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

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Published in Fakt (Warsaw)

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.