The Pot Again Calls the Kettle Red: Republicans, Democrats, the Fed and QE2

     Some conservatives are attacking current U.S. monetary policy as being too expansionary, as likely to lead to excessive inflation and debauchment of the currency.   The Weekly Standard is promoting a letter to Fed Chairman Ben Bernanke that urges a reversal of its policy of QE2, its new round of monetary easing. The letter is signed by a list […]

     Some conservatives are attacking current U.S. monetary policy as being too expansionary, as likely to lead to excessive inflation and debauchment of the currency.   The Weekly Standard is promoting a letter to Fed Chairman Ben Bernanke that urges a reversal of its policy of QE2, its new round of monetary easing. The letter is signed by a list of conservatives, most of whom are well-known Republican economists, some associated with political candidates.  Apparently the driving force is David Malpass, who was an official in the Reagan Treasury, and he is taking out newspaper ads later this week.  This follows similar attacks on the Fed by politicians Sarah Palin, Mike Pence, and Paul Ryan

     If the National JournalWall Street Journal and Politico are right that the Republicans are trying to stake out a position that Democrats are pursuing inflationary monetary policy, they are on shaky ground.   I will leave it to others to make the important point of substance:  the risk of excessive inflation is low now compared to the risk of an alarming Japan-style deflation, with the economy having only begun to recover from its nadir of early 2009.   Or to acknowledge that Quantitative Easing is only a second best policy response to high unemployment.    (Fiscal policy would be much more likely to succeed at this task, if it were not for the constraints in Congress.)

     I will, rather, respond to the political component of the National Journal’s question by pointing out some insufficiently understood history:

  1. Republican President Nixon successfully pushed Fed Chairman Arthur Burns into an excessively easy monetary policy in the early 1970s — leading to high inflation which the White House tried to address with wage-price controls.  Nixon, of course, also devalued the dollar, and took it off gold, thereby ending the Bretton Woods system of fixed exchange rates.
  2. Republican Presidents Ronald Reagan and George H.W. Bush tried aggressively to push Fed Chairmen Paul Volcker and Alan Greenspan into easier monetary policy, especially in election years.  This is documented in Bob Woodward’s 2000 book Maestro.   The White House succeeded in making life unpleasant enough for inflation-slayer Volcker that he eventually declined to be reappointed, prompting Treasury Secretary James Baker to exult “We got the son of a bitch!” (p.24).  Baker is also the man usually credited with the Plaza Accord and the associated 50 % depreciation of the dollar from 1985 to 1987.
  3. Democratic Presidents Jimmy Carter and Bill Clinton are the two presidents in the last four decades who scrupulously refrained from pushing their Fed Chairmen (Volcker and Greenspan, respectively) into inflationary monetary policy.  
  4. Under Republican President G.W.Bush, monetary policy once again became excessively easy, during 2003-06, contributing substantially to dollar depreciation, the housing bubble and the subsequent financial crash.

     Thus if the other party were to accuse Democrats of pursuing excessively inflationary monetary policy, it would be akin to them accusing Democrats of pursuing excessively expansionary fiscal policy.    Perhaps such accusations will strike some who don’t pay close attention as superficially plausible, even after all these years.  But they nonetheless fly in the face of history.   Another case of the pot calling the kettle “red.”   Yes, I know, the usual saying is about the color black.  But red is the color of deficits, overheating, … and Republicans.

    I document the history in “Responding to Crises,” Cato Journal 27, 2007. 

Gold: A Rival for the Dollar

     Robert Zoellick put a few sentences about gold toward the end of a column in today’s FT that are drawing a lot of attention.   I doubt very much if the World Bank President has in mind a return to the gold standard, but goldbugs and critics alike are talking as if he does.
      Even if […]

Robert Zoellick put a few sentences about gold toward the end of a column in today’s FT that are drawing a lot of attention.   I doubt very much if the World Bank President has in mind a return to the gold standard, but goldbugs and critics alike are talking as if he does.

Even if one placed overwhelming weight on the objective of price stability — enough weight to contemplate a rigid straightjacket for monetary policy — gold would not be a suitable anchor.   The economy would be hostage to the vagaries of the world gold market, as it was in the 19th century:   suffering inflation during periods of gold discoveries and deflation during periods of gold drought.   This is well-known.   I am confident Zoellick understands it.   (He and I were in the same macroeconomics seminar at Swarthmore College in the 1970s.)

I think he is making another point.  The world is moving away from a monetary system in which the dollar is the overwhelmingly dominant international reserve asset.  The dollar’s share of international reserves has been declining ever since Richard Nixon unilaterally ended the Bretton Woods system in 1971.   The dollar’s unique role is not an eternal god-given constant of the universe, any more than it was for pound sterling.  The US currency of course replaced the pound in the first half of the 20th century, with a lag of 25 years or more after the US surpassed the UK economically.

Will some asset replace the dollar, then?  No, not a single asset.  But we are probably moving to a system where there will be as many as a half dozen international reserve assets.  First, there is the euro.  Despite the serious troubles facing it this year, the euro has been a competitor for the dollar since it came into being 11 years ago.  Both the yen and the Swiss franc have to some extent played safe haven roles during the last three years of global financial turmoil.  The pound is not out completely.   Some day the renminbi will be added to the roster of major international currencies, when China’s financial markets are sufficiently developed and open.    Even the SDR (special drawing right) came back from the dead in 2009.

And, yes, gold too has re-joined the world monetary system.  Gold was seen as an anachronism as recently as a couple of years ago.  The world’s central banks had been gradually selling off their stocks.   But all that changed in 2009.  The People’s Bank of China, the Reserve Bank of India and other central banks in Asia have bought gold.  Understandably, they want to diversify their reserves.    It appears that central banks have stopped selling gold even among advanced countries and that aggregate gold reserves have risen over the last year.   This is a multiple reserve asset system.

[For those interested in gold and other mineral commodities, I have some relevant writings.  Others’ views on Zoellick are at the New York Times.]

Gold: A Rival for the Dollar

     Robert Zoellick put a few sentences about gold toward the end of a column in today’s FT that are drawing a lot of attention.   I doubt very much if the World Bank President has in mind a return to the gold standard, but goldbugs and critics alike are talking as if he does.
      Even if […]

     Robert Zoellick put a few sentences about gold toward the end of a column in today’s FT that are drawing a lot of attention.   I doubt very much if the World Bank President has in mind a return to the gold standard, but goldbugs and critics alike are talking as if he does.

      Even if one placed overwhelming weight on the objective of price stability — enough weight to contemplate a rigid straightjacket for monetary policy — gold would not be a suitable anchor.   The economy would be hostage to the vagaries of the world gold market, as it was in the 19th century:   suffering inflation during periods of gold discoveries and deflation during periods of gold drought.   This is well-known.   I am confident Zoellick understands it.   (He and I were in the same macroeconomics seminar at Swarthmore College in the 1970s.)

      I think he is making another point.  The world is moving away from a monetary system in which the dollar is the overwhelmingly dominant international reserve asset.  The dollar’s share of international reserves has been declining ever since Richard Nixon unilaterally ended the Bretton Woods system in 1971.   The dollar’s unique role is not an eternal god-given constant of the universe, any more than it was for pound sterling.  The US currency of course replaced the pound in the first half of the 20th century, with a lag of 25 years or more after the US surpassed the UK economically.

      Will some asset replace the dollar, then?  No, not a single asset.  But we are probably moving to a system where there will be as many as a half dozen international reserve assets.  First, there is the euro.  Despite the serious troubles facing it this year, the euro has been a competitor for the dollar since it came into being 11 years ago.  Both the yen and the Swiss franc have to some extent played safe haven roles during the last three years of global financial turmoil.  The pound is not out completely.   Some day the renminbi will be added to the roster of major international currencies, when China’s financial markets are sufficiently developed and open.    Even the SDR (special drawing right) came back from the dead in 2009.

      And, yes, gold too has re-joined the world monetary system.  Gold was seen as an anachronism as recently as a couple of years ago.  The world’s central banks had been gradually selling off their stocks.   But all that changed in 2009.  The People’s Bank of China, the Reserve Bank of India and other central banks in Asia have bought gold.  Understandably, they want to diversify their reserves.    It appears that central banks have stopped selling gold even among advanced countries and that aggregate gold reserves have risen over the last year.   This is a multiple reserve asset system.      

[For those interested in gold and other mineral commodities, I have some relevant writings.  Others’ views on Zoellick are at the New York Times.]

Leadership Need Not Come Only from the G7: The G20 Meeting in Korea

Korea may have an opportunity to exercise historic leadership, when it chairs the G-20 meeting in Seoul, November 11-12.    This will be the first time that a non-G-7 country has hosted the G-20 since the larger, more inclusive, group supplanted the smaller rich-country group in April of last year as the premier steering committee for […]

Korea may have an opportunity to exercise historic leadership, when it chairs the G-20 meeting in Seoul, November 11-12.    This will be the first time that a non-G-7 country has hosted the G-20 since the larger, more inclusive, group supplanted the smaller rich-country group in April of last year as the premier steering committee for the world economy.  With large emerging market and developing countries playing such expanded economic roles, the G-7 had lost legitimacy.  It was high time to make the membership more representative.    But there is also a danger that the G-20 will now prove too unwieldy, in which case decision-making might then revert to the smaller group.

When countries like China and India used to demand a larger voice in world governance based on their large populations, they did not get very far.   Substantive power in multilateral governance is allocated according to the Golden Rule: “He who has the gold rules.”    But after a few decades of miraculous economic growth rates they now have the economic heft.    China is now larger economically than Japan or Germany.   Brazil is also one of the seven largest economies.

Beyond GDP, we have recently seen a historic role reversal, in which debtor-creditor patterns have changed.    Many developing countries, breaking historic patterns, took advantage of the global boom of 2003-2007 to achieve high national saving rates, particularly in the form of strong government budgets, while the advanced countries did not.   As a result, the debt levels of the top 20 rich countries (debt/GDP ratios around 80%) are now twice those of the top 20 emerging markets.   And it is rising rapidly.   A number of emerging market countries now have higher credit ratings than a number of so-called advanced countries.  A stronger fiscal position is one of the reasons that countries like China could afford to undertake large and sustained fiscal stimulus in response to the 2008-09 global recession.   The United States and United Kingdom, by contrast, had wasted the preceding expansion running budget deficits, and hence by 2010 had come to feel heavily constrained by their debts.

It is understandable if Korea views its hosting of the G-20 as another opportunity for marking its arrival on the world stage (as when it hosted the Olympics) or for consolidating its status as an industrialized economy (as when it joined the OECD).  But it should make more of its opportunity than this.  Korea should seize the chance to exercise substantive leadership.   Otherwise, the risk is that its period in the chair could appear like a replay of the chaotic Czech presidency of the EU in the first half of 2009, which confirmed the feelings of some in the larger European countries that it was a mistake to let smaller countries take their turns behind the wheel.

Korea can serve as a bridge between the G-7 and the developing countries.  But chairing a successful meeting will be a challenge, with respect to both meeting management and substantive issues.

With regard to managing the meeting, the challenge comes from the size of the group.   There is always a tradeoff between legitimacy and workability.   The G-7 was small enough to be workable but too small to claim legitimacy.  The United Nations is big enough to claim legitimacy but too big to be workable.  The latest evidence of this was the Conference of Parties of the UN Framework Convention on Climate Change in Copenhagen last December.  The UNFCCC proved a totally ineffectual vehicle, in part because small countries repeatedly blocked progress.    President Obama was able to make more progress by spending a few minutes in a room with a few big emitting countries than the delegates had achieved in two weeks.

The G-20 has enough legitimacy for its purpose — which is more limited than the purposes of formal institutions such as the UN, IMF, and WTO.  It accounts for 85% of the world’s GDP, for example.    But it is too big to be workable as a steering group.  A principle of multilateral talk-shops is that conversation is not possible with more than 10 in the room.  With 20 delegations, each reads prepared statements;  there is no give and take and the communiqué is a watered down least-common-denominator press release.   Not only does the G-20 have more than 10 delegations; it actually has more than 20.

The G-20 needs a smaller informal steering group within the steering group, a G-6 or G-9 within the G-20.   It could meet in the evening before the main G-20 meeting and discuss how to organize the discussion in the larger group.

Who would be in the G-6 or G-9?   It would be unwise to be too specific at this point.  Nevertheless, the US, Japan, and Europe (represented perhaps by the EU Commission), must be there on the rich-country side; China, India, and Brazil must be there on the developing-country side.   Of course the pressure to expand is always irresistible.  Europe could be represented by both the U.K. and euroland.    In Seoul, Korea has to be there as the host. Who would be the 9th country in the G-9?   It should be the country of which the person reading this blog post is a citizen.

What about the substance of the meetings?   The group will discuss whatever the bigger countries consider it most useful to discuss at the time.    Five possible topics include:

  • At long last, giving more seats on the IMF executive board to big emerging market countries, in proportion to their rising economic clout,offset by consolidation of some of Europe’s seats.
  • More financial regulatory reform, such as coordination of any small taxes or penalties that members want to apply to risk-taking banks.
  • Global current account imbalances. Perhaps there will be a statement agreeing that large current account deficits or surpluses tend to lead to problem (absent some good economic justification), that exchange rates and budget deficits both bear some responsibility for current large imbalances, and that the burden of adjustment should be born by neither one alone, but rather by both.
  • Macroeconomic exit strategies. I personally would favor an articulation of the proposition that concrete steps toward long-term fiscal consolidation in each country need not require premature withdrawal of current fiscal stimulus. An example would be to raise the future retirement age or take other steps today to reform public pensions, even while simultaneously enacting some short-term stimulus in the US and UK.
  • Moving toward a new agreement on climate change to take the place of the Kyoto Protocol after 2012. Korea is in a good position to lead, as essentially the first post-Kyoto country to accept emission targets.

Don’t judge the outcome of the meeting by what appears in the media.   Press reviews usually pronounce such summits a let-down.   But occasionally such meetings are important, in ways that are often not clear until later.

Consider the London G-20 meeting of April 2009.    It was not obvious at the time that it had been a success in terms of substantive policies.   Observers even compared it to the infamous failed London Economic Summit of 1933, which was a way of saying that the world had not learned the lessons of the Great Depression.    But the 2009 meeting appears far better in hindsight.  Looking back on 2009, fiscal stimulus turned out to be more widespread in 2009 than one might have guessed.    Similarly, global monetary policy was easy, avoiding another big mistake of the 1930s.  The G-20 unexpectedly agreed to triple IMF resources and bring the SDR back from the dead.  Even in the area of trade policy, despite fears of protectionism, the outcome was not bad at all by the standards of past recessions, let alone in comparison with the Smoot-Hawley tariff of 1930.   Overall, policy-makers’ immediate response to the global recession in 2009 did not repeat the mistakes of the early 1930s.

Currently, however, the advanced countries are in danger of repeating the mistake that President Franklin Roosevelt made in 1937, when he cut spending prematurely and sent the US economy back into recession.  Perhaps the G-20 will be a venue in which the big emerging market countries can remind the U.S. and the U.K. of the lesson they once knew but have now forgotten — what it means to run a countercyclical fiscal policy.

[This column was written for Project Syndicate. Comments can be posted there.]