Edward SeagaThe financial crisis that is now threatening global financial stability has more than one precedent by which to guide a deeper understanding of the likely prognosis for the future.
There is a constant reminder of the financial crash of 1929 when the New York stock market lost 40 per cent of its value. That apocalyptic crash was due to a panic sale of stocks when legislation was in the process of being debated in the United States Congress which would allow increased tariffs to be imposed on 20,000 imported items.
The Great Depression
It was recognised that retaliation by other countries would cause US exports and imports to plunge. This created more panic in the stock market with losses finally increasing to a cumulative 89 per cent of value. The Great Depression was launched. Unemployment reached 26 per cent as businesses and banks collapsed and bankruptcies were rampant.
At this point in time, this is not a likely scenario as the underlying problem is one of scarce credit resources for lending. Although this is being addressed, the deeper problem is the confidence factor which is behind the wait-and-see attitude of credit institutions, even when there are funds available.
A far more likely scenario of the future is the recession, which started in the United States after the staggering increase in the price of oil from US$4 to US$ 12.50 per barrel overnight in 1974.
To compensate for the downturn in business resulting from the dramatic movement in the price of oil, the strategy implemented was to allow increased lending by the small savings and loan banks, which could provide larger loans if credit ceilings on loans were removed.
From my just completed autobiography, I quote:
The 1980 Depository Regulation and Monetary Control Act phased out a number of restrictions of the financial practices of the banks and broadened their lending powers. Many banks went wild in the deregulated environment. They rushed madly into real estate lending and made poorly secured loans. Their managers and directors, in some noteworthy cases, went on personal spending sprees.
runaway losses
There were 4,590 state and federally chartered savings and loan banks in the United States. Their net income was $781 million in 1980. This fell to negative $4.6 billion in 1982 and the net worth was zero by 1983. The runaway losses did not stop until it reached a staggering $160 billion.
Some of the features of the American economy in this turbulent period were:
Inflation soared to 13.5 per cent by 1980, four times the usual pre-crisis rate;
Unemployment moved to a startling 7.5 per cent in May 1980. By 1982, the unemployed totalled nine million, the highest since the Great Depression;
17,000 businesses failed, the second highest number since 1933;
Many thousands of farmers lost their lands.
The present state of the US economy is certainly not as frightening as these figures recorded for the 1980 period, which was at that time described as the worst recession in the 50 years since the Great Depression. But the figures quoted above can give an indication of how the present situation is moving with time towards a crisis level.
So far, the readily quoted indicator has been the run on the stock market worldwide. By itself, the decline in stock prices is not the crisis factor. These will rise over time again. The real crisis is that the declining prices will affect the value of the stock as collateral for loans. As the collateral value falls, banks would insist on repayment to maintain their prescribed loan to collateral ratios. Repayment would have to be made by the borrowers reducing their operational capital and scope of work. Failing this, the banks would be stretched to a point of closure. Unemployment would follow.
All this is yet to come as the credit crunch is still a good way from causing severe cutbacks in consumer spending.
A severe credit crunch in the United States will impact tourism expenditure and remittances from Jamaicans overseas, when and if it comes. But any prolonged credit crunch will have a far more devastating effect on the Jamaican economy, if it follows the path of the 1980s.
crippling the economy
At that time, the severe decline in consumer purchases in the United States caused a serious fall out in the demand for aluminium products, as it did also for other metals. The resulting plunge in demand for bauxite and alumina decreased Jamaican export earnings and domestic revenue to levels that crippled the economy. By 1985, the level of bauxite and alumina exports was less than half (40 per cent) the level in 1980 and it never fully recovered over the entire decade.
In the eighties, the bauxite industry earned 72 per cent of foreign exchange earnings in the economy. The loss of projected foreign exchange earnings over the decade was a whopping US$2.4 billion or 50 per cent of the normal value. This was virtually twice as much as the entire additional cost of oil to the economy in the 1970s. But the damage did not end there. The loss of revenue to government was US$810 million over the decade, a devastating 44 per cent of projected revenue. The total impact was an unprecedented disaster, 50 per cent of export earnings and 44 per cent of revenue. The damage was more than the total cost of all the natural devastations in the history of the country.
It was the near collapse of the bauxite industry which crippled the economy. These losses, together with the legacy of an impoverished treasury from the 1970s, were the critical factors which caused the Government to have to undertake the savage adjustment programmes of the IMF and World Bank. A study carried out by Paul Chen Young and Associates on the effect of the fallout in the bauxite/ alumina sector on economic growth is another way of looking at the impact.
The study showed that if the bauxite industry had not collapsed, economic growth would have been:
Eight per cent in 1982 instead of one per cent
Four per cent in 1983 instead of two per cent
Five per cent in 1984 instead of – 0.4 per cent
10 per cent in 1985 instead of – 4.7 per cent
addressing the crisis
There would have been no need for International Monetary Fund (IMF) or World Bank programmes.
We have not by any means reached this crippling situation in the current recession, nor is there any signal, except for a loss in Alcoa’s earnings in the last quarter. But I set out the frightening consequences to provide bench marks to guide those who are following the trail of what could be another economic disaster. It was not until 1983 after a time lag of two years that the effect of the world recession hit Jamaica. In the meantime, watch the reports of the aluminium industry for signs of any significant fallout in consumer demand.
What is of equal importance is how to address the crisis if it happens? If the worst case scenario should occur to the extent that it degraded the country’s credit rating, reducing borrowings on the bond market for budgetary financing, then the only recourse would be the IMF, which would demand massive expenditure cuts to balance the budget as a condition for lending. In the 1980s, the expenditure cuts included reduction of the public sector establishment from 130,000 to 100,000 employees with most of the reductions of 30,000 being lay offs.
horrendous blow
There was no other area of public expenditure from which huge cuts could be made. This was a horrendous blow to the political image of the JLP government, but there was no choice if the economy was not to collapse. The bitter medicine had to be taken. If I had looked away, as Michael Manley did when faced with an IMF requirement to cut 11,000 public sector jobs in the 1970s, the economy would have plunged into an indescribable crisis.
The World Bank prescribed a strategy in its structural adjustment programme for export prices to be reduced to enable the economy to export more to earn more from foreign exchange. If the same scenario as in the 1980s was to materialise now, the need to be more competitive for marketing Jamaican exports to EPA countries would be the justification for requiring devaluation of the Jamaican dollar to reduce costs. But devaluation of the Jamaican dollar did not succeed in making Jamaican exports marketable in the Caribbean Basin Initiative. Jamaican exports would still be uncompetitive in today’s economy even if boosted by significant devaluation, more so now with the worsening gap of the cost of electricity, utilities and other comparable costs.
Michael Manley
The devaluation to close the gap of the undervalued Jamaican dollar in the 1980s was a necessity, but after that devaluations were counter-productive. This contrasting view led to a battle between the IMF and me in which I refused to pay them until they agreed to the value of Jamaican dollar being pegged at the rate of J$5.50 to US$1:00. The IMF fully agreed in January 1987. Robust economic growth followed.
The pegging of the dollar was not the only stimulus, which resulted in creating recovery after 15 years, but it was the prime factor.
I make this observation on the success of pegging the value of the Jamaican dollar as my final point. It indicates a way out of the hardships of the present and possible damage in the future, if the present crisis reaches crippling proportions.
Without doubt, some hardship lies ahead. Let us hope that it does not reach the tsunamic proportions of the 1980s.
Edward Seaga is a former prime minister. He is now a Distinguished Fellow at the UWI. Email: odf@uwimona.edu.jm
