Page 2 of 2 G-20 fritters as crisis deepens By Hossein Askari and Noureddine Krichene
systems. Although they have divergent approaches, G-20 governments nonetheless
agreed that there was a need to strengthen the regulatory and supervisory
framework in their respective countries. It was proposed that G-20 reconvene on
April 2 this year to review progress in regulation.
Hence, while there is no dearth of explanations for the financial crisis,
attention has been completely diverted from a central cause of the financial
crisis, namely US fiscal deficits and highly expansionary monetary policy.
In response to a deflation scare in 2002, then Fed chairman Alan Greenspan
immediately cut interest rates. The Fed's decisions to
turn interest rates largely negative in real terms were not random. They were
deliberate decisions with the very purpose of boosting credit regardless of
risk. They were debated at the Fed's rate-setting Federal Open Market Committee
meetings, were adopted in full recognition by high ranking Fed governors, and
were recorded in FOMC proceedings. Banks, China, Sovereign Wealth Funds, hedge
funds, and money market funds were swamped with endless supply of dollar
liquidity deliberately pushed by the Fed.
So what did we do with this deluge? It went to subprime borrowers who suddenly
and happily became rich. Ponzis proliferated, CEOs and hedge-funds managers
made huge fees, and speculators made large gains. They all played by the Fed's
rule and accomplished exactly what the Fed wanted them to achieve: shovel
mountains of liquidity into the economy.
This is what the world should have coined as "shovel ready," way before the
projects slated for the bailout package. There is no way to absorb safely and
productively unlimited liquidity. The crisis is a natural outcome of the Fed's
mismanagement. While better regulation and supervision would have given signals
of the pending disaster and more warnings, it is unlikely that it would have
stopped the Fed.
There is no disagreement that financial systems have to be better and more
effectively regulated and supervised in every country. Yet, when central banks
by-pass prudent banks, lend directly to consumers and high-risk borrowers, and
incur capital loss, does regulation have a place? If the ultimate aim of the
central bank is to deliberately ruin the value of money, then tight bank
regulation becomes totally meaningless. Even a 19th century system with no
hedge funds, CDSs, or Black-Scholes formula would collapse, and as it did in
the UK in 1848.
Regulatory issues should also be a priority for the forthcoming G-20 summit.
But what should be the pressing priority for the G-20 summit is a reversal of
the dangerous financial policies that were responsible for the crisis and that
were being perpetuated regardless of food and energy crisis in 2008, GDP
contraction in 2008Q4, and growing unemployment.
The financial crisis was brought about by dangerous policies of major reserve
currency central banks. These policies would have devastated the financial
system and the economy even in best regulated banking environment. These same
central banks are now entangled in a furious war of zero-interest rates,
unlimited money supply, and competitive depreciation. Simultaneously,
governments are running record fiscal deficits.
Perpetuating fiscal and monetary disasters that brought about the current
financial crisis and world economic recession will be very dangerous for world
trade and freedom. The financial anarchy following the great depression and
beggar-thy-neighbor policies led to a full-scale world war. Only the war
convinced politicians that financial stability was a mandatory requirement for
world trade and economic stability.
G-20 leaders have to rein in central banks from destroying the value of money
and undermining monetary stability. Hyperinflation can be expected ahead. One
hears this warning not only from academicians but also from savvy investors
such as Warren Buffett. The members of the G-20 should talk each other into
reason before there is more despair and the inevitable march towards
protectionism.
In 1982, global economic recovery began with highest interest rates and
restrained monetary policy. Zero interest rates and abundant liquidities
destroy savings, which are necessary for investment and growth. Suppliers find
themselves awash with liquidity, the cost of carry for holding back commodities
is negligible when interest rates are near zero, and they have no need to sell
commodities for raising cash since cash is obtained freely from banks. Hence
they hold back their commodities from the market. This reduces real supplies
and exacerbates further commodity prices.
Unlimited credit expansion by central banks will push demand far beyond
commodity supplies. It will result in pure price increases. Real incomes will
decline and poverty will spread. Inflationary dynamics will intensify and
create a serious contraction of the real economy.
Large US fiscal deficits and the inevitable US current account deficits have
been another cause for the current economic crisis. Large fiscal deficits will
increase aggregate demand and contract real supply. They will simply exhaust
savings and fuel inflation. They will undermine private sector growth and
aggravate unemployment. Boosting fiscal deficits at this juncture will be a
dangerous path for world economy, which is in dire need of stability. It will
translate into rapid inflation, exchange rate instability, and growing
unemployment.
Large US current account deficits are simply not sustainable. The world has
known this but has turned a blind eye for about 20 years. The US must increase
its savings rate. It cannot simply tell China (or earlier Japan) to consume
more. The US must control what it can to restore international balances and
exchange rate stability.
The ongoing financial crisis has reached unmanageable proportions politically,
financially, and economically. Its fallouts are unpredictable and could be
indeed as severe as that of the Great Depression.
The G-20 summit should take a sober approach, be responsible and prudent, and
use this as the occasion for establishing the foundation for rescuing the world
economy from present fiscal and monetary chaos that is being propagated by
major reserve currency countries. The summit should re-order priorities, rein
in central banks, and renounce unsustainable fiscal deficits.
At the same time, the leaders should make a commitment to develop the
mechanisms for other supporting policies and initiatives: promote the G-20 as
the forum for international economic discussions by world leaders and
developing a permanent secretariat for the G-20, establish an international
system for financial regulatory and supervisory control, reform the IMF and
World Bank, revamp the international financial architecture, and broadly
coordinate economic and financial policies.
World economic recovery can occur only in a stable money and fiscal environment
as demonstrated in 1873-1907, 1950-1966, and 1982-2000. The private sector is
wary of present fiscal and money chaos. It will refrain from investing as huge
uncertainties continue to prevail. The G-20 summit is the best opportunity and
occasion to restore private sector confidence by restoring fiscal and monetary
restraints, removing interest rates distortions, re-establishing free market,
emphasizing world supplies of food and energy, and laying the foundation for
badly needed international financial and economic cooperation.
The world, more than anything else, needs a big boost in confidence. On April
2, the G-20 can take this opportunity to provide confidence by addressing the
real issues or it can waffle and let the international financial system and the
economy meander without a rudder. International meetings provide an opportunity
to provide leadership and confidence to demonstrate that countries are working
together for global solutions, but by building expectations, failure can cause
great harm. Such meetings are not costless. Preparation and follow through are
the keys to success. Let's hope that the ministers strengthen the April 2
agenda before it is too late.
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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