Why some want Fed to lower rates, now NTC


THE DOW Jones industrial average was probing new heights in the summer of 1929; Herbert Hoover had just moved into the White House; analysts were praising the economy. And George L. Harrison was worried.

"I am much concerned about the foreign situation," the governor of the New York Reserve Bank wrote to another central banker.

As well he might have been.

Commodity prices were falling around the world. A frenzy of international lending had yielded a glut of production and struggling borrowers.

Much of the debt was short-term, which raised odds of default and trauma. The world's monetary reserve of choice, gold, seemed scarce.

Currency imbalances rose, and capital sloshed across borders like bilge water on the Queen Mary.

One of the earliest problem spots was the Dutch East Indies, now known as Indonesia. Deteriorating prices for rubber, kapok and pepper in 1926 and 1927 kept Indies borrowers from repaying loans from banks in New York and London.

Australia suffered similar problems, and soon so did Latin America and and Canada.

Back in the United States, the stock market was ascending into no-man's land, showing a puzzling "asset inflation" even while prices for goods and staples froze or fell.

The Federal Reserve, the country's central bank, was smothering the money supply even though some economic specialists were starting to worry about events.

Can you name this tune?

Economic pundits have dined out for decades on penciling spooky parallels between current events and prologues to past disaster. The Depression of the 1930s, still echoing in national memory, is a frequent touchstone.

We haven't yet cloned the Depression and won't. History doesn't repeat itself; it just rhymes, Mark Twain said.

But, underneath the graph of current progress, faint tracings from 70 years ago are starting to glow with relevance.

"The deflationary forces that engulfed the world in 1929 and the 1930s actually started in the Dutch East Indies and Australia," says Lacy H. Hunt, economist and executive vice president at Hoisington Investment Management in Austin, Texas. "Then it actually spread to Latin America. Deflation hit there. Banking problems started developing out of Latin loans. It was these actions that preceded the deflation in the United States."

For a cheap scare, let's return to now.

Prices of commodities and goods are declining worldwide. A flood of international lending, much on short maturity, has fueled a production glut. Developing Asian nations are devaluing and defaulting, with the Indonesian rupiah, down 70 percent in six months, leading the way.

International growth in the world's preferred monetary asset, the U.S. dollar, has fallen to its lowest level since 1982. Currency rot is spreading from Asia to Latin America and Canada. Since February 1997, the Mexican peso has fallen 7 percent against the U.S. dollar; the Colombian peso, 19 percent; the Canadian dollar, 5 percent.

The U.S. stock market levitates, and so far global distress hasn't persuaded the Federal Reserve to juice the money supply and create dollars.

Nobody is saying another Depression is nigh.

Although some fear for stocks, many analysts believe that lower interest rates, lower commodities prices and ardent demand among U.S. consumers will keep powering the turbines of commerce. At the same time, modern leaders presumably have learned to shun the tariff battlements and monetary droughts that worsened the 1930s slump.

But analysts such as Hunt, learned in the ways of deflation and depression, are good and ready for the modern script to start deviating from the historical one. Despite the seeming strength of the U.S. economy and signs of inflation, they want the Fed to prime the money pump by lowering short-term interest rates. And they want it soon.

The lesson of the 1930s "is the Federal Reserve had to act not only in its own best interests but the interests of the rest of the world," Hunt says. "And that's one thing this Federal Reserve needs to understand."

It wasn't until 1932 that Fed Governor Harrison, prompted by "continued rapid deflation of bank credit" and "a seriously depressing influence on the whole business structure and price level," felt the need for serious liquidity, a $250 million purchase of government securities.

By then, unemployment was 24 percent. Prices had fallen by one-fifth. Commerce and morale had seized up. It was too late for monetary lubrication.

Pub Date: 3/02/98

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