Page 1 of 2 IMF lost on the high seas
By Hossein Askari
This past weekend, finance ministers and central bank governors held their
spring meetings in Washington. They yet again achieved little or nothing in
response to what may turn out to be the worse current financial crisis in
recent history, with adverse fallout that can be expected to come for years.
Nor did they do anything to address the underlying global threat that will
strike again and again.
The finance ministers made some noise about banking and financial reform, and
patted themselves on the back for their decision earlier this month at the
Group of 20 meeting in London to increase the resources of the International
Monetary Fund (IMF). But they forgot to discuss what the IMF's role needs to be
to safeguard global financial stability.
More money in the hands of the IMF to do what it has been doing will just
create a bigger crisis in the future. As guardian of the world economy, the
fund has told small developing countries what to do but has not dared to tell
the United States, the economy that can has brought the world to near collapse.
What good is the IMF, with a heavier load of gold on board, but a ship that
does not know where it is going and with a captain that has no authority on the
high seas?
Most importantly. the ministers missed the one common factor that has been the
catalyst to all financial panics over the last two centuries - excessive credit
creation.
A world financial system, based on reserve currencies and floating exchange
rates, faces unparalleled instability. The sky is the limit when it comes to
credit creation in reserve currency countries. Interest rates have been
effectively pushed to zero by reserve currency central banks. The floodgates of
rapidly expanding money supply have been opened wide, and reserve currency
central banks have decided to adopt unorthodox policies, that is, unlimited
printing of money, which some noted economists have rightly called
counterfeiting.
The world economy has recently experienced the worst commodity inflation in
years, triggering food and energy riots and bringing the world economy to a
standstill. The credit expansion has been so fast over the past decade that it
has pushed the national banking system in a number of countries towards
bankruptcy. There is little likelihood that over-indebted households will repay
their mortgage and consumer debt.
While G-20 leaders in London and finance ministers in Washington discussed
regulation and supervision of financial systems, major central banks have been
printing trillions of dollars, euros and pounds and injecting a frightening
degree of liquidity into the financial system. There is no banking regulation
or safety guidelines that can prevent the chaos that is likely to ensue.
The US has decidedly embarked on the most expansionary fiscal and monetary
policy in its history and has completely abandoned any notion of financial and
fiscal discipline. These demand expansion policies are predicated on the wrong
diagnosis by US policymakers, namely that the economic crisis is due to an
excess of savings and therefore a lack of demand, thus completely ignoring the
large US fiscal and external deficits and food and energy inflation.
The US household savings rate was practically at zero in 2003-2007, and US
national savings rate was negative during the same period. The Barack Obama
economic team, including National Economic Council director Lawrence Summers,
Federal Reserve chairman Ben Bernanke, and Treasury Secretary Timothy Geithner,
does not recognize that the financial crisis has been triggered by the
inability of over-indebted households to pay mortgages and consumer loans and
that banks have gone bankrupt because of excesses in credit and demand.
Unconscious of prevailing external deficits, they seem to believe that the
crisis was due to an abundance in consumer goods, including food and petroleum.
Most US policymakers are university professors; they think in terms of
classroom models and have little understanding or grasp of markets, economic
reality and facts. US policymakers are puzzled by the rising unemployment and
do not appreciate its monetary cause. With core inflation stacked at 1-2%, US
policymakers see total price stability and do not see an impact of inflation on
rising unemployment.
They believe US unemployment is a Keynesian phenomenon that can be simply
eradicated through fiscal and monetary expansion. Accordingly, Bernanke and
Summers predict full recovery by the end of 2009. But with external deficits
rising to excessive levels in the last decade, the US economy has simply lost
its capacity to save and grow. Our prediction of over six months ago of
double-digit unemployment in the US will come to pass, but we still may have a
chance to deflect years of stagflation if we act now.
Despite unsustainable fiscal deficits and household indebtedness, the Obama
team has dwarfed George W Bush's financial disorder and has launched a US$787
billion stimulus package, a $275 billion housing subsidy, and created a budget
with a deficit of $1.85 trillion, or 13% of gross domestic product. US
government bailouts are reported at $12 trillion. Geithner announced a
public-private bank with a capital of $1 trillion to buy toxic assets, called
by economist Joseph Stiglitz as "cash for trash" and by fellow economist
Jeffrey Sachs as "a robbery bank". It is a plan that will favor Wall Street at
the expense of Maine Street, socializing losses and privatizing gains.
Bernanke has put in place a $1 trillion lending facility for consumers,
allocated $600 billion for housing, and purchase programs of government debt.
Taken together, Bernanke's unorthodox measures are projected to inject an
additional $3.5 trillion in liquidity in 2009.
Because of extraordinary borrowing demands by the Treasury and the announcement
of Treasury purchases by the Fed, Bernanke can no longer reverse any of his
liquidity increase. The Fed's purchase of long-term government debt is
reminiscent of the period just before the Federal Reserve-Treasury Accord of
1951 when the Fed had lost its independence and was forced to keep extremely
low interest rates. Those low rates eroded savings and growth and kept
inflation high.
Hyperinflation is in the works - not today, but it will come, just you wait.
The incredible US fiscal and monetary expansion will tax the rest of the world
heavily, a world that uses the dollar as a reserve currency. The US government
will extract a huge seignorage benefit for its currency as a reserve asset. It
will shift the cost of bankruptcies and bailouts to dollar holders. In case of
a stampede out of the dollar, the real value of dollar holdings could simply
evaporate in real terms.
The IMF has been oblivious to the fact that global real economic growth reached
5-6% in 2004-2007 because of a fast expansion in demand that created pressure
on food, oil and most other commodities. The IMF refuses to recognize that the
financial crisis is a bankruptcy crisis, that debtors are mainly households and
that most loans have either been totally lost or their collateral has
depreciated substantially.
Based on misguided analysis, the IMF has called for firing up fiscal stimuli
and printing more and more money. The G-20 has called for increasing IMF
resources and more liquidity creation out of thin air through a new allocation
of special drawing rights so that developing countries can increase their
imports and help reduce unemployment in industrial countries. Those countries
will fall anew into the debt trap and impair their quest for economic
development.
Would the current financial crisis have erupted had the world economy been
under a pure gold system or, more realistically, been under a symmetrical
system with no country's currency serving as a reserve currency for the world?
The answer is
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