Regulation, Trade and Devaluation Wars
Carlos M. Pelaez

The influential economist Joan Robinson analyzed “beggar-my-neighbor remedies for unemployment” as the use of protectionism or impediments to foreign trade in promoting domestic employment, causing unemployment in other countries, which characterized the Great Depression (Robinson, Essays in the Theory of Employment, Macmillan, 1937). The credit/dollar crisis and global recession after 2007 is typically exaggerated as the “worst” financial and economic crisis since the Great Depression of the 1930s. Comprehensive review of the vast literature on the Great Depression reveals a contraction of output and employment that was immeasurably stronger than the world contraction in 2008-2009 (Pelaez and Pelaez, Regulation of Banks and Finance, 197-217). The decline in real or price adjusted GDP in 1930-1933 accumulated to 26.7 percent and 45.5 percent in current dollars or without adjusting by price changes (Pelaez and Pelaez, Financial Regulation after the Global Recession, 151). The cumulative decline of inflation adjusted GDP of the United States during the current recession in the last two quarters of 2008 and first two quarters of 2009 was 4.7 percent. GDP increased in the third quarter of 2009. The hyperbole has been used in proposing massive fiscal/monetary stimulus as required in “avoiding another Great Depression” and, subsequently, in the argument that in the absence of such stimulus there would have been another Great Depression and that the stimulus should be maintained indefinitely. There is no convincing method to disprove the assertion because it is a “counterfactual” or what would have been economic conditions in the absence of the stimulus, which cannot be fully resolved because there are no data without the stimulus and even if available no decisive method to isolate multiple effects in a comparison with the available data with stimulus. The current credit/dollar crisis and global recession bears more resemblance in dimensions to the world debt crisis that required interest rates of fed funds of 19.08 percent in January 1981 because of the inflation shock resulting from the fine tuning of the late 1970s exacerbated by the oil price increases following the Iranian revolution. The current worldwide regulation, trade and devaluation wars are reminiscent of the analysis by Joan Robinson of beggar-my-neighbor remedies for unemployment (Pelaez and Pelaez, Government Intervention in Globalization: Regulation, Trade and Devaluation Wars, 174-84, Globalization and the State, Vol. I, 157-206, and Globalization and the State, Vol. II. 205-13). The troubled world economic environment of regulation, trade and devaluation is analyzed below in turn.
First, Regulation. There is a heavy agenda of regulation of finance worldwide. The Banking Act of 1933 prohibited payment of interest on demand deposits and imposed limits on interest rates paid on time deposits issued by commercial banks. Interest rate controls imposed by Regulation Q and the rise of banking by buying money through certificates of deposit (CD) to lend in large volumes encouraged the permanent exodus of banking from New York to London (Pelaez and Pelaez, Regulation of Banks and Finance, 74-5). Regulation Q was a costly government failure. The objective of regulation is to correct “market failures” or the use of collective action by the government to attain improvements over freer markets. The approach of the new institutional economics (NIE) is that both markets and governments may fail (Pelaez and Pelaez, Government Intervention in Globalization, 83-4, Globalization and the State Vol. I, 139-43, and Globalization and the State Vol. II, 211-3). That is, there is no assurance that the intervention by the government could improve over the state of no intervention and the similar counterfactual difficulty in analyzing government intervention after it occurs. It is quite difficult or nearly impossible with the available knowledge and institutional structure for the government to control systemic risk without exacerbating it such as in downsizing large banks. Banking panics were more common and pernicious in the United States than in other countries because of the large number of small banks, so-called unit banks, restricted by regulation to operate with only one office or within the boundaries of states. Research by Calomiris and Gorton concludes that unit banking systems are more prone to banking panics (Pelaez and Pelaez, Regulation of Banks and Finance, 202-3). Smaller banks may not be able to provide the volume of loans and financial services required by large business. American banks and companies would lose in world markets competing with international companies and banks that attain optimum scale, that is, produce at minimum costs. The replacement of the Federal Reserve System (FRS) with less independent regulators may lead to more politicized decisions on monetary policy and regulation, similar to the debacle of Fannie and Freddie, which could increase financial instability causing a worst future crisis. Rushed recession regulation has seldom improved regulatory structure and its effectiveness.
Second, Devaluation. The regulatory agenda in parliaments departs from the analysis of the credit/dollar crisis and global recession as caused by “an era of irresponsibility” in the form of excessive leverage and risk motivated by compensation of bankers without relation to performance. An alternative interpretation is that the credit/dollar crisis and global recession was caused by the zero interest rate on fed funds in 2003-2004 that eroded the discipline of risk/return calculations, encouraging high leverage and risk, low liquidity and unsound credit. Overproduction of housing was induced by lowering mortgage interest rates by eliminating the 30-year Treasury bond, the yearly housing subsidy in the United States of over $200 billion and the purchase or guarantee by Fannie Mae and Freddie Mac of $1.5 trillion of nonprime mortgages (Pelaez and Pelaez, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4, Financial Regulation after the Global Recession, 157-66, and Regulation of Banks and Finance, 217-27). The erosion of bank discipline in risk management was caused by policy impulses. The zero interest rate in 2008 caused the carry trade of shorting the dollar and going long in commodities and emerging market stocks (Pelaez and Pelaez, Government Intervention in Globalization, 70-4). The dollar firmed as haven for risk aversion in world markets after the alarmist proposal of the Troubled Assets Relief Program (TARP) in September 2008 and then devalued after March 2009 with the return of risk appetite. World trade imbalances are primarily the trade deficit of the United States and the trade surplus of China. The Chinese renminbi needs to revalue, that is, fewer renminbi to buy a dollar, which cheapens imports into China and makes its exports more expensive. China moved in the path of adjustment by revaluing the renminbi from 8.28/dollar in 2005 to 6.83/dollar, or 17.5 percent reverse devaluation, but it fixed the renminbi against the dollar again in July 2008 to prevent an erosion of its competitiveness in exports during the global recession. The devaluation of the dollar caused significant loss of competitiveness especially in Asian exporting countries that intervened in their foreign exchange markets to arrest the appreciation of their currencies relative to the dollar. The employment report on November 4 showing loss of only 11,000 jobs and decline in the rate of unemployment raises the possibility that the Fed may increase interest rates in 2010, which are now at 0-0.25 percent per year on fed funds. The dollar would appreciate against most currencies making American exports more expensive and imports cheaper, contributing to the deterioration of the trade deficit. The zero interest rate could be considered a regulatory failure, causing financial instability. The world competitive devaluation would resemble those in earlier episodes such as the Asian crisis of 1997-1998. The countries that abandoned the gold standard in 1931 performed better than those that remained in gold as shown in vast literature on the Great Depression (Pelaez and Pelaez, Regulation of Banks and Finance, 198-217).
Third, Trade. Jobless recoveries encourage the use of collective action by the government to restrict the entry of foreign-produced goods and services or the protectionism for promoting domestic employment at the expense of foreign employment deplored by Joan Robinson. A recent Gallup Poll shows that keeping jobs in the United States by not importing goods and services is the most favored employment-creation measure of Americans even beating tax reduction. This is likely the view of populations across the world. The competitive devaluation and ongoing measures to create trade barriers may complement each other. There may well be a return of the image of throwing rocks in ports to prevent trade perhaps also frustrating the international transmission of ideas, raising frictions in international relations. (Go to: http://www.amazon.com/Carlos-Manuel-Pel%C3%A1ez/e/B001HCUT10)