Published in Emile’s Economics blog and on “Go Postal”
I find it instructive periodically to look back on what I have written before – even several years before.
It is instructive because it highlights my understanding of a particular issue at that earlier time, and raises the question of whether I still hold views previously expressed with such eloquence and conviction!
Let’s take it step by step, with examples.
Interfering with exchange rates
Some years ago I wrote:
“When Laker Airways went bust in 1982, its liquidator, the legendary Bill Mackey left us his own history lesson, which is now part of accountancy folklore.
“He produced a colourful checklist for prophesying a company’s financial collapse: lavish offices and flash company cars with personalised plates; a flagpole in the forecourt and fountain in the reception area; a Queen’s Award for Industry; recently changed bankers; audit partner who grew up with the company; a salesman as CEO; and Chairman known for his charitable works.
“But Mackey’s checklist is equally prescient beyond the corporate level. For example, that edifice of money-printing profligacy, the European Central Bank (ECB), has just laid down a marker for institutional permanence by celebrating the opening of glitzy new Frankfurt headquarters that will set back EU taxpayers a mere 1.2 billion euros, flagpoles and fountains included.
Could this prove to be the ultimate bailout?
“This is the bank, remember, that has agreed to underwrite, without limit, in flagrant breach of its own constitution, Spanish and Italian bonds, but whose own solvency rests on the promise by eurozone countries collectively to provide trillions of euros to meet the entirety of eurozone debt. Could this prove to be the ultimate bailout?
Another monetary milestone
“In 1992 Britain faced financial armageddon when speculators demolished the Bank of England’s efforts to keep the pound inside a contrived fixed rate currency system called the “Exchange Rate Mechanism” (ERM), designed as a staging post to accepting the euro as the currency of choice throughout the EU.
“The British Government had joined the ERM, cherishing the ill-founded belief that we could enjoy a German-style economy, characterised by low inflation and monetary stability, by simply tying the pound to the deutschmark.
“The fallacy surfaced with a vengeance when, two years later, the UK’s persistently weak economic performance caused market speculators to value the pound below the permitted convertibility rate against the DM. But Chancellor Norman Lamont (backed by Prime Minister John Major) would have none of that. Lamont embarked on a mission to boost the pound by hiking interest rates to 10%, then 12%, even a frantically futile 15%, coupled with mega-buying of pounds on the currency markets.
“Speculators, led by George Soros, sustained a ‘shorting’ spree with massive selling of pounds they did not even own. The risk paid off handsomely – for them. Then the penny dropped – so to speak. Lamont and Major belatedly, but sensibly, took the pound out of the ERM altogether. Inflation remained benign and the pound, without any contrived help, rose on the markets.”
Politicians cannot be trusted to keep their hands off the money supply
Looking back, this tale demonstrates what happens when leaders persist in the belief that brazen political ambitions can, somehow, overcome economic laws that they clearly do not comprehend. Politicians cannot be trusted to keep their hands off the money supply and interest rates.
National institutions cannot intervene unilaterally to beat the market. The ERM debacle of 25 ago provided a full dress rehearsal of the futility of pursuing political aspirations that depend on manipulated workings inside a fixed-rate exchange system.
So far, so good. I would have no problem writing this now.
Trade, currencies, exchange rates and debasement
But try this short piece, also written several years ago. It also concerns currencies and exchange rates:
“Compare the export of identical articles produced, respectively, in Germany and Greece, both priced in euros. The factor cost of the German product is lower (for reasons concerning technology, work ethic, scale efficiencies, productivity-related wage structures and tax receipts).
“The problem for Greece is that it is locked into an exchange rate of parity with Germany, who also benefits from interest rates kept unrealistically low by the European Central Bank to help struggling nations.
“For Greece to compete on price it would have to liberalize its working practices, relate wages to productivity and reduce tax levels to accommodate a far slimmer state sector. All this would be possible if they had their own currency, allowing the markets effectively to determine competitive pricing for their goods.
“But there is no incentive for change while they are locked into an insidious bailout mechanism that encourages them to delay reforms that alone will facilitate economic recovery. The growing mountain of debt inflicted by these bailouts can never be repaid and by now the Greeks are numb to the numbers.”
How does that sound to you? I obviously believed what I wrote at the time – but now? The piece is written with conviction, but it suffers from one major drawback – it’s wrong!
You will hear politicians bleating endlessly about the dire effects of being stuck with the wrong currency:“If only the Italians ditched the euro and returned to the lira their exports would be more competitive.” And the same sentiment is voiced over the Greek drachma, Spanish peseta, etc.
It is not currencies that that need to be more “competitive”, but production
This is all nonsense. It is not currencies that that need to be more “competitive”, but production.German cars are not world-beaters because they are cheap, but because their production methods guarantee value for money – any money! Not long ago all currencies were essentially based on gold – yet their economies were not of equal strength.
If the Greeks (or the Italians, etc.) went off the euro in order to reinstate the drachma or the lira, would that stop them from debasing it?
No – and those countries would then be thrown into chaos. A debased currency allows government to avoid reality. The world of economics is governed by scarcity and hard choices. Governments will avoid making hard choices by any means – but they can’t do this indefinitely.