Barry Eichengreen on Global Currencies

Barry Eichengreen's last book -- Money Beyond Borders: Global Currencies from Croesus to Crypto -- is great and worth reading, as almost anything he writes. This is specially the case, since it is his most ambitious work since Globalizing Capital: A History of the International Monetary System, first published in 1996. Other writings have been focused on much more narrow topics.

First, let me say two brief things before I even get to the book, that I just finished. This is NOT a thorough review, only just some impressions from reading without going into details. Second, Barry is incredibly generous intellectually and willing to discuss openly and to listen to people who he disagrees with, and that is not a minor matter in the current environment. He came to Kalamazoo College, and the University of Utah, when I invited him, and has a chapter in a book I edited two decades ago. He also debated with me on the cause of the collapse of Bretton Woods a few years back (video here; my paper here and his here in the same issue of ROPE, not ROKE). So, my critiques of the book are friendly critiques, mostly associated to the theoretical apparatus, since the book, like the earlier one, is incredibly rich in historical detail, and is a must read. 

My biggest issue with the book is that Barry treats the international monetary system, in analytical terms, as fundamentally a market equilibrium sustained by confidence, with states and geopolitics modifying that equilibrium. My view is that it is an institutionally constructed hierarchy sustained by state power, within which markets and confidence operate. For him, power largely follows successful international money. In my view, successful international money is to a considerable extent an expression of power. Barry gives too much causal priority to trade, confidence and network effects, and too little to the fiscal and military, I might say geopolitical, foundations of international money.

His historical sequence is, in an important sense, backwards. He tends to tell the story as one in which expanding commerce generates a demand for convenient, stable means of payment and particular currencies then emerge because traders converge on them. However, the monetary institutions that make those markets possible are already political constructions. The money of account, the enforceable debt contracts, the power to tax, and ultimately the hierarchy between different liabilities are constitutive of the monetary system rather than consequences of prior commercial development.

This is particularly important when it comes to the position of the dollar. Here the argument is somewhat circular.  The dollar is widely used because it is liquid and convenient, while it is liquid and convenient because it is widely used. My explanation puts considerably greater weight on the military, and geopolitical position of the United States. The dollar system was embedded in a political order organized by the United States after World War II, including alliances, security arrangements, international institutions, foreign lending and eventually the willingness of the United States to supply dollar liabilities to the rest of the world. Dollar hegemony cannot therefore be adequately separated from American hegemony.

His last chapter -- that is particularly gloomy -- emphasizes the importance of trade and confidence, and how these build network effects.  In a section titled "Trading Places," he gives considerable weight to the fall in the US share of global exports. But that historical fact that should cause trouble for his argument. The problem he describes, the fall in the US share of world trade and output has fallen enormously while the international position of the dollar has changed remarkably little. China is an even clearer counterexample. It is central to world trade and manufacturing but the renminbi remains a relatively minor international currency.

His invocation of the Triffin Dilemma is particularly problematic. The original Triffin dilemma was specific to Bretton Woods. The United States promised to convert official dollar holdings into gold at US$35 an ounce. International liquidity required supplying dollar liabilities to the rest of the world, but the accumulation of those liabilities relative to US gold reserves eventually undermined confidence in their convertibility. More importantly, the world does not even require a US current account deficit to obtain dollar liquidity. Dollars and dollar claims can be supplied through through many mechanisms. Banks and offshore or shadow banks can create dollar liquidity, as can capital outflows from the US, or the swap lines from the Fed discussed by Barry.

Perhaps, from my perspective, the weakest case is the notion that there will be a point at which the US fiscal position will become unsustainable. The United States can certainly default on Treasury obligations. Congress could refuse to raise the debt ceiling, or the executive could refuse payment. An institutional or constitutional crisis could prevent payment. But that would be a politically imposed default, not an inability to obtain dollars. That distinction is crucial.

A government promising to pay US$100 when it is the issuer of dollars is fundamentally different from one promising to pay US$100 worth of gold or 100 euros. In the first situation the government has a nominal payment capacity that it lacks in the other two. This means suggesting that rising debt ratios could ultimately make Treasury liabilities impossible to service, as Barry suggests, reproduces the conventional analogy between the federal government and a private borrower. Not that deficits and debt might not have consequences. But default and danger to the dollar position is not one. In fact, it is the ability to spend and borrow only in its own currency that is the foundation -- what Anthony Brewer called the Fiscal-Military State -- of the the international position of the dollar.

He concludes that the dangers of a less and less trustworthy American economy, and the fact that there is no alternative to the dollar, might lead to a collapse and de-globalization process akin to the 1930s. But one can take the exactly opposite conclusion. Key currency status is not simply a beauty contest in which investors periodically choose the currency inspiring the most confidence. If there is no alternative system capable of performing the same functions, these developments do not automatically culminate in abandonment of the dollar. Inertia should simply lead to the continuation of the status quo, even if Trump is erratic and creates unnecessary turbulence. In fact, the recurring phenomenon in crises has often been exactly the opposite as what he describes. Global instability increases demand for dollars, even when the crisis originates in the United States. 2008 is the obvious example.

Barry is extraordinarily knowledgeable about the institutional and historical evolution and functioning of the international monetary system. He knows that geopolitics and military power matter. He DOES have a section in the last chapter on that. So he does not neglect the subject. But then he concludes that: "the fate of the dollar will rest on the willingness of America's leaders to uphold the rule of law, respect the separation of powers, and honor the country's commitments to its foreign partners." It is subsidiary and dependent on the institutions that create confidence on the dollar. In other words, he tends to absorb all of the political and geopolitical facts into an essentially conventional analytical structure rather than allowing them to generate a rival theoretical interpretation. In a sense, the historical narrative is richer than the theory used to organize it.

Make Argentina Crash Again

 

My article for The American Prospect on the Argentina situation was just published online. Argentina is far from being out of the woods. The expectation that the country will stabilize prices, float its currency, and build up reserves, and restart economic growth is a chimera. Despite market support for Milei’s program, the crisis remains unresolved. In my article, I explain why the challenges persist, an why this will end like the previous three neoliberal experiments, with a crash. While an immediate crash may not be on the horizon, it is somewhat inevitable. It's a matter of when, not if. And it may very well be with the next president, if the U.S. continues to financially prop Milei's government.

Note that contrary to the IMF, or Barry Eichengreen, who actually provided the IMF justification for floating rates more generally (as he explains there), I don't think to abandon the dirty float (band in this case) would be a good idea.* On that I think Milei's administration is correct. I even think that some degree, even more I think, of a reintroduction of exchange rate controls (the government reintroduced some controls on individuals, I must add) is necessary. Something that supposedly the IMF also favors. Capital controls as a macro-prudential measure in times of crises.

I also want to make clear that this is mostly about the current macroeconomic circumstances. The point is not to return to a world of Bretton Woods, with fixed exchange rates, and capital controls. It is clear that Brazil, for example, did much better than Argentina, with a dirty float and no capital controls. But, as noted by Fabian Amico, in a talk at Universidad Nacional de Moreno, recently, Brazil accumulated reserves in a different macroeconomic scenario.

Brazil accumulated foreign reserves (see graph), maintaining a positive interest rate differential (the domestic interest rate minus the foreign reference rate, the U.S. one, the expected depreciation, and a measure of country risk). We discussed that with Amico and Serrano a few years back (in Spanish). Note that as capital inflows allowed Brazil's central bank to accumulate dollars, the real appreciated in nominal terms. In Argentina where both left and right of center governments have 'appreciation fear' (and their fear is about the real rate, let alone the nominal one), that would be politically difficult.

Exchange rate depreciation at this point would lead to accelerated inflation, and to contractionary pressures. Of course, there might be a situation (they had more than a few over the years) in which, with low country risk, and high interest rates at home, leading to a higher differential that allows for the profitability of holding peso denominated assets to be higher than holding dollars, we might finally get on the road to stability. That would be orderly macroeconomic policy, and not draconian fiscal adjustment. At any rate, that doesn't seem to be the case right now.

Over the long-term, it is very clear that all the previous experiments with this kind of policy (fiscal austerity, financial deregulation, and trade liberalization) ended up in a crash. There is also little reason to believe that this time it will be different. 

* It goes without saying that I would also be against dollarization, something that Milei promised in his campaign in 2023, and that has been recently floated by Laurence Kotlikoff in the Financial Times. This suggests that the old bipolar consensus has not been completely abandoned in more mainstream circles.

The End of Bretton Woods

  

End of Bretton Woods with Barry Eichengreen, myself and Lilia Costabile, organized by L-P. Rochon and the Review of Political Economy.

Nixon ends dollar convertibility

50 years ago this Sunday. A debate with Barry Eichengreen on that today at 1pm NY time, and you can register here.

My paper can be read here.

The Demise of Bretton Woods

ROPE will be hosting a special Zoom Webinar, hosted by Lilia Costabile. The webinar is on August 13, 2021, at 1 pm, NY time (Bretton Wood collapsed on August 15, 1971) . To register, please use the following link.

Handbook of the History of Money and Currency

The Handbook (subscription required) has been edited by Stefano Battilossi, Youssef Cassis and Kazuhiko Yago. It has many interesting chapters. Barry Eichengreen writes on what determines that a currency is used as an international currency (or even as the predominant currency). While he follows conventional views in suggesting that role of money as a means of exchange and the importance of the country in international transactions, he does also explore the role of power (military power) behind the key currency. My take on that topic in this paper with David Fields here.

There is also a very readable paper on the history of central banks by Stefano Ugolini here. It follows the evolutionary approach of Roberds and Velde, and in my view also suffers from conventional views on monetary theory that emphasize the exchange role of currencies, rather than the unit of account function. As a result, it downplays the role of fiscal agent of the state, that in my view was key in the early experiences with public banks. I would emphasize the importance of the development of public debt for the subsequent evolution of public banks, and the relevance of early central banks in the management of the Fiscal-Military State. On this see this and this.

There are interesting papers on paper money experiences, by François Velde (here) or on deflation, by  Richard Burdekin (here), to cite a couple.  There is, also, our entry (with Esteban Pérez) on the history of Central Banking in Latin America (here).

Economists don't read (enough) books

So Ann Petiffor twitted a link to a post on why economists do not read Polanyi's The Great Transformation (or the other GT; yes the one is Keynes' General Theory) The author, Marko Grdesic, basically suggests that economists do not read books, period.* I would add, let alone Polanyi that was always at the fringes of mainstream economics. He estimates that about 3 percent of economists have read Polanyi. That reminded me of a story that Eichengreen had told me about a course he taught based on reading books, since he thought that graduate students in economics do not read them anymore, and, even worse, do not quite get the point of writing books. He was nice to twit the link to the current version of the course. I taught in Utah a course that was not directly based on books, but instead on what I referred to as unresolved issues in economic history. These are the ones that involve the big questions, the ones economists do not deal with anymore, at least not often (as discussed yesterday). In a way, I think that the inability to read and appreciate books is also connected to the reduced ability to engage in the big questions.

* He points out that: "one economist said, 'I haven’t read Polanyi, nor have I read Smith, Keynes, Hayek, Schumpeter, or Friedman'." Yes, we noticed it.

The Great Depression and the Great Recession compared

So I teach a course on the two (old syllabus here). One of the initial classes looks at Eichengreen and O'Rourke's comparison of the two events, and how, even though at the beginning the shock seemed similar, the recovery has been faster the second time. O'Rourke had noticed in his blog last year that the current recovery started way before, but has been so slow that now the 1930s look better when industrial output (rather than GDP) is used as a measure. Below the same data for the US economy (he uses world industrial output).

Note that I added more of the 1930s recovery, and one can see the effects of the Roosevelt recession in 1937-38 (the indexes are monthly and start in October 1929 and December 2007 as 100 respectively). Industrial output growth has slowed down in the last year, by the way. I don't think we are on the verge of a recession in the US. My guess is that sluggish growth will continue. But it is an additional reason to be cautious about hiking interest rates, and presuming that the economy is all fine.

The end of the Gold Standard

NYTimes September 21, 1931

84 years ago Britain left the Gold Standard. Some thought it was the end of Western civilization. Keynes thought it was the beginning of the end of the Depression, at least in Great Britain. He was certainly happy. He said: "There are few Englishmen who do not rejoice at the breaking of our gold fetters. We feel that we have at last a free hand to do what is sensible. The romantic phase is over, and we can begin to discuss realistically what policy is for the best." On the functioning of the Gold Standard and why the conventional view, which according to Eichengreen can still be roughly understood with Hume's specie-flow mechanism, is incorrect go here.

The Gold Standard and the Depression

I have been teaching on this topic this week. One of the accepted views on the Depression is that countries that depreciated earlier recovered faster from the crisis. The classic paper by Eichengreen and Sachs sort of established the result.* The notion is the traditional one. Depreciation leads to lower prices in foreign currency, increased competitiveness and higher exports. Graph below shows the correlation between depreciation (since the exchange rate is measured as the foreign price of domestic currency, lower rate means depreciation).

The indexes show the difference between the exchange rate and export volumes in 1929 (100) and 1935. So in 1935 France had not left the Gold Standard and the exchange rate remained at 100, while the exports were close to 50% of their 1929 level. There seems to be a clear negative relation between the exchange rate depreciation and export performance. However, note that in the United Kingdom a depreciation of about 40% implied exports at around 75% or so of the 1929 level. Only Norway and Finland seem to have higher exports in 1935 than in 1929. This was not an external demand led recovery.

This suggests that if depreciation had a role it was more likely related to the space that breaking with the Gold Standard rules provided for domestic authorities to pursue expansionary policies at home. Note that in this context, the depreciation, as much as higher tariffs and other trade related policies, are less relevant for their role in stimulating external demand, than by their role in protecting domestic production.

In the US the group of economists that were in favor of the depreciation of the dollar (see the letter by Harvard economists J. Raymond Walsh, Lauchlin Currie, John B. Crane, John M. Cassels, Robert Keen Lamb and Alan R. Sweezy in support of FDR's depreciation policy in 1934; and yes that includes Currie, later advisor to Eccles, and Paul's brother Alan, a Keynesian, not a Marxist), were also in favor of domestic fiscal expansion, which was at the end of the day Keynes point too. You can see Keynes arguing why the abandonment of the Gold Standard would be a good thing here, at the beginning of John Kenneth Galbraith's documentary.

This is still an important point, since there are significant lessons, at least it seems to me, for the European periphery story, in particular Greece. Depreciation alone cannot do the job. But a combination of import substituting policies, to reduce external constraint problems, with expansionary demand policies might work.

* There are also issues related to the role of the Gold Standard in causing the Depression, since the crisis was international, and many authors think that this suggests that it must have international causes. Hence, the Monetarist contraction story, or the Keynesian consumption collapse story (including the more radical version in which income distribution plays a role) would be incomplete. In this view, the relatively high rate of interest, related to the not credible inter-war Gold Standard, would be the cause of the depression. This view, as I noted before, seems closer to Keynes' Treatise on Money than his GT.

NBER: Mutual Assistance between Federal Reserve Banks, 1913-1960

By Barry Eichengreen, Arnaud J. Mehl, Livia Chițu, & Gary Richardson

This paper reconstructs the forgotten history of mutual assistance among Reserve Banks in the early years of the Federal Reserve System. We use data on accommodation operations by the 12 Reserve Banks between 1913 and 1960 which enabled them to mutualise their gold reserves in emergency situations. Gold reserve sharing was especially important in response to liquidity crises and bank runs. Cooperation among reserve banks was essential for the cohesion and stability of the US monetary union. But fortunes could change quickly, with emergency recipients of gold turning into providers. Because regional imbalances did not grow endlessly, instead narrowing when region-specific liquidity shocks subsided, mutual assistance created only limited tensions. These findings speak to the current debate over TARGET2 balances in Europe.

Read rest here (subscription required).

Keynes on the causes of the Great Depression

By 1932 a draft of the General Theory (GT) was basically finished, including the central concept of effective demand, and Keynes have moved away from the Wicksellian framework of the Treatise on Money (TM). From a policy point of view the new view implied that the cause of the Great Depression was less the high rates of interest (above the natural rate), and the emphasis on the Gold Standard, that had dominated his views in the TM, to a more straightforward blame on reduced spending in the US.

In The Means to Prosperity from 1933, in which most of his policy views were expounded (and published before the GT) Keynes argues that:

Note that he clearly suggests that the global crisis had its epicenter in the US. Also, even though he is concerned with the role of expenditure in the level of activity, he still refers to the recovery as having price effects ('raising world prices').

PS: Arguably those authors like Eichengreen and Temin that emphasize the role of the Gold Standard remain closer to the TM and its Wicksellian framework (which would make sense for New Keynesian authors), while Romer, even though she remains firmly wedded to the idea of a natural rate, would be closer to the Keynes of The Means to Prosperity and the GT. See older post here.

What can we learn from the Depression?

Free Exchange has discussed in a recent post the academic views on the Great Depression. They suggest that recent research (say the last 20 years or so) has produced a different view, and "that many traditional views about the causes of the Depression have been overturned by academics in recent decades." In particular, they suggest that neither protectionism nor the financial crash are seen as central anymore. They correctly note that the dominant view, associated to Barry Eichengreen and Peter Temin,* now puts an emphasis on the effects of the Gold Standard (note that Keynes also emphasized the role of the Gold Standard, to which he referred to as a 'barbarous relic'). 

And by the way that means that the consensus is that a demand shock caused the Depression. Note that a few authors have pushed the Real Business Cycle (RBC) story in recent times. For example, Prescott argues that:

“In the 1930s, there was an important change in the rules of the economic game. This change lowered the steady-state market hours. The Keynesians had it all wrong. In the Great Depression, employment was not low because investment was low. Employment and investment were low because labor market institutions and industrial policies changed in a way that lowered normal employment.”

In other words, the changes in incentives led to less supply of labor and less demand for investment goods by firms. Same ideas have been put forward by Cole and Ohanian, and by popularizers like Amity Shlaes in her The Forgotten Man. However, most of the New Deal regulations that the revisionists abhor, actually came to late to have caused the Depression. They generally try to explain the 'slow' recovery (growth averaged 8% in the first FDR term) as a result of the New Deal, and leave the question of what was the supply side shock that caused the Depression.

Lucas, who converted to RBC at some point in the 1980s, asked (cited here) poignantly: "Where is the productivity shock that cuts output in half in that period? Is it a flood or a hurricane? If it really happened, shouldn't we be able to see it in the data?" For that reason Lucas still believes, like Friedman, that the Fed did it. And if one is going to blame regulation for the duration of the Depression, one must deal with the fact that in the 1950s, if anything, labor and financial regulations were as stringent, if not more, than in the 1930s and unemployment was fairly low.

A more subtle critique of the conventional view, and its emphasis on the Gold Standard comes from Christina Romer. She suggests that the path of American output and unemployment before 1931 can be explained quite well with only domestic factors, and that even after 1931, international factors affected American economic conditions mainly through their impact on American policy decisions. Note that that this is not incompatible with Kindleberger's view that the US, in the process of becoming the hegemon, was central for the global economic collapse.

This should cast some doubts on FE's conclusion that:

"putting all the blame on Wall Street for the Great Depression -- or on bankers in the current crisis -- does not stand up to historical scrutiny. The responsibility may more properly lie in a complex combination of factors, like how global financial systems are structured."

Romer notes that in the US the collapse in consumption was more important than in other economies (harking back to Peter Temin's reply to Friedman that it was the collapse in consumption, not monetary policy, that caused the Depression). And the collapse in the demand for consumer durables, which depended on credit for their purchase, was affected by financial conditions. Romer argues:

“Both the initial recession in the United States in the summer of 1929 and the acceleration of the decline in late 1929 and 1930 are ultimately attributable to the stock market boom and bust of the late 1920s. The stock market boom is the prime explanation for why the Federal Reserve was pursuing tight monetary policy starting in 1928. The stock market crash is the prime source for the collapse in durable goods purchases starting in November 1929.”

So the financial bubble and the crash did matter, and John Kenneth Galbraith (among others) was correct about it. I would add that income distribution, which we know from Piketty and Saez, was as bad in the 1920s as now, did also play a role in the bubble and the expansion of private indebtedness. So Wall Street was to blame indeed, as much as it should be too in the recent Great Recession.

* Kindleberger, in his classic The World in Depression, goes further and suggests that it was the absence of an hegemon that acted as a source of demand in situations of crises (distressed markets), as a stabilizer of exchange rates, and as a source of international finance (an international lender of last resort) that caused  the Depression, since the UK was incapable and the US unwilling to assume that position. The Depression was essentially an hegemonic crisis.

PS: For further reading my forthcoming paper in the Cambridge Journal of Economics here.

Balance of Payments Adjustment and the Euro Crisis

It is worth remembering that according to Eichengreen (1996, p. 25) “the most influential formalization of the gold-standard is the price-specie flow model of David Hume. Perhaps the most remarkable feature of this model is its durability: developed in the eighteenth century, it remains the dominant approach to thinking about the gold standard” (for a critique go here).

The idea is that, at least in a fixed exchange rate regime, inflation and deflation do all the work of adjusting the balance of payments (BOPs). Modern versions add credibility and all that (which includes austerity) for the stabilizing flows of capital to work. Why do I bring this up? Because of Martin Wolf's column (subscription required) in the Financial Times today, which has the graph below.

Note that the countries in crisis, Greece, Ireland, Italy, Portugal and Spain have already adjusted their BOPs (in this case their trade balances). Yet the adjustment is more Keynesian than Humean, or to be more precise, it follows the analysis of A.G. Ford, who argued that peripheral countries, like Argentina, adjust their current account deficits with a good old recession not by lowering domestic prices. And yes, Wolf is right, the specie-flow would only work in a parallel universe.

A Tale of Two Depressions?

Eichengreen & O'Rourke wrote back in 2009 a very popular post on Vox.eu here, updated in 2010 (and here) which suggested the different nature of the two events (one depression and a recession really). Their data was global. Looking at GDP, rather than industrial output, in the US alone, we have something like the figure below (data from Measuringworth).

Note that it's hard to compare the two events. Clearly automatic stabilizers like unemployment insurance do work. Also, the Fed reaction and the fiscal stimulus worked quite well, at least in precluding a collapse of output of the same proportions. And yes the pace of the recovery is much slower now than what it was when it finally started in the 1930s.

Demographic transitions, Malthusian traps and supply constrained growth

Gregory Clark's book The Farewell to Alms re-popularized the Malthusian model (for the relevant chapter go here). The basic idea is that population dynamics and the so-called demographic transition do have an important impact on economic growth. Robert Malthus' idea is relatively well known, even if there is an incredible amount of confusion in the way it is explained by modern neoclassical authors.

As all classical authors, Malthus assumed that real wages tended to be at subsistence levels. He emphasized more than others, eg. Smith or Marx, the physiological elements associated to subsistence, and his theory of population influenced David Ricardo (friends sometimes will push you in the wrong direction, but this should not be exaggerated; Ricardo was no Malthus). And this has nothing to do with some Iron Law of Wages (again this reflects the fact that mainstream authors like Clark have limited, to say the least, understanding of the surplus approach; for Ricardo and other classical authors on real wages see Stirati here).*

At any rate, Malthus notion was that if wages increased, population growth would ensue and bring them back to subsistence levels, hence real wages could not grow. In the mainstream story this is connected with lack of growth of income per capita. The economy would be in a Malthusian trap.** Population growth is bad in this Malthusian world, that is why the good reverend, like modern Republicans (and I would assume more than a few neoclassical economists), was for abstinence and delayed marriages.

The idea is that higher population, for a given technology, leads to more mouths to feed. Classical ideas that suggest that the extent of the market (and, hence, population) might have a positive impact on the division of labor (who said that?) are not discussed by modern neoclassical authors (also explains their dislike of Kaldor-Verdoorn Law). At any rate, the modern theory of economic growth is still dominated by supply-side explanations, in which technological progress is either exogenous (Solow) or endogenously determined by spending on education (or some variation of the topic in the endogenous growth literature).

Demographic transitions, in which the rates of mortality and fertility decline have in this view particular effects on growth. The notion is that the initial fall in fertility leads to a lower youth dependency ratio (less youngsters to feed), and is growth enhancing. Further, mainstream authors assume that workers in the labor force would have a higher savings rate (given life cycle hypothesis arguments) and that would lead to investment (yes, Say's Law). Jeff Williamson suggests (see here) that this, the so-called demographic dividend, in part explains the Economic Miracle in parts of Asia.

On the other hand, the same population dynamics leads to higher old age dependency ratio, and that should have (even if evidence is mixed on that) a negative impact on growth. Note that Eichengreen and his co-authors, suggest that slowdowns in growth are associated to falling productivity (not population dynamics), even if they measure that using Total Factor Productivity (which is not a measure of productivity, but of the changing patterns of functional income distribution; see here).

Mind you there is a more reasonable, demand-led, explanation for why population transitions might have an impact on growth. As the process of structural transformation from agricultural to industrial societies continues, more workers are incorporated in industrial jobs with higher pay, and even if income distribution might worsen, the expansion of urban population (and higher real wages) means an expansion of demand. Obviously once the transition is done, the expansion of real wages (not just from the rural workers moving into cities) must continue. In this case, the main cause for the limits to real wage expansion (demand expansion), and continued growth, come from the balance of payments, since higher wages and consumption lead to increasing imports.

There are many more limitations in the resurgence of Malthusian views in the mainstream. Including the Social Darwinist flavor of Clark's ideas, as noted by Deirdre McCloskey (here). But I'll leave those for another post.

* The main point that mainstream intepretations of classical authors miss is that there is no systematic decreasing relation between real wages and employment in Ricardo and other classical economists, something that Stirati makes clear.

** Note also that some authors suggest that this is the basis for Carlyle's epithet the 'dismal science' for Political Economy. As noted before by Vienneau (see here): "Thomas Carlyle did not coin the phrase 'The dismal science' to refer to Thomas Malthus's anti-utopian theory of population."

Newton and the Gold Standard

My limited knowledge of Newton's involvement with the Gold Standard, as the Master of the Mint, came from Barry Eichengreen's discussion in Globalizing Capital [a book that is very influential in spite of his claim that a variation of Hume's specie-flow is still the best view of balance of payments adjustment; for a critique go here or here; mind you the book is the best description of the mainstream views of balance of payments adjustment in historical perspective]. In that book he suggests that Newton got the price of silver incorrectly against gold, a too low gold price for silver, with the consequence that Britain moved effectively into a Gold Standard by accident. In this view, the new supply of Gold from Brazil, and the undervalued price of silver explain the slow move into a Gold Standard.

The more recent book by Thomas Levenson, not an economist (that's often good), Newton and the Counterfeiter, which is more of a police story, suggests that Newton was well aware of the correct exchange rate between gold and silver, but was prevented from changing it by political reasons. He cites two reports by Newton an early one from the mid-1690s arguing that gold was cheaper in France leading to silver scarcity in England, and another one from 1717 or so suggesting that the problem was that gold was much cheaper in China and India, and that arbitrage opportunities moved silver eastward. Other than that Newton seems to have been favorable to paper currency an other financial innovations (getting famously entangled in the South Sea Bubble).

The Real Bills Doctrine and the Persistence of Monetarism

The Real Bills Doctrine (RBD) suggests that the central bank passively provides liquidity to the system.* The name of the doctrine results from the notion that banks only discount real bills, associated with the functioning of the economy, in particular for international trade that was essential in the 18th century when the doctrine was developed. In terms of central banking policy, the RBD fundamentally meant that there was no need to lean against the wind, and money supply should adjust to the needs of trade. It is generally presumed that in the 1930s a more activist position – leaning against the wind – was developed.

In particular, Allan Meltzer in his A History of the Federal Reserve seems to believe that the RBD was the main cause of the Depression and that its abandonment was essential for the recovery from the Great Depression, since, in his view, the increase in money supply was the crucial element in the recovery, rather than the New Deal policies. Meltzer (2003, p. 282 and p. 357) says: "the main reason for the failure of monetary policy in the depression was the reliance on an inappropriate set of beliefs about speculative excesses and real bills," and "passage of the 1932 legislation recognized that the real bills doctrine did not provide the flexibility (elasticity) to expand the note issue or prevent the crisis from deepening." In other words, the RBD led to too much contraction, and the Glass-Steagall Act signaled its abandonment.

This view, both of the causes of and the recovery from the Depression and about central banking practices, has been generally accepted and is canonical among economists and policy makers, Old Monetarists like Meltzer, or New Keynesians like Christina Romer, by the way. Friedman and Schwartz's A Monetary History of the United States is the locus classicus of the monetarist view of the Great Depression. Richard Timberlake suggests (here) that the RBD, not the Gold Standard was behind the Great Contraction. Barry Eichengreen is the main defender of the view that the Gold Standard (see here), not the RBD, was behind high rates of interest and contractionary monetary policy, a view not very different from that of Keynes in the early 1930s.

I point this out, since in this view money is essentially exogenous, contrary to the RBD, but also in contrast to the conventional New Keynesian model, which assumes some version of an interest rate rule (i.e. Taylor's Rule). I've already referred to this strange persistence of Monetarist ideas when it comes to economic history (here). I guess that is why Meltzer thinks that inflation is around the corner. By the way, I suggested somewhere else that is not clear that the Fed actually abandoned the RBD in the 1930s, and that a more Keynesian approach to monetary policy does not (in fact it shouldn't) require the abandonment of an endogenous money view.

* The RBD suggests that money is created according to the needs of trade. Hence, money cannot be issued in excess, and is endogenously created by banks. Adam Smith was an early proponent of the Real Bills Doctrine. The RBD is, in a sense, an early version of endogenous money and of some aspects of MMT.

In the long run we are NOT all dead

Niall Ferguson has apologized for his offensive suggestion that Keynes' phrase on being dead in the long run was somehow related to his sexuality or the fact that he was childless (more here and here). Good for him. Note, however, that in that famous phrase from the Tract on Monetary Reform, from 1923, Keynes was still very much a conventional Marshallian author who thought that full employment would reassert itself, and that the Quantity Theory of Money (QTM) worked pretty well. In fact, it is often said that the Tract was Milton Friedman's favorite among all of Keynes' books.

The full quote says:

"But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again."

The point of the quote is that in the long run everything would be fine, since markets do get to full employment, and so, even without intervention, deflation and inflation do its magic, but the process is too long and painful, so it would be more reasonable to act in the short run. This was typical of the Cambridge version of Marginalism, which was very much in favor of government intervention to deal with market imperfections in the short run. This is true of Marshal and Pigou, as well as Robertson, and certainly Keynes, before the General Theory. Note that this does not mean, as most people think, that one should only be concerned with the short run. The point is that action in the short run facilitates the road towards the fully adjusted equilibrium in the long run.

This was still essentially Keynes' view by 1930, when he published the Treatise on Money, a book that is at heart Wicksellian [so at least he got rid of the QTM in this book], and that suggests that unemployment results from a monetary rate of interest that is too high with respect to the natural rate, in practice as a result from the Gold Standard rules, which Keynes wanted to abandon. [This precedes the modern views that the Gold Standard caused the Depression, by the way, as say defended by Barry Eichengreen]. This was a cyclical crisis that could be solved by reducing the monetary rate of interest, and in the short run employment programs, something Keynes defended in Can Lloyd George Do It?

The point of the General Theory (GT) is that there is no natural rate of interest, meaning that reducing the rate of interest would not bring investment to the full employment level of savings, and that the crisis was caused by lack of demand. The equilibrium between investment and savings was determined by variations in the level of output, and in the long run we are not self adjusted to full employment. Hence, the very logic of the phrase above is debunked by Keynes, when he became Keynesian, so to speak, and got rid of the old modes of thinking. Intervention is not needed because in the long run we are dead, but because the long run depends on the short run, and we tend to fluctuate around a sub-optimal position.

So in the long run we are NOT dead in the GT, in the absence of counter-cyclical policies we are all in deep trouble. Keynes was very much concerned about the possibility of capitalism to promote well being for all in the long run. In other words, not only is Ferguson wrong about the effects of Keynes' sexuality and lack of children on his economic reasoning, but he does not even get the point of the phrase.

PS: The best book to understand the theoretical changes in Keynes' views is still Edward Amadeo's  Keynes' Principle of Effective Demand, his PhD dissertation, supervised by Murray Milgate, and co-supervised by Lance Taylor, published with an intro by Vicky Chick.