods. In fact, they need to export to the United States more than ever to compensate for the refusal of their own consumers to buy much.

A quick decline by the United States "will be a double whammy for Japan," said Kazuo Mizuno, senior economist for Kokusai Securities in Tokyo. And a double whammy for the world's two largest economies could easily be a double whammy for the new administration.