By George P. Brockway, originally published January 17, 1994
THE NEWS FROM RUSSIA these days reduces one very quickly to hysterical laughter or hysterical tears. We sometimes seem to be well on the way toward Cold War II or World War III; and if we achieve one or the other (or both), we’ll have the economists of the world, with our economists in the vanguard, to thank.
Of course, the economists won’t be entitled to all the glory. They couldn’t do it alone. They’ll need the help or at least the acquiescence of the statesmen and bankers of all countries, particularly the United States. Crucial will be the austere devotion to austerity of the International Monetary Fund. No less important will be the casual mistranslation, miscomprehension, or misrepresentation of the news by the daily press and television. If, as economists never tire of repeating, we consumers are sovereign and get what we demand, it will in the end be our fault, and the world will suffer for our stupidity, our ignorance and our laziness.
The foregoing diatribe could have been prompted by almost any day’s news, but was in fact inspired by the lead story in the New York Times a couple of days after Vladimir V. Zhirinovsky‘s surprising showing in the election. The Times correspondent wrote: “In what may be a sign of a weakening of economic resolve after his electoral rebuff on Sunday, President Boris N. Yeltsin today granted new heavily subsidized loans that could aggravate the budget deficit and inflation …. The loans were for farm machinery enterprises at 25 per cent interest a year, far below the Central Bank’s discount rate of 21O per cent, the Interfax news agency said.”
Let’s start with the end. It may be that the Interfax news agency, or someone representing the agency, actually said something like what the Times attributed to it. It may also be that “discount rate” is an accurate translation from the Russian. But maybe not. With us, the term has a precise meaning and requires a developed banking system, which Russia is having difficulty organizing.
According to the Federal Reserve Board, “Discount rates are the cost to member banks of reserve funds obtained by borrowing from Reserve Banks …. discounts for member banks are usually of short maturity-up to 15 days.” A discount rate of 210 per cent is not so outrageous as the GI loan shark‘s “six for five” (a loan of $5 today to be settled with $6 on payday, next week), but it is bad enough to stop all business except gambling and thievery dead in its tracks.
With us the prime rate is usually about double the discount rate. It is inconceivable that the best-run medium-size businesses (who are given the prime rate) should be expected to survive paying 420 per cent for their money. They would do better to sell their assets for whatever they could get for them and lend the proceeds to the suckers still trying to earn a living by working for it.
It makes me sick to think of it, because it was not very long ago, when Paul A. Volcker was chairman of the Federal Reserve, that many thitherto profitable American companies found themselves saddled with such an array of “finder’s fees,” “lawyer’s fees,” “compensating balances” and so on (not to mention a 21.5 per cent prime) that they were paying what was effectively more than 40 per cent interest for their money. Those who survived the shock treatment did so by firing people, cutting production and raising prices. Otherwise they couldn’t have paid their bankers’ bills.
President Coolidge observed that “when many people are out of work, unemployment results.” I myself have observed that when many people raise prices, inflation results. In Volcker’s day we got it both ways: the highest unemployment rate since the Great Depression, and the highest inflation rate since World War I. The Russians are getting it both ways now and, oddly enough, they don’t seem to like it.
But let’s not forget about those lucky (or well-connected) farm machinery manufacturers who got the “subsidized” loans at “only” 25 percent, thus somehow throwing the budget out of whack and lighting a fire under inflation. I’ll agree that a loan at 25 per cent is inflationary (not so inflationary as 210 or 420 per cent, but sufficient unto the day). After all, interest is an expense, just as rent and wages are expenses; all expenses increase the cost of doing business; and all costs have to be covered by prices charged. I do not, however, believe that is what the Times story meant.
No, the Times (like the Wall Street Journal and all lesser media) is possessed of the curious fancy that interest expense has the mysterious property of lowering prices, whereas all other expenses raise prices. How this magic works is never explained. In contrast, the Times never mentions the prime rate without pedantically telling its financial section readers what it is, and always makes sure business people understand that when the bond market rises, the interest rate falls. (For more on the mysteries of interest, I refer you to “Why a Low Interest Rate Is the Proper Preventive of Inflation“ in a forthcoming issue of the Journal of Post Keynesian Economics.)
Let’s put those farm machinery manufacturers in a larger context. We are told that Russian agriculture is in a bad way, and that Russia needs billions of dollars in foreign aid in order to feed its people. It certainly would be better for everyone (except, perhaps, American, Canadian and Australian wheat farmers) if Russia boosted its own wheat production. And it is, I suppose, no secret that the purpose of farm machinery is the more expeditious production of food. So it should be obvious even to an economist that it would be a smart idea, as well as less inflationary, to get cracking on the production of farm machinery.
But economists know, if they know anything, that international trade is good because it is good, as they have recently taught us in regard to NAFTA and GATT. So even if Russian firms make the best farm machinery (for all I know, they do: Poland is said to make the best golf carts), economists would advise Moscow to import farm machinery on a shock program (shock programs are good because they are good), rather than “subsidize” Russian manufacturers with loans at usurious rates. The alleged subsidy is, they say, inflationary. But assuming the inflation were due to the supposed subsidy, it still could not hold a candle to the inflation caused by unnecessary importing.
There are two sorts of inflation. The sort we’re familiar with is what happens to our Consumer Price Index. The other sort is what is happening to the Russian ruble on the international money market. The two are not closely related, for when all is said and done, even in the brave new global village, domestic markets are many times larger than the import-export business. In the early 1980s, for instance, when our CPI kept on setting new double digit records, our dollar was far “stronger” against foreign currencies than it is today.
The Russian CPI, whatever it is, is undoubtedly very bad because of the usurious interest rates. But it is nothing compared with the free fall of the ruble, which is tumbling because Russia has lost its export markets in Eastern Europe and consequently is unable to import in the style it was accustomed to. When it is said Russian inflation is in excess of 20 per cent a month, that does not mean today’s $2 loaf of bread will be $2.40 next month and $5.97 in six months. It merely means that if you want to show your neighbor what a wheeler and dealer you are, you had better buy your Mercedes today, because it will cost you three times as much if you wait six months.
It is this second kind of inflation that exercises the International Monetary Fund, since it is the Fund’s purpose to make all the world’s currencies interchangeable. It is also this kind of inflation that attracts the attention of Western reporters, who exchange Western for Russian currency to pay for their food and shelter and entertainment. More important, it is this kind of inflation that can get out of hand and pass over into hyperinflation, as it did in the Weimar Republic and then several other places.
Hyperinflation comes about when a nation has debts it can’t repay that are denominated in foreign currencies. Our contribution to Russia’s troubles is a clutch of economic advisers, mostly from Harvard, who seem determined that Russia must destroy the industry it has and borrow to import state-of-the-art factories from us. How else will the Russians be able to compete in the global village (where they were, only yesterday, sufficiently competitive to scare us silly)?
Now, THERE IS in the world a good example of what can happen if you tell the IMF to go peddle its papers. All of a sudden China is being hailed as an economic miracle, more miraculous than Taiwan. I am an authentic old China hand, having spent three weeks there in 1976, when Chairman Mao was still alive. Mao tried shock treatment long before Harvard thought of it. He called it “The Great Leap Forward,“ and had befuddled peasants trying to make steel in their backyards. It proved a disaster. He tried another shocker – “The Great Proletarian Cultural Revolution” – and that, too, passed away, but not before thousands of people were killed and thousands more ruined. After Mao’s death and the defeat of the “Gang of Four,” Deng Xiaoping, who had twice been disgraced by Mao, took over.
Deng is an eclectic gradualist. He followed Mao in scorning foreign loans, in not breaking up the less-than-state-of-the-art factories, in plowing with oxen when tractors were not available, in encouraging (or requiring) teams of workers to plan their year’s work. The plans were subject to veto, but they had the virtue of getting some people to think about what they were doing. It was a form of privatization more meaningful than selling shares of stock on a trumped-up exchange.
Recently Deng has accepted substantial investments by “round-eyes” and has relaxed some controls, especially those on retail trade. Now he is regularizing the currency. Yes, I remember Tiananmen Square; and no, I do not favor the extension of China’s most-favored-nation status. I cite China as an example of what can be done if you take a little time and eschew international finance.
As an example of what is likely to happen after shock treatment, I would cite almost any country in sub-Saharan Africa or South America. All of them are crushed by debts denominated in foreign currencies.
Most of them, bowing to the advice of their IMF masters, have tried to balance their budgets by destroying their civil service, whose officers then supplement their starvation wages with extortion.
The enthusiasts for shock treatment cite Germany’s successful ending of hyperinflation in 1924. They forget that the inflation ran for more than three years, and that those who really got shocked were the bankers and investors who lent Germany money to “pay” the War debts, which were ultimately forgotten. Yeltsin wouldn’t mind that sort of shock.
The New Leader