THE WORLD media's attention has been so focused on George W Bush's plans to attack Iraq that little notice has been taken of the fact that the global economic crisis is getting worse. Take the three biggest economies – the US, Japan and Germany.
Japan has been experiencing a serious economic slump for a decade now. At the heart of this slump is the plight of the major banks, which play a key role in financing industrial investment. During the speculative 'bubble economy' that Japan enjoyed in the late 1980s these banks lent massively.
As a result the banks have lost huge amounts of money in bad loans that will never be repaid. A few weeks ago the Japanese central bank announced that it was going to start buying bank shares to prevent the financial system from collapsing. This forced the hand of the prime minister, Junichiro Koizumi, who the Bank of Japan blames for doing nothing about the crisis.
He appointed a new head of the Financial Services Agency with a brief to reorganise the banking system. But the danger is that this restructuring will unleash a wave of bankruptcies that will push Japan into an even deeper slump.
Now Germany, the economic powerhouse of the European Union, is beginning to face what some see as a Japanese-style crisis. Nearly one in ten people are unemployed in Germany, with almost one in five in the east. Last week Deutsche Bank estimated that the German economy will grow by just 0.1 percent this year. The DAX index of leading shares has fallen by 48 percent in 2002, the worst performance of any leading stockmarket.
The falling stockmarket has hit the German banks very hard. The value of their shareholdings has fallen, and they are carrying a heavy burden of bad loans.
As in the case of Japan, German banks play a key role in funding industrial investment, so their crisis affects the entire economy. The situation is made worse by the European Growth and Stability Pact, which forms part of the basis on which the euro was brought in. The pact forces governments in the euro zone to keep public expenditure and government borrowing within very tightly defined limits whose aim is to produce balanced budgets.
This stops governments from reacting to economic slowdowns by spending more to prevent a slump in employment and output. Last week Wim Duisenberg, the unelected chief of the European Central Bank, attacked countries like France for ignoring the Growth and Stability Pact. Unfortunately, the recently re-elected Red-Green coalition in Germany is strongly committed to maintaining the Growth and Stability Pact, even though it is one of the few left-of-centre governments still holding office in the European Union.
Some economists fear that Germany faces the kind of deflation that Japan has experienced in recent years. Deflation means falling prices, which increase the burden of debts like mortgages and therefore discourage spending.
'I have been one of the people who have been saying deflation definitely could not happen; but I'm getting nervous,' Charles Posen of the Institute of International Economics in Washington told the Financial Times. 'With the coming slowdown in the US, with the demise of Japan, the stakes of Europe making a mistake are much bigger than they were.'
The US itself is suffering from the collapse of its own speculative bubble economy at the end of the 1990s. New investment is very low because so much money was spent at the height of the boom creating productive capacity that can't now be profitably used.
The US economy has been kept going by high levels of consumer spending. This has been encouraged by low interest rates that have encouraged a housing boom. As in Britain, mortgages are cheap so people are encouraged to buy new homes. As they see the value of their property rise, homeowners feel richer and borrow and spend more.
This housing boom is really the last stage of the speculative bubble that blew up in the late 1990s. The history of past bubbles suggests that sooner or later the property market will collapse, removing one of the last props holding the US and British economies up.
The wild card in all this is the economic impact of war in Iraq. Any serious disruption in oil supplies from the Middle East would push prices sharply upwards. In all the great recessions of the past 30 years it has been an oil crisis that precipitated global slump. Our rulers are steering the world economy into stormy waters.