Keynes' 'Long Run' Rears Its Ugly Head

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There are a great many curiosities that set up this current economic era, particularly as unsatisfying as it is to the vast majority that participate in it. It may not be a common topic of conversation to even those with a passing interest in economic affairs, but it is noteworthy in its own right that more than a few orthodox economists have taken to bashing the US dollar as an imposed burden upon these very United States.

Without detecting a hint of irony, these very same people detest the gold standard for its supposed restrictions on the flexibility, to use Ben Bernanke's phrasing, of central banks to create smooth, fluctuation-free economic existence. In shaking off the last version of the gold standard in the 1960's (Nixon's full relinquishment in 1971 was but the last step in a far longer process whereby economists, especially monetary economists, decried the burden of the US dollar on these very United States) and undertaking the fiat standard it was believed that floating currencies would allow the very same effective capitalism without the depressing tendency toward depression.

Sitting in the middle of those extremes were to be enlightened central banks dedicated to the proposition of currency elasticity informing what amounted, to them, economic elasticity. In the "good" name of John Maynard Keynes, debt would be used as an "automatic stabilizer" to "fill in the troughs without shaving off the peaks." It was as if the angelic ideal of an uninterrupted trend in upward economic advance was at hand, replicating the unquestionable progress of the 19th century without all the mess and bother.

Of course, planning for utopia is relatively easy but its execution is starkly biting. In the name of anti-gold, floating currencies were supposed to be the answer to mechanical restrictions upon domestic "money supply." Freed from exogenous restriction and swelled with unimaginable discretion, the Federal Reserve was unleashed into enforcing all economic function into the middle of the bell curve - a permanent plateau of prosperity where everything was just easy, including stock prices.

To hear it now is to be amazed at all that was left out, as those advocating an end to the "dollar" standard decry the very same things in almost the exact same language; as if changing to fiat was simple banality of bureaucratic function and nothing more significant than that.

Writing in the New York Times, Jared Bernstein refers to calculations (of course regressions are involved) done by Treasury Department official Kenneth Austin as to be almost conclusive in this regard.

"But new research reveals that what was once a privilege is now a burden, undermining job growth, pumping up budget and trade deficits and inflating financial bubbles. To get the American economy on track, the government needs to drop its commitment to maintaining the dollar's reserve-currency status."

The main thrust of the argument is as old as political lament gets, namely that by having the dollar as reserve currency means an overvalued dollar. That, to this thinking, makes US products more expensive, US labor more expensive, and pretty much anything that looks like it might explain the current malaise more expensive. It is the old anti-competition argument, except in this case the orthodox economists making it are seemingly unaware of how the gold standard actually ended.

To that end, they are aided in no small part by what passes for understanding in authority. Ben Bernanke, for example, gave a speech in April 2005 in St. Louis that underpinned much of this current dirge over "the dollar." There is no question that what he presented then ties directly to the foundation underneath the current dollar self-loathing:

"I have presented today a somewhat unconventional explanation of the high and rising U.S. current account deficit. That explanation holds that one of the factors driving recent developments in the U.S. current account has been the very substantial shift in the current accounts of developing and emerging-market nations, a shift that has transformed these countries from net borrowers on international capital markets to large net lenders. This shift by developing nations, together with the high saving propensities of Germany, Japan, and some other major industrial nations, has resulted in a global saving glut. This increased supply of saving boosted U.S. equity values during the period of the stock market boom and helped to increase U.S. home values during the more recent period, as a consequence lowering U.S. national saving and contributing to the nation's rising current account deficit."

The guts of this viewpoint is as is stated in the common argument about America being "too expensive", the supposed recycle of "dollars" across the globe in a rewarmed version of Triffen's Paradox (that wasn't really much of a paradox unless you lock yourself into monetarist thinking). What Bernanke was saying was in effect that "too much money" in the US wasn't his fault. And that was partially true, but only in a strictly mechanical sense.

What replaced gold exchange was not a naked "dollar" standard where stacks of printed US currency was moved from vault to vault as bars of gold once did, but rather ledger entries of formerly custodial banks in London trading eurodollars. The transformation toward "ledger money" meant the easy intrusion of credit and debt upon what was once simple property exchange. In a purely gold standard, the bank is nearly unimportant acting more as an accountant and security guard than anything truly financial; in the eurodollar standard, all that matters is the bank and the "liquidity" upon which it operates since there are no actual dollars involved.

Bernanke's description then of a "global savings glut" is patently false - it was not "savings" at all but rather transformed finance. The amount of "dollars" in existence was proportional to the manner in which "flexibility" afforded various central banks around the world to turn local balances into global financial markets.

Going back to Mr. Bernstein, he uses an example of South Korea and Brazil to highlight what he believes is a dollar disadvantage:

"Suppose South Korea runs a surplus with Brazil. By storing its surplus export revenues in Treasury bonds, South Korea nudges up the relative value of the dollar against our competitors' currencies, and our trade deficit increases, even though the original transaction had nothing to do with the United States."

Only on the surface is this description correct (and only in that ceteris paribus way in which economics defines its own unappreciated limitations). What really happens is that South Korea obtains "dollars" solely by way of Brazil's borrowing them in eurodollar markets (more specifically still, Brazilian banks borrow them in eurodollar markets to be on offer domestically inside Brazil to companies that wish to engage in global trade; all of this dollar/real financing "governed" by what's called the cupom cambial whereby the Banco do Brasil attempts to influence the "cheapness" of this short-term dollar borrowing on the part of Brazilian banks in order to create a convoluted sense of economic management). Once those "dollars" appear on a bank balance sheet in Brazil to be "paid" to the South Korean company, they are simply ledgered from that perception to the next.

Of course, in reality, the exchange may never actually get to South Korea as the company that is counterparty to the Brazilian trade may never actually repatriate that piece of global finance, instead keeping the dollar balance on offer globally (likely in UST or actually eurodollar repo) as it would probably maintain dollar balances as a measure of prudence. Assuming it does wish to convert to won, the balance simply transfers again to like a South Korean bank or its central bank which does the exact same - offering those "dollars" as what looks like "flow" into US assets.

The origin of those "dollars" is not, again, this mysterious "global savings glut", though it might look that way to Bernanke in his simplified viewpoint, but rather some eurodollar bank (and one that is not all that likely to be even American) expanding its balance sheet to create a new asset, i.e., a debt balance.

These dollar diminishers think that depresses the US economy precipitously as it drives the "price" of the dollar harmfully upward. That is manifestly and empirically false. The exact opposite happens, as it actually happened when this whole new measure of finance attained its turbo boost in the 2000's under Greenspan's monetary "genius."

Starting around 1995, this eurodollar chain of liabilities increased to the point where it was no longer limited in significant proportion to fostering trade between South Korean and Brazilian companies, instead "leaking" backward into the United States as structured finance toward mortgages, i.e., the housing bubble. Tracing back further still to eurodollar futures introduction in 1985, liquidity had rapidly become ever easier in eurodollars so that banks moved balance sheet capacity to London to "take advantage" of all of that, especially how "capital" (in bank accounting terms, not the actual capital) was so much "cheaper" there.

The net result of this "flood" of eurodollar finance was what looked like exactly how Bernanke and Mr. Bernstein described - a flow of "dollars" "back" into the US. What did the price of the "dollar" do during the 2000's? It did not rise as they proclaim, instead dropping against every major currency in existence, and a few minor just to emphasize it all. You can actually see this in unmistakable terms in the Treasury Department's TIC flow data, as what shows up as "flows" into the United States were growing and huge (which is what Bernanke was arguing, without recognizing any number of levels of irony, was the cause of all these imbalances).

The fact that the dollar was "falling" at that very same moment is nothing more than supply and demand factors intruding upon orthodox ideological rigidities - the actual supply of "dollars" and quasi-dollars (which is what eurodollars actually are) was far outpacing anything anywhere. We know this not just from TIC and domestic sources, but also from bank balance sheets all over the world but especially Europe (and Switzerland). The "global dollar short" became immense, too large even to measure with any degree of hoped for accuracy (ending even the domestic calculation of M3), which is just a fancy way of saying global banks "printed" trillions (and maybe tens of trillions) of "dollars" that weren't anything like traditional dollars through balance sheet and liquidity expansion.

As far as I know, there is no orthodox definition of "savings" that includes money printing, naked as it may have been not in central banks but their close offspring. And so the eurodollar standard now becomes restrictive to central bank activities. Where gold once thwarted expressed monetarism (in periods where sterilization were not permitted or acceptable) eurodollars now do the same because traditional central bank decrees no longer penetrate as intended. This is especially confounding to the central banker as it contradicts what they regard as their sacred duty to depress the economy into the middle part of the bell curve (recessions are "unnecessary tail risks" to a central banker). It "evolved" to the point by 2007 where defining a dollar or what constituted the currency part to be subjected to elasticity was not at all clear. That itself should be and remains a warning about modern finance as it relates to the real economy.

With the danger of falling into sophistry in mind, the track of "money" eurodollar trading amounts to a chain of liabilities stretching across multiple perceptions and even accounting systems, combined with derivative "securities" that simply transform liabilities into various pieces to be further traded and sliced among other perceptions. In other words, Bernanke's "global savings glut" or what should be referred to simply as the "global dollar short", is nothing but a liability of a liability of a liability of a liability of a liability, etc., etc. The most common form of this engineering is the rehypothecation of collateral common, even today, in repo.

Where global finance has evolved is toward a place where there are close to infinitesimal means by which transform and transfer "dollars", whereby the actual relative importance in finance has shifted from quantity to the means of transaction. Because of that, the "supply" must always be rising, for even the slightest denouement in trajectory forces a descending cycle of impactful disorder. So they railed against gold, were given a blank slate in which to replace it, and ended up in the same place anyway? Maybe the problem was never gold to begin with?

To sum up: central banks aided the eurodollar standard simply to have a credit-based tool by which they could force the global economy (specific national systems working in concert, as the global economy is quite an open system) out of any tail tendencies. Because it went further than they ever imagined, they now seemingly reject it as incompatible with the utopian ideal of a perfectly "average" economy free of disruption.

So the lamentation against the "dollar standard" is actually simple inefficiency, exactly the means by which gold was a bulwark (and not anything like perfect) against immense imbalance. It is almost comical to see how those complaining against the dollar today cite the tendency of foreign counterparts to build up "reserves" in US dollar assets when those "reserve" balances (built up by eurodollar expansion) were actively encouraged not so long ago. After all, it is the size of all this incomprehensible finance that is the active clue as to the extent and location of the problems plaguing the global real economy.

It took trillions of eurodollars (again, maybe even tens of trillions) to create even an unsatisfying economy in the 2000's. Such immense waste is undoubtedly harmful to the longer-term prospects of pretty much anyplace involved in the process. That kind of distortion is corrosive to the actual productive tendency of capitalism to foster long-term and sustainable growth. I used the example last week of the "law school scam" which is a pretty representative process by which inefficient monetary intrusion combines with government "planning" to create that negative multiplier.

Out of this current malaise has been born, from my perspective, an attempt to reboot Keynesian mythology. The idea of the global recovery is dying, and hard in many places, and there is palpable almost panic among the policy class to try to preserve this status quo while begrudgingly recognizing the reality of their combined failure. Into that breach there was first flirtation with newish sounding Marxism, particularly Thomas Picketty's academic semi-paean to Occupy Wall Street, but now I detect a resonance of Keynesian revival.

All that monetary convolution has created a bit of a backlash even in places ostensibly friendly to it (again, a tempered admission of failure of monetary policy). The answer, apparently, to the malaise is Keynes' idea of government spending, which Paul Krugman, among others, has viewed as wholly insufficient. This is not a unique thought either, as even Ben Bernanke tried to assert on numerous occasions about how monetary policy alone was far less effective than when combined with fiscal "stimulus." So where we already tried government "stimulus" (anyone remember the ARRA?) it is now judged too small, a message that Dr. Krugman is spreading globally these days.

What is most detestable to these economists and central planners is the idea of a truly free market, even to those that really are not power hungry bureaucrats and are trying to do what they think is the "right thing." Somehow, the idea of messiness has overtaken the idea of advance - the huge and seemingly unstoppable growth of America and the world in the gold days was not in spite of all that "messiness" it was in large part due to it. Innovation is axiomatically messy, representing, for statistical analysis, the tails. Freedom is messy which is where growth comes from, so why should we expect its expression in economics and finance to be any different?

Enforcing conformity through monetarism or fiscalism is simply sapping the vitality that marked economic progress. The means by which that has been done in the past forty years and the incomprehensible degree to which global finance has mutated speaks proportionally to how much the global economy has been moved "out of the tails" by erstwhile "do gooder" central planners. And their answer now is to sap even more vitality all over again.

They hated gold so they allowed the creation of eurodollars. Now they hate eurodollars even though they don't really know what they are or how they actually work (and maybe nobody really does). Japanification lingers onward; after all, everything I describe here was due to Keynes' admonishment against thinking about the long term.


Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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