Ben's Bet

I was recently reading some economic
material on Depression of the 30s trying to figure out what Ben's bet of the
dollar means for the global economy. I began to worry my memory was
faulty, an occurrence of greater frequency these days. However, on this
matter, it wasn't my memory. Instead, I discovered "revisionist
history" had occurred, and this makes me even more nervous about
Ben's bet.

The matter I researched was the "beggar thy neighbor" policies of the
30s, where countries enacted trade tariffs, import restrictions, and
currency depreciations in the fight against economic contraction. I
had understood currency depreciation to be an important aspect of
beggar thy neighbor policies. In the early 30s, a number of countries raced to
devalue their currencies for export advantage, only aggravating global
deflationary movements. However, I found Micheal Pettis, who has some interesting insights on China, had linked to a paper being touted by the National Bureau of Economic Research entitled, "The Roots of
Protectionism." The abstract states:

Thus, the 1930s' rush to protectionism was not so
much a triumph of special-interest politics as it was a result of second-best
macroeconomic policies, the authors write. Their study "suggests that
had more countries been willing to abandon the gold standard and use
monetary policy to counter the slump, fewer would have been driven to
impose trade restrictions."

So, there it was. As monetary theory ascended, history was rewritten or
revised accordingly. Currency depreciation moved from the "beggar thy
neighbor" problem column, onto the monetary solution part of the
ledger. So, I thought, "This is what wily old Ben is thinking." I went
and looked up Mr. Bernanke's "Essays on the Great Depression," and in chapter-three(page 78), Mr. Bernanke writes:

Eichengreen and Sachs(1985) similarly focused on the
beneficial effects of currency depreciation(i.e., abandonment of the
gold standard or devaluation). For a sample of ten European countries, they showed that depreciating countries enjoyed faster growth of exports and industrial
production, than countries which did not depreciate. Depreciating
countries also experienced lower real wages and greater profitability,
which presumably helped to increase production. Eichengreen and
Sachs argued that depreciation, in this context, should not necessarily be
thought of as a "beggar they neighbor" policy; because
depreciations reduce constraints on the growth of world money supplies, they may have
conferred benefits abroad as well as home(although a coordinated
depreciation presumbly would have been better than the uncoordinated
sequence of depreciations that in fact took place).

Professor Bernanke writes:

If monetary contraction propagated by the gold standard was
the source of the worldwide deflation and depression, then countries abandoning
the gold standard(or never adopting it) should have avoided much of the
deflationary pressure. This seems to be the case.

"This seems to be the case." Now there's scientific rigor. Why
such a hedge? Because data from the 30s, particularly worldwide is
notoriously sketchy, as Bernanke writes further down, "We included
countries for which the League of Nations collected
reasonably complete data on industrial production, price levels, and
money supplies." Hey-ho - "reasonably complete data," good enough for
the science of economics.



Both Professor Eichengreen and Professor Bernanke state the data show
countries which abandoned the gold standard, that is depreciated their
currencies, were the first to mitigate deflationary problems. First,
the data remains at best sketchy to come up with any grand conclusions,
and in fact if it is of value, proves "beggar thy neighbor" worked -- if you acted first.



Secondly, even if the data is of much value, the Professors, looking to
prove the case of a monetary hammer for pounding all economic nails, at
best commit the eternal freshman mistake of correlation as causation.
The "money shot" is then Professor Bernanke's conclusion:

The expected differences in the monetary policies of the
gold and non-gold countries seem to be in the data, although somewhat less
clearly than we had anticipated.

In summary, data from our sample of twenty-four countries support the
view that there was a strong link between adherence to the gold
standard and the severity of both deflation and depression. The data
are also consistent with the hypothesis that increased freedom to
engage in monetary expansion was a reason for the better performance of
countries leaving the gold standard early in the 1930s, although
evidence in this case is a bit less clear-cut.

There's the golden words of economics -- "seem to be in the data," --
even better, "although the evidence in this case is a bit less
clear-cut." Good enough evidence for now Chairman Bernanke to bet the
dollar like some drunken sailor at the roulette table, "It's been black
four times in a row, 'seems to be' red is now inevitable. Bet the wad!"
And that's what we're doing.



Now, I'm not making an argument that getting off the gold standard
wasn't helpful. What I'm questioning is the value of a coordinated
global currency deprecation. Mr. Bernanke's monetary policy of
depreciating the dollar, classic beggar thy neighbor, is hurting exporting nations not pegged to the dollar. East Asian countries intervened in currency markets a few
weeks ago to try and keep the dollar up, and the dollar's
weakness continues to impact Euro-zone exports. As the dollar is the
equivalent of the gold standard today, we are not depreciating just
currency, but the standard itself. Despite all worrying about the
dollar, what we are seeing is the Fed Chairman trying to instill his
theorized policies prescriptions for the 1930s of "coordinated
depreciation." Mr. Bernanke, it would seem, is trying to force currency
depreciations across the board to prove his theory "a coordinated
depreciation presumably would have been better."



Monetarists' theory was behind this financial crisis, a belief in what
Professor Eichengreen calls, "the self-equilibrating tendencies of the
market." Phew -- "self-equilibrating." In the 30s that would have been
known as a ten-cent word, it's a belief today that has cost us tens of
trillions, and counting. the The financial crisis was proof of the
fallacy of much of theory at the foundation of monetarism and other
market theory, the idea it's going to get us out of the mess seems
incredulous. We're in the hands of academics trying to bend reality to
their theories. Place your bets, Professor Chairman Ben has made his.

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