Rethinking the Global Money Supply - Economics Theory

The People’s Bank of China jolted the financial world in March with a proposal for a new global monetary arrangement. The proposal initially attracted attention mostly for its signal of China’s rising global economic power, but its content also has much to commend it.

A century ago almost all the world’s currencies were linked to gold and most of the rest to silver. Currencies were readily interchangeable, gold anchored exchange rates and the physical supply of gold stabilized the money supply over the long term.

The gold standard collapsed in the wake of World War I. Wartime financing with unbacked paper currency led to widespread inflation. European nations tried to resume the gold standard in the 1920s, but the gold supply was insufficient and inelastic. A ferocious monetary squeeze and competition across countries for limited gold reserves followed and contributed to the Great Depression. After World War II, nations adopted the dollar-exchange standard. The U.S. dollar was backed by gold at $35 per ounce, while the rest of the world’s currencies were backed by dollars. The global money stock could expand through dollar reserves.

President Richard Nixon delinked the dollar from gold in 1971 (to offset the U.S.’s expansionary monetary policies in the Vietnam era), and major currencies began to float against one another in value. But most global trade and financial transactions remained dollar-denominated, as did most foreign exchange reserves held by the world’s central banks. The exchange rates of many currencies also remained tightly tied to the dollar.

This special role of the dollar in the international monetary system has contributed to the global scale of the current crisis, which is rooted in a combination of overly expansionary monetary policies by the Federal Reserve and lax financial regulations. Easy money fed an unprecedented surge in bank credits, first in the U.S. and then elsewhere, as international banks funded themselves in the U.S. money markets. As bank loans flowed into other economies, many foreign central banks intervened to maintain currency stability with the dollar. The surge in the U.S. money supply was thus matched by a surge in the money supplies of countries linked to the U.S. dollar. The result was a temporary worldwide credit bubble, followed by a wave of loan defaults, falling housing prices, banking losses and a dramatic tightening of bank lending.

China has now proposed that the world move to a more symmetrical monetary system, in which nations peg their currencies to a representative basket of others rather than to the dollar alone. The “special drawing rights” of the International Monetary Fund is such a basket of four currencies (the dollar, pound, yen and euro), although the Chinese rightly suggest that it should be rebased to reflect a broader range of them, including China’s yuan. U.S. monetary policy would accordingly lose its excessive global influence over money supplies and credit conditions. On average, the dollar should depreciate against Asian currencies to encourage more U.S. net exports to Asia. The euro should probably strengthen against the dollar but weaken against Asian currencies.

The U.S. response to the Chinese proposal was revealing. Treasury Secretary Timothy Geithner initially described himself as open to exploring the idea; his candor quickly caused the dollar to weaken in value—which it needs to do for the good of the U.S. economy. That weakening, however, led Geithner to reverse himself within minutes by underscoring that the U.S. dollar would remain the world’s reserve currency for the foreseeable future.

Geithner’s first reaction was right. The Chinese proposal requires study but seems consistent with the long-term shift to a more balanced world economy in which the U.S. plays a monetary role more coequal with Europe and Asia. No change of global monetary system will happen abruptly, but the changes ahead are not under the sole control of the U.S. We will probably move over time to a world of greater monetary cooperation within Asia, a rising role for the Chinese yuan, and greater symmetry in overall world monetary and financial relations.

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Peter Schiff on Fox Business Channel 03 July, 2010 Barry Horowitz,

03 July, 2010.

Excellent panel, great content. As always Peter Schiff stole the show, Barry Harrowitz is excellent also.

The current economic contraction longest since 1929 Economics Theory

The current economic contraction began in December 2007 with unemployment at 5.0 percent. Joblessness climbed slowly month after month until it peaked at 10.1 percent in October 2009. Today, according to the June report from the Bureau of Labor Statistics, unemployment stands at 9.5 percent. Congress, the White House, and the media have hammered away at this near double-digit jobless rate for months in part because President Obama insisted that joblessness would not climb above 8 percent if his stimulus package were approved. Thus, most Americans including those who have not been personally touched by the economic slump are aware that the last time joblessness reached 10 percent was in the early 1980s. However, the public probably does not know that the current contraction very likely is the longest on record since the 43-month contraction in August 1929-March 1933.

The official agency that dates the business cycle in the United States is the Business Cycle Dating Committee of the National Bureau of Economic Research. Unlike many others, the Committee does not define a recession as two consecutive quarters of a decline in GDP. Instead it defines a contraction as a significant decline in economic activity across the economy that lasts more than a few months as indicated by real GDP, real income, employment, industrial production, and wholesale-retail sales. It has not yet determined the date of the trough in economic activity that identifies the end of the current contraction.

If the Committee determines that the trough came in May 2009 the current contraction would have lasted 17 months and would become the longest on record since 43-month contraction in August 1929-March 1933. Longer than the 16-month contractions in November 1973-March 1975 and July 1981-November 1982.

Since the jobless rate to date has not fallen below the May 2009 rate of 9.4 percent, Mayo Research Institute expects the Dating Committee to fix the end of the contraction sometime later in 2009, possibly October when joblessness hit 10.1 percent. An October 2009 trough would make for a contraction that lasted 22 months. What sets this contraction apart from the other 12 contractions since 1929-1933 is a combination of a very high unemployment rate and a nearly two-year duration.

Concerns about the size of the federal deficit and the public debt, the still fragile housing and commercial real estate markets, continuing bank failures, cash-laden investors shying away from shaky financial markets, sagging consumer confidence, the weakening of the euro, the future of deepwater drilling, contagion related to the sovereign crisis in Greece that may spill over to Italy, Spain, Portugal, and Ireland, already scheduled higher tax rates starting in 2011, not to mention geopolitical instability in Mideast, make for fears that any economic expansion following the current contraction will be cut short. In other words, we may be headed toward a double-dip recession.

There are two instances of double-dip recessions since the end of World War II: the April 1958 trough that was followed by an expansion phase that lasted only 24 months; the July 1980 trough followed by an even shorter 12-month expansion phase. In sharp contrast the last three expansion phases lasted 92, 120, and 73 months.

With the two double-dip recessions, tax cuts were the prescribed remedy though in the first case President Kennedy’s Keynesian economic advisers justified the cuts in the early 1960s as necessary to strengthen aggregate demand. In the second case President Reagan’s supply-side advisers, having lost confidence in Keynesian economics, argued the need in the early 1980s to bolster aggregate supply.

Is the United States headed toward a double-dip recession? NO, if the necessary market corrections already have taken place and prices across the board have declined sufficiently to clear away surpluses in labor, resource, product, and financial markets. YES, if those surpluses remain in place and further corrections are necessary.

It could be argued that the very duration of the current contraction has provided all the correction needed. But keep in mind that the huge contraction that ended in March 1933 did not provide all of the correction necessary to haul the U.S. economy out of the Great Depression. That 43-month contraction was followed by a 13-month contraction that got underway in May 1937.

Even the best economic analysts see the future as if “through a glass, darkly.” Even so, Mayo Research Institute hazards two forecasts, both based on the historical record. First, whether a double-dip recession is in our immediate future or not, we can say with considerable confidence that the jobless rate will remain high for several more years because economic history demonstrates that labor markets respond slowly to market corrections. To illustrate, it took 14 years for the August 1983 jobless rate of 9.5 percent to drop to 4.9 percent.

Second, whether there is a double-dip recession in our immediate future or not, we can say with even more confidence that there is another contraction further down the road. Leaving aside the war years of the early to mid 1940s, we experienced two contractions in the 1940s, two in the 1950s, one in the 1960s followed by another that began at the very end of the decade and extended into the next, one other in the 1970s, two in the 1980s, one in the 1990s, and two others more recently.

What we don’t know with any measure of certainty is when that contraction will take occur. Mayo Research Institute is inclined to think that next expansion phase will not run as long as the last three which averaged 8 years because all three were driven by the job-creating, entrepreneurial energy of the ICT revolution. Based on the 9 other expansions since the end of World War II, our best guess is that the coming expansion will peak in approximately 4 years. If as we suggested earlier the latest trough is dated sometime around May-October 2009, it follows that the coming expansion phase will top out sometime in 2013.

The historical record establishes clearly that economics has not yet figured out how to prevent a contraction. Further, economics is split on how best to cure a contraction with Keynesians, monetarists, supply-siders, and neoclassicals offering different remedies. At best we are able to alleviate some of its effects through programs like unemployment insurance until the slump ends and expansion sets in. Some argue, however, that by putting off the necessary market corrections alleviative measures such as extending the maximum duration of unemployment insurance benefits from 26 to 99 weeks make the contraction even worse.

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So what exactly is a 'double-dip' recession? Economics Theory

Concerns are rising that the economy is at risk of slipping into a "double-dip" recession.

High unemployment, Europe's debt crisis, a slowdown in China, a teetering housing market and sinking stock prices are all weighing on a fragile U.S. recovery.

So what exactly is a double-dip recession?

Robert Hall has an idea of what one looks like but no precise definition. He's chairman of the National Bureau of Economic Research, a group of academic economists that officially declares the starts and ends of recessions.

In Hall's view, a double dip is akin to a continuous recession that's punctuated by a period of growth, then followed by a further decline in the economy.

The NBER doesn't define a double dip any more specifically than that, says Hall, an economics professor at Stanford University.

In econo-speak, Hall explains: "The idea — hypothetical because it has yet to happen — is that activity might rise for a period, but not far enough to complete a cycle, then fall again, and finally rise above its original level, only then completing the cycle."

Hall says the closest the United States has come to a double dip was in 1980 and 1981. But the NBER concluded that those were two distinct, though closely spaced, recessions — "not a double dip," he says.

Not so, says Sung Won Sohn, professor at California State University, Channel Islands. Sohn says the back-to-back recessions of the early '80s fit his definition of a double dip: A recession followed by a short period of growth followed by a recession.

Brian Bethune, economist at IHS Global Insight, has a view similar to Hall's: A period in which the economy shrinks, starts growing again and then shrinks again — for at least six months.

"There is no mathematical formula; it's a judgment call," Bethune says.

The NBER has declared the economy fell into a recession in December 2007. It hasn't yet pinpointed an end to the recession. It said in April that it would be "premature" to do so.

Many other economists say the recession ended in June or July of last year. The economy returned to growth again in the third quarter of 2009, after four straight quarters of declines. More recently, the economy has added jobs in each of the first five months of this year.

Still, the threats to the recovery from overseas and at home are growing. So are the risks that the recovery will fade out. Economists say the odds of that remain low but have crept up since a couple of months ago. Analysts are downgrading their growth forecasts for the second half of this year.

In determining the starts and stops of recessions, the NBER reviews data that make up the nation's gross domestic product. The GDP measures the value of goods and services produced in the United States. The NBER also reviews incomes, employment and industrial activity.

The panel, based in Cambridge, Mass., tends to take its time in declaring when a recession has started or ended.

It announced in December 2008 that the recession had actually started one year earlier — in December 2007.

And it declared in July 2003 that the 2001 recession was over. It had actually ended 20 months earlier — in November 2001.

In President George W. Bush's eight years in office, the United States fell into two recessions. The first started in March 2001 and ended that November. The second started in December 2007; its end date is pending the NBER's determination.

The timing of the NBER's decision likely means little to ordinary Americans now muddling through a sluggish economic recovery and weak job market.

Many will continue to struggle. Unemployment usually keeps rising well after a recession ends. After the 2001 recession, for instance, unemployment didn't peak until June 2003 — 19 months later.

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