Author Archives: Mark

The Pound, the Exchange Rate Mechanism (ERM) and George Soros pockets $1bn

Teaching  exchange rates with my AS Level class and couldn’t get away from the events in Britain on the 16th September 1992 – known as Black Wednesday. On this day the British government were forced to pull the pound from the European Exchange Rate Mechanism (ERM). The video below explains the drama that unfolded very well.

Background

The Exchange Rate Mechanism (ERM) was the central part of the European Monetary System (EMS) and its purpose was to provide a zone of monetary stability – the ERM was like an imaginary rope (see below), preventing the value of currencies from soaring too high or falling too low in relation to one another.

It consisted of a currency band with a ‘Ceiling’ and a ‘Floor’ through which currencies cannot (or should not) pass and a central line to which they should aspire. The idea is to achieve the mutual benefits of stabel currencies by mutual assistance in difficult times. Participating countries were permitted a variation of +/- 2.25% although the Italian Lira and the Spanish Peseta had a 6% band because of their volatility. When this margin is reached the two central banks concerned must intervene to keep within the permitted variation. The UK persistently refused to join the ERM, but under political pressure from other members agreed to join “when the time is right”. The Chancellor decided that this time had come in the middle of October 1990. The UK pound was given a 6% variation

Black Wednesday

Although it stood apart from European currencies, the British pound had shadowed the German mark (DM) in the period leading up to the 1990s. Unfortunately, Britain at the time had low interest rates and high inflation and they entered the ERM with the express desire to keep its currency above 2.7 DM to the pound. This was fundamentally unsound because Britain’s inflation rate was many times that of Germany’s.

Compounding the underlying problems inherent in the pound’s inclusion into the ERM was the economic strain of reunification that Germany found itself under, which put pressure on the mark as the core currency for the ERM. Speculators began to eye the ERM and wondered how long fixed exchange rates could fight natural market forces. Britain upped its interest rates to 15% (5% in one day) to attract people to the pound, but speculators, George Soros among them, began heavy shorting* of the currency. Spotting the writing on the wall, by leveraging the value of his fund, George Soros was able to take a $10 billion short position on the pound, which earned him US$1 billion. This trade is considered one of the greatest trades of all time.

* In finance, short selling is the practice of selling assets, usually securities, that have been borrowed from a third party (usually a broker) with the intention of buying identical assets back at a later date to return to that third party. The short seller hopes to profit from a decline in the price of the assets between the sale and the repurchase, as the seller will pay less to buy the assets than it received on selling them. Wikipedia.

Impact of an appreciating currency

Currently looking at exchange rates with my AS class. Below is a mindmap showing the causes and effects of a rise in the value of a currency. Also looks at how a rise in the currency may reduce inflationary pressure. Good for revision purposes when dealing with exchange rates and trade. Also gives a structure for essay questions / long answers in CIE and NCEA respectively.

Adapted from CIE A Level Revision by Susan Grant.

The New Corporation – Documentary

Following on from the very successful documentary ‘The Corporation’ comes ‘The New Corporation’. The Corporation​ examined an institution within society. THE NEW CORPORATION reveals a society now fully remade in the corporation’s image, tracking devastating consequences and also inspiring movements for change. Click on the link below to view screening options – The New Corporation

The Supercycle and MMT

I listened to a very good interview on the David McWilliams podcast in which he talks with Dario Perkins the super cycle and the end of neoliberalism. A lot of the discussion was around the paper that Dario Perkins had written – A New Supercycle Running on MMT – in which he sees MMT as delivering a superior fiscal-monetary mix.
The fact that fiscal policy must take over from monetary policy has been the apparent with the range of policies that were implemented after the GFC. Since the late-19th century the super cycle can be placed into three phases of Capitalism influenced by macro-financial-political regimes – see chart below. MMT could provide the intellectual rationale for a new form of capitalism – Capitalism 4.0. Over the last century the pendulum has swung between extreme fiscal and extreme monetary policy with the global economy primed for another change.

1920’s – Monetary policy dominated but ineffective during the Great Depression
1930’s – Fiscal policy dominated as there was a need for government intervention to get the economy moving after the Great Depression
1940’s – 1960’s – Fiscal Policy – with the 2nd World War and the recovery process post-war.
1970’s – Stagflation and fiscal policy is no longer effective and Keynesian economics as government spending just causes higher inflation and higher unemployment.
1980’s – Monetary policy gains traction and inflation is brought under control. Central Banks become independent and fiscal policy and government intervention is seen as a restriction to growth. With Reagan and Thatcher Neoliberalism was the ideology of the day

Source: A New Supercycle Running on MMT

Have we reached a new regime – Capitalism 4.0?
The GFC was a warning that capitalism in its present form was not working and there was potential for a new regime change. However governments adopted austerity and QE which made inequality worse. The issue was that there was no alternative to the neoliberalism Capitalism 3.0 but with the arrival of COVID-19 governments have been forced to spend up large and there is a belief that the old system doesn’t work and that maintaining Capitalism 3.0 will not make the situation any better. Stephanie Kelton, author of The Deficit Myth, argues that we need to rethink our attitudes towards government spending.

Modern Monetary Theory (MMT)
MMT states that a government that can create its own money therefore:Cannot default on debt denominated in its own currency;

  • Can pay for goods, services, and financial assets without a need to collect money in the form of taxes or debt issuance in advance of such purchases;
  • Is limited in its money creation and purchases by inflation, which accelerates once the economic resources (i.e., labor and capital) of the economy are utilised at full employment;
  • Can control inflation by taxation and bond issuance, which remove excess money from circulation, although the political will to do so may not always exist;
  • Does not need to compete with the private sector for scarce savings by issuing bonds.
  • Within this model the only constraint on spending is inflation, which can break out if the public and private sectors spend too much at the same time. As long as there are enough workers and equipment to meet growing demand without igniting inflation, the government can spend what it needs to maintain employment and achieve goals such as halting climate change.

It will be interesting to see if MMT can enjoy the same presence in economic policy that monetarism and Milton Friedman experienced in the post-stagflation time period. Back then there was a political revolution primed to embrace monetarism and neoliberal ideas and an electorate that had experienced a serious economic crisis – stagflation. Subsequently the influence of MMT will come down to politics.

Joe Biden seems to have embarked on a more radical macro-economic policy which has various instruments that are found in MMT. Will there be other political leaders who embrace this paradigm like Reagan and Thatcher in the 1980’s with Friedman and monetarism?

Source: A New Supercycle Running on MMT

Behavioural Economics course for school students

At various stages of my teaching I have delved into the area of Behavioural Economics as it is part of the CIE A2 course and from a personal interest perspective. I have attached a course booklet that consists of lesson plans on various topics and resources that are required to supplement the course. Click below to download the course notes and workbook. If you would like the PowerPoints that complement the course please email me – m.johnston@kingscollege.school.nz – and I will forward them on. Ideal for those Friday afternoon classes.

Behavioural economics is about bringing reality into economic analysis. It borrows from psychology, sociology, politics, and institutional economics (which focuses on the rules of the economic game) to describe and explain human behaviour and economic phenomena. Behavioural economics builds upon conventional economics, offering more tools for understanding why people behave the way they do when it comes to income, wealth, ethics, and fairness. It uses prospect theory to describe the choices that the typical person makes. The course is split up into 4 topics and is designed for approximately 12 periods in length.

1. Understanding Choice

Free choice in Economic Decision Making – Nudging – Anchoring and Framing – Free – Placebo Effect – Paradox of Choice – Loss Aversion and Endowment Effect – Conventional v Behavioural Economics

2. Ethics and Economic Growth

Ethical Behaviour – definition – Milton Friedman and ethical behavior – The Conventional – Perspective on Ethical Behaviour and the Economy – A Good Company – Ethics / – Happiness – Examples of Companies with socially responsible norms – Ethics and Profits
Ethical consumers

3. Behavioural Finance

Definition – what is it? – Efficient Market Hypothesis – Random Walk Hypothesis – Irrational Exuberance – Bubbles and Busts – Tulip – Great Crash – Dot.com – 2008 Global – Financial Crisis – Causes of Bubbles

4. Game Theory

Introduction to Game Theory – Football – Penalty Shoot outs – Golden Balls Game Show

5. Money and Happiness

Conventional Theory – Money = Happiness – Measuring Happiness – Gross Domestic Product v Gross National Happiness – Diminishing Returns for Income and Wealth
Easterlin Paradox: Money doesn’t buy happiness
– The Hedonic Treadmill – Money leads to more happiness but not for too long – Differences in happiness between countries – Government Policy and Happiness- Smarter Spending

Sources:

Behavioural Economics for Dummies – Morris Altman
Thinking, Fast and Slow – Daniel Kahneman
Economic Naturalist – Robert Frank
Nudge – Richard Thaler & Cass Sunstein
Inside Job – DVD
Black Gold – DVD
The Corporation – DVD
How Algorithms Shape our World – TED Talk

Degrowth – is life better with less?

Most economics courses will include the topic of limitations of Gross Domestic Product as an indicator of standard of living. US senator Robert F Kennedy pointed out 50 years ago that GDP traditionally measures everything except those things that make life worthwhile. Increasing GDP has been the indicator of a healthy economy but is it time for degrowth? This CNBC video looks at whether degrowth is the way forward and should we priorities social and ecological well-being? Scotland, Iceland and New Zealand have focused on well-being rather than economic growth. New Zealand’s recent ‘well-being’ budget indicated this. Good video for the future direction of macro policies and where we are going as a society.

The New Inflation Threat – Cost Push and Demand Pull – should we be worried?

If you are teaching macro policy this podcast from the BBC Business Daily programme is excellent. They debate whether inflation will be a short-term phenomenon or have a longer lasting impact on the global economy. It features Mohamed El-Erian, economic adviser and president of Queens’ College, Cambridge, who thinks central banks are already behind the curve when it comes to keeping inflation in check. Dana Peterson of the US Conference Board takes the view that it will be temporary. They also interview a restaurant owner Luke Garnsworthy. Now that England’s third lockdown has mostly lifted, customers are itching to spend and he can’t find enough staff for his kitchens. But, he says raising prices and wages isn’t an option for him. The key points from the podcast are below:

Demand Pressures
A year ago the global economy was in shutdown mode with no demand as consumers had nowhere to go. However with significant spending by governments to support those who have lost their job and the fact that people can’t spend has meant that there is a lot of pent up demand waiting to unleash itself on the market. Now that a lot of countries have opened up their economies, aggregate demand is surging and making up for lost time. This has been a surprise to many but something that is likely to continue especially in those countries that are able to contain the virus and vaccinate their citizens.

Supply constraints
Many supply chains have been slow to return to their pre-covid volume. Problems with containers, availability of container ships have made it very difficult for producers to access component parts, raw materials etc. Commodity prices, eg oil, are on the rise accompanied by semiconductor chip shortages and the Suez Canal tanker incident have caused both businesses and consumers to worry about rising prices.

Countries like Bangladesh, India and Vietnam are central to the global supply chain but the severe nature of the pandemic in these countries has added another bottleneck.

A further problem is the lack of available labour which has resulted in some firms increasing their wages in order to attract workers – Amazon and McDonald’s have done this. But higher wages are unlikely to compensate for structural unemployment – mismatch of skills – which has been very prevalent. In order to compensate for these increasing costs companies will be tempted to put up their prices.

But should we be worried?
Dana Paterson, chief economist at The US Conference Board, believes that the long-term threat of inflation is exaggerated. She suggests that prices are rising in areas that were very popular during the pandemic but as it subsides consumers will switch their spending to other areas that wasn’t possible during the pandemic – eg. bars, restaurants, movies, theatre etc.

The emergence of working from home should offset some of the minimum wages increases in some economies as employees can save on commuting costs and move to cheaper accommodation. Businesses can also save on office space and hire more workers from low-cost areas.

The rise of e-commerce has generated more competition and has helped to keep prices lower. International supply chains, outsourcing and the likely continued relative strength of the US dollar will work to keep prices down. The US Fed view higher prices as a healthy economy and want to see it rise above its 2% target before increasing interest rates. Also tolerating more inflation gives the Fed time to meet its full-employment mandate. There should be more concern about the type of inflation that becomes prevalent – asset price inflation. This is especially true in New Zealand.

New Zealand benefiting from high commodity prices.

New Zealand’s commodity prices have increased by 17% this year and is expected to increase by 22% by December 2021. What has caused this increase in prices? With Covid restrictions lifted in many countries this has seen an increase in demand especially from China and South East Asian countries. Dairy, horticulture and forestry commodity prices have been the big winners. Kiwi fruit returns are expected to be the highest on record and log prices have increase over 20% in the last 6 months. Furthermore with the opening up of restaurants in the northern hemisphere the demand for meat will undoubtedly increase which is a good omen for sheep and beef farmers. At this time of year lamb prices normally fall but prices have actually increased over April and May.

Shipping costs have been very high of late but as they start to come down with more supply this will be a further boost to exporters especially bulky exports like forestry. It is expected that wood export volumes will be approaching record high levels over 2021 and 2022. The strong return from commodity prices will mean higher national incomes and will support the strength of the NZ$ and interest rates.

This could be a honeymoon period for New Zealand exporters as supply will eventually catch-up with demand and bring down prices. From a longer-term perspective, environmental constraints are biting on global food production. New Zealand’s dairy sector is at the coal face and the demands by government for fencing and other environmental restrictions means that there is less land being used and lower stock numbers. Other dairy exporters in Europe are also experiencing the same restrictions and it is the consumer who is likely to bear the increase in costs with higher retail prices.

Source: Economic Overview. Reshaping the world. May 2021

How do deal with a resource curse – Venezuela and Norway

I have been doing exchange rates with my AS class and we talked about the problems some countries have when they are blessed with natural resources – the resource curse. Africa may have enormous natural reserves of oil, but so far most Africans haven’t felt the benefit. In Nigeria, for instance, what’s seen as a failure to spread the country’s oil wealth to the country’s poorest people has led to violent unrest. However, this economic paradox known as the resource curse has been paramount in Africa’s inability to benefit from oil. This refers to the fact that once countries start to export oil their exchange rate – sometimes know as a petrocurrency – appreciates making other exports uncompetitive and imports cheaper. At the same time there is a gravitation towards the petroleum industry which drains other sectors of the economy, including agriculture and traditional industries, as well as increasing its reliance on imports. Economists also refer to this as the Dutch Disease which makes reference to Holland and the discovery of vast quantities of natural gas during the 1960s in that country’s portion of the North Sea. The subsequent years saw the Dutch manufacturing sector decline as the gas industry developed. The major problem with the reliance on oil is that if the natural resource begins to run out or if there is a downturn in prices, once competitive manufacturing industries find it extremely difficult to return to an environment of profitability.

A future resource curse in Indonesia: The political economy of natural resources, conflict and development.

Venezuela could learn off the Norwegians
Venezuela is home to the world’s largest oil reserves, and its economy has been tied to the ups and downs of the international price of oil for decades — oil constitutes about 25% of the country’s GDP and 95% of its exports. But the country’s oil production reached its lowest point since 2003 this year, when production went from 1.2 million barrels per day in the beginning of 2019 to an average of 830,000 barrels per day. The energy sector is only producing a fraction of the 4 million barrels of oil a day it could be producing.

Norway, the world’s third largest oil exporter behind Saudi Arabia and Russia, puts away a large share of its wealth in a national pension fund, now worth more than $300 billion. The problem here is that Norway is a small, homogeneous country of about five million people that was relatively advanced when its oil started to flow. It already had the sorts of public institutions that enabled it to cautiously manage its newly found wealth.
In 1969 the discovery of oil off the coast of Norway transformed its economy with it being one of the largest exporters of oil. A lot of countries in similar positions have succumbed to the ‘resource curse’ in which countries tend to focus on a natural resource like oil. The curse comes in two forms:

  1. With high revenues from the sale of a resource, governments try and seek to control the assets and use the money to maintain a political monopoly. This is where you find that from the sale of your important natural resource there is greater demand for your currency which in turn pushes up its value. This makes other exports less competitive so that when the natural resource runs out the economy has no other good/service to fall back on.
  2. However it is the fall in commodity prices that is now hitting these countries that have, in the past, been plagued by the resource curse. As a lot of commodities tend to be inelastic in demand so a drop in price means a fall in total revenue since the the proportionate drop in price is greater than the proportionate increase in quantity demanded.

Norway – has a different approach.
In Norway hydrocarbons account for half of its exports and 19% of GDP and with further oil fields coming on tap Norway could earn an estimated $100bn over the next 50 years. Nevertheless there is a need to wean the economy off oil and avoid not only the resource curse that has plagued some countries – Venezuela is a good example as approximately 90% of government spending was dependent on oil revenue – but also the impact on climate change. Norwegians have been smart in that the revenue made from oil has been put into a sovereign wealth fund Its value on 31 December reached 10.9tn kroner, or US$1,311bn – equal to assets worth US$241,000 for each of Norway’s 5.39 million inhabitants. This ensures that they have the means to prepare for life after oil.

Policies for Developing Economies

Finishing ‘Developing Economies’ with my A2 class and doing some last minute revision before they have an assessment on it. There is usually an essay question on this topic in the A2 CIE Paper 4. Below is a useful mindmap which has been sourced from Susan Grant’s CIE Revision Guide outlining Economic Development.

Policies for Developing Economies.

The solution is shown in the figure below, where foreign help, in the form of official development assistance (ODA), helps to jump-start the process of capital accumulation, economic growth, and rising household incomes. The foreign aid feeds into three channels. A little bit goes directly to households, mainly for humanitarian emergencies such as food aid in the midst of a drought. Much more goes directly to the budget to finance public investments, and some is also directed toward private businesses (for example, farmers) through microfinance programs and other schemes in which external assistance directly finances private small businesses and farm improvements. If the foreign assistance is substantial enough, and lasts long enough, the capital stock rises sufficiently to lift households above subsistence. At that point, the poverty trap is broken, and the figure comes into its own. Growth becomes self-sustaining through household savings and public investments supported by taxation of households. In this sense, foreign assistance is not a welfare handout, but is actually an investment that breaks the poverty trap once and for all. Adapted from Jeff Sachs – The End of Poverty.

The Role of ODA in Breaking the Poverty Trap