Vol. 18 No. 22 · 14 November 1996
pages 3-7 | 6353 words
Central Bankism
Edward Luttwak
Communism is dead, socialism has been repudiated by the socialists themselves, fewer and fewer Europeans are believing Christians but it seems that a fanatical new religion – also practised in America – has replaced all of them: Central Bankism. Like all religions, it has both a supreme god – hard money and a devil, inflation. Common sense suffices to oppose high inflation, and to fear hyper-inflation as the deadly disease of the currencies. But it takes the absolute faith of religion to refuse even very moderate inflation at the cost of immoderate unemployment and stagnation, as the Europeans have been doing, or to accept slow economic growth for years on end, as in the United States.
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Letters
Vol. 18 No. 23 · 28 November 1996
From Victor Smart
I can scarcely believe that I have laboured through Edward Luttwak’s article (LRB, 14 November) on central bankism and find hardly a mention of the money markets. Surely, the principal reason why central banks and their religion of hard money have become tyrannical is that the money markets make them so. Thanks in part to round-the-clock trading made possible by new technology, flows of currency are far greater than they were even twenty years ago. The currency men and women can outgun governments. They like what they see of the Bundesbank, which painfully built up the Deutschmark’s credibility over decades and helped foster Germany’s economic success. They have a choice where to invest and now punish mercilessly any country which opts for a soft money policy.
Victor Smart
<em>European</em>
Vol. 18 No. 24 · 12 December 1996
From Edward Luttwak
In complaining that my article on central bankism ignored the influence of the money-markets, Victor Smart argues that they ‘punish mercilessly’ any country which opts for a soft money policy (Letters, 28 November). Very true – but how is that punishment inflicted? By marking down a country’s currency of course. And what consequences ensue in these deflationary times of chronic excess capacity? Cheapened exports rise, dearer imports fall, increasing employment at both ends, in import-substitution as well as export trades. That is exactly what happened in Italy in 1993-5, after the lira was forced down by the money-markets, alarmed that the country’s political turmoil would accentuate its fiscal and monetary laxity. As the lira fell the Italian economy enjoyed an export-led boom, while Germany and other EU countries of exemplary monetary discipline were suffering from increasing unemployment. With the lira then being much in demand to pay for all those Ferragamo shoes and everything else, it started a slow climb that still continues – even though only the more courageous fraction of investors and currency traders bought liras and lira-denominated bonds and stocks, adding their own capital demand to the trade-generated demand for liras. At the time, grave warnings were issued that Italy’s inflation would soon accelerate because of the rising cost of imports. That is what is written in textbooks – but then textbook-writers do not know much about Ferragamo shoes: when the cost of dollar-denominated ostrich skin increased, the import content of 300,000 lira shoes went up from 1000 liras to 1500 liras, i.e. to 0.005 per cent of their total value – and that was just about the extent of Italy’s import-induced inflation. Advanced economies are like that.
To be sure, in inflationary times with productive capacity already fully utilised, the down-valuation of the currency by money markets cannot result in increased exports, while rising import prices further accelerate inflation. My ‘central bankism’ critique is meant to apply to the present situation of chronic deflation and excess capacity. Everyone knows that inflation results from too much money chasing too few goods. Everyone knows that there is now an abundance of capacity, the equivalent of too many goods, so that much money can be printed without causing much inflation.
Edward Luttwak
Chevy Chase, Maryland
