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Behind the Scenes at the Central Banks that Created our Modern Monetary System
Behind the Scenes at the Central Banks that Created our Modern Monetary System
[From the Summer 2018 Quarterly Journal of Austrian Economics. A review of How Global Currencies Work: Past, Present, and Future by Barry Eichengreen, Arnaud Mehl, and Livia Chitu, Princeton, N.J.: Princeton University Press, 2018, 250 pp.]
The present volume is an engaging and intriguing account of how global currencies, such as British sterling and the U.S. dollar, have risen to global dominance in the international monetary arena, and how currencies such as the Chinese renminbi, for example, could follow in their footsteps. Divided into twelve chapters, the work focuses primarily on the international monetary history of the 20th century, complemented by a comparatively brief account of the 19th and 21st centuries. The narrower focus of the discussion in these chapters—and most of the data supplied in each chapter’s appendices—concerns the composition of foreign reserves, i.e. the balance between holdings of pounds and dollars, and later of yen, euro, and renminbi.
From this, the authors propose to tease out a few new factual discoveries and some implications for the future of the international monetary system. More precisely, they disavow the traditional theoretical view which argues that international currency status resembles a natural monopoly that arises organically from the benefits of using the currency of the most economically (commercially and financially) powerful country in international economic transactions, i.e. a monopoly due to network returns (p. 4), and winner-takes-all and lock-in effects.
Because, argue the authors, this ‘old’ model is not supported by much of the data from the 20th century, they propose a ‘new’ view arguing that multiple currencies can be used concomitantly on an international scale, such as the pound sterling and the dollar during the 1920s. These currencies played “consequential international roles” (p. 11) demonstrating that inertia and persistence due to network effects in international transactions are not as strong as previously thought.
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Trade Tariffs Won’t Crash the World Economy, Monetary Policy Will
Trade Tariffs Won’t Crash the World Economy, Monetary Policy Will
As the Trump administration announces 25% tariffs on over $50bn of Chinese goods, and Europe and China prepare retaliation measures, The Economist concludes that “Rising tariffs are the worst of many threats to the world economy”, because, among other things, “Tariffs temporarily push up inflation, making it harder for central banks to cushion the blow.” This statement displays a deeply entrenched confusion—if not utter misunderstanding—of some basic economic concepts. Most important, many people fail to correctly distinguish between the causes and effects of price inflation and those of monetary inflation.
Monetary inflation is the increase in the quantity of money in an economy. This inflation causes the purchasing power of money to fall, which brings about price effects—a general rise in prices of goods and services—which we can refer to as price inflation. However, this general rise in prices following monetary inflation is disproportionate and staggered: prices will rise at different times and to different extents as money reaches a lower purchasing power.
But monetary inflation also has non-price effects. One of these is the transfer of wealth between the last receivers of the new money toward the first receivers.
Another—and even more important—is the distortion of the pattern of investment and production, as the new money being created through credit expansion reaches stock markets and businesses—thus artificially reducing the interest rate. This latter effect explains the occurrence of production booms misaligned with consumer preferences, and the later, inevitable economic bust or crash. These price and non-price effects of monetary inflation are general and underline every possible economic activity.
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