Now don’t get me wrong. I don’t think that Arthur Burns (1970-79?) was a particularly adept Fed chairman. It’s the hysteria, combined with the rosy or ignorant view of the panics of the 1800s, that I take issue with. See for example Panic of 1819 - Wikipedia and entries regarding the panics of 1837, 1857, 1873, 1884, 1890, 1896, 1901, 1910 and 1911.
Actually, the Fed exists to give grist for the left wing and right wing nutcases.
I think they do a pretty good job.
Hey! You missed the important one for this thread: The Panic of 1907.
I just worked the numbers on the Wiki site Past GDP (PPP) and it would appear you’re correct:
1820-1870: 0.92%
1870-1913: 2.11%
1913-1950: 1.85%
1950-1973: 4.90%
1973-1998: 3.01%
Interestingly, the classic gold standard period (1870-1913) was markedly better than the periods that preceded and came after, as was the Bretton Woods period (1950-1973). Which rather supports the case that a well-respected international standard for currency values is a good thing.
I have a feeling that if you ran the figures from 1998 through today, they would show another major rise, btw, because this period has been called Bretton Woods II, for the enforcement of a de facto dollar standard, again, by the Chinese and other Asian central banks, and recent world economic growth has been very high. The problem is that this era features that large account imbalance between the US and Asia, especially now China, which everyone knows isn’t sustainable. It will be interesting, to say the least, to see how this ends.
Good catch regarding 1907… The Wiki site is pulling its figures from Angus Madison as well, so the agreement isn’t surprising…
This view deserves careful investigation (as does your observation regarding the 1870-1913 era, though expanding international trade (sustained in part by the international financial system???) also played a role).
But I would emphasize other factors. Today’s global imbalances are linked to the US’s low private savings rate and high present and projected federal budget deficits. Sure it’s unsustainable, but I can’t see how any international system of payments could correct that.
Similarly, it’s true that the former Soviet bloc had a tough time. But that’s not the international system’s fault: I think it stems from the world’s total lack of experience with shifting from planned to capitalist economic structures. The experts were simply relying on guesswork.
OTOH, I think the Asian Crisis indicated a weakness in the international financial system. Then again, Clinton handled the Mexican crisis of the mid-1990s pretty well, notwithstanding opposition by the Republican majority.
This is a very interesting post. I disagree with the bolded parts. Ideology is a big part of the debate, but it’s under the surface. Those who favour monetary rules do so for two reasons: (1) they don’t trust anyone to make policy based on judgment and (2) they believe that market economies are essentially stable. An explicit monetary rule like Friedman advocated was a complete failure.* Current central bank practice - inflation targeting of some sort - is not a rule. It could not be made a rule by saying that the Fed must keep inflation within some bound. It is discretionary. It requires judgment. It admits not only that the central bank cannot control the money supply, but also that the central bank can and should smooth monetary conditions because volatility emanating from the private sector can cause macro disturbances.
But current practices are not a vindication of activist monetary policy either. Yes, judgment is required in setting monetary policy, but it’s judgment employed to effect stable monetary conditions, not stable real conditions. Within very broad bounds it is supposed that stabilising monetary conditions is a way of preventing private financial market volatility from affecting the real economy through monetary conditions. The role of the central bank is to provide predictable monetary conditions, even if this doesn’t mean a predictible money supply.
Mind you, none of this has been really tested. If there is a big blow-up about the US fiscal and/or current account situation, who knows what will happen.
- To flesh out Measure for Measure’s citation of Goodhart’s Law: the central bank controls the money base, not the money supply. The fairly stable relationship between the two broke down when central banks tried to use the former to control the latter. The reason: there are close substitutes between different forms of liquidity. Whether this means that inflationary pressures come from the private sector and take form in monetary conditions or that inflationary expectations induced by the central bank take time to break down, take your pick. Seeing as that last point kind of addresses the OP, I’d better make this bit full sized text.
A Federal Reserve note does not say “This note is redeemable in gold.” Nor does it say, “This note is guaranteed to hold the market value of its year of issue, indefinitely.” It says, “This note is legal tender for all debts, public and private.” And it is. I’ve never had any trouble spending one; no merchant has ever refused to accept a note and demanded payment in gold or silver instead. Where’s the fraud?
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Of course the government can borrow money, gold standard or no. That’s what federal bonds and T-bills are for.
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What limits government’s funds to fight unjust wars would also limit its funds to fight just wars. Do you really think we could have fought WWII on a pay-as-you-go basis?
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If you have an objection to the government doing X, Y or Z at all, you should fight each particular issue on its own merits – not try to hamstring government’s financial ability to act in any sphere.
Again, so what? Neither the government nor anyone else even pretends there is any connection between a modern coin’s value as currency and the market value of the metals in it. It’s merely a token, just like a bill. Where’s fraud?!
All true – but what’s fraudulent about it?
Not in my experience. See above. Have you ever had trouble spending or investing your fiat money?
So what? It works. The government does have the authority to create money out of thin air. But it doesn’t do that very often – if it did, it would have no need to collect taxes.
Perhaps. But why would that have to involve gold? The nations of Europe created an international currency, the Euro, without keying its value to gold. They simply did it by treaty. Assuming we need a system where all the world’s currencies have some fixed relationship to one another, that could also be done by treaty, couldn’t it?
What is “inflation targeting”?
Basically, the central bank(ie Federal Reserve) sets a target inflation rate(here in Canada, it’s 1%-3%) and makes that target public.
I didn’t say it had to involve gold, necessarily. Read the post: I said the problem isn’t with the first word of the phrase, “gold standard”, it’s with the second word: there is no current standard for valuing currencies. In its absence, you have the current mess.
By treaty is precisely the mechanism that will have to work, eventually. But, and here is where the euro breaks down, what gold had as a device for monetary union was that as a result of the flow of gold between different countries, interest rates flexibly responded to the current economic conditions within each country belonging to the union. The euro, and any world currency that is proposed without such a device, will also lack this flexibility. Mundell, for some reason, seems blind to this. But that gets us into some really technical territory. I’ll go there if this thread veers in that direction, but the posts sure won’t be short.
I think the above imbalances are precisely because you have the dollar as the world’s standard currency, the US gets to pay back its debts in its own currency without question as a result, and so it gives in to the temptation to just go as far into debt as it feels like, both in private through the current account deficit, and in public through the fiscal deficit. This is why you need something that isn’t a national currency as a standard.
Mundell has an excellent line of reasoning as to why you need a standard:
So, it’s necessary to have a standard. Making it a national currency, though, is too much temptation for a nation to resist. Of course it’s also true, as he points out in that same speech, that the most powerful country gets to set the currency system, usually. So it’s a tough problem.
I think you are confusing a feature for a bug. Revaluing currencies allows underperforming economies to become cheaper, so that they can theoretically attract more investment than they otherwise could stomach. Turns out there is a method for evaluating and valuing currencies: do people want it, or not? Works every time.
Well, yes. I’m not sure what that answer means here.
Interest rates are the price of money, in one way. Currency values are the price of money also, expressed in a different way. What I was saying is that the old gold standard had built into it a way of valuing different currencies within an overall monetary union, a unique feature that the euro lacks, based on that exact mechanism of supply and demand you cite.
So like I said, I don’t know what your answer means.
Thanks for the remarks hawthorne and pantom.
- Apropos nothing, permit me to circle back to the long-run growth rate issue. We’ve really had a remarkable run since WWII. pantom pointed out the comparatively strong growth that occurred from 1870-1913: 2.11% per year. How does that compare with US growth during the years of stagflation?
It’s only slightly better. From 1973-79 (peak to peak years) the geometric average of per capita real growth was 1.93%, which is terrible compared to what preceded it, but rather respectable by 19th century standards.
hawthorne:
2. Yeah, ideology is a huge part of the debate. But 1) it really shouldn’t be: at bottom this is a rather empirical issue, 2) among economists and the chattering classes (WSJ), monetarism has few advocates left largely due to it’s failure in the 1970s-1980s. Those with a conservative bent have mostly moved on to other greener pastures.
--------- Current central bank practice - inflation targeting of some sort - is not a rule. It could not be made a rule by saying that the Fed must keep inflation within some bound. It is discretionary. It requires judgment.
Hm. I would say that the Fed does not have explicit inflation targeting. I understand the the European Central Bank does, however, so perhaps your comments apply there. (Actually, I’m not aware of any central bank that ties itself to a rigid rule. I suspect there are 2 reasons: a) bureaucrats don’t like to tie their hands, and b) the powers that be think pragmatism and flexibility are good things (as do I for that matter)). Ultimately, I lean towards discretionary policy, but remain interested in some rules-based approaches. Nominal GDP targeting is another possibility.
Tying the world economy to the vicissitudes of the gold industry doesn’t seem too bright however. **
---------- But current practices are not a vindication of activist monetary policy either. Yes, judgment is required in setting monetary policy, but it’s judgment employed to effect stable monetary conditions, not stable real conditions.
I’m confused. Nobody stabilizes the money supply anymore. Central banks aim for real economic growth consistent with stable inflation. To quote one British central banker, “We are not inflation nutters.”
----------- the central bank controls the money base, not the money supply.
Agreed, but I prefer to think that central banks control short term interest rates.
** Which leads us to pantom’s remarks. As I understand it, he suggests that world financial systems can really benefit from a solid currency anchor – though it doesn’t have to be a particular shiny metal.
It boils down to a tradeoff. A floating exchange rate permits devaluation when an economy slumps (thus boosting exports and import substitution) and the opposite when the economy overheats – the currency can act as an automatic stabilizer.
But investors also affect exchange rate levels, which means that the value of your floating currency can be subject to faddish behavior. Problematic. Also, fixed exchange rates (or moving pegs) permit better business planning (though currency futures can play a similar role).
Also, what happens if the country controlling the world’s reserve currency runs up a current account deficit of, oh, say 6% of GDP? Is that sustainable? For how long? How will that play out?
Very interesting link.
They’re picking the wrong model, of course.
We’re in the same pickle as back in the sixties, with Iraq’s Pelion standing in for Vietnam’s, piled on Ossa’s tax cuts, standing in for LBJ’s War on Poverty. The due date for the bills back then was August 15, 1971, when Nixon closed the gold window. It took almost exactly eleven years to get out from under the subsequent debacle, as the new bull market in stocks began in August, 1982.
So the model is the US about 40 years ago. The seventies, or some inflationary variation thereof, await.
Unless China collapses and we get worldwide deflation. That would be interesting.
I’ll make a prediction: 12 month CPI core inflation will remain below 6% for the next 4 years.
Here’s why: we won’t get a huge boost in inflation unless the Fed permits it and the current Fed chairman is not a hack, in contrast with the late Arthur F. Burns.* Furthermore, the shift from manufacturing implies that a given increase in the price of oil will not lower US productive potential as much as it did in the 1970s.
I won’t rule out a collapse in the dollar though, and I certainly wouldn’t rule out a spike in interest rates and resulting recession.
If core inflation spikes though, I’ll have to reconsider my underlying model of the economy. It wouldn’t be the first time: for example, I find current long term interest rates puzzlingly low, comparisons to the 1950s notwithstanding.
Oh, and I think we could get deflation without the collapse of China: current central bank preferences for inflation in the 1-2% range subject economies to enhanced deflation risk, which is why I’d prefer a bracket of, say, 1-4% with implied loosening below 2%.
- This assessment may be unfair. Lots of countries had high inflation during the 1970s: it may very well be that central bankers understand their job today better than they used to. Also, Nixon apparently threatened Burns with legislation that would decrease the independence of the Federal Reserve, so it’s not like the Chairman had an easy job.
No, I don’t think so.
In a classic currency crisis, the central bank is forced into raising rates to defend the currency. Meantime, import prices spike, which of course provides another reason for raising rates. Bernanke, or whoever is around if/when something like this happens, is not going to have much room to maneuver.
In another thread about the economy, I quoted an article that said that for the first time since the Depression, we’ve had two years in a row where the savings rate has gone negative. I don’t think that’s a sign of solvency, especially not when you combine that with our current account deficit.
All these debts are going to have to get paid, one way or the other. Rapid inflation combined with high unemployment would be the side effects of a currency crisis in the dollar.
Alternately, if Ernst and Young was right and Chinese banks really are carrying close to a trillion in bad loans, we could see a sudden collapse over there, which would drastically affect liquidity worldwide, and possibly bring on a deflation and high unemployment.
Or, we could see first a dollar currency crisis, and then a Chinese bank crackup. That would be even more fun.
Like Ben Stein’s father said, things that can’t go on forever, don’t.
BTW, I’m not sure why you picked a four-year time horizon.
The current situation of low long-term rates was partially brought about by a deliberate decision to stop issuing 30 year bonds, shortly after 9/11. They’ve recently decided to issue them again.
The decision to stop issuing them of course increased demand for what was left, and mostly, IMO, accounts for the weird yield curve we have now.
This decision is analogous to Operation Twist, an operation the Fed pulled way back in the Kennedy admin, I believe, to defend the dollar at that time. It involved raising short-term rates to keep the value of it up against gold, whose free-market price began to rise. It was the first sign of strain in the Bretton Woods system. It took a lot longer than four years from the start of Operation Twist to see that system finally break up.
So, we could be here a while. The final result will still be the same: a severe recession, with some version of instability in the currency.
I agree, up to the last sentence.
You can’t have rapid inflation (eg upwards of 8%) without a wage-price spiral. And you won’t get a wage-price spiral if the Fed doesn’t allow it. You could, however, experience a recession.
------ BTW, I’m not sure why you picked a four-year time horizon.
Jeez, you want a forecast past 2011? I thought I was out on a limb as it was. (Please interpret that remark in a conversational manner.) I see that Bernanke’s term ends in 2010: maybe I should stop there! 
Moving on: 10 year rates are low as well. And the “carry-trade” between Japan and the US may explain our low rates, along with foreign central bank’s burgeoning reserves. (Oddly enough, if foreign central banks target a share of their reserves in US currency, then a declining (but not crashing) dollar would result in greater purchases of US bonds, driving down interest rates.)
::Muses:: The thing is, the US has been on an unsustainable path for years.[sup]1[/sup] But I understand that the budgetary figures get pretty harsh starting in 2010…
Hm… Here’s another prediction. We can’t rule out the possibility that the US could have a soft landing: it seems unlikely I know, but so did the aftermath of the Louvre accord of the 1980s. How about if I extend my prediction (thought experiment?) out to 2016, subject to the assumption that we continue to have a non-hack Fed Chairman? Otherwise, all bets would be off.
Apropos nothing, a little bit of humility is always wise: for example, I was genuinely surprised by the persistent liquidity trap that the Japanese found themselves in during the 1990s. I had believed that huge budget deficits would have cured their ills. I have yet to read a good treatment of that era, but I suspect that I was insufficiently attentive to the damage that a broken banking system can inflict.
[sup]1[/sup] Nice point about the 4 year unraveling of Bretton Woods, btw.