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Keynes, Mundell and The Money Trap

The vast majority of economists have no answers.

Most economic commentary, such as that of Roubini,  falls into this category (see Diary of  21/11/12).

The “analysis” amounts to saying: “Oh, what a mess we are in!”

We knew that already.

Some vary their message by claiming to detect chinks of light in the gloom. Others conclude by saying things like, “If only the Chinese would behave better”; “If only Congress would face up to the fiscal cliff and deal with it”; “If only the Europeans would get their act together”. Uttering such sentiments may make the writer feel better, but don’t advance understanding.

Today, economists abjure grand theories. For instance, they have no time for Marx. Yet Marx, like Weber and Schumpeter, had a feeling for the dynamic, revolutionary character of capitalism, how change and conflict are generated by the inner springs of society, and the role of ideology and social or religious passions, that is crucial to an understanding of history and how it continues to affect the present. They talk about Keynes of course. But as Robert Skidelsky has himself pointed out, Keynes had very little feeling for social forces underlying economic change. His was a Bloomsbury/Cambridge Weltanschaung – a world view compounded of ethics and logic.

I agree we still have much to learn from Keynes. But what? The dream of Keynesians and indeed some modern monetarists is that the Master returns and, with effortless superiority, orders expansionary polices “a l’outrance” (to employ the term Keynes himself used in “The Treatise on Money”). This is Keynes as Prospero, restoring order by waving a magic wand over his Kingdom.

I think Keynes would have drawn different lessons from those his modern self-appointed disciples take from his teaching. They largely ignore his internationalism. They ignore his call for an international currency. Essentially, Keynes wanted gold with flexibility – an international monetary standard with limited discretion for national policies. But his followers have chosen to neglect that strand in His Master’s Voice.

The Money Trap takes up the baton. It traces the roots of our discontents to the lack of trustworthy international standards for money and banking, coupled with futile (“Keynesian”) attempts to boost demand one country at a time.

Such efforts inevitably run into debt buffers. It sees Keynes as an iconic figure, not as Prospero.

The contemporary economist who understands this best is Robert Mundell. Bob has sent me his latest thoughts on the crisis. I summarise:

Current arrangements have the following key defects:

  • Lack of an international unit of account – the fundamental function of money
  • Lack of an anchor for currency stabilization….contributing to
  • Wild swings in major exchange rates,
  • Wild swings in raw material prices
  • An indefinite build up of international reserves

Mundell relates these faults to changes in the power structure of the global financial system. The dollar replaced sterling and gold but now the euro competes with the dollar. This has split the mainstream of the world economy into two parts. The consequences include radical instability and liability to economic and financial crises. The decline of the dollar has changed the way US monetary policy works. The Fed does not understand this, or how it should behave in the new world. For example, it wrongly let the dollar soar in the middle of a recession in the 2nd half of 2008, triggering the worst phase of the financial panic. Extreme swings in exchange rates destabilise third countries and the world economy. The weakening of the dollar calls for the development of a global currency.

I would add that US current policies are not in its own long-term interests.  Yet vested interests are so powerful that the views of dissidents are rarely heard.
We need to learn the right lessons from Keynes, Hayek and Mundell. That is the case put forward in The Money Trap.