Keynesian "Easy Money" Is Nothing But Currency Devaluation


April 12, 2012

(This item originally appeared at Forbes.com on April 12, 2012.)


http://www.forbes.com/sites/nathanlewis/2012/04/12/keynesian-easy-money-is-nothing-but-currency-devaluation/

“Keynesianism” is the label I’m using here for what is actually the modern representation of Mercantilism. Mercantilism was conventional economic thinking in Britain in the 1600-1750 period before being swept aside by the great Classical economists. Virtually all mainstream academic economists today are Keynesians/neo-Mercantilists by this measure, although they probably would not label themselves such. Part of the career strategy of most any academic today is to apply a veneer of novelty or innovation to what are in fact ancient ideas.

In the 1930s, the failure of the economists of the time to adequately analyze and remedy the Great Depression – indeed, they were a major cause of the Great Depression due to their fondness for “austerity” including immense tax hikes – caused the political pendulum to swing back toward the Mercantilist pole, where it has remained ever since.

The Keynesians are very fond of hypercomplication, but in the end, their policy prescriptions typically don’t amount to much more than government deficit spending spending and some form of “easy money” policy.  I say that this “easy money” policy is basically just a policy of currency devaluation.

Now, here’s a funny thing: the Keynesians themselves very rarely promote outright currency devaluation, at least for their home countries. They are less shy about smaller foreign countries – like Greece today, which all the Keynesians say needs its own currency which can be conveniently devalued. In the 1980s or 1990s, the IMF was always busy recommending currency devaluation to smaller countries around the world, with the usual dismal results.

This pattern also goes back to the 1930s. During the 1931-1933 period, most of the major countries of the world devalued their currencies. (France was the laggard, devaluing in 1936.) These were not conducted by central banks as part of any sort of “easy money” policy, involving interest rate targets, “quantitative easing,” “Operation Twist,” “Long Term Refinancing Operations,” “central bank swap agreements,” “acting as a lender of last resort,” “nominal GDP targeting,” or any other silly ad-hoc rationale for printing too much money. They were done essentially (especially in the U.S. case) as outright policy decisions of the executive branch.

This proved to be unpopular. Already by 1934, governments were getting tired of “beggar thy neighbor” currency devaluations, and agreed to cease any further steps in that direction. They quietly settled back into a worldwide gold standard system, which was formalized in 1944 as the Bretton Woods arrangement.

Thus, when Keynes’ book The General Theory of Employment, Interest and Money was published in 1936, the political tide had already moved away from an explicit policy of currency devaluation. I often think of the book not so much as a how-to guide for policymakers – it is far too incomprehensible for that – but rather as a guide for career economists to make a living in the new political environment. Remember, mainstream economists looked pretty bad at that point, and you didn’t want to lose your economist job because it was the middle of the Great Depression.

Thus, led by Keynes’ example, the new Keynesian economists adopted a strategy of hypercomplication involving a lot of abstruse mathematics, and a dizzying array of various “easy money” rationales – without ever mentioning the now-unpopular “currency devaluation” – to give politicians what they wanted. What politicians wanted was by then established by the precedent of the past five years or so: an excuse for big government deficit spending, and some quick and dirty way to slap the economy into good enough shape in the short-term to get re-elected, like an “easy money” policy.

“Currency devaluation” is pretty easy to understand, and already politicians had proven capable of doing it without the assistance of academic economists. The hypercomplication gave economists a rationale to maintain their treasured sinecures as high priests of economic gobbledygook, which was fine by the politicians as long as they came up with the desired conclusions.

Usually the “easy money” arguments of today’s neo-Mercantilists revolve around some interpretation of “lower interest rates,” as a way to ultimately resolve unemployment, as explained by the title of Keynes’ book. The funny thing about this is, the existing gold standard system had always provided rock-bottom interest rates. From 1825 to 1914, a period of 90 years, the average yield of the British Consol bond was 3.14%! This was a government bond of infinite maturity, comparable to today’s 30 Year U.S. Treasury bond.

Wasn’t that low enough? It was low enough.

The average yield of the U.S. long-term (20-30 year) government bond was 3.46% in September 1929 and declined steadily to 2.01% in December 1940. Except for the devaluation of 1933, this was all with the gold standard, without any overt “easy money” policy from the Fed.

From 1934 to 1940, the average yield of the 3-month Treasury bill was 0.15%.

Certainly no problem with high interest rates there.

Even today, with the Federal Reserve undertaking a barrage of unprecedented steps to “lower interest rates” in the Keynesian fashion, the yield of the 30-year Treasury bond is 3.19%. Is that the best you can do? By gold standard metrics, that kinda stinks. Britain did better than that, for ninety years straight, until being distracted by World War I. This with a bond not of 30 year maturity, but infinite maturity! Hey Ben Bernanke, how long can you tread water?

Any bond investor will tell you that, assuming a currency of stable value such as is provided by a gold standard system, yields on high-quality debt will tend to decline in a recession. Thus, declining interest rates is a natural feature of a capitalist economy with a gold standard system in a recession, and doesn’t need to be artificially manufactured by some “easy money” policy. The only purpose of these various “easy money” techniques is to induce a decline in currency value.

“Inducing a decline in currency value” is a euphemistic way of saying “currency devaluation.” All of the Keynesian funny-money tricks – notably the artificial decline in unemployment that Keynes aimed for – don’t work unless the currency declines in value. How would they? The gold standard system already provided very low interest rates.

However, instead of a bald-faced act of official policy, where everyone knows exactly who is responsible, you could blame the resulting currency decline on “speculators” or the “free market,” or whatever else happens to be politically expedient that day.

That’s why I say that, when you get past the smokescreen of bluster, rationalization, and silly math, Keynesian “easy money” is nothing but currency devaluation.