Re: General Theory Seminar

["ÁÎ×Ó¹â HenryC.K.Liu ¹ù¤l¥ú" <hliu@xxxxxxxxxxxxxx>]

Because of the so-called linked exchange rate mechanism adopted by Hong Kong,
which is neither a full fledge currency board nor a tightly fixed currency peg.
Hong Kong is at best a unique situation that proves only that a government can
talk out of both sides of its mouth.  The HK government basically used its sizable
reserves to intervene in both the equity and property markets and kept the bubble
from total collapse.  The penalty is that HK will be among the last in the region
to recover.

The HK$ has been pegged to the US$ at a rate of 7.8 to 1 since 1983.  The peg was
introduced, more for political reasons, with a 50% devaluation, from 5 to 7.8 to
the US$.  Since the Plaza Accord of 1985, when the G7 decided to push the US$ down
in relation to the Japanese yen and the German mark, the US$ dropped from 250 yens
to a dollar to 100 yens to a dollar.  That made the HK$ undervalue in trade terms
from 1985 to 1995, causing negative interest rates in HK and high inflation, but
an export boom.  In those days, a depositor had to pay the bank for keeping his
HK$ in the bank while it was illegal to hold US$ in HK banks, but not off shore
banks.  HK asset value bubbled until the Asian crises of 1997.

After July 2, 1997, starting with the collapse of the Thai currency,  the HK$
became overvalued in regional terms when the yen dropped to 147 to a dollar in
August 1998.  Since the HK$ is fixed to the US$, HK interest rate went up (HIBOR,
interbank rate normally 9 to 9%, reached 280% on October 23, 1997) when the market
sold HK$, and HK asset value dropped to reflect the over valued HK$.  (from a HSI
high of 16,673 on August 7 1997 to 6600 on August 14 1998).  It cause the Dow to
crash, the first time in history that an Asian market affect the DOW.  Greenspan
lowered fed funds rate immediately.
Of course all values are judgmental. When the HK economy contracted because of a
sudden and massive outflow of funds, the market concluded that the HK$ was
overvalued and the pain caused by the currency overvaluation, (interest rate rise
and asset deflation, economic downturn etc.,) would cause the HK$ to fall
(devaluation).
The HK$ was attacked in anticipation of its eventual devaluation. It is still
going on erratically and will continue until the HK$ falls in line in with HK's
economic reality. A slowing economy requires low interest rates which in turn
requires a cheap currency.  When HK insists on a high currency in the face of
economic contraction, it is depriving itself of corrective monetary measures.

Warren, you may be right that a liquidity trap had not been seen in the time of
Keynes because of the Gold Standard, although it would be inaccurate to say all
the currencies were convertible.  In fact, they were not convertible freely except
with gold.
On the other hand, counterfactuals are good only for amusement.  In 1929, even it
trade did not collapse, would the crash recover quickly?  I doubt it, something
else would have been the culprit.

I read you paper 'Exchange Rate Policy and Full Employment' and find your ideas
very applicable.

Henry C.K. Liu

Warren Mosler wrote:

> And recognize that with a fixed exchange rate the nominal rate of
> interest is unlikely to fall to that which it is convertible into, as then
> the holders of the currency could eliminate the risk of devaluation by
> converting, with little or no loss of interest.  So in HK, for example,
> if the rate of interest in the $HK fell to that of the $US, it would
> be expected that holders of $HK would convert to $US at the monetary
> authority and eliminate any risk of devaluation without loss of interest.
> The current interest rate differential between $HK and $US is the risk
> premium, the risk being devaluation.
>
> In Japan, on the other hand, there is no convertibility, so the rate can
> be 0, as it is, without incident.
>
> So perhaps a liquidity trap had not been seen in the time of Keynes because
> all the currencies were convertible?
>
> http://www.warrenmosler.com
> see  'Exchange Rate Policy and Full Employment'
>
> "J. Barkley Rosser, Jr." wrote:
>
> > Paul,
> >      Certainly on p. 202 Keynes lays out a general "squares"
> > argument.  But on pp. 207-208 he talks about exceptional
> > situations.  Thus (GT p. 207):
> >      "There is the possibility, for the reasons discussed above,
> > that after a rate of interest has fallen to a certain level, liquidity-
> > preference may become virtually absolute in the sense that
> > almost everyone prefers cash to holding a debt which yields so
> > low a rate of interest.  In this event the monetary authority
> > would have lost effective control over the rate of interest."
> >        He then declares that he has never actually seen such a
> > case.  But, he later says that he has seen the opposite int he
> > "financial crisis of liquidation" in the US in 1932, "when scarcely
> > anyone could be induced to part with holdings of money on any
> > reasonable terms" (pp. 207-208).
> >       Of course, mathematically it is possible to have the square
> > root law and have a "liquidity trap" as long as there is a positive
> > constant term so that the hypebola asymptotes to a positive
> > interest rate.
> > Barkley Rosser
> > -----Original Message-----
> > From: Paul Davidson <pdavidson@xxxxxxx>
> > To: POST-KEYNESIAN THOUGHT <pkt@xxxxxxxxxxxxxxxx>
> > Date: Monday, February 07, 2000 10:42 AM
> > Subject: Re: General Theory Seminar
> >
> > >At 05:15 PM 02/05/2000 -0500, Barkley wrote:
> > >>       Given the lively discussion that has come out of
> > >>Chap. 12, I would like to see bringing in some of the
> > >>material from the nearby Chapters as well, such as
> > >>11, and 13-15.  One question:  is a crash best
> > >>characterized as a surge of liquidity preference?
> > >>Is a liquidity trap related to a crash, perhaps the result
> > >>of one as in Japan?
> > >
> > >
> > >the concept of a liquidity trap, i.e., a perfectly elastic
> > >[horizontal]  segment of the speculative demand for money is a not a Keynes
> > >concept--- as I ave pointed out at various times in the literature. On page
> > >202 of the GT, Keynes points out that the speculative demand for money
> > >follows a square root rule -- and is therefore a rectangular hyperbola --
> > >which by definition never has a truly horizontal segment.  The liquidity
> > >trap or what Milton Friedman calls "absolute liquidity preference" is
> > >a  delusion -- not required (i.e., not a necessary condition) for Keynes's
> > >liquidity preference analysis of involuntary unemployment equilibrium .
> > >
> > >moreover, as Keynes argued in his 1937 EJ  finance motive addendum to his
> > >liquidity preference theory , an increased in planned spending  (an hence a
> > >decrease in unemployment) can be held up  by a lack of sufficient
> > >additional liquidity added to the system.  So it is not a "surge of
> > >liquidity preference" in the sense of  a "surge" in bear holding position
> > >that may prevent employment expansion, Barkley {See  chapter 8 in my POST
> > >KEYNESIAN MACROECONOMIC THEORY book]
> > >
> > >>       BTW, I would note that we now have a rather complicated
> > >>and nuanced collection of actors in financial markets, not
> > >>just the old fundamentalists and chartists, but true-false
> > >>switchers, insiders and outsiders, noise traders and quiet
> > >>traders, informed and uninformed, and others, with few of
> > >>these distinctions necessarily correlating with the others.
> > >
> > >But that is just Alan's pragmatic and realistic economists trying to
> > >categorize each player as a separate entity . Of course if there are a
> > >million players there may be a million differing reasons for each players
> > >action.  Just as there are millions of humans -- most of whom do not look
> > >very much alike.  We do not separate hunmans by say their height  or
> > >weight,  etc-- when trying to explain market behavior. Taxonomy requires
> > >that we categorize by the fewest necessary and sufficient properties and/
> > >or functions into homogeneous groups -- despite individual differences
> > >among members of the group. [ See , for example, page 33 of my PKMT book]
> > >
> > >Paul
> > >Paul Davidson
> > >Holly Chair of Excellence in Political Economy
> > >Editor, JOURNAL OF POST KEYNESIAN ECONOMICS [JPKE]
> > >Economics Department -- 523 SMC
> > >University of Tennessee
> > >Knoxville, Tennessee 37996-0550
> > >email: Pdavidson@xxxxxxx;   phone: (865)974-4221;    fax: (865) 974-4601
> > >http://econ.bus.utk.edu/Davidson.html
> > >
> > >