Jun 13, 2016

Lars Christensen on the Eurozone Crisis and International Monetary Policy

David Beckworth Senior Research Fellow , Lars Christensen

Lars Christensen is an internationally renowned Danish economist who specializes in international finance, emerging markets, and monetary policy. Lars has over 20 years experience in government and banking, and is the founder of Markets and Money Advisory, and is a Senior Fellow at London's Adam Smith Institute. Lars joins David to discuss how poor monetary policy has plagued the Eurozone. Christensen argues that Europe from the beginning was not an optimal region for its members to share a single currency and that the European Central Bank’s decisions have greatly worsened the Eurozone’s economic pain. Lars and David also turn their conversation to the lesser-known “dollar bloc,” the group of countries that either use the U.S. dollar or peg their currencies to the dollar.

David Beckworth: Lars, welcome to the show.

Lars Christensen: Thank you, David.

Beckworth: Lars, I want to begin by asking what is market monetarism? Now, some listeners may know that may seem like a silly question coming from me because I have been labeled a market monetarist, but I want you to spell out for us what is a market monetarist, and how is that different than a regular monetarist?

What is Market Monetarism?

Christensen: I think that one thing is important to people like you and me and some of our friends in the blogosphere, is that we think of money as being at the center of both what is happening on the nominal side of the economy, but also on the real side of the economy in the short-term. Not only will the demand and supply for money determine inflation, nominal demand in the economy, but also being the main cause of fluctuation in economic activity because of recession. And that, of course, we have in common with what's a regular monetarist of the traditional school of Milton Friedman.

But also we emphasize that market is at the core of understanding where the monetary policy are tied. We tend to like newest markets to tell us what is happening with money demand and money supply.

Let me give you an example. If we have more demand for money than we have supply of money, monetary policy is tied. What should happen in a situation where money is tied? Well, in the case of the US, for example, the dollar should strengthen. We know that. Tied monetary policy is also associated with declining stock markets. But the dollar is strengthening, and the stock market decline. If we at the same time see market expectations for inflation decline, it's a pretty good indication that markets are filling up and monetary policy's becoming too tight.

Of course, this is very closely linked with rational expectation of theory that market players, consumers, labor unions, investors, are forward-looking individuals. It also means that we would not only look at what happens, for example, to the money base today, but what is the expectation for the money base tomorrow, and even in 10 years? And that, I think, is a new development relative to, let's say old school monetarism.

Beckworth: Yeah, I think a good example of that would have been in 2008 where we would look back and say, "Look, the break evens, the expected inflation coming from the bond market was screaming, "Fallen inflation ahead." They knew something bad was happening. But the Fed was focused on headline inflation, which was going up. The market side would say, "Hey, look at these market signals in real time," and that may have caused the Fed to have acted differently in 2008.

Christensen: Yes, absolutely. I think 2008, of course, is a very key example that we see something realistic happening just from looking at the market. Market expectation was generally telling us that there was less supply of money than there was demand for money, and that was very visible in the market. And observing that, you could see that monetary conditions very suddenly was the main cause of the Great Recession of 2008.

Beckworth: Yes. It's interesting how this market monetarism has emerged naturally or spontaneously. So, we didn't know each other. I didn't know Scott, but the technology that connected us, blogging, it's been fun to watch and see different groups of people have been able to emerge, to find their tribe, so to speak. So it's been a great journey for me, at least. Many people like you, Scott Sumner, and others.

Let's now move to your areas of expertise. You're an international economist and you're in Europe. So one of the persistent problems it seems over the past few years has been the eurozone crisis. And I think at the heart of it is this question as to whether the eurozone is an optimal currency area. So help us understand. What is this optimal currency area criteria and how does it fit in with the whole eurozone crisis story?

Is the Eurozone an Optimal Currency Area?

Christensen: I think that if we go back to optimal currency area theory, we of course have to go to Robert Mundell, the man behind the thinking of this, of course the Nobel Laureate, who in many ways is said to be the father of the eurozone. It's a bit paradoxical about Mundell is said to be the father of the eurozone. Indeed, he is a big fan of the eurozone, but his theory was also that if you want to build a currency area, the countries participating in the monetary union should be relatively similar. And mostly they should be similar in terms of, you can say, the supply side of the economy. The level of productivity to be more or less the same and very importantly, the shock that hits the economy should be the same.

So, that would also mean, essentially, we're assuming that one size fits all. So if we have a shock to one economy, you should expect the same shock to hit the other economies. And indeed that's not been the case in Europe, where we have hugely divergent economic development in the past six, seven years in Europe. Essentially, if you look at Germany, Germany is out of the crisis, more or less. If you look at real GDP, back on the pre-crisis footing, unemployment down to more or less … and the same goes for all of Europe sometimes. And then on the other hand, we have countries like Greece, Spain, Portugal, which continue to suffer real, real crisis and we have seen in recent months actually that growth is faltering once again, in these countries. So you can say now, in a situation where we still have a significant need for monetary stimulus in countries like Spain or Portugal or Greece.

Whereas Germany might need tighter monetary conditions. I'm not entirely sure exactly they would need. But there is clearly a divergent in what kind of monetary policy they need. And therefore it's pretty obvious. It's not an optimal currency area. That being said, I do also believe that monetary policy mistake adds to the problems, if you don't have optimal currency area. So, I think there are two dimensions in the euro.

One thing is that this is not a optimal currency area. Another thing is simply that monetary policy has been bad. It has been, in fact, horrendously bad. Particularly on the former ECB.

Beckworth: Yeah, as critical as we've been of fed policy in 2008, 2009, they didn't raise interest rates, while the ECB did raise interest rates, which just blows one's mind. And then in 2011, they raised it twice. So the eurozone, correct me if I'm wrong, the eurozone has gone through something as severe as the Great Depression of the 1930s. Is that right?

Christensen: Oh yeah. I think that expressed it very well, saying that this is a longer depression. It's not only longer, it's longer and a deeper depression. If you look at a country like Finland, Finland is doing all the right things, if you listen to the Eurocrats. "Oh, you should do a structural reform. You should have fiscal conservative policy." Things that both you and I normally are supportive of. But would also say that they ... very little in a monetary induced recession. Finland has been following the rules. But beside of that, Finland really haven't seen any growth since 2007. And both real and nominal GDP today is lower than it was in 2007, in Finland.

If we compare the situation in Finland, this crisis is worse than the Great Depression was to Finland, and it could be worse than the rather horrific Nordic banking crisis in '90s where Sweden, Norway, and Finland suffer from deep and prolonged recessions. So Finland is doing quite bad.

Take a country like Italy, essentially they haven't grown for a decade. And Greece, of course, being the worst of them all, really, really, in a massive, not only economic depression but also serious social crisis.

Beckworth: Scott Sumner has said the Achilles heel of the right is monetary policy. And I think, what you've written and what you've said about the eurozone is you see that happening, the rise of nationalism there, to some extent is tied to the effectively tight monetary policy in parts of Europe. Is that right?

Christensen: Yes, I think that it's a bit of a horror show to watch. Particularly for those of us interested in economic history and monetary history. And the way the crisis in Europe plays out, much more so than in the US, it's eerie in the sense how much is similar to what played out during the Great Depression.

So if you go back to the Great Depression, Europe and the US started out similar, with the same shock. But then in '32, '33, we got real bad, a second round effects of a monetary crisis in Europe, particularly with the collapse of ... in Austria and the Austrian, German banking crisis that spread. And at that time, you had a gold standard and across the board in Europe, countries refused to give up the gold standard. It was gold standard mentality as some have suggested to name it. This was at the core of economic policy, you could not leave the gold standard.

And very much the same thing in the euro. The euro is being ... as this sacred thing that dictates everything else, no matter the consequences for the economy. And as that was developing an economic crisis, the social crisis even, we saw a general loss of confidence in democracy across Europe on the 1930s. Of course, the horrible ... in terms of the rise of Hitler, Mussolini in Italy, and so the social ... and the ... consequence of that was very clear.

And I think we are seeing something very, very similar today. We are seeing right now, we're seeing a debate in Britain about Britain leaving the EU. One can be positive or negative on the EU, but ... the debate about ... Brexit, it's not really about economics of being inside or outside of Europe, it actually turned into be a debate about immigration. Should we allow immigration into Britain from countries like Poland, Lithuania, and Romania? Very similar to the debate we have in the US from Donald Trump and his anti-immigration rhetoric. The rise of anti-immigration sentiment, in my view, is very, very closely connected with the fading trust in the global system to solve economic crisis.

Obviously, I believe the crisis have been misdiagnosed by the popular masses, so to speak, being a cry to the democracy rather than a cry of monetary policy. But I think it's very clear that we're seeing now, in countries like Greece, we have seen the rise of Golden Dawn, the neo-nazi party. We have ... in Hungary, also neo-fascist, neo-nazi parties. And recently ... uniformed Nazis coming into the ... Parliament. We have 24 Parliament in Europe ... wearing uniforms in Parliament. And it's just eerie how similar that is to the 1930s.

I have written about the ... the support for Front National in France, the party of Marine Le Pen, the ultra right-wing, anti-immigrant party. If you look at the regionalism, it was very clear that the support for Front National was particularly high in areas of France with high unemployment. So there's a clear connection between lack of economic performance and support for the extremist groups, both on the left and on the right.

So what we're seeing is the second or third round effect of monetary policy area being the rise of nationalism, anti-immigration issues, and indeed, intervention in economic policies. We are also seeing that in the US to some extent, just the wave of increases in minimum wages in states around the US. And cause for ... policy that clearly is damaging long-term economic growth. So the first round of the crisis is the monetary policy failure.

But then, as the crisis has evened and we haven't gotten out of it, in particular because ... has been so meager. Also in the US, you're seeing increased tendency to support parties on the left or the right supporting interventionist economic ideas that then leads to more supply side problems. And I think that's actually where we are now, the suppLy side policies that is a direct consequence of the rise of ... is beginning to have a ... on growth.

Beckworth: If you look back at history, and I went back and was looking at the 1920s, 1930s in Germany, you mentioned Hitler. I was surprised to learn that a number of historians point to the Great Depression for the rise of Adolf Hitler, right? So we typically, the casual interpretation, what went wrong in Germany was hyper inflation. But a more careful look actually points to the Great Depression, which was the other way, it was too tight monetary policy caused by the gold standard. And some of these historians have carefully documented that unemployment went up in Germany during this time, the Great Depression, so did the number of seats in Parliament that the Germans had. And then Hitler's rise to power was closely tied to that. So I think Barry Eichengreen and Peter Temin, I believe, they have a piece where they argue, what would have happened had the gold standard been dropped earlier, if monetary policy had been different during the late '20s, early '30s. And they argue, World War II could have been avoided.

It's hard to know for sure, because it's counterfactual, but they really underscored the importance that the messed up ... gold standard had on the rise of nationalism and ultimately war, in Europe during that time.

Now, I want to go back again to the comments you were making earlier about the eurozone being optimal currency area. Something that's struck me, when the eurozone was first formed, late 1999, the first euro notes were introduced, Germany was growing relatively slow. Ireland on the other hand was just red hot. It was the tiger, it was the high-tech, boom place. So you look at the ECB, it comes into being and now suddenly it's in this dilemma. It has to set monetary policy, and who do you set monetary policy for? Do you set it for Germany, which is growing maybe 2% a year? Or for Ireland, which is growing 10% a year? And no matter what you do, you're going to mess up. If you cater towards Germany, you're going to be way too stimulative for Ireland. If you try to slow Ireland down you're going to crush Germany. And so, you're stuck in a bind. And my question is, what ultimately did they do? Did they do a policy that was more favorable to Germany or do you think the average of the eurozone overall?

Christensen: Let me tell a story. Back in October, I did a lecture at Dallas Federal Reserve, so October 2015. You know my big hero is Milton Friedman, he's one of your big heroes, as well. And Milton Friedman, exactly 10 years prior to my lecture at the Dallas Fed, did a lecture at the Dallas Fed. So I went back and looked at what Milton Friedman was saying at that lecture. Because we were talking about a similar topic, globalization, international economics. And Milton Friedman was actually ... Germany, so this goes back to 2005. And interestingly, Friedman noted in his presentation, the sick child of Europe at that time, being Germany. And Friedman highlighted two facets about Germany. He said, on the one hand, Germany has terrible structural problems, the supply side issues, here. It's labor markets were very high, and generous welfare benefits, very strong union, etc, etc. And then you have a monetary policy problem that really goes back to German reunification, that monetary policy has become too tight in Germany.

So early 2000s, Germany was not growing strongly, it was indeed the sick child of Europe. And while we had these booming economies, we had Spain, we had Italy, we had Portugal and in Greece, growing very strongly. And you can say the monetary policy, in fact, was way too easy for these countries. And they were really booming.

But relative to the eurozone, Germany was the important thing. Germany is the main economy in the eurozone and therefore the very dominant economy terms of how to set monetary parameters, so to speak. So monetary policy has to be developed ... easy during that period, and that was okay for Germany. And Germany indeed recovered, due to this, but also due to structural reforms, I should add, on the later market that has been helpful.

Meanwhile, countries like Spain and Greece are growing very rapidly, too rapidly with visible and fairly strong ... growth, they're visible in relatively ... demand growth. And it was visible in increasing the external balances that's a way to spot where the demand grows fast. So then supply in a small, open economy is visible on the current account situation. So, in theory, it's pretty clear that monetary policy was problem becoming too easy.

I'm tempted to say that there were signs of Austrian school kind of ... in parts of Europe in that period. Indeed, I wrote about it back in 2006 and 7, regarding ... for example, of ... in the politics. And what happened there was very much positive supply shocks, what auditors or economists calls relative inflation. You couldn't see the headline inflation, but because of positive supply shocks, inflation was kept down, but demand was very buoyant. And that created imbalances and then eventually had to unwind.

And as that started, we then were hit by a global, very strong negative ... very visible for the so-called ... Portugal, Italy, Ireland, Greece and Spain. But also for the ..., who of course, at that time was outside of the ... to the euro. It was visible to Romania, Bulgaria that went through this. And contrary to this, of course, the countries in Europe would slow the exchange rate. Sweden for example, Poland, Czech Republic, Hungary, that also was hit by a ... in 2008, but because of monetary policy ... in the monetary policy sovereignty, they control their own monetary policy, were able to allow their currencies to ..., cut interest rates, and allow monetary condition to ease to offset the shock that came from the global crisis.

And I could highlight the performance of, for example, my own country, Denmark, which is not a euro member, but is pegged to the euro. Denmark hasn't seen any economic growth essentially since 2007. There are obviously structural problems but very much so the peg exchange for the ... too tight monetary conditions. If you compare Denmark's neighbor, Sweden, Sweden has fully recovered, indeed is growing fairly strongly now and one could argue that we're getting close to a situation where Sweden ought to tighten monetary conditions, at least if you use the metrics the two of us apply to the nominal GDP growth. Then it's very striking. Of course, the most extreme sense of this is the country I started ... namely, Iceland.

Iceland, of course, have a floating exchange rate. And went into this dramatic banking crisis in 2008, where the entire Icelandic banking system collapsed. The international parts of the banks indeed defaulted and the Icelandic government was very close to sovereign default. The currency then collapsed. The central bank reacted by slashing interest rates, and after a quite deep recession, recovery started in mid-2010 and indeed since then has been very strong. And Iceland is fully recovered from the crisis, indeed. If we look at real GDP, the most successful recovery ... meaning Finland, Denmark, Norway, Sweden, and Iceland. Iceland's indeed the country that have done the best, with just ahead of Sweden.

Guess what? The two floaters among the five, Norway is also a floating country, but Iceland and Finland, which is in the euro and Denmark which is pegged to the euro are still in prolonged crisis. And I think it's very hard to get around that this relative performance of the five Nordic countries is very much a monetary question.

Beckworth: So, just to be clear, you mentioned earlier, your country Denmark has not done well because it pegs to the euro. So, for the listeners who are making the connection, they effectively import the ECBs monetary policy, given there's capital flows in a peg, then they are doing whatever the ECB tells them to do. Now, going back to this point again about the one size fits all monetary policies, prior to 2008, what you're saying is that the periphery, all the countries that are... Spain, Portugal, Italy, Ireland, all those countries in the periphery, they got monetary policy that was too accommodative, too easy for them, while it was more catered towards Germany during the pre-2008 period. But what you're saying is afterwards it flipped the other direction. So, it became effectively too tight for them. And so, either way they can't win. Is that what I'm hearing?

Christensen: Absolutely. And it was working out fairly okay, as long as we had growth. Having ... strong growth, ... in that period didn't create much tension, it didn't create financial disturbances. But on the downside, of course, it becomes much worse because when you have negative growth for prolonged periods, you very fast run into public finance problems. And once you run into public finance problems, you get financial distress.

And what we of course see, is that we have weak nominal demand growth, very weak nominal GDP growth. And as a result of that it's very hard to service your public ..., even when interest rates are very low, as is the case in Europe at the moment. And I think it's very interesting in that regard, to look at the development in public ... across the eurozone countries.

It's often said, it's a misunderstanding, that Greece hasn't done anything on the public finances. Indeed, Greece ... policy very dramatically since 2010. If you look at the accumulated change in the structure of ... the tightening of fiscal policy in Greece, is ... 20% of GDP. This is indeed one of the largest fiscal consolidations in history, in any developed nation in the world.

And despite that, ...  GDP has just continued to rise. And this is because GDP has collapsed. So, it's impossible to do enough fiscal ... to get out of this crisis. I'm not arguing here that this is ... crisis, it's not. The fact that ... fiscal ... itself that is causing the crisis, is the monetary causes of the crisis, but it's impossible to consolidate public finance, when there's no growth in the economy.

And if you listen, and this connection's also interesting, that particularly in 2010, 11, 12, the ECP, to a very large percent, made a ... connection between the willingness to ease monetary policy and political development. So the ECP more less says, unless you elect pro fiscally conservative government in Greece and Italy, we will not need monetary policy in Europe.

And an interesting thing about that is, political event in itself became monetary policy. Let me give you an example. And this very much comes in line with market monetary thinking. I'm ECP and I say, "If you elect a non fiscally conservative Prime Minister in Italy, we will hike interest rate." The market really looks at opinion polls and sees that a non-reformist politician is gaining in the opinion polls, meaning the likelihood of monetary tightening increases. The market will then ... that in already now and therefore effectively tighten monetary policy.

And that's where we have that paradoxical situation. The opinion polls in itself, in that period, 2010, 11, 12, became monetary policy. And I think that is one of the contributions of market monetarism, is how key market expectations are. And we really cannot just sit around and looking at what interest rate the central bank is setting or we have to put an end to the perspective of what is the expectation of future monetary policy conditions. And what quality rule is the given central bank following?

Beckworth: So, you're saying, during that time, the ECB signaled it wouldn't adjust its stance on monetary policy unless fiscally reformed minded individuals were elected. Are you saying bailouts or actual adjusting of interest rates in QE?

Christensen: Well, I think that that is an ... problem is that, you and I very well know the difference between credit policies and monetary policy, because we've read Leland Yeager. So we know the difference between the two. I think that from the onset of this crisis, both in the US and Europe, there has been a huge problem for central banking for most economies, to figure out the difference between monetary policy and credit policy.

Credit policy is just essentially a form of fiscal policy conduct with the help of central banks. It's not about money creation, but it's more about distorting a market and getting subsidies to players in the market. And that would be, for example, a bailout.

Beckworth: So you're speaking of bailouts when you're saying that, when the market was seeing whether the right person's been elected, they're using that to price in whether there'd be a bailout or not. Is that what you're saying?

Christensen: No, it was ... in whether the ECB would ease or tighten monetary policy. It might have had a view also on whether they would pay bailouts or not. ...-

Beckworth: You're saying actual policy setting, too.

Christensen: Yes. Absolutely, ....

Beckworth: That's interesting. I didn't realize that. That's very interesting.

Christensen: Very, very clear in the rhetoric. Scott Sumner at one time, something that inspired me very much, and of course, something that is very visible and such in new book, and ... paradox, is that in the 1930s, politics kept on showing up in the financial picture. And I think I have used that reference quite a bit in regards to what is going on in Europe. Because there was such a politicization of monetary policy. Not only that politicians was pressuring the ECP, but also that the ECP was pressuring politicians. So there was this, I would say, collusion between the Eurocrats and ECP bureaucrats to push for a certain quality agenda.

And some of it was quite irrational to me, very much driven by anger among policy makers in Europe, in Frankfurt, with the ECP and across the EU, that countries like Greece have been let off the hook, historically. Obviously, we know that Greece lied about its statistics. And we have a number of examples of this. And when crisis then hit, there was, now we're going to get them. I would say followed China's behavior on the part of policy makers in Europe and key policy institutions in Europe.

And so, you get very much driven by who is selected. And just take now, if you look at what is happening in Europe, I'm actually worried about this, is that we're seeing in Europe now that because of the refugee crisis, among other things, where Germany has played a role of being relatively liberal on immigration policies and has accepted a lot of Assyrian refugees, we have seen increased support in Germany for the Alternative for Deutschland, which is a populist right-wing party, very strong anti-immigration, but also anti-Europe. And Alternative for Deutschland is now pressuring the center-right government in Germany from the rising immigration policy, but indeed also on the euro and on what is to ... in Germany as letting the sovereign Europeans off the hook.

So what is happening now is that recently, Schäuble, the German ... of finance, from CDU, the center-right governing party in Germany has renewed its attack on the ECP for having ... monetary policies .... So now there's a direct connection with internal political discussion in Europe and Schäuble calls, the German government calls for ending monetary accommodation.

So imagine now, we are beginning to see growth, again in Southern Europe, and this is indeed what we are seeing, as a result of that, we are also beginning to see now the Spanish, the Portuguese, the ... government, all coming out and saying, "You know, our fiscal targets for 2016 and 2017, we are unlikely to meet them." We don't have to run back to the EU and say, "We cannot do that." The EU will then say, "You need to do more fiscal ...." And say, "We cannot do that. We have no support for that in our population." And at the same time, we're going to have a German government that is being pushed by anti-immigration forces to do something to look tough.

And the way they have to look tough is to call for the ECP to end fiscal .... And so you get, the politics of Europe in itself becomes a monetary ....

Beckworth: Yeah. Poisons the monetary policy process.

Christensen: Absolutely. Absolutely. And if we go back to, really go back, and I think something we all missed, is John Stuart Mill talked about the monetary machinery. When the monetary machinery works, nobody talks about it. When it's not working, and it's not working in Europe, then we are seeing all these problems that we are seeing now in Europe.

Beckworth: The challenge is, is that many people don't identify it as a monetary problem. They'll identify it as a structural problem, as an immigrant problem, as a us versus them problem. So it's incumbent upon the leaders and the economists to make sure they get this proper message out.

Now, I want to go back to the point you raised earlier about the ECB. At the end of the day, it all boils down to the eurozone was never well designed from the get-go. And there are a number of economists that said, "Be careful." In fact, Martin Feldstein said in a foreign affairs article, I believe in '98, '97, argued there might be even war in Europe at some point over this. But I think what you argue is that in addition to the fact that the eurozone is not an optimal currency area, you can exacerbate it with bad policy.

So, for example, we talked about the ECB raising interest rates in 2008 and 2011, when they were faced with these inflation shocks. The very same ones that the US saw, the US also saw these concerns. But the US acted differently, maybe not ideal, but they acted differently.

Why is it? What is it about the ECB that caused them to tighten and not the Fed? The Fed, I guess, interpreted these inflation shocks as temporary, as commodity prices. So why does the ECB have such a inflation hawkish bias to it?

ECB as Inflation Hawk

Christensen: Well, I think one of the things is, of course, the ECB is a young institution. It's also an institution where you have surprisingly little monetary insight. That could seem paradoxical for a central bank. But if you look at the ECBs ... you have a lot of people who are essentially politicians rather than monetary economists. Which is in stark contrast to the US.

Another thing I think is very important, is a real strength of the US system, is the diversity of opinions in the US. That you actually have people who would stand up and say, "I am a ... economists. I am a monetarist. I'm a market monetarist. I'm a .... I'm a ...." There is all kinds of ... views. The number of participants in a typical ... meeting is somewhere between 60 and 80 participants. When, not only do they hear from seat members but also look about different experts are brought in. You can say its ... process is there, but after all there is some learning in the Fed.

Both you and I have been very critical about how the Fed has been conducting monetary policy, and it's most definitely not been perfect. But it has been gradually inching in the right direction, under the leadership of Ben Bernanke. I would say we have taken a turn for the worst, since Janet Yellen became chair of the Fed.

But you can't say that for the ECP. There seems to be no learning. And there seems to be a lot of the fact that Europe is not a country. The fact that it's not so that when Robert Kaplan, the president of the Dallas Fed, vote on the FOMC, he is not sitting and looking at Texas and saying, "How well is Texas doing? I ought to vote for Texas." He is looking at the entire economy, in the same way as Jeff Lacker, from Richmond's Fed. He's not sitting and looking at the Richmond area and saying, "Oh Richmond is doing bad," or, "Richmond is doing good." No, they tend to look at the entire US economy.

While in the eurozone, it's actually very much driven by a national interest. And then it's also driven by a political positioning that we have to show that we are strong, independent nations. We will not cave in to political pressures. And the paradox is here, that the ECP have caved in to all kind of political pressures. They have got all kind of horrible ... policies they have participated in, distorting ones market and participating in all kinds of actions that increase ....

The only thing they haven't done is done real monetary... So they've done a lot of credit policy, but what would they expect? It's very much driven by political rather than monetary economical considerations.

Beckworth: That's interesting because if you look at the German economy, it did relatively well, after the Great Recession bottomed out. So it's unemployment rate fell relatively low, it grew rapidly. So there was no sense of urgency on the German's part to engage in something like QE or any kind of stimulus program. Whereas, in the rest of the eurozone, on the periphery, definitely there was the need.

So, it is interesting, you mentioned each country looks out for their own interest more so than in the regional Fed presidents do in the US. And so, had Germany been more like Robert Kaplan or Lacker, they would have been pushing for QE sooner, I imagine. They definitely would have been pushing for the interest rate hikes in 2011.

Christensen: Maybe .... Good examples in that direction. But yeah, they ... the case. And I do think there is a parallel to the Great Depression and the actions of the Federal Reserve System, because similarly, during the Great Depression, the Fed was a very young central bank. Correct me if I'm wrong, the Fed was established in 1913. And so, it was quite young when the crisis hit. And that time, we were very much a regionally based central bank, much more so than today. Today the Fed regions is more about maintaining jobs for certain people. But it is one central bank, thinking towards... in one way. At least it comes to a collective wisdom of some kind.

Just imagine being a central bank over in Greece. You're 30% unemployment, a seven year long depression, continuous deflation, ... pressures. And you can see that the government's continuing to struggle with public finance problems. So even though they're trying to fix the problem systematically, it's just getting worse and worse. And you have the rise of neo-nazism and you have now the governing parties ... that have been in power for more than a year, is indeed a ... party. And you're sitting there and you can see at the core, you know that the country needs dramatic monetary easing.

And then you go to Germany and say, "What are you talking about? The economy's doing fine. Growth is strong. The only complaint we have is pension savings interest rates are too low, so we don't get any return on our pension savings." Typical German debate. Interest rates are too low, so we don't have any returns on our pension savings, is a complete focused debate, of course. But this you'll see ....

And there is undoubtedly also, so cultural issues in place here. There is a perception in Northern Europe that the Southern Europeans are lazy and they're lying and they're corrupt and they're not doing their job properly. And here, I think the example of Finland is very good. When I used to be in Danske Bank, which of course is one of the largest lenders in the Nordic region, I spent quite a bit of time in Finland. Go back to 2010, if you were in Finland and talking to Finns, at that time, Finland was just in the midst of the ... of everybody else and not doing particularly worse. Finland didn't have massive public finance problems because Finland, going into it had quite healthy public finances. So the Finns didn't feel particularly hard hit by the crisis, all of them compared to anybody else. But the Finns are very eager to tell everybody that those lazy Southern Europeans, they should just do as we did in the 1990s, do fiscal reform, tighten the belt, do proper structural reforms.

And I remember telling a Finnish client and Finnish colleagues back then, you didn't really do a lot of fiscal reform, you didn't really do a lot of structural reform. What happened in Finland in the '90s was a massive devaluation of the Finnish market ... and the euro. So you had monetary ... to take you out of the crisis. And you actually still have very substantial structural problems, particularly in the .... And people know that in Finland. And now you actually see that Finland is beginning to look like a Southern European country, seven years with no growth. And now it's beginning to hurt. And Finland, of course, used to be a ... rated nation, but has been downgraded because of ... public finance problems.

So you have these cultural things with the Finns. And the average Finn would say, "Oh, these horrible Southern Europeans are not doing anything." And I'm sure if you asked an average European or average Northern European, a Dane, a Swede, a Finn, a Dutch or German, "What do you think about Greece fiscal policy?" "They're not going anything." While, in fact, Greece has tightened fiscal policy very, very dramatically. They just haven't got the right outcome.

Beckworth: Well, that attitude, those cultural differences suggest to me that this currency union's days are numbered. To really make it successful, you're going to have to get big fiscal transfers, increase the ..., and what you're suggesting is that's not very likely going to happen, given these attitudes.

But let's move on in the time we have left here. We're going to go from one currency area that's not optimal, the eurozone, to another one that you've written about and spoke about many times. And that is the dollar bloc. So the dollar bloc would be all those countries that either use the dollar explicitly, or they peg to it, one way or the other. And the dollar bloc is the biggest currency union of sorts, in the world. And you've written about it, that it's been destabilizing lately. So tell us about that.

Recent Destabilization in the Dollar Bloc

Christensen: Yeah. I think what's interesting is that if you look at monetary development over time, it's really been the gradual success of Milton Friedman, but then Friedman of course would have added support or floating exchange rate, very skeptical about peg exchange rate. And Friedman's success in freeing up currencies really started in 1971 when President Nixon closed the so-called gold window and effectively ended the Bretton Woods' system and of course, that started a period of a peg exchange rate which was falling apart at that time, essentially global peg exchange rate regime.

Then in Europe we have tried to put together peg exchange rate regimes. We first had the so-called ... and then we had the European exchange rate mechanism and now of course, we have the euro. But during that period, a number of countries have fallen out of that, are now floating currencies, Switzerland, Sweden, Norway, Poland, so forth, are floating exchange rate.

And then, if you continue that in 1997, we had the Asian crisis, with countries like Malaysia, Thailand, South Korea giving up their peg to the dollar, essentially leaving the dollar bloc. So, we had this ... process moving from one unified monetary policy globally, essentially, in ..., to more and more countries having floating exchange rates.

And I think ... very positive tendency, but the problem is it's not happening in .... But there has been, as you said, the dollar bloc still exists. Of course, the major players in the dollar bloc is China and the US. The US of course, being the dollar creator. But essentially, for a very long time, the Chinese ... pegged to the dollar. Of course, that peg has been loosened since 2005. We're actually ... towards the strengthening of the renminbi. And then recently it saw weakening of the renminbi against the dollar. But still, the China's monetary policy has been shattering the dollar.

So that's been quite a strong link between the dollar and the renminbi. So the two largest countries in the world essentially is following the same monetary policy patterns. So when the US decides a monetary policy, China ... policies ... that. And given China is doing that is also having dramatic impact on, for example, commodity prices. And then if you go to another member of that dollar bloc, looking at all of the ... states, largest among them, of course, Saudi Arabia. Saudi Arabia had a peg to the dollar since 1986. So when China is tightening monetary policy and the US is tightening monetary policy, the dollar is strengthening, but so is the Saudi Riyal. For Saudi Arabia the oil price is also declining, so ... a double whammy.

Do China and the US together determining monetary policy for Saudi Arabia and of course, that is creating a lot of tension for Saudi Arabia. The same goes for Hong Kong, where we have seen the import of monetary conditions. The same goes for a number of emerging markets, ... to be Angola. And what we have seen in the past two to three years is a gradual move away from this. We have seen, particularly among the commodity exporters, countries like Angola as I mentioned, but also Azerbaijan, Kazakhstan, that used to have their currencies pegged to the dollar, recently have been forced to give up the peg, because they have imported China monetary conditions ever since the first ... rate hike now nearly two years ago when the dollar started .... So a country like Kazakhstan or Azerbaijan was importing China monetary conditions, but since they were exporting oil, which was plummeting, they really needed an easier monetary policy rather than China monetary policy. And here, of course, the power of the eurozone is very clear.

We have a situation where in the eurozone, we have Germany needing tighter monetary conditions only, it's not easier. And then you have Greece on the other hand. ... taking the dollar bloc, the US needing at least to ... normalize monetary conditions. While a country like Saudi Arabia would need easier monetary conditions. But because they're in the same monetary union, essentially, that's not possible and creates then imbalances in the economic development. And I think that that is creating these tensions in the dollar bloc and we have seen that. And I do think that it's curated where more and more countries gradually would let go of their close relationship to the dollar. ....

Beckworth: So more countries are slowly peeling off the dollar bloc. But there's still enough to make a difference. It's sobering if you're a Fed official, when you sit down and you vote on US monetary policy to think, to ponder, that your decision is not just effecting the US, and that is their mandate, they're not supposed to think about China or Saudi Arabia. But really, they're setting monetary policy for a good portion of the world's economy. It's kind of a mind-blowing thought, right? The Fed makes a decision, it affects some poor person in Saudi Arabia or in China or Angola, as you mentioned. And what's-

Christensen: Yeah. And-

Beckworth: Go ahead.

Christensen: Yeah, the interesting thing in that is that not only for these countries that are directly pegged to the dollar, but indeed for countries ... monetary policy maturity, where you don't have a lot of maturity policy positions, where you have policy makers who essentially conduct monetary policies by letting their currency shadow the dollar.

So, it's like, "Oh, our currency is weakening." ... the dollar, then monetary policy has become too easy. So they use that as their angle so you can say there are peripheral dollar bloc countries. And that is a very, very large part of the ... country. And then, of course-

Beckworth: The dirty peggers. They loosely follow-

Christensen: Yeah, exactly. The dirty peggers and there, I think, commodity prices also plays a huge role. We have had a discussion, if you follow the debate about what happened with oil prices, and both you and I have written about it, ... thinks that the reasons given for the dropping oil prices is all wrong. It's not about supply side issues, it's not about Saudi Arabia wanting oil prices to be low or sanctions being lifted against ....

No. This is about the dollar bloc tightening monetary policy. If you look at the global dollar nominal GDP, it has declined dramatically in the past two years. In fact, if you look at nominal GDP on a global basis in dollar terms, the contraction is more or less in the same scale as 2008. So it's no surprise that commodity prices are declining. But if you're a commodity exporting country, which is shattering the dollar, you are getting that right in the nose. And of course, that is why a country like Pakistan eventually has to throw in the towel and let their currency float. Interestingly enough, ...-

Beckworth: The last few minutes, I'm going to suggest a scenario to you. And you just tell me what you think, briefly, we only got a few minutes left. So my view has been that since mid-2014, when the Fed started talking up interest rates, that cause the dollar to depreciate, but the dollar depreciated 20% since then, and it's come down a little bit, when the Fed has pulled back. But the dollar itself, ... dollar is about 20%, which has pulled up all these either explicit peggers or dirty peggers, as you mentioned. And that is causing global demand to slow down, because they've imported this tightening. And that is what you've suggested is effecting at least some part of the price for oil.

Now, Ben Bernanke on his blog recently estimated that about 40 to 45% of decline of oil prices since mid-2014 can be tied to weakening global aggregate demand. So the story you're telling me, just to be clear, is that this is tied to the Feds tightening and it's effect via the dollar bloc countries. Is that right?

Christensen: Oh yeah. I very strongly think so, that a very large part of the time ... global commodity prices is effectively caused by the tightening of monetary conditions and dollar bloc. And now we, of course, going full circle, what is market monetarism? The commodity market is telling us monetary conditions globally through what, I believe you invented the term, global monetary super powers, the Federal Reserve and the People's Bank of China, they are tightening monetary conditions and market prices. Price of oil is sitting on that. The dollar is sitting on that. The ... is sitting on that. Market expectations for inflation is sitting on that.

And that is why we have so meager growth in the US in the first quarter. It seems like Q2 is slightly better. But I continue to think it's very odd that the Fed still talks about essentially hiking interest rates, in a situation where albeit monetary conditions is tightening rather than easing. And we are having nominal demand growth. And I would say, presently, that the Fed should just focus on nominal GDP growth from ... level.

And this is indeed what Ben Bernanke said was doing, from essentially 2010 and on, was probably to look at that very nice 4% ... growth in nominal GDP, we have been now consistently for a year, so falling below that. And I think that there has been a change in monetary policy ... that direction.

Beckworth: Well, Lars, we are out of time. We thank you so much for being on the show. Our guest today has been Lars Christensen. Lars, thank you.

Christensen: Thank you.

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