Best of the Week
Most Popular
1.Stock Market in DANGER of Strangling the Bears to Death - Nadeem_Walayat
2. Germany Pivoting East, Exit US Dollar, Enter Gold Standard - Jim_Willie_CB
3.Flight MH17 – Kiev Flash Mob's Last False Flag? - Andrew_McKillop
4.Stock Market Crash Nightmare! - Nadeem_Walayat
5.Gold - The Million DOLLAR Question... - Rambus_Chartology
6.Gold And Silver – BRICS And Germany Will Pave The Way - Michael_Noonan
7.The Jewish Selfish Gene, People Chosen by God, Everyone Else is Goyim to Kill - Nadeem_Walayat
8.The Israeli Promised Land Dream - The Criminal Roadmap Towards “Greater Israel”? - Felicity Arbuthnot
9.Which Way is Inflation Blowing? Watch Commodities - Gary_Dorsch
10.U.S. Economy Quarterly Review and Implications for 2014-2015 - Lacy Hunt
Last 5 days
Gaza Death Cloud Hangs Over Sheffield Eid Festival 2014 at Millhouses Park - 1st Aug 14
Israels Final Solution of Turning Gaza Concentration Camp into a Grave Yard - 31st July 14
US Failure: Unintended Consequence - 31st July 14
Stock Market Breakdown! - 31st July 14
Echoes Of The Great War – Only An Echo In The Elite Mind - 31st July 14
This is Bad News for U.S. Economy and Stock Markets - 31st July 14
The Important Impact of This “Secret” Gold Agreement - 31st July 14
The Something For Nothing Society Death Spiral - 31st July 14
The Social Memory Dump, Shredding Society - 31st July 14
How Safe Are Unallocated Gold Bullion Accounts? - 31st July 14
USDJPY Big Bear Market - 31st July 14
No More School in Gaza Because All the Children are Dead Chant Israel's Jewish Fundementalists - 31st July 14
The Iron Dome Inside The Heads of Israel’s Leaders - 31st July 14
You Know a Politician or Talking Head is Clueless When….. - 31st July 14
Don't Get Married to Your Gold Stocks—It's a Performance-Based Relationship - 31st July 14
Stock Market Parabolic Collapse - Sowing the Seeds of the Next Depression - 30th July 14
How to Profit from the Russia Ukraine Conflict - 30th July 14
Greenspan: U.S. Economy Running Out of Buffer; Stock Market to See Significant Correction - 30th July 14
Rogue States And Loony Tunes - 30th July 14
Anne Elk’s Theory On Brontosauruses - 30th July 14
Our Totalitarian Future - Totalitarianism NOW! - 30th July 14
Stocks Bear Market Formation Revealed - 30th July 14
We Just Found “The Future” - 30th July 14
What the “Steak Bandit” Says About Asset Values - 30th July 14
Designer War By Default - Seven Types of Elite Madness - 30th July 14
Death of the U.S. Dollar? Gold an Inflation Hedge? Really? - 29th July 14
We’re Ready to Profit in the Coming Gold Price Correction—Are You? - 29th July 14
Their Economy Will Collapse, Including Ours - 29th July 14
Silver Prices – Megaphone Patterns - 29th July 14
Real U.S. Interest Rates - Fed Exit a Blue Pill? - 29th July 14
Why Israel Should NOT Exist, Just Like Any Other Rogue State - 29th July 14
Gold Still Looking Good - 29th July 14
Silver Price Set To Star - 29th July 14
Our Population Growth Totalitarian Future - 29th July 14
World War 1 Cause and Consequences - The Planned Destruction of Christendom - 29th July 14
Will Crashing Commodities Crash the Stock Market? - 29th July 14
Ukraine MH17 - Washington Thinks Americans Are Fools - 29th July 14
Stock Market Bubble Warning - 29th July 14
Gold Price and U.S. Dollar’s July Rally - 28th July 14
Second Quarter Corporate Earnings: Marching Toward a Strong Economic Recovery - 28th July 14
Time to Put a New Economic Tool in the Box - 28th July 14
Mossad in Gaza, Ukraine and the Cult Of The All-Powerful Elite - 28th July 14
Elliott Wave Gold Price Projection Since 1970 - 28th July 14
Investors Remain Uncertain As Stock Fluctuate Near Long-Term Highs - Will The Uptrend Extend? - 28th July 14
The Mass Psychology Of Decline - 28th July 14
Will the US Destroy the World? - Don’t Expect to Live Much Longer - 28th July 14
GDM and GDXJ Gold Stocks In-depth Look - 28th July 14
Stock Market One FINAL High? - 28th July 14
What It Means - Paradigm Collapse And Culture Crisis - 27th July 14
Wall Street Shadow Banking: You Can’t Taper a Ponzi Scheme: “Time to Reboot” - 27th July 14
6 Tips for Picking Winning Gold Mining Stocks - 27th July 14
Israel's War on Children, Exterminating the Palestinians Future - 27th July 14
Guilt By Insinuation - How American Propaganda Works - 26th July 14
Surprise Nuclear Attack On Russia To Liberate Ukraine - 26th July 14
Use "Magic" Of Gold/Silver Ratio To Greatly Increase Your Physical Holdings - 26th July 14
Derivatives Market Species Origins - Abuse, Props and Risks - 26th July 14
Stock Market Manipulation and Technical Analysis - 26th July 14
China’s Stock Market Finally Looks Like A Buy - 26th July 14
Ed Milliband Fears Israel Jewish Fundamentalist Gaza War Massacres Backlash - 26th July 14
The Big Energy = Power Battle Is Coming - 25th July 14
USrael - Zionists in Control of America's Goyim Brainwashed Second Coming Slaves - 25th July 14
More Weakness Ahead for Gold Miners - 25th July 14
Gold Price Strong Season Starts - 25th July 14
Geopolitics and Markets Red Flags Raised by the Fed and the BIS on Risk-taking - 25th July 14
Gold Lockdown Until Options Expiry - New Singapore Gold Contract Threatens Price Manipulation - 25th July 14
The Bond Markets, Black Swans, and the Tiny Spirit of Santo - 25th July 14
No Road Map For Avoiding The Future - 25th July 14
Israeli War Machine Concentrating Women and Children into UN Schools Before Killing Them - C4News - 25th July 14
Israeli Government Paying Jewish Fundamentalist Students to Post Facebook Gaza War Propaganda - 25th July 14
Why the Stock Market Is Heading For A Fall - This Time Is Not Different - 25th July 14
An Economic “Nuclear Strike” on Moscow, A “War of Degrees” - 25th July 14
BBC, Western Media Working for Israeli Agenda of Perpetual War to Steal Arab Land - 25th July 14

Free Instant Analysis

Free Instant Technical Analysis


Market Oracle FREE Newsletter

The Biggest lie in Stock Market History Revealed

Krugman's Magic Solution to Budgetary Woes

Economics / Economic Theory Nov 13, 2009 - 01:01 PM GMT

By: Robert_Murphy

Economics

Best Financial Markets Analysis ArticleLong-time readers know that I am second only to Bill Anderson in my constant criticism of Paul Krugman. Indeed, I quite recently defended the gold standard from Krugman's ridicule.

Given this context, I am very surprised to confess that Krugman has convinced me of the virtues of currency debasement. As I was reading his blog post on the tragic fate of Ecuador, I applied Krugman's lessons to my personal life, and suddenly everything became clear. In a flash, all of my household's financial stresses were solved.


Please allow me to share Krugman's tale — and my own personal salvation — so that you too may be freed from the bondage of creditors and scarcity.

Krugman Explains the Problem with the Gold (and USD) Standard

In a late October blog post titled "Fixed Rates and Protectionism, 2009 Edition," Krugman explained that the horrible trade wars of the early 1930s were the fault of — you guessed it — the gold standard. Herbert Hoover, for example, had no choice but to sign into law the Smoot-Hawley Tariff, because he stubbornly refused to let the US dollar depreciate against gold. I'll let Krugman explain:

Barry Eichengreen and Doug Irwin have a new paper challenging the conventional wisdom about protectionism in the 1930s. It wasn't about economic ignorance, or at least not about microeconomics; it was about the attempt to escape the "golden fetters" of the exchange rate. The most protectionist countries were those that tried to keep their peg to gold.

Fortunately in our times, no government foolishly pledges to pay a certain weight of a commodity in exchange for the pieces of paper it prints up and gives the force of legal tender. We've long since left behind that bit of "economic ignorance." (Phew!)

Alas, just as you kill one superstition about "hard money," another rises to replace it. For example, apparently a bunch of developing nations with histories of volatile paper currencies try to inspire faith by linking their own money to the US dollar.

In fact, some countries with very bad inflationary histories have gone so far as to literally replace their own currencies with the US dollar. Krugman has seen the awful ramifications firsthand:

I'm blogging from Quito, Ecuador. Ecuador is dollarized — no currency of its own, just US dollars. And this leaves the country with very limited room for maneuver during the current crisis. And here's what happened:

In January 2009 Ecuador announced a series of stiff import restrictions on 630 tariff lines, affecting 8.7 percent of its 'tariff universe' and 23 percent of the volume of imports. Duties were raised on 369 tariff lines and quota restrictions imposed on 271 others for a one-year period. They cover products ranging from processed foods and shoes to cars, mobile phones and sunglasses, as well as many other goods that can be manufactured in Ecuador.

Ecuador insisted that the measures it proposed were necessary to balance its widening current account deficit. GATT Article XVIII allows developing countries to impose temporary import controls to "forestall the imminent threat of, or to stop, a serious decline in its monetary reserves; or, in the case of [a Member] with very low monetary reserves, to achieve a reasonable rate of increase in its reserves."

Can you really say that Ecuador was wrong to do this, given its lack of other policy tools? At the very least, you have to say that there's a pretty good second-best case for the policy — and the WTO has reached a compromise allowing Ecuador to keep the measures in place at least for now.…

Anyway, no deep moral here, except to say that the problems that faced nations on the gold-standard in the 1930s are being replicated in countries pegged to the euro or the dollar today.

Now I have to admit, at first my knee-jerk Krugman-phobia kicked in, and I thought the above arguments were silly. First of all, the whole reason a country pegs its currency to the dollar (or better yet, gold) is to reassure investors, both domestic and foreign.

No one wants to open a factory in a distant country if there's a decent chance that a military coup will crash the currency and cut his property value in half overnight. By building up reserves in a foreign currency that is supposed to be much more reliable, the governments (or central banks) of volatile countries can allay that fear.

Since the whole point of pegging a currency is to reassure investors, Krugman's analysis ignores the downside of his proposal. Namely, investors are going to be much more cautious about exposing their wealth to a foreign government that has already burned them once by breaking its peg.

However, there's something even stranger going on in the case of Ecuador. Everything I said so far would be applicable to a country that had its own currency, but then pledged to redeem it in a certain ratio against a foreign currency like the US dollar.

After a string of trade deficits, there would be increasing pressure on the domestic currency to depreciate, which would ultimately fuel speculative attacks against the country's reserves of the foreign currency (such as the dollar). In this case, Krugman would simply be saying that if a country prints too much currency, its attempts to artificially peg that currency above market exchange rates will lead to disaster.

Yet this standard analysis doesn't seem to be applicable in Ecuador. There, as Krugman himself suggests in his blog post, the people literally use the US dollar as their currency. In other words, the people in Ecuador don't "peg their currency to the dollar," but actually walk around with US dollar bills in their pockets. (I have confirmed this fact with both a cosmopolitan world-traveling economist, and the infallible Wikipedia, so I hope it's true.)

Now in this case, Krugman's analysis seems especially nonsensical. To say that Ecuador is running trade deficits and hence running low on its "foreign reserves" of US dollars — when its official currency is the US dollar — makes as much sense as saying Governor Schwarzenegger declared a fiscal emergency because his government is running low on dollar reserves, and therefore needs to prevent Californians from spending their money on goods made in Nevada or Oregon.

I'm hoping that even Paul Krugman would recognize this as an absurd interference with trade, when the real solution would be for the California government to balance its budget. (Ha ha, a little joke there for you. Of course Krugman wouldn't say that.)

Let It Begin With Me

As I mentioned in the beginning of the article, I eventually came around and saw the wisdom of Krugman's analysis, but only after I applied his principles to my own life. You see, up until now I've been in a rat race: when the family budget was tight, I thought my only options were to either earn more income, or spend less money. But thinking about Krugman's analysis of Ecuador and applying it to California, I had a flash of insight.

The real problem with my household finances wasn't that we were underearning or overspending. No, the real problem was that our superstitious bank decided to peg its unit of account rigidly to the dollar at 1:1.

So, for example, if I had earlier deposited $2,000 into my checking account, then I would go around writing checks on that. But if I wrote a check for, say, 500 units of currency, then my bank would dutifully pay out at the rate of 1:1! Thus I would only have 1,500 US dollar bills left in my stockpile of reserves, which would seriously crimp my sushi purchases.

I have since forwarded a copy of Krugman's blog post to the managers of my local bank. I informed them — in case the boobs didn't already know — that Dr. Krugman not only teaches at Princeton, but is a Nobel (Memorial) laureate, for goodness' sake. Taking his advice, I henceforth want to devalue my checking account, so that when I write a check for 500 units, the bank only transfers $250 to the person whose goods I am purchasing.

This step solves so many problems; I can't believe I didn't think of it earlier. Immediately, my household's budget crisis is solved, for I now have double the effective reserves as I previously did. Making my mortgage payment is no longer a struggle!

But this isn't just about me. With my depreciated bank currency, I can spend more freely on local merchants, thus boosting business in my community. Before removing the absurd 1:1 dollar peg, my wife and I would have had to sharply curtail our consumption. This is no longer a concern, thanks to the magic of modern monetary analysis.

Thank you, Dr. Krugman! Now if only governments and central bankers would heed your words of wisdom, the worldwide recession would be ended immediately.

Robert Murphy, an adjunct scholar of the Mises Institute and a faculty member of the Mises University, runs the blog Free Advice and is the author of The Politically Incorrect Guide to Capitalism, the Study Guide to Man, Economy, and State with Power and Market, the Human Action Study Guide, and The Politically Incorrect Guide to the Great Depression and the New Deal. Send him mail. See Robert P. Murphy's article archives. Comment on the blog.


© 2005-2014 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Free Report - Financial Markets 2014