In his speech on the world economy before the Council on Foreign Relations, President Clinton said that the most pressing problem facing us is global “financial turmoil.” But his solutions take us entirely in the wrong direction. He recommends more IMF funding, more environmental and labor regulations, and a new international conference to create a new financial “architecture” for the world economy. These policies can only exacerbate the problems that stem from the fundamental institutional failures that lie at the heart of the modern monetary regime.
What gives rise to this speech is the continuing meltdown of once-growing economies in Asia, the collapse of the Russian economy, the strong signs of contagion in Latin America, and the fear that it will all come home to roost in the U.S. unless something is done. What he does not seem to understand (and in many ways, he speaks for the banking and financial elite as well) is that these events are not due to the inherent instability of markets, but to government manipulation of them.
Clinton began by drawing attention to the problem of inflation, which he considers long gone. In Clinton’s mind, the problem of inflation and the problem of global financial instability are unrelated. They have different causes and different solutions.
But he could not be more off the mark. Inflation and financial instability flow from the same source and both date from a critical turning point in the history of politics. During the Great American Inflation, depreciation has taxed away the purchasing power of the 1969 dollar and reduced it to 22.6 cents today. This has resulted in incalculable losses to the efficiency of the American economy, and dramatically redistributed wealth from savers to debtors.
The price has been a shrinkage in savings, a reduced incentive for capital accumulation, and thus lower incomes and less economic growth. It changed the psychology of personal, government, and corporate finance as well. Debts were inflated away and excessive speculation was encouraged. The savings rate plummeted by half, and a dependency developed between the monetary regime and the financial sector that did not exist in a time when money was honest.
Chronic price inflation began to abate in the early eighties, but the problem of credit on the loose began to show up in other ways. Starting with the domestic rescue and restructuring of the S&L industry, policymakers came to believe in the magical power of the financial bailout to fix all problems. No more would there be a price to pay for systematically bad investments and overbuilt capital sectors; they would instead be saved by a combination of fiscal intervention, debt conversion, and credit guarantees.
The troubles with the S&L industry began to be duplicated on an international level, first in Mexico and then in Asian countries and now, increasingly, in Latin America. In each case, the details are different but the overall structure is the same. A certain sector of the economy becomes overvalued and bloated relative to the underlying savings and consumer demand available to support it over the long run. Look deep enough, and you discover excessive and unchecked bank lending, subsidized by political design, at the root of each.
What happened thirty years ago to inaugurate this epoch of inflationary instability? In 1968, the gold exchange standard of the Bretton Woods system began to unravel. After a decade of credit expansion to support the burgeoning welfare state and the invasion of Vietnam, artificially overvalued dollars began to pile up in foreign countries, which were increasingly being redeemed from the U.S. at the fixed price of $35 for one ounce of gold. Meanwhile, on the free gold market, which the U.S. was pretending to ignore, prices were soaring. Fearing the loss of its entire gold stock, the Nixon administration suspended gold redemption at the same time it imposed wage and price controls in 1971.
The monetary crisis resulted in one of the most disastrous experiments in monetary planning of all time. Currencies were entirely decoupled from their historic linkage to a physical anchor. And for the first time in history, central bankers and governments the world over were completely unshackled from the outside monetary discipline that the gold standard, even the unstable one created in the postwar period, had imposed on them. Now, the dollar would be backed by nothing other than the promise of politicians and central bankers to make good in the long run.
At the time, experts opined that we had entered into a wonderful new era of monetary flexibility that would permit central bankers to impose stability on an inherently unstable global market economy. In reality, the opposite happened. The global market economy would no longer be protected from the ravages of unchecked credit expansion, fiscal profligacy, and unlimited debt accumulation. We experienced stagflation, hyperinflation, and a long round of financial calamities which continue to this day.
The experiment in free-floating, global fiat currencies has nearly unraveled many times in the past. It has also resisted every attempt to try to bring it under control (one thinks of the pitiful efforts of Treasury Secretary James Baker to fix exchange rates in the 1980s). What we are witnessing now is the definitive judgement that such unsound currencies are no basis for consistent and stable international economic development.
Clinton shows no awareness of the roots of the current global crisis. He referred to the problems of “financial turmoil,” but equally to the problem of “declining economic growth” and “negative economic growth.” His solution is a simplistic one: “spur growth.” But he has confused the condition with the cause, and thereby begged the whole question. As Clinton made clear, in today’s political lexicon, spurring growth means flooding the world economy with ever more credits and bailouts, in the vain hope that problems can be literally papered over rather than fundamentally solved.
It’s hard to believe that anyone can deny, at this late stage, that making the IMF the world’s lender of last resort doesn’t generate a moral hazard for governments. But in urging Congress to refund the global bailout fund, that is precisely what Clinton is doing. What’s more, he is agitating for the Ex-Im Bank to underwrite (or “generate,” in his words) more of the kinds of projects in foreign countries that are most in trouble, and also to make the expansion of world trade conditional on more labor and environmental controls.
To top it off, he announced that he wants a meeting of the finance ministers and central bankers from the major industrialized countries to “recommend ways to adapt the international financial architecture to the 21st century.” He means yet another attempt to realize the dream of monetary central planners since the 1940s: global deposit insurance, or, even worse, a global central bank with the power to create money out of thin air.
The road away from recession and financial crisis, and to a solid and stable prosperity, begins with a recognition that downturns serve a genuine market function. By purging unwarranted investment and deflating inflated prices back to their market level, recessions serve the crucial function of putting the economy back on an even keel.
Yes, a market-driven transition from recession to recovery can be painful. But the option of more debt, more bailouts, and more putting off the inevitable, is frankly unthinkable, except for an administration that seems to have a knack for denying the obvious and papering over problems in a vain hope that they will go away.
