Mar 22, 2021
Welcome to episode 72 of Activist #MMT. Today I talk with Texas
Christian University PhD. economics professor and Cowboy
Economist, John Harvey. The topic of our conversation is
exchange rate determination. However, be forewarned that this
episode is not an introduction but a deep dive into the weeds of
John's 2009 textbook,
Currencies, Capital Flows, and Crises. For a proper
introduction, you'll find links in the show notes to several good
recommendations, including two MMT Podcast episodes (December
2020 with John, and October
with Steven Hail), John's August 2020 lecture with Modern
Money Australia, a
2012 interview on the economics blog Naked Capitalism, and a
layperson-friendly
2004 book by psychologist Thomas Oberlechner.
(Here is a link to
part two with John.)
This interview took three months of preparation. When I first
read John‘s book, I only made it halfway through and, in all
honesty, aside from the introduction, I got very little out of it.
John's writing has nothing to do with it, it's simply an intense
and completely (if you'll forgive the pun) foreign topic. Chapter
two, especially, was impenetrable. It's a summary of the major
exchange rate models in neoclassical economics and frankly made
zero sense. I took a nap after every few paragraphs and watched
videos on each type of model, but none of it felt relevant. (John
briefly goes over this chapter in his August 2020 lecture.)
I started the book over again and grew fascinated by a five page
section in chapter one called Post Keynesian Economics. You'll find
it on pages five to nine. The section is an introduction to post
Keynesianism and specifically how it contrasts with neoclassicism
(the latter of which is currently mainstream economics). Without
exaggeration, I read the section around twenty times and wrote
pages of notes and questions, several of which I posted on the
Facebook group, Intro to MMT (which, I wasn't then, but am now, a
moderator of… and I recommend you join it).
I spent the next two months diving into the basics of mainstream
economics, starting with a 2019 paper expressing the common concern
for the long-term fiscal sustainability of government spending, and
its corresponding debt and interest. I then read
and interviewed the authors of the 2020 paper responding to it,
by German MMT economist Dirk Ehnts and Danish PhD. candidate Asker
Voldsgaard. I also read a paper on historical time as recommended
by Asker, and a 2006 paper by Scott Fullwiler. The interview
inspired a post where I break down the topic in detail: The long-term fiscal
sustainability of government spending (is a non-issue)
I then read Steve Keen's 2011 book,
Debunking Economics, second edition. I didn't
understand much more than I did understand, but it was
fascinating and enlightening nonetheless. It also provided
excellent background for my next interview with UMKC PhD economics
candidate Sam Levey, with whom I discussed the core assumptions of
mainstream economics [parts
one and
two]. Links to all of these papers, posts, and interviews can
be found in the show notes.
Before returning to John's book, I read several papers by John
and Ilene Grabel, plus the 2004 book by Oberlechner, called
The Psychology of the Foreign Exchange Market. I especially
recommend Oberlechner's book as a layperson introduction to
exchange rate determination. It's particularly easy-to-read and
also comes highly recommended by John. As is made clear in
Oberlechner's book, one of, if not the, most important determinant
in the reality of exchange rates is group psychology.
Finally, I read John‘s book straight through, beginning to end.
This time, I was better prepared to distinguish between what to
discard and what to focus on. Re-reading chapter two, I now realize
that it's less that I didn't understand it and more that it's just
not understandable. You would not lose much from skipping the
chapter entirely. Its primary benefit is not to learn about foreign
exchange but to provide a benchmark for just how far off mainstream
is from reality.
The other major lesson I take from John‘s book is that people do
not want only to trade – meaning purchase physical goods and
services from a company in another country – actual human beings
want to accumulate financial assets, and especially, to profit in
the short term. Neoclassical economics assumes people only want to
purchase stuff (meaning trade), and the only reason they
need and want to use money is in order to purchase that stuff. But
in the world in which we actually live, only between 1.5 to 8% of
all international transactions are for trade. The rest, well over
90%, is for purely-financial assets.
Despite this obvious contradiction by the facts, minstream
economics assumes barter for every person, in every country, at all
times. In fact, the assumption of barter is required in order for
their assumption of balanced trade (either right now or soon to be)
to also be true. And that assumption, of balanced trade, is
required in order for the assumption of full employment in a single
country (any country!) to also be true. In other words, if the myth
of barter is indeed a myth (and it is indeed a myth), then
mainstream economics falls apart. John and I discuss this in part
one, and it inspired me to write a post where I elaborate on the
concept, a link to which can be found in the show notes: The neoclassical
assumption of full employment requires balanced trade.
If we are to be a civilized society, then we must do what it
takes to achieve full employment. Mainstream economics falsely
assumes that doing nothing is the only possible avenue to achieving
it. MMT demonstrates that full employment can
only be attained and maintained, in both good times and bad, by
a federally-funded jobs guarantee; one paid for by a currency
issuer with a freely-floating currency and little to no debt and
other currencies. Despite mainstream's protestations, full
employment doesn't and can't happen "naturally." It can only happen
with the deliberate and ongoing intervention by the central
government – and this will only happen when we stand up and make
them do it.
Two notes before we get started: first, a minor correction: I
say that "today's" exchange rates are determined by the forecast
for next week's exchange rates. I should have said tomorrow.
Second, my full question list can be found in the show notes.
And now, onto my conversation with John Harvey.
More resources
- By John:
- By Ilene Grabel (her
website):
- Other academics recommended by John to learn more about
exchange rate determination: Anina Kaltenbrunner, Rogerio Andrade,
and Daniela Prates
Full question list
- First things first! Today is a red letter day in the history of
exchange rate determination. (brief Battle of the Bulge
summary)
- Before discovering MMT, I never followed or read about
economics. Before discovering your work, I never followed or read
about foreign exchange. In my ignorance, coupled with how
simplistically it seems to be portrayed in the media (such as
"China and the United States trade lots of stuff"), I thought that
foreign exchange was only trade (which is the exchange of physical
goods and services). I also thought that this trade was mostly done
directly between two central governments. But the very existence of
exchange rates and currency exchange at all, suggests that exchange
actually happens, at least substantially, between
companies within two different countries. Governments
don't need their own currency! Companies do. So a company in
country M (M for import) wants to purchase something from a company
in country X (X for export). So company M needs currency
from country X, before it can do business with
company X. This is not really a question, but I found the
opening pages of your book to be pretty eye-opening, and I suspect
my ignorance is not unique among the general public.
- The trading of goods and services is only about 1.5 to 8% of
all International transactions. The rest is the trade of financial
assets. On page 2 in your book you quote a 2005 BIS survey that
says the average daily currency transactions worldwide was about
$1.5 trillion. This is around 40 times the value of daily trade. In
the show notes, I put a link to a 2019 tweet from Scott Fullwiler
that refers to an interview, where it's stated that $5 trillion of
settlements are made each day in the Federal Reserve system in the
United States. I don't remember which one, unfortunately, but Scott
also states in a paper that it may be actually between five and $20
trillion per day. Obviously the data quoted in your book is from 15
years earlier, but I'm shocked that the whole planet is only $1.5
trillion when the US alone is $5 trillion. Are these numbers
comparable?
- Regarding a single nation: A major assumption of mainstream
economics is that full employment is here now or soon will be. A
critical assumption underlying that is that people (households) are
insatiable and will spend every dollar of their income on consumer
goods and services. This maximizes aggregate demand, which means
companies always need to hire more, hence full employment. A
critical assumption underlying this is that all of the spending
stays within that country. If even one dollar more leaves the
country than comes back in, then total demand is lowered and full
employment is put in jeopardy. This is why the assumption of
balanced trade, either right now or soon will be, is what you call
"one of the legs by which the full employment assumption is
maintained." Each country must be a perfectly self-contained,
hermetically-sealed bubble, or mainstream theory falls apart. Can
you elaborate on this connection, and also briefly describe the
other legs that undergirds mainstream's assumption of full
employment?
- One of the most important determinants of exchange rates is
group psychology. There's a great moment in your book discussing
how the most important determinant of today's exchange
rate is today's forecast for next week's rate (or however
far into the future). So the idea that your forecast of next week
affects next week's actual rate is mostly an illusion. And by the
time next week rolls around, you don't care about those actual
results anymore! In other words, the expectations are
self-fulfilling prophecies. Expectations create the
future. Mainstream or neoclassical economics primarily
evaluates this situation by comparing those expectations about
future values to the actual future values. This is
not useful because (A) it pretends the result is unaffected by the
expectations (which is called logical time where PK has historical
time) (B) Conversely, it suggests that next time maybe we could
predict the future. (C) It pretends (I'm not sure how to elegantly
say this) that, as if flipping heads five times in a row then makes
flipping tails five times in a row more likely and (D) it distracts
you from trading and forming expectations in the now! Post
Keynesian focuses exclusively on the process of forming those
expectations. Can you elaborate on this difference? (I read
Oberlechner‘s book. It was very good and in my opinion very
layperson friendly. I don't know why it only addressed foreign
exchange since it seems to me that almost all its findings apply
just as much to traders at any geographic level.)
- Mainstream acknowledges that it has nothing to say about
exchange rate determination in the short run, and only models for
the long run. All of those models are wrong, but let's
pretend that they're right. So mainstream can predict what will
happen, say, 10 years from now, but nothing sooner. So what at
all is useful about mainstream economics? 10 years off is
always 10 years off. 10 years from now, 10 years from
a year from now, 10 years from six years from
now. So how is it not just an every-man-for-himself rat race
at all times? If I'm correct, then how is mainstream anything more
than propaganda for the status quo, which by definition only
benefits those already in power. Does that make sense?
- So much time and energy in foreign exchange is spent on
nonsense. Analyzing meaningless charts (chartism) or random
economic rules (the fundamentals), pretending that we can somehow
predict the future, that we don't affect the future, that we aren't
affected by others or the past. So on one hand, because we can't
predict the future, what alternative is there? How can it be
anything but a big gigantic game? On the other hand, it seems that
the vast majority of traders think that neoclassical fantasy world
is indeed real. Perhaps a select few that know the reality,
deliberately use that knowledge to manipulate and dominate the
masses. That seems like a reasonable speculation. Aside from the
elite being less elite and neoclassical economists being thrown to
the street, what if every trader read your and
Oberlechner's books, and Ilene Grabel‘s work, and really got it?
What would this alternate foreign exchange universe be like?
Trading wouldn't stop! How would it be different?
- Two meta questions: I'm pretty sure these things are not
related, but I'm going to ask them together: (one) I've heard you
say that you disagreed with some aspect of MMT but that it's
something in the weeds, nothing major. What is your
disagreement?
- (Two) knowing that the book was written well over a decade ago,
on page 72 you state, "we [the US] have a fractional reserve
banking system…." I can only guess that you would agree that that's
no longer the case. So to ask this more broadly: if you were to
rewrite the book again today, or update it for a second edition,
what would change? How much would each of those changes impact your
conclusions, diagrams, and mental models?
- My ultimate goal, which is clearly impossible to achieve today,
is to make a clear connection between your work and that of Fadhel
Kaboub. My instinct is that there's something important there. In
your late-Mexican-delivery, margarita-fueled, yet very
entertaining "horrifically boring" lecture (which was
organized by the fine folks at Modern Money Australia and a MMT
Podcast), you
said the following: "What if I'm a small African nation. Can I
follow MMT policies? I don't know. I have always wondered about
that." You then clarified that your area of expertise is not
developing nations. I believe I understand your specific concern
and I'd like to clarify your thinking. First, speaking of MMT in
general. We as MMTers know, with total certainty, that the central
government's of at least the US, UK, Canada, Australia, and so on,
have the capacity to provide dramatically more for public purpose.
The challenge is to inform the people and take back control of our
government and our money. This may turn out to be unlikely or even
impossible, but that's a purely political and social obstacle, not
financial. This is analogous to developing nations: although
clearly with less bells and whistles than in developed countries,
all nations, no matter how developing they are, have the financial
capacity to float their currencies and, given enough time, to
provide full employment. At that point, they can indeed provide
much more for public purpose. The challenge is therefore not
financial, but rather to escape out from under the thumb of their
colonizing overlords. This may prove unlikely or even impossible,
but that's mostly a political and social problem. So when
you say "I wonder" and "I don't know," I can only guess (and
honestly, hope) that you're referring to those political obstacles,
not the financial ones. Is that a fair characterization?
- A major cause of currency crises is the discrepancy or tension
between groupthink (bandwagons and herd behavior) and the
underlying conditions in the real world. As the difference grows
larger, the tension is more susceptible to smaller and smaller
final straws. But often it seems that the final straw is blamed for
the years, and sometimes decades, of problems that the final straw
merely exposed. An example is the December Surprise which is blamed
for the Mexican Currency crisis in 1994, even though it had been
building for at least a decade. This is quite analogous it seems,
to the false idea that "creating too much money was the cause" of
famous historical hyperinflations. As if the war never happened in
Weimar, or the decades of terrible circumstances and decisions
never happened in Zimbabwe. It even seems appropriate on a personal
level, of people spending years in denial, sometimes unknowingly,
and then some point years later, the consequences come out all at
once – or at least it feels that way. Can you elaborate on this and
bring it back to these exchange rate crises?
- How much does a country need to be concerned about (groups of)
individual traders sitting at computer screens on the other side of
the planet? Or are problems generally centered around large actors?
How did the internet and computer-based trading change things? Were
these problems dramatically different before internet/computer
based trading?
- As I understand your book and Ilene Grabel's work, the primary
problem regarding exchange rate is, essentially, we've let the mob
take over, and their loan sharks have been put in charge of our
economies and finances. The mob definitely does not care about
public purpose, they care about nothing more than in-and-out,
short-term profit. They also push all financial and real costs on
to everybody else, who happens to be more vulnerable and farther
from the levers of power. And it's all done with little to no
consequences. So a country or a company makes a deal with the mob
devil (neoliberal devil), and eventually takes out a predatory
loan: a cash injection in exchange for control. The country is put
into an impossible position and eventually fails to meet that
impossible condition. In order to bail themselves out, they must
often do something that contradicts with their long-term survival,
and give up even more control in the process. It inevitably leads
to financial ruin. I believe this analogy is in the ballpark, but
you'll correct it as necessary. The major solution according to you
and Grabel is to disincentivize short-term profit in order to
protect vulnerable countries and companies from predatory loans.
But since the mob is in charge of the planet, this is no small
task. Can you elaborate on this?
- Is there anything else you think should be said? Can you
recommend related work listeners can look into for more on these
topics?