G-20 makes it worse

Apr 8, 2009

G-20 makes it worse
By Hossein Askari and Noureddine Krichene

The contrast between the Group of 20 summit communiques of November 2008 and April 2009 is striking. While the first communique recognized that the surest way to restore economic growth was to rely on capitalism, international cooperation and the private sector, the second abandoned these principles and called for unprecedented fiscal-cum-money intervention to restore growth.

US President Barack Obama was not present at the November meeting; his absence, however, created uncertainty among leaders regarding the course of G-20 policy. With Obama leading the April G-20 summit, the group has been pushed to the far left.

While a G-20 subgroup continues to enjoy robust economic growth, large external surpluses and sound financial systems, the largest subgroup, ironically composed of leading industrial countries, continues to suffer from self-inflicted wounds - namely, it has bankrupted its own financial system thanks to expansionary fiscal and monetary policies and unprecedented credit booms in the past decade.

These policies have now led to gigantic bailouts that will imperil fiscal balances for some time to come, guaranteed bank debts, and to calls for public-private bad banks to buy toxic assets. Economic performances in this group have deteriorated between the two summit dates.

US Federal Reserve chairman Ben Bernanke's aggressive monetary policy and anti-depression doctrine has pushed interest rates to zero and resulted in the US unemployment rate jumping from 4.3% in 2007 to 8.5% in March 2009. Similar disasters have plagued the UK, the European Union and Japan. Thanks to unrestrained fiscal-cum-monetary policy, these advanced industrial countries are now experiencing contracting output and rising unemployment.

Frustrated by impotent fiscal and monetary stimuli, this group has desperately pushed cheap and unconditional fictitious loans, created from thin air, on developing countries - the international equivalent of the subprime market - in the hope of creating markets for their industrial products. Hence, after saddling their domestic subprime with debt, these G-20 countries have turned to bankrupting developing countries with purely counterfeited money. Such a strategy, while dangerously inflationary, will export unemployment to these developing countries, blow-up their banking systems, trap them in another debt cycle and impair their development process.

The communique reads:

We are undertaking an unprecedented and concerted fiscal expansion, which will save or create millions of jobs which would otherwise have been destroyed, and that will, by the end of next year, amount to US$5 trillion, raise output by 4%, and accelerate the transition to a green economy. We are committed to deliver the scale of sustained fiscal effort necessary to restore growth ... Our central banks have also taken exceptional action. Interest rates have been cut aggressively in most countries, and our central banks have pledged to maintain expansionary policies for as long as needed and to use the full range of monetary policy instruments, including unconventional instruments, consistent with price stability ... Taken together, these actions will constitute the largest fiscal and monetary stimulus and the most comprehensive support programme for the financial sector in modern times. Acting together strengthens the impact and the exceptional policy actions announced so far must be implemented without delay. Today, we have further agreed over $1 trillion of additional resources for the world economy through our international financial institutions and trade finance ... We will conduct all our economic policies cooperatively and responsibly with regard to the impact on other countries and will refrain from competitive devaluation of our currencies and promote a stable and well-functioning international monetary system.

Undeniably, the communique reads as one of Obama's election stump speeches, with the heavy economic and financial imprints of his economic advisor Larry Summers, now Treasury Secretary Timothy Geithner and Bernanke. At home, with a view to creating 4 million jobs, Obama has launched the largest-ever stimulus program at $787 billion; his budget deficit, at $1.85 trillion or 13% of US GDP, has shattered all records and pushed US public debt to unsustainable levels, while the Fed has been creating money out of thin air in the trillions of dollars.

Bernanke has pushed the US monetary policy on a course with incalculable economic costs that could end the era of dollar as a reserve currency. The outright monetization of Obama's fiscal deficits could send the US dollar to record lows and unleash the worst inflation in recent US history.

With Obama's unsound financial policies replicated by the rest of the world, it is impossible to forecast what the state of the world economy will be before the next G-20 meeting. Although G-20 experts were predicting 4% real economic growth, they forget that the private sector had never been subjected to such economic uncertainty and fear. In such a dire financial setting, it is impossible to predict what will be the state of the world economy in the medium-term. How is it possible to regain control of fiscal and money discipline? The G-20 has failed to restore confidence for a growing economy but has instead paved the way towards growing chaos.

The communique stipulates that "Taken together, these actions will constitute the largest fiscal and monetary stimulus and the most comprehensive support programme for the financial sector in modern times."

The G-20 experts failed to realize that over the past decade leading industrial countries have been experiencing the most expansionary policy in their history, yet the "Harvard multiplier" has so far been working in reverse. They forgot these same expansionary policies led to speculation and bankruptcies, pushed oil prices to $147 per barrel, triggered energy and food protests around the world, disrupted airline industries, trucking and marine shipping, played havoc with real economies, and finally ended up with a global economic recession.

Intensifying fiscal and monetary assault will eventually revive the nightmares of 2008 and could cause more financial disorder. While the Organization of Petroleum Exporting Countries has renounced a previously announced 4.2 million barrels a day cut in oil output with a view to stabilizing oil prices and supporting global economic recovery, the G-20 wants to stoke oil prices. With oil prices reflecting persistent upward pressure, prospects for world economic recovery could become dim.

The G-20 experts seem oblivious to the ravages already caused by monetary and fiscal expansion and seem to deny simple truths characterizing these policies. Namely, large fiscal deficits reduce real savings, crowd out private investment and undermine economic growth. Second, monetary expansion has regularly caused speculation and banking crises. Zero interest rates will erode real capital and strangulate banking and financial intermediation.

A simple economic principle evaded those experts: the real aggregate demand is downward sloping: a depreciation of money in the form of a rising general price level depresses real output. Some call it long-term stagflation. In particular, in recession, monetary policy finances pure consumption loans and depletes savings and investment - both necessary for economic growth. It contributes to deepening recession and strengthening inflationary expectations.

The communique announced a world gold rush: "Today, we have further agreed over $1 trillion of additional resources for the world economy through our international financial institutions and trade finance."

The G-20 applauded Mexico's request for $40 billion under the International Monetary Fund's newly created flexible credit line, irrespective of past Mexican debt crises and the country's inability to service its debt. In this atmosphere, maybe the G-20 would even applaud a multi-billion request from Zimbabwe!

While domestic banks should lend against good collateral, conditionality with international loans was meant to enhance the chance of repayment. When conditionality is removed, a lender has no reason for blaming the borrower. All countries will be washed with billions of dollars in reserves created out of nothing and will spend furiously with fake money that has no real counterpart.

With oil reserves depleting in most countries and oil output stacked at 86 million barrels per day, the impact on oil prices will be obvious. In the same vein, with depleting food stocks as noted recently by the head of the United Nations' Food and Agriculture Organization and pressures on the limited cultivable land, the effect on food prices could be overwhelming. Developing countries will have to run large fiscal deficits and expand domestic money supply to absorb new reserves and mountains of unconditional low interest loans.

When this cheap booze is all gone, they will be left with bankrupt public treasuries, dysfunctional domestic banking systems and a splitting hangover. As in the 1980s and 1990s, their economies will be in a dire state of disintegration, with boatloads of people sinking on their way to finding jobs elsewhere.

The communique became totally far-fetched in stating: "We will conduct all our economic policies cooperatively and responsibly with regard to the impact on other countries and will refrain from competitive devaluation of our currencies and promote a stable and well-functioning international monetary system."

This statement is certainly betrayed by a furious war among leading central banks in competitive devaluation and unorthodox monetary expansion. Each leading central bank has been endeavoring to depreciate its own currency and avoid any appreciation; interest rates have been cut to the lowest seen in the past three centuries. Exchange-rate instability has been at about its highest.

How monetary stability could be promoted in a system of floating rates is a question that may elude economists, with G-20 experts holding the secret! The blunt contradiction is inescapable in this statement: "Our central banks have also taken exceptional action. Interest rates have been cut aggressively in most countries, and our central banks have pledged to maintain expansionary policies for as long as needed and to use the full range of monetary policy instruments, including unconventional instruments." The more central banks engage in exceptional action, the more instability and contraction of trade volumes will be inflicted on the world economy.

Under the nostalgia of the George W Bush credit boom, the G-20 wanted to create an Obama credit boom at even far greater scale than has existed in modern times. The Obama team is beating the drums and making everyone dance the world over. Financial regulation becomes totally irrelevant when central banks are in pursuit of destroying currency. The world is now doomed to medium-term economic instability. So many uncertainties loom ahead. The inflationary consequences of G-20 approach could be devastating and may push vulnerable countries to the brink of starvation as seen in 2008.

Obama was elected to implement change. Unfortunately, his policy gurus have decided only to intensify previous financial policies and spread them far and wide. When insanity spreads you can only hide your sanity. Spreading insanity around the world is itself insanity. The G-20 could have spared the world economy unnecessary suffering. Unfortunately, it chose the continuation of financial disorder. The world cries out for private investment and growth, while the G-20 creates fake money and impairs growth.

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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