I start with a short autobiographical introduction. In the interlude between my brief academic career and my 25 years at the FTC, one of my jobs was as an antitrust economist at a consulting firm called NERA (National Economic Research Associates). The President (and founder) of the firm was then Irwin Stelzer who, after selling the business for a tidy sum to Marsh & McLennan, eventually relinquished day-to-day management of the firm. When I was at NERA, it actually had a reputation of being a Democratic-leaning, pro-enforcement, non-Chicago-School, firm, but, at some point after Stelzer left NERA, I began seeing articles and op-eds by him promoting a pro-Republican, pro-deregulation, agenda. He became Director of Regulatory Policy Studies at the American Enterprise Institute and subsequently Director of Economic Policy Studies at the Hudson Institute. Stelzer developed a relationship with Rupert Murdoch, writing regular columns on economic policy for a number of Murdoch publications, such as the Sunday Times and the Weekly Standard. The relationship with Murdoch has apparently made Stelzer a somewhat controversial figure in Britain, where he maintains a residence, but all details about that relationship are unknown to me. After not seeing Irwin for almost 30 years, I have recently chanced to meet him twice at concerts at the Kennedy Center in Washington, enjoying a very pleasant conversation with him, possibly even mentioning to him my new career as a blogger, and later exchanging a few emails.
I mention all this, because last night I happened to see Stelzer’s latest economic commentary in the Weekly Standard on the subject of currency wars. Given my past, and recently resumed, relationship with Stelzer, I do feel a little funny now that I am about to write somewhat critically about him, but, hey, a blogger’s gotta do what a blogger’s gotta do.
Stelzer’s first paragraph sets the tone:
Growth is the summum bonum of economic policy. Tough to arrange at home: stimulus packages don’t work very well, and monetary policy produces lots of fiat money but not very many jobs. The solution: export-led growth—the other guy will buy so much of your goods and services that your economy will grow. There are two ways to make this sort of growth happen. Lower the international value of your currency so that your output is cheaper overseas, or increase productivity at home by lowering labor and other costs and therefore the prices you need to charge foreigners. The first is painless, or so it seems initially. The second requires a politically difficult assault on benefits and union created labor market rigidities.
What we have here is a confusion of concepts and meanings. Starting with a facile identification of the highest good of economic policy with growth, where growth seems to denote growth in employment, Stelzer offers up a jejune dismissal of monetary policy, and concludes that exports are the answer. How are exports to be increased? The easy, but disreputable, way is to depreciate your currency, the hard, but virtuous, way is to cut your costs. The underlying confusion here is that between the nominal and the real exchange rate. Let me try to sort things out.
A nominal exchange rate tells you how much of one currency can be exchanged for a unit of another currency. The exchange rate between the dollar and the euro is now about $1.33 per euro. If the euro depreciated against the dollar, the exchange rate might fall to something like, say, $1.25 per euro. For given euro prices of stuff made in Europe, a depreciated euro would mean that the prices, measured in dollars, of European stuff would fall, presumably causing European exports to the US to rise. The reduced exchange rate would work in favor of European exports. However, prices do change, and a falling euro would tend to raise the euro prices of the stuff made in Europe. If the US and European economies were in (foreign-trade) equilibrium before the euro depreciated against the dollar, prices of European stuff would keep going up until the European export advantage was eliminated. So even as the nominal euro exchange rate depreciated against the dollar, price adjustments would tend to restore the real euro exchange rate back to its original equilibrium level, thereby eliminating the temporary advantage enjoyed by European exports immediately after the fall in the nominal euro exchange rate.
That’s not to say that monetary policy cannot affect the real exchange rate, just that doing so requires more than reducing the nominal exchange rate. I discussed this a while back in a couple of posts (here and here) on currency manipulation and the Chinese central bank. The upshot of those posts was that to prevent domestic prices from rising in response to a depreciated nominal exchange rate, thereby offsetting the reduction in the nominal exchange rate and restoring the real exchange rate to its original level, a country (or its central bank) would have to follow a tight-money policy aimed at sterilizing the inflows of foreign cash corresponding to the increased outflow of exports.
Apparently Stelzer did not read my posts on the subject (tsk, tsk). Otherwise, he could not have written the following:
Until now, China has been the world’s devaluer par excellence, keeping the yuan low so that its export-led economy could continue to provide jobs for the millions of Chinese moving off the farms and into the cities.
Well, to begin with, China has not been keeping the nominal yuan low. For a long time, the yuan was pegged at a fixed exchange rate against the dollar. More recently, the yuan has been appreciating against the dollar. However, the Chinese central bank has been sterilizing inflows of foregin exchange and preventing domestic price increases that would have slowed the growth of Chinese exports and encouraged Chinese imports. In other words, the Chinese central bank has been printing too little money. Let’s follow Dr. Stelzer a bit further.
Now, Japan’s new prime minister Shinzo Abe has joined the war, pressuring his central bank to print money and drive down the value of the yen to rescue Japan from “the strengthening yen.” From Mr. Abe’s point of view, so far so good: the yen has fallen about 15 percent against other currencies, making Japanese cars and other products considerably cheaper overseas; the Nikkei share price index is up about 35 percent; and U.S. importers are again ordering Japanese products that they discontinued in the stronger-yen era.
Stelzer is also afraid that Brazil and Great Britain under the new Governor of the Bank of England are going to follow the bad example of China and Japan. This has him really worried.
It should be obvious that the currency war is a trade war by other means. The use of traditional weapons—tariffs to keep out imports and thereby increase demand for homemade products and create jobs—was outlawed by mutual consent of the warring parties when they agreed to abide by the rules of the World Trade Organization. So a new weapon of trade destruction has been rolled out—the printing press. Run the presses, flood the markets with your currency, and later, if not sooner, your currency will depreciate, giving you an edge in world markets. Until trading partners respond.
I’m sorry, but this is all wrong. Trade war, Chinese style, involves reducing the nominal exchange rate to gain a competitive advantage and tightening monetary policy, i.e., not running the printing presses, repeat, not running the printing presses, to prevent the increase in the money stock that would normally follow from an export surplus. The depreciation of the nominal exchange rate in response to money printing makes everyone better off, because it raises the home demand for imports while increasing the foreign demand for exports.
Last February, I published a post about Ralph Hawtrey’s take on currency wars, aka competitive devaluation, quoting at length from Hawtrey’s excellent book, Trade Depression and the Way Out. I reproduce the last three paragraphs of the passage I quoted in my earlier post.
In consequence of the competitive advantage gained by a country’s manufacturers from a depreciation of its currency, any such depreciation is only too likely to meet with recriminations and even retaliation from its competitors. . . . Fears are even expressed that if one country starts depreciation, and others follow suit, there may result “a competitive depreciation” to which no end can be seen.
This competitive depreciation is an entirely imaginary danger. The benefit that a country derives from the depreciation of its currency is in the rise of its price level relative to its wage level, and does not depend on its competitive advantage. If other countries depreciate their currencies, its competitive advantage is destroyed, but the advantage of the price level remains both to it and to them. They in turn may carry the depreciation further, and gain a competitive advantage. But this race in depreciation reaches a natural limit when the fall in wages and in the prices of manufactured goods in terms of gold has gone so far in all the countries concerned as to regain the normal relation with the prices of primary products. When that occurs, the depression is over, and industry is everywhere remunerative and fully employed. Any countries that lag behind in the race will suffer from unemployment in their manufacturing industry. But the remedy lies in their own hands; all they have to do is to depreciate their currencies to the extent necessary to make the price level remunerative to their industry. Their tardiness does not benefit their competitors, once these latter are employed up to capacity. Indeed, if the countries that hang back are an important part of the world’s economic system, the result must be to leave the disparity of price levels partly uncorrected, with undesirable consequences to everybody. . . .
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.
I would have been happy to end the post here, having a) clarified an important, but often overlooked, distinction between the nominal and the real exchange rate, b) made the important analytical point that currency manipulation or trade war via monetary policy, requires tightening, not easing, monetary policy, and c) concluded the whole discussion with a wonderful quote from R. G. Hawtrey. Unfortunately, my work is not yet complete, because Stelzer writes the following in the penultimate paragraph of his piece.
The U.S. and the UK, among others, have already deployed that weapon, and the new head of Japan’s central bank is likely to be chosen by Abe from the warrior class. Germany, not overjoyed with Draghi’s hint that he might take up arms, continues to insist that the ECB remain a non-combatant. Angela Merkel has made it clear that the long unpleasantness that followed Germany’s decision to run the money presses overtime in the 1930s is still etched in Germans’ minds, and that she agrees with Vladimir Ilyich Lenin that “the surest way to destroy a nation is to debauch its currency,” a view on which John Maynard Keynes put his stamp of approval: “Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency.”
OMG! Something has gone very, very wrong here. I repeat the critical passage to make sure it sinks all the way in.
Angela Merkel has made it clear that the long unpleasantness that followed Germany’s decision to run the money presses overtime in the 1930s is still etched in Germans’ minds
I can’t tell if Stelzer’s memory has failed him, and he is misrepresenting what Mrs. Merkel believes, or if — and this is an even more frightening thought — Mrs. Merkel actually believes that Hitler came to power, because Germany ran the money presses overtime in the 1930s. But the plain facts are that the German hyperinflation occurred in 1923, and Hitler came to power in 1933 when Germany, after years of deflation, austerity and wage cuts imposed in a futile, and self-destructive, attempt to remain on the gold standard, was still wallowing in the depths of the Great Depression. If Chancellor Merkel’s policy is now premised on the presumed fact that Hitler came to power, not because of the misguided deflationary policies of 1929-33, but the hyperinflation of the previous decade, I tremble at the thought of what disasters may still be waiting to befall us.
Uneasy Money 
Glasner: A+; Stelzer: D-; Angela M: F
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It is not sure that thsi is Merkel true thinking, but was is undisputed is htat saying so (Hyperinflation=Hitler) seems to be good politics in Germany. And that is indeed very frightening.
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China devalued its currency by half in 1994. While the RMB has appreciated since then, the appreciation began from enormous undervaluation that could not be corrected by a free FX market. As the RMB isn’t now, and wasn’t then, freely convertible, it is likely that China gained a trade advantage. The export numbers from China show that to be the case. Comparing a freely traded currency to a managed one is muddled thinking.
The concept that EVERYONE can depreciate their currencies to gain a trade advantage is also muddled, and remarkably seems to be a universal policy prescription. Maybe we should start trading with Mars to solve this conundrum?
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“I’m sorry, but this is all wrong. Trade war, Chinese style, involves reducing the nominal exchange rate to gain a competitive advantage and tightening monetary policy, i.e., not running the printing presses, repeat, not running the printing presses, to prevent the increase in the money stock that would normally follow from an export surplus.”
David,
Your entire take on monetary policy is wrong. A central bank can set interest rates, but they can’t make people borrow money. And so the whole notion of the central bank “running the printing presses” is faulty.
Enter fiscal policy. A government can increase the propensity to save by increasing the rate of return it offers on the long dated liabilities that it sells above the prevailing rate of inflation. Those liabilities can be debt or equity. If they those liabilities are equity and the rate of return is higher than the private cost of servicing debt then Mr. Stelzer’s suggestion holds true:
“or increase productivity at home by lowering labor and OTHER COSTS.”
That other cost is the after-tax cost of money.
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What you know that just ain’t so is that “China is not running the printing presses”. You are just wrong. The way to lower the value of a fiat currency is to run the presses. China is running the presses.
http://www.tradingeconomics.com/china/money-supply-m2
I write the main Hyperinflation FAQ on the Internet. If there is anything that “I know that just ain’t so” please tell me.
http://howfiatdies.blogspot.com/2012/10/faq-for-hyperinflation-skeptics.html
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The head of the German central bank was “Havestein” who happened to be Jewish. The germans called the piles of paper money he was printing “jew confetti”. The chaos created did last for years and did help Hitler come to power.
https://www.google.com.ai/#hl=en&tbo=d&sclient=psy-ab&q=%22jew+confetti%22&oq=%22jew+confetti%22&gs_l=hp.3..0i30.833.5323.0.5788.14.12.0.0.0.0.1601.9648.0j1j2j2j0j1j1j3j2.12.0.les%3B..0.0…1c.1.2.hp.VjjbNVO2E1U&pbx=1&bav=on.2,or.r_gc.r_pw.r_cp.r_qf.&bvm=bv.42261806,d.dmg&fp=112cd32239143957&biw=959&bih=678
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Marcus, Are you playing favorites again?
erwan, Good point. Merkel probably knows the history, but chooses to recount it selectively.
RichL, China had minimal trade surpluses until the early 2000s, so there is no reason to believe that the 1994 devaluation, when China was still a very backward economy, had significant international implications. All countries cannot simultaneously succeed in depreciating their currencies, but all can certainly try to do so.
Frank, It is entirely possible that my take is wrong, but then so is the mainstream theory of money and monetary policy, which, I believe, I am faithfully and consistently applying.
Vincent, You said:
“What you know that just ain’t so is that “China is not running the printing presses”. You are just wrong. The way to lower the value of a fiat currency is to run the presses. China is running the presses.”
The Chinese money supply is increasing because income in China is increasing rapidly and so the Chinese public wants to hold more cash. The way they get the cash is by exporting stuff to the rest of the world. The rest of the world pays them money. The Chinese public takes the foreign money to the central bank and the central bank gives them money. If the Chinese central bank would print more money, the Chinese wouldn’t have to export so much to get the money they want to hold.
Thanks for your link. I will have a look.
Anonymous, I didn’t say that there were no long-term repercussions to the German hyperinflation. But the German hyperinflation was in 1923. Hitler was a nobody in 1923, and was still considered a clown in 1930. It was only after the brutal deflation of 1929-32 that Hitler’s maniacal outbursts gained a large enough following to win the 1933 election and become Chancellor. And the statement that I specifically focused on was “Germany’s decision to run the money presses overtime in the 1930s.”
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“Angela Merkel has made it clear that the long unpleasantness that followed Germany’s decision to run the money presses overtime in the 1930s is still etched in Germans’ minds”
It’s very possible that this is a case of a dangling modifier. The “in the 1930s” probably modifies “unpleasantness”, not “decision to run the money presses overtime”. It should have been written:
The long unpleasantness in the 1930s that followed Germany’s decision to run the money presses overtime is still etched in Germans’ minds, as Angela Merkel has made clear.
No one ever accused the Murdoch press of careful copy editing.
Of course, he’s still totally wrong about economics and the meaning of history, even if he might have his dates right.
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David, you and Krugman seem to think the motives for the Fed running the presses are good and noble while the motives for the Chinese running the presses are sinister and evil. The Chinese say the same things the Fed says, they want to lower interest rates to stimulate business. At least China could claim it has the advertised effect. I don’t think we can know the real motives, so it only seems reasonable to look at the actions and what those actions will result in. History has shown that if you run the presses then eventually the currency will be worth less in terms of real things like rice, oil, and gold.
It is hard to say when price inflation will come or how high the inflation rate will get. New tricks like paying interest on “excess reserves” confuse things.
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I’d have to say that an economic theory that can’t predict when inflation will happen or how much inflation there will be isn’t a terribly useful theory. Vincent Cate has turned Keynes on his ear; he can tell us that the sea is currently calm but can’t tell us when there will be a storm or how bad it will be – except that he knows eventually there will be one. That is just as easy and just as useless as telling us a storm will pass.
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Robert, many others have made the same complaint. However, if you know that 3% interest on your saving for the next 30 years is not going to make you happy 30 years from now when the money is worth far less, then at least we know something useful. Also, buying gold seems to work fine as long as they will keep running the presses. I don’t see how they could stop, so I buy gold. Even Krugman has noted that when interest rates are really low it makes sense for gold to go up. So with the Fed printing trillions to artificially lower interest rates it is a good time to own gold. A basically correct story for the future of inflation, even without exact dates, is better than an incorrect story.
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Robert if you know any theory that has been able to accurately predict the onset of inflation I would love to hear of it. It would make leveraged investing reasonable.
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Mitch, You are right that it is possible that the my reading of the quotation in question could be skewed by a dangling participle. But I am not sure that it is “very possible.” If “in the 1930s” is modifying “unpleasantness” rather than “decision,” I don’t understand why the unpleasantness is just in the 1930s. Surely the unpleasantness did not end in 1939.
Vincent, Sorry, you misunderstood what I said about China. I didn’t say that China’s running of the printing press is bad and the Fed’s running of the printing press is good. I said that China has not let the printing presses run fast enough. History has shown that the printing presses have been running and running all over the world without stop for over a century. There are only a handful of cases of hyperinflation. That’s what history shows. You need to explain why so many countries have had their printing presses run so fast for so long without causing hyperinflation.
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Inflation comes from running the printing press but to get hyperinflation you need lots of government debt and a big deficit. The usual numbers are debt over 80% of GNP and deficit over 40% of government spending (so nearly spending twice what they get in taxes).
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@Vincent – where are you getting these numbers from?
Scholarly studies of the economic history of hyperinflation generally show that it’s not so much “politicians running the printing presses to give the peoplez welfare” (or something) that leads to hyperinflation, but WAR.
How do you explain Japan and the US, for example? If you want to convince people, you need to show how your claimed “cause” of “X” leads to claimed “effect” at time “T+1.”
Simply saying “hyperinflation is bound to happen any day now” – which many discredited economists have been saying for nearly a decade, won’t get you very far with those who aren’t already part of the converted.
Also, perhaps I am just ignorant, but I am not aware of any studies that show a clear threshold of “debt over 80% of GNP and deficit at 40% of GNP” for hyperinflation to happen. Please show me links to those studies that establish that “fact.”
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And no, we are not exactly impressed by the fact that you run an FAQ on a website. I like answering FAQ’s on some specific topics on Yahoo!, but I’m pretty sure you would not accept that as evidence of my expertise on a given topic.
In other words, we will accept your expertise on a given subject when you demonstrate expertise, not when you wave credentials in our faces
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There is a book by Bernholz where he studied hyperinflation and he came up with the numbers. It is debt 80% of GNP and deficit 40% of spending (not GNP).
Click to access Monetary_regimes_and_inflation.pdf
I am not saying I have credentials, I am saying, do you see anything in the FAQ that you think shows I don’t understand something or have something wrong?
Both the “where do the numbers come from” and “40% of GNP” error are in the FAQ.
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We will see how the election is going to turn out. Even though I would vote for her. Germany is doing extremely well under her leadership. I really don’t worry about 1933. This is a new Germany that won’t have another Hitler.
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Vincent, Thanks for the clarification. I am used to hearing arguments that sound like there’s slippery slope, so that once you get a little bit of inflation you are ultimately going to get to hyperinflation. I think that the conditions that lead to hyperinflation are generally pretty extreme, and don’t exist in the US. The US is not Zimbabwe, not even Greece.
Tas, I don’t think we have to worry about 1933 either, but, according to Dr. Stelzer, Mrs. Merkel thinks it is relevant.
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David, I think the conditions that lead to hyperinflation are debt over 80% of GNP and deficit over 40% of spending. These are extreme but the US has these. If you don’t think these are the conditions that lead to hyperinflation, what do you think the conditions are?
It is not a simple slippery slope. A little inflation does not automatically result in higher and higher inflation. The key is the debt and deficit so that money printing gets out of control . Any government without large debt and deficit can stop printing money. Hyperinflation is a tipping point, death spiral, or positive feedback loop. It is clearly true that once hyperinflation starts it is very hard to stop.
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Vincent, I haven’t studied hyperinflations, so I don’t have a theory of what causes them. I can think of a number of possibilities, including loss of confidence in the ability of the state/government to maintain its sovereignty and enforce the payment of taxes. The size of the government’s debt may be one factor that affects expectations of the government to maintain its sovereignty, so there may be some common ground here. But I don’t have a well developed theory of the causes of hyperinflations.
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It seems illogical to say “the conditions leading to hyperinflation do not exist in the USA” when you don’t have a theory as to what the conditions leading to hyperinflation are.
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Vincent, I see your point. All I meant was that the kind of disfunctional government or political situation that led to hyperinflation in the Confederacy when it was clear that the South was going to lose the war, in Germany after WWI and WW2, and in Zimbabwe don’t yet seem to obtain in the US, but who knows? Maybe our time is running out.
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The US has not passed a budget the whole time Obama has been in office. The last couple months they spent about twice what they got in taxes. The US is disfunctional in the key way that those other governments were disfunctional, spending is way over income.
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The US never had a budget till the 1970s. The budget is just a plan, it is economically irrelevant; it’s a political statement. I could be wrong, but I thought that the Treasury actually ran a surplus in January. At any rate, if you think the US is in the same league as the Confederacy in 1865, Germany in 1923 and 1945-48, and Zimbabwe, I am afraid that your grip on reality is just a bit shaky. However, I do agree that watching the current cast of characters carry on does not exactly bolster one’s confidence in the future of the Republic.
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You must compare the US now to Germany, the Confederacy, or Zimbabwe before their hyperinflations started. Clearly once hyperinflation has started things are far more disfunctional.
I was wrong, the last two months have not been bad. The two months before that were. The first 4 months of this fiscal year have a deficit of only 290 billion compared to 340 billion for the first 4 months of the last fiscal year. So things are a bit better and they are predicting a deficit under $1 trillion for this fiscal year.
If the deficit really does go down then things are not spiralling out of control. However, I think we may have a next recession, and a bond panic. If there is another recession then taxes go down and spending goes up from here. Most of the debt is short term, so if interest rates go up the interest payments go up fast. So a recession and bond panic could make the deficit really go up. Also, when the interest rates are going up the Fed will be losing money on its bond purchases and so will stop giving the Treasury money. The Fed gave the Treasury about $89 billion last year. So these 3 things together could make the deficit much worse very easily. Time will tell.
http://www.businessinsider.com/us-budget-surplus-january-2013-2013-2
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