Uneasy Money

I started blogging in July 2011, and in one of my first blogposts I discussed an article in the now defunct Weekly Standard by Dr. Judy Shelton entitled “Gold Standard or Bust.” I wrote then:

I don’t know, and have never met Dr. Shelton, but she has been a frequent op-ed contributor to the Wall Street Journal and various other publications of a like ideological orientation for 20 years or more, invariably advocating a return to the gold standard.  In 1994, she published a book Money Meltdown touting the gold standard as a cure for all our monetary ills.

I was tempted to provide a line-by-line commentary on Dr. Shelton’s Weekly Standard piece, but it would be tedious and churlish to dwell excessively on her deficiencies as a wordsmith or lapses from lucidity.

So I was not very impressed by Dr. Shelton then. I have had occasion to write about her again a few times since, and I cannot report that I have detected any improvement in the lucidity of her thought or the clarity of her exposition.

Aside from, or perhaps owing to, her infatuation with the gold standard, Dr. Shelton seems to have developed a deep aversion to what is commonly, and usually misleadingly, known as currency manipulation. Using her modest entrepreneurial skills as a monetary-policy pundit, Dr. Shelton has tried to use the specter of currency manipulation as a talking point for gold-standard advocacy. So, in 2017 Dr. Shelton wrote an op-ed about currency manipulation for the Wall Street Journal that was so woefully uninformed and unintelligible, that I felt obligated to write a blogpost just for her, a tutorial on the ABCs of currency manipulation, as I called it then. Here’s an excerpt from my tutorial:

[i]t was no surprise to see in Tuesday’s Wall Street Journal that monetary-policy entrepreneur Dr. Judy Shelton has written another one of her screeds promoting the gold standard, in which, showing no awareness of the necessary conditions for currency manipulation, she assures us that a) currency manipulation is a real problem and b) that restoring the gold standard would solve it.

Certainly the rules regarding international exchange-rate arrangements are not working. Monetary integrity was the key to making Bretton Woods institutions work when they were created after World War II to prevent future breakdowns in world order due to trade. The international monetary system, devised in 1944, was based on fixed exchange rates linked to a gold-convertible dollar.

No such system exists today. And no real leader can aspire to champion both the logic and the morality of free trade without confronting the practice that undermines both: currency manipulation.

Ahem, pray tell, which rules relating to exchange-rate arrangements does Dr. Shelton believe are not working? She doesn’t cite any. And, what, on earth does “monetary integrity” even mean, and what does that high-minded, but totally amorphous, concept have to do with the rules of exchange-rate arrangements that aren’t working?

Dr. Shelton mentions “monetary integrity” in the context of the Bretton Woods system, a system based — well, sort of — on fixed exchange rates, forgetting – or choosing not — to acknowledge that, under the Bretton Woods system, exchange rates were also unilaterally adjustable by participating countries. Not only were they adjustable, but currency devaluations were implemented on numerous occasions as a strategy for export promotion, the most notorious example being Britain’s 30% devaluation of sterling in 1949, just five years after the Bretton Woods agreement had been signed. Indeed, many other countries, including West Germany, Italy, and Japan, also had chronically undervalued currencies under the Bretton Woods system, as did France after it rejoined the gold standard in 1926 at a devalued rate deliberately chosen to ensure that its export industries would enjoy a competitive advantage.

The key point to keep in mind is that for a country to gain a competitive advantage by lowering its exchange rate, it has to prevent the automatic tendency of international price arbitrage and corresponding flows of money to eliminate competitive advantages arising from movements in exchange rates. If a depreciated exchange rate gives rise to an export surplus, a corresponding inflow of foreign funds to finance the export surplus will eventually either drive the exchange rate back toward its old level, thereby reducing or eliminating the initial depreciation, or, if the lower rate is maintained, the cash inflow will accumulate in reserve holdings of the central bank. Unless the central bank is willing to accept a continuing accumulation of foreign-exchange reserves, the increased domestic demand and monetary expansion associated with the export surplus will lead to a corresponding rise in domestic prices, wages and incomes, thereby reducing or eliminating the competitive advantage created by the depressed exchange rate. Thus, unless the central bank is willing to accumulate foreign-exchange reserves without limit, or can create an increased demand by private banks and the public to hold additional cash, thereby creating a chronic excess demand for money that can be satisfied only by a continuing export surplus, a permanently reduced foreign-exchange rate creates only a transitory competitive advantage.

I don’t say that currency manipulation is not possible. It is not only possible, but we know that currency manipulation has been practiced. But currency manipulation can occur under a fixed-exchange rate regime as well as under flexible exchange-rate regimes, as demonstrated by the conduct of the Bank of France from 1926 to 1935 while it was operating under a gold standard. And the most egregious recent example of currency manipulation was undertaken by the Chinese central bank when it effectively pegged the yuan to the dollar at a fixed rate. Keeping its exchange rate fixed against the dollar was precisely the offense that the currency-manipulation police accused the Chinese of committing.

I leave it to interested readers to go back and finish the rest of my tutorial for Dr. Shelton. And if you read carefully and attentively, you are likely to understand the concept of currency manipulation a lot more clearly than when you started.

Alas, it’s obvious that Dr. Shelton has either not read or not understood the tutorial I wrote for her, because, in her latest pronouncement on the subject she covers substantially the same ground as she did two years ago, with no sign of increased comprehension of the subject on which she expounds with such misplaced self-assurance. Here are some samples of Dr. Shelton’s conceptual confusion and historical ignorance.

History can be especially informative when it comes to evaluating the relationship between optimal economic performance and monetary regimes. In the 1930s, for example, the “beggar thy neighbor” tactic of devaluing currencies against gold to gain a trade export advantage hampered a global economic recovery.

Beggar thy neighbor policies were indeed adopted by the United States, but they were adopted first in the 1922 (the Fordney-McCumber Act) and again in 1930 (Smoot-Hawley Act) when the US was on the gold standard with the value of the dollar pegged at $4.86 $20.67 for an ounce of gold. The Great Depression started in late 1929, but the stock market crash of 1929 may have been in part precipitated by fears that the Smoot-Hawley Act would be passed by Congress and signed into law by President Hoover.

At any rate, exchange rates among most major countries were pegged to either gold or the dollar until September 1931 when Britain suspended the convertibility of the pound into gold. The Great Depression was the result of a rapid deflation caused by gold accumulation by central banks as they rejoined the gold standard that had been almost universally suspended during World War I. Countries that remained on the gold standard during the Great Depression were condemned to suffer deflation as gold became ever more valuable in real terms, so that currency depreciation against gold was the only pathway to recovery. Thus, once convertibility was suspended and the pound allowed to depreciate, the British economy stopped contracting and began a modest recovery with slowly expanding output and employment.

The United States, however, kept the dollar pegged to its $4.86 $20.67 an ounce parity with gold until April 1933, when FDR saved the American economy by suspending convertibility and commencing a policy of deliberate reflation (i.e. inflation to restore the 1926 price level). An unprecedented expansion of output, employment and income accompanied the rise in prices following the suspension of the gold standard. Currency depreciation was the key to recovery from, not the cause of, depression.

Having exposed her ignorance of the causes of the Great Depression, Dr. Shelton then begins a descent into her confusion about the subject of currency manipulation, about which I had tried to tutor her, evidently without success.

The absence of rules aimed at maintaining a level monetary playing field invites currency manipulation that could spark a backlash against the concept of free trade. Countries engaged in competitive depreciation undermine the principles of genuine competition, and those that have sought to participate in good faith in the global marketplace are unfairly penalized by the monetary sleight of hand executed through central banks.

Currency manipulation is possible only under specific conditions. A depreciating currency is not normally a manipulated currency. Currencies fluctuate in relative values for many different reasons, but if prices adjust in rough proportion to the change in exchange rates, the competitive positions of the countries are only temporarily affected by the change in exchange rates. For a country to gain a sustained advantage for its export and import-competing industries by depreciating its exchange rate, it must adopt a monetary policy that consistently provides less cash than the public demands or needs to satisfy its liquidity needs, forcing the public to obtain the desired cash balances through a balance-of-payments surplus and an inflow of foreign-exchange reserves into the country’s central bank or treasury.

U.S. leadership is necessary to address this fundamental violation of free-trade practices and its distortionary impact on free-market outcomes. When the United States’ trading partners engage in currency manipulation, it is not competing — it’s cheating.

That is why it is vital to weigh the implications of U.S. monetary policy on the dollar’s exchange-rate value against other currencies. Trade and financial flows can be substantially altered by speculative market forces responding to the public comments of officials at the helm of the European Central Bank, the Bank of Japan or the People’s Bank of China — with calls for “additional stimulus” alerting currency players to impending devaluation policies.

Dr. Shelton here reveals a comprehensive misunderstanding of the difference between a monetary policy that aims to stimulate economic activity in general by raising the price level or increasing the rate of inflation to stimulate expenditure and a policy of monetary restraint that aims to raise the relative price of domestic export and import-competing products relative to the prices of domestic non-tradable goods and services, e.g., new homes and apartments. It is only the latter combination of tight monetary policy and exchange-rate intervention to depreciate a currency in foreign-exchange markets that qualifies as currency manipulation.

And, under that understanding, it is obvious that currency manipulation is possible under a fixed-exchange-rate system, as France did in the 1920s and 1930s, and as most European countries and Japan did in the 1950s and early 1960s under the Bretton Woods system so well loved by Dr. Shelton.

In the 1950s and early 1960s, the US dollar was chronically overvalued. The situation was not remediated until the 1960s under the Kennedy administration when consistently loose monetary policy by the Fed made currency manipulation so costly for the Germans and Japanese that they revalued their currencies upward to avoid the inflationary consequences of US monetary expansion.

And then, in a final flourish, Dr. Shelton puts her ignorance of what happened in the Great Depression on public display with the following observation.

When currencies shift downward against the dollar, it makes U.S. exports more expensive for consumers in other nations. It also discounts the cost of imported goods compared with domestic U.S. products. Downshifting currencies against the dollar has the same punishing impact as a tariff. That is why, as in the 1930s during the Great Depression, currency devaluation prompts retaliatory tariffs.

The retaliatory tariffs were imposed in response to the US tariffs that preceded the or were imposed at the outset of the Great Depression in 1930. The devaluations against gold promoted economic recovery, and were accompanied by a general reduction in tariff levels under FDR after the US devalued the dollar against gold and the remaining gold standard currencies. Whereof she knows nothing, thereof Dr. Shelton would do better to remain silent.