TODAY'S recommended economics writing:
• Tradable sectors in euro zone periphery countries (Vox)
• Some notes on Keynes' 1919 "grand scheme" (Edge of the American West)
• Senior IMF economist resigns, cites suppression and Europe bias (Real Time Economics)
• Robin Hanson on prediction markets (Scott Sumner)
• The philosophy of "you didn't build that" (Wonkblog)
Readers' comments
The Economist welcomes your views. Please stay on topic and be respectful of other readers. Review our comments policy.
Sort:
[1/3]
Re Tradable sectors in euro zone periphery countries (Vox)
This is also a case of what Keynes would call the humbug of finance. Most of the EM economies are short of own capital and hence an EM economy invite capital from abroad in an attempt of increasing its gross export. This leads to an increase in the gross external debt and unless its net export expands an increase in the gross external debt is likely to result in an increase in the net external debt. These are the major premise in reading the present situation and understanding the following accounts.
When markets found the yields not as high as they had expected, the marginal efficiency of capital (MEC) collapsed and the Great Recession started. The Great Recession is a recession because the MEC has been staying so low that an increase in the volume of the investment relative to effective demand has been requiring a considerable and rather unreal reduction in the market rate of interest (as opposed to the key rate of interest). As this requirement is rather unreal, the demand for money by what Keynes would call the transactions motive has been staying too low. Investors have rarely found opportunities of investment in the field relative to effective demand. This means that an attempt of increasing in the volume of money (e.g. QE) as a whole would soon result in an increase in the volume of money by what Keynes would the speculative motive after optimism comes back to markets and thus the players in the global banking system purchase assets and thus increase the volume of the investment relative to effective demand only for a short time – until they eventually find the optimism to have been delusional. This is a short-time move because the schedule of the MEC isn’t revived to a sufficient extent by the policy and the revival, if to any extent, is also short-lived. The revival is short-lived because a MEC is determined by the expected returns from a capital-asset and its replacement cost. (Keynes calls replacement cost supply price). This means a considerable increase in the liquidity preference at the global level. Keynes explains this scenario, particularly in the Chapter 22 of The General Theory of Employment, Interest and Money.
Due to the dramatic rise in the liquidity preference, the global banking system retreat from EM economies, and thus those economies has been suffering for higher costs of capital. In case of a typical EM, the capital famine could even be intensified by an attempt of reducing the market rate of interest at home, because capital used to come largely from abroad, i.e. the foreign banking system, particularly in the form of an increase in the (gross) external debt. On the other hand, a higher market rate of interest isn’t necessarily likely to attract players of the global banking system when the liquidity preference is so high today. They prefer what they regard as safe havens to high nominal yields. Thus wrongly reading the situation by the authorities of an EM country has resulted in a dramatic decrease in the effective demand at home. EM economies are desperately in need of capital to produce goods and services to export to pay interest to the foreign banking system but that is hardly been successful because the foreign banking system is not willing to invest their money into them due to the present position of the schedule of their MEC and the present state of the global liquidity preference. Thus investment has been insufficient in EM economies and hence their effective demand insufficient.
Inevitably, they couldn’t help underperforming.
[2/3]
That is what Keynes would call the humbug of finance. It is quite natural that what Mr Gaulier, Ms Taglioni and Mr Vicard call the tradable sectors of a number of EM economies, within the Eurozone or not, may in fact be of high potential productivity and high potential competitiveness. The sectors cannot mark satisfying yields in a state of the humbug of finance because they find it increasingly hard to raise their own funds for increasing their production. If they are still willing to export they will have to take another means of reducing the cost of production. One idea that everybody would dream up is to reduce the wages level drastically, but as Mr Gaulier, Ms Taglioni and Mr Vicard say and Keynes points out in the Page 269 (i.e. The first paragraph of the Chapter 19-III) of The General Theory of Employment, Interest and Money, that option is politically unreal in a democracy.
In a comment I posted the other day to another entry I quoted Joan Robinson’s accounts on the humbug of finance. Let me quote them again (though my comment becomes 3-pages long):
“There is a particular problem at the present time which needs to be introduced into the discussion, because it is a very clear example of how understanding a problem at the present time of the indebtedness of the third world countries. Here there is a perfectly ridiculous situation in the world. In the industrial countries there is unemployment and underutilisation of plant, and, in particular, extreme overcapacity for the production of steel. So there is unemployment and low profits in the industrial world for lack of demand. There is the third world which is supposed to be developing: development needs investment and investment needs steel. Here is an enormous real demand and an enormous real oversupply.
“They cannot be brought together. Why?
[3/3]
“They cannot be brought together because of the lack of finance. The third world countries are already deeply indebted. A great part of their exports have to be used to service the debt they have already incurred. So they are not able to carry forward a development plan for lack of finance and the developed countries are unable to produce the steel and the machinery which these peoples need because they have no purchasing power. This is a prime example of what Keynes called the humbug of finance. The whole world has tied itself up in this totally unreal tangle and why? The reason is that during the great inflationary boom, particularly in 1972 and 1973, a number of respectable banks were lending to the third world countries, and part of the debt which they now have to service, is debt to the western banking system, so that any reasonable solution, any way of reducing the amount of debt and starting demand again, would threaten the very basis of the financial problem.”
Perhaps, that is the fundamental problem inherent in the global open system where capital and goods are freely moving but you have to take into account balance of international payments. There a situation is likely to take place that the huge purchasing power or potential consumption in the economies abundant in own capital doesn’t match the huge potential of production in the economies thirsty for capital – due to the humbug of finance.
That is why Keynes advocated an International Clearing Union – for an organised development of free economy. In case of the Eurozone, a Fiscal Union should sooner or later be established. A lot of people misunderstand Keynes and his sort of economists, e.g. Joan Robinson, Richard Kahn, Michal Kalecki, Hirofumi Uzawa, etc.
Re: Some notes on Keynes' 1919 "grand scheme" (Edge of the American West)
I wonder if Keynes would propose the same today with, unlike in 1919, the United States being indebted so much. He might, even though the US is owing so much to the Chinese and the Japanese. Then who would really be ‘holding the bag’ today?
As for Mr Rauchway’s previous post, I say Keynes’s carrier ended with a dismal failure as well – his effort to prevail upon the peacemakers at Savannah, Georgia to establish an International Clearing Union, idea that he formulated as early as in 1942. In 2009 the author of Mostly Economics appeared surprised to find Nadia Piffaretti of the World Bank sort of excavating among Keynes’s works the idea of International Clearing Union which I had known by then actually (I re-started to study Keynes’s visions in 2007 when I came across Uzawa Hirofumi’s books in Japan):
http://mostlyeconomics.wordpress.com/2009/10/20/revisting-keynes-idea-of...
Piffaretti then ‘looks at more eco history and why it was not accepted’. But I had already known why the idea was not accepted, and you may as well easily guess why not after you have read Mr Rauchway’s post about the 1919 case.
The same is said of the euro peripheries. The euro area needs its own version of International Clearing Union – perhaps in the form of a Fiscal Union.
By the way, the issue is relevant with what Keynes calls the humbug of finance. Try and read my comment where I quoted Joan Robinson’s words:
http://www.economist.com/blogs/freeexchange/2012/07/euro-crisis-1?page=1...
All these things are easily to understand analytically once you have grasped the ‘general’ system of economics of the Post-General Theory Keynes which, unlike the Pre-General Theory Keynes, is not only about stimulus, and hence are, after all, rather a political issue.
As for the question I presented in the first paragraph, a similar question is dealt with in the abovementioned Piffaretti’s essay (p. 22):
“How would a Keynes Plan work today? The creation of an International Clearing
Union would need to take into account the existence of current large global imbalances, most notably between the US and Asian countries. This is not dissimilar from the situation in which Keynes was working, when after World War II the US presented a substantive surplus….”
Then I speculate that not only the US Congress but also China, the biggest creditor to the US Federal Government, will form the political obstacle.
Japan, by far the world’s biggest holder of external claims? You may forget Japan. As Zbigniew Brzezinski says, Japan is a ‘fragile flower’ and, I bet, will remain so for ever. You know this issue is largely political.
As Mr Rauchway’s blog says, “history can save your ass” indeed.
I doubt the IMF could have changed the course of events in the Big EZ. Had they been more emphatic, I doubt anyone would have listened to them.
Besides, they didn't see the problem early enough. Warning the farmer after his horses have escaped the barn is not much help. IMF economists needed to be much more forward looking than is possible for mainstream economists. Their problem is bad economic theory.
When you're only theory of crises is @#$% happens!, your aren't much good to anyone.