Hanke: Bulgaria Performs a Bit Better than Average
Bulgaria is performing a little bit better than the average in a very hostile environment, Steve Hanke, the architect of the country's currency board regime, said at a conference in Sofia.
"One reason is that the bank money has held up fairly well. Bulgarian banks are rather well capitalized and there has not been so much bank bashing," said Hanke, Professor of Applied Economics at The Johns Hopkins University in Baltimore, Maryland, USA and a Senior Fellow at the Cato Institute in Washington, D.C., USA.
The renowned economist spoke at the International Economic Conference: Bulgaria and the World in Progress, organized by Manager magazine on December 12.
To illustrate just how dramatically the currency board system (CBS) improved life for Bulgarians, Steve Hanke presented a Misery Index that he constructed (see chart number one here). The index is the sum of the inflation, interest, and unemployment rates, minus the annual percent change in the gross domestic product (GDP).
"The currency board system did have quite a big effect on Bulgaria and you can see why the popular opinion is backing it and people don't want to change it," Hanke, who served as an adviser to President Petar Stoyanov from 1997-2001, pointed out.
In an attempt to set the stage for what he called "the monetary mess" at the moment and give historical background, Hanke went back no less than 3 000 years, saying there has always been one single dominant currency throughout these years, backed by commodity.
"Today the dominant currency is the US dollar. Forget the euro. It is the second most important currency in the world, but the US dollar completely dominates and it will be very hard to challenge it," Hanke said.
According to Hanke one of the main reasons for the global financial crisis is the informal inflation targeting system, where they try to keep the inflation rate at about 2%.
It is namely the policies of the Federal Reserve, prompted by the inflation targeting regime, that created what he called "aggregate demand bubbles", according to Hanke.
"The Fed creates this aggregate demand bubble and every time they panic, the accelerator is put down to the floor board, inflation goes up, they put the brakes on and when the final bubble broke we went tumbling down."
Before the start of the crisis there was no problem with the consumer price index, but other prices were bubbling up and increasing very fast – house prices were going up by 15% per annum, the stock market – up by 13%, commodity prices - way up by 17% a year.
"Inside the aggregate demand bubble there were micro market bubbles going up. "
This, together with the low interest rates, made many speculators go chasing yields, trying to find a place, where they can get a positive rate of return, despite the high risks.
"The Fed enabled the credit boom and the bubbles", the professor said.
"At the moment the policy of central banks is ultra loose and they are just pumping money. Despite that there is money supply deficiency because of the bank regulations - banks are required to put in more capital relative to the assets that they have."
The eurozone suffers from big money supply deficiency – 8%, while Asia is doing well because the money supply is growing – China is above 10% over trend.
"Money supply is required for economic growth. Banks are much more important than the central bank because of the money supply," Hanke said.
The professor attributed the sharp rise in oil and commodity prices at the beginning of the crisis to dollar-euro exchange rate fluctuations.
He pointed out that the dollar-euro exchange rate is very important for Bulgaria because of commodities, which are priced in dollars.
"From 2002 until July 2008 the dollar got very weak against the euro and commodity prices skyrocketed. This is very important for Bulgaria, where the average inflation rate for 2008 was 12%."
"The Fed had become very worried about inflation, but was not even looking at the exchange rates, which were showing clearly the bubbles."
According to Hanke politicians and central banks are now just trying to rewrite history, claiming they are not responsible for the bubbles.
Hanke recommended that the world embrace an international system, based on an agreement for fixing the dollar-euro exchange rate and tying Asian countries currencies to the US dollar.
Thus the commodity price fluctuations, which hit Bulgaria very hard, will be gone, according to Hanke.
"The system will be automatic and you will have stability. Stability might not be everything, but everything is nothing without stability."