The Keynesian Multiplier is the Bigfoot of Economics—Something That Many Assume Exists But Is Rarely, If Ever, Seen

The Keynesian multiplier theory rests on the assumption that a dollar of government deficit spending can produce more than a dollar of total economic output after all secondary effects are taken into account. The multiplier is the Bigfoot of economics—something that many assume exists but is rarely, if ever, seen. The foundation of Keynesian public policy is called aggregate demand, or the total of all spending and investment in the domestic economy, excluding inventories. For example, if a worker is fired, he not only loses his income, but he also then stops spending in ways that cause others to lose income as well. The lost income and lost spending cause a drop in aggregate demand, which can feed on itself, leading more businesses to fire more employees, who then spend less, and so on in a vicious circle. Keynesian theory says that government can step in and spend money that individuals cannot or will not spend, thereby increasing aggregate demand. The government spending can reverse the slide and contribute to renewed economic growth. 

The problem with this theory of government spending to boost aggregate demand is that governments have no money of their own in the first instance. Governments have to print the money, take the money in the form of taxes or borrow the money from their citizens or from abroad. Printing money can cause nominal growth, but it can also cause inflation, so that real growth is unchanged over time. Taxing and borrowing may enable the government to spend more, but it means there is less for the private sector to spend or invest, so it is not clear how aggregate demand increases. This is where the multiplier claims to play a role. The idea of the multiplier is that one dollar of government spending will stimulate more spending by others and result in more than one dollar of increased output, and this is the justification for taking the dollar from the private sector. 

—James Rickards, Currency Wars: The Making of the Next Global Crisis (New York: Portfolio / Penguin, 2012), 184-185.

“Exchange” in “Gold Exchange Standard” Means that FOREIGN EXCHANGE BALANCES Are Treated LIKE GOLD for Reserve Purposes

Yet important changes had taken place since the heyday of the classical gold standard. The United States had created a new central bank in 1913, the Federal Reserve System, with unprecedented powers to regulate interest rates and the supply of money. The interaction of gold stocks and Fed money was still an object of experimentation in the 1920s. Countries had also grown used to the convenience of issuing paper money as needed during the war years of 1914-1918, while citizens had likewise become accustomed to accepting paper money after gold coins had been withdrawn from circulation. The major powers came to the Genoa Conference with a view to reintroducing gold on a more flexible basis, more tightly controlled by the central banks themselves.

From the Genoa Conference there emerged the new gold exchange standard, which differed from the former classical gold standard in significant ways. Participating countries agreed that central bank reserves could be held not only in gold but in the currencies of other nations; the word “exchange” in “gold exchange standard” simply meant that certain foreign exchange balances would be treated like gold for reserve purposes. This outsourced the burden of the gold standard to those countries with large gold holdings such as the United States. The United States would be responsible for upholding the gold value of the dollar at the $20.67 per ounce ratio while other nations could hold dollars as a gold proxy. Under this new standard, international accounts would still be settled in gold, but a country might accumulate large balances of foreign exchange before redeeming those balances for bullion. 

In addition, gold coins and bullion no longer circulated as freely as before the war. Countries still offered to exchange paper notes for gold, but typically only in large minimum quantities, such as four-hundred-ounce bars, valued at the time at $8,268 each, equivalent today to over $110,000. This meant that gold bullion would be used only by central banks, commercial banks and the wealthy, while others would use paper notes backed by the promises of governments to maintain their gold equivalent value. Paper money would still be “as good as gold,” but the gold itself would disappear into central bank vaults. England codified these arrangements in the Gold Standard Act of 1925, intended to facilitate the new gold exchange standard.

—James Rickards, Currency Wars: The Making of the Next Global Crisis (New York: Portfolio / Penguin, 2012), 61-62.

Economic Performance in the US and the UK Was Superior under the Gold Standard to that of Managed Fiduciary Money

Economists are nearly unanimous in pointing out the beneficial economic results of this period. Giulio M. Gallarotti, the leading theorist and economic historian of the classical gold standard period, summarizes this neatly in The Anatomy of an International Monetary Regime:

Among that group of nations that eventually gravitated to gold standards in the latter third of the 19th century (i.e., the gold club), abnormal capital movements (i.e., hot money flows) were uncommon, competitive manipulation of exchange rates was rare, international trade showed record growth rates, balance-of-payments problems were few, capital mobility was high (as was mobility of factors and people), few nations that ever adopted gold standards ever suspended convertibility (and of those that did, the most important returned), exchange rates stayed within their respective gold points (i.e., were extremely stable), there were few policy conflicts among nations, speculation was stabilizing (i.e., investment behavior tended to bring currencies back to equilibrium after being displaced), adjustment was quick, liquidity was abundant, public and private confidence in the international monetary system remained high, nations experienced long-term price stability (predictability) at low levels of inflation, long-term trends in industrial production and income growth were favorable and unemployment remained fairly low.

This highly positive assessment by Gallarotti is echoed by a study published by the Federal Reserve Bank of St. Louis, which concludes, “Economic performance in the United States and the United Kingdom was superior under the classical gold standard to that of the subsequent period of managed fiduciary money.” The period from 1870 to 1914 was a golden age in terms of noninflationary growth coupled with increasing wealth and productivity in the industrialized and commodity-producing world.

—James Rickards, Currency Wars: The Making of the Next Global Crisis (New York: Portfolio / Penguin, 2011), e-book.

A Currency War Is Fought By One Country through Competitive Devaluations of Its Currency Against Others

A currency war, fought by one country through competitive devaluations of its currency against others, is one of the most destructive and feared outcomes in international economics. It revives ghosts of the Great Depression, when nations engaged in beggar-thy-neighbor devaluations and imposed tariffs that collapsed world trade. It recalls the 1970s, when the dollar price of oil quadrupled because of U.S. efforts to weaken the dollar by breaking its link to gold. Finally, it reminds one of crises in UK pounds sterling in 1992, Mexican pesos in 1994 and the Russian ruble in 1998, among other disruptions. Whether prolonged or acute, these and other currency crises are associated with stagnation, inflation, austerity, financial panic and other painful economic outcomes. Nothing positive ever comes from a currency war.

So it was shocking and disturbing to global financial elites to hear the Brazilian finance minister, Guido Mantega, flatly declare in late September 2010 that a new currency war had begun. Of course, the events and pressures that gave rise to Mantega’s declaration were not new or unknown to these elites. International tension on exchange rate policy and, by extension, interest rates and fiscal policy had been building even before the depression that began in late 2007. China had been repeatedly accused by its major trading partners of manipulating its currency, the yuan, to an artificially low level and of accumulating excess reserves of U.S. Treasury debt in the process. The Panic of 2008, however, cast the exchange rate disputes in a new light. Suddenly, instead of expanding, the economic pie began to shrink and countries formerly content with their share of a growing pie began to fight over the crumbs.

Despite the obvious global financial pressures that had built up by 2010, it was still considered taboo in elite circles to mention currency wars. Instead international monetary experts used phrases like “rebalancing” and “adjustment” to describe their efforts to realign exchange rates to achieve what were thought by some to be desired goals. Employing euphemisms did not abate the tension in the system.

—James Rickards, Currency Wars: The Making of the Next Global Crisis (New York: Portfolio / Penguin, 2011), e-book.