Panic Fallout

This article appeared in the May 2009 issue of Globe Asia.
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The panic of 2008 has sent the political classesinto fits of hyperactivity. Their favorite ploy has beento scare the public into supporting gigantic interventionistpolicies designed to inflate government budgetsand re-regulate economic activity.

These scare tactics were on display as world leaders preparedfor the London meeting of the Group of 20 on April 2. The countriesrepresented in this grouping account for two-thirds of theworld's population and 90% of its gross national product.

After failing to predict a slow-down, let alone a panic, theInternational Monetary Fund finally issued a scary forecast onMarch 19 — just in time for the G-20 meeting.This forecast allowed the IMF to peddle its prescriptions.Once the G-20's communiqué was released, doom and gloomwere temporarily swept aside. The political classes had juststruck a mother lode.

The G-20 winner was the IMF. The IMF's managing directorDominique Strauss-Kahn — a seasoned French socialist politician — could hardly believe the IMF's good fortune. At a pressconference on April 2, Strauss-Kahn had this to say:

"Maybe some of you werein the IMF press conference atthe end of the Annual Meetinglast October. And if some ofyou were there, then you mayremember that what I said atthat time is that IMF is back.Today you get the proof whenyou read the communiqué, eachparagraph, or almost each paragraph — let's say the importantones — are in one way or anotherrelated to IMF work."

If the G-20 summiteerscome through with their pledges,the IMF's resources will beincreased by over $750 billion(USD).

To put that in perspective,consider that the IMF's creditsand loans outstanding at the endof 2008 were only $27 billion. Aspoliticians confront a new crisis,the opportunists are playing thesystem and exploiting it for theirown ends.

Much of the growth of governmentin the US and elsewhere occurs as a direct or indirect resultof national emergencies such as wars and economic slumps.Laws are enacted, bureaux are created and budgets are enlarged.In many cases these changes turn out to be permanent.

As Robert Higgs verified in his 1987 classic, Crisis and Leviathan,crises act as a ratchet, shifting the trend line of government'ssize and scope up to a higher level. History provides manyillustrations of how damaging this fallout can be.

Take the Great Depression. At that time, the organized farmlobbies, having sought subsidies for decades, took advantage ofthe crisis to pass a sweeping rescue package, the Agricultural AdjustmentAct, whose title declared it to be "an act to relieve theexisting national economic emergency."

Seventy-six years later, the farmers are still sucking moneyfrom the rest of society and agricultural policy has been enlargedto satisfy a variety of other interest groups, including conservationists,nutritionists and friends of the third world. Indeed, eventhough agricultural prices hit record highs last year, the river ofgovernment farm subsidies kept flowing.

Then, during the second world war, when government accounted for nearly half the US's gross domestic product, virtuallyevery interest group tried to tap into the vastly enlarged governmentbudget.

Even bureaux seemingly remote from the war effort claimedto be performing "essential war work" and to be entitled to biggerbudgets and more personnel.

Even smaller crises have sent the opportunists into feedingfrenzies. Let us return to the classic case of ever-opportunisticIMF. Established as part of the 1944 Bretton Woods agreement,the IMF was primarily responsible for extending short-term, subsidisedcredits to countries experiencing balance-of-paymentsproblems under the postwar pegged-exchange rate system.

In 1971, however, Richard Nixon, then US president, closedthe gold window, signalling the collapse of the Bretton Woodsagreement and, presumably, the demise of the IMF's originalpurpose. But since then the IMF has used every so-called crisisto expand its scope and scale (see the accompanying chart).

Total IMF credit & loans outstanding (USD, in constant 2000 prices)

The oil crises of the 1970s allowed the institution to reinventitself. Those shocks required more IMF lending to facilitate, yes,balance-of- payments adjustments. And more lending there was:in the 1970-1980 period, IMF lending increased by 123%.

With the election of Ronald Reagan as US president in 1980, itseemed the IMF's crisis-driven opportunism might be reined in.Yet with the onset of the Mexican debt crisis, more IMF lendingwas "required" to prevent future debt crises and bank failures.

That rationale was used by none other than President RonaldReagan, who personally lobbied 400 out of 435 congressmen toobtain approval for a US quota increase for the IMF. IMF lendingratcheted up again, increasing108% in real terms duringReagan's first term in office.With the fall of the SovietUnion in 1991, the IMF reinventeditself again. Accordingto the IMF, a temporarylending facility was needed"to facilitate the integration ofthe formerly centrally plannedeconomies into the world marketsystem."

The 1990s ended with theAsian Financial crisis (amongothers) — one that was misdiagnosedand made worse bythe IMF's medicine. Nevermind. The Asian crisis was yetanother justification for morefunding. During the 1990-1999 period, IMF lending increasedby 99% in real terms.

Not surprisingly, the eventsof September 11, 2001 did notcatch the IMF flat-footed. OnSeptember 18, Paul O'Neill, the then US Treasury Secretary, hadbreakfast with Horst Kohler, the then IMF's managing director,to discuss the financial needs of coalition partners.

The IMF received a bit of a post-September 11 bounce. Thenthe IMF experienced a free fall, when the Federal Reserve (alongwith other central banks) pushed interest rates to record lows.The flood of new global credit was drowning the IMF until thecredit bubble burst. That is when the IMF seized its opportunity.

The ratchet, of course, has many deleterious dimensions thatreach well beyond public budgets. For example, on the same daythe G-20 met in London, the US Financial Accounting StandardsBoard caved in to pressure exerted by the US Congress andaltered the accounting rules for banks and other financialinstitutions.

Instead of valuing assets at prices they can fetch in the market(mark-to-market), banks will be allowed to use their own valuationmodels to value assets.

This accounting change brings to mind the fallout from anotherpanic — the US panic of 1873. It was then that the publicationof bank statements was suspended on the hope that "whatyou don't know won't hurt you."

Let's hope the current tidal wave of interventionism fadesand a modicum of reason kicks in.

Steve H. Hanke

Steve H. Hanke is a Professor of Applied Economics at The Johns Hopkins University in Baltimore and a Senior Fellow at the Cato Institute in Washington, D.C.