Steve Baron: Christmas Economics

This Christmas must surely be one of the most financially depressing for many families around the world ,since the Great Depression. As the global financial crisis (GFC) continues to unravel in Europe and the USA, it's tentacles have certainly reached here in the South Pacific. Huge amounts of money have been lost in finance company failures, business failures and the sharemarket. This has led to many jobs being lost with the associated consequences. While we wait for our political leaders to come up with the economic answers, the prospects are not looking good and answers seem to be few and far between—it's not a good time to be a Prime Minister or Minister of Finance. It would appear to me that our politicians are struggling to come up with an answer—we've tried both political sides, with right and left wing governments here in New Zealand and around the world, but history keeps repeating itself. Trying to understanding the international monetary system (IMS) and how it can be fixed is mind boggling to say the least but bear with me while I attempt to make some sense of it and look for some possible solutions.

As Barry Eichengreen said in his book Globalizing Capital, the IMS is, “the glue that binds
national economies together. Its role is to lend order and stability to foreign exchange markets, to encourage the elimination of balance-of-payments problems, and to provide access to international credits in the event of disruptive shocks”. The IMS has changed dramatically since the days of 16th to 18th century Merchantilism. One of the first major developments in the IMS was the Bretton Woods Agreement signed by forty-four allied nations in 1945. This created the International Monetary Fund and the World Bank. This system was seen as a tool to create a stable IMS, which made international balance of payment settlements and world trade much easier. The monetary policy adopted maintained the exchange rate by tying currencies to the U.S. Dollar. Unfortunately the system started to fall apart in the 1960's when US President, Lyndon Johnson, started to fund his “Great Society” programme, which produced large deficits and created balance of payments problems—sound familiar? A number of external shocks then brought about a lack of confidence in the US dollar, which markets started to sell off. In 1973 the US dollar came under attack for being over-valued and many countries, including New Zealand in 1985, allowed their exchange rates to float against it, because it had become impossible for central banks to prop up their currencies. Currencies were then traded on foreign exchange markets, which encouraged the free flow of money which has also opened up trade.

In 2008 the GFC became apparent. This began with the collapse of investment banks like Lehman Brothers. This mostly came about due to sub-prime loans to people who could not afford to pay them back and consequently defaulted as property values plummeted because a bubble had been created through this toxic lending—it was bad debt that was used to gamble on property continuing to rise—not constructive debt used to grow businesses and the economy. The GFC that has ensued has raised many issues that effect the IMS. It has made the world focus on financial mechanisms, governance, transparency and the threats that economic bubbles pose. It has also made world powers realise just how economically integrated the world has become but few, if any, solutions have been found.

One proposed solution gaining plenty of support is from Economist Steve Keen. His answer is to bail out the public and not the banks—because it was the banks who created the GFC—not the public. For a more in-depth explanation search Steve Keen Hardtalk on Youtube.com. Another solution rarely, if ever, considered by Ministers of Finance and Reserve Bank Governors is the cost of creating new money when it enters the financial system (not to be confused with quantitative easing). The money supply of a country usually needs to expand as the amount of goods and services in a country expands, so that there is enough money to purchase these good and services. This is a fine balancing act, too much money in circulation leads to inflation (Nazi Germany), but too little also leads to deflation (the Great Depression). However, as this money comes into circulation through government open market operations and consequently the money multiplier effect of the banking system, it enters society as an interest bearing debt. This cost has a compounding effect on debt and must certainly create an unnecessary cost to society. If more money is required to keep the wheels of our financial system greased, then
governments need to find a way to inject this money into society without this cost. Perhaps
there is an opportunity here for a small country like New Zealand to lead the way to show the rest of the world how the IMS can be improved? A basic concept governments should remember and practice, and something that should stay in the back of our minds when buying all those Christmas presents, is that we shouldn't spend what we haven't got. If you buy stuff—you end up with stuff-all.