Funny stories in international finance

Paul Krugman has famously complained of a feeling of policy-despair, and now in the Atlantic, a former chief economist at the IMF has a similar complaint.

Without questioning the fact that they have good grounds for despair, I would like to point out that there is something funny here.

Funny issue # 1

Krugman, in the Japan crisis of the 90s, argued that the problem was entirely monetary, and that restructuring was not necessary. In the current US case, he is arguing that restructuring, at least in the form of bank-nationalizations is necessary. Fair enough. Instead of re-arguing the Japanese case, what I would like to point out here is merely the pattern.

What Krugman and others were urging the Bank of Japan to do was to be more aggressive in making interest rates (1) fall to zero; then (2) via "quantitative easing" flood the banks with liquidity reserves in exchange for their bad assets, supposedly in hopes they would eventually have so much liquidity they would start to lend to the real economy and finally (3) commit to keeping interest rates at zero nominal levels until inflation had heated up to a pre-defined level ("inflation targeting"). So it was zero interest rates; then in real inflation-adjusted terms sub-zero interest rates; to continue until inflation reached a pre-defined level. Banks (short-term borrowers) ended up borrowing almost exclusively from the Bank of Japan, making fish-in-a-barrel spreads buying almost exclusively government-issued securities.

Those whose ox was gored in this were obviously Japanese households, whose savings in the domestic market were now earning close to zero-rate yields, absent unfamiliar risk-taking (in a lot of cases this ended up being in foreign currencies), but the household sector was not much heard-from. They were particular losers in this (not to mention the fact that this chilled consumption spending and contributed to lengthening the slump in that way).

That seems to be what is happening now in the US, only this is not seen as aggressive and innovative, but rather as essentially corrupt, with "quantitative easing" now seen to be more appropriately called "cash for trash" (Krugman); and with inflation targeting now apparently a taboo expression. My point here is merely about the pattern. It seems to have become a form of orthodoxy: Rescue the banks first, by cutting nominal rates to zero; then by flooding them with liquidity. Krugman, who opposes this policy in his own back yard, was quite a vigorous proponent of it for the Japanese. So it goes.

Funny story # 2

Japan is a country with foreign currency reserves, and America can sort of create its own, but what about chronic international debtors? Here the pattern was set by the IMF in the debt-restructurings in Latin America starting in the 1970s. And here again I would just like to point up the pattern. The policy was to lend to these governments (via the IMF) but only on condition that the governments switch from supporting their domestic-demand sector, to supporting their export sector. Via things like currency-devaluations, elimination of consumption-goods subsidies, and other means. This was dressed up in different ways, but the people participating in the anti-IMF food riots of that period knew what the the story was: IMF policy was to force a switch to exports in order to earn foreign currency to repay the US and European banks. The threat was often made explicit. If a government defaults, it will never, ever again be able to access international capital markets.

The pattern here--for chronic-debtor countries--was to punish the domestic-demand sector in order to ramp up exports (naturally there was a trickle-down argument to go with this). While for countries like Japan and the US, the new orthodoxy is to punish the household sector via zero (nominal) and sub-zero (real inflation-adusted) interest rates. In both cases the pot of gold at the end of the rainbow has been to resuscitate the banks at the expense of the household sector.

(The former-IMF dude makes a point of IMF efforts in recent years to confront local oligarchies and force them to "take a hit", but one wonders. He skates around the essential structure of these deals with this: "Almost always, countries in crisis need to learn to live within their means after a period of excess—exports must be increased, and imports cut—and the goal is to do this without the most horrible of recessions. Naturally, the fund’s economists spend time figuring out the policies—budget, money supply, and the like—that make sense in this context. Yet the economic solution is seldom very hard to work out.") With the government and the oligarchs at the table with the IMF, and the working people having only the streets, it is a considerable imposition to be asked to believe, just on this man's word, that "what makes sense in this context" is the kind of crusading for social justice that he seems to be suggesting.

In any event, this is what I find funny: Krugman and the former IMF dude were participants and proponents in this process, and now they are against it. I believe the reason is that people where they live--in the USA--are suddenly waking up to what it means. As opposed to where other people live. Not perhaps waking up to what the whole picture is, but certainly enough to understand that there is a class that is being enriched, at the expense of another class that is being impoverished.

Hence this somewhat funny policy about-face. Not that they aren't right about the need for bank-nationalizations, just that I think they could be a little more forthright about how the system has been working.