Who is afraid of currency wars?

At the Central Bank of Chile conference the other day, talk naturally turned to the threat of what the Brazilian finance minister Guide Mantega called "currency wars" -- the danger that the world is headed for major conflict over currency movements. All of this is coming from a) unease about the exchange rate of the Chinese currency, which many American politicians feel is too low b) fear in the rest of the world that American pump-priming in the form of quantitative easing will put undue upward pressure on their currencies. On the bus over to the conference restaurant, I had the good fortune of chatting with Olivier Blanchard, currently chief economist of the IMF, and as we talked (without attributing anything specific to him or the IMF) it occurred to me that the current discussion is quite similar to what we used to think about the end of the gold standard during the Great Depression. The standard story used to say - everyone devalued against gold, i.e. against each other, in a bid to improve the competitiveness of their economies. By the end, relative rates were not much changed -- but you had tremendous turmoil in between, and world trade collapsed. That's saying currency wars in the 1930s were really bad, and the implication is gloomy -- we are at it again.

The new view, pioneered by Barry Eichengreen and others, holds that devaluing against gold was good because it broke the grip of deflation. Relative exchange rates may not have moved much, but that wasn't the point -- reflating by getting the money supply up was. In that sense, if we all did a bit of quantitative easing, a bit of "currency war" might be a good thing. It's also an interesting way of aligning incentives. The standard problem in an open economy is that we want our neighbor to stimulate his economy (especially if there is a risk of inflation) - much better than to do it at home. Because QE likely has an impact on exchange rates, this "free rider" problem is mitigated - you may still benefit from your neighbor's QE, but you will pay a price through a higher exchange rate if you don't move as well. In that sense, the non-cooperative policy setting that Mantega described may be a good "second best", provided you believe that Europe is being a bit conservative in terms of monetary policy... The part of the world that really does have a problem is epitomized by Mantega's Brazil, which as been booming and certainly doesn't need more stimulus. But then, perhaps it can live with a higher exchange rate as a price for equilibrating growth around the world.

Congratulations to Fernando Broner, who wins an ERC grant

Fernando Broner, a specialist on international finance and sovereign debt, was deputy director of ITFD for its first two years and is now on the steering committee as well as teaching 2 courses (and co-directing independent study projects). He has just won an ERC starting grant award. I want to congratulate him on this important distinction -- the ERC has been at the forefront of modernizing science funding in Europe, by making it more open, competitive, and all-round sensible (i.e. more like the NSF in the US). But then, I would say that -- I got one, too, in the first round of the advanced grant scheme a few years back. Jaume Ventura, who is in charge of student affairs at ITFD and teaching courses on "contemporary problems in macro" as well as "international finance", got one last year, and so did Nicola Gennaioli, who is teaching for us in the third term... which means that 4 professors involved in running our program got a love letter from Brussels. At least as a percentage, I think this must be higher than in any other masters program in Europe... and UPF economics must have one of the highest concentrations of ERC awards, given that Fernando is bringing our total to 8:

1. Jordi Gali
2. Jaume Ventura
3. Jan Eekhout
4. Gino Gancia
5. Nicola Gennaioli
6. Joachim Voth
7. Marta Reynal
8. Fernando Broner

Antipodean Reflections

I am in Santiago de Chile for a few days, attending the 14th Annual Conference of the Central Bank of Chile. There were plenty of papers that gave food for thought (perhaps even one by yours sincerely on fiscal adjustments and unrest). The one that particularly caught my eye was by Jeff Frankel of the Kennedy School at Harvard, who looked at the work of the Chilean commission that helps to decide which share of revenue the government should save (some related musings by Jeff are here). To put things in perspective, we know that a) output volatility in the developing world is much higher than in richer countries b) that fiscal policy in LDCs is typically procyclical. If tax revenues depend a lot on resource extraction (copper in the case of Chile), there is a big temptation to just go out and spend when the big times roll. Jeff argues that Chile has much to teach to the rest to the world. As part of a commitment to running a structural surplus over the cycle, it delegated forecasts of copper prices and tax revenue to an independent commission. This might be a good idea not just in countries suffering the wild swings of the resource cycle. He neatly shows that budget forecasts are almost always too optimistic, especially in the European Union. This is largely driven by people overestimating GDP growth. I like the idea of putting more of fiscal policy into the hands of non-politicians (part of "post democratic politics", I guess). The thing I am not so sure about is if the biases Jeff documents (in a place like Ireland, say) aren't partly to do with a general tendency to overestimate improvements in good times... which might affect technical experts too. It's one thing to be in a country with commodity booms, and to realize that these tend to last only so long; it's quite another to look at Ireland in 2006 (or Singapore in 1995, or the US in 2000) and to say - this can't last.

Bad news is good news ... again

Why do I have this sense of deja vu? No, it's not because I am heading to the airport tomorrow for another conference in far-flung lands (the Central Bank of Chile is having what promises to be a good one). It's that strange sensation I get from seeing stock markets rallying hard because Bernanke and friends are promising us more quantitative easing. So let's get this right. QE 2 is being discussed because a) output growth is slowing b) unemployment is high c) the US housing market is in the doldrums d) which means that the banks will have even more problems in the future e) which all sums up to a good chance of deflation. One can debate whether more money printing by the Fed is the right answer. As for the wisdom of bidding up stocks... either it works, which means that we will have anaemic growth plus rising prices, and then we have to worry about inflation (which has traditionally been bad for stocks). Or it doesn't, and we are getting something between the Great Depression and the Japanese lost decades. Neither prospect seems much of a cause for cheer. Now, when was it when I saw this last? That's right, in the fall of 2007, when increasingly bad news led markets to expect interest rate cuts from the Fed. For a few months, the bad news was accumulating, and the markets continued to move higher. Back then, people had complete confidence in the Fed's powers to make any recession disappear in... and when people realized it wasn't quite true, things really collapsed hard. It made for a good show back then. Given how untested QE is compared to good old interest rate tools, I wouldn't be surprised if we get a rerun in a stockmarket near you before long...

Stupid Germans and the surpluses

Talk to any German these days about economic policy, and they will soon share with you a sense of outrage that the world is conspiring against their hyper-competitive exports. The German press never talks economics - it talks business. And what's good for business is good for a country as a whole, right? So if Germany has big surpluses, it reflects highly competitive firms. The other - like Mrs. Lagarde of France - are just envious. One COULD actually make some arguments that make sense of the German pleasure in trade surpluses. An ageing country should accumulate assets; some of these should be held abroad. The strongest argument AGAINST piling up trade surpluses is that all those shiny Audis and machine tools sold to the rest of the world buy very few things that will make Germans richer, either today or tomorrow. Michael Lewis has a brilliant book called "Short" about the financial crisis. One of the recurrent themes is how the bubble in subprime really got inflated because of the superabundance of stupid German money. His latest piece on Bloomberg gives you a flavor:

The proprietary trading business turns in part on one’s ability to find the fool -- to find people willing to take the stupid side of the smart bets you are placing. One of the side effects of our seemingly endless financial crisis is to wash a lot of fools, many of them German, out of the game.

If you export lots and import little, you have to export capital, by definition - you are lending to the rest of the world. For whatever reason, German banks - many of them state-owned - have a singular ability to populate financial markets with klutzes who cannot tell garbage from fine food. The trade surpluses which should translate into a huge foreign capital stock, ready to pay the pensions of ageing Germans, instead have a habit of going up in smoke every time a Nasdaq/subprime/bond bubble bursts. The welfare implications of that are not very hard to figure out... and you won't read in the German press about it. So either the country fixes its financial system (beloved 3 pillars and all), or it should use some of those shiny cars at home.

Is history "fate"? The strike in Barcelona

Just this Tuesday, I was teaching the Comin, Easterly and Gong paper on whether today's riches were determined by technological development in the year 1,000 BC in the "Rise of the Global Economy" class in the ITFD. Today is the day of the general strike in Spain. By some strange accident, I was reading Orwell's "Homage to Catalonia" in the last few weeks, and - just as I was arguing in class - history really doesn't have to be spell "fate". Barcelona, the hothouse of Anarchist sentiment in the early days of the civil war, was remarkably genteel and tranquil today. Traffic flowed easily, taxis were available - with a bit of an effort - and a few posters apart, the university was quiet. Only a plume of dark smoke hanging over the Placa Universidad indicated some trouble (a police car had been torched, it turned out). In general, people seem to accept the changes to labor laws with a sense of frustrated resignation. Bizarrely, the people most likely to benefit - i.e. the young, university students, etc. - are more violently opposed than the rest. So the deeply ingrained instinct to start building barricades that Orwell describes somehow got mislaid... so big shocks - decades of Franco rule - really can change the cultural outlook and social fabric. Which reminds me of a paper I should have on the syllabus, one in the sequence of beautiful Acemoglu et al papers on institutions and economic growth. This one is on the impact of the French Revolution, and it's co-authored by our new UPF colleague Davide Cantoni...

congratulations

It's a tough job market out there. That's why it is very nice to see that our students are doing well, despite the headwinds. Clara Sofía Gómez Botero (ITFD 09-10) just got appointed as advisor to the Colombian Deputy Minister for Housing. I am particularly pleased since Clara and her team showed a lot of feel for the policy process in developing countries like Colombia as part of their policy memorandum exercise (which focused on social insurance and indirect labor costs). Good luck to you!