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Issue no. 39, 1 Oct 2006 back issues at www.paecon.net
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In this issue:
-The Future of Economic Policy Making
by Left-of-Center Governments in Latin America
Juan Carlos Moreno-Brid and Igor Paunovic (United Nations, Mexico) .........2
- Latin America: The End of an Era
Mark Weisbrot (Center for Economic and Policy Research, USA) ...............................8
- Will Computers Really Decentralize the Economy?
Ian Fletcher (USA) .........................................................................................26
- Is New Labour’s ‘ Third Way ’ new or just hot air in old bottles?
Grazia Ietto-Gillies (London South Bank University, UK) ......................................31
- A Solution to the Alleged Inconsistency in the Neoclassical
Theory of Markets: Reply to Guerrien's Reply
Deirdre McCloskey (University of Illinois at Chicago, USA) ...................................48
Opinion
- Keynes without Debt
Ron Morrison (UK) ...........................................................................................51
-The Dream of Creativeness as Outcome of Political Economy
Margaret Legum (SANE, South Africa) ................................................................54
Opinion
Keynes Without Debt
Ron Morrison (UK)
As the power of 'free market' Capitalism – or more precisely, the power of money, takes even deeper root in our 21st century, so also does the human vice of greed undermine our societies. Where once there were standards of behaviour and conduct whereby the democratic process would maintain some crude balance between self-interest and social responsibility, now our governments, ably abetted by a burgeoning 'middle class' seem intent upon dividing the world into 'haves' with even more and 'have-nots' with ever less. Such injustice is the fellow traveller of discontent, generating terrorism and disruption.
The challenge is to humanise the present style of capitalist system. We must recognise the social cost – not only in the obvious sense of the have-nots becoming poorer, but also the ever higher price being paid by the haves in terms of their own much vaunted lifestyles. If the wider infrastructure of society continues to deteriorate, there will be no green and pleasant environment to enjoy.
To this end there exists a practical and specific proposal to consider, which might be called Keynes without Debt. It embraces the economic principles of John Maynard Keynes. Currently unfashionable in the rarefied atmosphere of the neo-classical academicians who espouse the euphemistically styled free market, it was Keynesian principles which pulled the West out of the depression of the thirties and which helped Europe recover from the ravages of WW2.
As war developed into peace and the targets of full employment were achieved, so also began to grow once again the power of money. In the 1980's a new economic theory developed – that of deregulating the money business in the expectation that the market place would produce economic equilibrium. Much faith was invested in Adam Smith's 'invisible hand' - a much misquoted euphemism of the 'I'm alright Jack' fraternity. Hypnotised by this delightful simplicity, and encouraged by a body of bankers and financiers who were obviously extremely influential and financially successful, the politicians of the era – principally Thatcher and Reagan – committed the West to a world run by money as the prime mover of all other policy.
Not everyone was convinced of the long term effects of this, but the money lobby condemned spiralling taxation and the cost of government borrowing as becoming unsustainable and out of hand. The pro Keynes lobby were unable to marshal a counter argument - it was perfectly true that debt – both personal and National, was indeed beginning to spiral and Keynes' theories had never really got to grips with the role of the money system in the economic drama.
Keynes eschewed abstract mathematical theories based on apocryphal assumptions. He produced more practical theories than any of his fellow economists and he dealt with the real world and its problems. He firmly believed that government's job was to intervene where the free market broke down in social terms. However, he never really got down to the nitty-grittys of the money system - government remained obliged to borrow from the banking system in order to intervene effectively; and this implied increased taxation or an escalating National Debt.
Of course Keynes' General Theory was published in 1936 when currencies were still linked to the Gold Standard - indeed the US dollar was still linked to gold up until the early seventies. Keynes died in 1946, long before 100% fiat[1] currencies became the norm. At that time half the money supply in the UK was spent into existence debt free by the state and the other half was chequebook credit. It is not therefore altogether surprising that he felt constrained by traditional monetary theory and found it hard to look beyond bank borrowing to finance public expenditure. The concept of Keynes without Debt addresses our current domestic crisis of rescuing our obsolete Public Services without increasing taxation or cranking up the National Debt.
Now, fifty yeas on, bank credit supplies virtually all our everyday means of exchange, and this brings into sharp focus the simple fact that modern money is no longer constrained by outmoded intrinsic values. It is pure fiat and simply a glorified accounting system. Keynes did see money in this light when he conceived his International Payments Union (Bancor). Very briefly this was an international currency unit to be administered by the UN whereby all countries were encouraged to maintain a balance of payments and avoid excessive debt. Countries in surplus saw their balances reduced by the application of negative interest and those in debt had to pay interest or devalue.
Unfortunately for the developing world the Americans dominated the post war Bretton Woods Conference and were not prepared to permit the mighty dollar to play second fiddle to anyone or anything – no matter how good the logic. Even then they knew that whoever controlled the world's currencies also controlled the political power. However, the detail is not the point here, what is important is the principle – that money is now an accounting system which can be administered in such a manner as to optimise a declared objective.
Modern monetary reform is about displacing the current economic paradigm of 'what can be afforded' with 'what we have the capacity to undertake'. It is a unique situation that for governments the term 'affordability' in terms of money is a non word. All new money emanates from government either as cash or as credit authorised under the Banking Acts. The value of the money in our pockets and bank accounts is a function of good government acting responsibly to maintain its value. Nonetheless, the financial establishment (now over a quarter of the UK GDP)[2] reckons that it knows best how much our government can afford to spend on public services and infrastructure.
Governments have issued debt free finance for donkeys years and spent it into circulation interest free. It can be done again, given the political will. The evolution of credit this past fifty years has expelled this source and replaced our means of exchange with private, interest bearing debt. If government can issue Gilts and Bonds they can issue credit to finance the rebuilding of creaking national infrastructures. When government once again assumes its constitutional responsibility to issue the National currency and then lends it to the banking system to re-lend as intermediaries then we can reduce the tax burden and finance essential public services. Nowadays Wall Street and the roads in London’s City are not paved with gold but with paper and computer chips. The money supply is all to do with business and maximising shareholder value – nothing to do with benefiting the community. It is the road out of a mixed economy into a frightening new world order where money buys power, both political and military. We need an alternative route. It's sign posted - Keynes Without Debt.
[1] Financial Intermediaries – enterprises holding other people's money to make loans – were 27.6% of GDP in 1998. Abstract of National Statistics.
SUGGESTED CITATION:
Ron Morrison, “Keynes without Debt”,post-autistic economics review, issue no. 39, 1 October 2006, article 6, pp. 51-53, http://www.paecon.net/PAEReview/issue39Morrisont39.htm
Reprinted from the Scots Independent Newspaper May 2008
Financial Independence
There have always been those who make a lot of money from manipulating the financial system, but never so many as today. Thirty years ago the choice of a career was significant, but now it’s often seen as little more than a means to an end – just show us the money.
We produce acres of newsprint and listen to media dominated by financial data and markets. The world economy hinges on the forecasts and actions of a handful of bankers - and the financial interests of those who appoint them. Governments are constrained by budgets rather than the human resources they represent. Ordinary folk spend more time worrying about their debts and financial affairs than doing useful work or enjoying themselves. Money is King.
Over recent months The Federal Reserve has poured hundreds of billions into US financial markets – also called bailing out the banking system. Likewise the Bank of England has poured tens of billions into Northern Rock and opened a virtually infinite ‘line of credit’ to all the major clearing banks in the UK – all to keep our fragile money system from collapsing.
This is the system which sold 125% mortgages to borrowers on income multiples of six and seven times, didn’t bother to check income declarations and required no deposit. When credit is churned out like that then prices keep rising until the crunch comes. This is the same system which lends credit to hedge funds which buy up financial products on such a scale that the prices just keep on rising – until the crunch comes. it is bank credit which funds the private equity firms which buy up real companies, break them up and sell off the bits for a quick turn. It’s the same credit which funded the conversion of erstwhile Building Societies, the privatisations of the eighties and all the other financial wheezes – the latest being Scottish Water which will now be more efficient and competitive. In fact the only change is that tomorrow half a dozen new firms will produce bills for the same water, flowing through the same pipes maintained by the same Scottish Water employees. It follows the pattern of all the other utilities – a free gift to all the new ‘ competing’ power suppliers but the same gas & electricity flowing through the same conduits….. and like all the competing train operators running on the State subsidised rail network.
What does all this produce? Nothing but £100 billion more financial credit each year – that’s £346 million a day more financial air to inflate the bubbles constituting the Financial Sector – now thirty per cent of all UK earnings. Interesting too that there’s no new bank credit needed to abolish Council Tax so The Treasury describes replacing it with Income Tax as an ‘expensive fiasco’. We already collect 75% of local authority revenues this way – why should collecting the other 25% cost a penny more? Indeed abolishing the expensive process of collecting rates locally should be a worthwhile economy.
The State is constantly broke. They tell us only ‘private sector finance’ can fund new build State assets and all our public services survive in the shadow of the Treasury guillotine, so they invent PFI. This generates yet more bank credit, predicated upon the hapless taxpayer paying off the debt over thirty years. Yet this same State can fork out all these billions to the banking system, and £25 billion for Trident - not to mention £2bn a year to run it. It can afford military adventures and murder in Iraq and Afghanistan. We have become a client State of the White House Mafioso – another politically corrupt administration in obscene debt to the rest of the World but not giving a jot provided the money flows to the right people.
Government should be protecting us from self-interested moneygrubbers - not subsidising them, yet the gullible public nods its collective head to all this and listens to fairy stories about keeping the financial markets stable and inflation below 3%. It has taken some time, but the rest of the world has finally rumbled the con – the pound is following the dollar down the Swaney. Today all these imports and your holidays abroad will cost 20% more than yesterday and tomorrow probably another 20%, because there’s no sign of anyone stepping in to stop the rot. Why should they - the financial speculators make as much on the currency falling as rising …
You can fool all of the people etc. but you can’t manage an economy or a Nation by manipulating its payment system. As an accountant I was dumbstruck by the Thatcherite deregulation of the banking system. As a businessman I am nothing short of amazed how long the productive population has remained oblivious to the parasites of W all Street and The City sucking them dry. I don’t mind people gambling with their own money, but using mine, pocketing the winnings and then asking me for more when it occasionally goes pear-shaped is a bit much.
Corrupting the payments system has effectively destroyed the real economy; we are left weakened and undermined. We have been gullible and have assumed our government to be competent and responsible. It has been anything but - and there appears no prospect of change until the last billionaire fat cats and tax exiles abandon the sinking ship. Take a look at www.scottishmonetaryreform.org and see an example of what our Party Think-tank should be contemplating.
I became a Scottish Nationalist because I believed it was the only way we could save ourselves from this financial disease. There is simply no point in political Independence without financial independence. Our party leaders must take this on board and work out how we can reincarnate a responsible banking and payment system. I have a dreadful suspicion that many of the principles which drew old Nationalists to the Cause may be in the process of being dumped for short term political expediency, The prospect of a mirror image of the financial status quo but moved to Edinburgh will spark a New Clearance rather than a New Enlightenment.
A new set of values for society, finance and foreign policy should be the focus of the next election and we should not be frightened to say so.
(Ron Morrison is a retired accountant and businessman and a former member of the SNP Finance & Taxation Committee)
Also reprinted from the Scots Independent of August 2008 -
FAQ about 'New Banking' - refers to Banking & Society PowerPoint Presentations
Will the Newbank Charter protect my ordinary savings & deposits?
Yes –,. as Newbanks cease to depend upon each other & the markets for funds (apart from the Clearing Process) the State will guarantee deposits 100%. But it will NOT bail –out a failing bank by providing taxpayers’ money to bolster its capital or other liabilities.
Can a Newbank still go bust? Yes, but as an intermediary it does not have access to your money as an asset, other than to lend it to another customer. If a Newbank loan goes bad it will be a charge against its profits (i.e. the shareholders as at present) and if the Newbank’s capital & reserves are insufficient the bank will become insolvent. The purpose of Regulation will be to encourage prudent lending and moral hazard. It would be a criminal offence to use customers’ deposits to underwrite or subsidise shareholders’ obligations – with sanctions extending beyond the normal limitations of limited liability. An advantages of the Newbank arrangement is that there can be no chain reaction to a bank going down; there can be no sudden drying up of credit due to financial gridlock. The State will underwrite the deposits of normal customers – although there may be limits imposed.
Would such restrictions not close down the availability of medium/high risk lending?
Yes – banks would be discouraged from high risk business which would be left to specialist firms attracting funds with a high risk profile & return. Medium risk business would be written on appropriate terms. The overarching principle being that banks per se were perceived as safe.
Can Newbanks lend out credit in excess of customer deposits?
Not directly – the Central Bank is the sole source of all new money (both cash & credit) and Newbanks will require to tender for tranches of the National Credit as and when they deems necessary.
Will I receive interest on my deposits?
It is unlikely that interest will be paid on current accounts, indeed there will probably be a charge for providing this facility. Interest will be paid on savings or term accounts - probably at two basic rates. A low rate for under three month access and higher rates for locking in money for longer periods. Devices like instant access savings accounts are likely to disappear. It is likely however that there will be opportunities to invest in a Newbank in return for a higher return but also higher risk – i.e. these will be share accounts having various degrees of preference to risk ratios as well as ordinary shares.
Will Newbanks be able to offer customers other financial services like insurance, share dealing etc?
No. Their Charter restricts then to retail banking and managing the payments system.
Will Newbanks continue to offer credit card and normal personal & business overdraft facilities?
Yes, They will charge a margin of interest over what they themselves pay to customers and the Central Bank. The Central Bank will continue to fix base rates.
What about long term loans & mortgages?
Yes, but under the new regulations these contracts will not be sold on into the money markets or to other banks but tendered to the Central Bank as securities for further tranches of State Credit. Depending upon the risk or nature of the contracts the Central Bank may offer a risky bank less than 100% replacement credit.
What does the State do with these mortgage securities?
They produce a stream of revenue to the State which will underwrite the tranches of new National Credit to the banks. If a major drop should occur in house prices relative to these securities they are already underwritten by the State and do not affect the commercial viability of the Newbanks
Will the Newbank charter contribute towards any reduction in private & public debt?
Yes. Central Bank policy will be to cap present debt levels. New money is constantly in demand and will be available to Newbanks– i.e. money over & above that provided as replacement for securitised debt contracts. Newbanks will credit the account of the Central Bank with the value of all new money issued to them in this manner – be it in the form of cash or credit. This new money will not be loaned into circulation but spent by Government in the form of payment for new public assets. Thus any addition to aggregate money supply will not be debt but money backed by physical asset creation. This will reduce both private and public debt yet still finance public investment.
Will loans between banks still be permitted?
Yes, but generally restricted to the overnight clearing operations. As a matter of principle inter-bank lending will be regulated to avoid potential financial chain r
Unimaginable amounts of public money went into rescuing the banks, but precious little into what really happened. The governing elite dispenses the usual anodyne clichés - ‘lessons have been learned’ and ‘it’s time to move forward’ - but we must not permit them to get away with reinstating this flawed and volatile system under the guise of returning to ‘normality’.
It is unacceptable that ‘Public Inquiries’ into ‘unfortunate events’ occur only following significant public pressure. Even when grudgingly conceded they are inevitably chaired by a prominent member of the Establishment who forthwith nominates other members of the same Establishment to pontificate upon these events. On the rare occasion when an outsider is invited to submit a dissenting view this is inevitably dismissed as ‘fringe’. At best it warrants a minority report at odds with the overwhelming body of evidence from industry experts and high profile public personalities. Have you heard even a whisper of a Public Inquiry into this monumental banking scandal? In short the Westminster Establishment operates within the same parameters of ‘self-regulation’ and pocket lining as does its paymaster - the banking system.
Nothing new here then. We always seem to end up with a leadership which uses democracy as a platform to advance their own agendas – not ours. Just look at the millions who spoke out against the Iraq war – it made not an iota of difference. And now it is equally obvious that the banking system is operated exclusively in the interests of bankers and this same Establishment. Are our memories so short? Is apathy so universal? Is the human condition such that we can do no better?
We must focus our dissent upon the Paymasters who keep this Establishment in powerful office, and the money system they administer. Most of us understand money in the context of our personal lives and household budgets, and equally transparent is how legitimate fortunes are made (and sometimes lost) in running business like manufacturing, retailing and construction etc. and we appreciate the employment they create. But the glass clouds over w hen it comes to banks – how do they manage to lend all the billions they don’t have? Why does the State delegate the entire National money system to private companies - licensing them to create as much credit as they deem appropriate? Is this in the National interest? Can this ‘notional’ money ever be a stable and reliable means of exchanging our real goods and services?
The Queen’s image on our banknotes and coins suggests that money is a Constitutional responsibility. Not so, only three pence in the pound is cash – everything else is now bank credit – In effect the State has privatised this Constitutional obligation and handed it over to the banks.
Both cash and bank credit are regarded equally as money, and this is certainly convenient – no one would suggest otherwise. However what we should be thinking about is a world where the State creates the credit and the banks distribute it - just as the State creates cash and issues it to the banks to put it into circulation. This infers no change in customer relationships with banks – but it would transform public investment and curb abuse..
The Present Arrangement The Future
The commercial banks decide the sustainable volume of the National Credit – based purely upon maximising profit. Additionally they borrow from one another to finance investment banking activity, money market speculation etc - everywhere that retail credit creation is disallowed.
97% of all money is debt (notional money) entering circulation purely against criteria of profitable repayment and against no specific asset creation.
Government, the ultimate source and sole guarantor of the entire money system, currently borrows from the private banks. Ridiculous. Bank credit is habitually issued at three to four times the rate of economic growth (GDP). Credit enters and exits the system without regard to under or over employment, the balance of payments or indeed any macro-economic criteria
Banks exercise sole discretion over the purpose & availability of loans, They regard credit money as their own. Now we all know it is not their own – it is the National Credit.
Light touch regulation is good for ‘asset bubbles’ & short term bank profits - and bad for financial stability & inflation. The Central Bank, accountable to the Constitution, becomes the arbiter of how much money is appropriate to serve the domestic & commercial needs of the nation. It will be illegal for banks to ‘create’ credit – in future all ‘new’ money will source exclusively from the State. All else will be counterfeiting.
All new money entering circulation will be in step with public asset creation. Public debt will be capped at present levels and progressively repaid.
Banks will require to attract real money from savers with realistic interest rates.
As banks require new or additional money they will apply for it from the Central Bank. The government’s seigniorage a/c will be credited – precisely as at present when new cash is issued. Thus all new money will be spent into circulation when government draws a cheque on the seigniorage a/c.
A clear distinction is to be drawn between credit sought for genuine investment and that more aptly described as gambling or speculation – or stoking up inflation.
New regulation will oversee banks as financial intermediaries – attracting real money from depositors for re-lending.
The public perception is that governments nationalised the banks because letting them go bust was ‘not an option’. The result has been that gambling debts and executive bonuses (many based on fraud & deception) - have been paid from public funds. The government plans to further reward the banking system by encouraging it to refloat on the stock market at the earliest opportunity – thus putting the gravy train back on the rails and back to business as usual. Nationalisation was the preferred Establishment solution, calling ‘time out’ whilst the long suffering taxpayer put Humpty Dumpty back together again. Was there any alternative?
Ask why insolvent banks were not put into receivership like any other failed commercial enterprise. The accountants in conjunction with the Public Audit Office would simply have hived off the ongoing retail banking & domestic mortgage functions and sold off any residual assets to the highest bidder. The State would have guaranteed domestic deposits and the payments system. The accountants would have written off the bad loans and offered sympathy to the army of money market parasites claiming to be creditors - save for a one way ticket to Las Vegas and Gambleland. The public purse would have saved a fortune, the real economy would hardly have missed a beat, We could all have enjoyed the benefits of a return to Constitutional money - and the transparent money management system that implies..
Unionists say that the RBS & HBOS debacle would have brought an independent Scotland to its knees and only the strength of the Union was capable of nationalising the banking system. Agreed, there would have been no option but to liquidate and reconstruct – and in so doing we would have demonstrated to the world how to put their financial houses in order.
Of course all this has been submitted to the Treasury Select Committee – not only recently but regularly ever since Mrs Thatcher’s Big Bang. But no one at the Westminster Establishment wanted to know – they didn’t even re-arrange the deckchairs…
Endnote:
Interviewed on Business Daily on 10 June 2009 (BBC World Service, Prof Jeffrey Myron (Senior Lecturer in Economics Harvard University) agreed that bailing out the banks was a mistake and that they should have been bankrupted or put into administration.
The banks are already repaying the government loans and the banking system will soon be back to business as usual, he said. Little will change in the longer term and the cosy relationship of Wall Street & Washington will continue. There was no need to bailout these gambling debts. Prof Myron concluded that it was the politicians who put the wind up the public and manipulated public opinion with dire warnings of depression if the government failed to step in.
This crisis is already almost forgotten and those who naively thought it would spell a return to honest money have been sadly disabused. With bank borrowing between ½% to 2 % and lending at 4% on selected mortgages and up to16% on overdrafts and credit cards the banking monopoly won’t take long to soak their customers and repay the taxpayer…..
The moneylenders will continue to rule the world for as long asl public apathy permits dishonest politicians to stay in office.
Join the Building Societies Members Association and join us in the campaign to preserve our remaining Mutuals and real money
…
The following reprint of a historic but unreported speech relates to the actual process of a Nation disengaging from the International Banking system and IMF dependency -
VICTORIA FALLS OCTOBER 4, 1999
Prime Minister Mahathir of Malaysia apprised the 3rd Southern African International Dialogue (SAID) of Malaysia's experience in managing economic recovery while safeguarding the socio-economic responsibilities. Below is the full text delivered at SAID:
I believe you are all aware that Malaysia is a multiracial country. More than that the racial differences are heightened because the different races believe in different religions, the indigenous Malays, the biggest group are Muslims, the Chinese are Buddhists and the Indians are Hindus. These religions are usually incompatible.
But to make matters worse their shares of the wealth of the country are also linked to their racial origins. The indigenous Malays are the poorest, owning only one percent of the economic wealth when we gained independence, the Chinese and Indians had 30 percent, the rest being with the British and other expatriates.
Despite these differences the three major races managed to work together to obtain independence. There was a kind of social contract in which, in exchange for citizenship for most of the Chinese and Indians, the Malays should have a bigger portion of the economic wealth.
A decade into independence it became obvious that the indigenous people were not getting a fair share of the wealth. They began to condemn Chinese economic domination.
Tension rose and in 1969 race riots broke out in Kuala Lumpur following an acrimonious election campaign. More than 100 people were killed, motor vehicles and buildings were razed to the ground.
The Government declared an emergency, suspended Parliament and quickly put a stop to the riots. But the Government also studied the causes of racial animosities and decided that the Malays must be given a greater share of the economic wealth while the Chinese and Indians should be given bigger participation in the Government.
An affirmative action programme was initiated to bring the indigenous people to the economic mainstream while the Government invited more Chinese and Indians, largely from the opposition parties to join the Government.
The scheme worked out so well that racial tension was practically eliminated and Malaysians enjoyed almost three decades of stability and economic growth. So successful was the handling of race relations in Malaysia that even the recent recession caused by the currency devaluation and the collapse of the share market failed to spark racial fights as they did elsewhere in Southeast Asia.
But the attacks on Malaysia’s currency and share markets nevertheless damaged the carefully planned redistribution of economic wealth. The still young and friable indigenous business community suffered the most. If the economy is not resuscitated quickly and put back on the growth path, racial antagonism would return and Malaysia would be politically unstable. And political instability in turn would make economic revival difficult
The Government is acutely aware of this danger of racial tensions, riots and consequent political instability recurring and have to resolve the economic problems caused by currency and share devaluation without disturbing the delicate balance in terms of race relations.
Other countries faced with economic turmoil quickly resorted to IMF help. Unfortunately the IMF wants to use the loans given by it to force through its so-called economic reforms. For the IMF affirmative action, the active Government intervention in the distribution of economic wealth between races, is unacceptable. The economy must be completely ‘free of Government interference and furthermore it must be open to total and unrestricted foreign participation.
The result would be to deprive the indigenous people in particular of their share in the business sector and the wealth accruing from it. The Chinese on the other hand might still retain or even enhance their share.
The IMF solution is therefore not for Malaysia. We have to devise our own solution so that the Government can continue with the eradication of poverty among all races and elimination of the identification of race with economic function - the so-called New Economic Policy which had so successfully created a stable and prosperous Malaysia.
To restore the economy in the face of attacks by currency traders and share market manipulators, the Government set up the National Economic Action Council (NEAC). The NEAC studied the impact of the devaluation on the economy and came up with numerous proposals on resuscitating the economy. The banking and corporate sectors had to be reformed so as to be more resilient. Imports were curtailed while exports were stimulated. Consumption of imported sugar, milk and wheat flour was reduced. Price control was fully enforced to prevent undue inflation. Retail prices of food and goods were monitored closely so as to ensure no profiteering took place. The retrenchment and unemployment figures were scrutinized for signs of recession.
Statutory reserves of banks which stood at 13 percent were reduced by four percent to improve banking liquidity. Hire-purchase terms were also improved. Property, vehicles and retail sales were boosted through foregoing taxes during Government endorsed sales carnivals. Studies were made to improve food production as the biggest import item for the country is food.
The performance of the Stock Market and individual companies were also studied so as to know the effect of the downturn on them and to help them if necessary An asset management company was set up to buy over Non-Performing Loans in order to relieve the banks and help the companies to turn around. A company was also set up to finance banks. Mergers of banks and of stock broking companies were encouraged.
Sources of funds within the country were identified and assessed so as to reduce the need to raise funds abroad. Malaysia has one of the highest savings rates in the world i.e. 40 percent. This money could of course be put to better use so as to maximise returns. In the end it was found that domestic funds were sufficient to finance much of the recovery process and borrowing abroad became less urgent.
Many more studies and actions were undertaken so as to minimize the impact of currency devaluation and the fall in share prices. However, despite all that was done or could be done the devaluation of the currency and stock market’s near collapse placed the country in a very difficult position. In all, the country lost about 50 billion US Dollars in terms of purchasing power of imports and 150 billion US Dollars in market capitalization. If the currency devalued further the economy could be so weakened that we would have to turn to the IMF and accept its terms.
A solution had to be found which would protect the country from the rapacious currency traders and stock market manipulators. Malaysia actually had some experience in currency trading. In the early 80’s the Central Bank traded extensively in the currencies of Europe, America and Japan. It was pure speculation and the funds available were not adequate to move the market. In the end Malaysia lost a lot of money and decided to get out of the business. But the knowledge gained was useful nevertheless.
Malaysia studied the mechanism of currency trading thoroughly. It became obvious that the free convertibility of the local currency, the Ringgit , which facilitate trade is also the Achilles heel which exposed us to the attacks of currency traders. We have to stop the free convertibility of the Ringgit and to reassert the sovereignty of the Government over our currency.
Apparently no cash is involved in currency trading. When money is sold or bought the figures on the bank’s computers move and the buyer gets the figures representing the amount of money credited to him. Since the money is only legal tender in the issuing country actual money is held in banks in the issuing country. The foreign hank would instruct the domestic bank to credit the money to the buyer’s account. Clearly the buyer can only have the money if the domestic bank credits it to his account.
To stop the trade in currency the local banks were instructed by the Central Bank not to transfer any foreign-owned Ringgit held by foreigners except during the first month of the control. Effectively this made the foreign-owned Ringgit worthless unless it is transferred to a local account in the first month. After that no more transfers would be allowed.
Thus money belonging to foreigners held in their accounts in domestic banks would be useless after one month if it was not already transferred. If it was transferred it meant that foreign owned Ringitts would have been repatriated and would be available for banks to lend. Billions of Ringgits were repatriated in this way. Once repatriated it could not be taken out of the country again as it would not be allowed to return. Taking out the Riggit would render it useless as it could not be legal tender in any other country. And no one would accept it in exchange for other currencies.
This meant no Ringgits would be available outside the country for currency traders to borrow and sell. Trading in the Ringgit stopped and the Government was then able to fix the exchange rate within the country. Anyone needing foreign currency to pay for imports can change their Ringgits for foreign currency at the Central Bank. On the other hand if exporters earn foreign currency they can change into Malaysian Ringgits at the Government fixed rate at the Central Bank or authorised bank. All the while the Government would keep track of all incoming or outgoing money in whatever currency.
Had the Government fixed a high rate for the Ringgit exports would be costly and there would be a black market in foreign currencies. A low exchange rate would make import more costly and result in inflation. The Government fixed a rate that is neither too high nor too low.
Once the rate is fixed businesses can operate without the uncertainties of fluctuating exchange rates and the need to hedge. The return of all the Ringgits from abroad meant the banks have plenty of money to tend. Interest rates could therefore be reduced without fear of traders devaluing the currency further. Businesses could borrow and could repay loan, The rapid rise in Non Performing Loans was reversed. Debtors became solvent and could borrow again.
To recover fully the slide in the price of shares must also be stopped. Initially, the Government disallowed short-selling on the Kuala Lumpur Stock Exchange. But the short-selling went on as Singapore had opened a market in Malaysian shares without the consent of the Malaysian Government. They were able to continue short-selling and consequently the share prices kept on dropping. As a result our companies and bank were in distress as margin calls could not be met, and debts could not be paid.
Malaysia had to stop the operation of the so-called Central Limit Order Book (CLOB) in Singapore in order to make currency control effective. To avoid reporting changes in ownership of shares through sales on the CLOD, all shares were registered in the name of nominee companies on the Malaysian Stock Exchange. We could not track the transactions on the CLOB and so short-selling went on, depressing our share prices. To stop CLOB we made it necessary for all shares to be registered directly in the name of the substantive owner. Transactions not so registered will not be legally recognised. Nominees were not recognised. Trade on the CLOB stopped immediately and the Composite Index of the KLSE climbed rapidly. It is almost 50 percent higher than when CLOB was operating.
We also stopped repatriation of the proceeds from the sale of shares for one year. Thus we stopped the possible massive withdrawal of capital from KLSE by foreign investors which would have caused a severe plunge in the index and serious loss of market capitalisation
It was believed that when one year was up there would be a massive outflow of capital. But so good is the performance of the Malaysian economy after controls that there was only a little outflow, The stock market remained sound and the banks and companies were released from the pressure of bad loans. Besides the Asset Management Company and the bank re-capitilisation exercise helped the banks and the companies to deal with non-performing loans.
The efforts to revive the economy did not end with the stoppage of currency trading and shares short selling. As I pointed out numerous other steps were taken to bring back the growth performance of the Malaysian economy. But the most important steps were the frustrating of currency traders and short selling on CLOB.
Once selective control of capital flows were put in place ace the effect was quite dramatic and immediate. The Executive Committee of the NEAC watched the data daily, and what we saw was very encouraging. Firstly the foreign reserves up rapidly until it is now about 32 billion US Dollars against 20 billion when we started. Loans given out by banks picked up fairly well, vehicle and property sales went up, infrastructure work started again. The contraction of the GDP slowed down and we achieved a growth of 4.1 percent in the 2nd Quarter of the year.
We are on target to achieve one percent growth in 1999 although various experts predict bigger growth of up to four percent.
The stock market index rose from 262 points on September 1st 1998 to over 800 at one time. It has now come down to around 700, relieving both the banks and the companies of much of the NPL.
While most of the indicators are positive, the economic turmoil precipitated by the currency traders and stock market manipulators destroyed much of our achievement in correcting the imbalance between the economic performance of our multiracial population. While everyone was hit by the downturn, the indigenous businessmen were hit most badly. The big corporations they had successfully set up were unable to withstand the burden of debts they carried. They were forced to sell off to the non-indigenous people and this of course undid much of the redistribution we had achieved. The indigenous middle class, small compared to he non-indigenous, practically disappeared. And once again we find the indigenous people only among the low paid workers, hawkers and petty traders.
Now that we have to start all over again and it is not going to be easy. Already our affirmative action has been labeled cronyism. To our foreign detractors affirmative action only benefits the family and friends of the Government, in particular the Prime Minister. Explanations given to prove that it is not so have been totally ignored. The western Press, the IMF and other agencies in the west kept on repeating that our New Economic Policy directed at restructuring our society benefits only the rich friends and families of Government members.
Yet in truth, the New Economic Policy benefits every single indigenous person and even a fair number of non-indigenous people. Obviously the policy cannot make everyone of these deprived people millionaires. They benefit according to their own capability. Thus everyone could get free education and scholarships some could progress beyond secondary schools, while others could go to universities at home and abroad. Others went into business while others went out to acquire and manage billion dollar enterprises and were even able to venture out to acquire enterprises and were even able to venture abroad. Others went into business as a result of the opportunities, licences, premises and capital made available by the Government. Some could only manage small businesses’ while others went out to acquire and mange billion dollar enterprises and were even able to venture abroad. That some indigenous businessmen could rise to such levels depended on their abilities. Opportunities are created by the Government for all but obviously not everyone would be able to avail themselves of these opportunities and profit from them.
But the foreign detractors and their local supporters see everyone of the indigenous businessmen as cronies of the Government. That many of these people failed miserably and some of them were actually members of the families of Government members or their friends is ignored. Those who succeed were all regarded as cronies and families of the Government members. Even members and strong well-known supporters of the opposition were regarded as cronies or families of the Government they succeed. If they fail then they are not..
Because the affirmative action had produced very successful and therefore very rich indigenous businessmen and they were alleged to be cronies of the Government the foreigners demanded that affirmative action should be stopped. This would create disparities between the races as among the very rich and successful there would not be a single indigenous person.
The real reason for foreign dislike of affirmative action is because most of the highly profitable privatised projects went to the indigenous entrepreneurs in order to balance the surfeit of very rich and very successful non-indigenous entrepreneurs. This policy cuts off the foreigners from getting the privatised projects for themselves. And these areas which they are particularly interested in as they aim to monopolise them worldwide. The impoverishment and subsequent submission of the country to the IMF would have provided the foreign companies with this opportunity. But the Malaysian Government has not submitted to the IMF. We are under no obligation to jettison our New Economic Policy, and our affirmative action programme.
Economic management of the country is not about enriching it only. A country can be made wealthy without the wealth being evenly distributed. It was the extreme disparity between rich and poor in the old capitalist system that brought about the Socialist and Communist revolutions.
In Malaysia it would have been easy to give a free hand to the very dynamic and business oriented non-indigenous Chinese Malaysian to develop and enrich the country. But then the indigenous people would remain poor and have a sense of deprivation. They would be bitter and angry and would rise against people whom they regard as foreigners who had stolen wealth that rightly belongs to them. They would destroy the wealth which had been created and the country would fail to develop. In the end everyone would lose and the country would have to beg for foreign aid and accept the conditions imposed.
After our traumatic race riots of 1969 we in Malaysia are determined to have growth with equity. Our New Economic Policy was successful in achieving this. We are not about to give up this formula simply because the IMF and the Western media think we should do so. Our growth had not been stunted because we had a political and social agenda intricately bound with our economic agenda. We think we can continue to grow with equity by adhering to the objectives of our New Economic Policy, now that we have been able to defeat the attempt to destroy our economy and political independence by devaluing our currency and impoverishing us. End