International monetary economics is a big turn-off for many readers. There are hardly any articles on the subject in the press (it doesn’t sell newspapers, most finance journalists don’t understand it well enough to write about it authoritatively and it mostly concerns gradually shifting imbalances rather than newsworthy events). The few articles that do appear are mostly unhelpful in aiding understanding if not downright misleading (including pretty much any article with the word ‘China’ in it). Lack of understanding is in part due to the alien nature of the subject and its dependence on decades of history, as imbalances have developed gradually. There are also plenty who would rather not ponder the unpleasant conclusions which come from thinking about the subject. And there are no doubt some who would prefer to keep the public eye focussed elsewhere.
Yet monetary imbalances, and specifically (a) arguments over historical debts between nations and (b) the mechanisms for recycling surpluses, are important elements for understanding some of the biggest historical events of the last century. These include political repercussions from the 1919 Treaty of Versailles, the growth of fascism, the Second World War, Bretton Woods in 1944, the 1971 Nixon shock (when the dollar convertibility to its anchor, gold, was removed), the post-1971 search for a European monetary anchor and, also during the 1970s, the recycling of petro-dollars which led to Latin American debt crises. More recent milestones of international monetary economics include the evolution of the Franco-German relationship which created the Euro and the ECB, the post-1998 surge of Asian savings propping up the Dollar, the asset and credit bubbles leading to the financial crisis of 2008 and the mess which is European monetary policy ever since.
These events are linked in a chain, prompting and being influenced by political decisions – by governments but also by central banks, most notably by Volcker’s Federal Reserve and by the Bundesbank. The US “exorbitant privilege” (as Valery Giscard d’Estaing called it) was a deliberate design flaw imposed by a strong US at Bretton Woods in 1944. Keynes’ alternative plan would have promoted self-correction of imbalances, but at a short-term cost to the US, the pre-eminent surplus country at the time. Whereas Keynes’ suggested system would incentivise surplus countries to adjust and reduce surpluses, the lack of any such discipline has created a system prone to build-up of excessive surpluses – and consequent deficits, remembering that for every surplus there is somewhere an equal and opposite deficit. The result has been a series of crises. In 1971 the initial disruption was followed by an inflation free-for-all which eroded much of the historical debts, but did not solve the basic structural problem that surplus countries have little incentive to stop generating surpluses, and thus future crises.
Whether the global disruption which Paul Volker caused when he raised US interest rates precipitously in the early 1980s was deliberate (as Yanis Varoufakis, with some evidence, claims in his excellent book “And The Weak Suffer What They Must”) or merely consequential, it had the result of transforming the US twin deficit phenomenon into a mechanism to suck in savings from the rest of the world, spreading recession globally not just in the US. A consequence was a change of heart in Berlin in favour of France’s dangerous proposal for monetary union – as a mechanism to suck in European savings just as the US was sucking in global (including German) savings.
France mistakenly thought they could control the institutions at the heart of the new European Union in this Faustian exchange with Germany’s hard money, but whatever might have been, this long-term gamble has now completely failed. Until and unless there is a recognition by Germany that their surpluses are the flip side of everybody else’s pain in the Eurozone, the risk of a spectacular break-up continues to grow. With it also grows disillusion with the anti-democratic policy-formation and governance structures at the heart of the European Union. And so, ironically, the dream of a united Europe is being eroded by the premature birth of its illegitimate common currency.
Can the US not pull it off again though? Through brash assertiveness of its own creditworthiness and fiscal splurging, can the US again create enough aggregate demand (and deficits) to boost other countries’ exports? The problem is that we have seen years of this already – but without Volcker’s high interest rates to tempt international capital and with already stretched asset valuations and QE-enhanced bubbles everywhere. Plus, for all the rhetoric, is a resurgence of US growth really a credible scenario right now?
Varoufakis argues that for a US-led global recovery to have any chance, Germany, a country which has benefitted from huge debt forgiveness in the past, should also participate in adjusting its surpluses. Without this, US efforts are doomed to failure. My own view is that the bubble cannot last even if Germany suddenly became more constructive in boosting aggregate demand abroad. A more understanding German approach could extend the model a few more years, but the best chance of avoiding another major blow-up is through the creation of massive additional aggregate demand in the emerging markets, but that would involve overcoming another whole heap of prejudices….
By Jerome Booth