G-20 maps road for chaos
By Hossein Askari and Noureddine Krichene
As the leaders of the Group of 20 (G-20) countries gather in London this week
to discuss their latest views on how to get out of the world financial crisis,
a damning picture of the progress likely this week emerges from the pledges
made by G-20 finance ministers and central bank governors at their own meeting
in London on March 14. Then, the promise was that they would act to restore
global growth and support lending and reforms to strengthen the global
financial system.
Their communique reads: "We have taken decisive, coordinated and comprehensive
action to boost demand and jobs, and are prepared to take whatever action is
necessary until growth is restored ... Fiscal expansion is providing vital
support for growth
and jobs. Acting together strengthens the impact and the exceptional policy
actions announced so far must be implemented without delay. We are committed to
deliver the scale of sustained effort necessary to restore growth, and call on
the International Monetary Fund to assess the actions taken and the actions
required. We will ensure the restoration of growth and long-run fiscal
sustainability ... Interest rates have been cut aggressively in most countries,
and G-20 central banks will maintain expansionary policies as long as needed,
using the full range of monetary policy instruments, including unconventional
policy instruments, consistent with price stability."
It would appear that the G-20 finance ministers and central bankers diagnosed
the cause of the economic crisis as only a lack of demand and ample energy and
food supplies as they have dismissed the role of the energy and food crisis of
2008. Their economic theory was that boosting demand will boost jobs; a great
novelty that has not been discovered by poor countries that suffer 30%
unemployment and underemployment.
Such theory contradicts classical and neoclassical economics of exchange,
production, distribution, and accumulation, and refutes the law of scarcity. If
the G-20 finance ministers and central bankers hold the stores of nature and
are to create abundance of all imaginable goods costless through fiscal
expansion and unconventional money policy, then why worry about job creation?
If they can turn stone into bread, why not let humans enjoy unlimited
abundance?
What is the finality of work when fiscal expansion and unconventional monetary
policy is restoring growth and securing all human wants? Why impose on people
disutility of work in such fabulous world of bliss? So please turn on the
abundance tap and let us have fun without work!
The G-20 communique is a recipe for chaos. The groups policymakers are wrong in
their diagnosis of the current crisis and therefore in the policies they have
been and are prescribing. They have simply ignored that major G-20 countries
have had imprudent expansionary fiscal and money policies in the last decade
and that these same policies have caused financial chaos. They have been
oblivious to the risks of conflagrating the present crisis and intensifying
exchange rate instability and protectionism.
Contrary to the G-20 diagnosis, the problem with world economy is not only the
lack of demand. It suffers from impending stagflation, which means excess money
supply and falling real supplies. Stagflation is a state the economy reaches
following an episode of fiscal deficits financed by money creation. Some G-20
countries are running record external deficits, indicating excessive demand.
For instance, the US external deficit rose from $39 billion in 1993 to $753
billion in 2006. By telling the world that it is suffering from deficient
demand, G-20 ministers and central bankers can be seen as telling a village
that it has a deficient demand for food when it is plagued by a famine
following depletion of all food supplies!
World demand is plentiful in terms of money supply. Money supply in most G-20
countries has been running at close to 20% in recent years. However, the real
purchasing power of money has gone down. As the saying goes: we used to go to
the market with money in our pocket and return with provisions in our basket.
Now we go to the market with a wheelbarrow of money, and return with provisions
in our pocket. Such was indeed the reality of Germany 1920-23, Zimbabwe 2008,
and many hyperinflation experiences.
People in Europe and the US have plenty of cash; however, the real purchasing
power of money has depreciated so rapidly as testified by housing prices, food
prices, and the price of basic necessities.
The cause for impending global stagnation was the relentless policy of Federal
Reserve chairman Ben Bernanke and his major central bank counterparts who have
injected massive money since August 2007, reduced interest rates, pushed energy
and food prices to a limit that has disrupted the economy. Bernanke and
counterparts had the conviction that aggressive monetary would produce an
instantaneous magic and produce an economic boom. Unfortunately, they have
pushed world economy into an impending stagflation.
Besides their wrong diagnosis and their failure to recognize the present
economic condition, the G-20 charted a dangerous course for destabilizing world
economy by unleashing fiscal deficits and printing money - the same policies
that brought about stagflation. The way out of this crisis is to restrain
fiscal and monetary policies. Certainly, politicians remain adamantly reluctant
to any fiscal or money restraint. Hence, the crisis will last as long as
government pursue fiscal and money extravagance and resist fiscal and monetary
adjustment.
The G-20 ministers and central bankers have been irresponsible with fiscal and
monetary policy. With regard to fiscal policy, traders in an exchange economy
do just that - exchange commodities against commodities. In taxation, the king,
call it government if you like, levies by force a tax on what the traders'
produce. No exchange takes place. If the king uses tax to feed his army, or
employees, or fight wars, then it will be a burden on the peasants, call them
the private sector, who have to settle with less produce, thus impairing their
investment capacity.
This type of spending is called unproductive spending. If the king uses tax to
build social capital in education, health, infrastructure, called productive
use, then such spending would enhance growth and productivity in the economy.
If the king decides to overtax, that is overspend, he can do it by de-basing
the currency, borrowing or falling into arrears. At any rate, peasants will
have much less produce for subsistence or investment. Their productive capital
will be depleted and growth impeded - the economy would be on the downside of
the Laffer curve.
During the past decade, many G-20 governments expanded fiscal spending for wars
and other unproductive spending, causing large external deficits, exchange-rate
instability, and a commodity and housing boom that have finally brought down
the real economy. These unproductive deficits were happily financed by China,
Japan and oil exporters. Now an increase in taxes will crush the private
sector.
Large fiscal deficits have already stalled the economy. Expanding fiscal
deficits at this stage will literally undermine private economy and deplete its
real capital. Real economic growth will be impeded because of lack of savings
and capital accumulation. Indicators show very low world inventories for staple
food and energy products. Food and Agriculture Organization statistics
indicated large world deficits in major products resulting in cutbacks in
consumption. By choosing fiscal expansion at a time when such a policy has
turned unsustainable, the G-20 has chosen an anti-growth strategy that will
impoverish further world economy. The best stimuli for most G-20 economies is
ironically no stimuli!
In the past decade, monetary policy in major G-20 countries, besides distorting
interest rates and leading to speculative bubbles and over leveraging, has
dealt a mortal blow to the financial system and wiped out wealth at an
unprecedented rate. By vowing to maintain expansionary money policy and
deploying unconventional policy instruments, G-20 central bankers have
undermined financial stability, intensified exchange rate instability, and
established the foundation for world inflation.
Former Fed chairman Alan Greenspan, Bernanke his successor, European Central
Bank governor Jean-Claude Trichet, and the like, have caused the worst
financial crisis in the post-World War II period and unprecedented bailouts,
the cost of which has yet to materialize over generations of taxpayers. In
spite of the financial disorder they have caused, central bankers, under the
illusion that they were minding their stores, did not see that their
unconventional instrument, that is money printing, would be devastating for the
economy.
By injecting money, Bernanke and Trichet are not creating oil, corn, rice and
real capital. They are simply redistributing wealth in favor of debtors. They
are heavily taxing workers, pensioners and creditors. They are destroying
savings and real demand. As they are printing reserve currency, they are
levying seignorage from non-currency countries, hence impoverishing poor
countries. The faster money expansion is, the faster inflation will pick up,
and the faster economic decline will be taking place.
By cutting interest rates to zero, G-20 central bankers have created serious
distortions in capital markets. Such distortions have led to a housing bubble
and speculation and been followed by the collapse of financial institutions. By
forcing real returns to capital into a negative range, real savings will
decline. Capital cannot be replaced. Public and private consumption will
increase tremendously as shown by widening fiscal and external deficits.
While the Organization of Petroleum Exporting Countries has renounced its plan
for cutting oil output by 4.2 million barrels a day, the G-20 has not been
responsible and has sought to accelerate fiscal and money policy mismanagement
without assessment of the risks that these policies pose for world economy.
It has been a characteristic of the US and European policy makers to try to fix
overnight an economic crisis that resulted from many years of fiscal and money
expansion and price distortions. In doing so, they have aggravated the crisis,
spreading it worldwide, but never conceding to the time element required for a
durable solution.
Stubbornly maintaining the same policies will delay a resolution and prevent
the crisis from running its course. Neither the US economy or many European
economies fit the Keynesian model. John Maynard Keynes was against inflation.
His policy prescription applies to an economy that has an external surplus, a
fiscal balance and a stable price level. Savings were not redeployed into
investment. He saw in such a context a role for the government to tap unused
savings for increasing capital expenditures. The Keynes model does not apply to
an economy that suffers fiscal and external deficits and is low on food, energy
and inventories of basic necessities.
In search of a quick solution, the G-20 has dismissed a role for the market and
for supply-side policies. While full employment is a priority objective,
classical economists neither called for fiscal deficits nor expansionary
monetary policy to resolve unemployment. Absent of labor market distortions and
wage rigidities, full employment prevailed during the 18th and 19th centuries.
Labor markets cleared through wages adjusting to marginal product. Demand for
goods was safely created from distributed wages, incomes, and economic growth.
Large fluctuations in employment arising from credit over-expansion and
contraction were limited.
Similarly, the G-20 opposed a market resolution for the housing crisis and
therefore delayed its resolution. The G-20 ignored supply-side policies and any
role for price stability in demand. They have missed the figures showing the
very low stocks of essential food products and the sharp decline in real
consumption of many products such as corn, meat and fruits, due to inflation.
Were they aware of tight supplies, they would perhaps have adopted policies to
expand supplies instead of expanding nominal demand and destroying real demand.
A few years from now, many G-20 governments will inherit even more financial
chaos and a crushing public debt. They will have to restore, under forced
conditions, a stable macroeconomic framework. They will have to go through the
pain of adjustment and endure even higher unemployment. Their task will be more
painful and costly because of the present disorderly policies that perpetuate
the financial anarchy of the past eight years.
Hossein Askari is professor of international business and international
affairs at George Washington University. Noureddine Krichene is an
economist at the International Monetary Fund and a former advisor, Islamic
Development Bank, Jeddah.
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