The headless chickens at the IMF, the World Bank, the Fed, and the White
House are running around in a panic, trying to cobble together some way
of dealing with the global financial meltdown. Robert Rubin has been
reduced to paraphrasing Rodney King: can’t we all just get along?
Some convergence does seem to be in the offing, however, which is bad
news for taxpayers and the future of the world economy. The financial
elite are endorsing a huge new lending/bailout fund administered by the
IMF, for countries whose currencies are under “attack” by international
money markets. This would allow “early intervention” to shore up the
currencies before matters got out of hand.
But these advocates do not understand the first thing about the
worldwide crash, much less the role that IMF lending has played in
deepening and prolonging it. They believe they can create an
international bailout fund while at the same time avoiding the “moral
hazard” inherent in all financial welfare programs, since irresponsible
conduct is encouraged by subsidizing it.
Starting with first principles, currencies do not come under “attack”
from money markets without good reason. Traders examine the books,
lending policies, debt structure, and money supply of a profligate
government, and conclude that its currency is overvalued. They reduce
their holdings of that currency relative to sounder ones, thereby
driving down its exchange rate. Markets are merely doing what they do
best: seeing through the fog to discover true value.
Of course the managers of the currency being sold are furious. They
denounce speculators and pledge to defend the currency by dumping their
hard-currency reserves and buying their own soft one. They attempt to
reverse the judgement of the markets, which only sets off more alarms.
Market forces then zero in on the government for its attempted defiance
of economic law, and eventually win. Every time.
Yet governments do, in fact, have a choice when swatted by the markets.
They can get their fiscal house in order, stop the currency printing
presses, let unsound banks fail, and permit the much-needed economic
contraction to take place on its own terms, so as to set a firm
foundation for future growth. Sadly, few regimes are wise and honest
enough to mend their ways. Instead, they start grasping for an easy way
In recent years, that’s where the IMF, the World Bank, the Fed, and the
White House have come in. If these institutions regard the exposed
government as a pal, or if big banks have large holdings in the falling
currency, they come to the rescue with infusions of hard currency. That
not only puts off the much-needed correction; it signals other
politicians and big investors that they too can avoid the consequences
of bad choices.
The proponents of global welfare tell us that they can create a bailout
fund and prevent it from generating moral hazards. How? Harvard’s Martin
Feldstein suggests the fund lend money at “above-market” interest rates.
But this is absurd. If private markets were willing to lend money at
lower rates and on the same terms as offered by the proposed fund, why
set up a fund? By definition, rates will be subsidized.
Moreover, it is not only the terms of the guaranteed loan that generate
the moral hazard; it is also the very existence of a fund. After Mexico
was bailed out, Bill Clinton assured us it would not set a precedent.
And yet, Thailand, Indonesia, Korea, Japan, and Russia have lined up at
the trough. Had Clinton never started this process, the current meltdown
might not be so messy.
Other schemes are similarly flawed. One proposal would force countries
to put up large amounts of foreign currency reserves and even their
industries as collateral. But here again, if collateral were enough to
compensate for the risk, private lenders would be happy to extend the
Clinton calls Congress irresponsible for failing to send more tax money
to the IMF during a crisis. In fact, we are not in a crisis that a power
grab by Clinton can fix. Rather we are in a much-needed correction, and
giving the IMF more cash to waste cannot prevent the inevitable.
Governments can do enormous damage to markets in the short run, but they
can never outwit them in the long run.
There’s been some recent nostalgia, expressed even in Alan Greenspan’s
pronouncements, for the predictability, efficiency, honesty, and
sturdiness of the old-world gold standard. But nostalgia doesn’t pay the
bills. The financial elite should define the dollar in terms of gold and
be done with it. If they can’t do that, they should do absolutely