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Copley News Service, 03/27/2001
The world economy is caught in a vice between the jaws of monetary deflation and fiscal austerity, the result of extraordinarily tight monetary policy and high tax rates. According to Bear Stearns Chief International Economist David Malpass, the global economy is likely to contract by about half a percent in nominal terms this year.
I spent last week in Seoul, South Korea, meeting with President Kim Dae Jung, members of the National Assembly, and leaders of both the ruling party and the opposition party. It is painfully obvious that the Korean economy is contracting.
Japan is flat on its back and likely to contract by double digits this year. The stocks on the Nikkei stock exchange recently hit a 16-year low. Exports are down and output is shrinking in developing economies such as the Philippines.
And the problems aren't confined to Asia. Production is slowing throughout Europe, and the European Union economy will likely grow little, if at all, after accounting for the oil-swollen price deflator. The economic outlook in South America is precarious as its second-largest economy, Argentina, deteriorates rapidly and fears of a currency crisis loom. Economic growth in the United States is flat, thanks to Alan Greenspan and the anti-tax cutting Democrats.
If the grip of monetary deflation and fiscal austerity isn't loosened soon, we may find ourselves in the first global crisis of the 21st century. If so, it will be a crisis created entirely by central bankers at the US Federal Reserve Board and the Bank of Japan, by bureaucrats at international financial institutions like the IMF and the World Bank, and by national governments preoccupied with deficits and debt and afraid or unable to cut tax rates.
The malefactors will insist that raising tax rates or keeping them high to reduce deficits and retire public debt is necessary to lower interest rates and increase saving and spur economic growth, although in reality these policies destroy incentives, destroy jobs and slow economic growth. They will protest that they had to raise interest rates and starve the world of liquidity in order to combat speculative bubbles and prevent too many people at work and too much investment from overheating the economies of the world. They speak of inventory and investment overhangs, but what do they expect when their policies undercut production? Monetary deflation and fiscal austerity create a self-fulfilling prophecy of economic pain and misery.
Deflation ultimately grinds away at the entire economy until all wages and prices adjust downward. Government revenues decline, along with falling profits, fewer capital gains, and the declining fortunes of workers who lose their jobs or must take wage cuts. Politicians and IMF bureaucrats then rush forward and insist that tax rates be raised or kept high to reduce deficits, preserve surpluses and retire debt.
The evidence of deflation is evident in the price of gold, which in dollar terms has fallen from $290 an ounce to $260 since the Fed undertook its latest effort to squeeze liquidity out of the economy. In Japan, the yen price of gold was more than cut in half over the past decade, falling from to an ounce before recovering slightly to Recently the Bank of Japan announced it was giving up on targeting interest rates, which have been driven practically to zero without restarting the economy, and will now target bank reserves, seeking to increase the supply of yen by 25 percent in an effort to reflate the Japanese economy. The price of gold in Japan didn't rise on the central bank's announcement, which is a pretty clear market indication that deflation expectations will be hard to dislodge.
The yen did weaken significantly against the dollar after the BOJ announcement and will continue to do so, in spite of Japanese protestations to the contrary, if the new policy succeeds in raising the yen price of gold and the Fed does not loosen US monetary policy. If the Fed persists in deflationary monetary policy in the face of rising Japanese liquidity and a declining yen, it may either force Japan to abandon a successful policy to stop the yen from sliding or if not touch off widespread competitive devaluations as countries, especially those nations whose currencies are tied to the dollar, seek to protect their competitive position vis-a-vis their trading partners.
Behind the gloom and doom, however, there is a ray of hope. Now is the opportune time for the United States and Japan to come to an accord in creating an international monetary standard that will allow both countries to halt the deflation without setting off competitive currency devaluations around the world. If both countries would agree in concert to revalue their currencies relative to the price of a basket of price-sensitive commodities using gold as a benchmark, we would put in place a new global monetary standard to prevent this kind of situation from arising again in the future.
It's ironic that everyone seems to agree on the need for global high-tech standards to ensure smooth commercial operations across national borders. It's time to create an international monetary standard to prevent the jaws of deflation and austerity from crushing the economies of the world.
Jack Kemp is co-director of Empower America and Distinguished Fellow of the Competitive Enterprise Institute. His column is distributed by Copley News Service.