Back to Kenneth Rogoff's Austere Future

Just when it seemed the economic discussion couldn’t get any sillier, Kenneth Rogoff, former chief economist at the IMF and now economics professor at Harvard, has channeled the discredited notions about economic growth offered up most prominently by the Club of Rome and President Jimmy Carter in the ‘70s.

In 1972, the Club of Rome released The Limits to Growth, which said if economic growth were allowed to continue, the world would run out of food and commodities. In a column last week for the Financial Times titled “The world cannot grow its way out of this slowdown”, Rogoff said much the same, arguing that the “huge spike in global commodity price inflation is prima facie evidence that the global economy is still growing too fast.”

Rogoff’s basic message is that in order to insure long-term economic health, we must crash the world economy now. It would be a hard to find a more impoverishing and absurd plan of action.

A Keynesian of the first order, Rogoff sees economic growth only in demand terms. Apparently unfamiliar with the classical economic principle that supply is demand, Rogoff views the latter as the cause of inflation. In that sense, and probably many others, he would feel very much at home within the hallowed walls of the Federal Reserve where similar views are held.

Unfortunately, what Rogoff and the Fed believe cannot be. Rising demand on its own can in no way cause a change in the price level. That is so because if excess demand makes a commodity such as oil or gas dear for consumers, those same consumers have less money to buy other goods. The broad inflationary impact is by definition zero.

Secondly, if we ignore for a moment the real reason commodities are expensive, we must conclude that economic growth is the solution to the problem of expensive goods. Indeed, growth is always and everywhere the result of productive work effort that attracts more capital for being productive.

If so, as in if demand explains what Rogoff deems “commodity price inflation,” it’s essential to have a booming world economy in order to fix the problem. In short, growth attracts capital, and it will be capital that funds the work effort that will either unearth more in the way of commodity supplies, or alternatives to the commodities very much in demand so that consumers can achieve price breaks on their purchases.

On the other hand, the slower economy that Rogoff advocates implies a destruction of wealth that would starve the very innovators intent on making commodities such as oil more plentiful. Rogoff’s austerity solution is charitably backwards.

Worse, while correctly explaining a worldwide run on paper currencies, Rogoff, much like the Fed once again, fails to understand why commodities are presently so expensive. As he points out, “Dollar bloc countries have slavishly mimicked expansionary U.S. monetary policy.”

The above is certainly true. Behind every commodity boom is dollar debasement whereby oil, gold and other commodities don’t so much become expensive as the greenback in which they’re priced becomes very cheap. Sure enough, thanks to a Bush Treasury that has encouraged a weak dollar in concert with a clueless Federal Reserve, commodities have risen in dollar terms, and as Rogoff correctly notes, the world has mimicked our monetary mistake. Absent worldwide monetary debasement in recent years that has led to a 250 percent rise in the price of gold versus the dollar alone, it’s fair to say that the price of oil would not be part of today’s economic discussion.

Rogoff’s failure to tie the commodity boom to currency weakness takes him down another false path given his belief that, “Absent a significant global recession, it will probably take a couple of years of sub-trend growth to rebalance commodity supply and demand.” His comment there is highly illuminating for his limited and incorrect understanding of inflation.

Owing to his view that rather than a monetary event, inflation results from too much growth, Rogoff remarkably believes that the ‘70s and this decade are examples of overly healthy economies. While stock-market returns in both decades clearly suggest a weak worldwide economic outlook, beholden to the unfortunate assumption that rising price levels are indicative of growth, Rogoff thinks otherwise. In doing so, he ignores the powerful economic acceleration that led to rising markets in the ‘80s and ‘90s, and that occurred in tandem with falling commodity prices.

Rogoff concludes that when it comes to today’s problems, “there is no easy, painless exit strategy.” And good Keynesian that he is, he suggests central banks should use their rate mechanism not to strengthen world currencies as so many strong-dollar advocates falsely presume they will, but instead he’d like rates increased to slow the world economy in order to bring down commodity prices.

Rogoff gets it wrong. Commodities are once again expensive because world currencies are cheap. Stronger world currencies and cheaper commodities would be a reward for the world economy after this decade’s ongoing inflationary outbreak, and even better, central banks need not raise rates to achieve this.

As history has shown, stable and strong currencies are consistent with low, not high rates of interest. Rather than going down Rogoff’s path to pain; a path we needlessly took in the early '80s, the U.S. Treasury should announce a stronger dollar definition in terms of gold that will provide an anchor for the rest of the world’s currencies, and that will lead to lower interest rates for the currencies that follow our credible lead.