Global Policy Forum

By Hirotoshi Sakamoto

This is the first installment of a three-part series about the effects of the U.S. stock market slump on the rest of the world.

The recent plunge in U.S. stock markets has cast a dark shadow over the global economy. In Tokyo trading Monday, the 225-issue Nikkei Stock Average followed Wall Street's lead as it briefly dipped below the 10,000 line for the first time in five months. Behind the slump in stock prices is a crisis of confidence in U.S.-style capitalism, which until recently has served as a model of prosperity.

The Japanese government may be forced to revise its view that the economy is on a recovery path after finally reaching bottom. Richard Grasso, chairman of the New York Stock Exchange, told NBC television Sunday that acts of terrorism against investors had been committed in corporate boardrooms. WorldCom Inc., the second-largest telecommunications firm in the United States, filed for bankruptcy the same day. According to Grasso, the corporate executives responsible for accounting malpractice had committed terrorist acts that could fatally damage the stock markets on which U.S. economic prosperity was based.

U.S. President George W. Bush told Wall Street executives on July 9 that he would do his utmost to uncover the truth about fraudulent accounting practices. A series of revelations of fraudulent accounting practices at U.S. companies, including energy giant Enron Corp. and telecoms firms Global Crossing Ltd. and WorldCom, have driven stock prices sharply lower. The Bush administration is targeting chief executive officers responsible for window-dressing accounts, blaming them for the slumping U.S. stock markets.

The accounting scandals have without question been responsible for the loss of confidence in U.S. stock markets and an exodus of funds from the United States. However, what lies beneath the falling U.S. stock prices and dollar is the crumbling of an economic structure in which the United States was previously the winner, successfully attracting funds from around the world.

The slowdown of the U.S. economy has been shown in various data. New car sales in June fell from a year ago for the second consecutive month, indicating a decline in personal spending. Corporate earnings also have been slow to recover. In the April-June quarter, all major airlines fell into the red, and major high-tech companies including Motorola Inc. and Intel Corp. suffered losses or profit declines. U.S. Federal Reserve Board Chairman Alan Greenspan, who has been considered the magician of the financial markets, appears to have lost some of his magic.

"Preventing Deflation: Lessons from Japan's Experience in the 1990s," a Fed report released last month, is the result of an investigation by the U.S. central bank into the Japanese postbubble slump, produced with the aim of averting the bursting of the U.S. economic bubble. The Fed has cut interest rates 11 times last year by a total of 4.75 percentage points to 1.75 percent in an attempt to prevent the bursting of the U.S. economic bubble. However, the recent slump in stock prices appears to have made the Fed's "experiment"--the first of its kind in human history--a failure.

Thomas McNamas, an analyst at Bank of America Corp., said the recent plunge in U.S. stock prices had deflated the stock bubble that had lasted since the 1990s, indicating that the full-scale collapse of the economic bubble was under way. The flow of funds around the world has changed course. There was a 50 percent drop in net inflows of funds into the United States during the January-March quarter compared with the previous year, down to 113.3 billion dollars. The flight reportedly is continuing. A survey conducted last year on 170 fund managers worldwide by Merrill Lynch & Co., a major U.S. securities firm, confirmed the recent trend. Fifty-six percent of those surveyed said they had reduced their portfolio weightings in U.S. stocks and instead had increased their investment in equities listed in Europe, Japan and other parts of Asia.

The driving force behind the prosperity of the U.S. economy has been its success in attracting funds from around the world for investment. Such capital inflows have offset U.S. fiscal and trade deficits and boosted stock prices to record highs. If the stock price plunge in New York is a sign of the full-scale bursting of the U.S. economic bubble, the shock waves emanating from the country that issues the world's key currency may seriously damage the global economy.

There are signs of the collapse of the global economic structure in which the United States has been the world champion. First, the twin deficits--fiscal and trade--that haunted the United States in the 1980s have returned. The U.S. federal budget for the 2002 fiscal year (October 2001 to September 2002) is expected to post a record 165 billion dollars deficit, the first such deficit for five years. The deficit soared by 56 percent in just six months following the initial estimate made in February.

While tax revenues have fallen due to the economic slowdown, tax cuts and increased defense spending on antiterrorism measures has raised expenditures. The U.S. current account deficit in 2001 was the second-highest on record, even though it dropped 6.1 percent from the previous year to 417.4 billion dollars for the first decline in six years. The current account deficit posted a record quarterly deficit in the January-March quarter, indicating an upward trend in the deficit since the beginning of 2002. If the slump in stock prices results in reduced fund inflows insufficient to fund the twin deficits, the entire U.S. economic mechanism may malfunction.

The revelations concerning fraudulent accounting practices appear to mark the beginning of the collapse of U.S. capitalism's reputation as being the most transparent in the world. The unfolding spate of crooked financial results has panicked investors across the globe. Following the collapse of Enron, a number of other accounting scandals have been revealed in which firms inflated profits and transferred debts to affiliates. In addition, major U.S. auditing firm Arthur Andersen LLP--the auditor of both Enron and WorldCom--which would be expected to uncover and prevent dubious accounting practices, was found to have cooperated with accounting malpractice.

It appears that both the players (corporate executives) and umpires (auditors) of the accounting game have engaged in fraudulent accounting practices--a type of systemic corruption. Previously a model for other countries, the system of U.S. corporate governance has been badly affected by the scandals.

A former CEO of ImClone Systems Inc., a major U.S. drugmaker, was arrested on suspicion of insider trading for allegedly selling a large number of shares in the company before the announcement was released concerning the failure of its anticancer drug to gain official authorization. A former chairman of Tyco International Ltd., a U.S. conglomerate, was indicted on charges of tax evasion involving purchases of expensive paintings. Such illegal acts appear to have been committed due to the declining ethics of executives who sought to accumulate personal assets during the 1990s stock price bubble and also the failure of company boards to prevent wrongdoing. Prof. Eric Orts of the University of Pennsylvania said many scandals involving the managers of financial firms, general contractors and retailers also occurred during the bursting of Japan's economic bubble.

According to the professor of business administration, corruption has been more easily fostered in the United States than in Japan due to the widespread use of stock options as incentives for executives, who reap huge rewards if their companies' share prices increase as a result of their reportedly successful performance. The main problem is that the checks provided by external parties have failed to function, he said. Should the U.S. economy's present situation mark the beginning of the bursting of an economic bubble similar to Japan's experience, the aftereffects will be strong in both their scale and intensity.

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