U.S. House of Representatives
Committee on Banking and Financial Services
Hearing on East Asian Economic Conditions
February 3, 1998
Statement by Dr. Ron Paul
Putting aside Constitutional and sovereignty issues (especially concerning the Exchange Stabilization Fund and the "warehousing" at the Federal Reserve), the arguments for more IMF money can not only be addressed and rebutted but should be rejected.
These bailouts come at a cost--both to the individual taxpayer and to the country. The taxpayer either has a portion of his or her paycheck seized in the form of higher taxes or loses purchasing power through increased inflation as a result of monetizing the debt. In order to subsidize corrupt foreign governments, make investors and bankers who made bad decisions whole, and fund lavish bailout bureacracy salaries, the taxpayer suffers the opportunity cost of forgone funds for education, child care, health care, food and housing for which they cannot go the IMF and get a loan for "Special Drawing Rights" to pay their own bills.
These bailouts also come at a cost to the country as a whole. Once past the shell games and other budgetary gimmicks, according the Congressional Research Service, the IMF added a cumulative $4.3 billion to our national debt as of January 1991. Despite a formal inquiry in November 1997 regarding this discrepancy, the Treasury Department has neither answered our question nor released up-to-date data which will show that the national debt has increased further because of our increased quota obligations. No political slight of hand can obsure the fact that this is not a "neutral exchange of monetary assets."
Requested reforms with money now will only exacerbate the problem. The IMF has proven that it will ignore any conditions as soon as it has its hands on the money. The IMF comes before us hat in hand for a replenishment of funds in part because it ignored previous lending conditions. The IMF cannot even be trusted to uphold basic human and economic rights such as the right of freedom of association to join a labor union as this Congress has so instructed. In South Korea, the IMF is not only bailing out sovereign debt but the private commercial debt of the very chaebol that compete with U.S. companies (see appendix A).
We must protect our economic and national security concerns. There is no more forceful proponent of privatization than myself, but, even I am wary of contracting out our national security to the IMF. Indeed, it is my firm belief that we should not repeat the economic and monetary mistakes that got us into this mess that compels me to urge this body to embark on another path. The arguments that we are only paying one-fourth to one-fifth of the Asian bailout bill and are leveraging the contributions of others becomes less appealing when one realizes that U.S. banks, according to a Bank of International Settlements report, have only an eight percent exposure in the region (The New York Times, January 28, 1998, p. D1).
It is our economic security that concerns me most. We must protect the value of the dollar and the free trading system. Market-led relative price declines (due to productivity gains, increased economies of scale, and new technology) as witnessed with the return of the gold standard after the Civil War until the establishment of the Federal Reserve System should not be confused with government-induced competitive devaluations of national fiat currencies as we experienced during the Great Depression and may see accelerate in East Asia.
The new money only insulates foreign governments from the need to be responsive to market forces (only compounding the problems) and the desires of their own people--not just their cronies and families. Visible U.S. support for these regimes and policies could haunt us as citizens of foreign countries see the U.S. propping up the very governments that oppress them.
Good afternoon, Chairman Leach, Congressman LaFalce and other Members of the Committee, thank you for this opportunity today. Although I am a Freshman Member on the Committee now, I served on this committee in the 1970s and 1980s and have some experience following the evolution of the International Monetary Fund and the nature of its bailouts. In addition, while a Member of this Committee, I served as a member of the U.S. Gold Commission and co-authored the minority report, the Case for Gold, with Lewis Lehrman. I have included "A Layman's Guide to the Asian Bubble Trouble," by John Mueller of Lehrman Bell Mueller Cannon, Inc. (see appendix B) because it provides a succinct and clear assessment of the situation.
We should not fund the International Monetary Fund (IMF) request for the New Arrangements to Borrow or the quota increase. The IMF is an anachronistic relic of the now-defunct Bretton Woods monetary system of fixed exchange rates and international redeemability of gold as a monetary unit. The Fund has not proven to be an effective tool in managing international currencies and has done nothing to effectively warn us of the dangers that have marred the international financial system over the past several years. The bailout of Mexico three years ago only served to encourage the same monetary policies that are now giving us the crisis in East Asia. We are at a point in our history where formidable figures, like former Secretaries of the Treasury William Simon and George Schultz and former chairman of Citicorp/Citibank Walter Wriston, are calling for the U.S. withdrawal from the IMF. Congress should seriously consider that option (see appendix C).
Cause of the Current Problem
The basic cause of the current crises the various nations are facing in East Asia, comes from a flawed monetary policy. Congressman Lee Hamilton writes of the cause of the Asian economic crises (January 28, 1998), "In a word, there was too much of everything: over-investment, over-lending, and over-building, in ill-conceived real estate and industrial projects...and over-guidance, with too many bureaucrats and government officials deciding which companies receive loans and investment." The Congressional Research Service concurs, "To one degree or another, most of these countries have been facing difficulties with their balance of payments, over-expansion of production capacity, rising real estate values, overvalued equities, and excessive bank lending (The 1997 Asian Financial Crisis November 25, 1997, p. 6)."
These countries have inflated their currencies at an annual rate of 20 to 30% over the past decade which has led to mal-investment, excess debt, over capacity, and an artificial boom period which predictably leads to a corrective bust. Fluctuating fiat currencies, according to sound monetary principles, always produce financial and monetary chaos. Without considering the basic cause of the problems that exist in East Asia, we are unable to devise sound policy here at home or internationally.
The most important Congressional responsibility, with regards to currencies, is to maintain a sound dollar. It has now been 27 years since our currency has been linked to gold. Since that time the dollar has lost more than 50% of its value. The Constitution mandates that only silver and gold can be legal tender. Because this admonition has been ignored in dollar terms, gold has gone up nearly tenfold. If we continue to follow current policy of bailing out foreign countries through appropriations and further credit expansion, we do exactly the opposite of what we should be doing. This will further undermine the value of the dollar expand our trade imbalances and lead to a crisis in the United States similar to that which East Asia is facing today. We should never lose sight of our responsibility to maintain the value of the dollar. We certainly should never deliberately undermine the value of the dollar in a feeble attempt to prop up the value of other currencies, for whatever reason.
Great danger lies ahead. I agree that the markets are in great danger, but this is no justification for doing the wrong thing. It is true that protectionist sentiments may well result from current conditions. We must oppose such sentiments as harmful to our own interests and to the prosperity of the global trading system. Obviously, competitive devaluations are even more troublesome than the lesser efforts at protectionism through tariffs. All world governments and central banks have embarked on a program of systematic inflation of their own currencies which serves to lower their respective values in the marketplace. The currency crises and trade disruptions are indeed very serious because, if uncorrected, these will lead to political chaos. My disagreement with those who have expressed the concern about the impending danger is that we ought not continue the very policy that brought such crises to Asia.
The only answer is a new approach to understanding currencies. A universal worldwide currency controlled by the marketplace and not the politicians would go a long way toward solving many of our financial and trade problems. Just as it would be devastating for the United States to have 50 different government fiat currencies with competing monetary policies, it is chronically disruptive for hundreds of countries throughout the world expanding credit at different rates and pretending that a sound efficient economy can operate under those conditions. The serious shortcoming of chronic currency devaluation is that although the money supply may gradually increase, the ramifications of these increases do not come in the same manner--they come with sudden jolts to the value of the currency as well as to consumer prices. The policies of the IMF exacerbate these gyrations.
There are three significant reasons why we in the Congress should oppose the replenishment of IMF bailout money: moral, economic and political.
1. It's morally wrong to take funds from innocent taxpayers and give part of their paychecks to special interests, whether they be foreign corporations, foreign governments or for the benefit of the lending agencies in this country, as well as U.S. corporations who have invested in East Asia. To argue that there is no cost to the taxpayer begs the question of why we are appropriating more money. Let us not ignore those who would have benefitted from the use of their own money: those same taxpayers.
2. We should oppose this bailout for economic reasons. The whole concept is based on unsound economic policy. A lack of understanding of how credit creation undermines the value of the dollar will make it difficult, if not impossible, to prevent the currency crises from affecting our economy. Transferring wealth from one country to another, diluting the value of a stronger currency for the benefit of a poorer currency, can never rectify the serious harm done by decades of monetary mischief. Even if it does work on a temporary basis, like is claimed in Mexico, there are still economic victims. The taxpayer of the United States did not benefit by the Mexico bailout, the Mexican citizens certainly suffered a lot, and it has encouraged the policies that have given us the East Asia crises.
Let us not ignore the lessons of the IMF-led Mexican bailout: The IMF will try to ignore with impunity the expressed conditions of the Member nations regarding its lending policies. The IMFs normal rules for lending limit it to 100% of a countrys quota at any one time and 300% cumulatively. This precedent was broken in 1995 with Mexico which was offered 688% of its quota. Last year, South Korea was lent nearly 2000% of its quota--20 times the IMFs own lending guideline. Conditionality on the IMF does not work. It is no wonder the IMF is "scraping the bottom of the barrel" after tossing away other peoples money in open defiance of its own lending guidelines. Equally bad, investors learned that profits are theirs to keep and losses are to be socialized with the burden falling on everyone else. Many analysts have commented that if we had not bailed out Mexico and instituted the moral hazard problem, we would not need to bail out East Asia today; I agree.
3. There are strong political reasons to oppose this bailout. I have yet to have any of my constituents come to me and ask me to vote a $20 billion appropriation for the benefit of foreigners or U.S. investors overseas. I also have not met any constituent who actually believes there is "no cost to the American taxpayers." When statements like that are made, it only serves to further undermine confidence in government. There's enough lack of integrity in government already, let alone pretending that this type of an appropriation is permissible because "it doesn't add to the deficit."
A defeat of the IMF appropriations by the United States will be a very positive step in the direction of tackling the very serious problem which must be addressed. That is considering a sound currency for the United States and setting an example for the world. Only a gold or other commodity standard of money can do this. Political, or paper money, can only work for a short period of time. Furthermore, it significantly contributes to the empowering of authoritarian governments. Only honest, sound money can protect the people from this.
Six largest Korean conglomerates (chaebols)
and the products and services they produce
Petroleum, natural gas, natural resources, project organizing, iron & steel, machinery, information & communication, chemicals, civil works, power plants, plant construction, architectural, urban & regional development, residential complexes, car sales, fashion & retail; multimedia products, home appliances, telecommunication, hardware & semiconductors; shipbuilding & plant construction equipment, forklift trucks, power plant & machinery, etc.
Memory-IC, logic-IC, hybrid-IC, module, microprocessor, LCD, wireless phone, hand phone, PC, workstation, monitor, motherboard, car-audio, car-CDP, CD vision, camera, video game, home automation system, etc.
Trefrigerator, micro wave oven, V, LDC, video display, AV, information system, disc media, washing machine, air conditioner, gas range, fan heater, appliances components, telecommunication, etc.
Steel & metal, chemicals, machinery, automobiles, electronics, textiles & light industries, general supply, defense & aerospace; construction equipment, industrial vehicles, rolling stock, aerospace products, machine tools, factory automation, defense products, shipbuilding, etc.
Polyester filament, staple fiber textile, acetate filament, polyester resin, specialty chemicals; steel & metal, energy & chemicals, plant, fabrics, garments, electronics & general merchandise, footwear, foodstuffs, etc.
Cement manufacturing, oil refining, petrochemical, LPG, asphalt, lubricant, benzene, jet fuel, kerosene, diesel, etc.
Information taken from the Federation of Korean Industries Membership Directory 1997.
A Layman's Guide to the Asian Bubble Trouble
by John Mueller
Our great difficulty in understanding the Asian financial bubble and its implications for the United States is not that we have too few explanations, but rather far too many. The crisis has been blamed, variously, on greedy speculators (by an Asian head of state), on Asian governments' failure to appreciate the important social function of greedy speculators (George Soros), on the folly of pegging exchange rates (monetarists), on the folly of not defending pegged exchange rates to the last ditch (supply-siders), on failure to deregulate Asia's financial institutions quickly enough (conservative economists), on deregulating Asia's financial insitutions too quickly (liberal economists), on IMF bailouts (libertarians), on failure to follow IMF advice (the IMF), on Clinton administration myopia (GOP presidential hopefuls), and on the failure of countries like Japan to follow the Clinton administration's far-sighted advice (Clinton administration) -- and this list omits technical arguments too stupefying to summarize.
The appeal of each of these partial explanations is that it boils down a complicated situation into a simple drama, whose tragic outcome can be traced to a flaw in one or more players. And there are kernels of truth in many of these theories. What doesn't make sense is the tremendous series of coincidences. Why did so many of the tragedians apparently fly off the handle all at once? And why these particular tragedians? After all, government policies in the Asian Tigers have been, on the whole, much more market-oriented than in Latin America or Eastern Europe. Also, most of the explanations amount to advice to various players as to how to deal more deftly with speculative bubbles and their aftermath. But where did all these bubbles come from?
I'd like to suggest that, if the crisis is to be considered a drama, it is less a Greek tragedy -- a story in which abnormal people mess up a normal situation -- than a story in which a number of relatively normal people are thrown into a thoroughly abnormal situation, more like a fairy-tale (or nightmare).
For an understanding of Asia's predicament and its disturbing implications for the United States, the first step is to grasp the Through-the-Looking-Glass nature of the international monetary system. This peculiar system is based on the U.S. dollar -- at least for all countries involved in the present crisis. To appreciate what it means that the dollar is the "reserve currency" for the world, imagine that all the people you met not only would accept your personal check, but actually carried your uncashed checks around in their wallets instead of money. This would have two effects on your personal finances. First, you'd no longer need to carry any cash, just your checkbook. Second, when you received your bank statement every month, you'd find a lot more money in your checking account than you had actually saved. The extra money would equal the value of the uncashed checks floating around. Under this arrangement, your purchases and investments would no longer be limited by your savings, only by other people's willingness to hold your checks.
This is what being a reserve currency country means for the United States. The fact that other nations' central banks hold dollars to back their currencies means that our country doesn't need to hold much, if any, foreign money in reserve; it also ensures that the U.S. makes more investments and purchases of goods and services abroad than are made in the United States -- the difference equaling the amount of dollar reserves acquired by foreign central banks.
Some Americans consider this a neat arrangement; what they overlook is that it gives foreign governments partial control of the U.S. "checking account." What the dollar-reserve-currency system does, in effect, is turn participating foreign central banks into so many Federal Reserve Banks of Tokyo, Seoul and Bangkok. These banks conduct open market operations, buying and selling U.S. Treasury securities in the New York money market, exactly as the U.S. Reserve Banks do (in fact, the New York Fed acts as their agent). The only difference is that the foreign currencies issued in this way -- unlike those issued by the Reserve Banks of Chicago, Richmond, and San Francisco -- may not be permanently fixed in dollar value.
This creates at least two policy headaches for the United States. First, monetary policy in the United States is no longer determined by the Federal Reserve alone, but by all the central banks in the world that buy or sell dollar assets. Second -- and this headache is more remote but potentially dire -- there is always the chance that too many of these "checks," or foreign dollar reserves, will be cashed at once. When foreign dollar reserves are sold, the same amount of U.S.-owned goods or securities must be sold at once, at whatever price they will fetch. If the amount is large enough, it causes a U.S. recession. That's what happened between 1929 and 1932, when virtually all dollar and sterling reserves were liquidated by other central banks, triggering deflation and depression.
The postwar Bretton Woods system was intended to prevent such a crisis. After 1971 and until just recently the U.S. Federal Reserve still set the pace for monetary policy, despite the end of fixed exchange rates. When the Fed lowered interest rates, the dollar sank, inducing foreign central banks to ease also. When the Fed hiked rates, the dollar rose, inducing foreign central banks to tighten. But because it no longer controls all central bank activities, the U.S. Fed is often astonished at the magnitude of the response to its policies -- the severity of inflation in the 1970s, for example, and the depth of the recessions of 1974, 1982 and 1990. But at least the timing used to be pretty regular. Now, the Asian crisis has revealed a new twist for the United States. By 1992, the total holdings of U.S. Treasury securities by foreign central banks began to exceed those of the U.S. Federal Reserve. And by 1995, the holdings of some individual foreign central banks were large enough to rival the importance of the Fed.
In 1995, the Bank of Japan began to act like a regional Federal Reserve Bank that had declared independence. After the Federal Reserve started hiking interest rates in 1994 and sharply curtailing its own purchases of Treasury bills (incidentally triggering the Mexican peso crisis and a sharp U.S. slowdown in 1995), the Bank of Japan not only didn't join in; in an effort to restart its economy with a cheaper yen, it began actually buying Treasuries, ultimately over $100 billion worth. To Japanese banks, however, the rest of Asia looked like a better bet than Japan itself. Monetary authorities in mainland China, meanwhile, purchased another $80 billion of Treasury bills; Hong Kong and Singapore about $22 billion each; Korea, Malaysia, Thailand, Indonesia and the Philippines scraped together another $30 billion or so. All told, these Asian countries account for virtually the whole increase of $260 billion in the world's foreign dollar resrerves between the end of 1994 and early 1997. The flow of dollars back and forth between New York and the Far East, and the Asian bubble, continued more than two years after the similar bubble had collapsed in Latin America.
This dollar-buying enlarged the already growing Asian bubble. When Americans invest abroad, the foreign country receives the dollars to finance the investment -- but the foreign country's central bank promptly turns around and invests the money right back in the United States. Mostly, it invests in Treasury bills held in custody at the Federal Reserve Bank of New York. The original investor's money is effectively cloned: ostensibly lent at one and the same time both to foreigners and to the U.S. government. But one thing doesn't change with this transaction. There is no more real wealth than before, and somewhere in the world, the price of something will go up without the prices of other things going down. The dollars may bid up stock prices in the United States, as in the 1920s; they may bid up commodity prices on the world market, as in the 1970s; or they may bid up real estate prices in Tokyo or Hong Kong. But the process leaves the same amount of money sloshing around New York as before.
As foreign stock-market or real-estate prices start going up, it seems attractive to borrow still more dollars and invest more; so more loans are made and more dollars go abroad, only to wind up right back in New York. In the process, the assets of the foreign country become more and more expensive, which typically results in a growing trade deficit in goods and services; but the flow of investment can be kept going as long as the expectation persists that the items rising in price will become more expensive still.
Judging the precise turning point is a fine art. (George Soros's response to the head of state who accused him of assaulting the currency in question was that he, Soros, was on the wrong side of the market at the time.) But once investment funds start flowing out faster than in, the local central bank is forced to make a choice: either slam on the monetary brakes until prices deflate back to their starting point, or devalue the currency, which accomplishes the same thing in terms of foreign, though not domestic, currency. Whether the country manages to keep its currency fixed to the dollar at this point becomes secondary: either way, the country's economy will go through the ringer.
There have always been speculative investors greedy or shrewd, foreign businessmen making fortunes or going bust, foreign policymakers corrupt or virtuous, and American and international bureaucrats adept or inept. But what the Asian crisis demonstrates is that the reserve-currency system vastly magnifies and prolongs the impact of their mistakes.
How will the crisis play itself out, and what will be its effect on the U.S. economy? Conventional wisdom, adding up Asia's share in U.S. trade, says that the impact will be negative but limited. Maybe, but the outcome actually depends on certain unknowns. Since the Asian currency crises began in mid-1997, foreign central banks have sold about $50 billion worth of U.S. Treasuries. This has tightened monetary conditions in the U.S. at a time when the Fed is trying to keep things on an even keel. But how much farther the process goes depends not only on the Fed, but on those foreign central bankers who still have the most policy discretion.
Think about the Bank of Japan, which started the ball rolling. After nearly doubling its chest of dollars, the Japanese government faces a loss of confidence in its currency. It is also up against the political problem of how to finance a bailout of its banking system costing $80 billion or more, in the face of strong objections to using taxpayers' money, and without causing a collapse of the yen. The temptation will be strong to sell some of the $100-plus billion in dollars acquired since 1994 -- and the Bank of Japan started doing so in December.
The second question-mark is China, whose dollar holdings have more than doubled to nearly $140 billion (not counting the $70 billion held by Hong Kong, now under mainland control). China's currency has weathered the storm so far, partly because the yuan was already devalued in 1994. But the Chinese economy is being hit heavily by the current crisis, and the leaders in Beijing don't seem to feel they owe Washington any favors.
A third though smaller question-mark is Latin America. In Mexico, for example, both the economy and foreign reserves have recovered in dollar terms roughly to levels they attained before the 1994-95 peso crisis. But in the process, Mexico has started to flash warning signals of the same sort as before the last crisis. The devaluation made Mexican goods cheaper for a brief period, but inflation has reversed that change. As a result, the current account balance, which shifted sharply from a large deficit to a small surplus, is likely to head back into deficit.
The U.S. economy is in better shape to weather a monetary storm than at any time since the mid-1960s, when a surge of growth in industrial capacity like the one we're seeing now meant that the monetary crunch of 1966-67 produced only a "growth recession" -- a slowdown but not a decline in output. Even so, despite all the talk of a "new economy," the business cycle has not been tamed any more than it was by the much-ballyhooed "new economics" of the 1960s. A large enough cashing in of America's "checks" -- say, the sale of $100 billion worth of Treasuries by Japan and China -- would suffice to cause not just a U.S. slowdown but a recession. Stay tuned.
John Mueller is a principal of Lehrman Bell Mueller Cannon, Inc., a financial markets forecasting firm in Arlington, VA.
The Articles of Agreement of the International Monetary Fund
Article XXVI--Withdrawal of Membership
Section 1. Right of Members to Withdraw
Any member may withdraw from the Fund at any time by transmitting a notice in writing to the Fund at its principle office. Withdrawal shall become effective on the date such notice is received.
Section 3. Settlement of Accounts with Members Withdrawing
When a member withdraws from the Fund, normal operations and transactions of the Fund in its currency shall cease and settlement of all accounts between it and the Fund shall be made with reasonable dispatch by agreement between it and the Fund. If agreement is not reached promptly, the provisions of Schedule J shall apply to the settlement of accounts.
(The United States is likely to receive a reimbursement of all previous contributions to the Fund totally over $42 billion. The negotiations would have to consider the previous gold contributions to the Fund at "official" rather than current market prices. The reimbursements are likely to occur in ten installments over a five-year period.)