The Mises Institute monthly, free with membership
January 1998
Volume 16, Number 1
Bailout Mania
by Jeffrey M. Herbener
When the IMF declares a country an "economic
miracle," look out. A financial crisis cannot be
far behind.
First it was Japan, the juggernaut that was said to be on the
verge of
supplanting the U.S. as an economic superpower. Then it was
Mexico, the model of how
former banana republics can be transformed into thriving market
economies. Then it was the
Czech Republic's turn as a model of de-socialization. Then the
Asian Tigers took
their turn in a financial fall from grace.
The IMF is fast becoming handmaiden to the new international
monetary
regime. That fact explains its pathetic track record of
predicting financial debacles and
its penchant for bailing out failing economies. At last, the
world has a
lender-of-last-resort, a menacing Fed for the world, and its name
is the IMF. The
intellectual inspiration of the new regime is no less than John
Maynard Keynes.
Keynes believed that one major defect of the free market was
that it
accumulated capital too slowly, in part because market interest
rates are always too high.
Society's progress, Keynes thought, depends on a policy of
reducing interest rates by
central bank control of money and credit.
The Federal Reserve does this by creating new money and using
it to
purchase securities from banks. These open-market operations bid
the price of bonds up and
push interest rates down. This entices entrepreneurs to borrow
for capital projects that
would have been unprofitable at market rates of interest. This in
turn brings about a boom
in capital projects that Keynes thought could be extended
indefinitely.
But as Ludwig von Mises showed, the interest-rate driven boom
must end in
bust since the newly created money cannot be confined to the
credit markets. Instead, it
will be spent again and again to buy consumer goods. Interest
rates will eventually be
pushed up again, and capital values and stock markets will
collapse. The boom comes to an
end.
Keynes recognized that the extent and duration of the
artificial capital
accumulation during the boom depends on the international
monetary regime. The U.S., home
to the world's reserve currency, is able to extend its booms
further and for longer
periods than any other country by "exporting" its monetary
inflation.
If the newly created money the Fed pumps into banks does not
go into the
hands of American consumers, it can be: (1) invested by American
companies in foreign
countries, (2) lent by American banks to foreign firms, or (3)
spent by American consumers
on imports and held by foreign central and commercial banks as
reserves against their own
currencies and in foreign commercial banks. If one or all of this
happens, we don't
suffer a domestic recession.
This is precisely what has happened. Consider the paradoxical
movement of
the stock market and the GDP. The meteoric rise in the stock
market, up about 28 percent
per year for the six years of the boom, has resulted from the
twin causes of low interest
rates and high earnings.
The relatively anemic increases in GDP, about 2.5 percent per
year during
the same six years, coincides with an overseas boom in investment
and production. This
overseas boom does not count in the U.S.'s GDP. The U.S. economy
dwarfs that of its
foreign partners, so this transfer of production will lower our
growth rate but greatly
increase growth in smaller economies.
On the 1996 list of developing countries that received the
largest amount
of foreign, private investment, Indonesia, Malaysia, and Thailand
rank third, fifth, and
sixth. The regions of East and Southeast Asia received nearly
half of the $243.8 billion
in foreign, private investment.
China, now called the next economic miracle, has been far and
away the
largest recipient of foreign, private investment since 1992. It
received $52 billion of
these investment funds in 1996. To the extent that these capital
projects are fueled by
central-bank inflation, they are part of the "exported" boom. (If
China escapes financial collapse, it will be due to its pace of
privatization.)
To continue their domestic booms, adjunct countries must
refrain from
conducting an "independent" monetary policy. They must
coordinate their own central-bank monetary inflation with the
Fed's. If instead their
central banks pile domestic monetary inflation on top of the
"imported" dollar inflation, domestic
price inflation will rapidly follow, since they cannot "export"
their own monetary inflation.
If they try to delay or deny the decline in their currencies'
purchasing powers by linking or pegging their currencies to the
dollar, then instead of
smooth, gradual decline they will face swift and massive
devaluation. Devaluation, like
its domestic counterpart price inflation, pushes interest rates
up, causing capital values
and stock markets to crash.
Evidence that this process was in full swing in Thailand was
obvious in
1997. Its central bank had been inflating the baht at higher
rates than Fed inflation of
the dollar. Flush with funds, Thai banks extended loans to
riskier and riskier projects
ending up with speculative indebtedness in the expanding real
estate bubble.
Thailand's central bank responded to the advent of devaluation
in
typical fashion by abruptly halting its monetary inflation and,
in an act of desperation,
increasing its demand for the baht by using its dollar reserves
to purchase the baht in
international currency markets. Neither of these measures could
overcome the force of the
previous monetary inflation.
The upward spike of interest rates from the decline in the
baht's
purchasing power and the reversal of central bank monetary
inflation and credit expansion
caused the real estate and stock markets in Thailand to crash.
The Thai stock market fell
45 percent since the beginning of 1997. Suddenly the growing and
profitable banks of
yesterday were bankrupt as the value of their collateral
collapsed and the number of bad
loans soared.
Far from poor entrepreneurial judgment or lack of vigorous
regulatory
oversight, bankruptcy is an inevitable part of a
central-bank-induced business cycle. It
is the downward counterpart to the artificial expansion of bank
loans and capital values
of the boom. From the S&L debacle of the 1980s, to the continuing
banking problems of
Japan in the 1990s, to the current problems in Southeast Asia,
the pattern is the same.
The Thai experience has been repeated with other Southeast
Asian
currencies. The Malaysian ringgit, Indonesian rupiah, Philippine
peso, Singapore dollar,
and Korean won all fell to speculative reassessment. Their
currencies, stock markets, and
banking systems collapsed. Malaysia's market fell 48 percent,
Indonesia's fell
30 percent, Phillippines's 45 percent, Singapore's 33 percent,
and South
Korea's 24 percent. (China is up 40 percent since the beginning
of 1997.)
The nature of the international dollar-reserve system explains
another
aspect of the Asian currency debacle. What the U.S. government
must avoid, if it wants to
avert a similar financial debacle, is a repatriation of dollars
held abroad.
According to the IMF, central-bank dollar reserves around the
world are
$423 billion, about 60 percent of their total reserves. In 1990,
before the current
dollar-led, worldwide boom, dollar reserves of central banks were
only 50 percent of the
total. From 1990 to 1996 the total foreign currency reserves held
by all institutions
increased by 80 percent to $1.45 trillion, of which 63 percent
are dollars.
Any significant disgorging of these holdings would set in
motion price
inflation in America and the resulting upward spike of interest
rates would result in a
stock market crash, bankruptcy, and liquidation, quickly bringing
our boom to an end.
Of these enormous and increasing foreign holdings, tens of
billions of
dollars are in the hands of the central banks of the Asian
Tigers. Thailand spent about
two billion dollars of its reserves to defend the baht before
being dissuaded from this
policy and convinced to let the baht float.
What convinced them was an IMF bailout of $17 billion. As with
Mexico's $50 billion bailout in 1995, the IMF arranged to
compensate Thailand, and
now the other Asian Tigers, so that defending the currency peg
became unnecessary. For its
part, Indonesia enjoyed a $23 billion gift from the IMF following
its currency debacle.
More bailouts are planned. The IMF recently announced that its
181 members
will increase its capital base by $285 billion, a 45 percent
increase, to be the
international lender-of-last-resort to bail out countries
bankrupted by their own folly
and greed. By increasing the incentive to inflate money and
credit, this new role for the
IMF will result in more frequent and severe international
debacles.
Who's next on the list of economies to fail? Brazil,
Argentina, and
Chile for starters. If an economic crisis is inevitable, the only
way to overcome it is
through a dramatic freeing of markets, such that bad investments
are quickly washed out
and prices are allowed to adjust.
Bailouts create perverse incentives and teach precisely the
wrong lessons.
The more of them the IMF performs, the more they will be made to
appear necessary. The
real lesson of the Asian currency crisis is this: only God can
perform miracles. Central
banks and the IMF merely produce inflation, business cycles, and
financial crises.
------------
Jeffrey Herbener teaches at Grove City College and is a senior fellow of the Mises Institute.
FURTHER READING: Austrian Theory of The Trade Cycle and
Other Essays,
edited with an introduction and postscript by Roger Garrison
(Auburn, Ala.: Mises
Institute, 1997); "Lessons
of Asia's Currency Crisis," John Greenwood, Wall Street
Journal (October 7, 1997).
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