Forbes India 15th Anniversary Special

The sources of our discontent with how the world is going

The US should take the lead on pro-growth reforms and other nations will follow suit

Steve Forbes
Published: Aug 26, 2016 07:44:13 AM IST
Updated: Aug 22, 2016 06:05:35 PM IST
The sources of our discontent with how the world is going

The world is unravelling, and only the US has the power and moral stature to stop a slide that could have catastrophic consequences. Hardly a day goes by without a hideous, unnerving event—another barbarous Islamic terrorist attack, an aborted coup in Turkey that has become a pretext for its Islamist leader to make himself a dictator in all but name, China’s increased aggression to illegitimately seize control of the South China Sea, Putin putting the squeeze on former pieces of the old Soviet empire. The global economy continues to sputter; the IMF has once again lowered projected growth rates for the remainder of this year and for 2017. The long economic stagnation is fuelling fiercer political resentments as radical, authoritarian parties gain strength in Europe.

There are two principal sources of this global malaise.

• The economy. Forget the nonsense chatter about “secular stagnation” and other seemingly portentous forces that supposedly doom us to sluggish or nonexistent growth. We aren’t doing well because of government policy errors—excessive taxation, regulation and spending. In political and economic circles the biggest cause, monetary policy, gets no mention at all because policymakers and observers think it’s a tool for growth. The central bank policies of quantitative easing and zero interest rates have perversely skewed credit markets in a way that is deflating economies, not stimulating them. Governments and corporations have access to cheap money, while the most dynamic, creative parts of the economy—small and new enterprises—suffer short rations.

Pro-growth structural changes in fiscal and monetary policy would lead to rapid revivals of dead-in-the-water economies.

Such reforms do not include blowing up the global trading system with new tariffs and other barriers to commerce. There are plenty of remedies on hand today to deal with actual trade abuses.

• Isolationism. Barack Obama deeply believes the leftist canard that the US—and before us, the European imperialist states—is the source of all the world’s woes. Pull back from the world and the rest of the planet will sort itself out. It might be a messy process, but someday it will end well and people will be happier.

But the 1930s showed us what happens when aggression is not forcefully countered. That’s why the US has been the free world’s leader since WWII. No other democracy has the strength and global reach to do this job. Expensive? What we spend on defense today is a fraction of what fighting a major war would cost, not to mention the horrific loss in lives. Not letting a hostile or potentially hostile power dominate a region or the world has been the foundation of the extraordinary expansion in global prosperity since 1945, fuelled by international trade. If we continue Obama’s isolationist policies, the world will turn into a more dangerous and less prosperous place.

Which brings us to Donald Trump’s musings on Nato, one of history’s and freedom’s most amazing success stories. It is the essence of simplicity: An attack on one member is an attack on all. Nato stayed the hand of the Soviet Union, and it is the reason that Putin hasn’t been even more aggressive against the former Soviet states of Lithuania, Latvia and Estonia, not to mention such one-time Soviet satellites and now Nato members as Poland. Under Nato’s security umbrella Europe became a prosperous, inward-looking continent instead of a cockpit of big-power politics. War between Germany and France today is inconceivable.

Yes, our allies should spend more on defense. But the profound, fundamental point is this: Their safety is our safety. The US is not some for-hire global protection agency.
As the US under Ronald Reagan did in the 1980s, we must take the lead on pro-growth reforms, such as a massive tax cut and stopping the central bank’s perversions of our credit markets. Other nations will follow suit, just as they did more than three decades ago.

And we must also actively engage with the world—not trying to remake it in our image but ensuring that the bad actors are kept at bay.

Price-Fixing by the Fed
The focus on whether the Federal Reserve will raise interest rates raises a question no one thinks to ask: Should the Fed—or any other central bank, for that matter—be in the business of manipulating interest rates in the first place?

The answer is no.

History shows that since Roman times—and even before—price controls don’t work. They deform markets, doing far more harm than good. President Richard Nixon imposed them in the early 1970s, and the result was disastrous, especially in the energy field. When Ronald Reagan, soon after taking office, removed oil-and-gas caps, the price of oil plummeted and the gas lines disappeared. Time and time again we’ve seen the baleful impact that rent controls have on the creation of new, affordable housing.

Setting interest rates is no different. They are the price that lenders pay borrowers for money. The question is, how much damage will the central bank’s machinations wreak on the economy?

That question has become especially acute since the economic crisis of 2008–09, when the Fed went from suppressing short-term rates to suppressing long-term rates as well. The Bank of Japan (BOJ) has been playing this game since the 1990s. Today the BOJ and the European Central Bank (ECB) have gone to negative interest rates on bonds. The impact of all this has been horrible. The manipulation of interest rates, combined with the excessive regulation of banks, has caused bank lending to small and new businesses to wither. Startups, essential to job creation and innovation, are a fraction of what they should be. Working capital to finance inventories has become less available and, contrary to the Fed’s motives, more expensive. Ditto the money for expansions. Remember, bonds are instruments for large, established businesses, not for the everyday enterprises and startups that are crucial to a well-functioning and expanding economy.

Whether it fully appreciates it or not, the Federal Reserve has gone into the business of credit allocation. Uncle Sam and large corporations find credit all too easy and cheap to obtain, while the rest of the economy suffers. Apple has cash and financial instruments totalling more than $230 billion, yet it has been issuing tens of billions of dollars in bonds to engage in financial engineering, namely buying its own stock and raising its dividend. Earlier this year Exxon Mobil sold $12 billion in bonds for buybacks, and other companies have done the same for the purpose of purchasing their own equity. And why not, when money is at virtually giveaway prices?

Noted economist David Malpass, a fierce and longtime critic of what the Fed and other central banks have been doing, has pointed out that the proportion of bonds to the US economy’s total credit has surged from 39 percent a decade ago to 53 percent today. Manifestly, this isn’t healthy, as the global economic situation testifies. The reliance on central banks to gin up growth has allowed governments to avoid making badly needed structural changes, such as cutting tax rates, reducing bloated public sectors, liberalising anti-growth labour laws and easing suffocating regulations.

Economists will cry that interest rates are different, that manipulating the price of lending money is essential to guiding the economy. Nonsense. Since when has such central planning ever worked? Economies aren’t like an automobile whose speed can be regulated by an accelerator. By such logic the Fed should have the power to decree price reductions for everything: Cut all prices by 50 percent, and watch the economy boom as people are thereby stimulated to buy more stuff!

But isn’t cutting the cost of money a crucial tool for fighting recessions? No. Economies, if not hobbled by structural barriers, will recover quickly enough on their own.
But what about the Great Depression? That catastrophe wasn’t caused by some inexplicable failure of free markets but by disastrous government policies, namely the collapse of global trade, which was triggered by the US’s enactment of the sweeping Smoot-Hawley Tariff Act and the retaliatory trade restrictions of other nations that followed. The debacle was worsened by countries responding to the downturn with massive tax increases (the US hiked its top income tax levy from 25 percent to 63 percent and boosted excise taxes on an array of items such as movie tickets).

Before the Depression central banks raised or lowered the rates charged to banks that borrowed from them only to keep their currencies fixed to gold.

The most constructive act the Fed could put in place would be to declare that at a date certain—say, a few weeks from now—it would cease interest rate manipulation. Borrowers and lenders alone would determine the price of money. The only rate the Fed would set would be its discount rate—that is, the price it charges financial institutions that wish to borrow from it.

None of this, of course, would take away from the Federal Reserve’s role as lender of last resort.

Freeing interest rates from these current shackles would beneficially impact today’s warped, ill-functioning credit markets.

Steve Forbes is Editor-in-Chief, Forbes

(This story appears in the 02 September, 2016 issue of Forbes India. To visit our Archives, click here.)