Page 2 of 2 Nero's ghost in Istanbul
By Hossein Askari
Essentially the same fate had befallen the Genoa Gold-Exchange Standard when
France and other countries converted their sterling holdings into gold, forcing
the United Kingdom out of the gold standard in 1931. International monetary
cooperation ended with the collapse of the Bretton-Woods system. However, it
was to be resumed at regional levels, particularly at the level of the European
community, reaching its zenith in 1999 with the creation of the euro.
Some economists, such as Maurice Allais and Joseph Stiglitz, warned in the
1990s about dangers of speculation in capital markets and the over-leveraging
that was taking hold. They considered the bailout of hedge funds by the US
Federal Reserve in late 1990s as erroneous and chairman Alan Greenspan's "put"
a prelude for a Great Depression-like financial crisis. Yet, the IMF
was never alarmed and appeared oblivious to these warnings. Over the years, the
IMF has neglected its monetary role and drifted away from its central mission.
Transforming itself also into a poverty reduction institution, the IMF
neglected monetary developments that finally undermined global financial
stability.
The catalyst for the current financial crisis is somewhat reminiscent of that
of the Great Depression. Namely, freed from the discipline of the gold
standard, the reserve currency centers faced no balance of payments constraint
and printed money and expanded credit as if there was no tomorrow.
Such abundant liquidity led the banking system to shower loans on the subprime
markets in form of mortgage and consumer loans with little regard for credit
risk. Moreover, it has been argued that dollar liquidities generated by
ever-growing US external deficits and held by foreign central banks were
immediately re-deposited at the US banks and served a basis for credit
multiplication and for amplifying the external deficits and dollar liquidity.
In contrast to a discipline-based system (as in a fixed exchange rate system
such as the gold standard), the flexible exchange rate system has no automatic
stabilizer and it is vulnerable to collapse under its own excesses.
Today's international monetary system is enveloped in turmoil. Exchange rates
instability is high; surplus countries - China, Japan and major oil exporters -
hold trillions in US dollars; if released, these liquidities could drown the
world economy with liquidity and trigger global inflation.
Reserve currency central banks have adopted an extremely loose monetary stand.
The world economy is arguably in the midst of even more monetary chaos than it
was in interwar period. Yet, the question of monetary stability and monetary
cooperation was never such a mirage as it has over this first decade of the
21st century.
Unfortunately, the concept of international cooperation as envisaged and
defined by the Group of 20 at their summits in London in April and more
recently in Pittsburgh affords little or no comfort and respite in the future.
There is no sign of the resolve and cooperation that was apparent in 1944, yet
the objective of monetary stability remains as relevant as it were in 1944.
Could a system of international payments be based on a gold-exchange system or
no standard be a surrogate to gold standard? Here is the biggest controversy
between those who condemn gold and those who see its virtues.
Prominent scholars such as David Hume (1752) and Jacques Rueff (1959) stressed
the futility of any system except a pure gold standard (that is a system with
no reserve currencies but only gold as a reserve asset). For these scholars,
the volume of gold is not a constraint. Hume was explicit. Any quantity of gold
would serve domestic or international needs. As money serves primarily as a
unit of account and a medium of exchange, prices would simply adjust to any
quantity of gold, as they do with regard to any quantity of paper.
Rueff repeatedly argued that attempts to salvage gold exchange, such as
creating the IMF's Special Drawings Rights (SDR), would not prevent the
collapse of such system. More specifically, reserve central banks are always
ready to accommodate any demand for credit and money; there is no international
law that can force a sovereign central bank into a prescribed credit policy. In
an exchange-based system (with reserve currencies), a reserve central bank can
expand credit to any limit it wishes without any regard to world financial
stability as clearly illustrated in the recent financial crisis. There is no
limit for monetary expansion by major reserve currency central banks. Such a
policy enables them to obtain a real tax on the rest of the world and reduce
the pain of deficit financing.
The IMF has endorsed the expansionary policies put in place by leading
industrial countries in Istanbul, as reflected in the communique of October 4,
2009: "We commit to maintaining supportive fiscal, monetary, and financial
sector policies until a durable recovery is secured, and stand ready to act
further as needed to revive credit, recover lost jobs, and reverse setbacks in
poverty reduction. We welcome the outcomes of the G-20 Summit in Pittsburgh and
support its commitment to articulating policies for strong, sustained, and
balanced growth in the global economy."
The IMF endorsement of policies that have resulted in financial uncertainties,
violent exchange rate instabilities, and affording no comprehensive approach
for international monetary reform could only pave the way for another financial
calamity. The G-20 has used the IMF as a vehicle for instantaneous and
unconditional loans to developing countries. Accordingly, the G-20 pushed IMF
lending power to over $1 trillion. Such gigantic lending was never contemplated
before.
Excessive lending to developing countries will end up, as in the past, in
another debt crisis similar to the generalized debt crisis of the 1980s. Many
developing countries are importers of industrial products and exporters of
primary products; they have limited export revenues for repaying fast-expanding
debt. It would appear that the IMF has been used by the powerful in the G-20 to
create markets for their exports in developing countries as they load them up
with burdensome debt.
The IMF's Istanbul communique praised the G-20 for its loose fiscal and
monetary policies as conducive to strong, sustained, and balanced growth in
world economy. The communique also acknowledged setbacks in poverty reduction.
These setbacks could be further aggravated with rapidly rising unemployment in
industrial country and rapidly declining real incomes of workers.
The communique ignored heightened uncertainties that are plaguing the world
economy. Gold prices are setting new records above the $1,000 mark. What will
be the price of gold six months from now? Although oil is climbed above $75 per
barrel mark, will it revisit its July 2008 highs? Or what will be the
dollar-euro exchange rate? How much is the rest of the world willing to finance
record US fiscal deficits at 13% of GDP while holding rapidly depreciating
dollars? Central bankers are even under increasing pressure to hedge their
foreign reserves by buying more gold. Investors could shun dollar assets. A run
on the US dollar would create unimaginable exchange rate instabilities.
Achieving strong and sustained economic growth with such instabilities would
only indeed be miraculous.
The IMF-World Bank meetings in Istanbul had an eerie feeling reminiscent of a
burning Rome as Nero played the fiddle. In the midst of the ongoing financial
chaos, the prime subject of reform was how to reshuffle the voting power in the
IMF to better reflect economic and financial realities. But will a new and more
effective IMF arise out of the ashes, as did a more glorious city of Rome?
Hossein Askari is professor of international business and international
affairs at George Washington University.
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