Monday, April 11, 2011

More on Center-Periphery cycles

As pointed out in a previous post, Yilmaz Akyüz describes the stylized post-Bretton Woods boom and bust cycle nicely. From the perspective of the developing world, low interest rates in the US lead to an inflow of capital, currency appreciation, and often times a commodity price bubble. As the current account worsens, a trigger event causes a sharp withdrawal of capital (which often results in a debt crisis). Reductions in the level of income then adjust the balance of payments. From the perspective of the US, this has been associated with debt driven consumption cycles.

But the post-Bretton Woods US is only the most recent protagonist in what was originally a British drama. Throughout the 19th century, the British, often responding to rising commodity prices, pulled "gold from the moon" by manipulating the Bank of England discount rate. From the Baring Crisis of the 1890's to the 1860's cotton boom in Egypt, to the US boom of the 1830's, to the first Latin American debt crisis in the 1820's, the British were able to direct the international flow of capital and thus the fates of peripheral countries. The cycle is astoundingly similar. Long periods of disinflation in the center, associated with capital inflows and commodity booms in the periphery. Peripheral exchange rates appreciate, a large external account deficit opens, and the whole process is ended with a sharp increase in interest rates by the central bank in the core.

The example of the US in the late 1830's is particularly ironic as it learned some harsh lessons in the school of international financial hegemony that it now conducts. Long term capital began to flow into the US after during the British recovery of 1833-34. It was associated with a rapid increase in commodity prices, particularly cotton. As the dollar appreciated against the pound, a large trade deficit emerged, as Americans bought British manufactured goods. A decline in the British bank rate in 1835 further increased the mania. By 1836 the Bank of England increased it's discount rate, causing commodity prices to collapse and throwing the US into recession. High real interest rates then resulted in a wave of US state defaults not unlike the Latin American defaults of decade earlier (notably Andrew Jackson had paid of the federal debt with revenues from land sales - else we might have had a full on sovereign default!).

All of which is to say that the cycle is not new. Even prior to the classical gold standard, the center has conducted the orchestra, while the periphery faces strongly asymmetric adjustments. It is however ironic that a country that used to be in a minor chair position now conducts. The difference of course is that as the 19th century came to a close and international competition mounted, the British turned inwards, increasing trade with countries within the Empire (as pointed out in DeCecco's fantastic book "The International Gold Standard: Money and Empire").

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