Page 2 of 2 Geithner's folly By Hossein Askari and Noureddine Krichene
Geithner's top priority was to clean up toxic assets irrespective of the fiscal
cost for such a clean-up and its social inequity. Not doing so would, in his
opinion, have incalculable consequences for American families. He omitted the
incalculable consequences that will befall American families as the debt burden
of these bailouts unfold over time.
While billions have been, are being and will be rushed to bankers, no social
program has been drawn to help a rising number of homeless and poor people. As
the TARP became a precedent, he
has not hesitated to contemplate a new facility at $500 billion for buying
toxic assets.
While his predecessor at the Treasury, Henry Paulson, found out that handling
toxic assets was prohibitive and impractical, Geithner still wants to buy these
assets. Bernanke and Geithner have become entangled in a vicious circle. By
expanding the TAFL to $1 trillion, Bernanke will create the toxic assets that
Geithner will have to buy. The beneficiaries of these loans will enjoy free
wealth!
In hearings with banks on February 11, the US Congress admonished banks to lend
irrespective of risk. Banks defended themselves and confirmed that they were
lending. A new ideology has taken hold both in the US Congress and the new
administration: force banks to lend regardless of risk and reward. Such has
never the role of banks, to hand out cash to all borrowers that will never pay
it back. This practice will endanger the very existence of banks and will lead
to legal looting.
Banks that surrender to pressure to lend indiscriminately will certainly face
losses and even liquidation. The US Treasury is moving towards nationalization
of the "banks that are too big to fail" in the most costly way. If it wants to
save these banks it should move quickly and desisively to temporary nationalize
these banks to minimize taxpayer costs and reduce market uncertainties.
In a Wall Street Journal article on February 11, Peter Ferrera, a former member
of Ronald Reagan economic team contrasted Reaganomics with Obamanomics. He
noted that Obama wanted higher taxes, more regulation, more spending and loose
money. He compared Obama's program with Reagan's economic recovery program,
which had four specific components.
The first was across-the-board reductions in tax rates to provide incentives
for saving, investment, entrepreneurship and work. The second component was
deregulation to remove unnecessary costs on the economy. The third was the
control of government spending. The fourth was a tight, anti-inflation monetary
policy, which was spectacularly successful. Inflation was cut in half to 6.2%
in 1982 from 13.2% in 1980, and cut in half again to 3.2% in 1983.
These policies worked, and put the economy on a sustained growth path in just
two years, an economy that was arguably in far worse shape than today's, and
pulled it from a protracted double-digit inflation, double-digit unemployment,
double-digit interest rates, declining incomes, and rising poverty.
The Obama Administration's economic policies do not include any of the four
Reagan components. In fact, the stimulus plan is one of the biggest increases
in government spending known to man, while the Fed is furiously reinflating,
sowing more havoc down the line.
Is the Obama stimulus program capable of pulling the economy from recession?
The answer would be yes if the fiscal deficit was small or the budget was in
surplus as inherited by Bush from the Bill Clinton administration, the external
current account was in surplus, and the economy was not suffering from
exorbitant food prices.
With the US fiscal deficit at historical record and the external current
account at its largest level, a stimulus package would have no impact, as shown
by House speaker Nancy Pelosi's $160 billion package. The latter translated
into higher inflation and more external deficit.
The financing of Obama's stimulus program has been deliberately avoided by the
Obama administration and Congress. If it is financed by foreign borrowing, then
it will have negligible effect on growth and unemployment and will contribute
to enlarge the external deficit. If it financed domestically, it will crowd out
the private sector and still will have a negligible impact on both growth and
employment. If it is financed through inflation, it will have disastrous
economic and social consequences.
Nonetheless, in view of its ominous size, the stimulus package will have grave
inflationary impact on both the US and the rest of the world, and reduce the
real wealth of foreign holders of US dollars, with ominous implications for the
future role of the dollar as an international reserve asset.
Could Obama have chosen a less controversial and safer economic program? The
answer is yes. Obama could have considered a stabilization program that would
narrow the fiscal deficit, bring monetary policy to orthodoxy, free interest
rates, and uproot inflationary pressure especially in food prices.
The present monetary policy is unsafe and is only laying the groundwork for an
even more devastating financial crisis in the future. There is no economy that
can grow with zero interest rates. Keynes has long discussed the role of
expectations in entrepreneurial decisions. When interest rates are at a minimum
level, below which they can no longer fall, banks expect interest rates to rise
significantly, and they cannot commit long-term loans that will suffer capital
losses and negative income margins.
The US economy will remain depressed as long as interest rates are depressed by
the Fed. The Obama administration could have freed interest rates so that
capital markets could resume lending without any government intervention. It
could have addressed exorbitant foods prices that will depress non-essential
spending and elaborated programs for higher food supply and more competitive
food industries. As shown clearly by the rise in retail sales in January 2009,
a decline in prices of necessities could have a quicker and more powerful
effect in reviving the economy.
Obama has evidently embraced Bush's economic policies. With his stimulus
program now approved and his monetary policy out of control, the US economy is
facing high uncertainties and economic and financial instability. The dollar
could come under renewed pressure. Poverty could reach painful dimensions. His
program may ruin the growth foundations of the US economy for some time to
come.
Geithner knows why we are "here". His resolute adherence to out-of-bound fiscal
deficit, grandiose bailouts, combined with Bernanke zero interest rates and
unlimited destruction of money, will keep us "here" for a number of difficult
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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