Global Monetary Instability and the Role of the Financial Crisis G. (Tassos) Malliaris Mary Malliaris LOYOLA UNIVERSITY CHICAGO The Korea Institute of Finance and The Athenian Policy Forum Conference Seoul, Korea June 16-18, 2013

Focus of the Paper State Keynes’ Incompatibility Hypothesis Emphasize the Persistence of Global Financial Instabilities Explain How Global Financial Instabilities Have Contributed to the Global Financial Crisis Examine Policy Choices

Keynes’ Incompatibility Thesis The Global Economy Cannot Achieve Simultaneously and Automatically Free Trade, Flexible Exchange Rates, Free Capital Mobility, Financial Stability and Global Full Employment.

Problem Restated for 2013 What is needed for the U.S., the Eurozone, China, Japan, the other Asian countries, Emerging Economies and the Rest of the World to avoid … Currency Wars? Financial Instabilities and Crises? Answer: Global Coordination vs. Domestic Economic Policies Lessons from Economic History

The Gold Standard Period

Global Instabilities Now

Global Imbalances Source: IMF World Economic Outlook 2010

“It is characteristic of a freely convertible international standard that it throws the main burden of adjustment on the country which is the debtor position on the international balance of payments.” Keynes, Post War Currency Policy, 1941, pp. 29-30

“An essential improvement in designing any international payments system requires transferring the onus of adjustment from the debtor to the creditor position. This transfer would substitute an expansionist, in place of a contractionist, pressure on world trade “ Keynes, Post War Currency Policy, 1941, pp. 29-30

Crisis Dates By Country: 1870-2008 From: Jorda, Schularick, and Taylor 2011

1944 Bretton Woods Conference U.S. Major Creditor Europe and Japan Are Devastated Need to Grow Global Economy Presence of Economic Imbalances Keynes’ Estimate of $10 billion needed Dexter White proposes $3 billion Marshall Plan Over 4 Years: $13 billion

Bretton Woods 1947-1973 Stabilized Global Economy Promoted Growth Created New Global Imbalances Core or Center (U.S.) vs. the Periphery (European and Asian Countries)

Collapse of Bretton Woods I U.S. Unable to Cope with Global Imbalances French Conversion of Imbalances into Gold U.S. Inflationary Monetary and Fiscal Policies August 15, 1971 U.S. abandons Gold Convertibility Global Imbalances Lead to Global Instability

The Modern History of Gold Current Price: $ 1369.5 /oz (2013-06-11)

The Global Monetary System After 1973 More Flexible Exchange Rates Exchange Rate Volatility and Uncertainty Accelerated Global Capital Mobility Independent Monetary Policies Several Currency Crises, Leading to Banking Crises and often to Real GDP Declines

Major Facts of Bretton Woods II Flexible Exchange Rates Do Not Resolve Global Imbalances Several Currency Crises, Leading to Banking Crises and often to Real GDP Declines Such Crises Expected to Occur in Emerging Nations The 2007-09 Unanticipated Global Financial Crisis in U.S. and EU.

Collapse of U.S. Trade Balances

The Dollar-coaster

Appreciation of Chinese Yuan

The Global Financial Crisis of 2007-09 Started in September 2007 as a Subprime Mortgage Crisis with a $300 billion Potential Loss Developed into a Major Financial Crisis The Role of Easy Domestic Monetary Policies The Bernanke/Taylor Debate of Global Savings Glut: Role of Global Imbalances Aggressive Export Oriented Growth by China, Japan and Germany

What Theories Guide Us? Standard Neoclassical: Stable Markets Return to Equilibrium Minsky-Kindleberger: Booms and Busts Conflicting: Market Adjustment vs. Policy

Country Share of World GDP Percentage shares of selected countries and areas in world GDP, 1870-2050 (at2005 exchange rates) Sources: Angeloni et al (2011)

Asset Bubbles Source: Fred

Housing price appreciation vs Housing price appreciation vs. current account accumulation, 1996 – peak of housing market Source: Economist Intelligence Unit, OECD, IMF, State Administration of Foreign Exchange (China), De Nederlandsche Bank, BEA. The area of each circle is proportional to 2008 GDP. 

Current Policies and Regulations Primarily National: U.S., EU, England, Japan, China, others Quantitative Easing Strategies The Emergence of the G20 as the Global Governance Group The Reform and Expansion of the Financial Stability Board

Current Difficulties Global Imbalances Persist Asset Bubbles in Equity and Bonds Sovereign Debt Crisis Currency Wars Austerity vs. Growth

Future Possible Scenarios Domestic Consumption Led Growth vs. Export- Oriented Growth? Central Banks as Lenders of Last Resort. Keynes and Kindleberger: Importance of Hegemony: the Recycling of Accumulated Reserves; Bold and Unlikely. An Asian Monetary Union? China, Japan, Others Continued Depreciation of the U.S. Dollar?