Jim Rogers, one of the most respected investors of recent decades—and rightly so—thinks Fed Chairman Ben Bernanke is clueless on matters of macroeconomics. But enlightened macroeconomic analysis and succcessful investment evaluation don’t always reside at the same address. “Dr. Bernanke unfortunately does not understand economics, he does not understand currencies, he does not understand finance,” he charged last week in a speech, according to Bloomberg. That’s a powerful criticism and, if true, would be deeply disturbing. Is Rogers right? No, or at least the criticism doesn’t hold up given the framework Rogers set up to deliver his attack.
The core of Rogers’ case is that the central bank is printing too much money these days. His rhetorical coup de grace: “Debasing your currency has never worked.” It sound persuasive, but there’s just one problem: History doesn’t back up the statement. Printing money is sometimes the wrong choice, but not always. The economic context matters.
But before I offer some supporting evidence, a quick digression into the alleged debasement of the U.S. dollar. Yes, the hazards that apply to fiat currencies are well understood, and the risks apply to every central bank that issues paper money. Over the long haul, inflation is the path of least resistance. But this problem applies to every central bank, and so it’s unfair to single out the Fed on this point.
On that note, consider how the U.S. Dollar Index has fared in recent years. As the chart below shows, the greenback is valued at a slightly higher level today compared with the depths of the financial crisis in late-2008. Conclusively declaring that the dollar has been debased is somewhat premature. We shouldn’t minimize the risk, but for the moment the dollar is off its lows of recent years.
As to the claim that engineering a lower currency value is always destined to fail as a part of useful macroeconomic policy, history suggests otherwise. True, a lower dollar in and of itself isn’t a silver bullet. But the timing matters quite a bit. In periods of falling inflation and a generally weak economy, a weaker dollar can be productive. That’s another way of saying that a stronger dollar may bring deeper problems.
Exhibit A is the experience in the early 1930s, during the Great Depression. Economists have analyzed this period for decades and in considerable detail. Among the fundamental conclusions: efforts at maintaining a strong currency were counterproductive to creating macro policies that favored growth. Economist Christine Romer, for instance, wrote a few years ago that the sooner countries abandoned the gold standard in the early 1930s—an act that effectively devalued their currencies—the sooner their economies witnessed growth. As she writes:
Given the key roles of monetary contraction and the gold standard in causing the Great Depression, it is not surprising that currency devaluations and monetary expansion became the leading sources of recovery throughout the world. There is a notable correlation between the time countries abandoned the gold standard (or devalued their currencies substantially) and a renewed growth in their output. For example, Britain, which was forced off the gold standard in September 1931, recovered relatively early, while the United States, which did not effectively devalue its currency until 1933, recovered substantially later. Similarly, the Latin America countries of Argentina and Brazil, which began to devalue in 1929, had relatively mild downturns and were largely recovered by 1935. In contrast, the “Gold Bloc” countries of Belgium and France, which were particularly wedded to the gold standard and slow to devalue, still had industrial production in 1935 well below its 1929 level.
Romer’s analysis is hardly a radical idea. Indeed, economists have studied the economic history of the period and made similar observations for years. Barry Eichengreen in a widely quoted 1992 article in Economic History Review, for instance, reported that “the timing and extent of depreciation can explain much of the variation in the timing and extent of the economic recovery.” A chart from that paper illustrates the point. Countries that left the gold standard earlier experienced strong industrial production earlier. At the extreme, France stayed on the gold standard the longest, which came at a high price of depressing industrial production for several years.
More recently, the economic case has only strengthened for indicting the gold standard as a detrimental factor in identifying cause and effect for the deepest economic problems linked with the Great Depression. Keep in mind that the gold standard is effectively a policy of promoting a strong currency. That was exactly the wrong policy, however, during a time of weak employment growth and falling inflation. For instance, Douglas Irwin’s research shows that France’s ultra-hawkish embrace of the gold standard was not only hurting the French economy, it had devastating effects on the global economy in the 1930s. According to Irwin, “countries not on the gold standard managed to avoid the Great Depression almost entirely, while countries on the gold standard did not begin to recover until after they left it.”
As for the current situation, what of the recently revived sentiment? Economists are now saying that the odds of a double-dip recession have fallen sharply. Why? What happened to change the outlook from the summer, when the forecast was much darker? Monetary policy surely has played a role. Back in June, there was criticism that the Fed wasn’t doing enough. Now there’s criticism that the Fed’s doing too much. But it’s hard to overlook the fact that the improved outlook on the economy coincided with a more aggressive monetary policy in recent months. Will it work? No one really knows, but forecasts are slightly better and there’s even some recently improved news for the labor market, as last week’s jobs report shows. Is everything fine? No, of course not. But the first question is whether monetary policy is helping or hurting. For the moment, it seems to be helping…again, on the margins. That’s better than the alternative.
Is the higher degree of monetary stimulus and the rebound in the economic outlook coincidence? Not likely. Yes, there are other factors beyond monetary policy. And the Fed isn’t the one and only solution to the economic ills of late. But dismissing the Fed’s efforts in recent months as worthless is a misreading of history, distant and recent.
Clearly, there are still many risks to consider, and debating what should be done now (or not) is productive. But before we do anything, we need to focus on what actually happened in economic history and draw reasonable conclusions.