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.
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
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.
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.
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
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.
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.)
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.
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.
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
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 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.)
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.
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.
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
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.
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.
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.
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.
originally appeared in The
Free Market, January 1998.
Herbener teaches at Grove City College and is a senior fellow of
the Mises Institute.