New Policies, Not Arguments : Stock Plunge May Force Action by U.S. and Allies

WASHINGTON —  For all the fortunes lost during Monday’s day of reckoning on Wall Street, the collapse of the stock market may at long last force the United States and its allies to recognize that disaster for one will inevitably mean disaster for all.

And that realization, analysts say, could open the door for this country and its major trading partners to stop their incessant jockeying for national advantage and revamp the economic policies that helped to precipitate last week’s crisis in the first place.

“The silver lining to the clouds on Wall Street is that the crash may have pulled Washington, Tokyo and Bonn away from the collision course they were on,” said Alan Stoga, an economic analyst at Kissinger Associates in New York. “It looked like nobody was in control of the policy levers. Now, at least, there is some real hope for cooperative action rather than squabbling inaction.”

It is only a hope, analysts emphasize. Deep divisions remain over economic policy, and many remain skeptical that even the shock of last week’s market earthquake--followed quickly by collapses in Tokyo, London and other overseas securities markets--will be powerful enough to break the current impasse.

“It still seems to be business as usual in Washington,” said John Makin, senior economist at the American Enterprise Institute here. “They are still arguing as though nothing has happened.” David Wyss of Data Resources Inc. in Lexington, Mass., echoed that complaint: “Fear does wonderful things for uniting people, but whether it will last after the current stampede is over is questionable.”

Certainly inaction is the pattern that has prevailed for years. Global trade imbalances continued to worsen during the 1980s even as the dollar first soared and then plummeted against foreign currencies.

Two years ago, the major industrialized nations agreed to manage an orderly decline in the value of the dollar, and they did make periodic efforts to work together. But as crisis after crisis flared, the allies frequently resorted to their favorite tactic--blaming each other.

The United States demanded that West Germany and Japan, where domestic economic growth has been anemic, expand their economies and begin consuming a greater share of the world’s products.

The trading partners insisted that the United States first reduce its massive budget deficit, which they called the major cause of its dependence on foreign capital. The United States replied that in an otherwise weak global economy, a retrenchment of that sort could trigger a worldwide recession.

May Be Persuaded

Neither side was willing to move. But last week’s worldwide financial meltdown may finally persuade all sides to act.

Japan already had begun haltingly to stimulate its economy last summer. Last week the Germans gave up--at least for now--their efforts to squeeze the last drops of inflation out of their increasingly sluggish economy.

And, most importantly, the Reagan Administration is finally talking about abandoning its confrontational approach to Congress on how to reduce the budget deficit.

“Don’t miss the significance of the President saying he is willing to consider taxes as part of a budget settlement,” one senior Administration official said. “He is listening now.”

The moves must occur in tandem, most experts agree.

“The U.S. budget deficit will require correction, but this must be a careful, gradual process or we may well bring about a recession in the U.S. and around the world,” Lord Harold Lever, a key British economic adviser, wrote in the International Economy magazine.

International Consequences

“The present dangerous situation emphasizes the need for countries to take the international consequences of their domestic policies more into account than is their autarchic and insular habit.”

Economists fear that the stock market crash means that time is running out.

“The force of the markets is now pushing governments to move in the right direction,” said Stephen Marris, a British analyst at the Institute for International Economics here. “But it’s a race between economic reality and political immobility in both the United States and Germany.”

No one really knows what touched off the panic on Wall Street. It is clear, though, that the crash was not exclusively made in the United States. One of the triggers was a series of recent interest rate increases in West Germany, which were exacerbated by the West German government’s proposal to impose withholding taxes on bondholders.

Warning From Baker

That threatened to retard growth in West Germany just when the United States and other European nations had hoped that it would finally begin to expand. So Treasury Secretary James A. Baker III went public on the Thursday before the crash with a warning that the United States would welcome a decline in the dollar relative to the mark--a step that threatened to depress West German exports--if West Germany tightened any further.

Breakdown loomed in the international currency stabilization agreement to which the United States, Germany and four other industrialized democracies had subscribed as recently as Febru ary--raising fears that the dollar would spiral downward in an uncontrolled free fall. Such plummeting would be inflationary for this country and disastrous for Germany, Japan and other nations dependent on selling goods to the United States.

Other factors, such as unease over whether newly installed Federal Reserve Board Chairman Alan S. Greenspan could be counted on to stand fast against inflation, also contributed to the crisis in the markets, which seesawed wildly all last week.

Initial steps to patch the differences between Baker and economic officials in Germany took place during a surprise meeting Monday evening in Frankfurt. But there is no question that more substantive actions are needed.

The next steps, analysts say, will need to take place in Washington. “It’s in our interest to act even if the foreigners don’t join us,” said Charles L. Schultze, chief economic adviser to former President Jimmy Carter. “And they are more likely to cooperate if they see us moving to control the deficit and reduce our reliance on foreign capital.”

Danger of Token Progress

The danger here is that the different factions within Congress and the Administration may prove so locked into their positions that the budget talks will achieve only token progress or, worse, break down in disarray.

“If each party takes the current crisis as merely another opportunity to rally the troops . . . there is virtually no chance of fashioning the sort of bipartisan front that is needed to contain this crisis,” states a private document being circulated among political leaders this week by a leading Democratic economic strategist.

“Neither political party enjoys particular credibility on deficit reduction,” says the memo, which was made available to The Times on the condition that its author not be identified. “What the markets will want to see is a fairly dramatic movement away from the current political stalemate--actions that push the FY (fiscal year) 1989-1992 deficits down by something on the order of 1% of GNP (about $40 billion) per year.”

Gramm-Rudman Cuts

The deficit was $148 billion in fiscal 1987, which ended Sept. 30. It would be expected to rise next year in the absence of further action to restrain it, and even the mandatory spending cuts required by the Gramm-Rudman act would leave the deficit barely less than its 1987 level.

Although there is little dispute over the need for action on the deficit, deep differences do indeed exist over what the measures should be.

Republicans fear that steeply higher taxes will retard economic growth and fuel greater government spending while the deficit gap grows wider than ever. Democrats contend that additional taxes are necessary as part of any serious deficit reduction package aimed at reducing the government’s borrowing and freeing up additional savings for private investment.

An equally bitter dispute revolves around the effort to stabilize currency values at roughly today’s levels.

Many analysts are convinced that the goal is misguided. The dollar, they argue, still needs to fall significantly to a level where investors are confident that it can be sustained, helping to continue the turnaround in the underlying U.S. trade imbalance that began last year.

Anticipating Dollar Drop

“The major cause of instability in the markets has been the anticipation of dollar depreciation,” said Robert Solomon, a specialist in international economics at the Brookings Institution. “That’s what causes foreigners to hold off buying U.S. assets, because they think they’ll be able to get them cheaper if they just wait.”

Other analysts, however, say that the focus on a weaker dollar as the cure for the trade deficit is profoundly flawed. Further dollar depreciation will only raise fears that U.S. policy-makers will try to inflate their way out of the nation’s debts.

“The trade deficit is the least of our problems,” said Alan Reynolds, a supply-side economist for Polyconomics Inc. in Morristown, N.J. “The real danger is that we have become so obsessed with it that Washington will try to fix it through a weaker dollar, protectionism or an engineered recession. That’s what really scared the markets.”

One way out of the predicament, recommended by a growing number of analysts, calls on the Democrats in Congress to abandon the protectionist features of the proposed trade bill in return for extracting the Administration’s support for a substantive deficit reduction package.

‘One of the Worst Things’

“There will be a tendency among politicians to blame foreigners for our problems,” said Barry Bosworth, a senior economist at the Brookings Institution, “but one of the worst things hanging over the markets right now is the prospect of a damaging trade bill.”

And the memo prepared by the Democratic economist points out that, “if one set oneself the task of devising ways to turn a financial panic into a generalized economic collapse, one could scarcely do better than to enact a series of tough new trade barriers. . . . The pending trade bill is a step in the direction of an international trade war.”