The Death of Money

by James Rickards

  From these comparable initial conditions, divergent policies were pursued. The GIIPS initially continued so-called economic stimulus and made only slight cuts in public spending. Greece actually increased the number of government employees between 2010 and 2011. The principal way of addressing fiscal issues in the GIIPS was through tax increases. The internal adjustment process of lowering unit labor costs began in the GIIPS only in 2010, and serious fiscal and labor market reform was begun in 2013; much work remains.

  In contrast, the BELLs took immediate, drastic measures to put their fiscal houses in order, and strong growth resumed as early as 2010 and is now the highest in the EU. The turnaround was dramatic. Latvia’s economy contracted 24 percent in 2008–9, but then grew over 10 percent in 2011–12. Estonia contracted 20 percent in 2008–9 but grew at a robust 7.9 percent rate in 2011. Lithuania’s economy did not suffer as much as the other BELLs in the crisis and actually grew 2.8 percent in 2008. Lithuania’s growth did decline in 2009, but it bounced back quickly and rose 5.9 percent in 2011. This pattern of collapse followed by robust growth in the Baltic BELLs is the classic V pattern that is much discussed but seldom seen in recent years because governments such as the United States use money printing to truncate the V, leaving protracted, anemic growth in its wake.

  How does one account for this sharp turnaround in the Baltic states’ growth compared to the EU periphery? Anders Åslund, a scholar at the Peterson Institute for International Economics in Washington, D.C., and an expert on the eastern European and Russian economies, has written extensively on this topic. He attributes economic success in the Baltics and failure in southern Europe from 2009 to 2012 to specific factors. When confronted with severe economic contraction, he suggests, an affected nation must embrace the crisis and turn it to political advantage. Political leaders who explain clearly the economic choices to their citizens will gain support for tough policies, while leaders such as those in the United States and southern Europe who deny the problem’s depth will find that the sense of urgency recedes and that citizens are less willing over time to make the needed sacrifices. Åslund also urges that countries facing economic crises should embrace new leaders with new ideas. Vested interests associated with old leadership will be most likely to cling to failed policies, while new leaders are able to pursue the cuts in government spending needed to restore fiscal health.

  Åslund also recommends that the emergency economic responses be clearly communicated, front-loaded, and weighted more to spending cuts than tax increases. Citizens will support policies they understand but will be ambivalent about the need for spending cuts if politicians sugarcoat the situation and prolong the process. He also says that “credible culprits are useful.” In Latvia’s case, three oligarchs dominated the economy in 2006, and 51 percent of the seats in parliament were held by parties they controlled. Reform politicians campaigned against their corruption, and by 2011 the oligarchs’ representation had shrunk to 13 percent. The United States also had corrupt bankers as ready-made culprits but chose to bail them out rather than hold them accountable for the precrisis excesses.

  Finally and most important, Åslund emphasizes that the restructuring process must be equitable and take the form of a social compact. All societal sectors, government and nongovernment, union and nonunion, must sacrifice to restore vigor to the economy. With regard to Latvia, he writes, “The government prohibited double incomes for senior civil servants . . . and cut salaries of top officials more than of junior public employees, with 35 percent salary cuts for ministers.” Again, the process in the Baltics contrasts sharply with that of countries such as the United States, where government spending has increased since the crisis. In the United States, public union and government employee salaries and benefits have mostly been protected, while the brunt of adjustment has fallen on the nonunion private sector. Åslund concludes by noting that these recommendations were mostly followed in the Baltics and disregarded in the southern periphery, with the result that the Baltics are now growing robustly while Europe’s southern periphery is stuck in recession with uncertain prospects.

  The BELLs’ success in quickly restoring growth and competitiveness contrasts sharply with the GIIPS, which have stretched the process out over six years and still have a considerable way to go to achieve fiscal sustainability. Reports from the Baltic region are overwhelmingly positive on the economies there. Reporting on Estonia in 2012, CNBC’s Paul Ames writes, “Shoppers throng Nordic design shops and cool new restaurants in Tallinn, the medieval capital, and cutting-edge tech firms complain they can’t find people to fill their job vacancies.” The BELLs have also made good use of their human capital and a relatively well-educated workforce. Estonia in particular has become a high-tech hub centered on its most successful company, Skype, which has more than four hundred employees in a worker-friendly campus near Tallinn.

  The New York Times published a story on Latvia in 2013 that accurately captured the trajectory of steep collapse and strong recovery that used to be typical of business cycles but is now mostly avoided by Western governments at the expense of long-term growth:

  When a credit-fueled economic boom turned to bust in this tiny Baltic nation in 2008, Didzis Krumins, who ran a small architectural company, fired his staff . . . and then shut down the business. He watched in dismay as Latvia’s misery deepened under a harsh austerity drive that scythed wages, jobs and state financing for schools and hospitals.

  But instead of taking to the streets to protest the cuts, Mr. Krumins . . . bought a tractor and began hauling wood to heating plants that needed fuel. Then, as Latvia’s economy began to pull out of its nose-dive, he returned to architecture and today employs 15 people—five more than he had before.

  Even the IMF, which has generally counseled against the sharp government spending cutbacks used in Baltic states, acknowledged the Baltics’ success in a 2013 speech by its managing director, Christine Lagarde, in Riga:

  While challenges remain today, you have pulled through. You have returned to strong growth and reduced unemployment. . . . You have lowered budget deficits and kept government debt ratios to some of the lowest in the European Union. You have become more competitive in world markets through wage and price cuts. You have restored confidence and brought down interest rates through good macroeconomic policies. We are here today to celebrate your achievements.

  The peg to the euro and, in the Estonian and Latvian cases, actual conversion to the euro, have proved instrumental in the recovery and growth stories in the BELLs. Anchoring a local currency to the euro, and ultimately adopting it, removes exchange-rate uncertainty for trading partners, investors, and lenders. The benefits of offering economic certainty were illustrated in a recent Bloomberg report:

  Today, Estonia’s economy is the fastest-growing in the currency bloc, consumers and businesses are paying lower interest rates, and business ties with Finland—a euro member state and Estonia’s main trading partner—are tighter than ever. . . .

  “The most important thing was that we ended all the speculation about a possible devaluation” of the kroon, says Priit Perens, the chief executive officer of Swedbank AS, Estonia’s biggest lender and a part of Stockholm-based Swedbank. . . . Fears that all the Baltic countries would eventually devalue had hampered investor confidence for a long time. Devaluation would have been ruinous, since Estonia’s banks had started lending in euros before the country switched to the common currency. Paying off euro-denominated loans in devalued kroon would have imposed a crushing burden on businesses and consumers.

  Lithuania and Bulgaria constitute an experiment within an experiment since they have not pursued fiscal consolidation as strenuously as Latvia and Estonia and, as a result, have not recovered as robustly. But overall, the BELLs have implemented fiscal consolidation and other reforms far more rigorously than have the GIIPS, and they are achieving sustainable debt and deficit levels, trade surpluses, and improved credit ratin
gs as a reward.

  If not a perfectly controlled experiment, the contrast between the BELLs’ and the GIIPS’ policy choices is a powerful case study. The findings show that economic prudence works and Keynesian-style stimulus fails. The results are not surprising, given Keynesianism’s dismal track record over the decades and the lack of empirical support for its claims. But the BELLs example is likely to resonate for decades among objective observers, who look for empirical economic proof as opposed to classroom hypotheticals.

  The cases of the BELLs and the GIIPS illustrate both the benefits of fiscal consolidation (as practiced by the former) and the costs of delay and denial (as practiced by the latter). The overriding lesson is that currency devaluation is not a precondition to recovery but rather a hindrance. A strong, stable currency is a magnet for investment and a catalyst for expanded trade. The essential ingredients for rapid growth following a crisis are accountability, transparency, fiscal consolidation, and an equitable distribution of sacrifices. The BELLs’ experience from 2008 to 2014 offers powerful lessons for Europe’s southern periphery as it continues to adjust in the years ahead.

  ■ BRICS

  While the BELLs were breaking new ground in demonstrating fiscal consolidation’s benefits, the more powerful BRICS have unsettled conventional wisdom and cast doubt on the U.S. dollar’s future as the world’s leading reserve currency.

  When the BRICS leaders convened a finance ministers’ summit in September 2006 in New York City, they showed every sign of evolving in line with O’Neill’s original prescription, not so much as a coherent economic bloc but as a political force. The meetings evolved into a formal leaders’ summit in Yekaterinburg, Russia, in June 2009, and the summits have continued at the ministerial and leaders’ level. In 2010 the original BRIC group of Brazil, Russia, India, and China invited South Africa to join its ranks, and the acronym was changed to BRICS. In April 2011 South Africa attended its first BRICS leaders’ summit as a full member in Sanya, China.

  O’Neill has consistently downplayed the idea that South Africa should be among the BRICS, because the size of its economy and population coupled with its unemployment problem do not put it in the first rank of developing economies. This is true economically, but ironically South Africa’s addition vindicates O’Neill’s original thesis that the BRIC project was more political than economic. The other BRICS were located in eastern Europe, Asia, and Latin America. The African continent was a conspicuous gap in the alignment of the East and the South against the West. South Africa, as the largest economy in Africa, filled that gap with its advanced infrastructure and highly educated workers, despite its relatively small size.

  The BRICS’ combined economic heft is undeniable. The members represent over 40 percent of global population, 20 percent of global economic output, and 40 percent of total foreign exchange reserves. The BRICS have emerged as a counterweight to the original G7 of highly developed economies and a powerful caucus within the more inclusive G20. However, the BRICS have not taken any measures to integrate their economies into a free-trading area or EU-style currency union except on a limited bilateral basis. The BRICS’ principal impact has been to weigh in on global governance and the future of the international monetary system with one voice.

  The BRICS leaders have begun to stake out radical new positions on five key issues: IMF voting, UN voting, multilateral assistance, development assistance, and global reserve composition. Their manifesto calls for nothing less than a rethinking or overturning of the post–Second World War arrangements made at Bretton Woods and San Francisco that led to the original forms of the IMF, World Bank, and the United Nations. The BRICS insist that unless those institutions are reformed to be more inclusive of BRICS’ priorities, the BRICS will take concrete steps to create their own institutions to perform their functions on a regional basis. The evolution of such institutions would inevitably entail a diminution in the role of the institutions they were meant to replace. It is unclear whether these proposals are a stalking horse to promote real reform in the existing forums or whether there are concrete plans to proceed in the direction announced. Perhaps both intentions are true. In any case, the BRICS are unwilling to accept the international monetary and governance status quo.

  Specifically, the BRICS have called for expansion of the UN Security Council permanent members to include Brazil and India. Russia and China are already permanent members. This would create a seven-member permanent membership with the BRICS holding four seats—a slight majority. There would be no elimination of the U.S. veto in this scenario, but the addition of a Brazilian or Indian veto would significantly increase BRICS leverage in the behind-the-scenes negotiations that precede formal Security Council votes. Inclusion of Brazil and India would increase the occasions on which BRICS hold the rotating Security Council presidency. The Security Council presidency gives the presiding nation the ability to set the agenda and affect Security Council processes.

  The BRICS, especially China, have also pushed for voting reform at the IMF. If population, reserves, and economic output are the relevant criteria, then current voting power in the IMF is skewed in western Europe’s favor and against the BRICS. The IMF leadership recognizes this, and managing director Christine Lagarde has been outspoken in favor of the needed voting reforms (called “voice” in IMF jargon), especially with regard to China. The difficulty lies in getting countries such as Belgium and the Netherlands to reduce their voice in favor of China. This process has dragged on for years. The BRICS have played their cards astutely by conditioning BRICS’ pledges for badly needed IMF lending facilities to progress on voting reform. The BRICS’ trump card in this game is to launch an alternative multilateral reserve lending institution if the IMF does not increase their voting power.

  A blueprint for BRICS alternatives to the IMF and World Bank was a principal result of their March 2013 summit in Durban, South Africa. At that summit’s conclusion, the BRICS issued a communiqué, which stated in part:

  We directed our Finance Ministers to examine the feasibility and viability of setting up a New Development Bank for mobilising resources for infrastructure and . . . we are satisfied that the establishment of a New Development Bank is feasible and viable. We have agreed to establish the New Development Bank. . . .

  We tasked our Finance Ministers and Central Bank Governors to explore the construction of a financial safety net through the creation of a Contingent Reserve Arrangement (CRA) amongst BRICS countries. . . . We are of the view that the establishment of the CRA with an initial size of US$100 billion is feasible. . . .

  We call for the reform of the International Financial Institutions to make them more representative and to reflect the growing weight of BRICS. . . . We remain concerned with the slow pace of the reform of the IMF.

  The BRICS summit also specifically addressed the U.S. dollar’s role as the world’s leading reserve currency, and its possible replacement by SDRs:

  We support the reform and improvement of the international monetary system, with a broad-based international reserve currency system providing stability and certainty. We welcome the discussion about the role of the SDR in the existing international monetary system including the composition of the SDR’s basket of currencies.

  Finally, and so as to leave no doubt about the BRICS’ status as a political rather than an economic project, the Durban summit devoted substantial time to topics such as the crisis in Syria, a Palestinian state, Israeli settlements, Iranian nuclear weapons development, the war in Afghanistan, instability in the Congo, and other purely geopolitical issues.

  The BRICS reaffirmed their commitment to their new multilateral lending facility at their summit in St. Petersburg on September 5, 2013, held in conjunction with the G20 Leaders Summit. At that summit, the BRICS agreed that their contributions to the new fund would come 41 percent from China, 18 percent each from Russia, Brazil, and India, and 5 percent from South Africa.

>   In a surprising coda to the revelations of U.S. spying on allies emerging from defector Edward Snowden, Brazil announced plans in September 2013 to build a twenty-thousand-mile undersea fiber optic cable network from Fortaleza, Brazil, to Vladivostok, Russia, with links in Cape Town, South Africa, Chennai, India, and Shantou, China, to be completed by 2015. This system is tantamount to a BRICS Internet intended to be free from U.S. surveillance. The United States has long had excellent capability in tapping into undersea cables, so the actual security of the new system may be problematic. Nevertheless, the proprietary nature of this system could easily be adapted to include a BRICS interbank payments system, which would facilitate the use of any BRICS-sponsored alternatives to dollar payments.

  In addition to the regular meetings of BRICS leaders, a large number of ancillary and shadow institutions have sprung up around the BRICS, including the BRICS Think Tanks Council, the BRICS Business Council, and a BRICS virtual secretariat, among others. The BRICS are also coordinating foreign policy through the BRICS foreign affairs ministers’ meetings in conjunction with the annual UN General Assembly meeting in New York. These initiatives have spawned a new international facilitator class: the “BRICS Sherpa” and their “Sous-Sherpas.” These BRICS institutions form a formidable caucus in the midst of other multilateral forums conducted by the IMF, UN, and G20.

  Today the BRICS must be regarded as a powerful economic and political force, notwithstanding a recent slowdown in growth rates in certain members, especially China. The global BRICS footprint in terms of territory, population, output, natural resources, and financial reserves is impossible to ignore. The world should anticipate a gradual convergence between the BRICS’ vision for the future and the West’s legacy institutions, now that the BRICS have found policies and processes that unite them.

  This convergence has many facets, which can be condensed into a single theme: the diminution in the dollar’s international role and a decline in the ability of the United States and its closest allies to affect outcomes in major forums and in geopolitical disputes. The BRICS may have had humble origins in O’Neill’s brief research paper, but the group has taken on a life of its own.