The ninth paragraph in the following Forbes article was the basis of my question:
Fact and Comment
Immolate The IMF
06.27.11, 6:00 PM ET
The tawdry and ugly Dominique Strauss-Kahn affair has once again raised questions about the International Monetary Fund: What is the IMF? And do we need it? To be blunt, the world does not need the IMF; it does more harm than good. The world would be better off without it.
The Fund is no minor institution. It possesses some $375 billion in assets, including 90 million ounces of gold. Most of the money came from you, the American taxpayer.
Once upon a time the IMF had a useful purpose. It was created in the waning days of World War II to undergird the new postwar international monetary system. The dollar was fixed to gold, and other countries tied their currencies to the greenback at a fixed rate. The Fund's task was to provide emergency short-term loans to countries that got into economic trouble, to give them breathing space in which to get their financial houses in order. The goal was to prevent a repeat of the competitive, catastrophic beggar-thy-neighbor currency devaluations that had deepened the Great Depression. Devaluations are a form of protectionism--almost on a par with imposing tariffs on imports--wherein countries get short-term advantage by cheapening their money, which temporarily make their exports cheaper. Longer term, all the exercise does is deepen the downward spiral and prevent a robust economic recovery.
The Bretton Woods system worked perfectly well, with the IMF playing a part from time to time. Devaluations were rare--and orderly. Then in the early 1970s the U.S. blew up the arrangement. Beguiled by false economic nostrums, Washington bought into the notion that trashing your currency could keep your domestic economy growing and unemployment low. No more fixed exchange rates.
Did the IMF close shop when its purpose was rendered moot? Ronald Reagan correctly observed that a government program or agency is the closest thing we get to immortality on this Earth. The IMF reinvented itself as a global economic doctor. Instead of helping a nation keep its exchange rate steady, the IMF would cure all the country's economic woes. Commercial banks loved it because the Fund could impose draconian measures on wayward borrowers, and the banks would avoid direct political flak for being Western economic imperialists.
Trouble is that the IMF's prescriptions almost always perpetuated poverty for its patients. It practiced ersatz Keynesianism on steroids. Countries were invariably advised to devalue their currencies--which only fed domestic inflation--and to raise taxes.
Thankfully, because of Ronald Reagan's policies the U.S. boomed, and the rest of the world started to engage in more free-market economics after the fall of the Berlin Wall. As a result, the IMF found fewer and fewer countries on which to ply its poisons. By the early part of the last decade the agency truly had nothing to do. Alas, the U.S. never entertained the notion of shutting the thing down.
Then came the economic crisis, and the IMF was back in business. Once again its advice has been toxic. It has put off the inevitable debt restructuring for countries like Greece. And it is peddling austerity without the necessary companion policies that engender growth. Greece, for instance, needs to rein in spending. It must engage in serious privatizations again. But it also needs policies that will enable its economy to come back to life, such as a low-rate flat income tax. Russia enacted one more than a decade ago. Collections doubled in Russia within four years for two reasons: the ease of enforcement and an economy that was once again expanding. During the 1990s the IMF had told Moscow to more vigorously enforce its unenforceable tax code (one that made ours look pristine).
And weep not for IMF employees, who, by the way, pay virtually no income tax. There's more than enough money to give them fabulous severance packages.
So let's do to this agency what Henry VIII did to monasteries: Shut it down and distribute the booty back to those who put it in in the first place. Uncle Sam would ultimately collect more than $70 billion.
Last month Prime Minister Dato' Sri Mohd Najib bin Tun Abdul Razak of Malaysia gave a remarkable speech at the Oxford Centre for Islamic Studies, a speech whose theme should be taken to heart by all leaders: Moderates of all faiths, including Muslims, must speak out forthrightly against terrorism. Najib quoted Edmund Burke's observation that all that's necessary for the triumph of evil is that good men do nothing. As the PM said, "It is for people who cherish moderation, dignity and justice everywhere to stand firm. … We cannot allow this moment to be overtaken by extremists. Modernization and moderation must go hand in hand. A world free from terrorism is possible. … It demands us to stop being a silent majority and to start reflecting the courage of our conviction."
Najib emphasized the theme that "diversity, dialogue and peaceful coexistence are important themes in Islam. I would like to emphatically state that those who strap explosives on their bodies and blow themselves up are not martyrs. They do not represent Islam."
The PM rightly cites Malaysia as an example of the point he was making: 60% of Malaysians are Muslims, and they peacefully coexist with Christians, Hindus, Buddhists and others. "In Malaysia Islam is synonymous with moderation, inclusiveness and good governance."
Malaysia is also a model of economic development. It has weathered the financial crisis well, and under Najib the country has been liberalizing and seeking foreign investment. An impressive but underheralded story.
Worried About Our Country? You Need To Read This
By Brian Domitrovic (ISI Books, $27.95)
Brian Domitrovic chronicles the extraordinary history of supply-side economics: how it came into being, gathered traction in the 1970s and then triumphed with the election of Ronald Reagan. He tells this neglected but enormously important story with sympathetic verve, superb research and acutely drawn sketches of the principal characters. It has sharp relevance today and for the 2012 elections.
And what a story it is. Without the supply-side movement the U.S. in the 1980s and 1990s would have become a sluggish western European-style economy, with anemic growth and a dearth of innovation--which would have had profoundly negative geopolitical implications. The nation could never have financed Ronald Reagan's rapid and muscular military buildup, which, combined with an ever more dazzling cornucopia of new technologies and Reagan's robust diplomacy, won the Cold War for the Free World. Our standard of living--and those of everyone else--would be far meaner today. But because of supply-side economics we, followed by the rest of the globe, experienced two-plus decades of economic miracles.
Keep three numbers in mind--3.3, 1.8 and 3.3. They tell an astonishing tale. Between the end of World War II and the early 1970s the U.S. economy grew, on average, at an impressive real rate of 3.3%. In the 1960s, with President John Kennedy's pledge to keep the dollar as good as gold and the passage of sweeping, across-the-board tax cuts, average growth exceeded 5% a year.
But then, like today, the U.S. went on a money-printing binge, and the gold standard, which had been in place for 180 years, was killed. Government spending erupted like a volcano. Taxes went up and up. Unemployment surged to higher levels than today. Innovation withered. Through the terrible 1970s and early 1980s our growth rate collapsed to 1.8%. And even that feeble performance, based as it was on riotous speculation in commodities, land and commercial and residential real estate, exaggerated the actual health of the economy.
By the early 1980s Japan and western Europe had virtually caught up with the U.S. economically. But then Ronald Reagan took office and supply-side economics was sitting firm in the saddle. The U.S. surged ahead again, achieving an average yearly growth rate of 3.3% until the recent financial crisis. Now, thanks to a reversion to 1970s-like policies--made worse by the seminationalization via regulation of the health care and financial sectors--we have returned to 1970s-like stagnation and disturbingly high unemployment.
All this is why Domitrovic's book is so instructive and timely. With the U.S. going back to the 1970s economically and geopolitically, the 2012 elections will be crucial. Unless a Republican with Reaganesque principles, political abilities and backbone wins the White House, we are in for more difficult, dangerous and turbulent times. This is both a cautionary tale of how we nearly collapsed in the 1970s and an inspiring road map of how we came roaring back.
While the media conjure up visions of the 1930s when they discuss the current economic crisis, a more apt comparison, Domitrovic makes clear, is the stagnant and inflationary 1970s. We've forgotten how discouraging and unnerving that period was. The U.S. seemed in an unbreakable grip of ever rising inflation, unemployment and economic malaise. Economists were befuddled. They'd been taught that increased government spending and the Federal Reserve's printing more money would stimulate the economy. Economists believed there was an inverse relation between inflation and unemployment, exemplified by the Phillips Curve. If you wanted less inflation, you had to accept higher unemployment; lower unemployment meant accepting more inflation. But in the 1970s we were getting more of both inflation and unemployment. The profession was at a loss as to why its Keynesian-oriented theories weren't working, yet most economists adhered to them with a Stalinist ferocity.
Two economists who defied the party line were Robert Mundell, winner in 1999 of the Prize in Economic Sciences, and the now iconic Arthur Laffer. They turned Keynesian orthodoxy on its head. Policymakers had it all wrong, they pointed out. The way to create an environment for growth and innovation was by reducing the tax burden through cutting income tax rates and by making the dollar strong and stable. Let producers, innovators and risk takers increase the supply of products and services, and the economy would boom. Hence the name "supply-side economics."
Given the ironclad Keynesian conventional wisdom that reigned then (and does again in the current White House), the supply-side victory was something of a miracle. "In the early 1970s all of two academic economists [Mundell and Laffer] could be counted in the movement. The rest of the first ‘supply-siders' comprised a subterranean crew of journalists, congressional staffers and business forecasters."
And what a motley crew they were. Jack Kemp, a noted football quarterback turned Buffalo congressman, became the sunny proponent of a massive, across-the-board cut in taxes and a gold-based dollar. Wall Street Journal editorial writer Jude Wanniski, once employed at a Las Vegas newspaper and married to a showgirl (they soon divorced), became a tireless proponent. Absolutely critical to this nascent and growing group was the WSJ's editorial page editor, Robert Bartley.
Meeting at the Michael 1 restaurant in lower Manhattan, these folks and others would engage in long discussions about what was going wrong in the U.S. and what should be done about it. Bartley became a full-bore convert, and under his guidance the WSJ became the supply-sider movement's foremost platform and advocate. The Mundell/Laffer thesis of low taxes and sound money would never have achieved political success without Bob Bartley.
Their triumph was not easy, as an ugly incident involving Laffer shows. In the late 1960s and early 1970s Laffer was seen as a brilliant up-and-comer in the world of economics. To gain a broader perspective he went to work as chief economist at the Office of Management & Budget during the first Nixon Administration. Laffer devised a new forecasting model that churned out an optimistic scenario for the coming year. His methodology is now widely accepted, and his forecast turned out to be spot on. However, Paul Samuelson, the éminence grise of the profession, lashed out at the young and obscure economist in a lecture delivered at the University of Chicago, where Laffer was a tenured professor (Samuelson was ensconced at MIT). The lecture was entitled, "Why They Are Laughing at Laffer." Even by the catty and nasty standards of academic political backbiting that was a stunning low blow. What offended Samuelson was obviously not the forecast but Laffer's free-market, sound-money principles. Samuelson's message to young economists: If you want academic success, don't associate yourself with the views of a man like this. Samuelson, who always had a soft spot for communist economies, was pining for an academic version of the Gulag.
Robert Mundell was too well established in the profession to be ridiculed, so his colleagues simply ignored him, Soviet-style, acting like he'd ceased to exist.
In business it's a truism that outsiders, not incumbent companies, usually come up with the revolutionary breakthroughs. So it is in the academic and political worlds as well.
Mundell is unusual among economists in that he has a deep sense of history, which was displayed in his Prize Lecture at the Nobel awards. He reminded listeners that the U.S. both enacted the income tax and created the Federal Reserve in 1913, which makes that year a seminal one, almost on a par with the following one, during which World War I began. Mundell recounted how botched economic policies after that war set the stage for future disasters. If not for these mistakes, "there would have been no Great Depression, no Nazi revolution and no World War II."
Econoclasts deftly takes us through the 1920s, 1930s and post-World War II period. Few other historians would know enough to appreciate the magnitude of industrial magnate Andrew Mellon's achievements during his stint as Secretary of the Treasury in the 1920s. Mellon quickly got the Federal Reserve to break off its disastrous postwar deflation policies and shepherded the U.S. through what would now be called supply-side income tax cuts. These moves made the decade one of eye-popping growth and innovation. Alas, the subsequent government-created Great Depression was portrayed as a failure of free markets and cited as proof that more government power and involvement in the economy were needed. Thus the rise of the easy-money, high-tax, big-government-spending ideology dubbed Keynesianism.
But the desperate 1970s gave supply-siders their opening. Congress--including many Democrats--was ready to try something new. Supply-siders won their first major victory in 1978 with the astounding passage--despite intense White House opposition--of a major cut in the capital gains tax, engineered by an obscure Wisconsin congressman, Bill Steiger. The maximum rate was reduced from almost 50% to 28%. Despite the steep reduction, the next year's receipts from the capital gains levy easily exceeded those of previous years. Jack Kemp's bill for a 30%-across-the-board income tax rate reduction gathered growing support.
However, it is clear that after Bartley and Kemp the biggest hero was Ronald Reagan. In the late 1970s he became a firm convert to the need for major decreases in the tax rates. No other Republican candidate seeking the presidency in 1980 could have pushed through the big tax reductions--personal and business--with the tenacity and success that Reagan did in 1981. The new President also sent an edict to the Fed that inflation was to be conquered once and for all. (One thing Domitrovic doesn't cover is that Fed Chairman Paul Volcker, who hadn't had much success in curbing inflation during the two years before Reagan took office, actually overdid the tightening, much to the chagrin of supply-siders. Only in late summer 1982, when Mexico threatened to default on its debts, which would have jeopardized the major banks that held so much of its paper, did Volcker finally relent. Subsequently, with a semi-stable Fed policy and the Reagan tax cuts kicking in, the American economy took off like a rocket.)
The success of the supply-side revolution can be seen in the fact that under Ronald Reagan the growth alone of the U.S. economy from 1982-89 exceeded the entirety of West Germany's economy, then the world's third largest. The U.S. became a font of invention and innovation. Silicon Valley became synonymous with exciting new technologies.
There are a couple of intriguing standouts in this book. One is that the conquest of inflation initially increased the budget deficit early in Reagan's first term. Inflation is a debilitating, destructive tax. Throughout the 1970s it had kicked people into higher tax brackets, even though their real incomes were stagnant or declining. With the end of inflation that source of tax revenue dried up. Economists, both liberal and conservative, who focused only on deficits blamed the red ink on the supply-side tax cuts. Even though Reagan engaged in a major military buildup that enabled us to win the Cold War, the truth is that by the end of the 1980s not only was the federal deficit sharply down, but also the combined budgets of the government sector nationwide were in balance--states were running surpluses.
During the time that subduing inflation temporarily caused budget deficits to increase, another turbulent thing was unfolding. Investments that had looked good when inflation was rampant suddenly became utterly unattractive when it was curbed. Building on the work of Harvey Wilmeth, economist at Northwestern Mutual, venture capitalist John Rutledge (now an occasional FORBES columnist and guest on Forbes on Fox) pointed out that there would be a major and disruptive shift in capital from tangible to intangible assets. He looked at the value of both categories, noting that in normal economic times the preponderance of the nation's assets were in financial instruments, with the remainder in such tangibles as land and houses. During the inflationary 1970s the worth of tangibles had surged past the intangibles, but under Reagan this artificial ratio was going to revert to the norm. Rutledge warned that it would take six to eight years for this to unfold, as companies and individuals would be trying to sell a raft of suddenly uneconomic assets to a market that no longer was interested in them. Rutledge's insights were resolutely ignored, and commentators once again blamed supply-side economics for the economic turmoil of the 1980s.
Someday we'll again make the dollar as good as gold (though Domitrovic has doubts that this is feasible), and the Rutledge analysis will have to be dusted off to explain and prepare for the inevitable turbulence.
Which brings us to the big thing that Ronald Reagan was unable to accomplish: relinking the greenback to gold. We can only hope that after 2012 Domitrovic will be working on a new book, this one about the resurrection of supply-side economics--and a gold-based dollar.