Andres Velasco’s plan: Save for a rainy day

Andrés Velasco may well have saved his country’s democracy, not just its finances.

Who is Andrés Velasco, you may be asking? He’s Chile’s Finance Minister:
Prudent Chile Thrives Amid Downturn

During the emerging economies’ commodities boom a few years back, Chilean Finance Minister Andrés Velasco was a wet blanket at the fiesta. Chile, the world’s largest copper producer, was reaping a bonanza from the quadrupling in the metal’s price. Mr. Velasco insisted on squirreling away a large chunk in a rainy-day fund.

As the savings swelled above $20 billion — more than 15% of Chile’s economic output — Mr. Velasco faced growing pressure to break open the piggy bank. In September, protesters barged into a presentation by Mr. Velasco, carrying an effigy of him and shouting, “The copper money is for the poor people.”

The 48-year-old Mr. Velasco, wary that a flood of copper income could generate lending and consumption bubbles, stood his ground, even as the popularity of the center-left government withered. Latin American history, he cautioned, was full of “booms that had been mismanaged and ended badly.”

Historically, what follows the booms is an economic crash, which provokes a coup, which in turn leads to a dictatorship, as it did in Chile:

Chile, which has long been a laboratory for economic experiments, had its thrifty fiscal consciousness forged by a national tragedy in the 1970s. To finance his plan of turning Chile into a socialist state, then President Salvador Allende cranked up the money presses, leading to inflation of more than 500% and alienating the middle class.

The societal stresses came to head on the morning of Sept. 11, 1973, when Chilean air force planes bombed the presidential palace in a coup by Gen. Augusto Pinochet. Mr. Velasco was 13 years old. A few years later, Mr. Velasco’s father, a law professor, was kicked out of the country by the Pinochet government for denouncing human-rights abuses.

Mr. Velasco studied economics at Columbia University, as part of what he calls a quest “to understand how did this happen [to Chile] and how do we make sure it will not happen again.” The conclusion reached by Mr. Velasco and other economists of Chile’s left was that runaway inflation had made Chile fertile ground for coup plots, and that political stability couldn’t be ensured without financial stability.

Of course, Velasco was under huge pressure to spend, spend, spend. He stood his ground and made the right decision.

Every Chilean who believes in democracy should thank him. Go read the article, to find out why.

Hat tip Greg at RCW Blog.

UPDATE
Meanwhile, here in the USA, Exploding Debt Threatens America:

Under President Barack Obama’s budget plan, the federal debt is exploding. To be precise, it is rising – and will continue to rise – much faster than gross domestic product, a measure of America’s ability to service it. The federal debt was equivalent to 41 per cent of GDP at the end of 2008; the Congressional Budget Office projects it will increase to 82 per cent of GDP in 10 years. With no change in policy, it could hit 100 per cent of GDP in just another five years.
…
To understand the size of the risk, take a look at the numbers that Standard and Poor’s considers. The deficit in 2019 is expected by the CBO to be $1,200bn (€859bn, £754bn). Income tax revenues are expected to be about $2,000bn that year, so a permanent 60 per cent across-the-board tax increase would be required to balance the budget. Clearly this will not and should not happen. So how else can debt service payments be brought down as a share of GDP?

Inflation will do it. But how much? To bring the debt-to-GDP ratio down to the same level as at the end of 2008 would take a doubling of prices. That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent. A 100 per cent increase in the price level means about 10 per cent inflation for 10 years. But it would not be that smooth – probably more like the great inflation of the late 1960s and 1970s with boom followed by bust and recession every three or four years, and a successively higher inflation rate after each recession.

The fact that the Federal Reserve is now buying longer-term Treasuries in an effort to keep Treasury yields low adds credibility to this scary story, because it suggests that the debt will be monetised. That the Fed may have a difficult task reducing its own ballooning balance sheet to prevent inflation increases the risks considerably. And 100 per cent inflation would, of course, mean a 100 per cent depreciation of the dollar. Americans would have to pay $2.80 for a euro; the Japanese could buy a dollar for Y50; and gold would be $2,000 per ounce. This is not a forecast, because policy can change; rather it is an indication of how much systemic risk the government is now creating.

Why might Washington sleep through this wake-up call? You can already hear the excuses.

“We have an unprecedented financial crisis and we must run unprecedented deficits.” While there is debate about whether a large deficit today provides economic stimulus, there is no economic theory or evidence that shows that deficits in five or 10 years will help to get us out of this recession. Such thinking is irresponsible. If you believe deficits are good in bad times, then the responsible policy is to try to balance the budget in good times. The CBO projects that the economy will be back to delivering on its potential growth by 2014. A responsible budget would lay out proposals for balancing the budget by then rather than aim for trillion-dollar deficits.

Which is highly unlikely.