Friday, February 17, 2012

The Economic Consequences Of Mr. Draghi

This post is somewhat on current events, and about topics I'm even less expert in than usual. I suggest that a certain historical analogy might be useful for understanding certain aspects of the Greek crisis1. Not that I'm willing to propose a solution. I look to, for example, Yanis Varoufakis for more informed takes on the Euro2.

John Maynard Keynes, in 1925, wrote a pamphlet, "The Economic Consequences of Mr. Churchill". Keynes' title is a suggestion of his previous best-seller, The Economic Consequences of the Peace, another work in which Keynes foresaw the dire consequence of then current events. In the case of Churchill, Sir Winton was then serving as Chancellor of the Exchequer.

Britain had gone off the gold standard during World War I. Churchill oversaw the restoration of the gold standard, with the Treasury insisting on establishing the foreign exchange value of the pound sterling to its pre-war parity in gold. Apparently, according to Keynes, the market value was about 10% below that at the time. The foreign exchange rate of a currency combines with the general price level to determine the standard of living in terms of foreign goods. If the British wanted to maintain their then-current standard of living, and Churchill insisted on the pre-war parity, then prices and costs, including wages, must drop 10%. And this process of deflation could be expected to be resisted. In fact, widespread unemployment and general labor unrest were some of the economic consequences of Mr. Churchill. I think you can see some of these consequences in the 1926 general strike in Great Britain.

Churchill refused to acknowledge the necessity of devaluing the pound. In the case of Greece, they do not have control over the value of their currency, as long as they remain on the Euro. So they cannot devalue their currency. But, as in the case of the British population in the 1920s, they are being asked for the functional equivalent - that is, for a general reduction of prices and wages throughout the country. Maybe the consequences in Greece will resemble the consequences in Britain in the 1920s. I don't see how this is likely to increase the odds of Greece fully paying back their external debts.


  1. I think of this post as, perhaps, an illustration of the usefulness of studying economic history and the history of economics. Even if you conclude that my suggested analogy is too facile, you might accept that discussing it is a useful point of departure.
  2. D-Squared also has a view on the topic, given certain constraints.


Blissex said...

«I think of this post as, perhaps, an illustration of the usefulness of studying economic history and the history of economics.»

Or perhaps of the futility of doing so, because policy depends on a play of interests, and past demented choices will be taken again if they are in the interests of powerful enough interest groups.

A more recent discussion of the current issues was done by Michael Pettis, in his extremely useful "The volatility machine".

But his conclusions are very optimistic: his main argument is that policy for countries (and companies) should be to borrow or invest in a countercyclical way, so that when a crisis comes, the impact gets softened.

The problem he correctly identifies is that many countries (and some companies) do the opposite, they invest or borrow in ways that are very sweet in the good times but are very sour in the bad times.

The reason is obviously that some interest groups want to make as much money as they can in the good times, and then they keep the money during the bad times, and actually welcome the bad times because they are a good opportunity to use that money to pick up cheap assets.

Sure, economic and policy history can be enlightening as to how you are being screwed, but it may not be enough to prevent being screwed.

BTW if you haven't done so, con sider reading that book, it is prophetic.

Just the brief history of 100-200 years go Greece-like episodes is worth it.

Blissex said...

BTW, they are not the consequences of Mr. Draghi, for his role is on rails, and he has to do what he has to do.

If the ECB reflated without EU member country (Germany etc.) popular authorization, it would be destroyed. They have to be very careful.

Also of all the countries with a financial crisis in Europe, Greece is the least deserving of sympathy, because they borrowed as much as they could in a clearly opportunistic way, just to spend the money and never repay it. Iceland and Ireland did almost as badly, Portugal is just an unlucky poor country, Spain and the UK just went on an unsustainable property bubble.

Naked Keynes said...

Blissex, sure interests are important, but history still is a good guide to understand the consequences of certain policies even for the groups that blindly defended them. My concern is that in history not just the similarities matter, but also the differences. And while I think Robert is right that the Gold Standard is an apt historical analogy to the current situation in Greece (and others in Europe too), there are important differences. The GS had not equivalent to the ECB, which could buy Greek bonds and fundamentally eliminate the problem. In that sense, there was nothing in the GS like the current German stance against monetizing debt, or the equivalent to what Sergio Cesaratto and Antonella Stirati have called German neo-mercantilism, that is at the core of the current crisis.

Robert Vienneau said...

Thanks for the comments. I'm not sure that Keynes was fair to Churchill - he, too, was filling an institutional role that did not give him a lot of choices. So in that way, maybe my analogy is good. I accept the differences between the gold standard and Greece.