The Bear's Lair: Unnatural monopolies - II

By MARTIN HUTCHINSON, UPI Business and Economics Editor  |  Nov. 26, 2002 at 1:01 PM
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WASHINGTON, Nov. 25 (UPI) -- It is a curious comment on the inflexibility of the human mind that, after an era in which breaking up public sector monopolies has been enormously fashionable -- with both political parties in the United States, in Asia, Eastern Europe, Russia, Latin America and even France -- there still remain certain areas of the economy in which public sector monopoly is thought to be the natural way to run things, and the inefficiencies thereof are never properly examined.

Part 1 of this column, examining the new Department of Homeland Security and ancillary organizations, ran Monday.

Another public sector monopoly that at first sight appears "natural" is the U.S. Federal Reserve system. Fed Chairman Alan Greenspan and other Federal Reserve governors persistently refuse to admit that they made a ghastly mistake at the time of Greenspan's "irrational exuberance" speech in December 1996, by not increasing interest rates to choke off the stock market bubble that had already developed and was spiraling out of control.

The error was compounded in 1998, by cutting interest rates because of the collapse of the derivatives speculator Long-Term Capital Management -- surely an example of "moral hazard" if ever there was one.

It was compounded again in January 2001, when the Fed embarked on its current policy of ever more desperate injections of fiat money, propping up a staggering economy and stock market that can only once again begin expanding on a sound basis after the bubble over-valuation has been wrung out of the system.

With the S&P 500 Index trading at more than 50 times "core" earnings, that point has very definitely not yet been reached.

Not only the United States is suffering from this error. Argentina, whose currency was from 1991-2001 pegged to the dollar, could have been dragged back to moderately responsible policies much earlier, before its debt had spiraled out of control, had the world's supply of dollars, as measured by dollar M3, not been allowed to expand after 1993 at almost 10 percent per annum, without any apparent limit.

It is of course not practicable to have competing entities setting monetary policy in the United States, although in some emerging markets, where talent is scarce, there have been cases where the local government has hired a Wall Street or London firm, on a consulting basis, to do so.

However, this restriction assumes a fiat currency. If instead the monetary system is based on a gold or commodity standard, then monetary policy becomes much less salient, operating only to choke off demand at crisis points, and a central bank's job is more easily privatized.

In Britain, before the 1946 nationalization of the Bank of England, for example, the private sector Bank had little influence over monetary policy, which, to the extent there was any (leaving gold in 1914 and returning to it in 1925, for example) was set by the Treasury.

The Bank of England had three functions: issuing high-denomination paper money and exchanging it for gold, managing the London money market through the discount window, and bank supervision, all of which it performed admirably. In 1890, unlike in 1995, the bank organized a rescue of Barings merchant bank with the utmost efficiency.

In the United States, the Founding Fathers saw the need for a central banking institution but assumed that it would be in the private sector, thus establishing the first and second Bank of the United States. Only Andrew Jackson's political pugnacity, and back-country suspicion of wealthy East Coast bankers, caused the destruction of a system that, with a gold standard, could have served the country well to this day.

Central bank independence is currently a shibboleth among the policy-making classes, because of the danger of populist governments printing money. However, as Greenspan and the current Fed have shown, there is with any fiat money system a danger simply of the Fed getting it wrong.

In this case, the Fed has printed too much money, relying on two theories that have turned out to be untrue: (i) that excessive money supply growth can trigger consumer price inflation but has no influence on an asset bubble, and (ii) that productivity after 1995 magically shifted onto a permanently higher growth track, making the stock market "exuberance" rational.

With a hard money standard and a private sector central bank, the danger of gross errors in monetary policy, or of political interference with bank regulation, are greatly reduced. Public sector monopolies, such as the Fed, are intrinsically prone to error because they are governed by political, not market forces. Once the true cost of unwinding the 1995-2002 asset bubble has been manifest, a move to an automatic hard money system, with privatization of the Fed, will become politically not merely possible but essential.

As I have argued elsewhere, the International Monetary Fund/World Bank nexus is another public sector monopoly that needs to be broken up. This nexus was set up in 1944 by John Maynard Keynes, who believed that public sector monopolies controlled by men like himself were intrinsically superior to the market, and by Harry Dexter White, now known to have been at the time an active Soviet spy.

The IMF is immensely proud, not only of Keynes but even of White, so much so that its main conference room is known as the Keynes-White room.

With the best will in the world, the World Bank/IMF nexus is bound to be sub-optimal, because of its public sector monopoly nature. Mark Weisbrot of the Washington-based Center for Economic and Policy Research has pointed out that Third World growth rates were much lower in 1980-2000 than in 1960-80. He attributes this to globalization, the opening of Third World economies to competition, being less efficient than the statist, protectionist autarky that Third World countries generally practiced in the earlier period.

This flies in the face of economic theory. Much more likely is the simplest explanation. The IMF, and with it the World Bank, became much more active in the management of emerging market economies, and as provider of funds to them, after the collapse of the Bretton Woods agreement in 1973 removed the IMF's original raison d'etre.

Their advice has generally tended to expand the public sector and squeeze private enterprise, while their funding has allowed bad governments, such as that in Argentina, to avoid reform and reinforce failure.

More important is the priority that the international institutions take in default -- they get paid back when private lenders don't. According to the Economist, 85 governments have defaulted on international debt from private lenders since 1975.

Of this, until Argentina's partial default last week, only 19 -- all small and very poor -- had defaulted to the IMF/World Bank duo. This has had the effect of subordinating private sector debt to that of the international institutions, thus making private sector lending to emerging markets more risky.

At the same time, it permitted irresponsible governments (of which there are many) to default, at least partially, to the private sector while maintaining the flow of money from the international institutions.

The IMF and World Bank must be privatized, and their lending and advisory functions separated from their function as facilitators of aid transfers from rich to poor countries. Once that has been done, a competitive system of international finance, including skilled private sector advisory groups, will provide countries with a much broader menu of policy possibilities, while ensuring that irresponsible governments are cut off from funding before they have managed to steal or waste too much of the world's resources.

Contrary to much firmly held opinion in the Bush-supporting "red states," most of the people who work for public sector monopolies such as the newly approved Department of Homeland Security, the Fed and the World Bank/IMF are above average in honesty, intelligence and capacity.

Structurally, however, the status of these institutions as public sector monopolies makes them unresponsive to customer needs and counterproductive to the U.S. and world economies as a whole. To the greatest extent possible, they must be privatized, and their functions opened up to the winds of competition.


(The Bear's Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that, in the long '90s boom, the proportion of "sell" recommendations put out by Wall Street houses declined from 9 percent of all research reports to 1 percent and has only modestly rebounded since. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)

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