Off the News

OFF THE NEW S Does a Government Barack Rumsfeld Need to Exist for fter the publication of the Obama Creditors to Make Interest Administration’s new “Defense Strategic Payments on Debt? AGuidance” proposal, many private U.S. national security strategists note that the President’s he question may no longer be whether new agenda bears a lot of resemblance to the the Greek government can pay by “Revolution in Military Affairs” approach proposed TMarch 20 debt totaling €17.4 billion by Donald Rumsfeld, George W. Bush’s first defense (a €14.4 billion bond and €3 billion in short- secretary. Rumsfeld suggested decreased levels of term bills). The issue may well be whether defense spending and a lean, highly trained, highly Greece even has an effective working gov - technological, special operations-oriented military that ernment in place by the third week of March. avoids “nation-building.” Of course, in 2003, the Bush Foreign observers in Athens say the Greek White House and the Central Intelligence Agency political system has broken out into outright killed Rumsfeld’s approach. If simply for budgetary war. Behind the scenes the situation is noth - reasons, the Administration now looks to be revisit - ing less than political chaos, as ministers ing significant points of the strategic approach first engage in attacks and counter-attacks in this offered by Rumsfeld. In its latest proposal, the uncertain period after the exit of prime min - Administration proposes huge drawdowns in deploy - ister and PASOK party chief George ments in Europe and the Middle East with a larger Papandreou. concentration of strategic assets in the Pacific Rim. Odd Couple Surprising Poll A December 12 Gallup Poll showed that “big government” is viewed as the “biggest threat to the country” by 64 percent of the American people. In 2009, when President Obama entered office, that number stood at only 55 percent. Now the fear of “big gov - ernment,” an admittedly unspecified phrase, is widespread among Republicans (82 per - cent), independents (64 percent), and Barack Obama Donald Rumsfeld Democrats (48 percent). 4 THE INTERNATIONAL ECONOMY WINTER 2012 THE MAGAZINE OF INTERNATIONAL ECONOMIC POLICY O FF THE N EWS 888 16th Street, N.W., Suite 740 Washington, D.C. 20006 Phone: 202-861-0791 • Fax: 202-861-0790 www.international-economy.com [email protected] The Fed’s and ECB’s Dangerously High Leverage Ratios he year 2009 was the first and only time that cent of GDP in tax revenues, is clearly at an advantage global GDP declined since the 1945 –46 since the obstacles to raising more tax revenue are Tdemobilization in the aftermath of World political and not objective as they are in the eurozone. War II, and also the first and only time that global The limits to central bank balance sheet expan - GDP declined since the world abandoned the gold sion are availability of qualified collateral and size of exchange standard in 1971 and the entire world central bank capital. The eurozone, again, is where economy began operating on fiat currencies. both of these limits appear to have been reached. Declines in global GDP have always been Already one major eurozone bank, Belgium’s Dexia, extremely rare. From the beginning of the second collapsed because it did not have enough qualified industrial revolution to date, there have only been collateral to merit liquidity injections from the three occasions apart from 2009 when global GDP European Central Bank. The episode was a reminder dropped: World War I, the Great Depression, and post- of (and defines) that which limits the lender-of-last- World War II. In each of these previous occasions, resort role of central banks. recovery followed the reduction of debt burdens, The chart below depicts the evolution of the cap - either via wartime wipeouts or via deflationary bank - ital (in)adequacy of the European Central Bank and ruptcy, or—as in the case of inter-war Germany— the Fed over the last decade. The world’s two most hyperinflation. important central banks—the generators of most of But the post-2009 recovery of global GDP is the the world’s liquidity—have leverage ratios at sole instance in which the cause of the recovery was extremely dangerous levels. The Fed’s ratio is twice as a massive expansion of central bank balance sheets high as that of Lehman Brothers at the time of its and the even more massive expansion of debt: bankruptcy and the ECB’s is eight times as high. The I Between 2008 and now, global GDP increased ECB is further impaired by the fact that the quality by $2.9 trillion (4.7 percent) and global debt increased of the assets on its balance sheet is inferior (especially by $25.7 trillion (14 percent); after its purchase of toxic government bonds from I The balance sheets of the Federal Reserve and Greece, Portugal, and Italy), and that quality will con - the European Central Bank increased by 140 percent tinue to deteriorate as the recession spreads across the and 90 percent, respectively. China’s central bank, eurozone. with its idiosyncratic system, increased lending by —Criton Zoakos about 100 percent. In its first-ever encounter with negative GDP growth, the post-1971 global fiat money system 500 responded with monetary and fiscal expansions on a scale that had been hitherto unimagined. In order to grow in its present configuration, the 400 global economy has depended absolutely on continu - ing monetary and fiscal expansion. 300 o i European Central Bank t There are, however, clear limits to the post-2009 a R fiscal and monetary expansion. Every attempt to raise 200 more tax revenue results in lower economic activity and shrinkage of the taxable base. It has already hap - 100 pened in Greece, Portugal, Spain, and Italy, where tax Federal Reserve increases have been attempted. Eurozone tax revenues 0 already are about 50 percent of GDP with no room to 3 4 5 6 7 8 9 0 1 00 00 00 00 00 00 00 01 01 grow further. The United States, with less than 20 per - 2 2 2 2 2 2 2 2 2 WINTER 2012 THE INTERNATIONAL ECONOMY 5 O FF THE N EWS Remembering Mussa was one of the first economists to Michael Mussa demonstrate empirically how the short-run vari - ichael Mussa, who died January 15 after ability of exchange rates a long struggle with heart disease, left an differed systematically Mindelible legacy at the Peterson Institute under alternative cur - for International Economics and in the world of rency regimes. He also economics at large. Before joining the Institute in made important 2001 as a senior fellow in charge of our biannual advances in the profes - forecasts, Mike was a legend at the International sion’s understanding of Monetary Fund, where he was chief economist for how expectations ren - nearly a decade. At the Institute he was deeply dered the behavior of Michael Mussa engaged in all our activities for a decade and never exchange rates similar to failed to improve, and even inspire, our internal that of other asset prices, debates and written products. such as equity prices. He argued that official inter - Mike was a very popular and persuasive partic - vention in exchange markets could affect exchange ipant in our seminars and briefings, where he could rates by changing the market’s view about the future be counted on for lucid analysis and pungent humor. stance of monetary policy. “My favorite economic policy tool is prayer,” he Born in Los Angeles in 1944, Mike had multiple once said. “It is not demonstrably less effective than careers. From 1986 to 1988, he served as a member the others and it carries none of the bad side effects.” of the Council of Economic Advisers under President In an essay on trade for the American Economic Ronald Reagan. Previously, he had been a professor Review in 1993, he memorably wrote: “In of economics at the University of Chicago Business Washington, the truth is just another special interest, School and at the University of Rochester. He also and one that is not particularly well-financed.” served as a visiting faculty member at the Graduate Mike was probably best known to the outside Center of the City University of New York, the world in recent years for his semi-annual global eco - London School of Economics, and the Graduate nomic forecasts. In 2009, he challenged those who Institute of International Studies in Geneva, said there would be little or no recovery from the Switzerland. He received numerous honors and recession, and lately asserted he had been proven awards for his contributions to international eco - right even though the recovery has been disappoint - nomics, macroeconomics, monetary economics, ing largely because the housing sector remains weak. municipal finance, and economic forecasting. More recently, he expressed doubts about the effi - On the occasion of Mike’s sixtieth birthday, the cacy of sizeable further economic and fiscal stimulus International Monetary Fund held a conference to for the U.S. economy. acknowledge both his scholarly work and his abil - Mike was often scathing in his criticism of what ity to communicate difficult economic issues in a he considered to be public policy failures in regulat - down-to-earth way, with a dose of good humor. We ing financial institutions, responding to recessions, will miss his wit, his deep intellectual curiosity, and or rescuing troubled countries. As Mervyn King, his knowledge about history, political science, and governor of the Bank of England, noted, Mike government. Most of all we will miss his friendship “forced the international community to face up to and vital presence as a colleague.

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