I feel guilty in purposefully setting up Francis Coppola and David Glasner in an internet economic blog flight – to econowonks there is no greater entertainment- even to watching republican candidates competitive accusations of who is the biggest liar. Here though the debate is conducted in terms of lucid and polite prose.
Frances had eloquently written on the current global deflationary spiral – arguing that in these conditions competitive devaluation was impossible for the system as a whole and therefore it would drive a global downturn – indeed just the kind of global downturn we are seeing which the markets didn’t expect, is spooking them, and driving a further downturn leading to risk of a global recession and negative interest rates, just at the point many conventional economists had predicted a fed led rise in interest rates globally backed up by and driving a final global recovery from the Great Recession. In terms of understanding what is going on then the stakes could not be higher.
I noticed that almost precisely the opposite to Francis’s view was taken by Hawtry many years ago, and David had eloquently blogged on it. A sample of Hawtry’s core argument.
The picture of an endless competition in currency depreciation is completely misleading. The race of depreciation is towards a definite goal; it is a competitive return to equilibrium. The situation is like that of a fishing fleet threatened with a storm; no harm is done if their return to a harbor of refuge is “competitive.” Let them race; the sooner they get there the better.
Of course I was setting France’s up and she rose to the bait, or perhaps swam into the nets to extend the fishing analogy and set out why she thought Hawtry’s position – as supported by David Glasner was wrong. A sample of the gist of her argument:
in a floating fiat currency system such as we have now, if I devalue my currency relative to yours, your currency rises relative to mine. There may be a domestic inflationary effect due to import price rises, but we do not value domestic wages or the prices of finished goods in terms of other currencies, so there can be no relative adjustment of wages to prices such as Hawtrey envisages. Devaluing the currency DOES NOT support domestic demand in a floating fiat currency system. It only rebalances the external position by making imports relatively more expensive and exports relatively cheaper.
This difference is crucial. In a gold standard system, devaluing the currency is a monetary adjustment to support domestic demand. In a floating fiat currency system, it is an external adjustment to improve competitiveness relative to other countries.
And the harbourmaster to our great joy responded. That it doesn’t matter even in a fiat system.
as Hawtrey showed, competitive devaluation is not a problem. Depreciating your currency cushions the fall in nominal income and aggregate demand. If aggregate demand is kept stable, then the increased output, income, and employment associated with a falling exchange rate will spill over into a demand for the exports of other countries and an increase in the home demand for exportable home products. So it’s a win-win situation.
The argument being that purchasing power parity still holds in a non Gold Standard World.
So who is right? As ever the starting point should be to define the issue in terms of the appropriate accounting identities and how these interact in a world of intersecting balance sheets.
Perhaps a clue to both parties, not having time to blog to the same length of these protagonists, the accounting identities underlying the impossible trinity and defining the conditions under which it is possible, for the global economy as a whole for aggregate demand to be ‘kept stable’ rather falling to the floor potentially dragging us into a spiraling downturn of debt deflation.
If France’s is right, and my instinct is she is, the effect of too many trading countries trying to have a positive balance of trade, and carrying out austerity at the same time must – through these identities, have much the same effect on the fleet of nations as draining the sea, leading those with the most negative current account balances (made worse by low oil prices to them) hitting the rocks, and there impact on global trade having the effect of slamming the harbour doors so that even the leading boats of the austerian exporters (in both senses) are stranded at sea in the storm just at the point they thought they had found a safe haven. Hawtrys ‘treasury view’ is the harbour master here, slamming the harbour gates on the global economy. Much as we admire Hawtry’s framework of a dynamic debt driven trade cycle, his failure to understand the accounting identities of aggregate demand, as Keynes of course demonstrated at book length in almost a letter to Hawtry to prove him wrong,
Lets put this simply, it is impossible for all countries at once to have a positive current account, conduct fiscal austerity and competitively devalue. If they try it leads to global deflationary spiral, with the trade weighted unit of account of nations ever falling.
Indeed as I have argued in a none gold standard world the numeraire of global aggregate demand is a kind of Bancor – the desire of investors to hold a piece of the pie of the GVA of that nation. And it is this desire which means that Central Banks can issue notes in their currencies which are a liability to their central banks.
Perhaps the best attempt to model theoretically these three intersecting identities comes from the recent work of my great friend Steve Keen. Sadly he forever frustrates us all by never having time to finish his magnum opus, which might settle this argument once and for all. It is why of course Steve was one of the very few to predict the events of the last few months and why he continues to top the charts of macro forecasters. Perhaps Steve if he has time to read this post – which he hasn’t – can post his recent lectures where he talked on their dynamic relationship. None of us have time to go through every post on his You Tube Channel.
Update: France’s replies to David here – I had not seen was as usual on an aeroplane.