It is over a month since Lehman Brothers caved in, and more than three weeks since Iceland’s Prime Minister warned that his country was close to national bankruptcy. Over the last few weeks, there have been a number of high-level meetings, as global decision-makers slowly begin to understand that this is no ordinary crisis.
The 43 nations’ Asia-Europe Meeting ended with a bland declaration that there was a consensus for a reform of the system. Only the UK Prime Minister, Gordon Brown, came out with the suggestion of devising a regulatory framework for international monetary institutions that work with little or no regulation at national or international level. Brown could not have meant the Bretton Woods institutions as the World Bank and the IMF have their multinational Governing Bodies and Boards of Directors as also a plethora of advisers of diverse nationalities.
The one institution that is strictly an American icon but has a vast international footprint is the US Federal Reserve, which, as the US central bank, controls not only the total quantity of dollars but also the price for its supply and is clearly the one that needs watching.
The former Russian President, Vladimir Putin, has been saying for some time that the world should abandon the US dollar as a global reserve currency since its fluctuations tend to harm everyone who uses it for trade or as store of value. OPEC calls the US dollar a worthless piece of paper. Argentina, Cuba, Iran, Iraq and Venezuela have already said “no” to the dollar.
The fact that the Keynesian system held up the US dollar as virtually the global currency put an enormous responsibility on essentially a national institution. What was the role of the US Federal Reserve (Fed) in the train of events that resulted in the current crisis? What was the responsibility of the Fed in causing the consumer boom that resulted in the sub-prime lending in the US?
At present, the US government is primarily interested in rescuing Wall Street and the banking institutions by throwing hundreds of billions of dollars in the pit without knowing its precise dimensions. The American tax payer, already deeply concerned about unprecedented deficits, huge expenses required for the restoration of infrastructure and the two wars, may not be fully sympathetic to the efforts of the government to save the banks without any attempt to save the economy. Housing prices are falling all around and will possibly fall further. There will be more foreclosures on the mortgages. Mere pep talks by policymakers, no matter how influential and reputed, are unlikely to rebuild the confidence of the people in the financial institutions unless such talk is based on a deep analysis of the causes of the crisis.
The assets in which the big players such as Citibank, Merrill Lynch and Bear Stearns invested, have suddenly ceased to have any market, as the other banks are not keen on financing such insecure assets. The rest of the world is also fast losing confidence in the US-centered financial system. What started as a sub-prime crisis in the US is fast developing into a global crisis. The rest of the world faces problems that are far more serious than those faced by the US. The essential functions of the central bank of any country are to raise money within the national boundaries and fix its price i.e. the rates of interest.
It is well-known that the Federal Reserve is not only the central bank of the US but also the de facto central bank of all the national central banks in the free world whose reserves comprise predominantly dollars. Furthermore, the Fed, as the central bank of all the nations, decides at what rate it will lend dollars to national central banks.
After the first Gulf War, dollar printing became the most profitable business for the US. The dollars, as global tender, was in perpetual demand by other nations as the Bretton Woods system was based on US dollars and gold.
In the post-Cold War years, in a situation of virtual US political and economic hegemony, the Fed appears to have followed a deliberate policy of large recourse to the printing press. The Fed cut interest rates repeatedly and the US households gradually stopped saving.
Thrift, the much-prized virtue in the laissez faire system, became, in the Keynesian ethos, an object of mirth and ridicule. Its place was taken by the Federal Reserve that prints and supplies more dollars to enable the consumer to spend on imports. The malls import goods from China and elsewhere and sell them to American households, thanks to the easy money created by the Fed. The flight of the dollars to countries exporting commodities to the US is compensated by borrowing them from foreign governments to bridge the current account deficit. The foreign governments are also happy with this system.
The Fed has thus promoted and supported a global financial architecture in which it has the means of forcing central banks of other nations to hold the reserves in the US securities, very much like the SLRs. The US dollars could function as store of value only to the extent that they are strictly limited in supply and the US government does not have the possibility of uncontrolled printing that allows it to print as many dollars as it wishes, at essentially no cost. By increasing the volume of dollars in circulation, the US government can also reduce the value of a dollar in terms of goods and services. This has swollen the Fed’s reserves outside the US to approximately $3.8 trillion.
The Great Depression of the 1930s was blamed on deficiency of effective demand caused, interalia, by savings and thrift. Thrift ceased to be a virtue. The antidote to the 1930s Depression corrupted the work ethic and mores of the society at large; creating an impression that one could spend one’s way to prosperity.
It must be admitted that it was not US’ consumers alone who benefited from this. It also created an environment of easy liquidity, which helped many countries in the developing world to escape poverty. Unfortunately, all good things must end. When people start prospering by spending rather than by the sweat of the brow, it was only a matter of time before sharks appear on the scene. Bankers themselves ceased to be genuine bankers and thought nothing wrong about financing questionable investments that could make their balance sheets look good.
Finally, the reality of the supply-demand situation had to assert itself and the morality that was engendered by the Keynesian anti-thrift preaching, combined with the short-sightedness of the Bretton Woods agreements and the cupidity of those responsible for the monetary management in the US, was bound to bring about a crisis and not only in the financial systems of the US but also that of the world.
To overcome the present crisis, it would be necessary to introduce a global tender that would be managed more responsibly. The obvious solution is to make the euro the global tender. It has the advantage of representing some sort of a basket of currencies and is controlled by the entire European Economic Community.
No comments:
Post a Comment