The Free Market 13, no. 7 (July 1995)
The Clinton administration, working with Republican leaders, wants to do for foreign governments what the Reagan administration did for the S&L industry. The idea, as discussed at the Halifax world economic meeting, is to create a global bankruptcy court. It would restructure government debt wherever it may be, so long as the nation is on the verge of defult. It would then lend ever more money to debt-ridden governments.
The Washington Post calls this “a package of modest proposals.” In reality, it’s an extreme attempt to create a global “too-big-to-fail” policy for governments, which would then cause them to behave even worse than they do already.
The bailout of Mexico already sent the wrong message to nations friendly to the U.S. Treasury Department. Let the International Monetary Fund make default “restructuring” an official policy, and Mexico will be just the beginning.
Let’s consider the S&L analogy. In its first term, the Reagan administration increased the “insurance” on S&L accounts to $100,000, backing them with the “full faith and credit of the federal government.” This promise subsidized deposits and allowed loan officers to fund excessively risky investments. Counting on further migration to Texas from the Rust Belt, S&Ls poured new loans into wildcat oil companies and housing developments. The depositors, whose money was being lent, didn’t seem to mind bearing their extra risk; they were, after all, “insured.”
After the collapse, the Fed and the Congress, lacking moral fiber to deal with the issue directly, created the Resolution Trust Corporation to reorganize and liquidate bad ventures. Properties stayed tied up in the RTC for years while the government sought buyers for failed enterprises. Eventually, all properties were sold, but at tremendous expense to the taxpayer and the economy at large.
The Clinton plan for foreign governments would replicate this debacle at the international level. It would give the IMF the same powers over governments that the Fed, the FDIC, and the RTC had over the S&L industry. But while the S&;L industry is now defunct, reckless governments would live in perpetuity.
You don’t have to be an economic genius to realize the hazards. With their central bank and taxing authority, governments already have an incentive system very different from private industry. In free enterprise, the benefits of business are experienced by consumers and producers, while the capitalist-entrepreneur assumes the risk and pays the costs of failure. But with government, the benefits of policies accrue to the government and its special interests, while the costs are spread among the general public.
In similar fashion, bankruptcy law affects private individuals and companies by making them less astute about how they use their money. By providing them protection from creditors, bankruptcy law increases the reckless behavior of debtors. Applying the same law and institutions to governments would make an already perverse system much worse. They would be allowed to spend themselves into bankruptcy and face no economic costs for doing so.
But wait, says the IMF. The dangers of the proposed policy will be eliminated by the exercise of “transparency” and “surveillance” powers. This means the IMF would carefully monitor the debt status of nations and impose correctives before it was too late. Yet the Fed has always had the ability to do this for financial institutions. Requiring reports and conducting audits did nothing to prevent the S&L crisis and bank failures of the late 1980s.
These powers invested in the IMF will have even less effect in reining in government financial mismanagement. Governments, unlike banks, are not subject to market discipline, and therefore, their financial data has little relationship to actual economic and financial conditions. It makes no difference that the Clinton administration wants to increase the IMF’s ability to monitor the accuracy of the official data of foreign governments. If it could, the place to start would be Washington, D.C.
The most dangerous part of this “modest proposal” is the new fund to provide “liquidity” to governments that are on the ropes. This would be the international equivalent of deposit insurance for S&Ls and banks. Deadbeat governments that couldn’t pay their creditors would be able to spread their losses around the entire industrialized world.
The purpose is to prevent the inevitable capital flight that accompanies any Mexico-style financial crisis. Investors in government debt would be “insured” by other governments and central banks, so they wouldn’t pull their funds out when they perceived financial shenanigans going on.
In theory, no one will need to worry about whether any government is squandering funds, inflating money, or pursuing lousy policies. If market pressure gets too great or the government goes belly-up, all funds are insured by the IMF. But financial risk is “built-in” to the real world; any attempt to eliminate it is a pipe-dream, with smoke rings made of other people’s money. Far from preventing market meltdowns and government bankruptcies, such a policy postpones the day of reckoning and allows reckless behavior to be extended. The eventual crisis will then be much more severe.
Don’t count on the Republicans to oppose this global lender of last resort. House Banking Committee Chairman Jim Leach (R-Iowa) supports it. It’s merely a “Chapter 11 process for the global financial system,” he says. If that’s benign, why not make the United Nations a “revenue enhancement” agency as well?
The genesis of these “modest proposals” is the fear that international traders strike in the hearts of government officials and central bankers everywhere. These traders make fortunes by punishing debt-ridden, inflation-addicted governments. They are instruments of market revenge against politicians and bureaucrats who manipulate markets.
Governments cherish the power to manipulate currencies and credit markets. It gives them vast control over market activity without citizens feeling the burden of direct taxation. Governments hate it when the market cripples that power. But they are pointing the finger in the wrong direction. The problem is not the lack of an international bankruptcy law, but that government officials cannot control themselves.
What governments ultimately want is a final escape from fiscal responsibility. A global bankruptcy law is great, from their point of view, but even better would be the power to print a fiat currency and force it on the entire world: that is, a world central bank. Only such a monstrosity could fully squelch the “disruptive,” but actually very useful, activities of international currency traders.
