Poland, the Euro, and the Dollar's Double Standard
 

by Dr. Michael Hudson, ISLET ©
 

Published in Fakt (Warsaw) on Wednesday, Sept. 1. 2004

Poland's vote to join the European Community has put an end to the
centuries of military rivalries that have long devastated the nation and
its neighbors. Entry into the EC makes future internecine wars
unthinkable.

That was the easy decision to make. Poland now must confront the
financial issue dividing Europe: the European Central Bank's destructive
monetarist ideology, and the constraint against running budget deficits
of more than 3 percent of Gross Domestic Product (GDP). If obeyed, this
3% budgetary constraint would depress business conditions by preventing
member countries from using the traditional counter-cyclical policy that
has pulled economies out of recession since the Great Depression -
budget deficits. For the past 75 years, governments have "primed the
pump" by running budget deficits when business cycles have turned down.
By acting as the employer of last resort in many instances, governments
have created jobs (preferably, useful ones) and helped restore market
demand to get the economy growing again.

Not all ECB members are willing to abandon this pump-priming policy.
Germany and France are ignoring the 3% budgetary constraint, because the
price of obeying it would be falling investment and employment levels
that would shrink market demand and lower profits for industry across
the board. In Britain, opponents of joining the Euro fear that the
Central Bank's tight-credit preference will hurt business as well as
labor.

Over the past two centuries the British public has come to realize that
every axiom of central-bank management is controversial. Most central
bankers have gone through a brainwashing education that leads them to
believe that preventing even a modest rate of inflation is more
important than promoting full employment. By depressing business
conditions, tight credit, high interest rates and budget surpluses
shrink labor markets. Central bankers who don't agree with this
monetarist ideology find themselves passed for promotion in favor of
more pure-minded true believers, whose preference for monetary austerity
is more ideological than scientific.

Monetarists demand that central banks be made "independent" of politics
precisely so that they can maintain under-employment austerity despite
the democratic will to the contrary. But this is a case in which the
people are right and the technocrats wrong. Most politicians and voters
prefer to keep the economy growing. A modest rate of inflation has
become normal in most economies, and statistics show that labor in
nearly every country does best in inflationary periods, because wages
tend to rise more than prices for the commodities that it buys. In the
United States, real wages peaked 26 years ago, in 1978 during the peak
of the Vietnam War inflation.

Instead of providing a larger economic surplus to finance trade
deficits, budget surpluses do just the opposite. They starve the economy
for credit, shrinking it and hence making it even more dependent on
foreign suppliers and creditors. Debtor countries sink deeper into
foreign debt as monetary austerity slows down their production capacity.

The failure of this policy to sustain long-term growth is clearest in
third-world countries that have adopted the International Monetary
Fund's austerity programs. Argentina and Russia are the two most
notorious victims that have been forced run budget surpluses in order to
squeeze out more income to pay creditors.

European versus American fiscal and monetary policy

In recent months there has been a growing belief in the United States
that its foreign policy simply can ignore Europe. As EC output and
exports grow more slowly, its population will shrink along with new
investment. Europe will commit geopolitical suicide if its politicians
believe that they do not have a choice when it comes to monetary and
fiscal policy.

But this feeling of being boxed in is merely an illusion. Europe has
been hypnotized by the monetarist theories - so-called theories of
wealth and capitalism - that have been exported from the University of
Chicago via the Washington Consensus and imposed by the International
Monetary Fund (IMF) as gospel.

What is so remarkable is that this monetarist fiscal policy is purely an
export item that benefits America, which has pursued a much more
successful domestic policy at home. Domestic U.S. economic policy is
diametrically opposite to the Washington Consensus that it broadcasts
abroad with fervor. The U.S. policy is to "ignore the foreigner." Ever
since World War I, America has refused to join any international
organization in which it does not have veto power, so that it can go its
own way whenever it chooses. And the present administration has gone its
own way in its decision to run government budget deficits of
historically unprecedented size, along with balance-of-payments deficits
now amounting to half a trillion dollars annually.

This policy has enabled the U.S. economy to get a free ride
internationally. The free ride comes mainly from Asia (China and Japan)
and Europe. It has been built into the international monetary system
ever since the United States went off gold in 1971. At the time this
occurred, it was viewed as a weakness. After all, the United States had
fought hard to keep the dollar "as good as gold" - until the costs of
its military spending in Vietnam, Asia and elsewhere in the 1960s broke
the linkage.

But severing the link to gold left the world's central banks in a
no-man's land. What were they to invest their growing international
reserves in, if not gold? What was OPEC to do with its oil money?

Central banks invested in U.S. Treasury bills because they were not able
to find an alternative to gold or dollars for their balance-of-payments
inflows. This meant that the larger their export surpluses to the United
States grew, the more dollars they had to invest in U.S. Treasury bonds.

In this way, central banks have financed America's balance-of-payments
deficit year after year, and decade after decade for the past 34 years,
since 1971. For the United States, running a balance-of-payments deficit
turned out to be a way to finance its own domestic budget deficit.
Foreign central banks rather than Americans bought up the bonds issued
to finance these deficits.

Nobody back in 1971 expected the United States to run budget deficits of
a size that now amounts to half a trillion dollars annually. But it has
done so, in order to spur its own economy. The U.S. Government debt has
doubled and redoubled, yet Americans have not had to finance these
deficits with their own money. Foreign central banks are doing this -
including that of Poland with its own dollar reserves.

The result is that when American companies or money managers buy
European stocks, companies and government assets that are being
privatized, the countries doing the selling find themselves obliged to
turn around and send surplus dollars back to the United States, where
they earn a much smaller rate of return on U.S. Treasury bonds. If a
country's central bank did not do this, its currency would rise, which
would price their exports out of world markets, leading to unemployment.

The alternative is for countries to turn more to their own domestic
market. This calls for more active government spending and
income-transfer policies - precisely the policies that the ECB prohibits
on anything more than a merely marginal scale.

A Free Ride for the United States

The Dollar Standard gives the United States a free ride by transferring
export and sales proceeds for European and Asian firms to the U.S.
Treasury in the form of U.S. Treasury bonds. This asymmetry in global
monetary arrangements does not bode well for Poland. If it exports more
and attracts more foreign investment, the Central Bank will find itself
obliged to lend these inflows to the U.S. Treasury at only about 3
percent interest - or else see its currency pushed up, stifling any
boom.

Matters would be even worse if Poland fell into deficit and had to
borrow to cover the cost of its imports. If Poland needs to borrow, the
IMF will tell it to raise its tax rates to discourage imports, and sell
off more of its public enterprises to pay foreign creditors. Higher
taxes lead to yet more unemployment Latin-America-style, while selling
public enterprises (privatization) gives global investors a rising
stream of income to move out of Poland. This would make the nation even
more dependent on foreign borrowing, obliging it to raise taxes, cut
investment and employment even more, and sell off what remains of its
public domain.

Is this what Poland voted for when it elected to join the EC? It seems
absurd for Poland's work force to finance America's budget deficit by
running surpluses to lend to the U.S. Treasury. But this is the problem
the ECB has imposed on its members by following the Washington Consensus
which the United States itself has happily ignored when it comes to its
own domestic policy.

Unlike the United States, European countries are prevented from running
deficits that are more than marginal, even for good reasons such as
increasing demand and helping employment recover. The result is that
unemployment threatens to get worse, while Europe transfers its economic
surplus to the United States. I doubt that this really is what Poland
voted for.

The Solution

The Euro must establish itself as an international reserve currency that
central banks will accumulate as well as dollars. There is only one way
to do this: There must be a substantial volume of government debt
denominated in Euros. Central banks only buy government bonds, not
corporate bonds and stocks - largely because these are deemed to risky
and hence inappropriate as a medium for holding international reserves.
But if governments are blocked from running budget deficits of more than
3 percent of their GDP, as called for by the EC's monetarist
constraints, there will not be enough government bonds available to
establish the Euro as a major currency alongside the dollar.

The only practical way for governments to issue and sell bonds is to run
budget deficits financed by bond issues. This public debt represents the
cumulative deficits that the government has run up. If the "austerity"
rule limiting budget deficits to just 3 percent of GDP is not changed,
it will prevent Europe from building up a volume of government debt to
serve as international monetary reserves. This would leave the dollar as
the only practical reserve currency for central banks to hold.

While deficits are needed to help promote thriving business and
employment conditions in Poland and other countries, they are not all
that is needed. Economic infrastructure needs to be modernized and
upgraded - and provided to the economy as a whole at as low a cost as
possible in order to make it competitive.

The United States has pursued a policy of budget deficits and active
government subsidy to achieve full employment and its present position
of world dominance. There is no inherent reason why Poland and the rest
of Europe cannot do the same thing. All that is needed is to adopt the
alternative doctrine that America itself has long followed, rather than
to retain the obsolete monetarist austerity philosophy pursued by EC
central bankers and, unfortunately, those of many other countries.

 

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