It's Alive!

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MARC FABERRemember how sweet life seemed just a few years back? Communism and socialism had broken down, the cold war was history and countries everywhere were opening their markets to foreign goods and investment. More than 3 billion people were suddenly freed from backwardness and integrated into the capitalist system. Optimism was fueled by the removal of foreign-exchange controls, relatively easy monetary policies and favorable credit conditions. Toss in instant communication and new information technologies, and the era of globalization had begun. Capital could flow freely and be allocated efficiently to those regions, industries and companies that promised the best returns. Financial markets soared practically everywhere--even in Russia!In recent months, of course, everything has turned sour. Asia has gone south, financial markets in emerging economies are melting down, Russia has defaulted, stocks are crashing, poverty is on the rise. The crisis has been unprecedented in its intensity and speed. And it came without warning, not even from the International Monetary Fund, the World Bank, the U.S. Treasury and the Federal Reserve (all of which, of course, now have just the right prescription for getting out of the mess).How did things go so terribly wrong? Among economists and policymakers, the usual suspects include: excess industrial capacity, private and government over-spending, crony capitalism, insufficient transparency, stock-market and real-estate bubbles and Japan's tight monetary policies. The list goes on to include rapid debt accumulation in places like South Korea, powerful global capital flows and evil foreign hedge funds out to destroy financially sound but helpless developing countries.But all of these so-called causes are merely symptoms of a wider problem. The ultimate culprit: excessive and uncontrolled credit growth. The global bond market has swollen from $780 billion to about $25 trillion since 1970, a pace more than double the world's nominal economic growth. We've seen an unprecedented increase in leverage, as witnessed by the explosive growth of mutual funds, wild derivative products and non-traditional financial institutions like consumer-finance and credit-card companies. The economic system itself has drastically changed. In the past, money and credit were the oil that greased the engine of capitalism. Today, inordinate credit growth has created a monster--a gigantic financial bubble--that no longer serves as the oil but has itself become the engine of economic development.PAGE 1  |  
 
As financial markets become, in effect, the world's most important commodity, their rise and expansion lead to economic growth, while their fall and contraction produce economic downturns, or even collapses. It is no longer the real economy that drives financial markets, but the global financial market--because of its disproportionate size--that drives the real economy. Factor in instant communications, performance-driven and risk-loving financial institutions and a gullible public, and you have a perfect recipe for disaster. When a region is perceived to be doing well, money pours in and creates bubbles that are inevitably pricked the day the optimistic assumptions are recognized as errors. Capital then runs for the doors.So far, the experts, including influential Fed boss Alan Greenspan, seem to be confusing cause with symptom. And their response has been to treat only the symptoms. Consider the bailouts of recent years: the U.S. savings and loans, Mexico, Asia's economies, Long Term Capital Management. Next up, no doubt, is Brazil. New solutions are being tried out: interest-rate cuts (Japan and the U.S.), capital controls (Malaysia), artificial support for property and stock markets (Hong Kong). But the real villain--excessive credit growth--isn't even discussed!The experts of yesteryear sounded prescient warnings. To combat the depression by a forced credit expansion, said economist Friedrich A. von Hayek half a century ago, is to attempt to cure the evil by the very means which brought it about. A decade earlier, Joseph Schumpeter declared: Any revival which is merely due to artificial stimulus leaves part of the work of the depression undone and adds, to an undigested remnant of maladjustments, new maladjustments of its own. In other words, today's policymakers and economists need to understand that an eternal boom is out of the question and that downturns are an integral part of a free-market economy. It is through bankruptcies, failures and defaults that our capitalistic system is continuously reinvigorated. Only through this process of destruction can capitalism's ultimate survival be ensured. Mark my word: tomorrow's economic textbooks will have few kind words for today's policymakers, under whose auspices history's greatest financial excesses were not only permitted but even encouraged.  |  2