More Wisdom from CPK
By Arnold Kling
The Kipper- und Wipperzeit [according to Wikipedia, translates to tipper and see-saw time] of 1619-1623…got its name from the action of money-changers who took the debased coins that were coming from the rising number of princely mints and rigged their scales as they sought to exchange bad money for good with naive peasants, shopkeepers, and craftsmen. Rapidly rising debasement spread from state to state until the coins used in daily transactions became worthless.
Will that turn out to be a metaphor for contemporary government behavior?
More CPK below the fold.
One feature of many liquidity crises is that interest rates seem extremely high, especially beecause they are always expressed as a percentage per annum when they are really premiums for liquidity for one, tow, or at most a few days.
I remember that when risk spreads widened in 2008, someone wrote that the increase in the risk premium was not as bad as people were making it sound. The point was that if there is a 1 percent chance of default on a 10-year instrument and on a one-week instrument, the one-week instrument requires a much higher interest rate, because you earn the risk premium for a much shorter period.
In a chapter called “International Contagion,” CPK reviews the sequence of banking and currency crises in the 1930s, and concludes on p. 140:
This history does not lead to the conclusion that the 1930s depression originated in the United States.
The hallmark of the 1930s was a sequence of currency crises, first the Austrian schilling, then the German mark, then the British pound, and then the U.S. dollar; finally the speculative pressure was deflected to the gold bloc currencies–the French franc, the Swiss franc, and the Dutch guilder. By the end of the 1930s, the alignment of currency values was similar to the alignment at the end of the 1920s, although the price of gold in terms of the U.S. dollar and most other currencies was 75 percent higher.
since the mid-1960s…These decades have been the most tumultuous in international monetary history in terms of the number, scope, and severity of financial crises. More national banking systems collapsed than at any previous comparable period…In some countries the costs to the taxpayers of providing the money to fulfill the implicit and explicit deposit guarantees amount to 15 to 20 percent of their GDPs. The loan losses in most of these countries were much greater than those in the United States in the Great Depression
Remember, of course that this pre-dates the most recent financial crisis. p. 278-279:
There have been more foreign exchange crises than in any previous period of comparable length, beginning with the breakdown of the Bretton Woods system…The range of movement in the foreign exchange values of many national currencies …was much larger than in any previous period…the scope of ‘overshooting’ and ‘undershooting’ of currency values relative to the values inferred from the differences in national inflation rates was much larger than in any previous period
Finally, on p. 279:
There were more asset bubbles between 1980 and 2000 than in any earlier period.
This instability was fueled by money and credit. p. 280:
The financial tumult since the early 1970s resulted from the impacts of monetary shocks and credit market shocks on the directionn and scope of the flows of funds across national borders.
These manic-type shocks resulted from extensive changes in the preferences of investors for securities and other assets denominated in different currencies. Investors became concerned that the U.S. inflation rate would increase in the 1970s; they sold U.S. dollar securities to get the funds to buy securities denominated in the German mark, the Swiss franc, and the British pound, and the U.S. dollar depreciated much more quickly than would have been inferred from the excess of the U.S. inflation rate…Early in 1980 investors became convinced that the U.S. inflation rate would decline; they sold securities denominated in the German mark and other foreign currencies to get the funds to buy U.S. dollar securities and the U.S. dollar appreciated at a rapid rate.
A couple of other notes. First, CPK emphasizes how steep the Japanese real estate bubble was. We think that in the U.S., house prices were overvalued by, what, 30 or 40 percent? Japanese real estate was overvalued by several hundred percent. Suppose that, from an Austrian or PSST perspective, the distortion in the real economy (the creation of unsustainable patterns of trade) is proportional to the distortion in asset prices. Then it is no wonder that Japan had a long period of poor economic performance. Rather than view their problem as a “liquidity trap” or “insufficient stimulus,” you could view it as a really, really, painful adjustment to a really, really distorted real estate market.
Second, CPK suggests that flexible exchange rates are at best a mixed blessing. The virtue, according to monetarists, is that they allow countries to pursue separate monetary policies. In theory, this gives you a tool to manage your relative national wage rate without workers having to change their approach to wage demands. This should permit the central bank to stabilize GDP growth and employment. In practice, however, the reaction of markets to differential rates of monetary growth is so strong that for the world as a whole it seems that flexible exchange rates are destabilizing.
One of the patterns in the data is that the flow of savings to a country was associated with an economic boom;this was evident in Mexico and other developing countries in the 1970s, in Mexico, Thailand, and other Asian countries in the first half of the 1990s, and in the United States in the second half of the 1990s. The appreciation of the currencies of this group of countries reduced the inflationary pressures associated with a robust economic expansion
In some sense, when global savings flow into a country, asset prices are boosted while tradable goods prices are suppressed. If the monetary authority is following inflation as measured in the prices of goods and services, it gets a signal that things are just fine. But the inflation is taking place in asset prices, and maybe things are not so fine.