No, We Don’t Live in the ’70s Anymore

A rare event: Twenty-three prominent economists and financiers have predicted high inflation and monetary breakdown for four years due to Federal Reserve policy. Speaking on the matter today, they confirm the prognosis isn’t false, and instead, reconfirm its veracity. In addition, this publication is sad to report a short obituary of the economist Ronald McKinnon.

We don’t know whether our colleagues at the Bloomberg news agency have just played on the issue because the European Central Bank is preparing to purchase securities even now. Regardless, a public letter to then-Fed Chairman Ben Bernanke published in mid-November 2010 by known economists John Taylor of Stanford and Niall Ferguson of Harvard, as well as asset managers including Cliff Asness of AQR Capital, made gloomy predictions due to security purchases made by the Fed.

This letter can be found here.

On Thursday, Oct. 2, Bloomberg published — here — the results of a recent survey of prophets who formerly predicted the crash. Some initially expressed themselves and their reactions of bewilderment on Twitter since hardly anyone admitted a mistake had been made.

False prognoses aren’t a catastrophe; it is well known that it is particularly difficult for forecasts to keep to their word when they involve the future. Many economists in Germany had also predicted a significant acceleration in inflation in recent years; a number of these projections were recollected a few weeks ago in an article in the Frankfurter Allgemeine Zeitung: .

It’s probably no coincidence that quite of few of these false predictions came from people who had enjoyed academic training in the 1970s and/or early 1980s. Since inflation was a big issue at the time — in the United States, it rose to around 14 percent — and with the teachings of the then-fashionable monetarists, a close relationship between the production of money at a central bank and the inflation rate was postulated.

A lot has happened since then, and the thesis of a very close relationship, where base money supply drives inflation, hardly represents the opinion of younger representatives in the field. There are also more mature experts who distance themselves from the old doctrines. We have quoted the Nobel Prize winner Chris Sims several times in such a context in FAZIT, and Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, can add on:

“So, it’s fun and educational to read about the 1970s on the Fed history gateway. I encourage you to do so. But it’s critical for monetary policymakers like myself to realize that the times, and challenges, that we face are different from the ones that Mr. Willson wrote about back in 1974.”

One of the signers of the open letter to Bernanke was Ronald McKinnon, 1935 to 2014, a Canadian who was a professor at California’s Stanford [University] for decades. McKinnon passed away due to an accident, and if we commemorate him in FAZIT, it is certainly not because of a faulty forecast four years ago, but because he was a very interesting economist. McKinnon’s specialties were international economics and monetary policy.

Mentioned again and again for early work with his elder Stanford colleague Edward Shaw, they dealt very early on with the current topic of “financial repression.” At that time, developing countries had a tendency to generate high inflation rates and negative real interest rates in order to create incentives for investment. During the 1970s, inflation wasn’t the boogey man for many countries. McKinnon and Shaw showed at that time that such a strategy doesn’t guarantee success, since no incentives to form savings existed in the presence of negative real interest rates.

Many works of the “mature” Ronald McKinnon revolved around one or more of the following topics: the importance of the dollar as the world currency, the consequences for the United States, and the question of how fast-emerging and developing countries should liberalize their financial systems. In this context, McKinnon was interested in the effects of short-term speculative capital flows — “hot money” — and related investment strategies such as “carry trades.”

McKinnon naturally looked from his office in California across the Pacific, not only to Japan, but also to China. McKinnon was not a supporter of American demands that China should unpeg the yuan so that the exchange rate could improve. In such a scenario, McKinnon expected strong inflows of “hot money” from the United States to China, lured by the interest rate differential and hopes for a revaluation of the yuan.

In one of his last essays, McKinnon once again turned to oppose floating the exchange rate of China’s currency. Instead of a pegged external appreciation of the currency, he advocated an internal appreciation in China by means of higher wage rates. McKinnon was a diligent writer, having published academic pieces, books and essays for popular media, including top journals such as The American Economic Review. Furthermore; it wasn’t uncommon for him to work for prestigious international economists as an advisor to governments and international institutions.

Author’s Note: Here is a brief but memorable statement from the Federal Reserve Bank of St. Louis, which shows why money supply has become questionable as an indicator: The velocity of money has declined dramatically. The St. Louis Fed was once a stronghold of monetarism.

Author’s Note: Shaw was previously made famous together with his colleague John Gurley by writing the book “Money in a Theory of Finance,” 1960. The book was temporarily forgotten but has recently experienced a small renaissance in some professional circles. One who knows and takes seriously the analyses of “inside money” and “outside money” would have debated whether to announce the arrival of inflation so boisterously, and that person wouldn’t be very surprised if the inflation rate drops and doesn’t rise in the Eurozone for some time: not in that this concept allows for precise inflation forecasts, but instead prevents too much self-confidence in the first place.