The world faces a major recession and a repetition of the 1978 dollar crisis unless U.S. authorties allow the American economy to slide into a gentle downturn or mild recession in the very near future.
That is the central conclusion of the annual report of the bank for International Settlements, published at its annual meeting today in Basle, Switzerland. The influential B.I.S., sometimes referred to as "the central banks' central banker," plays a key role in international monetary affairs.
The B.I.S. annually reviews the world's economy and makes recommendations that receive careful consideration within the European Common Market and in institutions such as the International Monetary Fund and the Organization for Economic Cooperation and Development.
On Saturday, the U.S. Congressiional Budget Office warned Congress to expect a full-fledged recession this year and through most of 1980. The gloomy forecast reflected the recent weakening of the U.S. economy and the impact of sharp oil price increases by the Organization of Petroleum Exporting Countries.
The B.I.S. report warned that the recent burst of oil price increases makes certain that the surpluses piled up by OPEC will swell, "raising again the tricky question of who is to shoulder the corresponding deficits."
To help stem the drift toward another worldwide recession, the report recommended western countries apply "a radical policy" of cutting oil imports through conservation and development of new sources of energy.
"It would not matter that much if the results were forthcoming only in the medium or long run. The mere fact of policy action being taken right away, and being seen to be taken, could have short-term effects on the supply and hence the price of oil," the B.I.S. said.
The report argues that the world learned from last year's dollar crisis that a large and persistent U.S. current account (services and trade) deficit cannot be tolerated because of the special role the dollar plays in trade and in reserves held by other countries.
"A loss of confidence in the dollar due to a large current account deficit is likely to lead to a disorderly and excessive depreciation, fueling inflation in the United States and causing excessive appreciations elsewhere - not to mention its impact on the prices of oil and other commodities," the report said.
In a telephone interview from Basle, the B.I.S. general manager, Rene Larre, said the major recession cited as a possibility in the report would be comparable to the sharp world contraction in 1974-75 that followed the oil price crisis.
But Larre said that in his view, the present economic stance of the Carter administration, stressing a tight fiscal and monetary policy, seems "satisfactory," and that "if they (the administration) remain on course for another six months, it should do the trick."
Treasury Secretary W. Michael Blumenthal, at a meeting with reporters last week, said an economic slowdown was proceeding according to plan and that real Gross National Product for 1979 would increase by only 2 per cent or less. Many private forecasters believe that an actual recession - meaning a decline in real growth rates - will begin before the end of this year.
In 1979, the U.S. had a current account deficit of about $16 billion, while the merchandise trade deficit was $35 billion. Blumenthal estimated that the current account deficit would shrink to about $10 to $11 billion this year, while the trade deficit will run to about $27 billion. Both the trade and current account deficits would have been reduced much more sharply were it not for OPEC's oil price increase since last fall estimated at 33 percent.
The B.I.S. said there are many similarities between the problems the world now faces and those faced in the winter of 1973-74 after the first major oil "shock." He cited two possible scenarios to illustrate the present "international policy dilemma."
In the first and optimistic one, the long U.S. expansion dies "a natural and gentle death," yielding immediate benefits in the U.S. international accounts, consolidating the dollar recovery, and even having a "soothing influence" on the price of oil. Inflation would cool, allowing other countries, notably Germany and Japan, to expand their domestic economies.
"This would be the best of all possible worlds," the report said. "World inflation would abate, the balance of payments adjustment would not be jeopardized, exchange markets would be kept calm, and growth in the western industrial world as a whole would continue at a moderate rate."
In the second and pessimistic scenario, the U.S. economy moves into an overheated cycle with very high levels of inflation, leading to a run on the dollar and rising international deficits. German and Japanese growth would be crowded out by U.S. inflation.
"This would be the worst of all possible worlds: renewed currency unrest and international inflation culminating with the collapse of the protracted U.S. inflationary boom in a major world recession."
The world urgently needs something closer to the first secnario, the report said, so that all outstanding monetary problems, including further development of the European Monetary System and diversification of official reserves away from the dollar, can proceed.
The B.I.S. praised the U.S. dollar-rescue program of last November, especially U.S. recognition that regular market intervention along with "sound fundamentals" are necessary to preserve confidence in a reserve currency like the dollar.
But the B.I.S. pointed to a rarely mentioned implication of intervention: U.S. acquisition of amounts of foreign exchange reserves "is a small, official step toward a multiple reserve currency system."