Re: floating vs fixed fx

[pdavidso <pdavidso@xxxxxxx>]

WARREN:

I think part of our communication problem is that you do not fully understand
the implcation of not having the Marshall-Lerner condition apply for a country
with a flexible exchange rate -- when that country is having a problem with
its balance of payments.

Suppose a nation is running an import surplus which you maintain is a good
thing since the nation's residents are receiving real goods (imports) in
excess of the cost of real goods (exports) it is selling to foreigners.
In a flexible exchange rate system, this will cause a tendency for this
importing nation to have its exchange rate to decline. If the Marshall -
Lerner condition does not hold, then the effect will be:

(1) EXPORTS WILL BECOME CHEAPER TO FOREIGNERS SO THAT REAL EXPORT GOODS (IN
TERMS OF PHYSICAL VOLUME) WILL INCREASE BUT--- the actual revenue received by
the exporters WILL DECLINE,

AND/OR

(2) REAL IMPORTS WILL BECOME MORE EXPENSIVE TO DOMESTIC RESIDENTS AND
THEREFORE REAL IMPORT GOODS (IN TERMS OF PHYSICAL VOLUME) WILL DECLINE BUT---
DOMESTIC RESIDENTS WILL PAY OUT MORE OF THEIR INCOME FOR FEWER REAL IMPORTS!!

THus, in your own terms of imports being a good thing for the nation and
exports being a real cost for the nation,  a flexible exchange rate in the
absence of the Marshall -Lerner condition is like to reduces the good (import
volume) of the nation and/or increasing the costs (exports).

And with a flexible exchange rate as long as the Marshall-Lerner condition
does not apply, this will force the nation's exchange rate to decline further
-- increasing the real costs (exports) and/or reducing the benefits (imports)
until the either the Marshall Lerner condition comes into affect -ending this
process of fuirther nation impoverishment -- or the nation's economy becomes
so impoverished it collapses.

And as long as the Marshall - Lerner condition does not apply, the exchange
rate will continue to decline, and therefore (1) and (2) above will continue
to reduce the good for the nation and increase the costs.

So a flexible exchange rate in this case reduces the good thing (i.e., the
volume of imports) for the nation and increases the costs (exports) -- where
good thing and costs are defined by you!!

  So what is so desireable about a flexible exchange rate? Especially when the
empirical evidence is that the Marshall -Lerner condition does not apply for
most nations in the real world??


If you want to read about the Marshall -Lerner condition see pages 215-219 of
my book POST KEYNESIAN MACROECONOMIC THEORY (1994)


If you want to read about the Marshall -Lerner condition see pages 215-219 of
my book POST KEYNESIAN MACROECONOMIC THEORY (1994)


Scondly, Keynes analysis was not for the Gold standard or even rigidly fixed
exchange rates. Keynes's analysis permitted exchange rates to change --if the
change reflected changes in the relative real wage (real costs of production)
between the trading partners.

Regarding advocates for flexible exchange rates -- I think you will agree that
Milton Friedman is one of the most articulate proponent of flexible exchange
rates. Yet in a debate with me in the JOURNAL OF POLITICAL ECONOMY (1972) --
later (1974) published as a book entitled MILTON FRIEDMAN'S MONETARY
FRAMEWORK: A DEBATE WITH HIS CRITICS (University of Chicago Press) -- Friedman
argued that flexible exchange rates are desireable -- as ling as the exchange
rates are stable over time -- for "violent instability in terms of a specific
money would reduce the usefulness of that money".

So flexible exchange rates are OK as long as they do not flex too much!!

Paul





Scondly, Keynes analysis was not for the Gold standard or even rigidly fixed
exchange rates. Keynes's analysis permitted exchange rates to change --if the
change reflected changes in the relative real wage (real costs of production)
between the trading partners.

Regarding advocates for flexible exchange rates -- I think you will agree that
Milton Friedman is one of the most articulate proponent of flexible exchange
rates. Yet in a debate with me in the JOURNAL OF POLITICAL ECONOMY (1972) --





The Marhall Lerner condition does not hold as long as the  price elasticity of
the demand for exports plus the price elasticity of the demand for importS IS
LE



>===== Original Message From wmosler@xxxxxxxxxx =====
>> Warren we seem to be going around in circles on this -- without much
>> communication between us.  Perhaps the easiest answer is to go to your
>> claim:
>>
>> >Yes, but those aren't 'forces' under floating fx.  The currency adjusts
>> >continuously so that markets are continuously at sustainable
>> 'indifference
>> >levels' regarding the trade picture.
>>
>> The idea that a currency adjusts continuously at sustainable levels
>> implicitly
>> assumes
>>
>> (1) a large Marshall-Lerner condition value so that the imbalance
>> between
>> value of imports and exports purchased and sold adjusts with a moinor
>> change
>> in price --AND/OR
>
>why does the trade balance have to adjust?  Why do you term it an
>'imbalance?'  why, for example, can't non residents accumulate $US
>financial assets indefinately?  Why is this accumulation considered an
>imbalance???  Same with Australia.  Why can't they run a trade deficit as
>long as the rest of the world wants to acculate $A financial assets?
>
>I suggest your terminology including 'imbalance' and 'adjust' originally
>came from fixed exchange rate regimes, where a negative trade gap meant a
>drain on fx reserves, etc. and the condition was therefore unsustainable.
>
>>
>> (2) a non-profit market maker in foreign exchange who has a virtually
>> unlimited amount (RESERVES) of both currencies (or can print , borrow,
>> swap,
>> etc.) as necessary to get as much of the currency falling in value to
>> keep the
>> market orderly!!
>
>Different point.  Yes, speculators can be disruptive, but all the
>disruption I recall has been in regard to fixed exchange rates of one sort
>or another.
>
>>
>> Now even financial markets get disorderly when there are pressures on
>> the
>> prices of certain assets traded in the market --what I have called "fast
>> exit
>> strategies" in my book FINANCIAL MARKETS, MONEY AND THE RFEAL WORLD --
>> and
>> sometimes the insitutional market maker  -- (e.g., specialists on the
>> NYSE,
>> bond dealerS in NYC in US treasuries ) can (will) not make the market --
>>
>> thereby requiring the central bank to help the private market maker
>> maintain
>> an orderly market.
>
>Yes, there can be liquidity crisis in any non govt market.  Sometimes it's
>a matter of public policy to intervene, sometimes not.  Markets function
>only within institutional structure.  This included everything from
>enforcable contract law to environmental standards, to limited trading
>hours.
>
>
>>
>> for a real world example, see page 111 of my book FINANCIAL MARKETS,
>> MONEY AND
>> THE REAL WORLD where the Federal Reserve snapped up all government bonds
>>
>> offerwd by dealers -BY BUYING  $70.2 billion on Thursday September 13,
>> 2001
>> and  the Fed bought an additional record $81.25 billion of government
>> securities on Friday September 14, 2001.
>>
>> The Fed dealt not only with the usual bond dealers who make the market
>> -- but
>> according to the WALL STREET JOURNAL also with investment bankers such
>> as
>> Goldman Sachs .  the JOURNAL reports that Goldman Sachs loaded with
>> liquidity
>> due to Fed activities, phoned the chief investment officer of a large
>> mtual
>> fund group -- just before the NYSE opened the following monday (it had
>> been
>> closed since 9/11/01) to tell him that Goldman Sachs was willing to buy
>> any
>> stocks the mutual fund managers wanted to sell.
>
>Not at any price, but at severe discounts to insure a profit for goldman.
>pure greed.  All the fed did was to assure the dealers that there would be
>funding available at normal terms.  Nothing 'bad' would have happened if
>they had instead decided to close markets an extra day to get the systems
>up, etc.
>
>>
>> Is this how you envision a freely flexible price financial market
>> "adjusting
>> continuously so that markets are continuously at sustainable
>> 'indifference
>> >levels'"?
>
>It's already happening.  We already have floating fx that adjusts
>continuously.  There haven't been any fx 'crisis' with floating fx regimes
>that I can recall?  And we and any other nation can today sustain full
>employment domestically without 'international support' of any kind.
>And imports are a benefit and exports a cost, etc.
>
>>
>> Nor do I think that I have to remind you that in the Long Term Capital
>> Management fiasco, it took intervention by the NY Federal Reserve to
>> "encourage" LTCM creditors to not to pressure the LTCM for payment --
>> and
>> instead the creditors merely took over pumping in my more funds to
>> prevent a
>> massive liquiditation crisis?
>
>Sort of.  There was no 'pumping in' funds per se.  The dealers were
>already financing the positions.  They decided to keep them rather than
>liquidate them.  So what?
>
>In 1987 the Japan's stock market dropped 75% in one large trade in HK.
>This happens all the time.  None of it prevents govt spending for full
>employment with floating fx.
>
>>
>> "Adjusting continously" --AND ORDERLY -- even in the classical model
>> requires
>> a Walrasian auctioneer who takes all buy and sell bids BEFORE any
>> transaction
>> is consumated -- and if the trade price turns out (from hindsight) not
>> to be
>> the NEW EQUILIBRIUM price (where demand and supply flows are matched and
>> so
>> the market remains orderly), then the theory REQUIRES RECONTRACT WITHOUT
>>
>> PENALTY BETWEEN THE PARTIES TO THE "false trade".ie., the trade at the
>> nonequilibrium price.
>
>What's the practical consequence of that truism?  Definition of 'orderly?'
>So markets gap?  They do it all the time.
>
>Point is, these can be big problems in fixed fx regimes- crazy interest
>rate moves, unemployment, etc.  floating fx regimes can sustain full
>employment throughout, and interest rates remain where the cb sets them.
>
>
>> >
>> >Not so with fixed fx, as reserves could be flowing out, threatening a
>> >financial 'crisis,' etc.  No such thing under floating fx.
>>
>> here again this is not correct-- for an exchange market to remain
>> orderly , in
>> the absence of the central bank interventions, there must be private
>> market
>> makers who have inventories (reserves) of both currencies -- or access
>> to
>> additional reserves on demand.
>
>first, you are merely defining 'orderly.'  Second, you are mixing up the
>notion of reserves.  with floating fx govt reserves are not a factor.
>Full employment and maxing terms of trade can be carried on at all times.
>not so with fixed fx.
>
>>
>> THere is an empirical study done by S. Weintraub (of the University of
>> Texas )
>> in the late 1970s when after Nixon abandoned the fixed bretton woods
>> system,
>> thast private market makers accumuloated inventories of foreign reserves
>> at a
>> greater rate than central bankers had done so before the end of Bretton
>> Woods.
>
>so???
>
>warren
>
>>
>> Paul
>> >
>> >
>> >> With floating fx,
>> >> >the balance of payments is what it is, etc.
>> >>
>> >> The actual accounting value of the balance of payments is whatever it
>> is
>> >> in
>> >> any period whether you have fixed or flexible exchange rates --
>> >> Equilibrium is
>> >> a concept Marshall borrowed from physics and requires a  balancing of
>> >> opposing
>> >> forces!!
>> >
>> >As above!  With fixed fx, reserve positions can be in or out of equil,
>> and
>> >imply future events, some climactic.  Not so with floating fx, as there
>> >are no reserve positions, making that point moot.
>> >
>> >
>> >>
>> >> No Keynes argued for a fixed exchange rate as a stabilizing force
>> >> permiting
>> >> entrepeneurs to make long range investment plans -- but the exchange
>> >> rates
>> >> were not to be fixed in perpetuity, but they could change under
>> >> conditions,
>> >> well specified in advance,  -- allowing people to make long term
>> >> international
>> >> contractual commitments in a world of (nonergodic)uncertainty -- a
>> >> necessary
>> >> aid for entrepreneurs to be able to attempt to balance cash flows
>> over
>> >> time--
>> >> and therefore avoid (a) a liquidity problem, and ultimately (b)
>> >> bankrupcy.
>> >
>> >Understood what he was arguing in favor of.  this is about the system
>> he
>> >descibed.
>> >
>> >
>> >>
>> >> Flexible exchange rates -- make it impossible to evaluate long term
>> >> international investment projects (for example) or even domestic in
>> >> vestments
>> >> aimed for export markets  -- because markets to hedge against
>> exchange
>> >> rate
>> >> fluctuations more than 180 days out rarely if ever exist .
>> >
>> >They change the nature of international investing for sure.  Companies
>> do
>> >it in local currency to be better hedged.  They borrow pesos to make
>> peso
>> >investments, for example, if peso profits are to be made, to not take
>> >currency risk.  Our fund does that continuously.  We borrow yen to make
>> >yen investments.  The profit margin is in yen.  There is no fx risk,
>> etc.
>> >
>> >>
>> >> Yet investment project profitability expectations requires one to
>> >> calculate
>> >> the flow of future quasi-rents over long-lived capital goods relative
>> to
>> >> the
>> >> money costs of these goods (when both quaasi rents and money costs
>> are
>> >> specified in terms of the same currency.)
>> >
>> >Yes, and it can and is all done in the local currency, unless companies
>> >want to take fx risk, which many do, for speculative motives.
>> >
>> > >
>> >> >
>> >> >> >  While mainstream doesn't know this specifically, they
>> >> >> >none the less aren't technically wrong in dismissing some of
>> Keynes
>> >> as
>> >> >> >inapplicable today (though I can do the same for their
>> ramblings).
>> >> >>
>> >> >> Not true! The belief
>> >> >
>> >> >mine's not a 'belief.'  just statements of accounting facts.
>> >>
>> >>
>> >> Accountin g facts are merely ways of keeping score and have nothing
>> to
>> >> do with
>> >> equilib rium in blanace of payments or the viability of industry,
>> >> nations,
>> >> etc.
>> >
>> >agreed!
>> >
>> >
>> >>
>> >> jusdt like a balance sheet is merely a way of keeping score-- and
>> even
>> >> DOA
>> >> entreprises have balance shhets!!
>> >>
>> >> Accounting facts are meaningless !!
>> >
>> >????  Accounting identities 'tell' us the fed is the single supplier of
>> >net reserves, and therefore price setter of the interest rate, etc.
>> >That has 'meaning?'  Or maybe I'm using the wrong term?
>> >
>> > >
>> >> > in a flexible exchange rate system which you
>> >> >> apparently
>> >> >> share with mainstream economists
>> >
>> >many of them seem to lean towards fixed, flex only when fixed break
>> down.
>> >
>> >those that like them often do for the 'wrong' reasons and continue to
>> >profess a budget constraint.
>> >
>> >
>> >requires the assumption of a very
>> >> large
>> >> >>
>> >> >> Marshall-Lerner condition.
>> >> >
>> >> >I never make those assumptions.  They don't matter to what I'm
>> saying
>> >> >either way- whether they hold or not makes no difference.
>> >>
>> >> Well if the Marshall Lerner conditions do not hold tghen ,by
>> definition,
>> >>
>> >> flexible exchange rares are going to make blanace of payments
>> problems
>> >> worse
>> >
>> >define 'worse'- more net imports, I presume, which under flex fx are a
>> >benefit, not a problem.
>> >
>> >> -- no matter what the "accounting facts" are at any point of calendar
>> >> time!!
>> >>
>> >
>> >true- imports are a benefit.
>> >
>> >> So if you are advocating flexible exchange rsates as a desireable
>> >> policy, then
>> >> you must implicitly be relying on large Marshall-Lerner conditios
>> >> values-- or
>> >> else you are advocating a suicidal policy for each nation!!
>> >
>> >importing is not suicidal with flex fx.  in fact, the opposite.  net
>> >exports are suicidal, in that lives are spent/lost building things for
>> >other nations.
>> >> >
>> >> > Otherwise flexible exchange rates
>> >> >> exacerbate,
>> >> >> rather than cure,  the problem.
>> >
>> >the exporters have the problem, not the importers.
>> >
>> >
>> >> >
>> >> >Of course, we disagree on what 'the problem' is.  To you it's net
>> >> imports,
>> >> >etc.  And that's a throwback to fixed exchange rates, where arguably
>> >> that
>> >> >was a problem, as net imports corresponded with an outflow of gold
>> or
>> >> >whatever the currency was convertible into.
>> >>
>> >>
>> >> It has nothing to do with net imports per se -- it has to do with a
>> >> balancing
>> >> of forces!!~
>> >
>> >right, as previously discussed.
>> >
>> >For example, in recent years, much of what you call
>> >> foreigner's
>> >> demand for net US assets - is the result of the Bank of China and the
>> >> Bank of
>> >> Japan (among other central banks) wanting to increase their holdings
>> of
>> >> foreign reserves in their balance sheets---
>> >
>> >right, a major benefit for the US standard of living.
>> >
>> >
>> > but these accounting facts
>> >> in
>> >> Japan and China are counted in terms of YEN in Japan and the local
>> >> currency in
>> >> China.
>> >
>> >right, so?
>> >
>> >>
>> >> Now what happens to the Bank of Japan's accounting fact (balance)
>> sheet)
>> >> if
>> >> the Yen was suddenly to be upward val;ued by say 30 per cent.  What
>> >> happens to
>> >> the asset side of the BOJ balance sheet -- as a matter of accounting
>> >> facts???
>> >
>> >What you are getting at is that in yen terms, the $US are 'worth less.'
>> >So what?  That doesn't make Japan poorer, or the US richer, or vice
>> versa.
>> >Japan's solvency is not at risk.
>> >
>> >I don't see the problem with that balance sheet info.
>> >
>> >>
>> >> >
>> >> >
>> >> > Emopirical evidence including the
>> >> >> J-curve analysis indicates that for most nations the
>> Marshall-Lerner
>> >> >> condition
>> >> >> does not hold in the short-run
>> >> >
>> >> >So???  Imports are a benefit, exports a cost.
>> >>
>> >> In real terms imports may be a benefit and not a cost  -- but not in
>> >> financial
>> >> terms -- and given the business that you are in, I should not have to
>> >> tell you
>> >> that its money (and finance) that makes the real world go round-- and
>> >> not vica
>> >> versa!
>> >
>> >Imports are a benefit at the macro level.  At the micro level there can
>> >and will be winners and losers.  That's always the case, including the
>> >case of unemployment.
>> >
>> >I assume we are talking macro???
>> >
>> >
>> > That's why Keynes called it the general theory of MONEY,
>> >> interest and
>> >> EMPLOYMENT where MONEY IS  NEVER NEUTRAL IN EITHER THE LONG RUN OR
>> THE
>> >> SHORT
>> >> RUN.
>> >
>> >Obviously!!!  Did I say otherwise???
>> >
>> >
>> >> >
>> >> > and in the long run we'll all be dead! So
>> >> >>
>> >> >> flexible exchange rates are the problem, not the solution.
>> >
>> >Sorry, I fail to follow the immediately above logic.
>> >Still looks like fixed fx is the problem, as it restricts imports and
>> it
>> >constrains net govt spending that is often needed for full employment,
>> and
>> >all because 'money isn't neutral.'  Yes, you can attempt to monkey with
>> a
>> >fixed fx system, make it adjustable, etc. and require all kinds of
>> >compliance costs to trade internationally, etc. and it will sort of
>> work.
>> >But not as well as floating, properly applied to sustain full
>> employment
>> >and maximize real terms of trade.
>> >
>> >
>> >> >> >
>> >> >>
>> >> >as above.  The problem is unemployment, not 'balance of trade,' etc.
>> >> >for that, one needs flex exchange rates to be able to sustain
>> domestic
>> >> >demand such that the domestic labor force is fully employed.
>> >>
>> >> THAT JUST AIN'T SO UNLESS THE MARSHALL -LERNER CONDITION HOLDS
>> >
>> >domestic deficit spending can always sustain full employment.
>> >
>> >OR TGHE
>> >> NATION
>> >> TURNS TO AUTARKY!
>> >
>> >you lost me here.
>> >
>> >>
>> >>   ANY nation
>> >> >can do that independently.  There are not 'global' constraints that
>> >> >prevent domestic full employment, only self imposed constraints.
>> >>
>> >> AGAIN THAT JUST AIN'T SO UNLESS ---(AS ABOVE).
>> >
>> >don't follow this.
>> >
>> >> >
>> >> >> I believe that by tying your argument regarding deficits and
>> foreign
>> >> >> savings
>> >> >> demands for US dollar denominated assets with the desire of
>> flexible
>> >> >> exchange
>> >> >> rates, you are tying you very correct innovative view of savings
>> and
>> >> the
>> >> >>
>> >> >> demand for net assets (which underlies Keynes's liquidity
>> preference
>> >> >> analysis)
>> >> >> to the very inapplicable flexible exchange rate system -- and
>> thereby
>> >> >> draw
>> >> >> away attention -- and deleting the importance --from your truly
>> >> >> important
>> >> >> deficit-savings message.
>> >> >
>> >> >The message is, the US or any other country employing flex fx policy
>> >> can
>> >> >independently sustain domestic full employment.
>> >>
>> >> AGAIN THAT JUST AIN'T SO IF YOU ALLOW THE ECONOMY SO THAT DOMESTIC
>> >> RESIDENTS
>> >> ARE ABLE TO ENTER INTO DEBT CONTRACTS WITH FOREIGNERS BEFORE A CHANGE
>> IN
>> >> THE
>> >> EXCHANGE RATE.
>> >
>> >what does that mean?  fx rates change continuously with floating fx.
>> >
>> >
>> > Contracts matter in our entrepreneurial economy-- and as
>> >> you
>> >> well know wshen Deutche Bank or any other foreign enterprise backsa
>> out
>> >> of a
>> >> contractual commitment because of rapidly changing exchange rates,
>> etc.
>> >> this
>> >> can play havoc with the the best laidplans of mice, men and
>> >> entrepreneurs!!
>> >>
>> >right, but don't prevent domestic full employment via any of a number
>> of
>> >govt options.
>> >
>> >> >>
>> >> >> But we have gone through this before and I don't seem to be able
>> to
>> >> get
>> >> >> you to
>> >> >> understand why the lack of  aMarshall -Lerner condition makes a
>> >> >> difference.
>> >> >>
>> >> >
>> >> >As above.  Can't get you to see imports are the benefit, not the
>> >> cost!!!
>> >>
>> >>
>> >> sEE MY ABOVE STATEMENT ABOUT MONEY MAKING THE WORLD GO AROUND.
>> >
>> >understood- very well!
>> >
>> >warren
>> >
>> >>
>> >> Paul
>> >>
>> >> Paul Davidson
>> >> Editor, Journal of Post Keynesian Economics
>> >> University of Tennessee
>> >> SMC 503
>> >> Knoxville, Tennessee 37996-0550
>> >> office phone #;(865)974-3303; office fax#(865)974-4601
>> >> home phone and fax # (561)369-1951
>> >> email pdavidson@xxxxxxx
>> >> http://econ.bus.utk.edu/Davidson.html
>> >>
>> >
>> >
>> >=====
>> >Warren Mosler, Valance Co. Inc.
>> >5000 Estate Southgate, Christiansted, USVI  00820
>> >340-692-7710, wmosler@xxxxxxxxxx, www.mosler.org
>> >
>> >Associate Fellow, Cambridge Centre for Economic and Public Policy
>> >Downing College, Cambridge University, Cambridge, UK
>>
>> Paul Davidson
>> Editor, Journal of Post Keynesian Economics
>> University of Tennessee
>> SMC 503
>> Knoxville, Tennessee 37996-0550
>> office phone #;(865)974-3303; office fax#(865)974-4601
>> home phone and fax # (561)369-1951
>> email pdavidson@xxxxxxx
>> http://econ.bus.utk.edu/Davidson.html
>>
>
>
>=====
>Warren Mosler, Valance Co. Inc.
>5000 Estate Southgate, Christiansted, USVI  00820
>340-692-7710, wmosler@xxxxxxxxxx, www.mosler.org
>
>Associate Fellow, Cambridge Centre for Economic and Public Policy
>Downing College, Cambridge University, Cambridge, UK

Paul Davidson
Editor, Journal of Post Keynesian Economics
University of Tennessee
SMC 503
Knoxville, Tennessee 37996-0550
office phone #;(865)974-3303; office fax#(865)974-4601
home phone and fax # (561)369-1951
email pdavidson@xxxxxxx
http://econ.bus.utk.edu/Davidson.html