1 See Reuven Brenner, “Dismiss Macroeconomic Myths, and Restore Accountability,” American Affairs 1, no. 1 (Spring 2017): 62–81.
2 Milton Friedman, “My Biggest Mistake,” interview by Michael M. Weinstein, New York Times, July 4, 1999.
3 This is a mistake, too, because there are times when these indices are gravely mismeasured, as in the years leading to the 2008 crisis. During that period, changes in capital gains taxes concerning houses turned them from “consumption” into more of an “investment,” and they became increasingly liquid assets. See Brenner, “Dismiss Macroeconomic Myths.”
4 See Reuven Brenner and Martin Fridson, “Treasury’s Little Buddy,” International Economy (Fall 2013): 28–33. In 2008, European and American shell-shocked, aging baby boomers lost significant portions of their wealth. Those aged over 55—the savers—were understandably not in the mood to take more risks, no matter what central bankers were doing. Instead, they predictably went into insurance mode. Low interest rates are not an inducement for this age group to take more risks. On the contrary, losing significant portions of their wealth increased their difficulty in finding decently paying jobs, and expectations of diminished pensions and higher health costs led them to deploy their diminished savings in capital preservation modes.
5 Brenner, “Dismiss Macroeconomic Myths.”
6 This is a reminder of bureaucracies’ staying power, even as their mandates change. In his book The Chastening: Inside the Crisis That Rocked the Global Financial System and Humbled the IMF (New York: Public Affairs, 2001), Paul Blustein reviews the IMF’s performance and describes the fund’s lack of practical expertise as it advised countries around the world. That should not come as surprise. The IMF had a rationale for its existence as part of the Bretton Woods system of fixed exchange rates, but no role under a floating system. The bureaucrats reinvented themselves as an international consulting company––accountable to no one. Blustein describes how the IMF and Treasury, among others, pushed for drastic devaluation of Indonesia’s currency, bringing about revolt and bloodshed, and how the fund’s top management dealt with the Russian crisis “atop a sand dune talking on a cell phone.”
7 Monetarists’ disbelief in the finding came from their view that inflation is a monetary phenomenon, whereas “unemployment” is a real one, and so unless people made the same mistakes repeatedly, there could be no such stable relationship. If governments pursued policies leading to higher inflation unexpectedly, this school of thought admitted that there could be a relationship, but an unstable one and of short duration. But economists did not take into account the use of unexpected, higher inflation for fiscal purposes and the resulting impoverishment.
8 See Reuven Brenner, History: The Human Gamble (Chicago: University of Chicago Press, 1983), chaps. 2 and 3. Chapter 2 examines the various shapes and forms credit and money took in what anthropologists call “primitive societies,” whereas chapter 3 is about usury laws, a topic also examined in my “Dismiss Macroeconomic Myths.”
9 See discussion in Brenner, “Dismiss Macroeconomic Myths.” Churchill acknowledged that mispricing the sterling after World War I was his biggest blunder ever.
10 See Milton Friedman, “Franklin D. Roosevelt, Silver, and China,” Journal of Political Economy 100, no. 1 (Feb. 1992): 62–83, and Arthur Nichols Young, China’s Nation-Building Effort, 1927–1937 (Stanford: Hoover Institution Press, 1971).
11 See Young, China’s Nation-Building Effort, 207.
12 See Reuven Brenner, The Force of Finance: Triumph of the Capital Markets (London: Texere, 2001), chap. 1. With hyperinflation in many European countries and high unemployment in both Britain and the United States, none of these countries’ models of society appeared worth emulating.
13 The reason for countries to pursue policies of undervaluing their currencies and giving their exporters an advantage is political: exporters depend far more on their political masters than importers. Centralized countries, with no domestic competitive capital markets that would disperse power (an impact which is enough reason for politicians whose power depends on controlling capital flows to oppose it), can still export successfully. But sooner or later such moves toward centralization in major countries destabilize a system of stable exchange rates.
14 Occasional devaluations were permitted. Though just how much flexibility there should be in exchange rates was never defined operationally. The IMF accepted the jargon of rationalizing devaluation when there is “fundamental equilibrium.” But as Per Jacobsson, the IMF managing director in the 1960s, stated (when such statements were still acceptable and no reason for instant firing), “You can no more define equilibrium in international trade than you can define a pretty girl, but you can recognize one when you see one.” See Lawrence Malkin, “Britain Took Devaluation with Ease,” Associated Press, November 19, 1968.
15 See Paul A. Volcker and Toyoo Gyohten, Changing Fortunes: The World’s Money and the Threat to American Leadership (New York: Times Books, 1992), 20–25.
16 This argument continues to be repeated, including in: Alan Blinder, “Five Big Truths about Trade,” Wall Street Journal, April 22, 2016.
17 The view was popular among all those identified with the so-called monetary approach to the balance of payment, including many in the economics department at University of Chicago, such as Harry Johnson. Contracts play no role in these models.
18 Robert Mundell, also at the time at the University of Chicago, and believer in “optimum currency areas,” predicted the harmful consequences of floating, left the department, and his views remained marginal for a while.
19 See Volcker and Gyohten, Changing Fortunes, 100–2, and the preface.
20 Some locking in is justified when, for example, a previously centralized country (say, under Communism) wants to decentralize. The country needs, then, a solid anchor for adjusting, and does not have a deep financial market to hedge, which would be necessary if it floated its currency.
21 See Lester G. Telser, “Futures and Actual Markets: How They Are Related,” Journal of Business 59, no. 2 (Apr. 1986): S12.
22 This action may briefly increase interest rates, though not necessarily. If investors did not expect such policy, they would have expected higher inflation rate, which would have been reflected in higher nominal rates. The firm commitment to stable exchange rates, and anticipating such “automatic” reaction by central banks, would keep interest rates stable.
23 What would prevent countries from serially overspending, and requesting recognition of “fundamental disequilibrium” often—is that then they would be no longer part of the new Bretton Woods–type agreement, would have a floating currency, and bear the consequences of the significant costs on the slowed flow and higher cost of capital, impoverishing the country.
24 Recall too the case of Argentina’s currency board, which linked its currency firmly to the dollar, only see the latter appreciate significantly, while all its trading partners were seeing their currencies devalued. Argentina did not have the credibility to argue that if they carried out a devaluation it would be due to a “fundamental disequilibrium,” and not that it is reverting to its past irresponsible monetary practices.
25 It is true, there are no free lunches in this world—and power would get more dispersed within China.
26 For example, enforcement of intellectual property rights: only when societies get richer do they begin to enforce patents. Remember the times when Israel was called the “one-diskette” country? History is now repeating: many European countries (Switzerland and Belgium, for example) introduced and enforced patent laws only after they already some industries to their shores—because they did not previously have such laws on their books. Switzerland, for example, did not have a patent law until 1887. The 1887 Swiss law covered only inventions that could be represented by a model, leaving all other processes unprotected. This was the main reason for the success of its chemical and aluminum industries, since the French and German companies who innovated, but whose production methods were considered too close to existing ones in their home countries, moved to Switzerland.
27 With a floating currency system, its role in effect expired. But trust bureaucracies to invent rationalization to perpetuate themselves.
28 See Ad van Riet, “Safeguarding the Euro as a Currency beyond the State,” European Central Bank Occasional Paper No. 173, May 2016.
29 Even the ability to seize sovereign assets as collateral is procedurally complex, cost-intensive and time-consuming. It is highly unlikely that any authority has the ability or willingness to “send in the Marines,” blockade the defaulting countries, or send in financiers to overhaul their treasury departments, which, until some ninety years ago, was an accepted international “bankruptcy regime,” though one destined to provoke greater political crises.
30 See The State of the International Financial System, Hearing before the Committee on Financial Services, U.S. House of Representatives, 110 Cong. 39–40 (June 20, 2007) (statement of Henry Paulson), and Faisal Z. Ahmed, Laura Alfaro, and Noel Maurer, “Lawsuits and the Empire: On the Enforcement of Sovereign Debt in Latin America,” Law and Contemporary Problems 73 (Fall 2010): 38–46. Already existing “national democracies” that had currencies backed by a treasury with a weakened tax base, which could do occasional devaluation, do not prevent monetary and financial crises. A currency that is not backed by rules that would force countries sharing it into the disciplined behavior its existence was supposed to be backed by—rules similar to clauses in the Bretton Woods agreements—cannot last long.
31 Quoted in Helena Smith, “Barack Obama Calls for ‘Meaningful Debt Relief’ for Greece,” Guardian, November 13, 2016, https://www.theguardian.com/us-news/2016/nov/13/barack-obama-calls-for-meaningful-debt-relief-for-greece.
32 Not that I give full confidence in the official Greek numbers about their domestic product, since their informal markets (such as tourism and agriculture—on its hundreds of island in particular—are the main industries) have been estimated to be in the high teens. And with the stable family businesses on those islands, and the deep culture of tax evasion, I doubt much tax enforcement can be carried out.
33 Lenders can never reasonably expect people with poor prospects and no collateral to pay interest and repay the capital. Giving loans to poor people with no prospects lead to disputes, conflicts and court proceedings. These impose heavy burdens on societies, requiring that families, religious institutions, and governments step in to re-stabilize communities. Usury laws for members of the tribe prevented these destabilizing consequences in these sparsely populated agrarian societies. The Biblical conclusion was that unfortunate people and people falling on hard times should be given charities not loans. Mr. Paulson’s comments appear to reflect this thought, applied to countries. But the few biblical “strangers’” situation was different: when they borrowed money, they posted collateral that the locals could capture in case of default. The “collateral” was not only any physical or monetary asset that the stranger/borrower could provide, but also, in case of default, the assets of any person belonging to this “stranger’s” fellow travelers. Rumors of default of one “stranger” induced his fellows to flee, preventing the local lenders from getting their collateral. This “mobility of the collateral” is why “strangers” had to pay higher interest than “immobile,” poor brothers.
34 Also: Europe’s aging population and diminished fertility rates imply a short horizon with “après moi, le déluge” philosophy—reminding one of the POW experiment in its final days. If the Spanish, Greek, and Italian tribes do not want to reproduce why would they have a long horizon—especially as they do not appear to be thrilled for Muslim crowds inheriting their Earth? The shorter horizons reduce the chances of finding the political will to make draconian changes in political institutions. Moreover, with the present pool of immigrants not appearing to desire and share local culture, and with Europe’s entrepreneurial youth moving to the United Kingdom, Canada, the United States, and Australia, the EU will see an increasingly weakened tax-base (unless, perhaps millions of Chinese with a pragmatic religion already separated from state, unlike Islam, flock to Europe).
35 If countries are bent on centralization, the entire analyses in this piece becomes moot, as prices are becoming a fiction, having no relationship to relative scarcities, and the currency is gradually reduced to being an accounting device—as currencies were, under communism.