The very unpleasant echo from the 1930s

I am trying very hard not to become alarmist, but I must admit that I see very little positive news at the moment and I continue to see three elements – monetary policy failure/weak growth, the rise of extremist politics (Trump, Orban, Erdogan, Putin, ISIS etc) and sharply rising geopolitical tensions coming together to a very unpleasant cocktail that brings back memories of the 1930s and the run up to the second World War.

It has long been my hypothesis that the contraction in the global economy on the back of the Great Recession – which in my view mostly is a result of monetary policy failure – is causing a rise in political extremism both in Europe (Syriza, Golden Dawn, Orban etc) and the US (Trump) and also to a fractionalization and polarization of politics in normally democratic nations.

That is leading to the appeal of right-wing populists like Donald Trump, but equally to the appeal of islamist groups like ISIS among immigrant youth in for example France and Belgium. Once the democratic alternative loses its appeal extremists and populists will gain ground.

The geopolitical version of this is Ukraine and Syria (and to some extent the South China Sea). With no growth the appeal of protectionism and ultimately of war increases.

Unfortunately the parallels to the 1930s are very clear – without overstating it try to look at this:

  • Syrian war vs Spanish civil war: Direct and indirect involvement of authoritarian foreign regimes (Stalin/Hitler vs Erdogan/Putin)
  • Euro  zone vs the gold standard
  • The rise of populists and extremists: Communists, Nazis and Fascists vs Syriza, Golden Dawn, Jobbik, Orban, regional separatism in Europe, anti-immigrant sentiment, Trump and ISIS (in Europe) etc.
  • The weakening (failure?) of democratic institution: Weimar Republic vs the total polarization of politics across Europe – weak and unpopular minority governments with no “political muscle” for true economic reforms across Europe.

Maybe this is too alarmist, but you would have to be blind to the lessons from history not to see this. However, that does not mean that history will repeat itself – I certain hope not – but if we ignore the similarities to the 1930s things will only get worse from here.

PS if you are looking for more empirical evidence on these issues then have a look at Manuel Funke, Moritz Schularick and Christoph Trebesch’s recent very good post on on The political aftermath of financial crises: Going to extremes.

HT Otto Brøns-Petersen.


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St. Louis Fed: “0% probability that inflation will average more than 2.5% over the next 12 months”

Laura E. Jackson, Kevin L. Kliesen, and Michael T. Owyang of the St. Louis Federal Reserve have constructed a new measure they call the price pressures measure (PPM).

According the authors the “PPM measures the probability that the expected inflation rate (12-month percent changes) over the next 12 months will exceed 2.5 percent”…the PPM is constructed “for both the consumer price index (CPI) and personal consumption expenditures price index (PCEPI).”

This is how the PPM is constructed:

In technical terms, the PPM index is constructed from an ordered probit model that is augmented with nine “factors.” A factor-augmented model is a common method of incorporating a large amount of data in a parsimonious fashion. The nine factors, comprising 104 separate data series, are grouped in the following categories: (1) consumer price indexes, (2) producer price indexes, (3) commodity prices, (4) housing and commercial property prices, (5) labor market indicators, (6) financial variables, (7) inflation expectations, (8) business and consumer survey data, and (9) foreign price variables.

The ordered probit model provides probabilities that inflation will exceed 2.5 percent, on average, over the next 12 months. But the model also allows us to assess the probability that inflation will average something different. In our original article we structured the model to assess the probability that inflation will fall within one of four bins: less than zero (deflation); 0 percent to 1.5 percent; 1.5 percent to 2.5 percent; and more than 2.5 percent. We could also assess probabilities for other outcomes. For example, we could condense the second and third bins into one, leaving three sets of probabilities: Inflation will be less than zero (deflation) over the next 12 months, inflation will average between 0 percent and 2.5 percent, and inflation will be greater than 2.5 percent.

So what is the measure saying now?

Well, the message is very clear – this is what the authors say: “As of October 2015, the PPM predicts a zero percent probability that PCEPI inflation will average more than 2.5 percent over the next 12 months.”

This is obviously wrong – we can never say that there is a zero percent probability of anything, but ok this is the kind of result you sometimes get from probit models. That however, is not the important thing, but rather the key message here is that there is very little likelihood that Fed will overshoot it’s inflation target in the coming next 12 months. In fact it is very clear that the likelihood of deflation is higher than inflation being above 2.5% in 12 months.

Therefore you gotta ask yourself why does St. Louis Fed president James Bullard continue to argue for the Fed to hike rates? After all the research done by his own research department tells him that he rather should worry about deflationary risks.


PS See the original paper on the Price Pressure Measure here.

PPS Scott Sumner should be delighted that Laura E. Jackson recently became an assistant professor at Bentley University.

Malaysia has a freely floating Renggit – and thank god for that!

The Chinese surprise devaluation yesterday and has put currencies across Asia further under pressure. This is only a natural and the most stupid thing local Asian central bankers could do would be to fight it. Rather as China moves closer to a freely floating exchange rate it should inspire other Asian countries to do the same thing and I am therefore happy to see that the Vietnamese central bank this morning has widened the fluctuation band for the Dong and in that sense moved a bit closer to a freely floating Dong. Even though the hand has been forced somewhat by the PBoC’s devaluation yesterday it is nonetheless positive that we are seeing a move towards more freely floating exchange rates in Asia.

In that since it is not a “currency war”, but rather a liberation war, which in the end hopefully will secure monetary sovereignty to Asian nations such as Vietnam.

The floating Renggit is a blessing – also when it drops

This morning we are also seeing big moves in the Malaysian Renggit and the Renggit has already been under some pressure recently on the back of a worsening of Malaysia’s terms-of-trade and increased political uncertainty.

The sell-off in the Renggit has sparked some local concerns and the demands for the central bank to “do something” to prop up the Renggit are surely on the rise. However, it is extremely important to remember that the problem for Malaysia is not that the Renggit is weakening. Rarther the Renggit-weakness is a symptom of the shocks that have hit the Malaysian economy – lower commodity prices (Malaysia is a commodity exporter), increased political uncertainty and Chinese growth concerns.

None of this is good news for the Malaysian economy, but the fact that this is reflected in the Renggit is not a problem. Rather it would be a massive problem if Malaysia today had had a fixed exchange rate regime has was the case during the Asian crisis in 1997.

So the Malaysian central bank (BNM) should be saluted for sticking to the floating exchange rate policy, which has served Malaysia very well for nearly exactly a decade.

In fact BNM should move even closer to a purely free float and waste no opportunity to stress again and again that the value of the Renggit is determined by market forces and that the BNM’s sole purpose of monetary policy is to ensure nominal stability. The BNM should of course observe exchange rate developments in the sense it gives useful information about the monetary stance, but never again should the BNM try to peg or quasi-peg the Renggit to a foreign currency. That would be the recipe for disaster. As would such stupid ideas as currency and capital controls.

My friend Hishamh over at the Economics Malaysia blog has an extremely good post on his take on the Renggit situation. You should really read all of it. The post not only tells you why the freely floating Renggit is the right thing for Malaysia, but it is also extremely good in terms of making you understand why every (ok most…) countries in Asia should move in the direction of the kind of currency regime that they have in Malaysia.

Here is a bit of Hishamh’s excellent comments:

Another week, another multi-year low for the Ringgit. Since BNM appears to have stopped intervening, the Ringgit has continued to weaken against the USD, to what appears to be everyone’s consternation. There is this feeling that BNM should do something, anything, to halt the slide – cue: rumours over another Ringgit peg and capital controls.

To me, this is all a bit silly. Why should BNM lift a finger? Both economic theory and the empirical evidence is very clear – in the wake of a terms of trade shock, the real exchange rate should depreciate, even if it overshoots. NOT doing so would create a situation where the currency would be fundamentally overvalued, and we would therefore be risking another 1997-98 style crisis. Note the direction of causality here – it isn’t the weakening of the exchange rate that gave rise to the crisis, but rather the avoidance of the adjustment.

Pegging the currency under these circumstances would be spectacularly stupid. I’ll have more to say about this in my next post.


In the present circumstances, it’s not even clear why BNM should in fact intervene. You can make the argument that the Ringgit is fundamentally undervalued, and the FX market has overshot; but I have no idea why this is considered “bad”. If you want to live in a world of free capital flows, FX volatility is the price you pay.

… Malaysia’s latest numbers puts reserve cover at 7.6 months retained imports, and 1.1 times short term external debt, versus the international benchmark of 3 months and 1 times. Malaysia is at about par for the rest of the region, apart from outliers like Singapore and Japan.

Australia and France on the other hand, have just two months import cover, while the US, Canada and Germany keep just one month. You might argue that since these are advanced economies, there’s little concern over their international reserves. I would argue that that viewpoint is totally bogus. Debt defaults and currency crises were just as common in advanced economies under the Bretton Woods system. The lesson here is more about commitment to floating rather than the level of reserves. One can’t help but see the double standards involved here.

…All in all, this alarmism betrays a lack of general economic knowledge in Malaysia, even among people who should know better. Or maybe I’m being too harsh – it’s really a lack of knowledge of international macro and monetary economics.

…The Bank of Canada, the Reserve Bank of Australia, and the Reserve Bank of New Zealand, have all aggressively cut interest rates and talked down their own currencies – it’s the right thing to do in the face of a commodity price crash. BNM on the other hand has to walk and talk softly, softly, because Malaysians seem to think the Ringgit ought to defy economic laws.

Bravo! Please follow Hishamh! His blog posts are always good and insightful.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: or

China should float the renminbi

The big news of the day is that the Chinese authorities have allowed the renminbi to depreciate by 2%. This has triggered the normal sensationalist warnings about an upcoming “currency war”.

I must say I find these warnings to be rather uneducated about monetary theory and about monetary history. Hence, normally it is said that devaluations have the purpose of improving “competitiveness” and that such policy is an act of beggar-thy-neighbor and that this kind of policies caused a protectionist spiral during the Great Depression.

However, this is not in fact correct. First, of all if a country needs to ease monetary policy to stabilise nominal spending then it follows logically that the currency of the country will have to depreciate. That, however, need not be the purpose, but rather a side-effect of monetary easing. Rather it is normally so that if we look at historical examples of large devaluations – for example the US in 1933 or Argentina in 2001-2 then the primary effect of the monetary easing is a sharp recovery in domestic demand, which actually tends to benefit exports from neighboring countries rather than hurt them.

Furthermore, during the 1930s it was not the countries, which gave up the gold standard and devalued, which introduced protectionist measures. Rather it was the countries, which refused to give up the gold standard, which instead increased tariffs and other protectionist measures.

Furthermore, we are in a situation of still relatively meager global growth and deflationary tendencies around the world and in such a world monetary easing should be welcomed rather than criticized as it will help spur global growth.

Finally it is somewhat paradoxically that anybody would criticize a 2% devaluation, while not at the same time demand that commodity exporters like Russia, Brazil and Norway –  which have seen the currencies weaken substantially recently – should do something to prop up their currencies. Obviously these countries should not be criticized for allow their currencies to weaken in response to a negative shock to the economy, but neither should China. Today’s devaluation is not a hostile act – it is a attempt to stabilize Chinese aggregate demand and as such the policy should be welcomed.

Give up the fine-tuning and let the renminbi float

That being said I also think that today’s devaluation is rather foolish – simply because I want more and not less. In my view the right policy would be for China to swiftly move towards a free floating renminbi and a total liberalization of capital and currency flows and to introduce a policy to stabilize nominal demand (NGDP) growth in the Chinese economy.

Hence, every other large economy in the world – with the exception of those trapped in the euro – have floating exchange rates and in general the purpose of monetary policy in these countries is to provide nominal stability in some form. China should of course do the same thing. That would be to the great benefit of China and would once and for all stop the silly discussion about “competitive devaluations”.

Have I written about this before? You bet – just have a look here:

Bernanke knows why ‘currency war’ is good news – US lawmakers don’t

‘The Myth of Currency War’

Don’t tell me the ‘currency war’ is bad for European exports – the one graph version

The New York Times joins the ‘currency war worriers’ – that is a mistake

The exchange rate fallacy: Currency war or a race to save the global economy?

Is monetary easing (devaluation) a hostile act?

Fiscal devaluation – a terrible idea that will never work

Mises was clueless about the effects of devaluation

Exchange rates and monetary policy – it’s not about competitiveness: Some Argentine lessons

The luck of the ‘Scandies’


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: or

NBER paper: “On the Desirability of Nominal GDP Targeting”

I should really read this paper and so should you….


This paper evaluates the welfare properties of nominal GDP targeting in the context of a New Keynesian model with both price and wage rigidity. In particular, we compare nominal GDP targeting to inflation and output gap targeting as well as to a conventional Taylor rule. These comparisons are made on the basis of welfare losses relative to a hypothetical equilibrium with flexible prices and wages. Output gap targeting is the most desirable of the rules under consideration, but nominal GDP targeting performs almost as well. Nominal GDP targeting is associated with smaller welfare losses than a Taylor rule and significantly outperforms inflation targeting. Relative to inflation targeting and a Taylor rule, nominal GDP targeting performs best conditional on supply shocks and when wages are sticky relative to prices. Nominal GDP targeting may outperform output gap targeting if the gap is observed with noise, and has more desirable properties related to equilibrium determinacy than does gap targeting.

HT My beloved Mr. Chance

The market’s message to Yellen: You have become too hawkish

Recently the communication from the Federal Reserve seems to have become more hawkish. It all started on July 15 when Fed chair Janet Yellen testified in front of the House Financial Services Committee. Yellen among other things said:

“If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal funds rate target”

This has been followed by comments from other Fed officials such as St. Louis Fed president James Bullard who in an interview with Fox TV on July 20 said that there was a “50% probability” a September rate hike. As my loyal readers know I like to watch the markets to assess monetary conditions. So lets see what the markets are saying about the US monetary policy stance right now – and how it has changed on the back of Yellen and Bullard’s comments. Lets start with the much talked about gold price. gold price It is hard to miss that it was Yellen’s hawkish comments that has sent gold prices down in recent weeks. So the drop in gold prices certainly is a indication that US monetary conditions are getting tighter. But it would of course be wrong to reason from the change in one price. We need more – so how about the dollar? DXY This is the so-called Dollar Index (DXY). Here the picture certainly is less clear than from the gold price. In fact the dollar index today is more or less a the same level as on July 15 when Yellen hinted at a rate hike this year.

However, we should remember that the exchange rate is telling us something about the relative monetary policy, so if US monetary conditions is in fact getting tighter and the dollar index is flat then it is an indication that monetary conditions are also getting tighter outside of the US. Given the Greek crisis and Chinese growth worries this is not an unreasonable assumption.

So how about inflation expectations? This is 2-year/2-year inflation expectations (so basically the expectation to the average inflation rate from August 2017 to August 2019) inflation expectations 2y2y Again the picture is clear – after Yellen and Bullard’s comments 2y/2y inflation expectations have dropped and equally important this happened at a time when inflation expectations already where below 2%. It should also be noted that prediction markets are telling the same story. Hence, from some time Hypermind’s market for nominal GDP growth in 2015 has been somewhat below 4% (which I believe has been Fed’s unannounced target for some time – see here.) The Fed is too hawkish and rate hikes should be postponed Concluding, the Fed’s more hawkish rhetoric has de facto led to a tightening of US monetary conditions already, which has pushed inflation expectations below the Fed’s own 2% inflation target. So effectively the markets are tellling the Fed that monetary conditions are becoming too tight and a September rate hike as suggested by advocated by Bullard would be premature. So if I was on the FOMC I would certainly vote against any rate hike in the present situation.

If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail:

Milton Friedman expresses his sympathy for Syriza supporters and his dislike of the “gnomes in Brussels”

BREAKING NEWS! I have found a comment from Milton Friedman on the present Greek crisis in, which he expresses, his sympathies for Syriza supporters:

It is not the announced intention of our present arrangements, or of any of the various proposals for strengthening international monetary cooperation, to delegate significant political power over internal economic policy to foreign central bankers or officials of an international agency. But that is unquestionably their effect.

That this is a very real issue was illustrated dramatically by the recent experience of the Greeks, just after the Syriza government came into power. Personally, I disagree sharply with the particular policies that the newly elected Syriza government apparently wishes to follow, and regard the policy changes imposed on Greece by the EU as the price of the rescue of euro membership as very likely far better for Greece itself.

Yet that does not alter the fact that Greek internal policy was shaped by officials who were not responsible to the Greek electorate and in directions that had not emerged through the regular political process. In this respect, I find myself in complete sympathy with those Syriza supporters who regard it as nearly intolerable that the “gnomes in Brussels” should have a veto power over internal Greek economic policy.

Ok, I cheated. This is really from Friedman’s paper “The Political Economy of International Monetary Arrangements” from 1965 (re-printed in “Dollars and Deficits”, 1968, see page 272) and I have altered the text slightly (the bold text is my changes).

Originally it was about “Britain” rather than “Greece” and “Labour” rather than “Syriza” and the ‘gnomes’ were from “Zürich” rather than from “Brussels”.

But the lesson is the same – In-Optimal Currency Union will lead to balance of payments crisis, which will necessitate an income transfer from the centre to the periphery, which in turn will lead to the demand for political centralisation.

Britain felt the consequences of that within the Bretton Woods system in 1964. Greece is facing similar consequences today as a result of euro membership.

It seems like policy makers in Europe are totally incapable of understanding and learning anything from monetary history. Do I need to remind anybody what happened with the Bretton Woods system?

If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: or


Talking to Joe and Alix about why “Euro Membership (is) Preventing Finland from Thriving”

Tonight I have been on Bloomberg TV talking to Alix Steel and Joe Weisenthal about Finland and the euro. See my interview here.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: or

Peggers and floaters – the story of five Nordic countries

There was a time when the Scandinavian countries had a currency union of their own. However, today the Nordic countries have chosen difference monetary regimes. Sweden, Norway and Iceland have floating exchange rates and inflation targeting, while Finland has joined the euro zone and Denmark is pegging the krone to the euro.

So essentially we have three countries – the floaters – which have monetary sovereignty to set monetary conditions to achieve their stated monetary policy objectives and two – the peggers – which have given up monetary sovereignty and have “outsourced” monetary policy to the ECB in Frankfurt.

How has that played out during the Great Recession? The graph low give you a hint. The floaters are gren and the peggers are red.

Five nordic countriesThere are obviously many reasons why the countries have performed so differently, but it is hard not to conclude that the monetary policy regimes have played a very important role in the length and depth of the crisis in each of the five Nordic countries.

By the way if you want a proper empirical analysis of the difference in performance of the floaters and peggers during the Great Recession then you should read this paper by Thomas Barnebaek,Nikolaj Malchow-Møller and Jens Nordvig.


If you want to hear me speak about these topics or other related topics don’t hesitate to contact my speaker agency Specialist Speakers – e-mail: or

My latest Børsen op-ed: “The euro is a fiasco”

If you read Danish or trust Google Translate then read my latest op-ed – “The euro is a fiasco” – in the Danish Business Daily Børsen here.


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