Understanding balance of payments crises in a fiat currency system

It's weird. Whenever I say that floating exchange rates can't absorb all shocks and that balance of payments crises can happen even in fiat currency systems, I am accused of gold standard thinking. Gold standard? Me? Perish the thought. I am the world's biggest fan of fiat currencies. And of floating exchange rates, too. But that doesn't mean I regard them as a panacea.

Firstly, about gold standards. Under a strict gold standard, the quantity of money circulating in the economy is effectively set externally. The domestic money supply can only grow through foreign earnings, which bring gold into the country. I have said a "gold standard", but the same is true of any FX reserve-backed fixed exchange rate system such as a currency board: gold is really only a universal FX reserve. The domestic money supply grows as the supply of FX reserves rises, and falls as the FX reserve supply falls. It isn't strictly true to say that a trade surplus is necessary for the economy to grow, but if the economy grows without a corresponding increase in net exports, the result is deflation.

This is evident from the quantity theory of money equation MV = PQ, which is fundamentally flawed in a fiat currency fractional reserve system but works admirably under a strict gold standard or equivalent. When the supply of goods & services (Q) rises but the quantity of money in circulation (M) remains fixed (and assuming that V also remains constant), consumer prices (P) fall. Some people regard this type of deflation as benign, though it is worth remembering that even in a naturally deflationary system, expectations of future price falls can dampen aggregate demand. A little bit of inflation can be a good thing. Nonetheless, this sort of deflation is far removed from the vicious deflationary spiral described by Irving Fisher in his Theory of Debt Deflation.

So under a gold standard or equivalent, it is much easier for countries to grow if they run trade surpluses. This is not because exports create growth, but because inflows of FX reserves act as a monetary stimulus: the risk, of course, is inflation. Conversely, trade deficits involve a net outflow of FX reserves, which is monetary tightening. There is thus a direct relationship between domestic growth, domestic inflation and the external balance.

More seriously, FX reserve outflows in a fixed exchange rate system can result in a balance of payments crisis. Because central banks can't print foreign currencies or gold, a country running a persistent trade deficit* can literally run out of money. The IMF's original role was to provide emergency funding to countries facing such a disaster and help them implement policies to restore the trade balance. Those policies typically involved depressing domestic demand to curb imports and reduce inflation, putting downwards pressure on business costs in order to improve external competitiveness, reducing external debt, and devaluing the currency relative to its anchor. This last was key. In a fixed exchange rate system, devaluation is domestic monetary stimulus, because it allows more money to be created relative to the anchor. Thus the IMF's standard solution to a balance of payments crisis was austerity offset by monetary stimulus in order to generate export-led growth. Does this sound familiar?

The era of gold standards ended in 1971 when President Nixon suspended the convertibility of the US dollar to gold. We now supposedly have a universal system of fiat currencies managed by inflation-targeting central banks.

In a fiat currency system with floating exchange rates, the quantity of money in circulation is determined by the central bank**. The country is not reliant on FX or gold inflows for domestic money growth, and FX or gold outflows do not threaten the country's solvency. All the central bank needs to do is create (or destroy) the amount of money needed to maintain a target inflation level and allow the external value of the currency to adjust. The external balance is not directly linked to growth or inflation, and trade deficits do not cause crises.

In such a system, a trade deficit is a monetary drain which must be offset by money creation. Central banks can create unlimited quantities of their own currency: if the currency is flowing out of the country via a trade deficit or capital flight, the central bank can simply create more of it.  Note that in a floating-rate fiat currency system - unlike the gold standard and its relatives - it is not necessary to devalue the currency deliberately to enable more money to be created. Creating money for domestic monetary stimulus may devalue the currency, of course, but that is a side effect.

Equally, the inflationary effect of a trade surplus can be offset by a monetary drain (raising interest rates). This tends to raise the exchange rate, discouraging exports and encouraging imports. In a floating exchange rate system where central banks are targeting inflation, trade imbalances should in theory be benign and short-lived.

However, this is not what we have. True, we have fiat currencies and inflation-targeting central banks. But we don't have universal floating exchange rates. The ghost of the gold standard still haunts the world monetary system, living on in the proliferation of currency boards, crawling pegs and other, more subtle versions of currency fixing. And there remains an enduring belief that depressing domestic demand and improving external competitiveness is necessary to restore growth. This is gold standard thinking, and it is not appropriate in fiat currency systems.

But even if every country had a floating exchange rate, balance of payments crisis would remain a risk for many countries.

The idea that currency depreciation will absorb all shocks rests on the assumption that there is infinite demand for all currencies. The balance of trade therefore simply reflects the movement of the domestic currency in and out of the country. Since there will always be some price at which the currency is exchangeable, the country can always pay for everything in its own currency and has no need for FX reserves. If an exporter doesn't want to accept the currency of a particular country, the country can refuse to trade with him, to his detriment.

Sadly, it is not that simple. All currencies are not equal. Just as the price of government debt depends on market views of future economic performance and government trustworthiness, so too does the exchange rate of a sovereign currency. There is a hierarchy of currencies. Currencies at the top of the hierarchy - the "reserve currencies" and a few other advanced-economy currencies - are highly liquid: they are readily exchangeable for almost any other currency and welcomed in most countries. The introduction of central bank swap lines also means that these countries can effectively treat certain other "premier" currencies as their own, further reducing their need for FX reserves. The chances of a genuine balance of payments crisis in these countries are very low.

But this is not true of other countries. Currencies at the bottom of the heap are not welcomed externally: there may be no market for them, and all trade with the country may be conducted in foreign currencies. The worst currencies may not even be particularly welcomed domestically: widespread use of "hard currency" is a feature of basket case economies. Most emerging market currencies are welcomed domestically but have only a qualified welcome externally.

Clearly, a country whose currency is not widely accepted externally must trade in foreign currencies. It will have to pay for imports in foreign currencies, and since it cannot print foreign currencies and there is a limit to FX borrowing, it will look to balance this with foreign currency income from exports. If the country's FX income from exports exceeds its FX obligations, it can meet those obligations from current FX income regardless of the external value of its own currency. In fact, when the currency depreciates, improved terms of trade would mean an increased inflow of FX reserves. This looks very much like the gold standard, doesn't it?

Of course, if the country is dependent on imports for essential goods - foodstuffs, medical supplies, energy - then a rapidly depreciating currency would be likely to result in rising demand for FX as exporters to the country demand payment in other currencies. But terms of trade improvement could offset rising FX demand. Alternatively, the country can run a persistent trade surplus in order to build up FX reserves, creating a buffer to protect itself from short-term trade fluctuations. This is what many emerging market countries learned to do after the 1997 Asian crisis. Better beggar-my-neighbour competition and depressed global trade than a repeat of 1997 - or 1931.

Clearly, therefore, countries dependent on foreign currency for external trade are operating on something akin to a gold standard internationally, even if their own fiat currency is floating. And it is a fallacy to suggest that the value of the domestic currency has no bearing on this.  The value of the domestic currency crucially affects the country's ability to attract the FX it needs for external trade. Indeed FX reserves may fall disastrously when a domestic currency depreciates rapidly.

When a fiat currency is not welcomed externally, its exchange rate falls regardless of the country's external balance. We see this at present with Venezuela: the real exchange rate (not the government fix) of the bolivar is falling catastrophically despite Venezuela's trade surplus. Venezuela is an oil producer, so the (real) exchange rate of its currency to the US dollar naturally tracks the price of oil. But the bolivar's value is falling far more than that. Such rapid falls set up a feedback loop, whereby those holding bolivars exchange them for hard currency, gold and other non-perishables as fast as they can, causing the exchange rate to fall even faster. This is how hyperinflations develop. Venezuela's inflation rate is currently thought to be over 750% and rising fast. Hyperinflationary capital flight causes FX and gold reserves to leave the country at a rate of knots. No improvement in terms of trade can possibly keep up with this. Severe balance of payments crisis is characteristic of hyperinflations.

Even without hyperinflation, balance of payments crisis in an FX-dependent economy with a local floating-rate fiat currency has widespread and damaging effects on private and public sector balance sheets. Most countries that run persistent trade deficits have to import FX. The central bank does this by selling its own currency, causing it to devalue, which in normal times helps to rebalance the trade position: the central bank then provides FX liquidity to banks for them to support FX demand from households and corporations. It is normal for banks to have currency mismatches on their balance sheets, and it is also normal for many exporters and importers: these mismatches may take the form of FX debt and local currency assets, or vice versa. Households, too, may have currency mismatches if they take on foreign currency debt, for example FX mortgages (Poland please note).

These currency mismatches are toxic. A balance of payments crisis is fundamentally a solvency crisis. A sovereign currency issuer can't run out of its own money, but it can run out of other people's. And if it does, then neither the private sector nor the sovereign can service foreign currency debts. If the currency is already depreciating rapidly, the central bank selling the currency to buy FX simply worsens its collapse: monetizing sovereign deficits has a similar effect. Since the private and public sector cannot service their existing debts, they cannot borrow to meet their obligations. The result is sudden, widespread and very damaging debt default among banks, corporations and households, along with severe cutbacks in consumption. Even the sovereign can be involved, if it has high levels of FX debt. Currency mismatches on corporate, sovereign, household and bank balance sheets are the blue touchpaper that is lit when a balance of payments imbalance becomes a crisis.

It is thus quite wrong to suggest that in our fiat currency system, balance of payments crises cannot happen. They can, and they do. And this, I think, partly explains the prevalence of export-led growth models, particularly in emerging market economies. The protection offered by a sustained trade surplus from the long-lasting and horrible effects of balance of payments (FX) crisis more than compensates for reduced living standards arising from repressed domestic demand.


* For the purposes of this post, "trade" includes services.
** As I don't wish to get caught up in arguments about whether governments do or don't create money when they spend, I am preserving the fiction of central bank and government separation. This means that the language in this post is that of monetarism, rather than MMT. I do not apologise for this: it is my firm belief that MMT and market monetarism are brothers under the skin, and the differences between them are largely semantic. Though there might be a difference in political ideology too.
UPDATE TO FOOTNOTE: This post is NOT about "who creates money". I'm well aware of the limitations of the monetarist framing I have chosen, and I did say that the quantity theory of money is fundamentally flawed in a fiat currency system. However, I've used a monetarist framing to enable a direct comparison of gold standard and fiat currency systems from a trade perspective. For the purposes of this post it does not matter whether the CB creates money, commercial banks do so when they lend or the government does when it spends. I'm not going to host a debate here about the effectiveness of monetary policy versus fiscal policy. Comments about the creation of money are therefore off topic for the purposes of this post.

Related reading:

Rethinking government debt
Competitive devaluation is not a free lunch
Competitive devaluation plus monetary expansion does create a free lunch - David Glasner
The limits of understanding of MMT - Neil Wilson
How to think about the balance of payments - JW Mason

Image from The Sunday Times. 


  1. Frances-

    "In a fiat currency system with floating exchange rates, the quantity of money in circulation is determined by the central bank**."

    NO!!!!!!!!!!!!!!!!! The CB does not determine the amount of money. It only determines the amount of Currency=reserves=base money, and even that it only partly determines as its just supplying an amount that corresponds to an interest rate target.

    "The country is not reliant on FX or gold inflows for domestic money growth, and FX or gold outflows do not threaten the country's solvency. All the central bank needs to do is create (or destroy) the amount of money needed to maintain a target inflation level and allow the external value of the currency to adjust."

    There is no reason to think that changes in CB balance sheets do anything of the sort. QE has demonstrated this over and over and over again, the composition of the CB's balance sheet is almost irrelevant (the mixture of reserves and TSY Cds), its the size of the CB's balance sheet that matters (fiscal policy changes the NUMBER of financial assets the Economy has, monetary policy only changes the TYPE of financial assets)

    "The external balance is not directly linked to growth or inflation, and trade deficits do not cause crises."

    This totally depends on the context. A trade deficit that is not offset with either increased private debt expansion, increased domestic velocity (increased spending out of existing income via redistribution to groups with higher propensities to consume) or a larger Govt deficit leads to a decrease in domestic employment and income.

    1. Auburn read the disclaimer:

      "As I don't wish to get caught up in arguments about whether governments do or don't create money when they spend, I am preserving the fiction of central bank and government separation. This means that the language in this post is that of monetarism, rather than MMT. I do not apologise for this: it is my firm belief that MMT and market monetarism are brothers under the skin, and the differences between them are largely semantic. Though there might be a difference in political ideology too."

    2. Auburn,

      I am not discussing the relationship of the CB and the government. Nor am I discussing the relationship of the CB and commercial banks. In fact I am not discussing the creation of money at all. Who creates it is not important.

      Nor am I discussing QE. What tools the CB uses are not relevant to this post. The mechanism by which money is created is not important, and nor is whether CBs do or don't directly influence the amount of money in circulation. I have covered these more than adequately in other posts. I don't need to explain it again here and it detracts from the point of the post. All we need to know is that money is created and destroyed.

      You are missing the wood for the trees.

    3. Yes Frances, I know you are one of the good guys (meaning in paradigm), and I was\am not trying to be a dick or overly critical. But there is absolutely no reason to write that line about the CB. The CB does not control the supply of money full stop. There is no amount of rationalizing or generalizing that can make that sentence into anything resembling reality.

    4. And if the CB cant control the money supply, there's no reason to think they can manage the economy effectively via balance sheet composition changes (QE) or interest rate tinkering. Which is the other part of the quote I commented on.

    5. With respect, Auburn, MMT adherents like yourself are not the only people who read my work. I've chosen in this post to use a monetarist framing, and I explained why in the footnote. You may not like it, but it is accurate enough for my purposes here. I don't want this post to host yet another MMT versus market monetarist dispute about the power (or lack of power) of the CB and the government. It is not remotely the point of the post. Please respect this.

      I will now extend the footnote to make it clear that discussions about who exactly creates money in the economy are off topic on this post.

    6. CBs do not control the money supply. This is not a rhetorical distinction. There is no money multiplier and as such, CBs cannot control the money supply. This is a fact and not an opinion.

      Money supply =\= currency

    7. You don't know when to back off, do you?

    8. When you admit that CBs do not control the money supply, and edit your post. I will stop pointing it out to mislead readers.

    9. I'm not going to "admit" any such thing. I've made the framing clear. I remind you that your opinion is not the only opinion, and if I made that edit I would then attract adverse comments from market monetarists - which is EXACTLY what I am trying to avoid.

      This subject is now closed.

    10. It does matter though.

      Trade surplus countries are only trade surplus countries because the banking system will discount foreign denominated assets. Without that the system runs out of the right sorts of money to allow transactions to complete.

      So when you sell your US-dollars for Canadian Dollars at a Canadian bank it's very likely that all that happens is the bank takes the US-dollars and creates the Canadian dollars by marking up your account. The bank's balance sheet then expands.

      That is the 'open' position of legend.

      If it is a multi-national bank then it is likely to net these off across the group - by contacting the US arm of the bank and doing the necessary swaps to get the reserves in the right place.

      The question is whether this sort of 'money creation' by discounting foreign denominated financial assets is detrimental to FX stability.

    11. That's a very good point. I did mention in the post that banks are responsible for FX exchange, but I didn't follow that through to the global financial stability implications.

  2. OOps- should have added here:

    "NO!!!!!!!!!!!!!!!!! The CB does not determine the amount of money. It only determines the amount of Currency=reserves=base money, and even that it only partly determines as its just supplying an amount that corresponds to an interest rate target."

    in a non-QE environment or in an environment where they are targeting price and not quantity of longer term TSY CDs

  3. This is a very good article Frances.

    But the evidence *with CBs running liquidity policies*. There is no evidence with CBs allowing liquidity to run out and leaving it to the counterparty CBs to run liquidity.

    You may as well say: “Man cannot fly, because when he flaps his arms nothing happens”.

    There is *no* exchange rate theory that fits the available evidence. None. Anybody who thinks they do have an exchange rate theory are welcome to try that out in the FX market.

    1. No, CBs don't allow liquidity to run out. They intervene to prevent it doing so. This involves being actively involved in the FX market. That's what my reference to "more subtle forms of currency fixing" was about.

      In the sort of crisis I am discussing here, really the decisions would be made by the government not the CB, since imposing strict capital controls to prevent catastrophic reserve outflows has consequences for welfare in an import-dependent economy, and private sector insolvency on this scale requires fiscal intervention.

    2. "No, CBs don't allow liquidity to run out. They intervene to prevent it doing so. This involves being actively involved in the FX market. That's what my reference to "more subtle forms of currency fixing" was about. "

      They do at the moment. But they don't have to. And if they do they should not be doing swaps into foreign currency, but offering to settle foreign debts for needed commodities. And other policies like banning bank lending for currency settlement.

      You shouldn't 'prop up the currency' on your side. That is a very bad idea because it puts a patsy in the market on the offer side which of course *everybody* then takes advantage of.

      But without a patsy on the offer side, who is going to take your shorts and who is going to cover them at 10pm when you have to settle your bets?

      Nobody. So you are forced to bid up.

      "strict capital controls to prevent catastrophic reserve outflows"

      OK. When a financial instrument is exchanged, the ownership changes. Depending on market conditions, the price may also change. Who the owners are and whether they live in a currency zone or decided to save in another currency is largely irrelevant other than wrt market conditions that affect price.

      So that has no aggregate effect. For you to get out of a currency somebody else has to come into the currency. So all that happens is the tag changes. No "capital outflow".

      The new person will either spend the money, via the banking system, or save it, in which case it is largely inert.

      Much ado about nothing. Nothing "goes" anywhere other than changing hands (ownership).

    3. Hah true, talking about money "leaving" the country is sloppy. It doesn't, its ownership changes. Actually that is also true of gold outflows under a gold standard. Nobody physically ships gold around. They leave it in the vault and change the label.

    4. Except the Germans, of course. They like their gold to be where they can kick it. In the Bundesbank.

    5. "They leave it in the vault and change the label."

      And then the French Navy turn up wanting their gold back.

    6. Understanding that gold standard money *can* leave a banking system but fiat *cannot* is key to understanding that your comparison between the two systems is *wrong*.
      The French Navy cannot ship fiat over the Atlantic.

    7. When a country defaults on fiat money obligations, the legal recourse is to that country's assets. This is most obvious in countries operating quasi-gold standard systems - Greece, for example - and those dependent on FX reserves because their own currency is not trusted. But it is also true of countries that choose to default on own-currency obligations. In default, fiat currencies are asset-backed.

    8. "But it is also true of countries that choose to default.."

      Why are you trying to move the goalposts? What has the choice of default got to do with anything? Fiat currency means that I cannot convert my money into anything else.

      If I take my pounds to the UK Treasury and say I want them to settle their debt with me, will they give me some of their assets for my pounds? I bet they've got some nice furniture I could have instead of their 'worthless' tax credits.

    9. You need to distinguish between the obligation itself and the means by which the obligation is discharged. If you default on an obligation, whether because you can't pay or you won't pay, your creditor can send in bailiffs to seize your assets. De Gaulle wanted to send in gunboats to seize America's gold in settlement of the obligations on which it had effectively just defaulted. The fact that the obligation was denominated in gold doesn't actually matter. If it had been denominated in USD but the US government had refused to pay, gunboats still could be sent to seize gold "to the value of" the unpaid debt.

    10. Oh, and cash in circulation is not an "obligation". It's a liability, but not a debt. Ownership of cash does not give you a claim on the government. But ownership of bonds does.

    11. I think you are now being deliberately obtuse about both the non convertible nature of fiat, and my analogy about going to the Treasury to try and convert some of it.

      Oh well.

    12. The question is not about the nature of money, it is about the legal framework of an obligation. Fiat money itself is not an obligation. But a debt is, even a sovereign debt dischargeable in fiat money. The fact that fiat money is not exchangeable does not provide a means for sovereigns to evade their international obligations.

  4. Is there an acknowledged "register" of countries' exposure to FX-dependencies?
    I figure this might be the IMF but how much might be scaremongery by the IMF to justify their existence and standing in a FIAT world?

  5. But even if every country had a floating exchange rate, balance of payments crisis would remain a risk for many countries.

    Things should be defined carefully. What is a "balance of payments crisis"?
    Nobody (no MMT academic) says bad things cannot happen to good countries with floating fiat money. Nobody says sudden currency depreciation might not cause pain to a country. There are a lot of people out there who may say things sloppily. What is at issue is the precise MMT statements.

    What MMT / FF says is that if a country issues floating fiat money, has no foreign denominated debt & does not mindlessly rescue private institutions with foreign currency denominated debt & acquire their debt - then there is no foreign constraint on spending, on full employment. In other words - if you don't have foreign currency debt, don't acquire such debt, you won't have foreign currency debt.

    I can think of only 2 situations where a sane government would acquire true foreign currency debt. (A) To buy food to prevent imminent mass starvation. "People don't eat in the long run. They eat every day." (B) To buy guns to defend against imminent invasion. In both cases there's the UN nowadays to whine to; so they aren't really all that common. What is common is crazy rhetoric insisting that your country is in those situations, when it really isn't, or that there are other situations where fx debt is reasonable.

    The idea that currency depreciation will absorb all shocks rests on the assumption that there is infinite demand for all currencies.FF / MMT makes no such assumption. It says the obvious, the tautological: a country's exports set a lower limit on its currency's foreign value. If you have something to sell, and your currency is needed to purchase it, even if nobody wants to save in your currency, your currency will have a nonzero fx value. The upshot, I hope, is that there is no real, substantial disagreement with this post and MMT. There are some differences in details. (E.g. "beggar-my-neighbour competition"- which is an untrue concept; that MMT = "market monetarism")

    My recommendation to anyone is Read Abba Lerner, Read Abba Lerner, Read Abba Lerner. The last two chapters of his Economics of Employment cover such matters. My position is that if someone disagrees with Lerner there, he doesn't need an economist or a philosopher or a mathematician to help him out of his difficulties. He needs a psychiatrist.

    1. This is not an MMT post. My work is read by many people from other branches of economics. Your framing is clearly MMT, but you should not read this post as in any way a critique of MMT. It is not.

      I did not suggest that MMT/FF made any assumption that there was infinite demand for all currencies. In fact I have heard exactly that argument from some market monetarists, and my post is aimed at them at least as much as those MMT adherents who think floating exchange rates solve everything and the financial system somehow automatically sorts it all out (see Neil Wilson's post under "related reading"). Indeed that is partly the reason for the monetarist framing.

      Nor do I make any recommendation for beggar-my-neighbour competition. Indeed, in my linked post under "Related reading" called "Competitive devaluation is not a free lunch" I take a prominent monetarist economist apart for suggesting that competitive devaluation can restore economic growth.

      On Abba Lerner, I completely agree with you.

  6. Great post Francis, I may even be quoting some of this in my next report on Argentina's trade balance!

  7. Without solution, here is another part of the foreign exchange puzzle:

    Follow the example of a foreign made car sold in the United States. That car was sold for dollars. The maker of the car probably owns those dollars, but the dollars are located in the U.S..

    Now the builder of the car paid his workers in yen or euros. So here is the problem: How does a nation (like Japan) build huge ownership of U.S. assets without the cooperation of the Japan banking system in some way?

    1. The Japanese and US banking systems are central to the whole thing.

    2. This comment has been removed by the author.

  8. That last paragraph gives me hives. Not your fault, of course, Frances, but maintaining an export surplus does not remove risk. It merely shifts risks around, and when gov't do that for the wrong reasons, it comes back to bite that gov't. If there's one consistent issue, it's that export surplus policies always take a life of its own, way past the sell-by date. Primarily when too many countries are trying to run the same strategy ie, when the partner countries starts being more interested in boosting export growth themselves.

    And let's not underestimate what reduced living standards means--Korea's government goes to great lengths to prevent Korean from taking advantage of better overseas pricing for important consumer goods. Places like Colombia, India, or Indonesia simply disregards the needs of vast swaths of their countries in favor of their isles of California. Mexico's effort in the last three decades to cultivate manufacturing exports has led to very little growth in gdp. Places like Singapore, Hong Kong, and Chile have, or had, programs where part of their worker's wages are automatically garnished in placed into investment pools that underperforms what current buying power can give or more astute investments in businesses, stocks, or bonds would give. And as with Japan and it's perpetual construction corruption (beyond the 70's), so much of what is retained is wasted. Or in the case of Finland, the savings never amounted to much in the face of a real (and by real, I mean adequately funded) investment and trade policy.

    And I can rant on and on and on...

    1. Heck yes. I'm not saying that trade surpluses are a good thing, just that after the 1997 crisis the reasons why EMs pursue them are entirely understandable.

    2. This comment has been removed by the author.

  9. Insightful post. Emerging countries like mine, Ghana, run a trade deficit while having a currency (cedi) not exactly loved outside the country. To prevent ridiculously quick currency depreciation we're forced to rely on FDIs, grants and a large external debt (43% of GDP). This makes us very sensitive to the monetary policy of the Fed and other CBs as well as commodity prices. I often wonder if we're not better off with protectionist policies instead of this "free" trade which leaves us disadvantaged.

  10. Hi Frances, Emerging market economies prefer the export led (investment driven ) growth model to shore up FX reserves as they cannot print an infinite amount of local currency - that will lead to severe inflation (there is no sterilization mechanism). Isnt that also another reason why the focus is on export led growth models?

  11. Frances, you would have been better off not writing this post. There is much confusing of the readers in your footnotes; your readers can't judge if you are adding any value to the debate.

    All the things you say you are not going to do, such as, who creates the money (the Treasury does when it spends). Or fiscal or monetary policy (the last eight years have proved that monetary policy can't increase aggregate demand, like fiscal policy can). These are the very things you should be doing. ;-)

    1. BTW, as Neil Wilson says "There isn't really such a thing as a balance of payments crisis in a floating rate exchange system. For those excess imports to exist at all, the saving of the local currency must occur at the same time. Otherwise the financing of the deal would have failed and the transaction would never have happened. And there would be no excess imports. The floating rate balances out the successes and failures automatically. That's its job."

    2. Neil's argument presupposes a perfect world and an efficient and unbiased financial system. Neither exists in reality. By all means continue to promote Utopia, but don't criticise me for pointing out that there is no such thing.

      The very fact that you object to me writing this post suggests that I was right to write it. It raises issues that you find uncomfortable.

      There are already plenty of people writing what you think I "should" be writing. I prefer to do something else. If you don't like it, you dont have to read it.

  12. Thanks Frances, great post!

  13. The markets are always challenging us, they are very static and we can't do anything but can change our self with the flow, some times I try to over simplify the process too much and forget price discovery happens through the auction.

  14. Good post. The balance sheet of the private sector is equally important as public debt in understanding the dangers of sustained currency depreciation. I'm in favour of ER flexibility, though I don't like the extremes (neither fixed ER nor freely floating). And the issue of the hierarchy of currencies is central. A cursory look at invoicing denomination in trade flows is sufficient to give an idea.

    1. This recent article by the BIS is also relevant to the argument of this post, in my view.

  15. This comment has been removed by the author.

  16. The modern economy is essentially a petro standard jurisdiction.
    This explains the lack of activity in a typical western Ireland ( or other euro jurisdiction area outside of financial Capitals)
    People must travel further and further distances to access purchasing power thus paradoxically destroying purchasing power.
    Local village exchange is dead.

    The orbital track absorbs all of the energy.

  17. A modern mercantalist country such as Ireland and Spain ( yes Spain is mercantalist given its tourist bias) must waste most of its energy seeking currency from abroad.
    This is the fundamental driver for basic rationing in these economies.
    Rationing is always required in war or consumer war economies.
    Production is not designed to satisfy human needs.
    Energy is vectored into the never ending war of production ( chiefly of the capital goods required to access the petro standard)
    Depreciation eats most of their registered Gdp increases.
    Activity observed ( trade etc) destroys living standards.
    It's important to realize that these banking standards of whatever form always force trade, they are not free trade systems.

  18. Cutting interest rates depresses the exchange rate, and depressing the exchange rate raises inflation ?

    Have you got a set of graphs that prove this ?


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