The Euro: a Step Toward the Gold Standard?

by Andreas Hoffmann (University of Leipzig)

In a recent piece Jesus Huerta de Soto (2012) argues that the euro is a proxy for the gold standard. He draws several analogies between the euro and the classical gold standard (1880-1912). Like when “going on gold” European governments gave up monetary sovereignty by introducing the euro. Like the classical gold standard the common currency forces reforms upon countries that are in crisis because governments cannot manipulate the exchange rate and inflate away debt. Therefore, to limit state power and to encourage e.g. labor market reforms he views the euro as second best to the gold standard from a free market perspective. Therefore, we should defend it. He finds that it is a step toward the re-establishment of the classical gold standard.

There has been much criticism of the piece that mainly addresses the inflationary bias of the ECB. I actually agree with much of it. In particular, imperfect currency areas have the potential to restrict monetary nationalism. This can be welcomed just as customs unions that allow for free trade (at least in restricted areas). But I have some trouble with De Soto’s conclusions and the view that adhering to the euro (as did adhering to gold) gives an extra impetus for market reform – in spite of the mentioned e.g. labor market reforms in Spain.

Krugman Redistribution or Ponzi Scheme

by Chidem Kurdas

A nice thing about Paul Krugman, he does not mince his words. Thus his new book, End This Depression Now!, repeats as boldly as possible the central point he’s repeatedly made in his New York Times columns and blogs for years. Namely, governments have to spend a lot more. They have to run gigantic deficits, much more than they’re doing now. His penchant for going straight for the jugular means that the full implications of the scheme he advocates are crystal clear.

M. Friedman Goes to Washington

by Chidem Kurdas

Early in his career, long before he became a Nobel prizewinner and the household name for free market economist, Milton Friedman worked for the US Treasury. The following anecdote is from his 1998 memoir with his wife Rose, Two Lucky People.  This revealing example of how public officials operate illustrates, in Friedman’s words, “the interaction between bureaucratic self-seeking and supposedly objective analysis.”  It complements my previous post on whether politicians pursue the public good.

World War II had started. For Friedman and others at the Treasury, the main mission was to figure out how to finance the war effort while avoiding inflation. 

No Way to Escape for the Swiss National Bank

by Andreas Hoffmann and Gunther Schnabl

It came as a surprise to many: the Swiss National Bank announced an exchange rate target. Accordingly, the Swiss franc will be held above the level of 1.20 francs per euro. Switzerland gives up a part of its sovereignty, when the ECB makes bad press in buying trash-rated euro area government bonds to support unsustainable national budgets.

But, particularly in an environment of global excess liquidity originating in too-easy monetary policies in major advanced economies, small open economies have incentives to stabilize exchange rates.

Stark quits ECB

by Andreas Hoffmann

This is good news for inflationists.

I am shocked that Jürgen Stark quit his job at the European Central Bank. Usually it is a good thing when central bankers quit their job – or at least it does not make a difference. But Jürgen Stark is known as an inflation hawk. Jürgen Stark – like the Mark writes Die Welt.

In my opinion, the main difference between the ECB and the Fed is that the ECB has people like Stark. Unfortunately, there are only a few.

He is opposed to cheap money policies. A while ago, he openly warned of rolling bubbles caused by too low interest rates in the media. Thus, he suggested a timely turn-around in interest rate policy. Recently he voted against further bond purchases of the ECB. More on this recent event can be found here.

Coming shortly after Axel Weber resigned due to his disagreement with Trichet’s policies, Europe’s anti-inflation block is now shattered. Something terrible must be going on at the ECB. I wonder where the ECB is heading?

Where is the Bubble?

by Jerry O’Driscoll  

The monetary analysis of the housing bubble focuses on the impact of low – even negative – real rates of interest on housing demand.  That theory suggests the Fed must be inflating new bubbles with its continued policy of a near-zero federal funds rate. Skeptics ask where are the bubbles?

In today’s Wall Street Journal Business World column, Holman Jenkins answers with “Plane Crazy.” He specifically points to the recently announced deal in which debt-burdened and unprofitable American Airlines will take delivery of 460 new planes.  How did American pull this off?

Boeing and Airbus will share the order and each will finance a substantial portion of the purchase. “Think about it this way: Two rival banks get together and offer you a ‘no-doc’ mortgage for 115% of the value of your home,” writes Jenkins. He characterizes this as an opportunity for a “go-for-broke shot at a turnaround” for American. It’s an offer the airline could not refuse.

There are an ample number of other candidates for a bubble: gold, oil, farmland in the Midwest and perhaps the S&P. The entire world is awash in cheap dollars and much of the impact of the Fed’s policy has been to inflate bubbles overseas. That can be seen directly with the AA deal. More than half the order is going to Airbus, a European company.

The Fed’s easy-money policy was supposed to stimulate the U.S. economy and produce jobs for Americans. Fed policy has produced prosperity and jobs, just not in the United States.

Does one size fit all?

by Andreas Hoffmann

In a recent article in the WSJ, David Wessel sees a “fundamental problem” in the euro zone’s one-size-fits-all policy.

We know from Mundell (1961) that a one-size-fits-all monetary policy cannot guarantee low inflation and unemployment in all members of a heterogeneous currency area, given e.g. labor markets are not fully flexible as in the euro area.

In general, capital market integration and free capital flows in two regions have the tendency to bring about convergence of real – not necessarily nominal – interest rates (assuming no risk premium) as capital is allocated to its best uses. But in a currency area, like the euro area, nominal interest rates are the same everywhere as they are set by a central authority. Thus, real interest rates can be zero or even negative in regions that experience higher inflation, while they are positive in regions with lower inflation. Then policy is too expansionary in some regions and too tight in others, while the average inflation rate may stay relatively stable at the target level.

Easy Money, Emerging Market Miracles and the Revival of Industrial Policies

by Andreas Hoffmann and Gunther Schnabl

While most advanced economies continue to suffer from high unemployment and record debt levels, monetary expansions in the advanced economies feed a tsunami of carry trades, hiking asset and raw material prices and accelerating growth rates in emerging markets from Brazil over the Middle East to China. While capital inflows drive miraculous catch-ups in many corners of the world – having learnt the lesson for the recent mega-crisis – the monetary authorities in the emerging markets are aware of the risk of financial market exuberance. They aim to prevent inflation and bubbles by absorbing surplus liquidity and tightening credit growth.

Yet by doing so, they cause distortions in the real sectors of their economies, which are not on the radar screen of the now ballooning financial supervision bodies.

Let Them Eat Chips

by Jerry O’Driscoll

In today’s Wall Street Journal, David Wessel (“Capital” column, A5) revisits the question of whether current Fed policy is inflationary. He correctly states the Fed’s position is that inflation is caused by expectations. Inflation will stay low if people expect it to stay low.  He quotes Fed Chairman Bernanke: “The state of inflation expectations greatly influences actual inflation and thus the central bank’s ability to achieve price stability.”  

The Fed chairman of course has the causation precisely backwards.

Sand Castle Monetary Policy

by Mario Rizzo  

Chairman Ben Bernanke says don’t blame the Fed for rapidly increasing commodity prices and probable bubbles forming in many investment markets throughout the world. I am just doing what is necessary for a recovery in the US and that is in the interests of the world. (See “Bernanke Defends US Policies” Wall Street Journal, February 19-20).  

The reality is different.