A New Perspective on the Global Economic Crisis III: The Way Forward

I. Introduction

The American economy has reached the cross-roads. Unfortunately, the majority opinion in the community of economists is headed in a different direction from the policies that I think would be prudent in the long-term. This majority opinion holds that the Federal Reserve's intervention in the financial system during the last one year has managed to prevent a return of the Great Depression, but that the economic recovery that lies ahead would be slow and uncertain. There is definitely a sense of being at the cross-roads. The drastic fall in industrial activity during the last three quarters seems to have been contained. The regular recurrence of financial panics that took the Dow Jones Industrial Average from 14000 down to 6500 between October 2007 and March 2009 seems to have been halted. For the second quarter of 2009, companies have reported earnings that have far exceeded expectations, especially the financial companies have done so.

On the other hand, the pressing question among economists at this time is whether the current recovery would be robust and sustained. To be fair, the dangers that the American economy would fall back in to a few more quarters of negative growth, as happened in the 1980-82 recession, are indeed real. The global economy seems to be in a slightly better shape, but since it is heavily dependent on the American consumer, its recovery at this point is suspect as well. However, this does not mean that America's long-term economic policy should continue to be dictated by the Federal Reserve, or by the Treasury, or even by the cabal of economists that currently exerts great influence on the American Presidency. In this article, I provide an alternate view for the long-term economic policy that governments around the world ought to follow.

II. Toning down American triumphalism in exchange for long-term economic growth

The fundamental theme in this article is that by 'toning down' the Cold War remnant of American triumphalism to the appropriate level, America could sail through the current economic crisis much more smoothly than economists expect now. This 'toning down' would involve better sensitivity to the concerns of the rest of the world. In particular, facilitating the high growth rates of the emerging market economies, instead of attempting to block them through shrill cries about global imbalances, should be one major goal. One other major goal is for America to bring serious commitment to eradicating global poverty. In return, America could avail of significant economic opportunities as the banker, the lawyer, the scientist and the doctor of the world. In my current estimates, which are admittedly crude, these economic opportunities could ensure between 3/4 and 1 1/2 percent of real growth in annual GDP for many years to come. With a conservative estimate for an additional long-term real growth rate of 1 1/4 to 2 percent that the economy could generate domestically, we see that America could achieve significantly higher growth rates than the "new normal" that is being touted in the media these days.

These methods that I propose in this article, for estimating the increased long-term economic opportunities that would arise by toning down American truimphalism, apply mainly for firms that provide services of the following nature: financial, legal, accounting, information technology, digital networks, computing devices, print and online media, sports, health-care, alternative energy and consulting. Hence, the methods introduced here would be supplementary to the durability approach that I had introduced in my recent article, "A New Perspective on the Global Economic Crisis II: Fear of Reverse-colonization Did It". Please recall that my durability approach enables estimation of growth in those industries whose operations can be explained by traditional economic theory, for example, manufacturing, agriculture, food processing, clothing, retail & distribution, construction and transportation.

We note here that, at this early stage, we do not provide estimates for economic growth that would arise from the increases in international trade that would result when American triumphalism is toned down. We only quantify these increases in international trade to the extent that they would confirm the estimate of 1 1/4 to 2 percent of real growth rate for the domestic economy that was cited above. In fact, in this article, our focus is mainly on discussing how the toning down of American triumphalism would bring benefits to America from the fact that the US dollar is the predominant global reserve currency. The equity premium for American companies taking more risks globally, the transaction charges for providing market making facilities in global markets, and the provisions of liquidity for the currency of international trade are already major drivers of economic growth for America. In addition, corporate law and company-based organization are two Western institutions that could provide indispensable services in a rapidly globalizing world.

With America managing robust long-term growth, the prospects for the emerging market economies to regain their rapid-growth path would be re-ascertained, in addition to the prospects that they would achieve rapid-growth on their own even if the world were to be de-coupled. As a result, robust growth, instead of "new normal" growth, for the global economy seems achievable as well. The main difference in my approach is that I have tried to quantify the enormous economic opportunities that have newly opened up due to the world-wide popularity of the Obama Presidency. Whereas the "new normal" folks are stuck with the Bush era mentality of American isolationism and military adventurism.

Even worse than the "new normal" folks are the Great Depression maniacs, who are stuck in a colonial era mentality. It was a standard trick of the colonial empire, in the time of Keynes and earlier, that before an economic downturn arrived, the policy makers at the center of the empire would constantly proclaim an exaggerated sense of calamity and crisis in the media. In this way, they would facilitate the printing of loads and loads of the colonial reserve currency. The colonial empire thus retained the great advantage of exercising 'first use' on the newly printed money, much before inflation or devaluation could catch up with the flood of liquidity. Moreover, when the money finally reached the colonies, it siphoned off economic growth from the colonies, and channeled it to the center of the empire. The gullible political leaders of the colonies, who had invariably received their education at the empire's leading universities, were not smart enough to figure out what was going on. Even as late as 1997, the East Asians did not figure it out.

It is unfortunate for Western intelligentsia, that at this current time, the Chinese have understood this game all too well. When the Federal Reserve printed several trillions of new money last year, the Chinese had quickly released their own currency into their own economy, in anticipation that over the next few years, a significant part of these several trillions dollars that the Fed has printed would flow into China. As a result, the weak dollar policy followed by Professor Ben Bernanke, the Chairman of the Federal Reserve, under the guise of the savings glut theory, has been a colossal failure. It is highly unlikely that the Federal Reserve led by a re-appointed Professor Bernanke would follow a policy of a stable dollar. For this reason, it is highly unlikely that the process of 'toning down' American triumphalism in exchange for long-term growth opportunities that are robust and stable, would be facilitated by the re-appointment of Professor Bernanke.

As feared in many quarters, it would be a grave mistake to appoint Professor Lawrence Summers as the next Chairman of the Federal Reserve. I would definitely agree that he has done a commendable job of stewarding the $787-billion American Recovery and Re-investment Act of 2009, right from its origins. However, in my opinion, his understanding of economic matters is not deep enough that he would be able to shrug off the strong sense of American triumphalism that he emanates in all his appearances at international fora, for example, at the annual Davos meetings. I hope that the fact that in contrast, Professor Joseph Stiglitz is hugely popular in foreign countries would help American economists understand that in the international arena, it would be very difficult in the future to pass off American triumphalism as a substitute for serious scholarship.

I would also recommend strongly that Professor Summers should not continue as the Director of the National Economic Council, since this position implies a near-daily access to President Barack Obama in an advisory and tutorial role on economic matters. In fact, I would support replacing the current Treasury Secretary Timothy Geithner with Professor Summers, in view of the Treasury Department's appalling performance in devising a program like the Public Private Investment Program (PPIP). I would also recommend replacing the budget director, Professor Peter Orszag and senior economic adviser Professor Austan Goolsbee. They have taken too long to retire the $260-billion of unused money from the TARP funds, so that the estimate for the budget deficit could be revised downward. Please recall that I had strongly advocated against enacting this $700-billion TARP in the first place. This would all have been far simpler, if instead, my price adjustment mechanism was adopted last September.

The third candidate, that is discussed in the media, for the position of the Chairman of the Federal Reserve Board is Professor Janet Yellen. I should say that I have not studied enough of her published work in economics to be able to make up my mind about the suitability of Professor Yellen for this position. However, I do have two strong candidates whose appointment as the next Federal Reserve Chairman, I would support strongly. My first choice is Professor Robert Mundell, whose appointment would come with his deep understanding of international currency systems. If he is not available, then I would support the appointment of Professor Edward Prescott. Professor Prescott has done ground-breaking research on the theory of business cycles, and he has been a senior adviser to the Federal Reserve Bank of Minneapolis since 2003. I would also comment here that the appointment of either Professor Mundell or Professor Prescott would demonstrate that the Obama administration is committed to supporting the public service of economists purely on the basis of their professional merit, and not on any considerations of political ideology.

III. Kudos to Professor Richard Cooper for anticipating some of my ideas, but our views are essentially different

In the last week, it has come to my attention that Professor Richard Cooper of Harvard University had already been writing about some of the same ideas that I have proposed recently. In particular, the radical idea I had proposed in my June 2009 article, "A New Perspective on the Global Economic Crisis", that global imbalances should continue was already proposed by Professor Cooper in his article "Living with Global Imbalances: A Contrarian View". His article was published way back in November 2005, and is available on his website. Moreover, Professor Cooper has also written an interesting article, "The Asian Crisis: Causes and Consequences" in 1999. I would definitely commend Professor Cooper for his early insights into the nature of global imbalances. Having said that, I would like to explain how his views are essentially different from mine.

Firstly, Professor Cooper believes that the Anglo-Saxon model of capitalism is what enables America to take relatively more risk in global economic ventures, in contrast, for example to the Asians, who tend to be risk-averse and save more. Secondly, Professor Cooper writes that the rest of the world sends huge amounts of its savings to America because of the unparalleled depth and liquidity provided by the American financial system. In fact, in his November 2005 article cited above, Professor Cooper says that the sophistication of the financial products available from America could enable continued imbalances in the US current account deficit. By sophistication is meant, of course, the theoretical advancements in risk management and portfolio theory that have been obtained, using mathematical foundations, during the second half of the 20th century, and the rapid implementation of these theories on computer-based trading systems which are heavily inter-connected through high-speed networks. Mathematical sophistication is the only type of sophistication that America operates on, at present, in its economic interactions with the rest of the world because of the 20th century's mathematization of every aspect of economic theory.

In contrast to Professor Cooper's perspective, in my view, the Anglo-Saxon model of capitalism is no longer adequate for studying drivers of global economic growth, especially after the financial crisis of 2008. Instead, I have elaborated on a new framework provided by a confluence of the Roman law and jurisprudence, and other ancient systems of law, in my recent article, "A Twist in the Tale". Moreover, the sophistication provided by mathematical theories and high-speed computational infrastructure would not be sufficient to account for the huge profits that the American financial system raked up before the current economic crisis. Asians could easily replicate this type of sophistication. What the Asians do not have is the long tradition of Roman law and jurisprudence that provides the legal foundation for modern company-based organizations. This legal sophistication is what enables Western institutions to participate in economic activities with high intensity and speed.

In fact, the emergence of highly successful Asian diaspora communities in the advanced nations demonstrates that, at the level of individuals and families, Asians are quite adept at taking large risks and putting in disciplined efforts to gain huge long-term rewards. In the second half of the 20th century, many millions of Asians have traveled half-way around the world, and started their lives from scratch in foreign countries, to obtain huge increases in their lifestyles and educational opportunities for their children. It is at the level of the company organization that Western countries continue to hold the edge in the creation of economic wealth. Professor Cooper is definitely gnawing at these issues in his writings. To wit, he is perhaps unique among Western economists, to propose that after taking the corporate savings of America into account, Americans are saving enough for their long-term future. However, Professor Cooper's methods are mostly restricted to econometrics, whereas, as I have explained above, I would like to employ a general framework of law and jurisprudence, applied specifically to company organization, to study the comparative advantages that the advanced nations have in the creation of economic wealth.

Further, in my opinion, a large part of the willingness of American companies to take more risk globally can be attributed to the fact that the US dollar has been the predominant global reserve currency ever since the Second World War. The worldwide supply of dollars is controlled by the Federal Reserve bank of America which is constitutionally mandated to strive for price stability and economic growth only for America. This provides an extra safe-guard for American companies in risk-taking ventures around the world. Here is where a significant divergence appears between Professor Cooper's perspective and mine. Professor Cooper, like nearly every other Western economist, has identified the root causes of the East Asian crisis of 1997-98 to rest within Asia itself. Professor Joseph Stiglitz is the rare exception among Western economists, who went to great lengths to fault the International Monetary Fund (IMF) in bailing out American banks first from the East Asian crisis. However, my perspective goes much further:

The East Asian crisis was a result of cheap money from the advanced countries chasing high growth in foreign lands. The profits from that high growth accumulates over a period of four or five years. When it is time for the investors from the advanced countries to look elsewhere for growth opportunities, then lo and behold, a much larger amount of funds than those that went in have to come back home to the advanced countries, in view of the rapid accumulation of profits. So, unless the foreign country has already accumulated a large enough reserve of international currencies like dollars, yens or euros, there would inevitably be a currency crisis. In fact, the East Asian countries, through an export-led boom stretching to 25 year or more, had indeed, accumulated large reserves beforehand. But they proved to be insufficient when a huge inflow of funds took place during 1992-97 as a result of the Federal Reserve's lax monetary policy. When this money accumulated profits, many more dollars had to go back home in 1997, which resulted in the crisis. The Chinese have understood this lesson all too well, and that is why they are waiting this time around with a foreign currency reserve worth of 2 trillion dollars. The East Asian crisis, is in fact, a well-worn trick from the exploitation of the colonial era, as explained in the previous section.

There is nothing wrong in one country trying to obtain mutually beneficial economic growth with foreign countries. The problem arises when that one country engineers a crisis in a part of the world that has long been growing healthily, purely through currency manipulations, and a whole generation of Western economists write article after article that cover up the root cause. This is why I propose a wider legal framework which would enable America to finance the rapid growth of the emerging market economies, and obtain as a reward, economic growth of its own, all done in a transparent and stable manner. For this purpose, it is necessary not to worry about global imbalances, but instead to guarantee the stability of the global reserve currency. I might add here that there is a certain unnecessarily destructive aspect to Western economic theory that would not sit well with the emerging market economies. What they are looking for is constructive approaches to shared economic growth. By toning down American triumphalism, America can avail these shared economic opportunities from the emerging market economies for a long time to come. To note, it is a common misconception that destruction is the only route to innovation.

Please select the Director, IEO, IMF solely on merit

(Dt. July 29, 2009)

Note: The following is an open request that I had sent out to economics professors at top schools for writing reference letters on my behalf.

The Director of the Independent Evaluation Office (IEO) at the International Monetary Fund (IMF) is finishing his term at the end of this month. I have applied for to be his successor. I do not have any patrons working their connections on my behalf. I am proud to say that I am applying for this position solely on my merit. Over the course of the last 18 months, I have demonstrated outstanding abilities in analyzing the current global economic crisis thoroughly and proposing far-reaching solutions for it. I have written over 25 articles on the crisis. Among these, the major articles have been e-mailed to renowned economists. An annotated list of the original contributions I have made for this economic crisis is given below.

I had written to the following four renowned economists on July 13, 2009 requesting reference letters for my job application: Professor Edmund Phelps, Professor Edward Prescott, Professor Kenneth Rogoff and Professor Joseph Stiglitz. I had heard from Professors Phelps and Prescott before, in response to my articles that I had e-mailed to them. And I had commented several times on the articles written by Professors Rogoff and Stiglitz on Project Syndicate. So I had assumed that these four Professors would be willing to write letters on my behalf. But I have not heard from any of them so far. The deadline for the job application has passed on July 24, and the applications are probably being processed now. So, I am left with no option but to make an open request for reference letters from the other economists at top schools to whom I have been sending my articles.

With the onset of the current financial crisis, the IMF has once again found itself to be struggling with questions about its external credibility, its institutional governance and the co-operation from its member countries. However, the fundamental problem that the IMF faces is the challenge of dealing with rapidly unfolding emergencies. The other problems about its credibility, governance and co-operation are consequences of this fundamental problem of conceptually understanding a rapidly changing world. It is for this main reason, that the Director of the Independent Evaluation Office (IEO) at the IMF needs to have outstanding abilities to analyze and cope with the current crisis. I have attached a 2-page "Statement of Purpose" explaining why it would be in the best interests of the IMF to appoint me as Director, IEO. I would be grateful for any recommendation that the Professors would write on my behalf. The e-mail address to write a letter to is imf-ieo@russellreynolds.com. Thank you.

Sincerely,
T V Selvakumaran

Original contributions I have made for addressing the current global economic crisis

1. Proposal for de-centralizing the American financial system. De-centralizing would enable the local processing of price information about mortgage markets. This would make the system more stable and avoid the unnecessary accumulation of trillions of dollars in New York. This proposal was made in this article: http://selvasblog.blogspot.com/2009/06/new-perspective-on-global-economic.html

2. Re-interpretation of Adam Smith's universal opulence in terms of the universal civilization of Rome. Interpret the legal foundations of the Chinese political economy in terms of Confucian principles. Then study the developments in the current global economic crisis as the confluence of two ancient traditions of law. More generally, the implications that other legal systems around the world have on the global economy can also be considered. I have also made a proposal to consider pre-mature and ill-prepared attempts at Pax Americana to be the initial cause of depression-like scenarios. Examples: (i) efforts at resurrecting the gold standard by America was an initial cause for the Great Depression, (ii) President George W. Bush's Pax Americana policies lead to current economic crisis. These above proposals were made in this article: http://selvasblog.blogspot.com/2009/07/twist-in-tale-proposal-to-reconsider.html

3. I have proposed a theory of reverse-colonization in this article: http://selvasblog.blogspot.com/2009/07/new-perspective-on-global-economic.html. This theory subsumes the two main theories on global imbalances -- savings glut theory and de-coupling theory. This theory also finds a creative outlet for the fears of Western intellectuals by re-examining mercantilism. Reverse-colonization theory retains great explanatory power for predicting and anticipating the policy recommendations in the global arena, that would be proposed by Western economists in the next few years.

4. A partial solution for the unemployment problem: use the good offices of the new President to make the world a safer place for Americans to work. Make the arrangements for 10 - 12 million Americans to live and work abroad in the next 10 years. http://selvasblog.blogspot.com/2009/07/whatever-happened-to-liberal-agenda.html

5. A New Perspective on the Global Economic Crisis: Proposed a new price adjustment mechanism that would remove the massive arbitrage opportunity that the Fed and the Treasury have created on behalf of the Wall Street banks during the current crisis. This price adjustment mechanism demonstrates that the American financial system is capable of solving the crisis on its own. It is not necessary to transmit trillions of dollars of losses to the rest of the world by engineering a dollar devaluation (http://selvasblog.blogspot.com/2009/06/new-perspective-on-global-economic.html). Please note that my price adjustment mechanism was first e-mailed to Professors in September 2008 when Congress was discussing the $700-billion TARP bill (http://selvasblog.blogspot.com/2008/10/dt_3325.html).

6. Exchange rate stability versus global imbalances. Analyzed existing theories on global imbalances, including the savings glut theory and the de-coupling theory. Explained why they are seriously wrong. Recommended focusing instead on exchange rate stability during the next decade with the goal of re-gaining America's credibility in the geo-political scene. (http://selvasblog.blogspot.com/2009/06/new-perspective-on-global-economic.html and http://selvasblog.blogspot.com/2009/07/new-perspective-on-global-economic.html)

7. Durability approach to growth projections. Divide the global economy into two parts, based on the durability of economic theories. In those parts of the global economy that function based on securely founded economic theories (e.g., factory-based manufacturing, agriculture, emerging market economies, small & medium business that deal with low-tech activities), the prospects for growth can be estimated using the rational expectations model. Besides, studying the production process from a historical perspective, enables one to measure trends for productivity, trade and consumption. For the other part of the global economy, (i.e., the more advanced parts of the modern economy), a re-examination of what constitutes economic wealth is called for. Here, again durability is a crucial factor. Durability also has relevance for the interactions of the two parts of the global economy, and thus has implications for exchange rates. Using this durability approach, I was able to provide reliable estimates for China's growth, after hearing Premier Wen Jiabao at Davos in January. I was among the earliest to warn that China's stimulus spending alone would ensure 8% annual growth in real GDP for the next two years, without counting the exports sector at all (http://selvasblog.blogspot.com/2009/02/in-response-to-professor-kenneth.html). This prediction has now come true for the first year. See #9 below for further applications of the durability approach.

8. I warned against adopting Keynesian economic theory point-blank by the liberals in the following articles:
(a) Explained the links between Keynesian policies and colonial exploitation (http://selvasblog.blogspot.com/2009/04/in-response-to-professor-kenneth.html).
(b) Explained that not even Keynesian theory would justify the adoption of a massive one-time stimulus (http://selvasblog.blogspot.com/2009/03/comment-on-professor-bradford-delongs.html and http://selvasblog.blogspot.com/2009/03/comment-on-professor-joseph-stiglitzs.html)
(c) "Some perspectives on the relevance of John Maynard Keynes to the modern economy" (http://selvasblog.blogspot.com/2008/12/some-perspectives-on-relevance-of-john.html). This article elicited a response from Professor Edward Prescott, who is now trying to politely ignore me :- It was in this article that I first identified that not even Keynesian theory would justify a massive one-time stimulus.

9. Contributed to debunking the bond traders on Wall Street who appear regularly in the media to promote their own self-interested projections for the future. The topics of their propagandizing have included "Credit crunch", "De-leveraging", "New normal for growth". Already in my FAQ on the Financial Crisis (http://selvasblog.blogspot.com/2008/10/faq-on-current-financial-crisis-q1.html) which I wrote in October 2008, I had suggested to economists that focusing on the credit crunch would not be the wise thing to do. In view of the massive accumulations of capital in private hands, credit would flow sooner or later. All the government needs to do was to provide adequate liquidity, and then furnish the markets with clear guidelines about its intentions and plans. Unfortunately, the Fed and the Treasury chose to spend trillions of dollars by way of averting a credit crunch. Even worse, these institutions took it upon themselves to prop up the securitization markets and the secondary markets. The securitization markets and the secondary markets are like mushrooms on a rainy day. In a dynamic market economy, these markets spring up when needed. This unnecessary propping up of these secondary markets has cost the Fed trillions of dollars of spending, and now the funding for fiscal spending is severely constrained. Here lies the roots of the predicament of dwindling public support that the liberals find themselves today. They can't afford to be spending too much for propping up the financial system lest they have to make compromises on their priorities like health care and alternative energy. On the other hand, they don't want to recognize that there must be some negotiated settlement between the security owners and the property owners for the markets to function well. This is because dwelling on property rights is seen to be a give-away to conservatives (See the last paragraph below about Mr. Hernando DeSoto).

10. In March 2008, I had proposed to study the market mechanism by focusing on the duration of interaction between the buyer and the seller. This resulted in three articles:
(a) A New Perspective on the Role of Markets in an Economy (http://selvasblog.blogspot.com/2008/10/dt_9352.html)
(b) Update 1: Housing Example in Role of Markets (http://selvasblog.blogspot.com/2008/10/dt_4707.html)
(c) Update 2: A Marginalistic Interpretation of the GARCH model (http://selvasblog.blogspot.com/2008/10/dt_1704.html)
Article 10(a) elicited a response from Professor Kenneth Arrow, and article 10(c) from Professor Edmund Phelps. I have not heard from them since. Alas, they have declined to engage my ideas and proposals on the global economic crisis, just when the game has begun to warm up.


Finally, as somebody who has thought seriously about the global economic crisis, I would advise professional economists that Professor Joseph Stiglitz is perhaps the one Western intellectual that has a serious and deep grasp of the global economic crisis. For a long time, Professor Stiglitz's insights into the crisis were deadly accurate. Unfortunately, on October 20, 2008, Professor Stiglitz ran into this idiot, Hernado DeSoto in a Town Hall meeting at CUNY, New York. Mr. DeSoto managed to confuse Professor Stiglitz thoroughly. Ever since, Professor Stiglitz has not been the same at all. The video recording of this Town Hall meeting is widely available on FORA.tv. Mr. DeSoto, who claimed to be speaking as someone from a developing country, said that the root of the current crisis was that the financial system in the advanced countries has foregone the security of property rights. He said that the world's financial system was functioning simply based on paper-contracts. The gullible audience was lapping up his populist utterances and rewarding Mr. DeSoto with loud and frequent applause. The moderator, Professor David Harvey, a wise man, asked Mr. DeSoto if his proposal implied that all the trading in financial derivatives should simply be abandoned because they are not based on property contracts. Mr. DeSoto confidently says yes, they should all be abandoned!!@!$ Professor Stiglitz is the only economist who could understand the delicate and subtle arguments that are necessary to negotiate through the current crisis. Unfortunately, since he was confused by Mr. DeSoto's shenanigans, the liberal movement has become rudderless, sorely missing a wise leader like Professor Stiglitz.

Statement of Purpose
(attached with my application for Director, IEO, IMF)

The International Monetary Fund (IMF) is entrusted with the difficult task of overseeing the global financial architecture. This task is even more difficult for the reason that the IMF lacks political and judicial authority. We note that, in contrast, similar organizations at the national level -- the central bank, the finance ministry and the law courts -- are collectively vested with such authority. In addition, unlike issues concerning development and global trade which play out slowly and steadily in the international arena, the management of global financial issues requires skills in dealing with rapidly unfolding emergencies. It requires being prepared for highly uncertain situations where the information available is only partial and not too reliable. It is mainly for these reasons that the IMF needs to "conduct independent and objective evaluations of its policies and activities" through its Independent Evaluation Office (IEO).

With the onset of the current financial crisis, the IMF has once again found itself to be struggling with questions about its external credibility, its institutional governance and the co-operation from its member countries. However, as explained above, the fundamental problem that the IMF faces is the challenge of keeping up the skills and knowledge of its personnel amidst fast-paced economic developments. The other problems about its credibility, governance and co-operation are consequences of this fundamental problem of conceptually understanding a rapidly changing world.

The IMF has had some appreciation for this fundamental requirement all along. As a result, it has made intelligent choices in the past, to be prepared in advance for unforeseen crises situations, by arriving at broad consensuses among policy makers beforehand. However, with the current severe crisis in the American financial system spreading unchecked around the world, we see that while such a-priori policy consensuses are necessary, they are not sufficient.

The first major test of the IMF's performance came at the end of the Cold War. The republics of the Soviet Union broke away to form their own independent nations, as did the communist satellite countries in Eastern Europe. With American-style capitalism triumphant, these countries looked towards America for guiding them out of communism. They started by adopting market-oriented economic models, along with de-regulation of private enterprise, and privatization of assets owned by the former communist states. Moreover, with the end of Cold War, the world was taking to economic and financial globalization with unprecedented vigor.

The IMF consulted with policy makers and arrived at the Washington Consensus in 1989. It was an intelligent move on the part of IMF to develop such a theoretical platform, in advance, to deal with the upcoming challenge of transforming the former Soviet Union and the East-bloc countries into market economies. However, in a rapidly changing environment, it is only a matter-of-time before any rigid theory or method, constructed a-priori, comes up short. There is no substitute for having highly qualified experts, who can think quickly on their feet, at the forefront of the crisis prevention effort.

It is here that the IMF failed. The Washington Consensus arose from a focus on supply-side economics and disciplined monetary policy, a policy framework that had rescued America from the stagflation of the 70s. However, after the Cold War, the ground-reality was that a different world was beset by two major phenomena simultaneously, namely globalization and the waning of communism. The shortcomings of the Washington Consensus to deal with this new world were clearly articulated by Professor Joseph Stiglitz when he was the Chief Economist at the World Bank during 1997 -- 2000.

Unfortunately, instead of reviewing the Washington Consensus to adapt it to a rapidly evolving post-communist globalizing world, the IMF meted out a heavy-handed treatment to Professor Stiglitz. After he left his job at the World Bank in 2000, he wrote a detailed critic of the policies of the IMF in his book, "Globalization and its Discontents". As a result, the IMF encountered wide-spread criticism of its credibility and its governance.

It was in this background that the Independent Evaluation Office (IEO) was established in 2001 -- as an effort to address the criticism on IMF. To its credit, the functioning of the IMF appears to have improved significantly in the last eight years. The IMF has become more receptive to the concerns of its member countries, particularly those in the developing world. The IMF has shown more responsibility to promote trade and development around the world. In recent years, there have been moves to enhance the representation of the emerging market economies in the IMF. With improved public relations, the IMF has been able to get better co-operation from its member countries. The IEO has been closely involved in these developments at the IMF.

However, the coming of the financial crisis has made it important for the IMF to continue to make efforts to keep up with a rapidly changing world. I believe that my qualifications are specially suited for this fundamental requirement that the IMF faces. Over the last two years, I have studied the various developments that led to the global economic crisis. I have closely followed the research work of eminent economists, especially Professor Edmund Phelps, Professor Edward Prescott, Professor Kenneth Rogoff and Professor Joseph Stiglitz. I have conducted further investigations, starting from the proposals in their writings. I have also pursued my own ideas about the solutions to the current crisis. I have written 25 articles on various aspects of the crisis. These articles are available at http://selvasblog.blogspot.com.

With my training as a professional mathematician, and my studies in economic theory, I feel especially qualified for quickly bringing a conceptual understanding to the rapid developments in the crisis. It is only with such clarity of understanding, that one could guide the regular staff and the consultants at the IEO to adapt to a post-crisis world. Thus I feel that appointing me as the Director of IEO, would help the IMF improve its functioning and adapt to the requirements of the current global economic crisis.

Sorry to say that you are mistaken, Professor!

I. Introduction

This article deals with three issues. In Section II, I explain why dollar de-valuation is not in America’s long-term interest. For this purpose, I analyze Professor Martin Feldstein’s latest article on Project Syndicate on the same topic quite closely. I explain how Professor Feldstein's arguments actually spring from the savings glut theory on global imbalances. In Section III, I make some remarks about how to de-toxify the toxic assets. This section is written in response to Professor Michael Boskin’s latest article “Of Banks and Bailouts” on Project Syndicate. I also refer to a recent article on the same topic, written by Professor John Taylor and Professor Ken Scott, that appeared in the Wall Street Journal. In Section IV, I study why my price adjustment mechanism, which I had explained in my recent article, “A New Perspective on the Global Economic Crisis”, is not being adopted by professional economists. To facilitate this study, I introduce the term “Old Keynesians”, and I raise the question whether the “Old Keynesians” would come to exert undue influence on the current administration, just like the “Neo-conservatives” came to hold extra-constitutional authority during the previous administration.

II. Why is Professor Martin Feldstein's reasoning in favor of the dollar's devaluation incorrect?

In his latest article, "America's Saving Rate and the Dollar's Future" on Project Syndicate, Professor Martin Feldstein makes the following prediction, "Although the higher level of household saving will limit the rise in US interest rates, it will not change the fact that the combination of large future fiscal deficits and foreign lenders' reduced willingness to buy US securities will lead to both a lower dollar and higher US interest rates". His reasoning is as follows. The savings rate of American households has risen sharply since the beginning of the year reaching 6.9% of after-tax personal income in May. This translates to an additional annualized savings of $750 billion. For comparison, the peak annual rate of capital inflow into America was $803 billion in 2006. Thus the increase in household savings has the potential to completely eliminate America's need for foreign funds to finance its business investment and residential construction.

Here's how that would play out, according to Professor Feldstein. The international value of the dollar declines (by the Fed's printing of trillions of dollars, which Professor Feldstein doesn't say). The dollar's decline implies both that foreign buyers will find US products cheaper in foreign markets, and American consumers will find US goods and services to be cheaper than foreign goods and services in domestic markets. Thus exports would increase and imports would decrease. Moreover, since the increased production of goods and services in the US would be financed almost exclusively by the increase in US household savings, the US current-account deficit would be eliminated almost completely, except for "net interest and dividends that America's government and businesses owe to the rest of the world". Further, Professor Feldstein warns that without a fall in the dollar, the current situation in which America has a higher savings rate and reduced consumer spending (in view of fall in house prices and in stock markets) could push the US economy into a deep recession. In contrast, a lower dollar would facilitate full employment since exports would then be more competitive, and domestic consumers would find American goods cost-competitive.

Professor Feldstein mentions that there are two caveats to this scenario of re-balancing the current account deficit. The first is that the US government's fiscal deficits are projected to remain high for many years. The Congressional Budget Office projects that the budget deficit will average 5.2% of GDP for the next decade, and be 5.5% of GDP a decade from now. Hence increased government expenditure would absorb all the rise in household savings. As a result, substantial inflows of foreign capital would continue to be needed to fund business investment and housing construction. This inflow would put upward pressure on the dollar and downward pressure on US interest rates. The second caveat is that, China and other foreign lenders, in all likelihood, will not be willing to continue to lend to the US. So, there would be reduced demand for the dollar and upward pressure on US interest rates. Thus the factors that moderate the US current account deficit would be the US government's spending, foreign lenders' willingness to continue to lend to the US, domestic business investment and residential construction in the US, and the international value of the dollar.

One should note that, except for his preference that the increase in household savings be spent by private businesses rather than the government, Professor Feldstein is essentially saying the same thing that Professor Krugman has been saying -- that America can finance its (public and private) spending plans through its own savings because there has been a 'savings glut' domestically, and that a revival of American manufacturing industry could be engineered this way. I had already explained the weaknesses of the savings glut theory in my recent article, "A New Perspective on the Global Economic Crisis" . I had, in fact, warned that the savings glut theory entertains certain elements of wishful thinking. But I have to say that Professor Feldstein's article does much worse damage. His analysis in his article essentially amounts to gambling away America's future.

First of all, Professor Feldstein assumes that the relative competitiveness of Chinese-made goods in American markets can be mostly attributed to the exchange rate policy of the Chinese government that holds the value of the Chinese currency steady against the dollar, which, in turn is achieved by the Chinese government accumulating massive foreign currency reserves. Professor Feldstein is going to find that in order to make American-made goods as cheap as Chinese-made goods, the US government would also have to provide massive subsidies to the American manufacturing industry. Moreover, American manufacturing companies have been languishing for many years, whereas Chinese manufacturing companies have gained expertise in reaching economies of scale very quickly. So, Chinese companies would be able to adapt more efficiently and retain their markets, if the US government favors American companies only moderately. Thus without an all-out protectionist trade war mentality, it would not be feasible for American manufacturers to re-capture markets from the Chinese manufacturers. Unfortunately, at this point, the American economy is in a precarious state. So, global trade policies that promote protectionism and isolationism, like the Smoot-Hawley tariffs of the 1930s, could result in more risks that America would fall into a depression-like situation than that China would.

Secondly, as I had explained in my article, "A New Perspective on the Global Economic Crisis", one weakness of the savings glut theory is that it is completely agnostic about connecting savings with investments. Professor Feldstein argues that the money that is saved in America would be invested in America, because of his implicit assumption that the domestic interest rates would adjust according to the global supply of funds. In reality, it is the money that is saved in China that is going to finance China's own massive fiscal spending programs (to the tune of $586 billion over two years). Whereas, the money printed by the Federal Reserve, in anticipation of the rise in household savings in America is simply lying dormant in the form of excess bank reserves (to the tune of $800 billion) because American businesses are not seeing growth opportunities that would induce them to borrow. Moreover, different people have different "expectations" for their money. The accumulated capital in America is going to find investment in the emerging market economies, like China, India and East Asia, quite attractive because of the expectation of high returns in those economies due to their rapid growth rates. Whereas, the high savings of Chinese households is going to find its way to America in search of a safe store of value.

In his article, Professor Feldstein considers only the annual $750 billion of extra savings in American households. The fact is that the accumulation of capital in the American financial system is in excess of 20 trillion dollars, mainly in the form of life-time savings of middle class citizens, for example, social security, mutual funds, pension funds, 401(k), IRA, stock portfolios, etc. It is quite conceivable that, in view, of the recession in America, and the high growth rate in the emerging market economies, a trillion or two of this accumulated capital would find its way to the emerging market economies in the next year or two. During this time, the American economy would get out of recession and start to show signs of robust growth. Then the global supply chain would restore itself because America's import orders from Chinese manufacturers would pick up. Meanwhile, China, which has been busy financing its own domestic consumption using massive fiscal deficits of its own in 2009-10, would get back to financing its exports. With the American economy revived and yet American consumers becoming more cost-conscious because of sharp drops in their personal wealth, there is going to be a revival of demand for cheap Chinese-made goods. Thus the trade deficit would continue to grow, and China would accumulate even more dollar reserves.

Thirdly, Professor Feldstein assumes that China would be neutral to the Fed's expansionary monetary policy. Perhaps he takes this position under the influence of the de-coupling theory -- that other things being equal, China would like to be able to sustain high economic growth on its own, without the assistance of exports. Professor Feldstein assumes that the Chinese would simply watch and clap their hands as the dollar devalues. In reality, China has closely pegged its future to that of America. So, while the Fed has flooded the American economy with 4 trillion dollars of excess money printing, the Chinese are doing a proportionate amount of fiscal spending financed partially by their own money printing and partially by their domestic savings. The money printing by the Chinese is calibrated exactly to the extent that the dollar-yuan exchange rate remains stable. Keeping this exchange rate stable preserves the value of China's foreign reserves (about 65% of the 2 trillion dollars of China's foreign reserves is currently held in dollars). Moreover, since the Chinese economy is growing so fast, there would not be a problem for the Chinese to keep lending money to the US. If China's GDP grows at an annual rate of 8% for 9 years, then the GDP would double. So the ratio of China's foreign reserves to its GDP could still stay at the same value, if China lent the US 2 trillion dollars more over the next 9 years.

The main benefit from the increase in household savings rate in America is that the American financial system would become more stable. Families would be able to put down more down payment towards the mortgages on their homes, or to buy cars. The purchase of luxury items and durable goods would be facilitated with people showing their ability to delay gratification and save. With people becoming more conscious of their households' balance-sheets, decisions regarding the long-term spending of families would show a marked improvement. For example, saving for children's college education or saving for retirement (in addition to automatic savings like social security and 401(k)) would be taken more seriously. There are many benefits to the increase of household savings in America. De-valuing the dollar is not one of them.

III. Why would Professor Michael Boskin's Plan B not work?

In his latest article "Of Banks and Bailouts" on Project Syndicate, Professor Michael Boskin says that he has a Plan B for dealing with toxic assets. Here's how it goes. The financial industry has shown huge profits in the second quarter and manufacturing has rebounded strongly in Asia. However, the economic recovery would not be strong and robust without dealing with the toxic assets. "Policymakers need a Plan B in the event that one proves necessary, modeled on America's rapid resolution of insolvent savings and loans in the early 1990s, together with sales of toxic assets in large blocks (to prevent so-called adverse selection from unravelling any bidding process)". I have to say that Professor Boskin is mistaken to suggest, in his Plan B, that the toxic assets could be valued by auctioning them off in large blocks. Isn't this the same principle by which the Public Private Investment Program (PPIP) had been designed? So, why doesn't the PPIP work then?

It is notable that conservative economists have suddenly chosen the present time to raise issues about toxic assets, after a long hiatus of nearly a year. In an Op-Ed, published in the Wall Street Journal on July 20, 2009, Professors Ken Scott and John Taylor have identified the massive complexity of the mortgage assets to be the main stumbling block for valuing the toxic assets. They propose setting up a centralized database for information on the mortgage assets so as to obtain transparency. Four letters to the editor referring to this article were published on July 27, 2009. These letters raised the question why it would become possible to value the toxic assets once one has a database. The main point is that there is no magic formula that would specify the value of the toxic assets once one has a database, or an auction to middle-men.

While dealing with toxic assets, it is useful to keep in mind that the value of a toxic mortgage security is not a single number. Rather, the market price of a mortgage asset is an inter-temporal quantity, with vast amounts of uncertainty associated with the asset, when the value is low (i.e., when the asset is toxic). The only way to deal with a given group of toxic assets is to auction this group among those home-owners whose mortgage loans are pooled together to form the mortgage securities that this group of toxic assets are a part of. Since there would be thousands of home-owners in these auctions, the market for toxic assets would not suffer from illiquidity or fire-sale prices that is currently afflicting it. To conduct these auctions, a direct channel of communication between the home-owners and the security-owners has to be established. It is for this reason that a centralized database is needed. In this way, the prices on mortgage assets is adjusted, in exchange for better loan recovery. I have explained this price adjustment mechanism in detail in my article, "A New Perspective on the Global Economic Crisis".

IV. Why wouldn't economists adopt my price adjustment mechanism?

In this section, we discuss why economists wouldn't adopt my price adjustment mechanism. We provide three reasons.

(i) Pre-occupation with global imbalances: As I had already explained in my "A New Perspective on the Global Economic Crisis II: Fear of Reverse-colonization Did It", during the last five or six years, professional economists, both conservative and liberal, had been pre-occupied with the imbalances in global trade, savings and current accounts. In my opinion, this attitude is mainly motivated by their fears of reverse-colonization. As a result, when the financial crisis hit due to the collapse of the mortgage industry, Western economists blamed it all on global imbalances. As the stock market crashed last Fall and the manufacturing industry took a nose-dive, the Chinese economy also tanked because exports to the advanced countries collapsed. The expectation was that the rapid growth of the Chinese economy would collapse, because of the loss of its exports markets. However, at this point, de-coupling did take place in earnest. China announced its own fiscal spending program and in the first two quarters of 2009, China was able to generate sufficient growth opportunities domestically so as to be able to get back to its rapid growth-path (8%+ annual growth in inflation-corrected GDP).

For this reason, engineering a dollar devaluation through the Fed's expansionary monetary policy is going to do permanent damage to America's geo-political credibility. Unfortunately, fears of reverse-colonization prevails supreme. Hence Western economists are trying to use some excuse to transmit trillions of dollars of losses to the rest of the world. I have explained in Section III of my article quoted in the previous paragraph, how the losses in the American financial system can be transmitted through dollar devaluation.

(ii) Economists from the cities: Economists who reside in metropolitan areas do not want the government to be promoting home-ownership. They would prefer that the government spend to clean up inner cities. Moreover, liberal economists don’t like the idea of property rights at all. So, they do not even want to consider my proposal for connecting the property owner with the security owner. These liberal economists believe that the government would be able to solve the financial crisis. They even went to the extent of suggesting temporary nationalization of the Wall Street banks. On the other hand, the conservative economists would like to be seen as friends of businessmen and financiers. So for a long time during the George W. Bush Presidency, they didn’t want to help homeowners avert foreclosures. Only recently, conservative economists like Professor Michael Boskin and Professor John Taylor are beginning to focus again on the issue of toxic assets.

(iii) The wrath of the Old Keynesians: The term “Old Keynesians” refers to a group of highly influential economists who have been using the current crisis as an excuse to implement Keynesian policies to the extreme. On paper, they say that their idea of paradise is the post-war American society of 1945 -- 70, when Keynesian economists wielded a lot of influence on government policies. However, in private, these economists would like to re-shape America as the Great Britain of the 1930s and 40s, when Britain came under great challenges to defend its colonial empire. These Old Keynesians have been working furiously to run up public debt, under various excuses that include (a) replacing the fall in consumer spending, (b) correcting global imbalances, (c) rescuing financial institutions, (d) preventing foreclosures, (e) propping up securitization markets. They have also been actively promoting Great Depression mania. These economists believe that a shared sense of hardship would make American society more cohesive in the future. That American youth would go out into the world to fight against impossible odds in the cause of an empire, just like the British youth did in the 1930s and 40s. Just like the so-called “Neo-conservatives” functioned as an extra-constitutional authority and exerted undue influence on the previous George W. Bush Presidency, there is a danger that the "Old Keynesians" would come to exert undue influence on this administration in due course of time. These “Old Keynesians” have been instrumental in cooking up dubious theories of economics, like the savings glut theory and the de-coupling theory, in complete dis-regard for the concerns of the rest of the world. They would not like to see a viable solution for the global economic crisis anytime soon.