Posts Tagged ‘Costantino Bresciani – Turroni’

Is the falling dollar good for the economy?

Thursday, August 28th, 2008

In the financial news media, we often hear reports that give the impression that the fall of the dollar (whether US dollar or the Australian dollar) is good for the economy because it benefits exporters. In reality, this is only half-true- exporters may benefit, but it may not be necessarily be good for the economy as a whole.

To see why, take a read at Chapter 6 (The Depreciation of the Mark and Germany’s Foreign Trade) of this book, The Economics Of Inflation- A Study Of Currency Depreciation In Post War Germany written by Costantino Bresciani – Turroni, an economist who lived through the German Hyperinflation of the 1920s:

The relations between exports and production deserve to be considered in greater detail. Three principal cases may be considered:

  1. The increase of exports of a given article, which is the consequence of the divergence between the internal and external values of the national money, is not followed by an increase in the production of that article. The rise in exports signified in this case a corresponding fall in the quantity formerly consumed at home.
  2. The possibility of increasing the exports of a given article provoked an increase in the production of it, but at the expense of other articles, the export of which is less attractive. On the whole, the production of the country is not increased; only the direction of economic activity is changed.
  3. The rise in exports is accompanied by an increase in the total production of the country with a depreciated currency.

Before we continue, we must first explain the concept of internal and external value of a currency. Basically, the internal value of a currency is its purchasing power domestically. Let’s say an apple cost 1 dollar domestically. This is the internal value of the dollar. Let’s say an apple cost 2 marks in a foreign country and the exchange rate is 1.5 mark for 1 dollar. Therefore, the cost of an apple overseas is 1.33 dollar. This is the external value of the dollar. In this example, the internal value of the dollar is greater than its external value.

Let’s say the dollar depreciate in value. As a result, there is a divergence between the internal and external value of the dollar. Since in the short term, the domestic economy cannot increase its production, effect (1) will be the result. In other words, using the example above, domestic apples will be exported, resulting in less apples domestically. The outcome is price rise for domestic apples. As Costantino explained,

The first case appears when a divergence between the internal and external values of money occurs suddenly and after a short time stops. The influence of that divergence is shown only in the sale of goods already in the warehouses; given the brief duration of the phenomenon, production in general does not feel it.

In the longer term, either effect (2) or effect (3) will be the outcome. That will depend on the situation of the domestic economy. Let’s say the economy has plenty of spare capacity. Perhaps there are far too many unemployed apple growers and land laying idle. In that case, all these idle resources will be put to work to produce more apples, which will raise national income. The nation becomes wealthier as a result. This is effect (3). As Costantino explained,

On the other hand, in a country where only a part of the machinery is occupied and where there is a considerable number of unemployed, a depreciation of the exchange, by stimulating foreign demand, can really provoke an increase in the total production.

What if the economy’s productive capacity is completely used up and can no longer increase its production of apples? In that case, the economy has to free up resources in order to produce more apples. This may mean that for example, clock makers may have to change their professions into growing apples. This means a restructuring of the economy whereby some industries will have to decline in order for the export industry to expand. This is effect (2). As Costantino explained,

But in a country where plant is already fully occupied, where unemployment does not exist, and where available resources are scarce, the effects on total production cannot be very considerable. If the divergence continues, a displacement of production is slowly produced: capital and labour move towards the production of those goods for which the divergence [in the internal and external value of the domestic currency] is most conspicuous.

In the next article, we will apply these insights into the study of real-life economies.

Harmful effects of inflation

Tuesday, June 17th, 2008

Lately, price inflation around the world looks to be getting out of hand (see A resemblance of the beginning of Weimar-style inflation). When price inflation was affecting asset prices, nobody complained because it conveys an illusion of prosperity. But when it spills over to the prices of daily living, it provokes a reaction of kicking and screaming among the masses. Indeed, 15 months ago, before the mainstream masses had any idea that the ravages of inflation will eventually hit them hard, we warned in Have we escaped from the dangers of inflation? that

… we are very sure that as all these liquidity work its way to the rest of the real economy, it will only be a matter of time before price inflation will show its ugly head. Yet we are simply amazed with Wall Street?s obliviousness to this danger and Ben Bernanke?s incredibly sugar-coated words in his recent economic report to Congress. Can we rely on the Chinese to forever keep the price of importable things down to save us from inflation?

Make no mistake about this: central banks around the world are still inflating the supply of money and credit. With such a colossal amount of debt in the global financial system, there is no other choice but to continue inflating in order to remain solvent. As inflation worsens, we will all pay the price for the harmful effects of inflation.

Today, we will look back into history and learn how inflation nearly destroyed a country. We will turn into an old book, The Economics Of Inflation- A Study Of Currency Depreciation In Post War Germany, written by Costantino Bresciani – Turroni, an economist who lived through the German Hyperinflation of the 1920s. In chapter 5 of that book, he wrote,

The inflation profoundly altered the distribution of social saving. It is true that at first a certain mass of “forced saving” was created. But it cannot be said that these savings became available to the most productive firms and to those entrepreneurs who were most able to employ rationally the capital at their disposal. On the contrary, inflation dispensed its favours blindly, and often the least meritorious enjoyed them. Firms socially less productive could continue to support themselves thanks to the profits derived from the inflation, although in normal conditions they would have been eliminated from the market, so that the productive energies which they employed could be turned to more useful objects.

Nowadays, the less socially productive businesses include investment banking, money shuffling (hedge funds) and home building (in the US). Inflation allow mal-investments, which consumes resources wastefully for unwanted ends. Since an economy has a finite amount of resources, such wastage means that they will not be deployed in means that really matters. Also, Constantino wrote,

Also the continual and very great fluctuations in the value of money made it very difficult to calculate the costs of production and prices, and therefore also made difficult any rational planning of production. The entrepreneur, instead of concentrating his attention on improving the product and reducing his costs, often became a speculator in goods and foreign exchanges.

Success was the lot not of him who increased the productivity of society’s efforts, thus contributing to the increase of general welfare, but to him who had the capacity for organizing and directing great speculations on the exchange and for using wisely, with the object of personal gain, the variations of the value of money.

The surging asset prices (e.g. stocks, bonds, properties, commodities and yes, even artwork!) of the past several years are not signs of a strong economy. Rather, they are symptoms of inflation, brought about by speculation (see our guide Are Australian residential properties good investments? for an example of such speculation). Indeed, the pain of rising food and oil prices were made worse by hoarding and speculating (see Who is to blame for surging food and oil prices?).

With inflation, there is less incentive to be productive and more incentive to hoard, speculate and gamble. This in turn will reduce productivity and increase price inflation, which further increase the incentive to be less productive. In addition, as we said before in How to secretly rob the people with monetary inflation?, inflation re-distribute wealth unfairly and exacerbate the divide between the rich and the poor.

As time goes by, the economy will be structurally damaged one step at a time. This process can take many decades to completely play out. Of course, with economic mismanagement, it can be accelerated, as in the case of Zimbabwe. Sadly, the world is still committed to inflation.

The economics of inflation

Wednesday, May 21st, 2008

Today, we will introduce another great book- The Economics Of Inflation- A Study Of Currency Depreciation In Post War Germany by Costantino Bresciani – Turroni, an economist who lived through the German Hyperinflation of the 1920s. That book was first published in Italian in 1931 and the English edition was first published in 1937. The foreword of this book begins:

THE depreciation of the mark of 1914-23, which is the subject of this work, is one of the outstanding episodes in the history of the twentieth century. Not only by reason of its magnitude but also by reason of its effects, it looms large on our horizon. It was the most colossal thing of its kind in history: and, next probably to the Great War itself, it must bear responsibility for many of the political and economic difficulties of our generation. It destroyed the wealth of the more solid elements in German society: and it left behind a moral and economic disequilibrium, apt breeding ground for the disasters which have followed. Hitler is the foster-child of the inflation. The financial convulsions of the Great Depression were, in part at least, the product of the distortions of the system of international borrowing and lending to which its ravages had given rise. If we are to understand correctly the present position of Europe, we must not neglect the study of the great German inflation. If we are to plan for greater stability in the future, we must learn to avoid the mistakes from which it sprang.

This book was recommended by Marc Faber and serves an excellent example of what can go wrong even in a highly cultured and advanced nation. Although history never repeats itself exactly, it rhymes and provides a grave warning to us today. If you have not already, we recommend that you read out guide, What is inflation and deflation? first before reading the rest of this article.

Now, let us turn our clocks back to Germany after the end of the First World War. For a period of time, the German economy seemed to be prospering- it was the envy of others. As Costantino wrote in Chapter 5,

It was often affirmed that only the inflation made it possible for German industry to continue to produce, there being the exceptional and interesting spectacle of extraordinary activity and prosperity in Germany at a time of general crisis in business in other countries, and especially in some of those who were victorious in the Great War.

To this view others objected that it was a question only of an “apparent prosperity,” which concealed the real and continual loss of capital, the disintegration of productive apparatus, the increasing poverty of many classes of society, and the symptoms of a crisis, which, after having remained latent for a long time, burst forth with unparalleled violence in the last months of 1923.

After the First World War, Germany had to sign the Treaty of Versailles, which required her to pay punishing war reparations. Up till 1919, the German mark fell rapidly and remained stable till the second half of 1921. As Costantino wrote in Chapter 1,

Throughout this period the movement of the mark exchange was analogous to that of the other principal European exchanges, save for a greater amplitude of fluctuation.

But from the second half of 1921 onwards (till 1923), the German mark began a downward spiral and depreciated exponentially (so much so that a diagram of the mark exchange rate with the US dollar was best drawn on a logarithmic scale). It was under this backdrop of a depreciating currency that (Chapter 5):

To that was added the influence of an economic conception, which is widely held in countries with depreciated currencies, that is the myth of “real value” or “intrinsic value.” It was thought that even if for the time being the entirely new equipment was not utilized, it nevertheless always represented an “intrinsic value,” a “substance” as it was called in Germany.

In times of inflation, the Germans hoarded capital equipment in an attempt to preserve the purchasing power of their rapidly depreciating marks. Today, we have a similar parallel- under the depreciating US dollar, prices of oil, gold, silver and commodities (including food and base metals) in general soared due in part to hoarding (see Connecting monetary inflation with speculation) and growing demand from China and India.

The initial effects of inflation in Germany seemed to be prosperity. German engineering industries were greatly stimulated during the fall of the mark. Demands for these capital goods eventually converged on the market for iron and coal, which was a great boon for these industries. There was a continuous reallocation of resources from the consumer goods industries to the capital goods industries. As Costantino quoted Professor Hirsch,

… from 1919 to 1921 an industrial migration occurred with a rapidity which had no precedent in history; more than 200,000 new workers were employed in the mines.”* The highest number was reached towards the end of December 1922.

This expansion resulted in Germany not only reconstructing their industrial capacity after the war, but also greatly enlarge them.

Sadly speaking, monetary inflation always result in distortion that are harmful to society in the long run. In Germany, the distortionary outcome was:

In the acutest phase of the inflation Germany offered the grotesque, and at the same time tragic, spectacle of a people which, rather than produce food, clothes, shoes, and milk for its own babies, was exhausting its energies in the manufacture of machines or the building of factories.

Looking back at history, we find many eerie parallels with today.