Thank you for the invitation to speak at the 1999 Cato conference on monetary policy. I want to lay out my concerns about the United States’ international economic policy, suggest a direction for its evolution, and present several specific policy changes. It is important for both our national and humanitarian interests that the techniques of U.S. prosperity have a better chance to flourish in other countries. We have been causing and excusing economic failure abroad. One of my hopes is that the U.S. will replace its current policies of impoverishment, under-achievement, and low expectations with policies to encourage growth and achievement for people around the world. The U.S. and its global institutions shouldn’t do more, they should substantially improve what they are doing. I think there exists a relatively straightforward set of ideas and policies to accomplish this.

Perpetuating Failure

The role of an international leader is to better itself, set an example, and encourage others to do the same. The U.S. can’t make other countries improve, but it wields huge influence. U.S. leadership abroad has soured. During our current prosperity, we’ve been party to decline in the prospects for poor people abroad. Already-small per capita incomes are actually shrinking in many parts of the world.

*In recent years, the U.S. has participated in the economic destruction of Russia, Ukraine, and Yugoslavia, and the sad chaos in Indonesia, Columbia and Pakistan. In each country, our policies of bad economic advice, negligence, and disregard caused the people’s money to become practically valueless, impoverishing them and driving them away from democratic capitalism.

*The Administration did almost nothing to help Latin America lock in its 1993-1998 test of free trade, stable currencies, and low inflation. In the midst of U.S. prosperity and booming imports, Latin America’s per capita income is sinking even lower; its trade policies have become more cynical and protectionist; tax rates for legal transactions have shot higher, including preposterously high value-added tax rates; income tax brackets are often not indexed for inflation or devaluation, penalizing success; and Latin America’s credit rating has declined significantly, both reflecting and causing a cost of capital that is so high that little investment is taking place.

*The U.S. has no discernible program to encourage U.S.-style constitutions abroad. To poor people around the world, the U.S. rule of law is not associated with separation of powers, a limited role for the federal government, or the importance of common-law precedents--it is associated with litigation, legal protections for big corporations, limits on immigration to the U.S., and secret economic negotiations among the elite. In our own hemisphere, Venezuela, Peru and Brazil all face constitutional challenges, yet the U.S. is neutral on whether constitutions should be long or short, clear or unclear, short-lived or lasting.

*We offer African governments small handouts and bad economic policy advice rather than encouraging out principles--sound money, low tax rates, limited federal government, constitutional law, economic freedom and growth.

*In a world desperate for sound money, the Administration used its full influence to stop the currency board movement in Indonesia. Our officials have thus far discouraged the dollarization movement in Argentina and Mexico, and seem oblivious to the urgency of letting countries experiment with sound money techniques. The U.S. feared Europe’s pro-growth choice to adopt the euro, and has done nothing to encourage sound money for the euro-zone’s neighbors.

Policy Failure in Japan

Through lack of leadership and bad economic advice, the U.S. government has prolonged Japan’s economic stagnation, leaving world growth slower than it should have been. To this day, the Administration pushes Japan to spend more of its taxpayers’ money on public works projects. This recklessly ignores Japan’s fiscal deficit and is ineffective given an already over-built public sector infrastructure.

Our Japan policy is built on inertia and the Keynesian economic policy. Japan needs a green light from the U.S., the world’s economic leader, to cut further its enormously high tax burden and to print sufficient yen to meet yen demand. Instead, the Administration’s advice is the meaningless phrase that Japan should "use all available means" to stimulate consumer demand. This 1970’s-style shotgun approach to economic stagnation--the failed Keynesian framework of manipulating both the monetary and fiscal policy faucets randomly without understanding the importance of stable money or the supply side of the economy--is the essence of the international economic policy vacuum the U.S. has created in recent years.

The Bank of Japan’s balance sheet has shrunk 24 percent so far this year, because it is not printing enough yen. The scarcity of yen causes deflation--Japan’s wholesale prices have fallen a whopping 3.9 percent in the last year, with a 0.5 percent decline in both August and September. U.S. academics have advised Japan to inflate its economy. The U.S. has a responsibility to undo the intellectual damage from this bad policy proposal. If it decides to print sufficient yen, Japan can make a clear distinction between stopping its deflation, a healthy step, and starting inflation, a harmful step. It should expand the central bank’s balance sheet up to the point deflation stops. The mechanism to accomplish this is central bank purchases of government securities in the open market using newly created yen. I was pleased to see Stanley Fischer’s comments two weeks ago in this regard. The Administration should have made this recommendation years ago rather than push the government to spend.

The Policy Failure in Indonesia

The cost of our leadership vacuum in international economic policy is not merely the backward drift in the many parts of the world where our leadership matters. It includes the lost opportunity in these countries. Indonesia’s per capita income is likely to be $900 or less in 2000. Straightlining the 1990-1996 trend, a reasonable projection was that Indonesia’s per capita income would be $1,700 in 2000. Indonesians have lost nearly half their livelihood.

Indonesia reached out repeatedly for U.S. leadership. After Thailand’s July 1997 devaluation, Indonesia asked for guidance on exchange rate policy, receiving only a cold shoulder. Indonesia knew that its prosperity was built on the rupiah maintaining its value, but it got no acknowledgment of this at the disastrous IMF meetings in Hong Kong in September 1997. After its October-November devaluation, Indonesia asked for economic guidance from the IMF. It received the fatal recommendation that it close banks. This fed the run on the rupiah and the banking system in December. In February 1998, Indonesia asked to be allowed to set up a currency board, but was again rejected vigorously by the U.S. and the IMF. There ensued months, now years, of financial, economic and social disintegration, a period for which Indonesians will pay for the rest of their lives.

A $30 Trillion Policy Vacuum

I apologize for belaboring the failure of our current policy. But I think it is a topic which should stir the emotions in the same way that our federal government’s failed systems of spending, taxation and education do. The U.S. is actively promoting an economic philosophy abroad in which power is centralized, capital is needlessly scarce for poor people, the value of money is unstable, tax rates are high even for those in poverty, and repayment of debt is optional. The Administration focuses on our own prosperity and pretends others are applauding and learning. While the U.S. and Western Europe prosper, many other nations are withering in wealth and spirit. This poses growing risks for the U.S., endangering our future well being and violating our responsibility as a world leader.

The world’s leading finance ministers and central bankers met in Washington at the end of September. The outcome was more harmful tinkering in the "global financial architecture" instead of a full-scale rethinking of economic policy. There was little talk of deflation plaguing China, Japan, Argentina and others; little talk about the high cost of capital for developing countries; little talk of the failure of IMF austerity programs in country after country.

Between 1996 and 2000, the vacuum in international economic policy has cost the world $30 trillion or more in lost income. This is the output that would have occurred if Japan had managed some growth and other countries had sustained their growth. By failing to lead and by leading in the wrong direction, the U.S. played a major role in creating this loss.

A Cloud of Confusion over Economic Policy

Part of the U.S. leadership problem is pure economics. The U.S. has allowed the cloud of confusion to grow over economic and exchange rate policy. In recent years, the U.S. has seemed to build its entire exchange rate view on the sound bite that "a strong dollar is in the national interest." Yet it has declined to explain how a currency’s strength should be measured or whether unlimited strength is good.

Clearly, a "stable" currency, not strong or week, is appropriate during most of a country’s economic life. A "strong dollar" policy made good sense after a period of currency weakness and inflation as the U.S. experienced in 1993 and 1994. President Clinton and Secretaries Rubin and Summers deserve credit for this constructive 1994 shift in U.S. policy. By continuing the policy into 1997 and 1998, however, the Administration has created a giant momentum play into the U.S. dollar, adding to our asset values and our growth rate, but subtracting from those abroad and increasing the difficulty of the transition to currency stability. (Emphasis added.)

Meanwhile, the jingoistic "strong dollar" policy of the U.S. confused foreign countries. Since 1997, the world has suffered from global competition to see who could have the strongest currency. The Japanese played the game, deepening their deflation spiral and prolonging their economic stagnation. Germany let the mark get too strong in 1998, setting the stage for a "euro crisis" earlier this year as the euro moved back to an appropriate value. Even Mexico has pursued policies to strengthen the peso over the last year, making credit unavailable and stunting the growth of small and medium-sized businesses.

The confusion sown by the U.S. in international economic policy has resulted in a world of momentum-based volatility in which exchange rates drastically overshoot a stable norm. At the core of the economic confusion is the prevailing, and harmful, view that the value of a currency should change with the business cycle to reflect economic fundamentals. When an economy slumps, the argument is that the currency should weaken, and visa versa. This was the market logic that pushed the euro to extreme weakness in early July when there was talk of it breaking par with the dollar. The same logic pushed the yen to 147 per dollar in May 1998 and has now strengthened it to 106 yen per dollar, so strong that it will choke off Japan’s recovery. These wild swings in exchange rates are anti-growth and are the responsibility of government.

Businesses don’t devalue their accounting unit when they lose money. Nor do they increase their unit of account when their profits rise. Suppose auditors advised companies to report earnings in frequent flyer miles if profit growth slowed. Not only would investors have to analyze the earnings slowdown but also the uncertainty caused by a new unit of account. The U.S. and IMF actively promote this illogic, causing economic decline across Latin America, Africa, Russia, and parts of Asia.

To reduce the confusion, the U.S. government should transition to a robust "strong and stable dollar" policy. It should provide a means for financial markets to evaluate the stability of the dollar in absolute terms. A policy of dollar stability would be a pro-growth, pro-investment improvement in U.S. policy and would help world growth.

An Opportunity for Europe

Since the euro is revolutionary, Europe should welcome a less jingoistic U.S. approach to exchange rates. Based on its uncomfortable experience earlier in 1999 with the "weak" euro (actually dollar strength), it is clear that Europe must create a benchmark other than the U.S. dollar for evaluating the euro. Otherwise, it will trap itself into viewing the world through American eyes and asset valuations. This would cause mistakes in monetary policy and would reduce the attractiveness of investment in the euro zone. My preference would be for the European Central Bank to evaluate the euro using the price of gold or another indicator of the euro’s absolute value--announce in advance that when the price of gold rises (meaning the value of euro is falling), the quantity of euros will be restrained and vice versa.

Evaluating the euro in absolute terms rather than relative to the dollar would allow Europe to refocus its attention on structural reforms. Governments in Europe are massive and growing at a time when world competition will tolerate this strategy. Taxes are struck at very high levels, forcing the flight of jobs from the continent. Labor laws discourage employment, threatening to create a permanently unemployed and skill-less European underclass. In order to focus on these true problems, the euro, like the dollar, should be "strong and stable" and should be evaluated in absolute terms, not relative to its fluctuations against unstable currencies elsewhere.

Filling the Policy Vacuum

I think it is possible to construct a better set of international economic policies. I start from the premise that the current system is broken, as evidence by stagnant incomes in much of the world, high unemployment, low growth rates, and high interest rates. I believe that poor economic performance outside the U.S. is against our national interest and that our leadership matters. We could do a lot to add to global growth.

Set higher expectations. The U.S. and IMF have low hopes for growth abroad. When foreign countries collapse, all that is heard is a sighing "tsk, tsk", a focus on how well we Americans do managing the crisis, and then request for more money for the IMF. Almost every poor country in the world could be growing 5 percent or even 8 percent by choosing sound money, low tax rates, and free trade. In negotiating with the IMF, countries should state a dollar GDP they hope to attain and then question the IMF as to whether the IMF’s approach will achieve their goal. The current U.S./IMF model of austerity, high tax rates, high interest rates, and paltry investment creates poverty and instability. Countries should ask to change it, and Washington should participate.

Use classical economic thinking. Now that Bob Mundell has won the Noble prize, maybe the U.S. can finally stop preaching Keynes around the world.

*When exchange rates float, monetary policy is very powerful. Country programs should match the supply of money with the demand for it. This should be a higher priority than the current IMF/U.S. priorities--raising taxes and interest rates, devaluing, reducing popular public subsidies, or transferring public monopolies to the private sector. To break a monetary deflation, as in Japan, increase the supply of money faster than the demand. To break an inflation, as has plagued Turkey and Ecuador for years under IMF tutelage, contract the money supply faster than the contraction in money demand.

*Regardless of the exchange rate system, a central bank should be accountable for the value of the country’s money. It should treat this as a contract with the people, a moral responsibility. The more independent a central bank, the more important its declaration of sound money and its accountability for it. High interest rates reflect poor prospects for the future value of money, not a tight monetary policy. Money should retain its value without regard to the business cycle. (Emphasis added.)

*Income tax brackets should be re-based for past inflation and indexed for future inflation. Raising tax rates causes an exodus of capital and labor, not a balanced budget. (Yet tax increases are at the core of almost every IMF/U.S. economic program.)

*Government taxes and spending decisions have a major impact on private sector behavior. Current models assume they don’t. The static models that permeate U.S. and IMF thinking on international economic policy assume taxes don’t slow an economy and that government spending is as productive as private sector spending. The Administration’s initiative to forgive the debts of poor countries channels all of the benefits to governments, not to tax cuts or the reduction of other debt. Implicit is the assumption that even the least successful governments in the world know better than their people.

*Free trade has become a field for lawyers, negotiators and legislators. Countries hold back their liberalization as a bargaining point for their negotiators. How far we’ve fallen from Adam Smith’s insight that free trade benefits the liberalizer and is a positive-sum economic game. Countries should focus more on their own trade policies as Chile has done in unilaterally lowering its maximum tariff and quota barriers.

Change the IMF’s role. If the IMF must exist, have it operate on classical rather than Keynesian economic principles. It should shift from an austerity model to a growth model. It should promote sound money, low tax rates including VAT tax rates, and indeed tax brackets. It should encourage central banks to reduce the quantity of money when capital outflows occur instead of the present "net domestic assets" model. It should stop using static budgeting models. It should promote unilateral trade liberalization. Take away the IMF’s monopoly and off-budget status. Let other countries, government agencies, and private sector bodies compete with the IMF. The IMF should be rewarded when countries do well, rather than the present system of rewarding it when countries do badly.

Gut current U.S. policy and replace it. Stop the global financial architecture initiative. It is harming world growth prospects. Take the IMF and World Bank out of the center of U.S. policy. They can’t be leaders. The U.S. should promote unilateral initiatives worldwide based on sound money, low taxes and free trade. Starting at home, the government should commit to the people to maintain dollar stability. It should state ways to evaluate its currency performance (example: the price of gold). The U.S. should encourage other countries like Japan to commit to stable currencies as a way of breaking deflations and inflations. It should allow other countries to dollarize or adopt currency boards based on the dollar if they want. The U.S. should examine each of the IMF’s country programs with the question of whether they make sense under classical economic principles and whether they are good enough.

Conclusion

Over the centuries, the United States has much to be proud of as an international leader. Our Constitution remains one of human history’s most important documents and examples of leadership in the legal relationship between people and their government. Our technological leaps at the end of both the 19^th and 20^th centuries lift up people everywhere, making their lives longer, easier, and fuller. The Bretton Woods system, based on a stable value for the dollar relative to gold, guided world finance for decades after World War II, helping avoid the economic disasters that followed World War I.

Some of the values which have let the U.S. economy burst forward in the 1980s and 1990s are spreading. Japan has cut taxes and Germany is trying hard to follow suit. The euro has brought a meaningful currency across most of the European continent, with more countries to join in coming years. Labor flexibility is making some headway in France. Mexico is holding party primaries this year and will have a competitive presidential election in 2000. Corporate interest in shareholder value is on the rise, bringing restructuring and adding productivity. It is easy to look around the world and see progress.