Wednesday, November 9, 2011

We Are Not in the 1930s

. Wednesday, November 9, 2011

It's easy to draw parallels between these days and the 1930s, especially for an IPE scholar. Drezner does it here, I've done it before, and so has practically anybody with any sense of the international or temporal dimensions of political economy. Here's DeLong:

I have been complaining for some time now that Reinhart and Rogoff think that the time is always 1931 and that we are always Austria--that the great fiscal crisis is about to erupt and send us lurching down toward Great Depression II. Well, right now guess what? The time is 1931, and we are Austria. The Federal Reserve needs to buy up every single European bond owned by every single American financial institution for cash before the increase in eurorisk leads American finance to tighten credit again and send us down into the double dip. The Federal Reserve Needs to do so now.

Is this 1931? Here's a partial list of similarities: an system of prosperous globalization is threatening to unravel as Europe's fixed exchange rate regime crumbles; macroeconomic imbalances presage a significant financial crisis; European governments respond to large fiscal burdens by attempting to devalue internally through austerity rather than devaluing externally through the exchange rate; movements towards trade protectionism and beggar-thy-neighbor policies (outside of Europe); etc.

But I don't think we're in the 1930s. I think the world is different now than it was then in a number of important ways, and that leaves me more optimistic than I otherwise might be.

First, I think the international economic system has been transformed from the way it was during the interwar period in a number of key areas. Unlike then, international politics is now highly institutionalized. We have a series of durable trade relationships that have been legally formalized, but which provide flexibility for national governments to address pressing short-run concerns. We have a credible international organization that monitors trade and provides a mechanism for dispute adjudication. Europe has a common trade market that is likely to remain even if the monetary union dissolves. A collapse in world trade -- and thus global output -- equivalent to that in the 1930s thus seems highly unlikely.

Perhaps more importantly, the present international monetary system is not dedicated to the orthodoxy of currency values fixed to a specific quantity of a sparkly metal. This has allowed central banks, especially the central bank of the global reserve currency, to inject liquidity into the global financial system at key points over the past few years. Even the ECB, which has rightly come under criticism for not doing enough to manage the crisis despite having no legal authority to take the necessary measures, has pursued a far more expansionary policy than it would if it were trying to maintain a gold standard. Indeed it has almost certainly already acted beyond the parameters set out for it under the Lisbon Treaty. In at least some key respects, the US Fed has followed Kindleberger's advice and acted as the World's Central Bank, a role left unfulfilled in the 1930s. While the monetary authorities may not have been expansionary enough, they have done much more than anyone did during the 1930s.

Countries within the eurozone, while not bound by "Golden Fetters", are certainly bound by Euro Shackles. This load is may be too great to bear for some, but there is little doubt that at the regional level this yoke is easier and the burden lighter than the gold standard restraint of the 1930s.

There are other reasons to expect better results than the 1930s. Unlike then, Europe is not the central pivot point in the global economy. Major exporters such as China are not financially exposed to Europe, and have stockpiled foreign exchange reserves sufficiently large to keep their economy moving forward, even if the pace slows somewhat. Even the US is not exposed to European financial markets in sufficiently large way likely to be exceptionally destabilizing, especially when compared to Europe's exposure to the US in 2008 or the US's exposure to Europe in the 1930s. While contagion is a real concern, it's not much of a concern in a European crisis as it was during the US crisis. If you don't live in Europe, that is.

Finally, unlike the 1930s, nearly all of the world's major economies are consolidated democracies. While this can place some unfortunate, even tragic, constraints on short-term policymaking, in the medium run geopolitical and economic stability is likely to benefit from democratic solidarity. Factor in close security ties and the sort of security dilemmas (including economic security dilemmas) that were operating in the 1930s just don't seem to apply today.

None of which is meant to imply that the current troubles are not serious. I remain concerned that the coordinating institutions that now exist do not have sufficient authority to operate effectively. The biggest problem in Europe over the past two years has not been macroeconomic fundamentals, or a currency zone that is not optimal, or even a central bank -- solely concerned with price stability -- that fiddles while Rome burns. The biggest problem is the deficit in governance by which the Euro-level coordinating institutions cannot act without unanimous approval of member states, many of which have preferences that are diametrically opposed. At the global level the problem is both better and worse. Better because the shackles are much looser than in Europe; worse because the coordinating mechanisms are weaker than in Europe. The only game in Governance Town seems to be the G-20, which has been... underwhelming in their policy responses since 2008. The IMF seems to be caught in limbo over the euro-crisis. But in the 1930s there wasn't even a G-20. There wasn't an IMF. There wasn't a central bank at the center of the monetary system willing to take the globally-minded actions that the Fed has taken. There wasn't a US Treasury Security like Geithner who, for all his faults, can never be accused of underestimating the downside risk of financial contagion.

It's difficult to draw perfect parallels to the current situation in Europe. But if I had to pick one, it would be closer to Latin America in the 1980-1990s than Europe in the 1930s. I expect the harshest effects to remain at the regional level. The US, Japan, China, Brazil, India, and other major economies will be affected, but not severely.

The next few years, like the last few years, will be a test of the resiliency of the global economic and political architecture. So far we've done fairly well all things considered. Hopefully that will continue.  


We Are Not in the 1930s




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