TWN Info Service on Finance and Development (Apr18/01)
17 April 2018
Third World Network

US and Major ICs "sleep-walking" towards war, unsustainability
Published in SUNS #8663 dated 17 April 2018

Geneva, 16 Apr (D. Ravi Kanth) - Major developed countries led by the United States are "sleep walking towards war" by implementing unsustainable fiscal and monetary policies since the 2008 financial crisis, with the destructive consequences to be borne by the developing countries, two former senior officials of the Bank for International Settlements warned on Friday (13 April).

Herve Hannoun, a former deputy general manager, and Peter Dittus, former secretary-general of the Bank for International Settlements (BIS), sounded this warning in presenting a comprehensive report titled, "Revolution Required - the Ticking Time Bombs of the G7 Model."

Speaking at a meeting convened by the South Centre at Palais des Nations on 13 April, the two former senior BIS officials argued that "the current economic model built on unsustainable growth of debt, asset prices inflation, arms r ace, and unsustainable use of carbon will come to an end."

They called for "revolution" to usher in a "sustainable model" that "uses little carbon," "stops the military build-up," "puts the common interest before the interests of the few," and "distributes the fruits of the economy more equitably."

In such a revolution, the authors argued, "state" and public policy must play a crucially "larger role" than becoming, as over the last [several] decades, "a servant to economic and financial interests."

Calling for transformational change, the two authors said, this is an imperative if the world were to avoid the worst crises on several fronts simultaneously.

Following the 2008 financial crisis, which was an offshoot of the unsustain able fiscal and monetary policies followed by the United States Fed and other central banks in the major industrialized countries, the G7 countries, with the exception of Germany, have continued to implement "lax fiscal policies" on a sustained basis.

Consequently, the gross liabilities (government debt to GDP) last year hove red around 221% in Japan, 157% in Italy, 124% in France, 121% in United Kingdom , 105% in United States, 97% in Canada, and 72% in Germany.

Since 1971, when President Richard Nixon ended unilaterally the direct international convertibility of the American dollar to gold, the US, which continues to enjoy the "exorbitant privilege" (of printing its currency and paying other nations for goods and services bought from them), has become the epic enter for the unsustainable monetary policies without any concern for its ballooning twin deficits.

The US, in turn, exported all its failures to curb the "twin deficits" (fiscal and current account deficits) to other G7 countries which religiously followed the US model except Germany.

"The US administration multiplies new expenditure and tax cuts by trillion dollars, with no funding other than more debt" which includes US$1.5 trillion tax bonanza for the big corporates, US$1.5 trillion infrastructure plan, colossal increase in the Pentagon budget by more than US$700 billion, Hannoun and Dittus argued.

Unfortunately, the other G7 countries chose to remain silent without any murmur about this dangerous "opening of the flood gates."

Meanwhile, the party goes on despite "the reckless behaviour" of the US.

The overall US fiscal deficit is projected around US$1 trillion in 2019, and this would not be possible without the permissive monetary policy conducted by the US Federal Reserve (the American central bank) since 2009, Hannoun and Dittus maintained.

"The silence or complacency of the Big Three US-based rating agencies (Standard & Poor's, Moody's, and Fitch group), with the blessing of the International Monetary Fund, exposes the hypocrisy of the watchdogs," the two said.

If anything, it vindicates the financial impunity with which the US could adopt such dangerous monetary and fiscal policies because of "the exorbitant privilege" arising from the dollar being the anchor of the international monetary system.

Moreover, the "bipartisan complacency" shown by the Republicans, who are supposed to be financial conservative hawks, and Democrats, who believe in higher taxes and spending, is equally disturbing, Hannoun and Dittus argued.

"First, a dramatization of the shutdown, followed by negotiations among politicians, and then an increase of suspension of debt ceiling," the former BIS officials pointed out.

Little wonder that the "G7 central banks have become the facilitators of unfettered debt accumulation."

And "the sorcerers' apprentices," according to Hannoun and Dittus, include incentives for unfettered debt accumulation such as "near zero or negative nominal interest rates."

Such low interest rates are the price of leverage in an economy, they maintained. The main beneficiaries of negative nominal interest rates are "non-bank corporations" who buy back their own shares, thereby increasing "leverage and deteriorating deliberately their gearing ratios to please their shareholders."

In effect, the total debt of the seven major developed countries is estimated at around US$100 trillion in the third quarter of last year. Of the total world debt, the US, Britain, Canada, Japan, and the Eurozone account for 64%.

The extreme fundamentalist monetary policies followed by the seven developed countries since 2012 have undermined "the foundations of the market economy."

Further, "the distortion of all asset prices," because of the intervention of the G7 central banks during the past six years, "have introduced a significant element of a command economy in G7 countries, which have moved towards a regime of centrally planned financial markets," Hannoun and Dittus maintained.

Consequently, "the G7 model is no longer complying with a textbook market economy model," as the long term interest rates are manipulated and fail to reflect the fundamentals of an economy.

The "everything bubble" engineered by G7 central banks is ready to burst, following the unprecedented asset prices bubble stemming from seven years of near zero or negative interest rates, Hannoun and Dittus warned.

Thus, the G7 monetary policies "are a common factor to most of the speculative excesses observed in bonds, stocks, and real estate."

The "US Federal Reserve has dealt with the bursting of every asset bubble of the last 20 years by creating another, larger bubble."

Since 2012, the G7 Central Banks are no longer seen as able to "take away the punch bowl when the party gets going," Hannoun and Dittus argued.

In short, the "asset price inflation engineered by central banks is a key driver of the rise in inequality," the former BIS officials maintained.

"The "everything bubble" of asset prices is another ticking time bomb of the G7 model," Hannoun and Dittus said.

The most scary asset price bubble is the bond bubble, with Japan, Germany, and France having nominal ten year bond yields between zero and one per cent.

Around 43% of G7 government bonds in major reserve currencies are now held by central banks and other public entities.

"By transforming quantitative easing into a permanent monetary policy tool, the G7 central banks are at risk of heading towards the slippery slope which ultimately leads to government debt monetization," Hannoun and Dittus maintained.

Because of the sustained reckless policies, the G7 central banks are facing a dilemma whether "to choose between two stylized scenarios - policy normalization or government debt monetization", they argued.

Arguably, the monetary and fiscal policies followed by the seven developed countries have resulted in the "capture" of monetary policy by financial markets and "regulatory capture" by large banks and financial industry.

Effectively, there is pushback against financial sector reform in the US and elsewhere. "The lack of integrity of the global financial system" can be seen in two major regulatory failures, Hannoun and Dittus pointed out.

The two regulatory failures are "zero risk weight for sovereigns in bank regulation of credit risk," and "no pillar 1 capital charge for the interest rate risk in the banking book," the two former BIS officials maintained.

The flawed monetary and fiscal policies being implemented by the G7 countries are contributing to the twin dangers of "the global warming time bomb" and "war," Hannoun and Dittus said.

During the discussion on the report presented by Hannoun and Dittus, the former governor of the Indian central bank (Reserve Bank of India, RBI), Yaga Venugopal Reddy, agreed with their finding and called for thorough "rebalancing" on several fronts.

"Rebalancing has to be between national and global economy, state and market, finance and real," said Dr. Reddy, maintaining that "policymakers cannot base their policies on hope or assumptions, but they should be based on the assessments of the rebalancing that occurs from time to time."

The former RBI governor cautioned against adopting a "single model for all countries or for the global economy as a whole" given the emerging complexities in the global economy.

According to Dr. Reddy, Hannoun and Dittus are correct about the "G7 monetary policy capture by financial markets" as well as "regulatory capture by large banks and financial industry."

The global financial crisis actually became the global economic crisis which was "transformed into a social crisis, and of late it is manifesting itself in political developments which we are unable to understand fully," Dr Reddy argued.

"The attack on multilateralism," according to Dr Reddy, "is really an offshoot of the global financial crisis and its consequences."

As a central bank governor, Dr Reddy said, he knew the difficulties involved in the global financial reform.

He gave as an example how he was dissuaded by the highest authorities in New Delhi and Washington from mentioning the "consideration of Tobin Tax" on cross-country financial transactions in a speech.

Wall Street, according to several accounts, including that of the former International Monetary Fund Chief Economist Simon Johnson, has become the "Wall Street-Treasury corridor," Dr Reddy said.

As regards the current face-off between the US and China, with China holding more than $1.3 trillion of US treasury bills, Dr Reddy said "while the real economic activity is shifting rapidly to Asia, in particular China, the financial sector continues to be dominated by the West."

Besides, public sector dominates in China by making public policy more effective, while private sector dominates in the US economy.

"While China has significant strength on the current account, the US has significant strength in terms of the return on external assets" which has implications for external sector vulnerabilities, Dr Reddy said.

The former UNCTAD senior economist, Mr. Andrew Cornford, concurred with the findings of the report while Mr. Martin Khor, the South Centre's Executive Director, said the report is a timely reminder of the dangerous period the world is going through at this juncture.

Former UNCTAD chief economist and director, Mr. Yilmaz Akyuz, in some concluding remarks spoke about the need to factor in the findings of the report for serious reforms in the global financial system.