Bernanke’s big speech from last week where he blasted China over currency manipulation is getting a re-read.
Yesterday FT Alphaville published a comment from economist Richard Duncan who concluded that what Bernanke was really telling us is that the world dollar standard is flawed:
In it he conceded the Dollar Standard is flawed. He said, “As currently constituted, the international monetary system has a structural flaw: It lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances.”
With that statement, the Fed revealed it has been won over by the logic expressed in my book, The Dollar Crisis (John Wiley & Sons, updated 2005). The first two lines of that book state: “The principal flaw in the post-Bretton Woods international monetary system is its inability to prevent large-scale trade imbalances. The theme of The Dollar Crisis is that those imbalances have destabilized the global economy by creating a worldwide credit bubble.”
Never before has a senior US policymaker admitted that the Dollar Standard is flawed. Former Fed Chairman Greenspan wrote in his autobiography that the trade deficit was far down the list of things the United States needed to worry about. With this speech, the Fed abandoned that position.
Shocking… except that Bernanke has been warning about the dollar standard for years, ever since the famous Helicopter speech on November 21, 2002.
Well, then, as now, you have to read between the lines.
But consider: That speech was all about how the Great Depression was remedied (in part) by the removal of the gold standard.
Although deflation and the zero bound on nominal interest rates create a significant problem for those seeking to borrow, they impose an even greater burden on households and firms that had accumulated substantial debt before the onset of the deflation. This burden arises because, even if debtors are able to refinance their existing obligations at low nominal interest rates, with prices falling they must still repay the principal in dollars of increasing (perhaps rapidly increasing) real value. When William Jennings Bryan made his famous “cross of gold” speech in his 1896 presidential campaign, he was speaking on behalf of heavily mortgaged farmers whose debt burdens were growing ever larger in real terms, the result of a sustained deflation that followed America’s post-Civil-War return to the gold standard.4 The financial distress of debtors can, in turn, increase the fragility of the nation’s financial system–for example, by leading to a rapid increase in the share of bank loans that are delinquent or in default. Japan in recent years has certainly faced the problem of “debt-deflation”–the deflation-induced, ever-increasing real value of debts. Closer to home, massive financial problems, including defaults, bankruptcies, and bank failures, were endemic in America’s worst encounter with deflation, in the years 1930-33–a period in which (as I mentioned) the U.S. price level fell about 10 per cent per year.
Although a policy of intervening to affect the exchange value of the dollar is nowhere on the horizon today, it’s worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt’s 40 per cent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 per cent in 1932 to -5.1 per cent in 1933 to 3.4 per cent in 1934.17 The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt’s devaluation.
Of course, the lesson Bernanke was expressing didn’t have anything to do with gold, because gold isn’t a part of the monetary system anymore. He was talking about the dollar (in code) then, and he seems to be talking about it again.