Posts Tagged ‘currency fluctuations’

An ultimatum game of ichi-go ichi-e

There was an opportunity, one meeting at Osaka for world leaders at the recent G20 summit. A valuable starting point for the policy-makers, faced with a menu of economic theories, is trust in each other and a new inter-disciplinary approach with an emphasis on ethics and economics. Climate change, migration and displacement, IoT and 5G, global income inequality, household mortgage debt, value of drinking water and food shortages present a grand ethical challenge. In 2015 we asked has economics become an illusion? An era of wistful economics:

Taylor Principle

This time, however, global economic policy should be less about money supply and demand, less about central banks modelling and the private sector and more about the strategic interaction between these ethical challenges.  There is an urgent need for coordinated action to stimulate the global economy with fiscal and monetary measures. The EU is fragmenting. Whither the Euro? Today, Federal debt is projected to jump to a record 144% of US GDP by 2049. There is a debt mountain in China reported at 250% debt-to-GDP. As the Scylla of the Taylor principle (of high interest rates when there is high inflation and low interest rates when unemployment is high) causes a modelling whirlpool with the Charybdis of the Ramsey approach to optimal monetary taxation, the appropriateness of an ethical fiscal policy as a stabilisation tool may calm the waters. So, more fiscal stimulus is required.


On a macro level, world politics is more about China’s transition to greater exchange rate flexibility and the internationalisation of the Chinese RMB. We had presented on this point in Shanghai in 2012. It’s a long game. In other words, RMB v US$ is an infinite game of playing the game not a finite game of first mover advantage. . A weaker RMB would probably mean a stronger US dollar and vice versa. We are reminded of Japan’s exit from its dollar peg in 1971 as today the game is one of reserve currency competition, whether or not the US dollar is destined to lose its standing as the preeminent international currency to Sterling, the Euro or the RMB. Trade wars, competitive devaluations, Brexit, military conflict create sudden disruptions to growth at a moment in time.

Productivity Bonus

As a countermove we become risk-averse on currency fluctuations. But there is a curved ball from the EU and the US regulators as their antitrust focus on big tech. Based on the presumption of a negative effect on competition it relies wholly on an attack on monopoly rents as a reward to innovators. Nonetheless, shareholders and investors and pension funds gain too. However, if the model builders could adapt the McKenzie model of classical general equilibrium theory so that technology is available to any company who can supply the resources required, ultimately, by happenstance, competition and innovation will coalesce into a productivity bonus. Big tech and technology could then be viewed as a way to escape classical monopoly by innovating to compete. To do so would require the equivalent of the 1919 Colgate doctrine for big tech, facilitating the introduction of new technology by allowing each of the big tech companies to decide, on its own, with whom to do business. They exercise discretion on innovation and technology; we, as onsumers,  decide. Our behaviour, after all, is less measured by prices, supply and demand but more influenced by small changes in innovation and technology over shorter time periods.

Onsumers & Complexity

Albeit, our policy advisers and central bankers are less likely to ever move away from the standard Ricardian DGSE models of economic analysis. There is a sunk cost to the modelling.  A key assumption in this model is that households like you and I are a homogeneous family of infinitely lived individuals. Really? This is 2019 and a more realistic and heuristic approach would address the fact that individual’s behaviour changes over shorter time periods with innovation and technology. Our well-ordered lives bring the occasional disturbance that can be characterized by an unmanageable degree of complexity. In our real world, we as onsumers, for example, shopping online, continue to bid against ourselves in the search for the best algorithmic deal.  In practical terms we do not behave as hyper-rational beings. At every G20 there is a risk-bucket and world leaders may get a chance to try again at another meeting; at this G20 there was one chance to try: ichi-go ichi-e. The ethical challenges of climate change, mortgage debt, migration and displacement, IoT and 5G, global income inequality, value of drinking water and food shortages all collapse into a generalized ultimatum game in which we as players must agree or we all get nothing.

Wistful Economics

Economics of times past, of Adam Smith and Keynes alas! Has economics become an illusion? Yes. It is an accidental tourist in the political landscape. Economic policy making is[1] ‘but a walking shadow, a poor player that struts and frets his hour upon the stage’ of natural numbers, coupled with policymakers throwing[2] ‘sixes and fives in games of chance’ and ‘as wise folk know the conditions in every country’ – targets and trends, patterns and probabilities. All the policymakers are merely players; they have[3] ‘their exits and their entrances sans teeth, sans eyes, san taste, sans everything’. There are no hard lines of distinction. Deflation may be temporary if capacity is absorbed by the real economy. However, a finite measurable increase in sales (thus, output) cannot be secured by small marginal reductions in price. Some industries are depressed and household balance sheets are insolvent. Ah, there’s husbandry in heaven and ‘a heavy summons lies like lead’ upon[4] the ECB: US dollar strength against the Euro is due to deflation in Europe and deflation in Europe is driving up the US dollar. Policymakers ‘cannot sleep’; with their ‘eyes severe, and beard of formal cut, full of wise saws, and modern instances’ they are actors in a Shakespearean play of infinite length as big data, social media and the Internet of Things transform real lives.

In a deflationary period a mismatch in prices and quantities occurs as companies and consumers both fear to spoil the chance of getting a better price later. This fear in a moment in time creates a short period. Competition breaks down and imperfections – for example, short term working, poverty and inequality, exchange rate volatility, competitive devaluations and lower wages – emerge with lasting impact.

Without China’s continued growth, there is no economy in the world large enough to absorb further contraction in the EU and the US. Only those who believe that economic policy making is akin to a Shakespearean play ‘full of strange oaths’ will enjoy the summer recess. But action is required now if deflation’s short period is to be defeated, best illustrated by the life of the mayfly than that of an elephant. A menu of policies should include a return to managed global exchange rates for a period of time, fiscal stimulus in order to ease domestic debt burdens and a continuation of QE in the EU. Falling prices are little comfort for the indebted householders and unemployed. The policymakers[5] sentence all of us to the sentence: ‘there is to-morrow, and to-morrow, and to-morrow, to the last syllable of recorded time’. It is better to end austerity now than regret doing economics by numbers.

[1] Act V Scene V Macbeth spoken by Macbeth

[2] Chaucer’s Canterbury Tales The Man of Law’s Tale 1st Part 130-134

[3] Act II Scene VII As You Like It spoken by Jaques

[4] Act II Scene I Macbeth as Banquo enters.

[5] Act V Scene V Macbeth spoken by Macbeth

Whither the Euro? The Liar’s Paradox

Whither the Euro? The Liar’s Paradox

In Dickens’ Hard Times the character Mr Gradgrind can’t help but speak about Facts to his pupils: ‘Now, what I want is, Facts. Teach these boys and girls nothing but Facts. Facts alone are wanted in life. Plant nothing else, and root out everything else’. As we listen to Mr Draghi, to Mr Carney and to Ms Yellen, as we read the Financial Times or listen to business channels, isn’t it all about the Facts and the numbers? Analyst’s commentary coupled with an over-reliance on Facts and numbers has thrown economic policy making into the lion’s den of semantic incoherence. We forget that the real economy is about losing a job, going bankrupt, losing your home, personal and household debt.

Facts and Numbers:  Relevance of Godel

Sadly, economic policy making has evolved into a game of natural numbers. In addition to semantic incoherence – ‘numbers on the upside’ or  ‘targets below forecasts’ – we would argue that Gödel’s first incompleteness theorem may have a direct relevance to policy makers, warning them of the incompleteness of an economic policy, reliant on numbers alone.  Each time a new policy statement – boosting credit in Southern Europe, changing interest rates or QE – is added as an axiom, there are other true statements that still cannot be proved, even with the new axiom. If an axiom is ever added that makes the system complete, it does so at the cost of making the system inconsistent. His argument shows that any consistent effective formal system that includes enough of the theory of the natural numbers is incomplete: there are true statements expressible in the language of economic theory that still remain unprovable within the EU system of policy signalling. For example, what would happen if QE were introduced by the ECB? Thus the policy problem for ECB and for the EU is that no formal system, reliant on numbers and number predictions, satisfying the hypotheses of the theorem, exists. Instead we have noise and signals.  

Godel’s sentence

Economic policy today is transmitted as number signals into the financial markets. Any decision to change interest rates, for example, will have already been discounted by hyperopic analysts. Mr Draghi like Mr Carney will push the forward guidance to ensure a target natural number is met – an inflation level or a growth rate target. On a quarter-to-quarter comparison, EU growth averages less than 0.5%. It is but a number. The Fed sets an unemployment target number of 7%, however measured, and only when unemployment converges to that number will the Fed signal an interest rate change. However, Godel’s incompleteness continues with the austerity mess, and the game of number predictions.

Waiting for Economics

What has happened to macroeconomics in the hands of bureaucrats and politicians? Once there was a policy mantra, P: ‘low (high) inflation explains currency appreciation (depreciation)’ and ‘low (high) interest rates explain currency depreciation (appreciation)’. The US Fed added QE which contributed to a devaluing US dollar. The ECB has been anxious about the strength of the Euro v US dollar, but the Euro has depreciated against Sterling. Is the interest-rate differential between the US and EU so much greater in natural number counting than that of the EU and UK to explain a depreciating-appreciation Euro. If policy prescriptions, P, each represent examples of the Gödel sentence that each time a new policy statement is added as an axiom, there are other true statements that still cannot be proved. We have the liar’s paradox embedded in economic policy decision making: Nominate a P. ‘P is false’. But it cannot be true for then, as stated, it is false – nor can it be false, for then, it is true.

Signals and Noise

Interest rates and inflation figures are Facts, they are numbers. Natural numbers that are allowed to guide policy – it is a mess. EU faces a deflation trap defined by a long period of low inflation, below a target rate of 2%.  The Economist in its May 24th 2014 edition referred to this period as one of ‘lowflation’. Mr Draghi had signalled in early June 2014 how he intended to tackle the imminent threat of deflation – lower interest rates and a European style QE boosting credit by providing funding to banks on the condition that they lend to business.  Now we await the ECB meeting this week (September 4th). He will be reminded that the economic fundamentals are just numbers. Interest rates, exchange rates and inflation are natural numbers. The EU target inflation is 2%, ECB interest rates are now at 0.15%, falling from 0.25% and the Euro/Sterling rate of exchange fluctuates around 0.7911 and 0.8123. Natural numbers but with a potent impact on policies that directly affect everyday life.

1944-2014: Breton Woods to Brisbane

Did Mr Draghi signal at the Jackson Hole meetings last month that the Eurozone needs a relaxed fiscal and monetary policy? Will we see a signal from the ECB this week towards a purchasing of securitised assets? According to European Commission figures last month (August 2014) Eurozone inflation was at 0.3%, well below the target of 2%. In the real economy, however, bad banks dominate the landscape, unemployment continues to rise and growth remains stagnant. Yet our policy makers remain persuaded by Facts and data and numbers.

A reliance on Facts and numbers will continue to stifle policy making; it will ensure that Europe is at least a decade away from any numbered gains in productivity, any increases in real wages or any increases in growth. There is always hope. But in the reliance on Facts and data there is a great danger for policy makers sailing between the Charybdis of raising interest rates too soon and the Scylla of raising rates too late.

Analysts could be predicting a weakening Euro, strengthening US$ and Sterling as we end 2014. FX analysts will try to predict likely movements in the currencies but currency misalignment still continues. Indeed, in a world of numbers we will continue to ask: whither the Euro and Eurozone economies in an era of stagnant growth? But unless ECB engages with QE, Europe will continue to drift into debt-deflation cycle. Maybe there is hope that at the G20 in Brisbane later this year our policy makers will consider an interim regime of managed exchange rates across the world #tuncnunc to facilitate a return to economics. Earlier discussion on managed exchange rates on


Godel’s Theorem

Gödel’s theorem shows that, in theories that include a small portion of number theory a complete and consistent finite list of axioms can never be created, nor even an infinite list that can be enumerated by analyst’s computer programmes.


 € Appreciates: Low inflation and High Interest Rates

If appreciates expect lower inflation, and high real interest rates

€ Devalues: High Inflation and Low Interest Rates

Low and negative rates of interest € devalues


 € Appreciates: Low inflation and High Interest Rates

If appreciates expect lower inflation, and high real interest rates

Higher unemployment and downward pressure on wages

Internal Member State devaluation


Drifting into a debt-recession trap

The despondency that has attached itself to the financial crisis is ‘taking shadows from the reality of things’. Dante would not approve. Europe is drifting into a prolonged recession as policy-makers worry about inflationary expectations and competitive devaluations. Households hope to be delivered from this agonizing crisis.  Are there solutions? The following is a grand narrative of policy options, contingent on a managed exchange rate regime, an idea first aired in the Letters to Editor page of the Financial Times in 2009. G20 has not acted. They meet in Mexico – maybe recent Yen, RMB, Euro, Sterling, Swiss Franc and US Dollar movements may persuade them to look at the role of exchange rate fluctuations ‘midst this financial crisis as Europe drifts into a debt-recession trap.

Drifting into a recession

There is a palpable sense of despair and hopelessness, a lack of demand yet inflationary expectations have become embedded in the policy-maker’s crystal ball. The real economy of households and companies is shrinking in a vacuous cycle of intermittent growth as rising bond prices and lower yields improve the real economy of the investor. Banks, the exogenous factor in the policy-makers’ macro-economic models, still fail to understand that job creation, time-to-build technologies and innovations require a flow of credit. Personal balance sheets are moving into safe harbours, given the wealth destruction that has occurred in the property and equity markets and will continue for the foreseeable future. Anybody who can is saving, more are spending less. Welcome to the debt-recession trap.

Household balance sheets

Recovery must be centred on the household balance sheet; however, household budget patterns are unpredictable. Current decisions depend on expectations of what future policies will be. This is a conditioned response for households in a debt-recession trap. The mismatch between policy-maker and reality creates a short period – a phenomenon that households imagine if they change demand and spend more the other households will neither keep demand unchanged (so all increase demand and prices go up) nor continue to keep their behaviour unchanged (so bargains become available to the first mover) if they alter their behaviour. How each household responds depends on how each believes the other will respond. The result is demand is less, output is less and the recession is prolonged.

In the interim, households have adjustment costs – no interest income from government bonds, no dividend income from company-issued equities and minimal after-tax spend so unlike in the macro-economic models of our Central Banks, households are not seeking to maximise the concave single-period utility function subject to a budget constraint wherein the present value of consumption equals the present value of disposable income. Savings, for example, in a debt-recession trap signal to policy-makers that rational householders are experiencing low levels of expenditure in the present period due to the short-period phenomenon thus reducing the marginal utility of expenditure in future periods. So there should be a greater willingness to spend when the personal balance sheet are restructured.

Policy prescription: reduce income taxation to increase after-tax spend

QE and the US Dollar

During the Great Depression banks restructured their balance sheets; reduced loans in absolute and relative terms and invested (mainly) in government bonds. Isn’t this happening today? The ECB/Bundesbank believes that purchasing government bonds is tantamount to monetising government debt, thus leading to high inflation or a loss to the ECB on a government default. Paradoxically pre-crisis banks were turning government bonds from across the Euro zone into cash at the ECB, as governments borrowed and the banks relied on short-term funding. So really, all Central Banks – the Fed, BoE, BoJ and even ‘the outright monetary transactions’ policy at the ECB/Bundesbank facilitate the buying of government bonds – so why the mystery?

The Fed signals less worry about inflation through QE and the printing of money. Lowering interest rates may be devaluing the dollar but it is facilitating increased US export competitiveness. Central Banks that want to support their currencies are willing to increase interest rates. The Fed does not. The US dollar has been captured by Fed announcements. It is widely accepted that QE has contributed to a weak US dollar.

Exchange rates

When Timothy Geithner described China as ‘a currency manipulator’ in 2009 the exchange rate became politicised. More recently, Jens Weidmann, President of the Bundesbank, expressed concern about Central Banks’ efforts to revive exports by facilitating competitive devaluations. Did he have the Fed in mind?  Music to the ears of Brazilian Finance Minister Guido Mantega, who first signalled the ‘currency wars’ in 2010 as Brazil worried about an overvalued real. Its current account deficit is now contributing to a reduction in its economic growth. And the new PM of Japan, Mr Abe has had an impact on the Yen’s exchange rate pushing it from 78 per US dollar to 89 as he asked the Bank of Japan to double its inflation target to 2% – and to buy government bonds until that target is met.

Policy prescription: looser monetary policy and higher inflation targets

China and the Yuan/RMB

Elsewhere we had argued that Yuan appreciation will not and cannot solve the Sino-US trade imbalance. China in time, will, we had argued then, move to a more flexible exchange rate regime but at its own pace. It could occur during the 12th Five-Year-Plan 2011-2015 as economic growth in China becomes less reliant on export-led growth. By 2015 China trade and FDI flows will have moved away from US and Europe and more towards what we had described as the ASLEEP economies We agree with Professor Subramanian at the Peterson Institute for International Economics that the RMB could displace the US dollar as the leading reserve currency in the next decade. Trading nations and TNCs are already diversifying into RMB – being able to trade in RMB reduces transaction costs and mitigates currency risks for exporters. Liquidity from China could relieve any inflationary pressures in trading economies.

Solution Template

Many trading nations are considering a looser monetary policy combined with a higher inflation target – it presents an optimal policy and an escape hatch in a debt-recession trap. An inflationary bias in the conduct of monetary policy might be optimal if inflation shocks can lead to (welfare enhancing) increases in output. Albeit, any comparative statics exercise emanating from policy-makers’ models should be interpreted with great caution. A looser monetary policy could drive their respective currencies lower but any hope of sustained growth will be frustrated by a beggar-my-neighbour policy of competitive devaluations in the race to win the greater share of increased exports.

As previously outlined, a period of managed exchange rates may be required under the auspices of G7, and ultimately G20. Europe, specifically, and the G20 trading nations more generally, need to manage their monetary and fiscal policies within a managed exchange rate regime in order to escape the debt-recession trap.

Policy prescription: managed exchange rate regime to align world currency fluctuations.

Rational households and companies may have ‘parked’ demand and production, delayed in the anticipation of an inflationary period with looser monetary policy and competitive devaluations. If their expectations were managed within a managed exchange rate regime then there could be some hope that the real economy may improve as the worlds’ trading nations together plan an exit from the financial crisis. ENDS/PatrickMcNutt