 We've learned who's as a background as a hockey fan interest in the Minnesota wild and a former hockey player himself Tells us his hockey playing days preceded the days of the hockey mask You must you must have avoided many contacts or that fuck since his visit seemed unscarred. I Present to you dr. Robert Mundell Thank you very much It's a great pleasure to be here and a great honor to receive this honorary degree from Gustavus Adolphus College I'm going to talk today on the subject Does the world need a global currency? Does the global economy need a world currency? and to set the stage for that I want to begin by commenting on a few key factors that are Important things to take into account in the world economy. There are five factors. I want to put as the backdrop of this lecture the first Factor is the new economy and the way in which the new economy has affected The lives of everyone around us. It's in economics. It's affected Factors of production. It's affected households. It's affected governments and all institutions and It's reflected in the new technology Which is lowered costs in all aspects of economic life and increased productivity everywhere and it's I think if you were looking for a common analogy it would be like a combination of the Electricity revolution and the printing press rolled into one The second trend I want to talk about is mentioned not talk about is the Globalization I Just came back from the Prague meetings of the International Monetary Fund and I had the good fortune and to Leave before the ceremonies and the big demonstrations that created such a turmoil for my colleagues there The Globalization has become a word Another word for it That might be used in another sense because it captures part of it Of the some aspects of what and people want to say is negative about it Americanization the a lot part of the world don't like the idea of Globalization because globalization in part means Americanization the use of the internet the Which which language is the language of the internet and the Fact of opening up each country to free capital movements allowing Whole processes of production to be to be affected and changing culture and in society in Unpredictable ways and this is the negative aspect of it that we look upon the group the positive aspect of it though is that it Presents the opportunity for tremendous far-reaching increases in the gains from trade and In the long run Globalization is going to come about we're living in a world where technology has increased Decreased transport costs and increased the speed of communications to such a high pitch that it's at a very Important stage, however, I'm going to talk and this is not Unconnected with the subject of my lecture about Some of the big defects of the international monetary system some of the big defects of the world economy which Create and allow the the more harmful aspects of globalization from Rearing their ugly heads now the third point I want to make is to mention is the US economic miracle for the past two decades the US Economy has been the backbone of the economic growth in the world economy It's very different from the period immediately after World War two when Europe and Japan were soaring ahead at unprecedented speeds high growth low employment low inflation and and Very successful economies Whereas the United States was struggling in a way with a kind of stagnation they couldn't get unemployment rates down But in that past two decades The shoes on the other foot that it's the European economies that have been stagnating. They've gotten into difficulties They've had excessive inflation excessive increases in their public debts and relatively high unemployment and very relatively low economic growth the source of that growth in the United States Really began with a revolution of the 1980s in the tax system in the United States in the If you think back those of you who are a little a little old enough to to 1980 The in 1980 the marginal tax rates were 70% at the federal level 70% at the federal level alone the margin top marginal tax bracket was 70% And if you added state and local Tax rates to that in a high tax state like the one where I live in New York It's another 15% so the marginal tax rate was very very high at the same time in 1980 There was a 13% inflation in the United States and unemployment was around five or six percent It wasn't very Extremely high, but it was much below above what economists thought the economy was capable of so you had high Inflation relatively high employment growth was very low as stagnating and tax rates were extremely high the corporate tax rate was 48% now eight years later when Reagan Was elected and Paul Volcker shifted course in monetary policy Toward a new policy mix instead of easy money Inflating and lowering the value of the dollar internationally and domestically You had tight money instead of increasing tax rates Caused not directly from programs that that legislated an increase in tax rates But through the fact that with a steeply progressive income tax system coupled with inflation of in 1980 of 13% people were being shifted into higher and higher income tax brackets and so the Reaganomics came to be characterized as very steep cuts in tax rates Combined with tight money to keep the economy in motion and what after a series of several measures including indexing the tax brackets for inflation By at the time Ronald Reagan left office the top marginal tax rate at the federal level was no longer 70% it was 28% and the corporate tax rate had been lowered from 48% to 34% That made the US economy the most efficient in the world and you had a period from after an initial recession From 1982 until 1990 where 19 million jobs had been created a great success story Now that part period ended in 1990 with a nine month recession But after that nine month recession in the spring of 1991 the economy Expanded again, and we were still in the expansion that began in the middle of 1990 So we have now a bush Clinton gore expansion if you like all through the 1990s that's added to the to the Reagan Bush expansion of the 1980s so just from 1982 from the recession of 1982 to the present time There's been no less than 40 million new jobs created that's more than the entire labor force of the third largest economy in the world the German economy and That is a great success story and recently things have been getting even better because with the new economy When economists were arguing about can we have a two and a half more than a two and a half percent? Long-run growth rate. Maybe we can have a three and a half percent growth rate I was pushing for that suddenly we've suddenly got into a four and a half percent even five percent growth rates when we add and figure Into it the the tremendous contributions from the new technology and an internet technology international technology so There's now we're still in this in this expansion The longest expansion in American history if you think of the 20th century just looking at the 20th century all the big Expansions have been in the 20th century first was 1938 to 1945 wartime expansion the second was the Kennedy Johnson expansion starting in 1963 and 64 with the tax cuts that were put on at that time the Kennedy Johnson tax cut was passed in 1964 your big expansion in 1960s and then the third big expansion was the in the second big overall Was the Reagan Bush expansion of the 1980s and now we're in the biggest expansion ever So it's a period of great growth and that has been backstopping the American economy The world economy and at a time when Japan has been sluggish and when Europe has been sluggish Europe is getting its act together of course with the With the euro and I'll I'll say a word or two about that in a moment The at the fourth factor I want to mention is this the new capitalism All around the world now, and I think it started probably with the milken Revolution of junk bonds buying and selling junk bonds suddenly now Corporations corporations companies have become commodities. They're bought and sold here and there and part their Companies are bought and sold. They're split up and changed around. That's also part of the corporation the the internet revolution because Now what companies can do is they can look inside and see what parts of the company are contributing how much What their contribution to the profit stream is and which are making losses and they can separate them and New synergies with other corporations. You're getting now with global capitalism the optimum size of the firm is larger and You're getting mergers companies are getting bigger and bigger fewer and fewer in Because we're now not thinking in terms of commanding the domestic market, but commanding the world market That's true also in banking particularly in Europe Where the the tall biggest bank in Europe is small very small compared to the biggest bank Relative to its own market in the United States. Deutsche Bank is the biggest bank in Europe Merged with bankers trust, but it's still small relative to the size of the biggest American banks in the big Japanese banks So much more of that is going to come and it's been made it within Europe itself Very important by the advent of the Euro the locking of exchange rates of several countries Well, then that we get then to the fifth important factor the advent of the Euro and what is the significance of it? It's certainly a big change in the international monetary system and some observers have said that it's an important change that's Comparable to the breakdown of the international monetary system the Bretton Woods arrangements in the early 1970s, but in an important sense. It's deeper than that because In the 1970s breakdown we had a fixed exchange rate system after the war that broke down in the early 70s And we moved to flexible exchange rates But it didn't change the power configuration of the system before and after that breakdown The US dollar was the dominant currency in the world and now the advent of the euro creates a possibility of at least a change in that At least is the possibility of that change. So I think that the advent of the euro is comparable to the Period in World War one when the dollar the US dollar took over from the pound sterling is the most important currency in the world Well, how how important is the euro? So much has been focused on the fall of the euro The fact that it's gone down from start out being worth the dollar 18 and then it hit as low as 84 a little above 84 cents big sweeping depreciation of Something like 28% in two years one half less than two years a very big change but remember we do have a floating exchange rate system and Volatility of exchange rates has characterized that system I'm going to spend time talking about that in my my the subject of my lecture remembers Does the world need to go global currency and I'm going to say yes to that question but we have a flexible exchange rate system that the International powers that be including the International Monetary Fund and its Board of Governors are insisting on We we have volatility and that's that focus though on on the rate itself And I know when I was last Friday or the Friday when I was speaking in Prague That very Friday the central banks of the G7 countries all intervened in order to Stabilize the to put a floor to the euro or at least to intervene and try to affect that exchange rate That was quite significant because that recognized that it It the exchange rate of the euro against the dollar and against the end and the pound Is an important international concern? It's not just a concern of a single country well When the euro was created beginning of 1999 it instantly became the number two currency in the world And that's what gives it importance from the standpoint of the power Configuration of the system when you think of power in the system. It's like you think of monetary mass How big is the total amount of transactions carried on by? One currency the best major we have of that would be proportional to GDP gross domestic product the US in round numbers the US GDP is about $10 trillion the GDP of the euro 11 countries is about $7 trillion the GDP of Japan is about $5 trillion so you get a sense of the proportion and the of those economies by those numbers You can think of these three areas the dollar area the euro area and the n area as together comprising 60 percent 50 to 60 percent of the world economy They represent really the core of the world economy and anything that happens to the structure of the international monetary system has to Ipso facto Take account of what is happening among exchange rates of these of these areas well The the static levels of GDPs give an indication of the current strength of those Currencies in importance of those currencies But if you look down the road over the next 10 years and you see expansion all the areas could in principle be expanding The euro area is expanding The There are three countries Greece has joined it's good the EU 11 is going to be at the end of the year the EU 12 soon because Greece will be locked into the exchange rate system after the beginning of the year three countries have stayed out including Denmark Sweden and Burton of these countries the British cases by far the most important because Britain has a big Possibility of influencing the rest of the system, but the Danes Denmark just had its referendum last week and decided no they didn't want They didn't want to join. They said I guess 46% of them said no to joining the European Monetary Union and Said yes to it and 54% or so said no to it to me This Is because the issue was put to the Danes more or less as an economic issue is a pure economic basis and the cost of giving up for them of Joining emu is that they'll have to give up the beloved crown and They've had that crown for 700 years or so and that has a lot of nostalgic to it now the crown they had those 700 years ago It was very different from the crown that they have today. This is a paper crown It's not like the gold or silver crowns that exist in the past. So it has a different sort of meaning nevertheless You must realize that Money is part of the sovereignty. There's a monetary sovereignty. There's a component of sovereignty in a country And the monetary system of a country is part of its monetary Heritage I would never want to say that's not the case I would never want Americans or Englishmen or Canadians to think that their money and the way they treat it that Use their monetary systems in the past is not an important part of their heritage and their tradition but in the case of the Denmark Denmark has great gain become such a rich country by its ability to join the eurozone And the issue was put as if this is a pure economic deal But without any consideration perhaps it was too delicate to bring up the real issue And the real motivation as to why the master's treaty was signed so quickly in 1991 It was tied to tie Germany a unified Germany and newly unified Germany into Western Europe so that the the Europe wouldn't have to face the Problem Germany wouldn't have to face the problem either of the tendency of the German economy and the German political system to dominate Europe And I think that that when Denmark signed the treaty of Maastricht they that included provision for a Monetary Union and the they recognized the importance of That emu monetary union in Europe and tying Germany into it Well when the other countries the 11 countries went ahead with it it became a done deal for them Now Denmark can say out say well We don't need to we don't need to take part in this venture of tying Germany into the rest of Europe Because the other countries are all doing it so they can play the role of the free rider and and say out I think it's a question morally a very questionable policy, and I hope that Sweden doesn't follow the same wrong policy itself Although Sweden has much more of a neutralist Tradition and then Denmark does and and in Sweden of course didn't suffer At the hands of the Nazis the way Denmark did so I think those political aspects are important now I I do think that all that's going to change and that Because I've been told by but from people in Danish Parliament that the next vote Referendum that the Danes will have is to either accept emu or Leave the EU That is get out of the common market treating get out of the whole thing either all out or all in That may be the case and if that's the case then the Danes will vote to go in all in because They've become so wealthy as a result of their own version of continental globalization has made Got them there was a tremendous increases in the gains from trade well more important than that is that in Once the bilateral exchange rates were locked and then in 1999 they were all exchange rates were fixed to the Euro the new Euro which was founded on the old Aiku the basket of the other of the European currencies Immediately 13 other countries in Africa were also locked to that zone Because the CFA Frank countries are 13 of them that were formerly locked to the French Frank are now locked to the Euro So there's really 25 countries now in the Eurozone and there are 13 other countries Invited to apply for admission to the EU Which counts? Turkey which may or may not come in so early, but the other countries apart from Turkey are quite likely to be in by the next by the end of the decade and The chances that they will all be in the Eurozone is very high So we're talking about 40 countries in the Eurozone in the next while And there's probably some countries in North Africa and the Middle East and in Eastern Europe Outside the 13 central European countries and county Malta and Cyprus also It would be linked to the zone So we're talking about 40 to 50 countries in the Eurozone in 10 years with the population anywhere from 450 to 500 million people and a GDP of that area that Will probably be 10 20 30 percent higher than that of the United States so in 10 years time the Euro area is going to vie with the dollar and Maybe central banks will want to keep the reserves about equally in dollars and euros within about 10 years if they're going to do that though, they have to start building that up soon because the Right now most reserves are in US dollars So to think ahead to a city-state equilibrium where it was about equal Maybe 40 percent of world reserves are in dollars 40 percent in euros and 20 percent other currencies in the year 2010 or 2012 Then we'll have about three over three trillion dollars worth of reserves then There'll be that would could only be achieved with the build-up as something like A hundred billion dollars a year of euros Somehow to get to over a trillion dollars of reserves by 2010 or 2012 And that would change trade balances and have a big thing But that pent up demand means that as soon as people think that the euro has hit bottom and central banks Think that the euro is hit bottom and the dollar does start to fall as it will fall When the growth rate of the United States tapers down a little bit then when the dollar falls immediately the biggest current account deficits in history In any country's history that we have now a current account deficit and a trade balance steps It called the same thing of over four hundred billion dollars will become very important That'll be an issue to finance and the capital that's coming in now to finance that four hundred billion dollars won't be there if the Dollars starts to fall. There'll be a movement to diversification And and then that's it the threat then would be the other Would be the other way that not that the euro is going to go down too much But that it'll shoot way up and that would be an embarrassment and a difficulty for Europe as well as well as for the United States And that's why I think and why I said in the Prague meeting that That what the central bank intervention is a good thing to put a floor to the euro and Every economist in the world thinks that the euro has now got got down to a really a low fire No one thinks that it should go down By any economic theory lower than there's now it's a floor at 85 cents and a ceiling to allow for this Possible problem in the future of a hundred and fifteen cents and it would be easy to fix that and it would be a clear-cut intervention that would be would be Maintainable in the long run so Anyway We have three islands of stability in the system make no mistake about it The dollar area the euro area and the n area our islands of stability in the sense that The purchasing power of the euro over euro goods dollar over dollar goods and the end over dollar over yen goods Is stable the inflation rate in Europe is below three percent the inflation rate in the United States is below three percent Or near three percent and the inflation rate in in Japan is two or three percent Or even less than it's even closer to zero and for a while. It's been even falling a little bit The fact is that each of these three currencies are stable in terms of an important basket of goods So the question that you have to ask then if the currencies are stable in terms of a given basket of goods Why aren't the currencies stable in terms of each other? What's the function of the? Volatility of exchange rates How volatile have these rates been and can you predict the euro in the future as being as volatile as its predecessors? well We've only a year and a half or a year and nine months to look at the euro, but we have the predecessor of the Euro which was the a coup and the backbone of the a coup was the deutschmark And so we can look at deutschmark dollar rates to see how volatile the system has been 19 for all the post war period the Dollar against the mark ever since the German currency reform in 1948 was 4.2 marks to the dollar Then 1961 there was a little tiny change in it to four marks to the dollar, but then by the middle of 1975 the dollar had got down to three and a half marks 1975 five years later the dollar fell in half To about 1.7 marks that was when the American inflation rate was going up and the dollar was depreciating From 1975 to 1980 the dollar fell in half from 3.5 to 1.7 marks, but then came reaganomics 1980 to 1985 the dollar soared to 3.4 marks it doubled 75 to 80 the dollar fell in half 1985 the dollar doubled then the next seven years the dollar did more than fall in a half It went from 3.4 down to Below 1.4 sweeping change it by 1992 in the pit of the ERM crisis of that year the dollar was below 1.4 and And then now the dollar is like 2.2 So you have these huge swings Doubling falling in half doubling and falling in half a hundred percent changes in exchange rates Just imagine what would happen to the dollar to Europe if the dollar Euro rates started to double against the dollar and then fall in half against the dollar and double again And then fall in half against and why should it take place between two areas that have price stability There's a as Keynes knew Keynes knew that if a country if the rest of the world is unstable You should never fix exchange rates to it to an unstable world because that would not give Domestic stability internal stability but if the rest of the world is stable then you can have both exchange rates stability and price stability and That's what we need to do. What about the yen? Japan Japan had a currency conversion in 1948 to just like the United States It wasn't an accent because they were both under American occupation and the Americans decided to do it And it was a brilliant stroke of luck for both economies because it set both the German and Japanese economies To be the outstanding stars of the post-war period that gave them monetary stability and they kept going But for the whole post-war period the dollar was 360 yen then by 1985 the dollar had got down to 250 yen But in the next ten years To 1995 the dollar went from 250 yen to 79 yen 1995 April 1995 and then between 1895 1995 and June 1998 the dollar soared 248 yen people said oh, it's going to go up to 200 yen Speculators were saying that it didn't it went down to 105 yen more or less like that But there you have this wild stability of exchange rates in a period when you had comparable price stability in these two economies and don't think that that wasn't a world-shaking event because the appreciation of the dollar against the yen from 1995 to 1998 or if you like want to put the depreciation of the yen against the dollar was what was 90% of the cause of the Asian crisis all those currencies that had latched on to the dollar around 1995 and then Their currencies soared against the end they became uncompetitive and then with the yen flopping around falling down Stopped investing in in Southeast Asia, and this is what brought on the basic crisis. So these this exchange rate volatility creates instability in the world and I I could go on I could I could argue as I have Many times before that the instability of the exchange rates between in the 1970s and 1980s Created the debt crisis for the developing countries the big overly expansive expansionary policies when Euro-dollar banks were shoving money at the less developed countries and then combined that When interest rates were very low real interest rates were even negative and then suddenly when Reaganomics came along Paul Volcker tightened the United States it had to get back to its own monetary stability But it was a devastating impact and created the debt crisis that emerged in the 1980s for those countries So now this is this is tragic for the world economy the volatility of exchange rates. Could you Do anything about it? Well, let's suppose that you took you took away your your political cynicism for a moment and just supposed Abstracted from politics of it suppose that We'll call them the G3 countries the United States Euro land or the Euro area and the and the N area these are the G3 areas Suppose they decide let's do what 11 European countries did Let's lock exchange rates Let's lock exchange rates and have a monetary union now Let me say this that when the 11 countries locked exchange rates when they locked them in the middle of 1998 Bilaterally, and then they locked them to the Euro in in January 1999 The moment they locked exchange rates speculative capital movements between Germany France Spain Italy completely disappeared There's no speculation one way or the other because people those locked exchange rates were credible and nobody speculated against them Well, let's suppose you could do the same thing among the G3 areas. Just take a skip of the imagination Would you do the same thing that the 11 countries did now how what did they do what was necessary in Creating that monetary union in Europe There are five things they had to do the five things were They first had to Have a common inflation target You can't have a monetary union if one area has a different inflation target then then The other if if Japan wants zero inflation the United States wants 3% inflation They can't have a monetary union, but let's suppose they can agree on a common inflation target And then the second thing they need is a common way to measure inflation in the common the three areas You need you can't have National baskets of goods or area specific baskets of good You have to have the same weights in all the indexes in order to measure the inflation in the common area Just as the euro stat the statistics version of the Bureau of Statistics in the United States in Europe Created what they call the HICP the harmonized index of consumer prices So that gives them a way of measuring inflation in the common area Then number three that they need to have they need to lock exchange rates If they're going to keep the currencies If they're keeping three currencies they have to lock exchange rates now The way to do that is there are different ways you could do it, but it's certainly easier if you choose one Sent one area as the leader. It's easier to choose the biggest area as the leader So suppose the Federal Reserve is the leader and then the Bank of Japan is assigned to lock exchange rates to the United set to the dollar Hopefully at a hundred yen equals the dollar would make it very convenient and if Europe would lock exchange rates to the dollar Hopefully at one that would be a very nice nice measure, but it may not be possible in the short term Lock exchange and then monetary policy would be carried out by open market purchases of on the part of the Federal Reserve system in the in the financial assets of either Europe or The United States or Japan and the people the open market committee would have to be composed of the Japanese The Europeans and the Americans and they'd make the decisions About whether to expand or contract raise or lower industries just as every three weeks the open market committee Makes those decisions today, and they'd fight about it They'd be beckering about whether they should go up or down and it'd be a division of opinion but they'd reach a decision about it and you would end up with a Monetary and the fifth thing they'd have to do is to make an agreement about redistributing Senior reach from monetary expansion as the Europeans do it. They do it They redistribute senior reach the profits from monetary expansion In proportion to the stock that each country holds in the center in the central bank more or less the size of the country Is the important thing so that gives it right? Well, you could have that kind of monetary union if if you thought that would be difficult Instead have a single currency monetary union as Europe is about to have after 2000 the middle of 2002 a single currency monetary union then you'd have one exchange rate You'd have a common central bank a combination of the three central banks and one decision-making process Composed of different groups making a decision to expand or contract you'd have zero volatility in exchange rates You'd have Unfortunately for some zero profits for the hedge funds Hedge funds have go up now to the assets and hedge funds go up now to twenty trillion dollars in the total amount just huge amounts to Daily turnover in the cross-border transactions is something like one and a half to two trillion dollars per day in turnover Just based on exchange rate Uncertainty you could live and the cost of that it goes up into the hundreds of billions of dollars in terms of lost welfare if you could lock exchange rates and you could you either have a common currency or just lock exchange rates and Do the same thing that Europe is doing at the present time then you would there'd be a tremendous saving here and All that would happen for the poor hedge fund operators some some of which are Students of mine, and they've complained to me when I they complained to me when I say things like this That they would have to move into more productive endeavors But there's no reason no reason for the world economy to be saddled with Mind you'd make no mistake about I'm not against or opposed to what the hedge funds are doing now I'm not blaming them. They're just Trying to make the best of a very rotten system in the world economy I'm suggesting we change the system in the world economy now What is you go on you What about the rest of the world well if you had those exchange rates of the dollar yen and euro rates locked together a Great part of the problems of the rest of the world would be taken care of many many countries might want to fix on to that That area and they'd find that if if a basket of goods of those three countries areas Japan United States and and Europe were Keeping their if if the those currencies were stable in terms of it the other countries could Keep their currencies fixed in terms of that too now other countries may choose to do their own to be independent the president of Brazil last April Suggested that maybe Mercasur needs a Sell a currency of its own a Mercasur currency Mercasur is that combination of four countries in South America Very different sizes Brazil Argentina Uruguay and Paraguay Uruguayan Paraguay are very small three and four million people Argentina has 35 million people and Brazil is 160 million so it's a dominated System in a way except that if Argentina I didn't go along with it It wouldn't happen, but if Argentina and Brazil got together it would probably happen I when I I was down there last spring asking what What should happen for those? What kind of what they have in mind about the common currency and I had made some Suggestions about how they might get toward that toward a Mercasur currency It turns out that what the Brazilians were thinking of mainly was using the Brazilian real as The currency for all the countries which would be about it was about as popular an Idea as using the Deutsche mark in Europe for the common currency after all a Hitler had a chance with the Deutsche mark and In in the 1940s and the Deutsche mark was the common currency once in Europe But it was run by Hitler and that didn't work out very well But anyway, there's the people are exploring this sort of idea and Recently in Asia I was talking in places like in Malaysia Jeffrey Sachs was there the same conference in Singapore and in Indonesia and the great deal of interest in the question does Asian need a common currency and That was what the subject of a speech there and my answer to that was that well, yes Asia needs a common currency So and but it can't be a single currency like the European currency Europe has gone for a single currency the strictest the most complete form of monetary integration Passing itself almost after the United States the Federal Reserve But they could only do that because a high degree of political integration has already been Attempted and achieved within Europe and because Europe has become a security area You can't have a single currency in a group of countries which Where there's still a possibility that there might be war between the countries? Security areas in area where war is ruled out that's happened Germany and France have buried the hatchet So to speak and so wars ruled out in Europe a single currency is possible in Asia That's not possible yet, but there's still with many some of the countries still reeling from the problems of the so-called Asian crisis then I this They they are looking for something new something important and it's difficult to create a nation currency right now like Europe because of the problems between the Straits with Taiwan China the problems between Japan and China and the dominance of Japan economically and the strength and Potential growing military power of China it creates difficulties and yet the need is very Is very great there Indonesia's had a very Difficult case Very unstable economy yet Indonesia is so important to this whole area because it's a country of 200 million people in that area the biggest The biggest in population not counting India, but after after China in this area and But the problem is still that Indonesia still has a currency crisis, and if I may just take Precious time for a little story that was running around Indonesia it goes like this that God calls for three world leaders and tells them that he's really annoyed With all the problems the world gives him and has decided to destroy the planet in three days Clinton goes back to Washington and tells his people I have good news and bad news The good news is that there is God and the bad news is that we have goofed up and the world will end in three days Zhang Jemin returns to the PRC China and tells his people I have bad news and worse news The bad news is that there is a God and The worst news is that he's going to stop our plan for world domination in three days Gus doer as they affectionately call President Wahid of Indonesia Returns to Indonesia with a big smile and says I have good news and better news The good news is that God thinks I am one of the three most important people in the world the better news is The currency crisis will be over in three days they They do have a problem and Now the solution to that problem would be of course if the Latin America has a problem Africa has a problem every country every part of the world has a problem North America has a problem There are many people thinking that there should be a North American Monterey Union The president elective Mexico vintende fox just came has come around talking about that and he was actually rather sharply rebuffed in Canada from it by the prime minister John cretin said no we don't even hear anything about a Monterey Union in Canada because they came back Wah actually have been Proposing that the Canadian dollar be fixed to the American dollar or that the Canadians start to use the American dollar Rather than their own is being in the long run more stable But the but there's still a need to think about it and everybody wants to think about well the Solution would be to do what was originally planned 46 years ago at the Bretton Woods Conference in New Hampshire 1944 in New Hampshire there were two major plans this was this big conference which set up ultimately the IMF the International Monetary Fund and the World Bank was set up in order to Get away from the currency problems that existed after World War one which were quite Terrible in unstable currency conditions. They want a post-war world that would be stable And there were two plans that were being discussed one was the British plan Which is really done by John Maynard Keynes and which had a plan for a world currency a World currency called bank or and a kind of world central bank and an overdraft system the other plan was the American plan largely written up by Harry Dexter White and It had a plan for a world currency called unit ass and it was a kind of a system where you would Contribute get over you'd be able to draw on the on the new institution They called the fund not the bank draw on the fund you'd put in your own currency and take out Currencies that you needed in the exchange markets But both these plans initially had a world currency and then sudden somehow or other In the negotiations in the discussion of it the United States decided they did not want a world currency the United States did not want a world currency and they withdrew that from their plan and whenever the British like Lord Robbins line Robbins tried to bring up the subject of the world currency. What about this the Americans changed the subject and Didn't want to talk about it. And so the issue was dropped the Americans didn't want it. It wouldn't happen I suppose the Americans thought that the gold gold and or the dollar would suffice in the future But you see what happened 25 years later gold and the dollar took separate went on separate ways The dominance of the United States was so so great Economy that it elbowed out gold from the system We know we lost we no longer on the gold standard We're even close to it because the dollar became easier to use and that Elbowed out gold in the system and then we moved on to the world moved on to floating exchange rates Because the United States was quite happy to go with floating exchange rates After all the United States currency area is so vast and huge. It's like a world of its own The US currency area today is 10 times bigger in terms of Monetary transactions than the whole world was a hundred years ago So vast is this so the United States could do without but the small countries didn't do it Didn't like it and couldn't do without it and they tried to cope with it Accepted cope with it did with Europe Said well least will go our own separate way and try to create a currency area of our own is the second best solution But our first best solution would be to have a world currency and how could you do that? And I just say this rather quickly It would be very easy to do I wrote about this somewhat in a Wall Street Journal article in March the 30th An op-ed page article, but if you got this G3 Monetary union going it could be keeping the three G3 currencies, but then created an instrument that was equal to Dollar or ten dollars let's say a thousand yen and a proportionate number of euros You met an independent Global money like the Bancor of Keynes like the unit tasks of the American plan back in 1944 That was equivalent to the either the end or the dollar or a hundred yen or 90 or a hundred euros and then that you let that become the unit of account and then Let that be produced by the international monetary system is a whole the they fund or some new Organization created like that and let all the rest of the world fix their currencies onto that And then you'd get back to the fixed exchange rate system That the Bretton Woods arrangements tried to create but you'd get back to it with a global currency and that global currency would be Would then have a stability of value just the same as the stability of value of that G3 monetary union and That would be a unit of account that could be endorsed by all the members of the fund and would be an approach that would be would be a great catalyst for world peace and It would be a help to all the individual countries in the area. So Don't think for a moment that it's so unrealistic as it may sound at first Not only do we have the past experience of it 2,000 years ago In the reign of Caesar Augustus there was a universal money gold the golden aureus Thousand years ago. There was a universal money Solidus of the Bezant Constantinople and a hundred years ago at the time Nobel was creating his Nobel Prizes there was a world money. It was gold notice it that In the past You to see how if you just think of the Nobel Prizes they they give a nice sum of money to the to the Ward ease They were in gold before And they were in in gold crowns of Sweden and then the crowns but look what happened Look how rapidly they've increased in paper crowns now. They're 7.9 million or something like that 7.9 million crowns Time back in the In the early days you could fix them in terms of gold and you would keep them constant because as long as gold was constant There was a some at least reasonable Constancy of purchasing power now they have to go up and up and up and increase it with the inflation rate And there's it would be much better to be able to price To have for all international Deals a common currency that's not the national currency and there's a great need for it the in the February issue in February of New York Times one February last February Paul Volcker did answer this very question that a global economy. He says it does need a global currency he was the Chairman of the Federal Reserve Board one of the most effective Chairman that the United States has had and he believes that that's necessary a large number of growing number of people start to believe that that there's a great deal wrong with the excessive currency volatility of the system we have to find a way of working to To eliminate it so I Conclude then with my thought with the answer to the question. Yes The world does need a global currency the global economy does need a global currency and do I think we're going to get one Well, I do think that in the next decade or two. There'll be a very large step in this Direction because I think all over the world now people have realized that over the 1990s the instability of the 1970s under floating rates the the debt crisis of the the currency crisis of the 1990s from Mexico to Argentina to To the Asian crisis has indicated that we're dealing with a dysfunctional system this volatility and that the best solution for it is for Coherent more coherent policy at the center of the international monetary system and the key point in that Would be the creation of a world currency. Thank you This point And we've invited the panelists up for questions Write your questions on the sheet of paper and the ushers will bring them to you Have a quick announcement before we begin here Because of the inclement weather yes, it is raining out there the complimentary coffee And hot cider that was scheduled for outside has been moved indoors to the Lund Center forum That would be through this door and in the building to the left of us here This is where some of you had bag lunches for lunch and more of you would have had it there if we would have told You where to find them. We're sorry about that Once again, we will begin our first lecture response by taking comments or questions from the other members of our panel While those comments and responses are being addressed by dr. Mandel. We will also be collecting Questions from the audience if you have questions you would like to pose for After Mandel you may pass those to the passing ushers who are out there We would like to get this portion of the program underway at this time So if you'll please take a seat begin our responses from the panel. I'll call them Michael Solman Mr. Solman Mr. Solman Well Dr. Mandel I would like to To make a comment about your description of the euro the Danish election referendum But in more general terms as I see it There is a credibility gap The euro has was launched with such promises of Success even of promises or threats against the dollar the euro would squeeze out the dollar and and such talk Which has not been substantiated by my The events That's one thing the second is there is a credibility gap within the EU Against Brussels and there are some quite serious questions of Democratic transparency and control Accountability which sooner or later will have to be addressed in a serious way and that has not been done And what we have seen in in in in Denmark is a very respectable turn out Some slightly below 90% of the population Which went to the referendum and if you're a Democrat Democratic-linked line you have respect for such an outturn Irrespective of your position and what we see as a reaction against the elite in Denmark and At the European level and if you go to to Germany as far as I know the opinion polls Are not very positive to the euro at present now this is for for so the democratic dimension then you have the The market dimension of the capitalist dimension You and here comes my question You said that yes the We have three areas of stability and In terms of inflation rate Nonetheless One of these three parties loses 25% of what they whatever it is in value towards the dollar Well, what what is the main explanation for this development if the expectations are that the the The inflation rates will converge there would be no reason for for such a movement But we had it I have my explanation that I would be interested to listen to your How come that the capital markets showed such distrust to towards the euro but when the euro Was created and it had that started off with the value of dollar 18 a Lot of people were very happy that it because prior to that a lot of people have been saying that the Big danger is that the euro will be strong. It'll be like the Deutsche mark and it'll Push up and make the European currencies more overvalued than they were to start with and at the same time there were people like Mr. LaFontaine in the German Parliament Mr. Finance who is advocating expansion or using the central bank to solve the problem of the European unemployment and Mr. Prodi in Italy had been saying something similar that the resources Foreign exchange reserves should be spent to increase employment. So when the euro fell to toward $1.10 or $1.05 then it looked as if that Completely undercut those arguments and that really was a very good thing for Europe And I think it was a good thing for the German economy and it was all that But is it the euro did go down as it started to sink below parity with the dollar it Started to raise deeper questions of why was the euro falling and you could List a large number of them. I had done this before the euro came into being in 1998 it listed six liquidity factors that would affect the euro when it was created four of which would Make the euro go down two of which would come along later and make the euro go up the positive factors were Central bank demand in the long run so but the initial factor was that when you suddenly replace one currency or 11 currencies with one currency the one Currency mass is much more liquid and effective and productive than the combination of the subcomponents And that it's as if you get a sudden increase in the money supply that would make the euro go down But there were definitely other factors at work and making it go down more and lack of confidence seemed to be one of them One of them and and this was a factor that was pushed very much by those who wanted European Big change in European policies that there was discontent that European cope with the problem of its labor markets that hadn't got its fiscal house in order and that it hadn't been Even lowering tax rates and deregulating to make the economies more efficient So it would have higher degrees of growth at the same time the dollar the US economy was Spreading its wings very rapidly and that is always a short-run factor that keeps the dollar strong but I myself think that and last February Last January even even in December. I was arguing that the central bank should intervene Because first of all the euro hadn't been created yet Euro and paper currencies not there yet. We're still in the transition stage people It's an it's partly an unknown quantity and there's a great demand for pure currency If you think of what happened in the in December, what was the big thing going on last December? it was the y2k problem everybody was worried about nobody knew how Significant was going to be or not, but the way in which the United States coped with that problem Was by creating 50 billion paper dollars 50 billion dollars worth of paper of paper dollars Europe couldn't do that. There was no mass. So the way you've got this tremendous shift into the dollars But there's no European currency out there yet, and there won't be until for another year and a half So so that's a big weakness in another part of the another weakness in the euro and causing it down And that Richard Cooper has brought this factor up that there's nothing in Europe that corresponds to the US Treasury bill a liquid instrument that can easily be Be got of course you can get to German Treasury bills and Italian Treasury bills But there's no Europe wide instrument and that's a weakness and another factor is that With the creation of the euro and the much more liquid much bigger Capital market now in Europe. Everybody was rushing into Europe creating euro bonds and The supply was in excess of the demand demand hadn't yet caught up with this and So what the way that that affected markets is that the euro had to go down until people would be willing to hold these euro denominated assets, but Don't ever believe that under the best of circumstances that a free market in exchange rates Will ever give you a free market equilibrium? It's not like when you're talking about paper exchange rates of paper currency There's nothing in economic theory that has ever proved that a Flexible free market in exchange rates will ever yield anything close to an equilibrium It's not it not an issue of Private enterprise or government interference government is head and shoulders into the money industry government monopolize that the the most socialized industry in the world is the money industry It's completely controlled by the government and it's not production through any means of by any competitive process It's a production of pure paper money overvalued paper money and everything depends upon the quantity fixing of the government In terms of the price of that, but there's no basis whatsoever for thinking that a free market in exchange rates Would ever give you an optimum position? Let me prove that to you in a moment Let's suppose that people were talking about flexible exchange rates and that Milton Friedman was arguing for in the 50s for flexible exchange rates and made James Meade was Very significant isn't it that the two countries that the two leading professors who were pushing for flexible exchange rates in 1950s came from the two leading powers of the world financial powers Britain the leading financial power of the 19th century in the United States leading financial power in the 20th century. Well They they weren't thinking about the world of anything abstract about the world economy They were thinking about the dollar that Milton Friedman was thinking about why should we worry about the exchange rate? for that and There's that's a defensible position for the United States But just imagine that when the world moved to a flexible exchange rates in 1973 imagine that there were is now 178 members of the IMF and each One of these members all had the same size Imagine 178 countries in the world 178 currencies and every currency the same size. Do you know what that means? How many exchange rates there would then be in the world? You'd have to think about you'd have to think about 15,504 you multiply it a half times 178 times 177 it comes to something like that over 15,000 exchange rates it'll be complete chaos and The only the move we never moved toward flexible exchange rates We moved to a dollar system what gave coherence and major a modicum of sense System for the world economy was the domination of the dollar After all suppose that the dollar was a world empire then the dollar would be a world currency and Suppose then the someone in that said well, let's have flexible exchange rates well There would be no exchange rates. So that would be a perfect system. It wouldn't matter Well, the dollar isn't the whole hundred percent of the world economy, but it's 25 percent of the world economy And so for the United States, it's a perfect system, but for the rest of the world It's a rotten system. It's never worked. Well, it's why Europe tried to Do something about it. It's why Latin America and Asia are trying to do something about it but why the International Monetary Fund, which is is manipulated by the United States and Europe is just going to Go on its own way. Anyway, the Danes I'm sure I I was spoke harshly about the Danes and their choice and of course they you can say they have a Democratic right to just say no on this and I agree that that's true But what I think was I think it was a great mistake on the part of Denmark and I think it is a mistake on the part of Sweden and I think it is a mistake on the part of Britain to have a Referendum on currency matters. This is not a subject for a referendum. It's not there's no way that The typical cab driver in London is going to become a currency expert and going to be able to talk about the nuances Whether it's a good idea or a bad idea to do that He can only listen to what the what the Murdoch newspapers say and that they're against it And so they're currently against it, but you don't get in you don't get any serious Discussion going there's been no serious discussion in the UK about joining or not and there can't be on this kind of issue but I remember a Robert Novak once at a conference was saying saying He was talking about what what did congressman think about the exchange rate or the international monetary system and and Novak's answer was well, you know the congressman think about exchange rates the way the the some Cleaning women ladies think about Windows are earning cleaning women sometimes say I don't do windows and congressman say I don't do exchange rates congressman Congressman don't do exchange rates, but the public can't make decisions on exchange rates. You would never want Not to put it to a referendum In in December the 8th 1941 Should the United States declare war in Japan after Pearl Harbor the government made that decision That's what it's elected to do the government's made elected to make subtle decisions Taking into account both sides, maybe you can have an election in between but let the government make the decision and not not Turn these issues over to referendum referendum democracy is a terrible Democracy calling Jeffrey sacks. Let me wade into this also First as always I learned an incredible amount listening to Bob And this is the third time now in four months also in Korea, so I've really been treated to a great feast again today I Want to I want to bring you back to your original article on optimal currency areas though which was one of the great The great economic path-breaking articles of the last half century and There if I remember correctly you treated the optimal currency area issue more as a trade-off than you seem to now Where you had pluses on one side and and negatives on the other side the pluses of a currency union were the reduced transactions costs The benefit of having one money covering a larger economy and the reduced Unnecessary volatility what you talked about today But there were also in the original analysis pluses of having separate currencies as opposed to having a currency union one of them for example was that the exchange rate under certain circumstances can serve as a shock absorber not just as a creator of risk and I would have thought that We can see that also at play even now Let me just take Two examples that you mentioned one is the Canadian US exchange rate It does seem to me that looking back on the 1997-98 Asian crisis When Canada was particularly hard hit because of the commodity price declines coming from the Asian crisis that the weakening of the Canadian dollar was a an important counter-cyclical Event for Canada that helped to keep the Canadian expansion going and if I remember correctly It sure looked like a classic Mandela effect to me that one of the two monetary regions was asymmetrically hit its currency therefore depreciated relative to the stronger region and therefore it was able to get its way through without recession and I Gave that lesson to my family when we decided to vacation in Canada in 1998 because the The ski area prices were lower and I told them this was just the Mandela effect at work And that they should they should appreciate it The second example seems to me at least in part to be the the euro effect right now I'm not quite so convinced that the euro depreciation is just a matter of confidence As opposed to a matter of the underlying weakness of the real economy in Europe Europe is not experiencing the new economy in the way the United States is Europe is a mess of labor market restrictions over taxation and the like and It seems to me that the relative weakness of the euro may be just what the doctor ordered in a sense again an asymmetric phenomenon Where the US has had a positive? Very strong productivity shock, which in your model in the early 1960s would lead to currency appreciation and The euro depreciation seems to me to have helped European unemployment coming down in the European economy relatively strong and it's precisely the fact that the euro is Commanding a stable purchasing power that seems to me to be the best argument for euro depreciation It's not an inflationary phenomenon. It is again to some extent a counter cyclical real shock absorber I know that's not as fashionable now as it used to be in economics But I actually still believe in these nominal exchange rate movements having their real shock absorber effects And since I learned it from you. I'm pretty sure it's right But I think that there are two other issues that I raise with you as well in terms of optimal currency area two other risks that I would add to your 1960s rendition of the balances of benefits and risks a fourth Area and another risk. I would add to the shock absorber loss if you peg is That you could peg to the wrong partner and One of the things that Britain is grappling with is that it doesn't look to Britain like the continental European Union model not the euro But the European Union model is the right kind of economy for the future and I have my own doubts about The dynamism of continental Europe when taxation is more than 50% of gross domestic products How deeply do you want to bind yourself to a highly labor market regulated highly overtaxed? regime policy regime that also seems increasingly in some ways to be anti technology for instance in agro-technology and so forth where a technology backlash seems to me to be an odd phenomenon at play a Final point on risk seems to me to be global risk that comes from a single currency, and I'd like your view on that You're of course, right that we did have a global currency in 1929 and I think there is little doubt in my view that that the fact that there was a near universal gold standard or at least a gold and silver standard in 1929 was one of the propagating mechanisms of the Great Depression that it was very hard to have independence of monetary policy to allow monetary expansion when it was needed and I wonder if there isn't one crucial fact of Having a global currency, which is that if you get it wrong You really make a doozy then whereas if you have a bunch of separate currencies and you get it wrong You get it wrong for your area, but but the average is a workout that you don't make a global disaster So these are the pluses that I see the shock absorber avoiding the wrong partner and not aggregating your risks unnecessary unnecessarily and I thought that the plus minus Kind of argumentation was at the core of your original analysis of this. So I'd like your reaction to it Well, those are very interesting Comments and not completely unexpected My Remember Someone wrote a book it was Oh, it was Robert Sayers on modern banking and he was talking to a student who said he thought he would write a book and Sayers said oh Don't never write a book. He says you say in it something then you have to defend that for the rest of your life Such a big especially in the more famous the article or the book becomes the harder It is to know the more you're stuck with those things however, I Have to say that a lot of people use the optimum currency area argument and they throw it back in my face Saying that I don't seem to Say I don't seem to be saying what I was saying then but I the first point I want to make is that The people who talk about the optimum currency area paper haven't read it very carefully in the very first paragraph it says the Main function of this paper is to cast out on the alternative an alternative to the present system the system of Flexible exchange rates linked to national currencies. It was to cast out on flexible exchange rates So the it is announced after in the first five lines of the paper that the article is an attack on flexible exchange rates or Casting doubt on that the second point to notice is it is that I Assumed in that paper for the sake of argument, and this was written in 1961 first presented in 1957 I Assumed in that argument that the arguments for flexible exchange rates made by the main people who were pushing them Maybe at that time Milton Friedman and and James Meade were valid But what was that argument the argument basic argument for flexible exchange rates was that Money wages are rigid. It was a Keynesian argument This is strange coming from Milton Friedman, but it was a king rigidly rigidities of wage rates and the exchange rate is a way of overcoming those rigidities of wage rates, and so what it meant was that You have a shock in the country Shock somewhere declining demand Unemployment But wage rates can't fall because money wage rates are rigid. Maybe they're fixed by agreements with trade unions So you can't all you you have you're stuck then with the unemployment but if you have the weapon of devaluation you can then raise prices and lower the real value of wagers and hope that the Workers are going to be fooled by this for a long period of time now I Assumed that this argument was valid I didn't I said for the sake of the argument we're going to go on making that assumption But I never endorsed that argument and I came very much to disagree with it I never to dislike it and as much of The rest of the profession came to just believe that argument that you can't fool People very much very often by exchange rates once you change the exchange rate Let's suppose you do this in a small cut depends on the size of the country suppose you devalue in a small country There's not much money illusion attached to this very quickly within a few hours Prices start to rise all price of international goods go up and and there's no money illusion and very quickly People's real incomes are hurt and they then ask for higher wages So you get no benefits for this take a case of a shock that's very specific to Regions in a case. Let's take the take the case of the oil shocks in the United States the oil shocks to In the 19th the first shock and the second shock 73 and 79 oil went up Three or four times in 74 and it went up two or three times more again in 1979 Now each time those went up that hurt very much the oil consuming regions of the world look at the United States The United States it hurt particularly in New England and you did get at that time professors from Harvard Arguing that well, it would be if we only had a doing has a separate currency If they could create a separate currency then they could devalue and that would save them from this oil shock now Just think what think of what they're saying The big problem for New England is that the oil prices have gone up four times And they're saying that if we had a separate currency we could devalue it and make them go up six or eight times That doesn't solve the problem Turn it around when it when it meanwhile, of course, Texas where it was Texas millionaires were were in in great shape of this period But in 1985 exactly the opposite happened the oil prices collapse And if Texas had had a separate currency they could they could have devalued at that time And it's true Texas in 1985 in 86 87 was a kind of basket case And maybe you could make the argument that if you had devalued if you had a separate currency You could devalue it you could spread the misery a little bit more because there is an element of the shock after all When a country devalues the they impose a tax on cash balances It's a tax on money a tax on cash balances And that new tax is quite generally felt and that does have there's some measure to it But in the process of this thing you would end up moving the United States with its magnificent currency system that's the envy of the world To the state that Europe is in or was in recently and is trying to avoid you'd Balkanize the United States the way Europe has been Balkans I just don't believe the argument anymore And I don't think that it helps out and about the installation against shocks including Canada At change in the exchange rate Does cannot do anything? To change the terms of trade The exchange rate in the terms of trade are a completely separate thing The terms of trade is the relative price of exports to imports expressed in the same currency Doesn't matter which one and the terms of trade Can't be changed by changing the exchange rate because you're affecting both sides. This is a common mistake I made this in the Attack on the Bank of Canada who was making the argument about the importance of exchange rates They said that we can the head to let the exchange rate change In order to offset changes in the terms of trade well late I pointed out that was a mistake and they they brought that up, but anyway So that's unfortunately, that's only the that's the first question. I've tried to be very brief on the on the Let me just let me let me just make it I won't talk. I won't talk about the Europe case. I won't talk about the your case Just let me just let me finish this one thing about the the thing about this below the belt hit by Jeffrey Shax When he talked about 1929 Now if anyone has read my Nobel lecture published in the June issue of the American Economic Review It makes it very clear what was the situation in 1929 the 1929 Arrangement was not a universal currency. It was not a gold standard. This was a badly Reconstructed gold standard that hadn't taken into account the fact that gold was undervalued at this time And it was exactly the gold standard going back to the gold standard of falsely and badly drove the United States into the Depression, so it was a deliberate creation many economists predicted It said said if you go back to the gold standard at current prices, you're going to have a huge depression Recession and that's exactly what happened So I think that if he he would what I would challenge him to do is to find a case During the heyday of bi-metallism or the heyday of the gold standard when a similar thing happened I there is after the Napoleonic war a similar kind of problem, but I think that his argument there is completely wrong We're facing the tyranny of the clock our schedule is going to adjust slightly We will take about a 15 minute break beginning from this time and reconvene for the follow-up lecture