Dollarize Argentina - Barokong

August 23, 2020    Comment   

Dollarize Argentina - Barokong

Argentina should dollarize, says Mary Anastasia O'Grady in the Wall Street Journal -- not a peg, not a currency board, not an IMF plan, just give up and use dollars.

Another currency crisis is roiling Argentina... The peso has lost half its value against the U.S. dollar since January. Inflation expectations are soaring.

The central bank has boosted its overnight lending rate to an annual 60% to try to stop capital flight. But Argentines are bracing for spiraling prices and recession.

...the troubles have been brewing for some time. On a trip to Buenos Aires in February, I got an earful from worried economists who said Mr. Macri was moving too slowly to reconcile fiscal accounts.

In 2016 and 2017 the government continued spending beyond its means and borrowing dollars in the international capital markets to finance the shortfall. That put pressure on the central bank to print money so as not to starve the economy of low-priced credit ahead of midterm elections in 2017....

A sharp selloff of the peso in May was followed by a new $50 billion standby loan from the International Monetary Fund in June. With a monetary base that is up over 30% since last year, in a nation that knows something about IMF intervention, that was like waving a red cape in front of a bull.

The peso was thus vulnerable when currency speculators launched an attack on the Turkish lira last month and the flight to the dollar spilled over into other emerging markets, including Argentina. After decades of repeated currency crises, Argentines can smell monetary mischief. A peso rout ensued.

Conventional Wisdom these days -- the standard view around the Fed, IMF, OECD, BIS, ECB, and at NBER conferences -- says that countries need their own currencies, so they can quickly devalue to address negative "shocks." For example, conventional wisdom says that Greece would have been far better off with its own currency to devalue rather than as part of the euro. I have long been skeptical.

It's not working out so great for Argentina. As Mary points out, short term financing means there can be "speculative attacks" on the currencies of highly indebted countries that run their own currencies, just as there can be runs on banks. And Conventional Wisdom, silent on this issue advocating a Greek return to Drachma, was full in that the Asian crises of the late 1990s were due to "sudden stops," and such speculative machinations of international "hot money."

Well, says CW, including the IMF's "institutional view," that means countries need "capital flow management," i.e. governments need to control who can buy and sell their currency and and who can buy or sell assets internationally.  Yet Venezuela and Iran are crashing too, and not for lack of capital flow "management." My understanding is Argentina does not allow free capital either. Moreover, if there is a chance you can't take your money out, you don't put it in in the first place. There is a reason the post Bretton Woods international consensus drove out capital restrictions.

So I agree with Mary -- dollarize. Just get it over with. What possible benefit is Argentina getting from clever central bank currency manipulation, if you want a dark word, or management, if you want a good one? Use the meter and the kilogram too.

There is a catch, however, not fully explicit in Mary's article. The underlying problem is fiscal, not monetary. To repeat,

"Mr. Macri was moving too slowly to reconcile fiscal accounts. ...In 2016 and 2017 the government continued spending beyond its means and borrowing dollars in the international capital markets to finance the shortfall."

So, I think it's a bit unfair for Mary to complain that Argentina's problem is that it "has a central bank." I don't know what any central banker could do, given the fiscal problems, to stop the currency from crashing.

If the government dollarizes, it can no longer inflate or devalue to get out of fiscal trouble. Argentina has pretty much already lost that option anyway. If the government borrows Pesos, inflating or devaluing eliminates that debt. But if the government borrows in dollars, a devaluation or inflation taxes a much smaller base of peso holders to try to pay back the dollar debt.

Still, a dollarized government must either pay back its bills or default. That's how the Euro was supposed to work too, until Europe's leaders, seeing how much Greek debt was stuffed into French and German banks, burned the rule book.

So the underlying problem is fiscal. With abundant fiscal resources, the government could have borrowed abroad to stop a run on the Peso. And without those resources, dollarization will not solve its debt and deficit problem. Dollarization will force the government to shape up fast, which may be Mary's point.

Dollarization will insulate the private economy from government fiscal troubles. This is a great, perhaps the greatest, point in its favor. Even if the government defaults, companies in a fully dollarized, free capital flow economy, can shrug it off and go about their business. Forced to use pesos, subject to sharp inflation, devaluation, capital and trade restrictions, the government's problems infect the rest of the economy.

Last, CW likes devaluation and inflation because it supposedly "stimulates" the economy through its troubles surrounding a crisis. That strikes me as giving a cancer patient an espresso. Argentina is getting both inflation and recession, not a stimulative boom out of its inflation.

Dollarization is not a currency board, which Argentina also tried and failed. A currency board is a promise to keep the peso equal to the dollar, and to keep enough dollars around to back the pesos. Alas, it does not keep dollars around to back all the governments' debts, so the government soon enough will see the kitty of dollars and grab them, abrogating the currency board. Dollarization means the economy uses dollars, period, and there is no pool of assets sitting there to be grabbed.

Europe's Banks - Barokong

August 20, 2020    Comment   

Europe's Banks - Barokong

My visit to Europe resulted in many interesting conversations. There was a stark contrast between the complex regulatory vision of formal presentations and papers, and the lunch and coffee discussion reflecting experience of people involved in actually regulating banks. They seemed to be quite frustrated by the state of things. Disclaimer: this is all completely unverified gossip, and remembered through a fog of jet lag. If commenters have better facts, I'm hungry to hear them.

Risk weights are ungodly complex, and not many people actually understand them, or the layers of buffers and how they are applied.

Risk weights are suspiciously low. Big banks are allowed to use their own models, calibrated on 10 years of data. That means the data have, now, 10 years of stable growth and very low default. Look, say the banks, our investments are nearly risk free.

"Micro" regulators who look at the specifics of an individual bank are prone to offset the "systemic" and "macro-prudential" efforts. Look, say the banks, we have to fulfill all these macro-prudential rules, give us a break. Regulators do.

The financial regulatory community has been preoccupied with writing reports about one thing after another. Meanwhile, the elephant remains in the room:  Italy may default or leave the euro.

Italian banks remain stuffed with Italian government bonds. I learned some new words for this: a "doom loop." If the government defaults, the banks go with it.  Some smaller foreign banks still have large investments in Italian bonds. Another new word: "Moral suasion," governments encouraging banks to buy a lot of their bonds.  I imagine the Godfather had more colorful words for it. On the other hand, Italian banks are reportedly happy for the moment, since as long as Italy doesn't actually default, they make a bundle from high interest rates. Government debt is still treated with low or no risk weights.

In case it isn't obvious here's the problem. A sovereign default is bad enough. But if the banks are stuffed with government debt, then a sovereign default brings down the banking system. Depositors lose their shirts, and the banks, who know how to distinguish good from bad borrowers, are shut down. A calamity becomes a catastrophe. And an economy with failing banks will be bringing in a lot less tax revenue and more likely to default.  Government debt in a currency union without banking union is a singularly bad investment, because as currently construed governments give deposit insurance (explicit or implicit).

All this is obvious to anyone looking at it, and leads to a big sigh about "political pressure." 10 years on, and Europe can't quite bring itself to say that sovereign debts are risky. Understandably. This is a club of equals, and it's awfully hard to say that some debts are better than others.

But this elephant has been careening around the room for 10 years. There was a Greek crisis which should have gotten some attention!

Some want a full banking union, breaking local bank regulation and allowing large transnational  banks to operate fully, breaking the doom loop. Some want full fiscal union to go with monetary union. The current model, pressure from the rest of Europe for governments not to borrow so much, and thus to never face a potential sovereign default, has clearly failed.

In my view, monetary union without fiscal union works fine, so long as we all understand that governments can default, and their debt should be treated just as risky (and sometimes junk) corporate debt on bank balance sheets. And, of course, if capital requirements were doubled, tripled, or more, so that banks could sail through a sovereign default, the problem would solve itself.

It occurs to me that simply removing risky local government debt from banks would go a long way to solving the problem. Defaultable government debt should be held via floating-NAV mutual funds, not via bank accounts.

Additionally, there is a big kerfuffle going on that Italy's central bank owes Germany's a lot of money.   Italians see this coming, and there is a lot of capital flight out of Italy. When an Italian writes a check from an Italian bank to buy an apartment in Germany, the money flows from Italian bank to Italian central bank, to German central bank, to German bank. Except the Italian central bank essentially makes a promise to pay rather than actually paying. Italy is basically expanding government debt in this way. I don't totally understand it, nor did most people I talked to about it, and there is a wide disagreement whether this is another debt or just an accounting glitch. Still, that most people at a financial regulation conference know this is a big problem and nobody is quite sure what it means is telling.

With this background of lunchtime and coffee conversations, the written products of the financial regulation community have a surreal quality. The illusion of technocratic competence is always present in bank regulation discussions, but even more stark with this backdrop.

Look for example at the website of theFinanical Stability Board and the issues it thinks are important. As one example, the summary of FSB priorities for the Argentine G20 Presidency. It starts well enough, "Vigilant monitoring to identify, assess and address new and emerging risks." But what's the number one such risk? You would think, in honor of the Argentine presidency, with Italy the number one topic of conversation at lunch, and with who knows who owes who what in China, it would be "sovereign risk." Nope. Crypto-assets is number 1: "The FSB will identify metrics for enhanced monitoring of the financial stability risks posed by crypto-assets and update the G20 as appropriate." Then,

Disciplined completion of the G20’s outstanding financial reform priorities....During the course of the year the deliverables to the G20 will include the following areas: the correspondent banking Action Plan including improving the access of remittance providers to banking services; a toolkit for firms and supervisors on the use governance frameworks to reduce misconduct in the financial sector; leverage measures for investment funds to support resilient market-based finance; guidance on financial resources available to support central counterparty (CCP) resolution to deliver resilient and resolvable CCPs; a cyber security lexicon to support consistency in the work of the FSB, standard-setting bodies, authorities and private sector participants; and the private sector-led Task Force on Climate-related Financial Disclosures’ report on voluntary implementation of its recommendations to highlight good practice and foster wider adoption.

Sovereign risk is not mentioned once in this document. And I did not find it anywhere on the FSB website.

If you read between the lines, there is a very worthy reaction to this tendency to produce complex hot air that changes with each presidency:

Pivoting to policy evaluation to ensure the reform programme is efficient, coherent and effective. The FSB is increasingly pivoting away from design of new policy initiatives towards dynamic implementation and rigorous evaluation of the effects of the agreed G20 reforms.

Brexit or Fixit - Barokong

August 18, 2020    Comment   

Brexit or Fixit - Barokong

Many commenters compare Brexit to the American revolution. I think the constitutional convention is a better analogy for the moment and challenge ahead. A first attempt at union resulted in an unworkable Federal structure. Europe needs a constitutional convention to fix its union.

The EU's first attempt was basically aristocratic/technocratic. Brussels tells the peasants what to do. The EU  needs a hardy dose of accountability, representation, checks and balances -- all the beautiful structures of the US Constitution. What little thought the EU put in to these matters is clearly wanting.

America did not wait for a state to leave. But, though even the Pope admits the EU structure wasn't working, the EU needed this wake up call. Bring the UK to the convention, and bring them back. Fixit. (#Fixit?)

Out of control economic regulation, labor laws, mandated social programs and "60% of British laws are made in Brussels" (I don't know the source of the widely quoted number, but the sentiment is as important as the fact)  are the most sensible arguments I heard for Brexit.

Fraser Nelson's WSJ essay expressed this well

The Brexit campaign started as a cry for liberty, perhaps articulated most clearly by Michael Gove, the British justice secretary... Mr. Gove offered practical examples of the problems of EU membership. As a minister, he said, he deals constantly with edicts and regulations framed at the European level—rules that he doesn’t want and can’t change. These were rules that no one in Britain asked for, rules promulgated by officials whose names Brits don’t know, people whom they never elected and cannot remove from office. Yet they become the law of the land. Much of what we think of as British democracy, Mr. Gove argued, is now no such thing.

The important point, I think, is not the outcome -- too much silly regulation, labor laws, and so on. Theprocess is the important point.

America is, in my opinion, also a victim of stifling economic regulation, job-killing labor laws, incentive-destroying social programs. But, we still have a process in place -- in trouble, creaky, under attack by results-at-any-cost progressivisim.  But we have a process. Regulations are supposed to be authorized by Congress; should follow the Administrative Procedures act, with public comment, cost benefit analysis, and so forth; can be challenged administratively and then in court; and Congress itself can pass laws over-ruling regulators (which the President can veto, as he has).  Europe is missing this process; and european law is even worse than economic regulation here.

Last week's immigration ruling is an example of the same forces under strain in the US. I happen to agree with the Administration on policy grounds: People who have been here their whole lives, parents of US citizen children, should not face the constant risk of deportation, and should be allowed to work legally. (I had no idea there was such a thing as a "work permit" in the US, until President Obama mentioned it.) But, Congress passed silly laws mandating the opposite, and the Administration moved beyond its authority. When States are suing the Administration in the Supreme Court over its actions, we are in danger of Texit. But at least Texas can sue. Britain had no similar way to object to EU edicts.

Process matters, because democracy needs to form consensus and acceptance. When you force things down people's throats, they eventually gag.

Again quoting WSJ

Instead of grumbling about the things we can’t change, Mr. Gove said, it was time to follow “the Americans who declared their independence and never looked back” and “become an exemplar of what an inclusive, open and innovative democracy can achieve.” Many of the Brexiteers think that Britain voted this week to follow a template set in 1776 on the other side of the Atlantic.

The answer for Europe is that it must allow people the optionto change things they don't like. And 1787, not 1776 is the inspiration.

On economics, I think it's overblown.

Will this be a disaster for the British economy? Probably not. Norway, Switzerland, and Japan seem to get along.  If the UK decided to be a free economy free trade and open banking center, it could do wonders.

It is nice to see a consensus (though sometimes implicit) on the advantages of free trade. Leave did not argue for the importance of preserving British jobs with trade restrictions.  Alas, "free trade" now means "access to markets" or managed mercantilism.

The benefits of a continent-wide open labor market are easy to see in my business. As I visit universities around Europe, the typical smart young professor might come from Slovakia, have done an undergraduate degree in Spain, Masters' in the UK, PhD in Italy, is working in Sweden, with spouse working in London. The result is a resurgence of European universities, now dramatically better than they were two decades ago. The irony of Brexit is that English is the common language of Europe, making this integration possible.

So why are markets going so wild? I think political follow-on is very unstable. If Brexit leads to Britain becoming Norway it's not a big deal. If the UK breaks up, and the EU breaks up, we have big trouble ahead. Fixit instead.

Negative rates and inflation - Barokong

August 11, 2020    Comment   

Negative rates and inflation - Barokong

Have negative interest rates boosted inflation? Here is a nice graph (source macro-man blog, HT FT alphaville)

Source: Macro-man blog

Not really. Explanations? Choose the chicken or the egg:

1) But for negative rates, inflation would have been even lower

2) We're living in a Fisher effect world. Lower rates lower inflation. (Which is arguably a good, if unintended, thing)

Long Run Lira? - Barokong

July 23, 2020    Comment   

Long Run Lira? - Barokong

Luigi Zingales inaugurated a series of essays in Il Sole 24 Ore, an Italian newspaper, on whether Italy should stay in or get out of the Euro, and graciously asked me to contribute. My view, here in English, here in Italian.

To be clear, I kept to Luigi's terms of the debate. This piece is only about whether Italy is better off in the long run, with a common currency. Whether it gets anything out of an exit, a devaluation, a default now is for another day. And this is just about currency, not about leaving the EU, not about debt or austerity, not about whether europe needs a fiscal union, or the rest of it. (Some subsequent correspondence verifies the wisdom, but also the difficulty, of talking about one thing at a time.)

Return to the Lira? A long-run view (Not very good English title)

The euro isn't perfect, but it isn't bad. (Much better Italian title)

Should Italy have her own currency, and run her own monetary policy? For today, let's focus on the long-run question, leaving out for now the transition and any immediate benefits and costs. When contemplating a divorce, it is wise to focus on what life will be like when everything is settled, not just who will have to wash today's stack of dirty dishes.

Remember first that monetary policy cannot substantially improve long-run growth. Long-run growth comes from people and productivity, how much each person can produce per hour of work. In turn, productivity comes from innovation, new companies, new ways doing business, and new products. Like Uber, consumers benefit and existing producers are disrupted. Improvements in long-run growth come only from structural reform, not monetary machination. Money is like oil in a car. Bad monetary policy, like too little oil, can drag an economy down. But after a point more oil will not help you to go faster — you need a bigger engine.

In the short run, monetary policy can also “stimulate” an economy. It's like an afternoon espresso — good when you're feeling a little sluggish, but not wise to drink all the time, and in the end no substitute for diet and exercise. And that is the major advantage offered for an independent currency and monetary policy — the possibility that a wise monetary authority can offset bad shocks with occasional bursts of devaluation and inflation.

But “wise” is a major caution. When the central bank lowers interest rates, inflates, or devalues, that helps exporters, but hurts importers; it helps government finances, but lowers the real amount the government pays its workers, pensioners, and bond-holders; it helps borrowers but hurts those who lent money to the government, homes and businesses.

Once hurt, they wise up. Anticipating the next devaluation and inflation, workers and pensioners demand indexed wages and pensions. Bond investors demand higher interest rates.

So having your own currency really only works for a government whose finances are in sound shape, and whose public institutions are strong enough to resist the constant clamor for one more inflation. Just this once. Again and again.

Staying in the euro thus represents an important pre-commitment. By forswearing the ability to easily devalue and inflate ex-post, Italy benefits from much better credit and investment ex-ante. It is up to her to use this credit wisely, as Greece so notably did not.

Devaluing and inflating is said to work because prices and wages are “sticky,” and do not quickly adapt to inflation. Thus people are fooled into working harder than they would otherwise, or into accepting wage and price declines they would refuse if they could see them directly. But, if used often, they too will wake up and stickiness vanishes.

Furthermore, devaluation and inflation to exploit such stickiness can address an overall level of wages or prices that is too high, but it cannot address an industry or a region that is too high while another is too low. And variation across industries and regions is larger than variation across countries. If stickiness is the problem, it would be much better to remove all the policies that encourage sticky prices and wages in the first place. For Italy in particular, the arguments for one currency are really arguments for two currencies, one for the North and one for the South.

If that sounds unappealing, perhaps one currency is unappealing too.

Italy will face tight limits on what it can accomplish with wise monetary policy. Let us hope that having its own currency means Italy still somehow remains a member of the European Union, or at least its somewhat free-trade and free-investment area, like Denmark, Norway, or pre-Brexit UK. Let us hope that Italians can still buy and sell goods freely across Europe, they can conduct their business in euro or lira, own bank accounts in both currencies, freely buy and sell securities, work in Europe and hire whom they please.

Do not take all of this for granted. The first thing many governments do, faced with weak currencies and government debt problems, or noticing their monetary stimulus efforts have little effect, is to force their citizens to use that weak currency, to ban foreign bank accounts, to limit citizens' rights to buy and sell euros or to borrow or invest abroad. They limit foreign banks, in order to prop up domestic banks who must hold domestic currency and debt. They limit the interest citizens get at banks, and allocate bank credit.

All this passes under bureaucratic bromides like “capital controls.” Economists call it “financial repression,” which gives a better sense of its effect. This is the kind of monetary policy that, like removing oil from a car, really can slow it down. And it is not clear that Italy even can leave the euro without leaving the EU.

If Italy remains open, as she must to grow, monetary policy will always be constrained by the exchange rate and competition from the euro. Too much loosening will cut the exchange rate too much, and vice versa. Wild exchange rate fluctuations are bad for business and investment all around. Italians will just use euros instead, undermining the value of a domestic currency, leading to capital controls. Even Iceland is now thinking it should peg to the euro. Switzerland and to a lesser extent Denmark are fighting hard to keep their currencies from rising.

So will Italy be better off in the long-run, back with her old sweetheart, the Lira? A well-managed currency within an economy open to trade, capital, and people, can have some benefits. The experience of pre-Brexit UK, Denmark, Switzerland, Norway, or Sweden offers small advantages, some challenges, and no particular disasters so far. The experience of pre-euro Italy is less encouraging, that of pre-euro Greece less so, and that of many small countries challenged by debt and growth less so still. Round after round of inflation and devaluation did not produce prosperity, and capital and exchange controls hurt growth substantially.

In the end, no monetary machination can substitute for a dynamic real economy. The Euro, while not perfect, is pretty good, and it offers an important pre-commitment against bad policy. The dangers and temptations of a Lira do not, in my view, compensate for the loss of an occasional afternoon espresso of stimulus.

Douthat and Feldstein on Euro - Barokong

July 22, 2020    Comment   

Douthat and Feldstein on Euro - Barokong

In case you missed it, this Sunday featured a creditable effort by the NY Times to look out of the groundhog hole. You have likely followed the explosion resulting fromBret Stephens' first column. Likewise,Ross Douthat tried to explain the attraction of Marine LePen.  I'm not a LePen fan, but appreciated his honest effort to explain how the other side say things.

I was interested in Douthat's views on the euro:

But on the other hand, our era’s “enlightened” governance has produced an out-of-touch eurozone elite lashed to a destructive common currency,..

There is no American equivalent to the epic disaster of the euro, a form of German imperialism with the struggling parts of Europe as its subjects...

And while many of her economic prescriptions are half-baked, her overarching critique of the euro is correct: Her country and her continent would be better off without it.

Douthat does not pretend to be an economist, and I have no beef with his expressing such views. Because such views are commonplace conventional wisdom from our policy elite. And if the euro falls apart, they will bear a lot of blame for its passing. Be careful what you write, people might be listening.  No, when Germany sends Porsches to Greece in return for worthless pieces of paper, it is not Germany who got the better of the deal. And while you're at it, get rid of that silly common meter, and restore proper nationalism of weights and measures too. (Of course perhaps my admiration for the euro is wrong. Then they will deserve credit for the wave of prosperity that flows over Europe once it unleashes the shackles of the common currency dragging it down. )

As a concrete example, consider  Martin Feldstein writing in the Il Sole series on the Euro, (I don't mean to pick on Feldstein. He has been a consistent anti-euro voice, arguing the great benefits for Italy and Greece of periodic inflation and devaluation. But he is just a good sober example of the common view in Cambridge-centered economic policy circles.)

Topic sentences:

Although Italy was an enthusiastic adopter of the euro when the single currency began, the Italian experience of the past decade suggests that was a mistake.

...it seems plausible that Italy’s economy would be in better condition today if Italy, like Britain, had decided to keep its own currency and therefore to be able to manage its own monetary policy and its own exchange rate.

Analysis:

Advocates of adopting the euro argued at the time that members of the Eurozone would be forced by market pressures to converge to a high common level of productivity and a corresponding level of real wages. That never happened. Instead, Germany powered ahead with rising productivity that has resulted in real per capita income 30% higher than Italy’s, an unemployment rate that is less than half Italy's and a trade surplus that is 8 % of its GDP.

Huh? It is a new proposition in monetary economics to me that adopting a common currency forces countries to move to common productivity, any more than adopting the meter forces countries to do so.  Alabama and California share a currency and not productivity. Fresno and Palo Alto share a currency and not productivity.   A common market in products with free movement of capital and labor might force out economic, legal, and regulatory inefficiency, but that would happen regardless of the units of measurement.

The most basic proposition in monetary economics: The choice of monetary unit has no effect on long-run productivity or any other aspect of the long-run real economy. Using the euro vs. the lira has no effect on long-run productivity, any more than using the meter forces Italian tailors to cut Norwegian-sized suits, or that using the Kilo forces Italian restaurants to serve bratwurst and beer rather than pizza and wine.

The countries that adopted the euro never satisfied the three conditions for a successful currency union: labor mobility, flexibility of real wages, and a common fiscal policy that transfers funds to areas that experience temporary increases in unemployment.

This is another repeated truism. In my view the main condition for a currency union was present in the euro and the problem was forgetting about it when the time came. In a currency union without fiscal union, bankrupt governments default just like bankrupt companies. Neither labor mobility (which exists in Europe), flexibility of real wages (doubtful in the US) or common fiscal policy (also limited in the US) are necessary. Europe lived under a common currency -- the gold standard -- for hundreds of years. Sovereigns defaulted.

I suspect Feldstein means by "common currency" far more than I do. I mean, we agree to use a common currency. I suspect Feldstein means far more than that, including that no government debt may ever default and that the ECB must print money to ensure that fact. Like all disagreements perhaps this one simply reflects a difference in meaning of the words. If so, it would be good to say so. Objections to "the euro" are not objections to a common currency per se, but objections to the rest of the legal, regulatory, banking, fiscal, and policy framework that accompanies the euro.

To be fair, there is also a different underlying world view here. In Feldstein's world, national governments and central banks can be relied on to diagnose "shocks," and artfully devalue currencies just enough to "offset shocks" when and only when needed; in the european case likely imposing "capital controls" as well, but to do this rarely enough that investors will still buy government bonds, invest in their countries, and avoid the slide to banana republic inflation, repression, and trade and investment closure. In my world, as I think in the real world of Italy and Greece before the euro, national currencies are not such a happy tool of benevolent dirigisme. The commitment not to devalue, inflate, and grab capital after the fact is good for growth and investment before the fact. A government sober enough to use Feldstein's tools wisely is also sober enough to borrow wisely when offered low rates. A government not sober enough to borrow wisely when offered low rates is not sober enough to artfully devalue, inflate, grab capital "just this once" in response to shocks.

Long run money - Barokong

July 20, 2020    Comment   

Long run money - Barokong

Continuing in the Il Sole series on Italy and the Euro, Alberto Bagnai writes that the euro is a "big defeat for the economics profession'' here in English, here in Italian.  He takes particular issue with my earlier case for a common currency, here in English, in Italian, andblog post.

"John Cochrane’s idea that money is irrelevant for growth (economists say that money is “neutral”) not only clashes with major scientific results, such as Dani Rodrik’s analysis of the role of excessively strong exchange rates in slowing the growth of a country, but also with what the European institutions are finally admitting through clenched teeth: the reforms are causing deflation and failing to promote employment in any decisive way (footnote 23 in the above-mentioned ECB Economic bulletin).

The best economists had also addressed this point: the negative consequences of structural reforms on the productivity of labour were illustrated by Robert Gordon in 2008. For Cochrane, money is like oil in a motor. The metaphor is (unwittingly) correct. Bad management of oil has long-period consequences like bad management of currency: in the first case the head fuses and the motor stops; in the second a continent, and the world economy stops.

If De Grauwe is incoherent with data and Cochrane with theories,..."

I have long been accused of being theoretically pure but incoherent about the "real world." (As if the real world could ever conform to no theory, rather than a better theory). This is the first time I, or the proposition of long-run monetary neutrality, have been accused of theoretical incoherence.

First let's be clear what we're talking about. My article was clearly about long-run growth. And I wittingly made the oil comparison -- and also said that bad monetary policy, like not enough oil, can drag an economy down.

"For today, let's focus on the long-run question, leaving out for now the transition and any immediate benefits and costs...

Remember first that monetary policy cannot substantially improve long-run growth. Long-run growth comes from people and productivity, how much each person can produce per hour of work.... Improvements in long-run growth come only from structural reform, not monetary machination.

Money is like oil in a car. Bad monetary policy, like too little oil, can drag an economy down. But after a point more oil will not help you to go faster — you need a bigger engine."

We shouldn't be arguing about things I didn't say!

But to the substantive point.  How about "the idea that money is irrelevant for growth (economists say that money is “neutral”) not only clashes with major scientific results, such as Dani Rodrik’s analysis of the role of excessively strong exchange rates in slowing the growth of a country"

The clearly stated proposition is that money is irrelevant for long-run growth. Italy's postwar miracolo economicowas not the result of a finely calibrated monetary policy under the Lira. The fact that Italians today are so much better off than their ancestors in 1917, 1817, or, heck, 1217, is just not centrally about better monetary policy under the Lira than under gold coins.

Rodrik? Sure. Out of whack anything can cause trouble for a while. A stack of dishes in the kitchen causes a spat. That's not a reason to divorce.

Structural reforms not working? What structural reforms? In my view, they haven't started. Call me when you can hire and fire people, government spending is under 50% of GDP, marginal tax rates are less than half, rent control is gone, it takes less than a decade to get a building permit, or when the World Bank ease of doing business ranking doesn't look like this

Update: Alberto Mingardi graciously came to my defense in the arguments following this post. Yes, I got rent control wrong (it was a big problem the last time I lived in Italy, but this tells you how long ago that was.) Alberto points out that it's still hard to evict people, as it is in the US. And he goes over a number of detailed sands in the Italian gears.

Institutionalized nonsense - Barokong

June 18, 2020    Comment   

Institutionalized nonsense - Barokong

When, last week, the Treasury issued its currency manipulation report, I thought it was a joke. Treasury put Germany and Italy on its "monitoring list" of countries suspected of "currency manipulation."

Germany and Italy are, of course, part of the Euro, the whole point of which is that they cannot, individually, "manipulate" their currencies, whatever that means. It is precisely this inability to devalue -- to "manipulate" the Drachma to regain "competitiveness" (another meaningless term) -- that conventional wisdom bemoaned of Greece.

I had a little chuckle, envisioning some frustrated mid-level Treasury economist bemoaning the trade and currency idiocy floating around Washington, putting this little message in a bottle to see if anyone noticed the reductio ad absurdum.  If so, hello there, somebody noticed.

But then  read the report.

It is shocking. It's supposed to be about "currency manipulation." The statutory mandate is clear (p. 3):

Under Section 3004 of the 1988 Act, the Secretary must: “consider whether countries manipulate the rate of exchange between their currency and the United States dollar for purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade.”

Whatever "unfair competitive advantage" means -- remember, trade is trade, not a basketball game, and only is done if it benefits both parties -- this sounds pretty clear: it's about currencies. If you don't have a currency, you can't manipulate it. The additional statutory guidance quoted on p. 3 also all ends with "currency."

This minor technicality will no longer constrain our Treasury, in its desire to dictate trade. In big bold letters on p. 2

"Starting with this Report, Treasury will review and assess developments in a larger number of trading partners in order to monitor for external imbalances and one-sided intervention."

(Just what is a "two-sided intervention?" Exchange rates that go both up and down?) More specifically,

Beginning with this Report, Treasury will assess all U.S. trading partners whose bilateral goods trade with the United States exceeds $40 billion annually.

(My emphasis.)

Bilateral trade "deficits" are meaningless. China sends us shoes, Australia sends China coal, the US sends Australia airplanes. Pieces of paper flow the other way. We all come out ahead despite three bilateral "deficits." (In quotes as this is a horrible word too, implying something is deficient every time you go to the Starbucks and suffer a coffee trade "deficit." )

Bilateralgoods deficits are even more meaningless. Italians send us prosciutto (goods), we send them software (services), and this is somehow a problem reflecting "currency manipulation?"

Italy's sins, meriting "monitoring:"

Italy recorded a current account surplus of 2.5 percent of GDP in 2018, while its goods trade surplus with the United States rose to $32 billion.

Aha, Italy, that dynamic powerhouse, is growing exponentially, at the expense of all those unemployed pasta makers in Appalachia, because it somehow devalued its corner of the Euro?*

Italy should be running big trade surpluses. That is the only way it will pay down its vast foreign debt. If Italy were running tradedeficits we should worry.

Here is the whole table of "criteria."

And thus we get to the madness that a country without its own currency can be accused of its manipulation.

The only possible conclusion: Treasury now wants to jawbone countries into directly controlling bilateral trade in goods.

My  secretly sane economist at Treasury did, then, sneak in a pretty good description of Italy's problems:

Italy’s competitiveness continues to suffer from stagnant productivity and rising labor costs. The country needs to undertake fundamental structural reforms to raise long-term growth – consistent with reducing high unemployment and public debt – and safeguard fiscal and external sustainability.

Yes. But "fiscal and external sustainability" is not about recycling your Gucci bags. It means running trade surpluses with which to pay down debts! This report now flatly contradicts itself.  Then, in case you need banging over the head about how there cannot be a whiff of manipulation here,

The ECB has not intervened unilaterally in foreign currency markets since 2001,

a phrase repeated poetically regarding the other suspect countries, Ireland and Germany.

I called this post "institutionalized nonsense." Yes, every president brings to his (or, someday, her) Administration some nutty ideas, some campaign rhetoric that does not correspond to cause-and-effect reality. Sensible cabinet secretaries and career staff must indulge the rhetoric.

But by this document the Treasury is institutionalizing nuttiness -- setting up rules and procedures that monitor bilateral goods "deflcits,"  and waste our Nation's vanishing prestige haranguing countries about their "macroeconomic policies" that produce such undefined and ill-measured ephemera. Why listen to us on, say Iran sanctions or Tiananmen square if we are going to indulge in this sort of nuttiness?

Meanwhile, the administration continues to badger the Fed to lower interest rates in order to... well, to manipulate our currency!

*Note to the humorless: I don't mean to disparage Italy, actually the home of excellent small manufacturers. Also, if Italy does introduce MiniBots, or go off the Euro then the fun might really begin. But the Treasury report is not about this. Next post.

Update: Tim Worrstall and Don Boudreaux cover the same report. Tim points out that the US runs bilateral goods trade surpluses with lots of countries, who by rights should be accusing us of "currency manipulation"

... the United States has goods trade surpluses with some places. Like, say, the Netherlands. Or Hong Kong. Or Belgium. Each of those places the US has a goods trade surplus with over $20 billion a year ...

So, by the new US rules Holland, Hong Kong and Belgium should be declaring the United States a currency manipulator and imposing corrective tariffs to compensate, should they? You know, sauce for goose, sauce for gander. And if you’re not willing to use the same criteria then you’d better have a damn good explanation why.

Don concludes that "we Americans are today governed by imbeciles." I guess I am a little optimistic in my view that by making it so ridiculous -- by including countries on the euro -- some small point of light at Treasury was making fun of the whole mess.

Podcast and Goodfellows - Barokong

May 01, 2020    Comment   

Podcast and Goodfellows - Barokong

Here are links to this week's grumpy economist podcast, and Goodfellows discussion with Niall Ferguson and H.R.  McMaster. Grumpy on the careful reopening and debt. Goodfellows on Europe.

Carnivorous Moose (?)