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The global meltdown
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December 19, 2001: 3:26 p.m. ET
In 2001, the world's economies sank together with the U.S leading the way. Can they rise together, too?
By Staff Writer Mark Gongloff
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NEW YORK (CNN/Money) - This year taught some hard lessons to the world: Most important is that - for better or worse -- many nations' fortunes are increasingly bound together.
The terror attacks of Sept. 11 made that point most starkly. Though the United States was the prime target, citizens of 80 nations died when the twin towers of the World Trade Center fell, and few of the world's economies avoided the aftershocks of that day.
"The tragic events of Sept. 11 exacerbated an already very difficult situation in the global economy," the International Monetary Fund said in its year-end World Economic Outlook report, released Tuesday. "Following the attacks, consumer and business confidence have further weakened across the globe.
"A particularly disturbing feature of the current slowdown is its synchronicity across nearly all regions, the most marked for at least two decades," the IMF said.
Global Recession
The Organization for Economic Cooperation and Development said recently that the global economy slipped into its first recession in 20 years, with output shrinking in the last two quarters of the year and likely remaining weak in the first half of 2002.
Though the world's tumble accelerated all at once after Sept. 11, its top three economies had already paved the way.
A group of private economists recently said the U.S. economy, the world's largest, entered recession in March.
Meanwhile, Japan, the No. 2 economy, had two straight quarters of sharply contracting GDP between April and September. And GDP growth in 12 critical euro-zone countries was paltry in both the second and third quarters and is not likely to improve anytime soon.
With the U.S. economy making up nearly a third of the total global economy and having a more direct impact on Asian exporters such as China (the world's No. 6 economy, according to the World Bank), it's tempting to finger America as the culprit in the downturn preceding Sept. 11.
"In Europe, it seems there were parallel weaknesses. Japan sort of sits by itself as being bad at the beginning of the year and getting marginally worse since then," said Edward Graham, senior fellow and economist at the Institute for International Economics. "That's not something directly related to the U.S. downturn, though you could argue that the U.S. situation has made Japan's worse."
Waiting for a U.S. recovery
In a similar vein, the world is looking to the U.S. to lead a global recovery. "Clearly, the U.S. economy was and still is the locomotive pulling the world economy," said Sung Won Sohn, chief economist at Wells Fargo & Co. "All across Asia, Latin America, everywhere I go, they are looking to the United States for recovery."
Appropriately, then, the U.S. central bank has led the way in setting monetary policy to respond to the crisis. The Federal Reserve has slashed its target for short-term rates 11 times this year in an effort to encourage borrowing and spending.
However, the European Central Bank, hamstrung by its dedication to keeping inflation below 2 percent, has kept interest rates relatively high. "The outlook for Europe next year is very poor," said Manu Kumar, European economist at Barclays Capital, who expects euro-zone GDP growth of just 0.4 percent in 2002, compared with expected U.S. growth of 2.2 percent.
Meanwhile, Japan's recovery hinges more on government reforms rather than on its central bank, since its key short-term interest rate is already near zero. In part because Japan's government has been reluctant to initiate effective reforms, economists expect weakness to continue throughout 2002.
"The Fed's cutting rates more than other banks are cutting rates, the United States is cutting taxes more than other governments are able to and is getting more stimulus from defense spending," said Gary Thayer, chief economist at A.G. Edwards. "We won't see an upswing in the global economy until 2003. The United States will do better before then."
Elsewhere in the world
That's good news for exporters like China, whose shipments to the United States helped fuel 8 percent GDP growth in 2000 and expected growth of 7.3 percent in 2001, according to the IMF.
But that healthy pace could slow down once China's entry into the World Trade Organization reaches practical fruition. Falling trade barriers will shrink its carefully guarded trade surplus, and rising imports will cut into GDP.
While China began to emerge from isolation in 2001, Argentina shrank into it, as investors put as much distance as possible between themselves and the country as it staggered toward bankruptcy. As the year ended, even the IMF, which was created to help developing nations straighten out their finances, refused to extend more credit to Argentina until it met budget requirements.
"If Argentina works extremely hard, it can lay the groundwork for a recovery in 2003," said John Welch, Latin American economist at Barclays Capital. "But, right now, 2002 looks very difficult for Argentina."
Possible solutions for Argentina, which is about $132 billion in debt, include more government belt-tightening, a plan to swap short-term debt for long-term debt and plans to change the country's currency. The task has been made more difficult by political unrest and the resignation of six economic advisers this year.
In any event, most observers think Argentina's small size and isolation, among other factors, will likely keep a debt default from causing too much trouble for the rest of the world.
"Argentina is not a potential nightmare," said Wells Fargo's Sohn. "It's a relatively small economy compared to Mexico and Brazil."
Still, one of the lessons of 2001 is that no problem in the world is so small that it can be ignored forever.
"There are no longer really state economic systems that can function by themselves," said Delos Smith, chief economist at the Conference Board. "Most of our largest corporations are in every major market in the world. We're intertwined." 
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