Following years of economic stability and growth, the global economy is now undergoing some major upheavals that could have significant impacts on the US economy and American agriculture. Below is a general description of some of the major happenings in the global economy followed by a check list of factors to watch as economic conditions evolve over the next few months.

Global Economic Factors

Asia: The Asian economic crisis has captured headlines over the past few months. Several of the Asian economies, including Japan, South Korea, Thailand, Malaysia, and Indonesia, are in recession. The crisis is mainly a financial crisis caused by weak regulation of the banking industry and a multitude of bad debts made when times were good and growth was the norm. It is somewhat akin in many ways to our own savings and loan crisis, and the Mexico crisis. In both those cases, the economies went into a tailspin but eventually recovered. (Texas and California were in really bad shape in the depth of the S&L crisis.) The same story is likely to play out in Asia. The question is how long it will take, and the answer depends on how long it takes for governments in the region to effectively deal with the financial root causes.

Asia is a very important export market for the US, amounting to about 40 percent of agricultural exports and 30 percent of all exports. These exports have fallen in 1998 and will fall further in 1999. Growth in the US will be lower, probably at least a half percentage point lower, this year than it would have been without the Asian crisis. However, the Asian crisis alone is not sufficient to bring the US economy into recession. All exports represent 13 percent of our economy, so even if exports to Asia fall by a quarter (up to the present, the fall is less than 10 percent) and don’t increase elsewhere, the impact on growth would be about 1 percent. However, it is possible that agricultural commodity imports in Asia may be slow to pick back up because some labor will have shifted back to agricultural pro-duction, whereas processed food imports could come back sooner even though the demand is more income elastic.

Russia: Another region experiencing tremendous economics difficulty is Russia (and many of the other former Soviet Union countries). The Russian economy has col-lapsed, and Russia has essentially defaulted on its foreign debt. The impact of the Russian economic collapse on the US is mainly psycho-logical, because Russia accounts for less than 2 percent of our exports. However, it was apparently, at least in part, the fear of major political changes or even anarchy in Russia that triggered the early September tumble on Wall Street. US banks do not have as much exposure to Russian debt as do German financial institutions.

United States: And finally what about the US? Assuming we continue to grow through the fourth quarter, the current economic expansion will become the second longest in US history. Looking beyond our borders, there is ample cause for concern, but within our own economy, the basic fundamentals continue to be strong, albeit not as strong as over the past few years. US growth likely will be lower next year, perhaps around 2 percent or lower, as contrasted with 3.5 percent over the past 12 months. Interest rates likely will remain steady or fall even further, and inflation, and unemployment could increase a bit from their current very low levels.

Commodity Prices: Another important factor in world markets is the virtually universal collapse of commodity prices. As we all know, agricultural commodity prices have fallen substantially. But agriculture isn’t alone. Oil prices have been as low as$12/barrel. While US consumers like the resulting low gasoline prices, countries like Mexico, Venezuela, Brazil, and the major OPEC countries have experienced significant drops in export earnings. Without those earnings, the major South American oil producers are likely headed towards recession. Copper prices have decreased as well, hurting the export earnings of Chile, another South American country. As these South American economies stumble, they also import less, thereby reducing American exports. Many other developing countries depend on primary commodities for their economic growth, and many of these economies are experiencing low or negative growth.

Europe: And what about Europe? The European economies have been experiencing moderate growth rates but very high unemployment. In recent months, the high unemployment rates (often 12-20 percent) have begun to ease a bit. European growth prospects for the rest of 1998 and 1999 continue to be strong, but German bank expo-sure to Russian debt could be a drag on German growth.

Financial Transfers: Another source of uncertainty is the role of financial transfers and hedge fund operations in world economic instability. There is no doubt that huge amounts of financial assets are transferred around the globe each day. It is fairly clear that some of the large shifts in financial resources have been instrumental in significant changes in currency values in recent months (e.g., Japan and Malaysia). Clearly, arbitrage operations have some positive benefits in financial markets, but, frankly, we do not understand all the ramifications of the large volume of financial transfers that are occurring today. This uncertainty is one reason some leading economists are calling for some form of capital controls that could restrict capital flows to some extent, and provide better information on financial transfers.

Key Drivers: In any depiction of the future, there is always uncertainty. It is important to keep in sight the key drivers of how eco-nomic events will unfold. What follows is a check list of things to watch in the months ahead.

1. Financial restructuring in Japan – If the Japanese actually begin to implement serious reform of their financial institutions and regulations and to absorb the inevitable financial losses associated with the mountain of bad debt, that could mark the beginning of the end of their crisis. On the other hand, if they continue to postpone the needed changes, the recession will be prolonged.

2. Devaluation in China – Up to this point, the Chinese economy has suffered less than most of the other Asian economies. However, China has significant trade relations with its neighbors, and they could put a significant drag on the Chinese economy. China may be tempted to devalue its currency to counter the falls in other Asian currencies. If it does, that could lead to another round of further devaluation of Asian currencies.

3. Political instability in Russia -While the direct economic impact of Russia on the US is slight, political instability there would certainly make market players nervous. A further downturn there could adversely impact stock markets worldwide.

4. European growth – Economic growth is likely to continue in Europe. However, European banks, particularly German banks, have much greater expo-sure to losses in Russia and other former Soviet Union countries than do American banks. Also watch for any significant stum-bling when the Euro is introduced on January 1, 1999.

5. Recession in South America – Several South American countries are already headed towards recession, and others may join. If these economies go into a deep recession, it could have a significant impact on US and European economic growth down the road. Brazil is particularly important, because it is the eighth largest economy in the world.

6. 6. US consumer confidence – Our economic growth has been led by strong consumer spending. In fact, consumers are now spending virtually all of their income and saving almost nothing. If, due to economic events in other parts of the world or for other reasons, consumers lose confidence in our future economic growth, they may diminish that strong rate of spending. The confidence index fell in October for the fourth month in a row. While the index is, at present, still quite high, watch for further changes in the months ahead.

7. Wall Street – American household wealth has doubled over the past three years due to the rapid rise in our stock markets. That increased wealth has no doubt boosted consumer confidence and induced higher spending. So long as the market stays in the 7,000-8,000 range or higher, consumers may not change their behavior. But if the markets falls much below that, a negative wealth effect on consumer spending could reduce US economic growth.

8. The Fed – What will the Federal Reserve Bank do with interest rates? The current Fed has a reputation for fighting inflation as its first priority. However, the Fed has now lowered interest rates twice to stimulate growth and slow the rise of the dollar, which has dampened US exports. The effects of the Fed actions have been mixed. The direct effect is to stimulate the economy. However, an indirect psychological impact could be related to the signal an interest rate reduction sends—that the Fed believes the economic situation is getting worse. The first time the Fed lowered rates, stock markets fell, perhaps because the market thought the reduction was too little or perhaps because of this psychological factor.

9. Interest rate spreads – Over the past year, the interest rate difference between government bonds and private sector borrowing has roughly doubled. This change has occurred because domestic and foreign lenders are seeking less risk in their portfolios. Thus, the demand for government bonds has increased and the return on them decreased. If this spread were to diminish, it could mean that lenders were once again willing to take more risk.

10. Unemployment rates, especially in manufacturing – Manufacturing unemployment has traditionally been a leading indicator of economic activity. Although overall unemployment rates are relatively low, manufacturing unemployment has been edging up in recent months.

11. US export levels – If US exports start falling by large percentages not only to Asia but also to other destinations, that change would drag US economic growth down.

12. US farm policy – By our estimates, returns to corn farmers from the current US policy set

(transition payments, loan deficiency payments, and market prices) are not very different from what returns would have been under the old 1990 farm bill pol-icy set (deficiency payments, set-asides, and market prices). However, current market prices are low, and there have been calls to revisit agricultural policy. Congressional action this year has led to a temporary boost in payments. But Congress could consider longer term changes next year.

(Several of our faculty contributed ideas to this paper.)