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A man poses for a picture with a painting during an exhibition by the Trick Art Museum of Japan at the National Taiwan Science Education Centre in Taipei March 4, 2011. Do easy money policies create an illusion of economic well-being? (Nicky Loh / Reuters / File )
Easy money and economic illusions
While most advanced economies continue to suffer from high unemployment and record debt levels, monetary expansions in the advanced economies feed a tsunami of carry trades, hiking asset and raw material prices and accelerating growth rates in emerging markets from Brazil over the Middle East to China. While capital inflows drive miraculous catch-ups in many corners of the world – having learnt the lesson for the recent mega-crisis – the monetary authorities in the emerging markets are aware of the risk of financial market exuberance. They aim to prevent inflation and bubbles by absorbing surplus liquidity and tightening credit growth.
Yet by doing so, they cause distortions in the real sectors of their economies, which are not on the radar screen of the now ballooning financial supervision bodies.In line with Mises’ oil stain theory monetary policy intervention to bail out financial sectors in the advanced economies is followed by the revival of government intervention and industrial policy in the emerging markets.
How does it work? Speculative capital inflows and accelerating reserve accumulation in emerging markets are counteracted with sterilization measures and capital controls. In Brazil capital controls prevent a free allocation of capital to the best uses. In China non-market based sterilization and credit rationing is used to further stimulate the already overinvested export sector. While sterilization keeps credit generally tight (for instance for consumers), the export industries and state owned enterprises enjoy low-cost credit to keep the capital stock growing. As sterilization operations also hold inflation low, the real exchange is kept undervalued what helps to clear the overproduction on international markets.
Even worse: In countries with large raw material sectors, the global liquidity driven raw material price inflation causes huge public surpluses, which are distributed by mostly autocratic governments ad libitum. Rising public expenditure and/or thriving stabilization funds replace “competition as a discovery procedure” by guided structural change and state funded economic development. Dubai loves to invest in a palm shape island and Babylon towers. Russian bureaucrats see potential in pharmaceutical and military industries. Venezuela and Algeria pump money into social security systems to create political stability. The Saudi Arabian General Investment Authority sets up glamorous new cities that shall create more jobs in the name of the King.
While all these policies may be well intended, they distort markets, as public investment in subsidized industries misguides private investment decisions. Investment in industries, which are picked by the government, is risky. Once the golden rain stops, the readjustment will set in. This may happen, once the advanced economies exit from easy money policies as growth prospects lighten up or inflation accelerates. Only then, it will be obvious which of the many economic miracles which we currently observe is real and which is an illusion.
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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
A 1900 photo shows Max Weber, a German economist and sociologist. Weber wrote about how religion affected capitalism. (akg-images/Newscom)
The genius of Max Weber
This semester, I am having the pleasure of teaching Max Weber‘s The Protestant Ethic and the Spirit of Capitalism for the second time. Doing so is renewing my appreciation for one of the great works of social science.
Weber’s historical thesis is fascinating in itself, but what really makes the work is that it is a mini-study in how to historically investigate a social-science proposition, complete with asides on method were Weber explains what he is doing. He takes two situations that are in most respects the same (that of German Catholics and that of German Protestants) and notes a crucial difference (besides religion): the two populations have significantly different degrees of participation in the capitalist mode of economic organization (as of 1905).Then, he asks whether the first-noted difference (in religion) could be to some extent responsible for the second (in economic circumstances). He systematically rejects alternative explanations as inadequate, and then shows why religion was, indeed, an important factor in the rise of capitalism.
Weber was careful to be humble about what he was achieving — not the complete explanation for the historical events in question (which is only provided by a complete history of the events), but a partial explanation stressing a particular point of view. (That makes it all the more remarkable that his work has regularly been criticized for ignoring this or that factor, when he explicitly admitted it would do so right from the start!) Here is his description of the limits of his project:
“These ‘points of view’… are, in turn, not at all the only ones possible with which to analyze the historical phenomena we are considering. For a study different points of view, other features would be the ‘essential ones,’ as for any historical phenomenon.”
And Weber notes that these foci are concrete, not abstract:
“’Historical concept-formation’ does not seek to embody historical reality in abstract generic concepts but endeavors to integrate them in concrete configurations, which are always and inevitably individual in character.”
Finally, it is interesting how important the United States is for Weber in this work, from his personal observations after touring the States to his invocation of Franklin as a paradigm of the capitalist spirit. The editors of my (Penguin) edition call him “the German Tocqueville,” which I think is just right.
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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
A microchip is shown in this photo. Guest blogger Mario Rizzo writes that the Fed's policy too strongly encourages Americans to consume electronics. (SPM-Gruppe Prof.R. Wiesendanger/medicalpicture/Newscom)
Let them eat microchips!
In today’s Wall Street Journal, David Wessel (“Capital” column, A5) revisits the question of whether current Fed policy is inflationary. He correctly states the Fed’s position is that inflation is caused by expectations. Inflation will stay low if people expect it to stay low. He quotes Fed Chairman Bernanke: “The state of inflation expectations greatly influences actual inflation and thus the central bank’s ability to achieve price stability.”
The Fed chairman of course has the causation precisely backwards. Fed policy systematically shapes inflation expectations. His statement is the product of the focus on the short-run and ephemeral over the long-run and permanent. In that, Ben Bernanke follows a long line of central bankers.
In A History of the Federal Reserve, Volume 1: 1913-51, Allan Meltzer summarizes the central bank mindset from the banking school writers like Thomas Tooke down to the Fed. Tooke “denied that money, credit, or base money bore any consistent relation to prices. Most Federal Reserve officials remained in this tradition in the 1920s. They denied that their actions affected prices” (57-58).
Unfortunately for defenders of Fed policy, today’s paper is filled with stories of rising inflation. In Singapore, consumer price inflation is running at 5.5%. In Vietnam, consumer price inflation is running at over 12%. There are food riots in India. In yesterday’s Wall Street Journal, George Melloan detailed the linkage between economics and turmoil in the Middle East. Consumer price inflation in Egypt rose to 18% annually in 2009 from 5% in 2006. In Iran, inflation rose from 13% in 2006 to 25% in 2009. As Melloan wryly observes, “about the only one failing to acknowledge a problem seems to be the man most responsible, Federal Reserve Chairman Ben Bernanke.”
Monetary policy is not the sole culprit in food price inflation. There have been supply shocks. Central bankers always point to supply shocks to explain rising prices. But it is not just food prices rising, but most commodity prices. Plus, as noted, broad measures of consumer prices around the world are signaling rising inflation.
The Bernanke’s response is two-fold. First, he questions the linkage between his policies and what is happening to global prices. Second, he argues other central banks are in a better position to mitigate the effects of Fed policy. Both arguments are disingenuous.
Commodities, plus most traded goods, are priced in dollars. The Fed creates base money. The more base money, the higher the dollar price of goods globally.
The Fed Chairman argues that foreign central banks can offset the Fed’s policy. As discussed here recently, this is true only to a limited extent if at all. Small, open economies have great difficulty in offsetting inflows of the global currency. If these central banks raise domestic interest rates and appreciate their currencies, they are likely to attract additional capital flows. If not, they risk sending their economies into recession.
Bernanke’s defense amounts to a restatement of Treasury Secretary John Connally’s quip to Europeans during the Nixon prequel to current dollar policy: “It’s our currency, but your problem.” The Fed inflates, and other central banks must mitigate.
Consumers purchase daily and weekly the goods whose prices are increasingly rapidly: food, energy and clothes. The goods whose real prices are falling, such as consumer electronics, are purchased infrequently. But they keep measures of consumer prices subdued. Marie Antoinette famously remarked that the French peasants rioting over bread prices could eat cake. Policymakers apparently believe US consumers can do the equivalent of eating microchips: stop eating and driving, and just buy more electronics. In reality, US consumers face the prospect of a falling standard of living. They can’t eat chips.
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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
Carl Menger, born February 23, 1840, was the author of the book Principles of Economics. Guest blogger Mario Rizzo writes that the book is still one of the best texts on the importance of knowledge in economic development. (Album/Oronoz/Newscom)
Carl Menger still woth reading
Today is the birthday of Carl Menger, born February 23, 1840. Menger was, of course, the founder of the Austrian School of Economics. His Principles of Economics, a great achievement for its time, is still well worth reading. It conveys like no other book at the time (and unlike most basic texts today) the importance of mind, knowledge, ignorance, causal relationships between goods and wants, and of course marginal utility. I think we can still learn from Menger’s book today, especially about the importance of knowledge in economic development. Austrians should be pleased to have such a great mind as the founder of their school.
Menger’s work has garnered respect from even those who have not considered themselves Austrians. George Stigler, for example, wrote a very appreciative essay on Menger in his Production and Distribution Theories. For a long time Menger’s contributions were not clearly distinguished from those of Jevons and Walras, the other leaders of the “marginalist revolution.” We have William Jaffe to thank for his de-homogenization of the three great economists. But, really, a moment’s perusal of the three books should make the differences obvious. Walras is concerned about mathematical elegance and Jevons is so enamored of hedonistic psychology that he gives the appearance, at least, of casting marginalism as an application of Jeremy Bentham’s philosophy – thus unduly limiting it.
Menger also made contributions to the Scottish Enlightenment project of spontaneous order, especially with respect to the evolution of money and of common law. In this he shows himself a worthy successor to Adam Smith in a way that Walras and Jevons are not.
Personally, I find the legacy of his part in the Methodensteit (“War of Methods”) to be a mixed one. On the one hand, he was obviously correct in his criticism of the naïve historicist method of Gustav von Schmoller and others of the “younger” German Historical School. On the other hand, much of his philosophy of science is a confusing mix of nineteenth-century scientific philosophy and Aristotelianism. I don’t think this is a good approach to imitate in the twenty-first century. Nevertheless, Menger was right in believing that theory (“exact laws”) was critical in understanding the economic world.
Postscript: When George Stigler won the Nobel Prize in economics in 1982, I sent him a letter congratulating him and said jokingly that I understood he received it in large part because of his essay praising Menger. He wrote back saying that I was incorrect. He received the prize for his essay criticizing Eugen von Boehm-Bawerk! (It should be noted that Menger himself did not like Boehm-Bawerk’s capital theory.)
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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
A 32.49-foot-tall sandcastle in Myrtle Beach, SC, is shown in this June 2006 file photo. Will the Fed's monetary policy be able to withstand time longer than sandcastles built by the ocean? (Courtesy of Copter Views / File )
Is the Fed building sandcastles?
Chairman Ben Bernanke says don’t blame the Fed for rapidly increasing commodity prices and probable bubbles forming in many investment markets throughout the world. I am just doing what is necessary for a recovery in the US and that is in the interests of the world. (See “Bernanke Defends US Policies” Wall Street Journal, February 19-20).
The reality is different. From a short-run point of view there is no reason for Bernanke to care what is going on in other nations. He will be judged “by history” by what happens here in the US. Therefore, he cannot be trusted to take the costs of policy – elsewhere in the world – fully into account. However, since bursting bubbles will affect asset markets here, he may begin to worry later.
And yet our fellow is boxed in. As he creates more money, and keeps interest rates low, in an effort to spur spending, much of the money will chase higher, riskier yields in foreign markets. From a US perspective, damage to foreign markets may just be the price we – oops they – have to pay.
But is the US successfully shifting the costs of its monetary policy to foreign countries? The prevailing view at the Fed and elsewhere seems to be as long as “inflation” is under control then the appropriate policy is further stimulus through quantitative easing. But wait a minute. The last two recessions – including the so-called Great Recession – were not preceded by bouts of inflation. Obviously, then, bad things can happen without general inflation.
Bernanke realizes that overall measured inflation is not increasing (as much as he thinks bad, that is) because (1) the prices of services are relatively stable and (2) food and other commodity-dependent prices are excluded, by definition, from core inflation.
On the first point, I should think that service prices – closer in general to the consumer stage – would not be as affected by low interest rates as those sectors farther from consumption. Certainly, at the early stages of massive credit expansion with low interest rates this is the case. On the second point, there is a sensible case to be made for excluding food and fuel if they are simply being “normally” volatile – that is, experiencing ups and downs due to weather or other temporary factors. (Let us put aside for the moment commodity price appreciation due to political unrest in the Middle East. The rise in commodity prices predates this.)
But we have other plausible explanations. Commodity prices are a frequent indicator of inflationary fears. They are also, because of their volatility, a good vehicle for speculative demands – money in search of higher returns. Furthermore, to the extent that other economies are over-heating, in part due to US policy, their demands for commodities of all kinds will increase. These demands are not sustainable – which is the point.
Closer to home, the stock market (S&P) has now experienced the fastest rise ever in the past two years, just about doubling. Is that because the Fed has made everything all better now and we are almost back we started from? Or are we witnessing the curious combination of firms being cautious about real investment and financial investors seeking yield? Money created out of thin air needs to find a home.
(Of course, the averages are helped a lot by bank stocks doing well as a result of the infusion of TARP money. But that has covered up the real negative value of the banking sector and built expectations of further rescues when behavior is not sustainable.)
A non-sustainable stock market rise based on expectations of bailouts if bubbles burst is a fine recipe for future difficulties.
I do not pretend to have definitive answers but there is certain complacency emanating from Bernanke that is not warranted either by his personal record at the Fed or by the facts. I know people will say that he must project self-confidence for the sake of the markets. I am not of big fan of purely atmospheric confidence, that is, of thinly-based confidence.
I fear we are living in a precarious world with the Fed building sand castles. But at least Bernanke has his self-confidence.
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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
A woman tries to decide which shoes to buy in a department store. Can people know themselves well enough to understand their true preferences? (Photo illustration/OJO Images/Newscom)
Behavioral economists, can people really know what they want?
At the turn of the new-year the Financial Times published two small articles about why people often do not adhere to their new year’s resolutions. One article was by a philosopher (Julian Baggini) and the other by a psychiatrist (Antonia Macaro). Interestingly, they each seem to focus on whether people really want what they resolve to do or not do. More fundamentally, the authors say, if people understood themselves better they would know more fully what their personal goals are and not have so difficult a time achieving them.
To put things in the words of the ancient philosophical question: If you know the better, will you do the worse?
Perhaps much apparent weakness of will is actually a failure to know oneself well enough to choose appropriate goals. As the philosopher says, “W]eakness of resolution could be a sign of weakness of conviction.” Thus, we are dealing not with a failure of will power but a failure to choose goals that really reflect what, given the agents values, would make life better.
I suggest that this is not an empirical question but a philosophical one. For one reason, there is no independent way of ascertaining when an individual has sufficient self-knowledge to really know the better for himself. So we cannot say: Joe knows what is better (by empirical test A) and yet he does not do or choose it (established by a separate empirical test B). Plato argued that failure to do what is best is failure to know truly what is best.
The error here is thinking that the individual is in a specific kind of disequilibrium in which he knows what he wants to do but cannot (for some reason) do it. Instead, perhaps, the individual is in a constant state of experimenting with his choices and is seeking something better but with no clear idea, ab initio, of what that might be. As both our psychiatrist and philosopher say, the individual will be in a better situation if he reflected more deeply on his values. And yet none of this, it seems to me, means that the outside observer can tell us or him what should be done. Doing and reflecting are part of the same action. It is a process of self-discovery.
This is not a comfortable position for today’s behavioral economists who want to establish normative preferences based on what individuals really want at some deep level. As the economist Frank Knight argued, the only thing we really want at a deep level is better wants. But they never simply arrive in stable form; the process is personal, uncertain and never ending.
The root of the problem may be that economists (behavioral and standard) have allowed a mental construct of preferences – either simply revealed by choice or arrived at by some alternative means – to act as a normative standard. It is true that behavioral economists have argued that preferences are not fixed but sensitive to all sorts of bias-inducing factors like framing, visceral influences on decisionmaking, temptation, and so forth. And yet unless they want to give up subjective value theory entirely, they must privilege some expressions of preference – those made under idealized circumstances of “full” knowledge, perfect cognitive abilities, and no weakness of will. This is their gold standard by which the choices of agents are to be evaluated. But is there anything there? Do such preferences exist?
While this framework may be useful for certain scientific problems of prediction, it does not seem to capture the process of decisionmaking through time. It is rather an attempt to adapt a static conception of choice (fixed preferences, fixed constraints) to internal dynamic problems. People may be dissatisfied with their own behavior and may be seeking to understand what might be better as they choose and act. I do not see any compelling reason to transform a simple construct that is useful for some purposes into a normative standard. If the construct doesn’t work in certain cases to predict behavior, then so much the worse for the construct.
Remarkably, behavioral economists who have spent much time and trouble to show the positive limits of the standard analytical apparatus are saying, “So much the worse for the troublesome individuals.”
This is not the last word on the subject by any means. But it does demonstrate the mental trap into which even smart people can get themselves when they fail to understand that models are constructions useful for some purposes and naive for others.
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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
Hungry and thirsty protesters reach out for food and drink during mass demonstrations inside Tahrir Square in Cairo February 8, 2011. What could Egypt learn from South Korea about government repression and angry protests? (Dylan Martinez / Reuters )
What Egypt can learn from South Korea
Compared to the turmoil in the Middle East, South Korea appears to be an oasis of calm. But as recently as 20 or so years ago you could still smell tear gas on the streets of Seoul. Violent demonstrations shook the city for decades—-making it look like Cairo today.
Despite continuing tensions with North Korea, Seoul is now relatively peaceful and the economy is humming along. How did South Korea get out of the cycle of angry protests and government repression?
Certainly part of the answer is prosperity. South Korean real gross domestic product grew at an average of 8% from the 1960s to 1990. Per capita GDP is now close to the level of Japan’s (at purchasing power parity). But the expansion of jobs and income was in part a result of government response to public fury.
One of us (Young Back) grew up in Seoul and as a young teenager joined protests that pitted the police against the protestors. He remembers the widespread anger about an undemocratic and repressive regime. Political rent extraction was rampant. Much American aid was channeled through a corrupt political network with little benefit to the economy at large. Even youngsters like him, mere children, believed justice was on the side of the opposition. So he rushed to join the demonstrators.
South Korean democracy did not develop immediately in response to the public’s demands. The process was convoluted. Since the founding of the Republic of Korea in 1948, there has been six distinct regimes, including the military regime of Park Chung-hee, who was in power for 18 years. In 1979, amid protests, Park was assassinated by the head of the Korean secret service.
Park and other Korean rulers saw economic growth as a way to gain acceptance and weaken the opposition—thus the protests encouraged pro-growth policies. But even as governments promoted investment and exports, there were huge roadblocks along the way.
When international credit dried up in the late 1970s, Korea could have gone bankrupt. Factories were still under construction, exports were small and foreign exchange earnings were insufficient to buy the equipment and materials needed to produce exportable goods. Loans from Japan eased that economic crisis.
One basic lesson is that political stability and economic success cut both ways. While greater affluence would calm Egyptian demonstrators, overcoming major economic barriers requires a government that is accepted by the population. This may or may not mean political liberalization. China shows that fast growth can happen under a repressive regime. But a chaotic environment is an impediment to growth, with the recent financial and economic disruption caused by political unrest in Egypt a vivid example.
As we know all too well from the history of the developing world, it’s easy for societies to get trapped in a vicious cycle. Exploitative government causes political unrest and economic stagnation, which in turn leads to further repression, unrest and economic stagnation.
The interaction of a responsive political system and income growth creates a virtuous cycle. In South Korea, this took several decades. Over time the government became more representative. The sixth Republic – currently in place – started in 1987, when demands for reform led to direct presidential elections and the restoration of civil rights.
Challenges remain, of course. South Korea is heavily unionized and higher wages have made exports less competitive. Faced with aggressive union demands at home, Korean companies often invest abroad—like the Hyundai Motor plant built in Montgomery, Alabama, in 2004 or a plan by Posco to build a $12 billion steel factory in India. But these are the issues of a modern economy.
Let us hope that when they reach middle age, the young protestors of Egypt and Tunisia will look back to today as a crossroads that led to better lives, in the sense of both greater liberty and material wellbeing.
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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
Indian girls on a boat, return with drinking water collected from Nal Sarovar, a wetland bird sanctuary, 64 kilometers (40 miles) west of Ahmadabad, India, on Wednesday. Guest blogger Mario Rizzo writes that behavioral economics rocks the boat of economics orthodoxy. (Ajit Solanki / AP )
Rocking the boat with behavioral economics
It seems as if it has become increasing common for bloggers who are also academics to post the syllabi of courses that may elicit some general interest. In that spirit I post my syllabus for a graduate course in behavioral economics here. Behavioral Economics 2011 Course
Despite some rhetoric to the contrary, academics are a very conservative group. They (me too?) hate disruption of their research agendas by young upstarts who rock the boat. Where is the respect for their elders who have given the best years of their lives to orthodoxy? From the orthodox perspective, behavioral economics is, I should think, especially unpleasant. Luckily, I do not consider myself a part of an economics orthodoxy.
A few observations are in order. First, I believe that behavioral economics, interpreted broadly to include experimental economics, is the most important development in economics in a long time. To a large extent, it stands as a challenge to standard economics, including Austrian economics. It challenges the revealed preference approach of neoclassical economics, especially as developed by Samuelson, but also as amended more recently by others. It also challenges the Austrian view insofar as Austrians have also eschewed psychology in their elaboration of the theory of value and choice. As readers of this blog will know, I have been critical of Ludwig von Mises’s approach to rationality which makes irrational action impossible, by definition. Behavioral economics is causing us all (or should be) to think more deeply about rational decisionmaking.
Second, there are many areas in which behavioral economists have set the agenda and to which others are simply responding. This included the recent boom in policy recommendations under the rubric of paternalism or the malapropism “libertarian paternalism.” I am exasperated at the superficiality of the work here.
Third, most courses in behavioral economics are by practitioners who want to convey to students their excitement about the field and the new revolutionary framework to which they are contributing. I am trying to do something different. I am trying to get graduate students both to learn behavioral economics and to evaluate the whole paradigm with a rigorous critical eye.
I hope teaching this course will increase my own insights and understanding of not only behavioral economics and its neoclassical opposition, but also perhaps will help me find a new way of dealing with the issues raised by both schools of thought.
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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
US dollars are exchanged for Turkish liras in Ankara, Turkey, in this file photo. As inflation picks up, Turkey is taking unusual action: lowering interest rates and raising reserve requirements. (Burhan Ozbilici / AP / File )
Is Turkey bracing for a crisis?
While the US, Japan and Europe slashed interest rates to unprecedented low levels, growth remains sluggish. Dealing with debt problems and supporting the recovery, the ECB provided money to quasi-finance the euro area problem children. Similarly the Federal Reserve is trying to jump start the economy and has been flooding markets with money so that they have no idea about what to do with all the liquidity.
But – wait – there are emerging markets. They are booming from Brazil to Turkey. Hence, investors target emerging market asset markets until there is something to gain at home. As a consequence Poland and Brazil just raised interest rates to fight inflationary pressure in goods and asset markets. On the contrary, while inflation picks up (expected rate for 2011 is 5.9 percent), Turkey LOWERED interest rates and raised reserve requirements.
This might seem odd?
But it makes sense: Turkey has a history of severe crises (1994, 2001) and turbulence (1999, 2006) over the last two decades caused by sudden capital flight and depreciation. And again, an economy that is growing at rates of eight percent, faster than any European economy, is the natural target for speculative investment. “Can it happen again?”, asked the Turkish Prof. Onaran in 2006. The Turkish authorities seem to think so:
In my opinion, this unorthodox measure shows not only that Turkey’s primary fears stem from hot money inflows, but also that the country is already preparing for a possible crisis. As higher interest rates might attract more speculative capital inflows due to appreciation of the lira, this is not seen as a wise option to fight inflation. The policy answer of the Turkish central bank makes a lot of sense: First, lower interest rates. In a second step, raise reserve requirements. Raising reserve requirements increases interest rates back to where they were or even more. But then banks are better prepared to deal with possible capital flight.
Unfortunately this unorthodox policy has shown that it might already be too late. Easy money investment is already very sensitive to devaluation. After the Turkish central bank lowered rates (19.Jan. 2011), financial stocks lost about 20 percent as the depreciation of the currency led foreign investors to sell out their portfolio. Therefore it seems that Turkish authorities have nothing to stop easy money inflows without risking severe disinvestment. They are trapped.
But what is worse: this immediate market turbulence signals that the risks taken by investors in emerging markets around the world might be very high and trouble may be ahead. Once the major economies return to a more moderate monetary policy stance, it is likely that emerging market asset market booms go bust. The longer they wait, the worse it will be. Let us hope the Turkish turbulence is just a small cloud on a clear sunny sky!
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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
A health care worker measures pills in Boston in the file photo. Guest blogger Bill Butos writes that new drug development center in the National Institutes of Health does too much to help commercial drug developers. (Sarah Beth Glicksteen / Staff / File )
Government should stay out of the medicine cabinet
The New York Times of January 22 reports that the Obama administration has created a “billion-dollar government drug development center to help create medicines” as part of the federally funded National Institutes of Health.
According to the article, its rationale is to undertake research leading to the commercial development of drugs that has mysteriously lagged in the U.S. The article makes no mention of the regulatory costs drug firms face. The moving force behind this new center is NIH Director Francis Collins, famously (and embarrassingly) associated as runner-up in the Human Genome Project to Craig Ventner’s privately funded effort.
The Times marvels at Collins’ “ability to conceive and create such a center in a few short months.” Yet his political connections apparently run quite deep. As Thomas McQuade reminds me, Bill Clinton arranged for a face-saving event for Collins in which the human genome “race” was declared a tie.
The intended role of this new center meshes well with Obama’s call for managing American competitiveness via government intervention. But such enthusiasms are not new or peculiarly American. Explicit government collaboration in commercial R&D with private firms has been de rigeur in Europe for many years and has been gradually accepted and implemented in America by politicians, the government run funding bureaucracy, and firms eager for special guarantees and subsidies for the past several years.
The flawed market failure arguments pertaining to “basic research” have morphed to apply to the commercial end of R&D to further “competiveness in the global knowledge economy.” In reality, however, this unwarranted extension of government insinuation into the private sector is just a more modern version of 1970s “industrial policy” and should be rejected for the same reasons.
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The Christian Science Monitor has assembled a diverse group of the best economy-related bloggers out there. Our guest bloggers are not employed or directed by the Monitor and the views expressed are the bloggers' own, as is responsibility for the content of their blogs. To contact us about a blogger, click here. To add or view a comment on a guest blog, please go to the blogger's own site by clicking on the link above.
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