Krugman is Wrong About the Market and Hot Money – Flassbeck (1/3)
As “hot money” wreaks havoc around the globe, Heiner Flassbeck, former director of UNCTAD, says economist Paul Krugman continues to have faith in the market to establish exchange rates
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay in Baltimore.
On Wednesday, the Fed announced it was going to slow down its purchase of Treasury bills, which points to higher interest rates in the United States. There was a quick reaction in many markets around the world. In Turkey, interest rates went from 7.75 to 12 percent as what’s called hot money exited Turkey, or at least threatened to exit, forcing up interest rates there, in South Africa, in Argentina, and many countries.
Paul Krugman, writing about this in The New York Times, said the following.
“For a generation after World War II, the world financial system was, by modern standards, remarkably crisis-free–probably because most countries placed restrictions on cross-border capital flows, so that international borrowing and lending were limited. In the late 1970s, however, deregulation and rising banker aggressiveness led to a surge of funds into Latin America, followed by what’s known in the trade as a ‘sudden stop’ in 1982–and a crisis that led to a decade of economic stagnation.
Further down, he writes:
“Most recently, yet another version of the story has played out within Europe, with a rush of money into Greece, Spain and Portugal, followed by a sudden stop and immense economic pain.”
Now joining us to discuss what’s happening in Turkey and how it might affect the global economy is Heiner Flassbeck. Heiner served as director of the Division on Globalization and Development Strategies at the United Nations Conference on Trade and Development, known as UNCTAD. He was formerly a vice minister at the Federal Ministry of Finance in Bonn, in Germany, from October 1998 to April 1999. And he’s now a professor of economics at Hamburg University.
Thanks for joining us again, Heiner.
HEINER FLASSBECK, PROF. ECONOMICS, HAMBURG UNIVERSITY: Thanks for having me.
JAY: So why did Turkish interest rates skyrocket? And who benefits?
FLASSBECK: Well, it skyrocketed because the Central Bank put them up. The Central Bank reacted to the flight of capital out of the country that brought down the lira, the Turkish currency, depreciated the lira. And so they want to stop the depreciation of the lira. And this is the main reason why it went up. And this is a big shock for the Turkish economy and will have massive consequences later.
JAY: What effect does–well, first of all, the announcement by the Fed is on Wednesday, and they going to slow down by $10 billion a month. I think they’re still doing $65 billion a month of purchases. And this affects long-term interest rates in the United States. But why would that trigger this events in Turkey?
FLASSBECK: Well, you see, this is considered–the Turkish lira and the assets in Turkey were considered risky assets by all the speculators all around the globe, and whenever something happens like this announcement of the Fed, they’re panicking immediately and they’re trying to get their money home. This happened, as you said, in many countries, so it’s not a Turkish problem. It’s a problem of this kind of speculation with currencies that we have seen time and again, called carry trade, where people are carrying money from low interest rate countries to high interest rate countries. And Turkey was one of the high interest rate countries. And this appreciates the currencies there, creates a totally untenable situation, because it creates current-account deficits. And then, at a certain point, whatever the trigger is, these people are rushing back home, and we have the sudden stop or the return of capital, the reversal of the capital flow.
JAY: Now, I’ve heard some people refer to these type of people that manage these big flows of capital–some people have called them sovereign raiders, and that they kind of look for opportunities to stop the hot money and essentially pressure countries to raise interest rates. And then they go right back in again, except instead of earning seven and change on their money, they’re now earning 12 on their money. I mean, to what extent is this a kind of manipulation that’s taking place?
FLASSBECK: Yeah, that’s definitely so, that they’re coming back whenever the risk is gone or the risk is not as big as it was before. Well, whether the situation in Turkey is already like that I’m not quite sure. But nevertheless, we have to see that in the first round they are creating the problem. These flows of money, the hot money that’s flowing in creates the problem, and then it’s creating a new problem by getting out. And maybe it’s creating a third problem by getting in again. That’s all possible. And that is why it’s absolutely necessary to stop this kind of very short-term capital to flow in huge quantities into these countries.
JAY: And just so everybody gets what we’re talking about, an example of this is the big American banks have been borrowing money from the Fed at practically zero, close to zero interest rates. And apparently they’re very much involved in this carry trade, where they take money that’s costing them almost nothing and then take it to these markets that are paying 7, 8, 9 percent, sometimes even more. And it’s enormous profit-taking by them.
But what are the consequences for ordinary people when this hot money goes in, goes out, the rates go up? How does this–what could ordinary people, for example, in Turkey might expect from all of this?
FLASSBECK: Well, first of all, it looks good if the hot money comes in. The currency’s appreciating. People feel richer. The government feels that it has the confidence of the international markets. So they’re all fooled by the inflow. But when it gets hot–and it has to get hot at a certain point of time, because the appreciation leads to an overvaluation, and then the overvaluation has to be corrected–then many people are indebted in foreign currency, for example. And then this foreign debt is exploding when the currency goes down.
And, as I said, the big problem is how to stop this depreciation. The central banks normally do not have enough reserves to stop it at a reasonable point. They need a depreciation, but they do not need an infinite depreciation or a depreciation of 50 percent or 60; maybe they only need 20. And then they have to call the IMF in, the International Monetary Fund in Washington. And then they come with all their nice conditionality, and the government is suspended, so to say, from governing the country.
JAY: So the big pools of capital, they make money creating the bubbles. Then they pull out and burst the bubble. But the reaction of these countries is to raise their interest rates even higher, so now they can make more money going back in again.
FLASSBECK: Yeah, that’s really observant. They shouldn’t do that. But what can they do? They have two alternatives. They can either call the IMF directly in–what they do not want to do, because, as I said, they’re losing all their sovereignty overnight, because the IMF will tell them what to do for the next ten years–or they’re doing stupid things like dramatically increasing interest rates, which did not even even help in the Turkish case. And in the past, we have very often seen that it doesn’t help, really, but it worsens the situation, because it destroys the domestic economy. And so it is not really helping anyone except for the people who might go in afterwards.
JAY: Now, we’ve talked a bit about this before, and I know this issue of exchange rates is quite complicated. There’s many factors involved. But one of the main factors, it seems to me, if I’m understanding it correctly, is interest rates are so low in the United States because the Fed is making sure they stay as low as possible, but to a large extent because there’s so little real demand in the United States, wages are so stagnant and so low, that they’re doing everything they can to kind of keep, you know, as much as they can, boosting the economy with cheap credit. And then this has global consequences, not just American domestic consequences. Do I have it right?
FLASSBECK: Yeah, that’s one thing, that’s one factor that’s very important. But, as I said before, it’s not only the U.S. We have zero interest rates in Japan. When the U.S. still had higher interest rate, the hedge funds went through Japan, borrowed money in Japan, and carried it to Brazil and other countries. So it’s always–there’s always a low interest rate country. Or it was done through Switzerland. So it’s not important how it is done.
But the crucial thing in here–I fully disagree with Paul Krugman. Paul Krugman said, you had capital controls in the ’50s and the ’60s under the Bretton Woods system. That’s true, but that’s not the whole truth. The much more important thing is that we didn’t have flexible exchange rates. We have flexible exchange rates, and these flexible exchange rates, with these huge flows of money, of hot money, are going in the wrong direction, they’re going definitely the wrong direction, because countries with a rather high inflation rate, like Turkey or Brazil, get an appreciation of their currencies, and everybody knows that’s absolutely untenable. Every good economic textbook will tell you that the country with the high inflation needs a depreciation. But the flexible exchange rate, the markets, the markets are doing exactly the wrong thing. And Krugman also is shying away from saying this very clearly. And this is the problem.
We had attempts in 2011 in the G20 to talk about a new monetary system, but everybody is shying away from touching this hot issue. This is the hot issue. The markets get the prices wrong. And this has to be addressed head-on. And that means you need intervention, international intervention into the market to avoid the misalignment in the first round, the misalignment driven by the market.
JAY: But the pegged exchange rates don’t seem to work either.
FLASSBECK: Well, you’re never prevented from inventing a smarter system than you had before, but you need a system. The system Bretton Woods didn’t work quite well, because it was a system that corrected the exchange rates when it was too late. I have proposed with someone other people in UNCTAD a system when you anticipate, so to say, the changes in the exchange rate that are needed and you do it right away, so that the big imbalances do not have time to build up. And this is a much smarter way to do it. And so why shouldn’t we learn?
But what is absolutely clear but is not mentioned by most economists, not even by a person like Paul Krugman, whom I like very much for many of his assertions, but he is not saying, well, flexible exchange rates do not work. But this is the fact and this is the core of the matter. And this–but if you say this, then it has harsh consequences for Wall Street, and nobody wants to tackle that.
JAY: Okay. In part two of our interview I’m going to ask the question, is a more rational global exchange rate system possible? What might it look like? And I should say again, is it actually possible? Because my point of view, it seems to me there are certain people that are quite happy with the current situation, even if it’s isn’t very good for most other people on the planet.
So please join us for part two of our interview with Heiner Flassbeck on The Real News Network.
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