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Spotlight: Almanac of American Politics

Economist Magazine Takes Dim View of Global Economic Prospects

Points to deflation as major culprit

by Lucas Everidge

The Economist summarized in its June 28th Special Report that the American fed interest rate cut will not be the ingredient to revive the ailing world economy.

Deflation in the USA The main culprit in economic woes is the spectre of deflation, a situation where consumers and businesses would have less money to pay their debts. In fact, households have done little to repair the debt on their balance sheets, unlike their business counterparts. They quote a Merrill Lynch study that shows people have simply borrowed against the rising value of their homes. "The ratio of debt to household income has risen to 111%, up from 102% in 2001."

They note that businesses have corrected on the whole better during the recessions, however economists assume that profits will continue to rise - an element that will prove difficult if deflation hits.

They discuss the issue of the weaker American dollar. "Devaluation will merely serve to export deflationary pressure to economies that already look vulnerable." Germany is already weathering a recession, and the big unknown is whether the European Central Bank will lower interest rates in Germany. Some forecasters believe that for the dollar to achieve a proper correction, the euro could hit US$1.40 by the end of the 2003.

They look at Japan as a lesson in navigating these economic waters. They note that cutting monetary policy through lowering interest rates will not solve the world economy's ills. They are far more concerned with reducing US private-sector debt.

(This summarizes the special report Breaking the Deflationary Spell from the Economist (06/28/2003). This article, along with 26,000 others are available to magazine subscribers. Subscribe here.

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