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Where there is no law, but every man does what is right in his own eyes, there is the least of real liberty
Henry M. Robert

Yuri Pakhomov: “A financial crisis is when the economy is stupid and the banks great”

13 November, 2012 - 00:00
The Day photo archive: Yuri Pakhomov

Ukraine’s financial crisis, threatening to get out of control from above at any moment now, is being closely followed by politicians, economists, and scholars.

This time The Day hosts Academician Yuri Pakhomov of the National Academy of Sciences, Director of the Institute of World Economy and International Relations. As was to be expected he offers to look at the situation in the context of world development.

Q.: What are the reasons for the financial crisis in Ukraine?

A.: Fundamentally, they are the same as those behind all the other troubles befalling Ukraine’s economy and people (and the same is true of Russia). However, over the past 2-3 years these causes have been modified, quite logically under the circumstances, resulting in this landslide crisis.

It is an open secret that starting in 1992, Ukraine has been using an IMF reform model which is totally unsuitable for Ukraine, gradually depleting and ruining the economy, with plummeting living standards, degrading people’s skills, soaring crime, and hard cash flowing westward and into the pockets of the so-called new Ukrainians.

The stages and means of immobilizing the Ukrainian economy are generally known. Shock therapy, meaning the total depredation of the people; sudden (not predetermined) opening of borders for exporting the loot; the emergence of trusts and other artificial conditions for pumping out money and transferring them to the bottomless strongboxes of the Ukrainian nouveaux riches; financial stabilization and privatization breaking the industrial backbone, destroying science, depriving millions of their hard-earned wages, while stepping up the monetary outflow by the release of capital and import expansion.

The situation that has developed reminds one of a graveyard and would seem a reliable guarantee against a financial landslide. Everything thus “achieved” was officially referred to as stability. The people remained relatively quiet and those with glib tongues — particularly small businesses — were kept under control by the authorities in collaboration with the underworld increasingly present at the upper echelons. All that remained was let the investors loose in the vacant space formed by that “stabilization.”

Ukraine, however, is not Bolivia. The idle factories were not deserted, because millions of workers and engineers simply had nowhere else to go. They had to be fed somehow, meaning that the giant social sphere had to be maintained, along with science, culture, medicine, and public education that refused to be curbed. Social spending, even though ruthlessly curtailed, was racking. The state budget, denied previous revenue (including fake inflation returns), was going to pieces; the overtaxed machine was halting. Investors declined invitations, fearing the rackets working hand in glove with the authorities.

To top it all off, stabilization did not live up to expectations (Ukraine is not Bolivia). It failed to automatically shift credit to the real sector; money was still best placed mainly in financial speculations. Of course, the situation could be improved in many respects, but to do so a host of changes had to be made in industrial policy, as compared to the IMF model. This, in turn, would deny certain quarters their easy and comfortable lifestyle, relying on the monetarists promising that the market would straighten things out by itself. Moreover, the decision-makers overseas would take a dim view of any digression from the monetarist model. Last but not least, the overall atmosphere of easy investments and almost instant mind-boggling revenues was too tempting — in a word, a feast during the plague.

The above factors, as well as other circumstances (e.g., the IMF’s censure of emission and devaluation) determined the “post-stabilization choice”; capital was kept increasingly aloof from the real sector, being used to supply narrow interests, ruling out foreign investment here, implying plugging holes in the budget, with the emphasis shifting to the high-yields in the securities market and pyramid speculations where profit increment was achieved by slipping the noose of domestic and foreign debts around society’s neck.

Of course, borrowing money is a perfectly normal phenomenon. But in Ukraine the situation was deadlocked because the authorities were incapable of allowing this money to pass through the high-yielding and quick- return real sector. Thus Ukraine’s debt, while constituting only 30% of GDP (not much, all things considered) turns out heavier than any truly giant liabilities.

Naturally, living on credit, by speculative borrowings, with practically all production facilities devastated, ought to be the logical outcome of many years of immobilizing the economy. Even at this sluggish stage there is an obstacle being erected which will become insurmountable precisely due to the present course of reform. Creditors, especially foreign ones, are a very special category. They are not like Ukrainians accustomed to misery and humiliation over decades. So when the state becomes deadlocked and the debt pyramid topples over, there are only two possibilities: abandoning the destructive reform course or bracing oneself for a major social outburst.

The policy of speculative borrowing serves to quicken the approaching financial crisis, but the same negative role is played by a firm national currency in a terribly weak country like Ukraine. I mean the overstated hryvnia exchange rate or that of the ruble in Russia. This is hard to imagine; a stable hryvnia is probably the only actual attainment of all the Ukrainian reforms, yet the fact remains that this artificially strong hryvnia cuts the ground from under our feet. Grigory Yavlinsky was right commenting on the roots of the Russian crisis: “The ruble is plummeting because its rate was overstated due to loans. Now that it is time to pay our debts everything is back to the harsh reality.” Even without a crisis a strong national currency in a weak country is a luxury no one can afford, because keeping it strong costs too much, largely because revenues in this case are reallocated for importers’ benefit, while exports suffer. This is precisely why (because of the importers’ benefit) the West — and, of course, the IMF — welcomes the hryvnia’s overstated value, while condemning any attempts to devaluate national currencies in transition economies (I mean controllable evaluation, not a landslide one, of course).

Q.: What is the difference between controllable and landslide devaluation?

A.: There is a lot of difference. An avalanche devaluation is destructive. A controllable one is creative; it makes banks and importers suffer, but livens up the industries and attracts investors. Even industrialized countries like the United States and Germany resort to devaluation now and then, which benefits their economies in terms of competition.

The central national bank plays the decisive role in the currency (exchange rate) policy. However, even in the event of a strictly controllable, salutary devaluation, the banking system finds itself in a difficult situation, because it inevitably suffers losses. Hence, the central bank’s policy should be subject to corrections, even if partially, and to compensations when sustaining losses. But this is possible only in a healthy polity.

The NBU Governor stated the other day that his bank is responsible only for the hryvnia. He is right, of course, but there is another aspect to this responsibility. In a country dominated by monetarist macroeconomic regulators (in fact, in any given country), the bank’s responsibility for the national currency must also be implemented as its responsibility for the national economy. Otherwise that bank’s influence on the economy will be on a scope incompatible with its responsibility for the country’s destiny. It’s like a western with the bank being the good guy and the economy the bad guy. And the same is happening in Russia. Of course, now that we are threatened by a financial avalanche a controllable devaluation is highly questionable, but it is important to consider to trace the deep roots of the crisis.

Q.: What do you think is the way out of the crisis in Ukraine?

A.: There are different methods and choosing between them depends on many factors, but largely on the situation that has actually developed. Beyond it there are two categories of circumstances to be considered.

To begin with, it depends on the country itself, whether it is strong or weak. A country may be strong having a liberal political system (like the US, German, even Poland, and Estonia) or an authoritarian system (China and Uzbekistan). By the way, when crisis broke out in Thailand and Hong Kong, the Chinese leadership believed that it was all the work of transatlantic corporations scheming to undermine China in retaliation for Hong Kong. Measures were taken in China and they proved so effective that its financial curve remained intact and the yuan grew even stronger, so much so that local experts started talking about devaluation. You see, they don’t take orders from IMF or anybody.

Secondly, it depends on whether the Ukrainian authorities will yield to the temptation of fishing in troubled waters, solving their own and other people’s problems, including explosive issues. If they do, crisis could be unleashed artificially and then die out without gaining momentum. Now a regime oriented toward serving its own people stands a good chance to both prevent this crisis and, if it happens anyway, reduce its consequences to a minimum.

In the situation that has developed, assuming that the crisis will gain momentum (which is unlikely and I think it will be folded up) we cannot use a strong country recipe for the obvious reasons; we won’t even manage the Argentinean approach being propagandized in Russia. In that country the people trusted their state. And I am not ruling out the possibility of changing government, considering the scope of the overall disillusionment caused by financial cataclysms (I mean in both Ukraine and Russia), in which case the firefighting arsenal would be considerably expanded.

Under the circumstances, “structural changes” has become a catch phrase and is thrown about left and right as almost a way out of the crisis. This assumption is more than strange, because there were no prerequisites for such changes even when there were no signs of crisis. And I have already mentioned the reasons. The more so that such changes would require nationwide strategic decisions, whereas now everyone is busy fighting the fire. Also, structural changes require different people in the corridors and offices of power, a different reform model. In a word, all this talk is purely speculative.

Q.: All right, but the West says we must carry out reforms. Won’t it regard any change in the present course as an unwelcome deviation?

A.: The West, demanding reforms, has in mind their general contours. We must bear in mind that in most cases their calls for reforms (the US Treasury Department and IMF) meet not out shameful realities but the market-economy-democratic vector as such. The West knows neither the degree to which we are brainwashed by expansionary monetarism or the danger of implementing the IMF model in toto. In fact, this is where the West is at a considerable disadvantage, because the results of what little we have achieved by way of reforms have caused most intellectuals to lose confidence in the Western approach — and I do not mean the “elite,” for this is how our Mafia identifies itself, I mean people who only recently were ardent exponents of the West and its ways. Now it is important to prevent an atmosphere of hostility, and we have solid grounds to fear just that, because the West was the first to realize that the IMF model, much advertised in the early 1980s by the so-called Washington consensus and geared only for Latin America at that period, not now, was no good in Eastern Europe.

Now, at long last, there is a definite trend to shift the reform emphasis. By analogy with world science and technological trends, one-sided approaches are being replaced by a reform synthesis. Accordingly, aggressive models claiming universality are being discarded on an increasing scale. Primarily, this is true of IMF monetarism whose ambitions are far ahead of Keynesianism, let alone the recent Soviet planned economy model.

Remarkably, this monetarist model was publicly disowned by its founder and IMF partner, the World Bank, which admitted that it had discredited itself, especially in transitory economics. And WB went further than that, implementing its largest research project dedicated to reforms, and its Vice President and chief economist Stiglitz’s paper at the UNU/Wider in 1998.

Judging from this project and report, monetarism is following in the footsteps of Soviet-type planned expansion. Of course, monetarism, like Keynesianism and planning, will remain among the greatest attainments of world economics, but will be an effective implement only in that particular niche where it is truly relevant. Without doubt, the current changes will revive genuine monetarism, making today’s biased mutant step down.

Getting back to the Stiglitz report, the document’s leitmotif is discarding the bankrupt model. Among other things, the author is glad to know that the IMF monetarist zealots failed to contaminate American economics with their ideas. If their recommendations were heeded, writes Stieglitz, the United States would have never shown such tangible economic growth. Further on, he infers the importance of replacing the Washington consensus (i.e., the IMF model) by a post-Washington one. The second principle of the new consensus, he points out, is remarkable modesty, being aware that we do not have answers to all questions. We need further studies and discussions, he adds, involving not only the World Bank and IMF, but also representatives of all countries. A statement best described as a very pleasant surprise, isn’t it?

Q.: How do you think Ukraine will respond to this?

A.: The political Olympus is waiting in silence, and we have the same people in power that we had. And they have 20:20 hindsight.

 

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