Perry Mehrling - Ideas Lab Series - February 1st, 2023

[00:00:07] Perry

A lot of the challenge of explaining this to people is appreciating that these are banking operations. This isn’t about the US taxpayer lending money to foreigners. That’s not at all what’s happening. It’s an expansion of the balance sheet of the Fed on both sides. There’s no real resources being transferred by these liquidity operations, but that’s actually hard to explain to people. Because our intuitive layperson concept of a loan is, I can’t lend you a bicycle unless I own a bicycle. But if I’m a bank, I can lend you money just by expanding my balance sheet on both sides, and that seems fraudulent or something, on the face of it.

[00:00:51] Intro

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[00:01:47] Niels

For me, the best part of my podcasting journey has been the opportunity to speak to a huge range of extraordinary people from all around the world. In this series, I have invited one of them, namely, Kevin Coldiron to host a series of in-depth conversations to help uncover and explain new ideas to make you a better investor.

In this series, Kevin will be speaking to authors of new books and research papers to better understand the global economy and the dynamics that shape it so that we can all successfully navigate the challenges within it. With that, please welcome Kevin Coldiron.

[00:02:21] Kevin

All right. Thank you, Niels, and welcome, everyone. Our guest today is Perry Mehrling. He’s a Professor of International Political Economy at Boston University. Many of you will probably have heard him on Bloomberg’s Odd Lots podcast where it seems like anytime there’s a crisis, they bring him on to explain to us what’s going on.

He may have also unwittingly founded a new genre of economics books where we tell particular economic history through the life of one of the key participants. He did this in one of his earlier books called Fischer Black and the Revolutionary Idea of Finance. And he’s here today to talk about his new book, Money and Empire: Charles P. Kindleberger and the Dollar System. So Perry, thanks so much for joining us, and welcome to the show.

[00:03:15] Perry

Happy to be here. Looking forward to it.

[00:03:18] Kevin

Speaking of books that you published in the past, in 2011, you published a really wonderful, and I think, quite important book called The New Lombard Street, and you say that’s kind of a biography of the Fed, and that you wanted to follow it up with a biography of the dollar. You ended up choosing to tell the story of the dollar through the life of Charles Kindleberger.

I wanted to ask, why Charles Kindleberger? I think a lot of listeners might know him as the author of Manias, Panics and Crashes, which is a hugely popular history of financial crises. But it’s probably fair to say he’s not someone who was as well-known as Fischer Black. So why choose to tell the story through his life?

[00:04:10] Perry

Well, originally, I had in mind writing a book more similar to The New Lombard Street, that was a biography of a fictional character. But when I discovered the Kindleberger archives at MIT, I actually discovered him more in the Modigliani archives, there was a correspondence between them, and they were both at MIT at the same time. And then I found there were 50 boxes [of correspondence] and this was a very good story. So, I reverted to my former way of telling, like Fischer Black.

I had in mind that he was a man whose dates were just perfect for me, because he was born in 1910, approximately at the time when the Fed was born in 1913. And he went to graduate school in 1932-37, sort of in the depression. So he was formed during this formation period of the global dollar system. He couldn’t get an academic job, so he was at the Fed for a while and then he was at the BIS. And then he only started academia in 1948, more or less right after Bretton Woods.

So his dates allowed me to tell the bildungsroman of a person. It seemed to fit and there was a lot of material. Another thing that makes these books work (and I invented the genre, I don’t know, possibly, I invented the genre), it seemed to be a way to tell the story and it’s important to choose the right person: someone (who I always say) is like a spider in the middle of the web; that he has contacts with everybody. So, MIT became the central department in the post-war period.

He was in the State Department during the Marshall Plan. He was involved. So, he was actually a spider in the middle of the web although he was a staffer, mostly. He did not seek the limelight. He did not want that. He was a scholar, really, even when he was in government service. So, he was really kind of perfect for this story. And if you’ve read the book, you’ll maybe see why he’s more perfect than you might think.

Perhaps I should add, you say, I think it is true, that to the extent that anyone has heard of him, it will be in Manias, Panics and Crashes, which is just coming out in its eighth edition. So, he lives on through his co-author of the new addition (Bob McCauley, actually, is the co-author in this case), who was a student of his. He was a Harvard graduate student who took his classes at MIT, so there’s a connection there as well. But I think that people who read Manias, Panics and Crashes maybe don’t understand exactly what Charlie was about in that book or the context of it in terms of the rest of his work.

You’ve read my book, now, and so you know that there’s a lot more to this guy. One of the reasons you haven’t heard about him is because his approach to international monetary economics, which I call the key currency approach that he got from John H. Williams, is a minority view in the post-World War II period. His student, Bob Mundell and the Mundell-Fleming model became the dominant frame, but that was never his view of how the world worked. And so naturally, he’s pushed aside a little bit.

Plus, he’s a pre-World War II intellectual formation, so he’s not seeing economics in the post-World War II way or even in the MIT way. Imagining that economics is really a job of mathematical modeling and statistical modeling, he was never about that. Economics is about confronting the major problems that are confronting us with whatever tools you have. So as I say in the book, I really think of him more as a kind of intelligence analyst, that his formation was during World War II, when he was in the OSS in London and his job was to sort of tell the generals where to bomb in order to wipe out the German V-2 rocket capability, or to impair their economy, or to prevent resupply after D-Day.

All of these were very concrete problems that you have to have something to say to the generals even if you don’t have all the information you need to run a nice regression or you don’t have a nice little mathematical model. You’re putting together this little piece of data and that little piece of data to say, “I think this is where you should bomb.” And I think that formative experience in World War II, the fact that that worked, that’s another thing to say, and that the Marshall plan worked even though it was not backed up by any of the tools of modern economics gave him great confidence in these methods that he knew how to think about economic problems even without the tools of modern economics.

[00:09:09] Kevin

I’d like to talk about some of those formative experiences. As you were talking, I actually remembered one of my own semi-formative experiences. Charles Kindleberger wasn’t unknown to me because early on when I first met my wife, we lived in London, and we’d get away for these weekend trips. She’s a big reader, but fiction. I’m a big nerdy reader of non-fiction. So I think I showed up to our first trip with this, I can’t remember what the book was, but it was a nerdy economics book and, on the jacket, it had an endorsement that said, “Sizzling read, Charles P. Kindleberger.”

And she just loved that because number one, she had never heard an economics book be described as a sizzling read. But also, she just loved the name Charles Kindleberger. She thought that was perfect for an economist. So ever since then, if I show up with a book, she’s like, “Well, what’s Kindleberger think of that one?”

As you said, Charlie was born in 1910. He got his PhD 1937 so, yeah, I guess his studies would have been looking back at the sterling system that existed in the late 1800s, early 1900s, pre-World War I. And that would have (and did) inform his view of how a key currency should work. Can you explain, maybe, to the listeners how that system evolved and operated?

[00:10:35] Perry

The sterling system you’re speaking of?

[00:10:37] Kevin

Yeah.

[00:10:37] Perry

The sterling system was operated out of London, and the Bank of England was the lender of last resort to that thing. Maybe a couple of things to appreciate about that, it’s important to appreciate that it grew organically; that it was built on the domestic bill market, inside Britain, that was for financing local trade. But the rest of the world started to use this bill market to finance international trade, even if no part of the trade was in London. So the sterling bill market was the way you did international trade by the end of the 19th century.

Sterling, as a currency, was convertible into gold, but mostly, nobody ever converted it because sterling was the actual reserve that was used by the rest of the world. Now, some of this was connected to the British Empire, and in particular, the role of India as a big trade surplus country that held its surpluses at the Bank of England in London, which therefore financed the British deficit in the trade. Britain was a big capital exporter during this period.

So, this pattern of trade, that basically London was the bank for the world where people held their reserve balances even if they weren’t British, if they were Indian, but also if they’re French or whatever, it’s the City of London that is the banking system for the world. There’s a great book, by the way, I should mention, by Marcello De Cecco, who you can’t interview because he recently passed away, about that system. It’s called Money and Empire, and it is about the sterling system. I am deliberately signaling, with my title, that I am trying to bring that story up to date and to pay homage to him as writing a book about how that system, with an explicit empire (the British Empire) worked. Whereas, in the US case (as I’m sure we’ll get into), it worked out a little bit differently. But that was what was in people’s minds, the key currency people in particular.

Everyone thought that after World War I, that we were just going to return to status quo ante. Really, everyone thought that, and that’s what was attempted in 1922. And then when sterling went back to gold at the pre-war par in 1925, everyone thought that that’s what we were doing. The Fed, remember, was only created in 1913. So the notion that the dollar was ready for the world, no. Sterling was the center of the world.

But as more and more countries returned to the gold standard, this put more and more pressure on sterling and the Bank of England because Britain had lost a lot of its overseas investments and other things. It was too much pressure. So it was September of 1931 that the Bank of England was basically forced off of gold. There were attempts to cobble together a central bank cooperation agreement that would support sterling.

[00:13:51] Kevin

This is the tripartite agreement that you talked about.

[00:13:55] Perry

Well, no. First, the World Economic Conference of 1933 was first, and particularly, the Fed was prepared to do something here. But Roosevelt said no, and took the US off gold and therefore off sterling too. So there was this period of really international chaos. And then in 1936, that’s when there was explicit cooperation created in the Tripartite Agreement for the first time.

It was really not so much by ’36 about supporting sterling, it was about supporting a fixed exchange rate system between sterling and the dollar so that sterling and the dollar would jointly be the global currency. That was the idea. But that all fell apart because of World War II finance. But I mentioned that because that’s a little piece of history. Most people think that the international monetary system was created from the mind of Zeus, at a little hotel in New Hampshire in 1944. I think that’s just a myth.

[00:15:00] Kevin

I wanted to pick up on that point. Actually, as you were describing the sterling system, so many things were racing through my head. One is that there seems to be an interesting substitution of India for China, and sterling for dollar, and you get our current system operating in a way that’s somewhat analogous. In terms of Charlie’s thinking, what’s interesting to me is he’s looking back on the sterling system, and as you say, it wasn’t created through grand design.

It evolved organically, initially as a domestic financing system and then hey, there’s a pretty liquid market there and we can use it to finance international trade as well. So he’s looking back on how that system evolved and operated. And then there’s this interregnum period, from say, the end of World War I through the end of World War II, where there’s, as you say, a lot of monetary chaos. He’s also observing that.

I assume then that the combination of the stability of the sterling system and the chaos of the interregnum period where the UK was unable to be the supporter of the system and the US was unwilling, informed his view of what the post World War II system ought to look like.

[00:16:27] Perry

Well, that phrase that “the Bank of England was unable and the Fed was unwilling,” this is Charlie’s phrase and it comes from a later retrospective. So in ’37, he’s not really thinking like that. This is from his book, his 1973 book, The World in Depression, which is another actually pretty well-known book among economic historians, certainly. Everyone still reads this book, and your listeners should too: The World in Depression. There’s a second edition, 1986, which he revised, which I would recommend, in favor of the first edition.

To go back to your question, what was he expecting? So he’s a graduate student in the ‘30s and his main professor (I tell the story in Chapter Two), was H. Parker Willis, who was a real bills doctrine guy, but he had been very much involved with his own professor, Laurence Laughlin, in creating the Fed in the first place. One of the big ideas of creating the Fed, in the United States, was to unify the dollar system inside the United States. So, inside the United States, there had not been a central bank.

This is very important to appreciate that there had developed a system of clearing, inside the United States, that did not rely on a central bank. There were these money clearing systems in different regional centers. Basically, JP Morgan in New York City was, in effect, the central banker for the United States, at least for the elite New York banks, part of it. But whenever there were these agricultural crises (and they were periodic), they would draw on London, on the gold stores of London.

So, London was the central bank of the United States, and London didn’t like this very much, because the United States was becoming a very large country and these imbalances were a problem.

[00:18:27] Kevin

Was this an early form of a swap line type of thing?

[00:18:35] Perry

It wasn’t a swap line because there wasn’t a central bank. But it was operating through private bank flows – an money market, international money market kind of thing. So H. Parker Willis was really a domestic guy creating the Fed. I make the argument, in Chapter Two, that that’s where Charlie got an early idea that the optimal way of organizing the international system was just taking that idea of unifying the dollar system inside the United States and saying now we have to just do it for the globe. And so it was not much more complicated than that, than saying that that’s the future that we should work toward.

Of course, the chaos of the ’30s is a very disappointing period. But his opportunity to join the BIS seemed like an opportunity to join, maybe, the possible future central bank of the world that had been created after World War I (we can talk about exactly why). He came to think, I think, through the influence of an analogy with the sterling system, that what we’re going to do is basically that New York is going to become London.

Now, the United States (it’s important to appreciate), did not have a large bill market and that was a big disappointment at the beginning of the Fed because they thought they were going to be operating in this bill market, but it did not because the United States, at the time, was a developing country. So really, long-term capital was what was needed – government railroad bonds and mortgages for farmers.

The banks did have short-term credits, but they were not really short-term credits. They were credits that were expected to be rolled. So these are five-year mortgages, interest-only mortgages, that are expected to be rolled when that five years comes. And that, of course, is a rather vulnerable form of finance. So, it turned out (and you’re making the point about the analogy between the sterling system and the dollar system), the important point to appreciate is that the domestic money market was not at all of the kind that was inside – that was in London. So, you were going to have to build a different kind of system on top of that. A lot of what the Fed was getting used to in the ’20s is like, how are we going to be a central bank if we can’t really operate in the bills market, in the real bills market? And they invented open market operations because there were all these treasury bills that were left over from World War I.

Benjamin Strong, the head of the New York Fed, basically, in the 10th annual report of the Fed kind of invented that way of intervening in markets. But of course, this is in the ’20s. You can see they’re learning how to be a domestic central bank, they’re not at all ready to be an international central bank. Even worse is the political challenges. You need to appreciate, your listeners need to appreciate, that to get a central bank, at all, in the United States was a great political challenge.

Americans hate the government, and they hate Wall Street. What is the central bank? It’s the government plus Wall Street. So that was a very tricky political thing to get a central bank in the first place. The other thing that Americans hate is kind of the rest of the world because it’s such a large country. So, having a central bank that’s going to be the central bank for the whole world? No way. No way.

[00:22:25] Kevin

The devil incarnate.

[00:22:28] Perry

The Federal Reserve Act, if you go back to the original text, is very explicit that it’s going to be lending to manufacturing and to farming, not to the government, and it has no international responsibilities. It is responsible only for the United States. It’s very clearly written. And almost immediately, it violated the first of those because of World War I finance. It wound up having to lend to the government to support the bill market, the treasury bill market, to finance World War I.

So it wound up, after the war, stuffed full of treasuries when it wasn’t supposed to have any treasuries at all. So immediately, it evolved.

Conspiracy theorists don’t like this. They say the Fed abandoned it and we should go back to the originals. There are people on the left and on the right like this, but I tell the history. I say, well, there’s a reason they did this. They’re responding to circumstance. I’m telling a story of growth, of development, of responding to crises, and World War I was a very formative crisis for the Fed.

[00:23:34] Kevin

Yeah, I think that’s absolutely right. I think you do say this in the book that ironically, where we are now, in terms of the role the Fed is playing, is very similar to what maybe Charlie would have wanted or imagined, especially with the seeming permanence of swap lines. So, the Fed has sequentially responded to crises over the years. We can argue whether or not their response has been correct, but it’s got us to a place where they kind of are operating like the central bank for the world.

So maybe we could roll the clock back a little to the end of the Second World War. What had changed domestically with the US that allowed the dollar to take over from sterling as the global currency? It wasn’t entirely a political willingness in the US to do it, but it seemed to be more like economic circumstances had changed to facilitate that transition.

[00:24:49] Perry

Well, the United States emerged from World War II as the only developed country that was not war-damaged, and it of course had financed the whole war through Lend-Lease. It had sent some troops over there at the last minute. Most of the deaths were not Americans, they were others. But a lot of the finance and the material, the warfighting material, 50,000 planes Roosevelt promised. So, the United States ended World War II undamaged. If it were not going to take responsibility for the world for reconstruction, there wasn’t anybody else to do that.

Quite definitely, everyone appreciated, at Bretton Woods, that the US was going to be a surplus country in trade for quite a while, because everyone else was needing to rebuild and they needed the US help to do that. The question was, what kind of financial arrangement would make sense there? And they were listening and remembering the problems after World War I with the overhang of the war debts. Basically, because of reparations at Versailles, Germany owed a lot of money to France and England; and France and England (because of war debts) owed a lot of money to the United States.

The United States said, how you pay that is not our problem. If Germany pays you, that’ll be good. So that worked for a while because the US loaned Germany the money through the Dawes Plan and the Young Plan (I talk about that in the book). But it was always a pretty fragile arrangement and it collapsed under its own weight, basically. So the Germans repudiated and then the war debt was the Hoover moratorium.

So after World War II, we didn’t go down that road again. There were no reparations, Lend-Lease basically canceled. So we started afresh, and in fact, with fresh money. That’s what the Marshall Plan was. It was fresh money (and it was a grant, it wasn’t a loan), to get this whole thing going again.

[00:26:50] Kevin

So it’s essentially an equity infusion into the European economies.

[00:26:56] Perry

The way Charlie came to understand it, yeah, I suppose that’s right, because it’s not a loan. The important thing was to get restocking going. Of course, we’ve experienced some of this because of COVID, now. The entire European economy was on a war footing for a long time. It wasn’t really organized around producing for trade or much less multilateral trade.

So you had to shift over to a peace economy, and you had to shift over at a time when much of your transport system is destroyed and your housing stock is destroyed. There was a lot of reconstruction that was needed. We, in the United States, had the same problem of converting from a war economy to a peace economy, but our economy was not destroyed. So, we had a little post-war inflation here, in the United States, because of that, because there are bottlenecks, and so forth, but it got sorted out.

Then we started the post-war boom where all that wartime savings was being spent. So, there was a very strong demand. Of course, abroad, people were spending as well. The Marshall Plan was a demand infusion to the United States economy. That was only a couple or four years or so. So, that got that going.

You were flashing back, but flashing forward. In Charlie’s mind (and I think this is really correct), the important thing, after the war, was integration of Europe and the United States to create a functioning industrialized part of the world. And that was basically the United States, on its own, not using Bretton Woods or anything.

So the IMF was about the periphery. It wasn’t really about Europe. The Marshall Plan was about Europe, and this was unilateral. This was the United States operating on its own as a leader. I don’t think that you should really say that the Fed is the global central bank by itself right now. The swap lines that you mentioned, this is exactly right. I think it’s better to say that it’s a committee of central bankers, that the swap lines are the mechanism through which this committee of central bankers is managing global monetary affairs.

You haven’t mentioned this so I will (I don’t know if I even say this in the book). The swap lines were around since the global financial crisis, and then they were older still. They were around to help Europe return to convertibility in 1958. Those swap lines were run on the BIS balance sheet, but they were effectively dollar swap lines. So they’re the same kind of thing that we’re talking about today.

The new thing, that is now on the Fed’s balance sheet, is the FIMA Repo Facility, which provides basically discount window access to countries that don’t have swap lines but have Treasury securities that they can use as collateral. This was created after the COVID crisis. It’s new and we’re going to find out how well it works in the coming crisis. You know we’re in a tightening cycle now.

[00:30:29] Kevin

There’s so many questions I want to ask. That FIMA Repo Facility was not heavily used in COVID, but I think you’re right, it could potentially be much more heavily used in the future. This brings to the fore the question: the Fed has introduced these new policy tools (or in the case of swap lines, old policy tools), but formalized and expanded them; the Repo Facility is a new policy tool, but that’s all been done without any kind of legislative oversight. It certainly wasn’t something that people voted on.

So we’ve evolved into the central nexus of this network of global central banks that supports the monetary system. But it hasn’t really been explicitly made clear (I think, to the public) that that’s what is actually going on. It will be interesting, in the next crisis, when those facilities get used more aggressively, if that’s something that’s considered popular or not.

I wanted just to try to circle back to something you said about the situation the US was in at the end of World War II. It was a surplus country, and at the same time, gradually taking over the role of, again, maybe not central bank to the world, but the key currency. Was that an unusual position or an unsustainable position to be in for the key currency country to be a surplus country?

I think Charlie talked about and wrote about this, but ultimately, it needs to provide liquidity to the rest of the world. Was it predestined to evolve into a deficit country because it assumed this role of the key currency provider to the world? In other words, does a key currency provider have to be a deficit country? Does it have to run a deficit in order to create the key currency that the rest of the world uses? And if so, how do we know (and I think this is a problem Charlie wrestled with), how do we know what the sustainable level of that deficit is? How much liquidity provision is necessary versus a sustainable trade balance?

[00:33:00] Perry

Well, Charlie’s view on this, which I guess I’m sufficiently convinced of that I’m playing with it for our current situation, is that, in fact, there is no reason that you need to be a deficit country on the trade account (that’s what you’re talking about), in order to be the key currency country. So, he would use the word international financial intermediation, that you can provide dollar reserves to the rest of the world simply by lending them to them and through the private banking system.

So the big New York banks, that are making dollar loans to Europe, are also taking in dollar deposits from Europe. That’s international financial intermediation. Those dollar deposits are the dollar reserves of outside. Now that, in Charlie’s view, should not be considered running a deficit because it’s an expansion of the balance sheet of the banking system on both sides. The way it was measured, in standard national income and product accounts, it showed up as a deficit. Really, we’re selling liquidity services abroad.

Of course, this is where Triffin comes in, that the gold was leaving the United States and it was ultimately less gold in the United States, then there were short-term liabilities abroad. That all just means that you’re moving to a fractional reserve international system, which there’s nothing wrong with that. But yes, if there was a run on the dollar, there wouldn’t be enough gold to cover every single dollar liability. But why would there be a run on the dollar? People are accumulating these dollars to use them as an international reserve.

Here’s where we come back to what I was saying at the very beginning, that the key currency approach is a minority view in the post-war period. Everyone is thinking like, here’s this model, Mundell-Fleming, that applies to every country, including the United States, which is the creator of international reserves. So, Kindleberger thought well, no, you need a different accounting system for the country that is supplying liquidity reserves. In 1969, actually, when Mundell was editor of the Journal of Political Economy, he wrote more about this measuring balance of payments in balance of payments equilibrium, where he made these arguments.

This is his mature statement of this in 1969. So you don’t have to be a deficit country in order to be the supplier of world liquidity. How much should you be supplying? Well, in a way, you could apply the monetarist growth rule, that on average, if the world economy is growing at 3%, well, then its demand for reserves will be growing at 3%, and so this kind of international financial intermediation thing should be growing at 3% on average. Now, you’re also going to have some responsibility.

When there are crises in various places, the demand for reserves is going to go up. So being a lender of last resort means that you’re going to grow more than 3% during a period of time, and then presumably claw that back later on. So that’s the way to think about it, anyway, is to appreciate that the United States is a bank, as he said. Now, I mentioned 1969, when he wrote this, because very shortly after that, Nixon took the dollar off gold and basically unilaterally. He was convinced by the economists who were arguing that the dollar was weak and that you needed a flexible exchange rate in order to help the situation for the United States.

Charlie rejected both of those things, but it happened anyway. So the consequence of all of that (fast forward to what you were saying), is that it wasn’t New York that became the center of international financial intermediation. It happened offshore. It happened in London in the eurodollar market, in the eurobond market. All of that business (Charlie was imagining)would be in New York, because he was analogizing to the sterling system. That business is not in New York. There’s no actual particular reason that it needs to be in New York apparently. It can be in London, it can be in Singapore.

So, we have a global dollar system now, where there are centers of dollar intermediation in the global banking system that are not inside the United States. They do not show up in the US balance of payments because they’re in other countries. That’s how we sort of solved this political problem, in a way, by pushing it offshore. Similarly, the Fed, as I say, it’s not really the central bank of the world. It’s a cooperation between central banks. So the offshore elements of this are as important as the onshore elements, and are, in fact, sort of the line of first resort (if you look at what’s happened to the balance sheets of the ECB, of the Swiss National Bank, of the Bank of Japan). So, these are the buffers for the global dollar system, actually.

[00:38:32] Kevin

That’s a really great explanation. I guess when I initially read Charlie’s comments, I think he said the dollar is finished as international money. I think that was in reference to the final end of the…

[00:38:48] Perry

Yeah. Nixon 1971, 1973. Yeah, that’s right.

[00:38:53] Kevin

I was surprised by that because to me (I may have my history wrong, obviously, you know it much better than me), to some extent, Nixon was bowing to market pressure. I always saw Charlie as someone who appreciated that the monetary system was a function of what the market wanted. It wasn’t, again, created from on high, it was a response. And so to the extent that going to a pure fiat system was a response to market demands, it seemed to me a little surprising that he didn’t like it.

But then there seems to be this tension in his thinking (maybe tension is not the right word), or slight contradiction. On the one hand, he’s a pragmatist. He says, “Let’s allow the market to determine things and when markets don’t work, we can step in.” On the other hand, he’s also kind of an idealist as well. He wants the world to cooperate. He thinks that we can have an international system where people look out for the public good as opposed to just their own domestic concerns. So, perhaps what he was really upset about was the fact that it seemed like there was no longer any kind of international cooperation with the initial phase of taking the dollar off gold, that it was basically we’re just going to let this thing rip and not care anymore.

[00:40:28] Perry

So there’s a lot in there. Let me take a piece at a time. He really was blindsided by Nixon in 1971, which he explicitly analogized to the Bank of England in 1931. So remember, he grew up as this being the moment when the international monetary system basically broke down. What happened after it broke down? Worldwide depression. That’s the frame that he has in his mind. That didn’t happen, and he was surprised that it didn’t happen. He’s glad that it didn’t happen. Even in ’73 when we went to flexible exchange rates, that’s like you’re embracing hot money. Why? That’s not good.

He’s imagining that short-term international capital markets and long-term international capital markets are basically going to close down with exchange volatility, as they did in the ’30s. That didn’t happen. Why didn’t it happen? Well, you could say one reason was because we didn’t have all of this war debt overhang stuff that was a problem in the ’30s. But another reason is that because of that, bankers did not stop using the dollar. They moved it offshore. It was bankers who moved it offshore. It wasn’t governments that moved it offshore.

Nixon, I think, quite clearly wanted to kill the dollar system. He had been trying [along with] various American politicians. This is not a Republican initiative, it was shared. They were trying to not have New York be the center of the global capital market throughout the ’60s, and Charlie was upset about that. This is getting in the way of the organic emergence of a functional dollar system. You’re trying to kill it. Please stop trying to kill it. Understand that this is actually a good thing for the globe. But they finally did kill it, as they thought in 1971, but the bankers didn’t allow it to die. That’s the point. They created systems of foreign exchange hedging.

This is the beginning of active private forward futures markets that allow you, at least in the short-term credit markets. In long-term credit markets, businesses that are making long-term investments in other countries aren’t really thinking. They’re looking through the fluctuation of exchange rates. They’re thinking, “Is this a good investment or is it not a good investment? What do I care if the exchange rate is fluctuating around and around.”

So this is the beginning also of global reach, the multinational corporation that is thinking about its operations. So Charlie looked, he studied the multinational corporation, and so he was surprised that we did not have a return to depression. What we had instead, interestingly, the monetary chaos that had led to deflation in the ’30s, there was a lot of monetary chaos in the 70s (this is when I grew up, I think I’m a little older than you) and it led to inflation. Worldwide inflation was the consequence until we could get things sorted with Volcker in ’79 and then Plaza in ’85. That’s how he viewed it.

This is about putting the international monetary system back together, and there are two pieces of it. One is that the US, under Volcker, is going to accept responsibility to be the leader of that system, which it was not in 1971.

[00:44:05] Kevin

Do you see a sort of irony there? Nixon taking the dollar off gold in 1971 because he wanted to destroy the dollar system, he didn’t want New York to be the center of global finance. In fact, that action only (as you say), seven, eight years later facilitated the deepening and broadening of the dollar system.

[00:44:31] Perry

Well, as I say, it was the action of bankers that deepened and broadened the dollar system. Volcker’s movement with the Fed is kind of recognizing this new fact. This is about the politics coming into line with the economics, just as Bretton Woods ’44 is sort of recognizing that the dollar is the emergent world currency. So, the politics comes after the economics. Often, the economics is not visible because it’s only really people who know how banking works that are seeing this emerging system. So the US said, “Okay, we will accept our leadership responsibility again.”

And the rest of the world, having experienced the ’70s, flexible exchange rates did not prove to be the panacea that everyone thought they were going to be. So, the rest of the world learned from that experience too, and said, “You know what? It’s not so bad to let the US be the leader. We will cooperate with the US going forward.” That’s what Plaza was about. That’s how Charlie viewed it. But this is an evolving Darwinian system and so nothing is ever fixed forever. There are more challenges that come later, and there are economic challenges and there are political challenges.

We’re in that process today. So it’s ongoing and it’s a seesaw system. He always used that word. That it’s two steps forward, one step back, two steps forward, one step back. It’s not just Charlie, but pretty much everybody has said the dollar is a goner and repeat it sometime in their life. But it has never been a goner, really, if you look at the broad sweep of history. Why is that?

I just wrote a paper on that. It has just come out from INET, trying to figure out why is the key currency point of view a minority view, since it seems actually to be correct. That’s the way to understand, why do we still have the dollar system? After Charlie (who was an advocate of the key currency approach), he thought that the politicians had the power to kill it. It turns out they didn’t actually have the power to kill it. It grew up anyway and the politicians had to accommodate to it. The politics had to find a way.

So, I think that’s going to be the answer too, to this new role of the Fed in COVID. What you notice, in COVID, is that the turning on of the liquidity swap lines to the global north happened almost immediately, and no one made a peep about it. Whereas, in the global financial crisis, there were congressional hearings about this. So, we have accommodated to that politically. The new piece, that we haven’t accommodated to because it’s new, is, I think, this FIMA Repo Facility.

But remember, the collateral are Treasury securities. So if your counterparty defaults, all that happens is the Fed winds up owning more Treasury securities, and they own lots of Treasury securities already. A lot of the challenge of explaining this to people is appreciating that these are banking operations. This isn’t about the US taxpayer lending money to foreigners. That’s not at all what’s happening. It’s an expansion of the balance sheet of the Fed on both sides.

There’s not real resources being transferred by these liquidity operations, but that’s actually hard to explain to people. Because our intuitive layperson concept of a loan is I can’t lend you a bicycle unless I own a bicycle. But if I’m a bank, I can lend you money just by expanding my balance sheet on both sides. That seems fraudulent or something, on the face of it.

[00:48:40] Kevin

It seems like magic. I think banking has always seemed a bit like magic to many people.

We’ve got about 10 minutes left. I want to try to circle back to some of your own work here. I think our discussion is kind of naturally leading to it. You have this concept (I don’t know if you were the first one to come up with it, but certainly, I first became aware of it through reading your book) of the Fed having evolved from being a lender of last resort to a dealer of last resort. That makes total sense to me because the global financial market has evolved from a bank-based system to a market-based credit system.

You titled your book The New Lombard Street and the original Lombard Street was written by Walter Bagehot, and he has this famous central banking rule that in a crisis, you lend aggressively against good collateral, but at a penalty rate. In the dealer of last resort framework, you’re no longer the lender of last resort, you’re the dealer of last resort. What is the Bagehot rule for the dealer of last resort? I know you talk about this in your book, but I want the readers to hear how you think that analogy is, how the central bank ought to operate in a crisis as the dealer of last resort.

[00:50:18] Perry

Bagehot never used the word “penalty rate,” he used the word “high rate.” This is important to appreciate because, and here’s why. The whole idea is that in a crisis, the central bank is providing lending, but at an unattractive rate so that when the crisis is over, this new lending will naturally roll off the balance sheet, because people who are paying that high rate will enter into the private market at a better rate once the crisis is over, and they’ll use that money to pay back the central bank. So that was kind of the idea. It was also to discourage people from borrowing who didn’t need it. It’s like, make it expensive.

So the analogy to that, for the market-based credit system (which you’re quite right about, that’s why I invented that word, dealer of last resort, and why you need to expand the concept because of market-based credit, which by the way, has to do with globalization also – we’re going to come back to that), in this particular case of the global financial crisis, we were starting this securitization business with the US mortgage market that was being booked abroad in these global banks in Europe because of the eurodollar system and things like that.

The analogy to lending at a high rate, comes (in my mind) from thinking about the economics of the dealer function. The dealer function ( and here, we start to come around to some of the things you’ve thought about too) dealers are suppliers of liquidity in these markets by quoting bid-ask spread; they’re willing to provide trading options to other people for a price. What dealer of last resort then is, is actually a rather wide bid-ask spread is the idea. That you want to be willing to accept collateral, but not on very good terms, terms that will, when the crisis is over, people will find there are better terms that they can get. This will naturally roll off the balance sheet of the central bank. So one of the challenges is trying to do that.

We see this that after the crisis was over, a lot of the facilities that were created in the global financial crisis did in fact roll off. They did, in fact, roll off. They were that sort of dealer of last resort. But then we did QE to try to goose the economy, and that meant low rates. So this is sort of not dealer of last resort anymore. This is being driven by, I think, not understanding how monetary policy needs to run in a market-based credit system. I think probably we have (and this is maybe for another time, a longer time because we’re running out of time), in economics, there’s a framework of thinking of general equilibrium which kind of abstracts from liquidity and so imagines that the natural price of liquidity is zero. That is not the case in the key currency view or the money view, which I teach. So what you do not want is the central bank making liquidity of free good, because then you get all kinds of craziness happening. So we are on the same side in that regard. But the dominating intellectual apparatus is not yours or mine.

I would distinguish between dealer of last resort and then QE. It’s hard to distinguish because a lot of the balance sheet operations are similar, that you’re expanding the balance sheet on both sides, but the prices will be different. If you look at the emergency lending facilities, they rolled off, they mostly rolled off. But the decision that we were going to support the mortgage market at low rates, that meant that you are now making loans that are not going to roll off, unless you’re willing to take a capital loss. You’re going to be holding these to maturity or until they refinance (which is really how they’re rolling off is through the refinancing operations). But now, interest rates are rising and so no one’s going to refinance. So they’re stuck with these positions.

[00:54:49] Kevin

What about the swap lines? Do you think of those as a dealer of last resort function?

[00:54:58] Perry

Yes, they are a dealer of last resort. So this gets to the globalization piece.

[00:55:03] Kevin

Could I just ask one question about that, because I followed it quite carefully during COVID, who drew on it, how quickly they paid back. But also, what I was frustrated with was, again, it didn’t seem like it was provided at a wide bid-ask spread. It was, I don’t know, 20, 25 basis points or something like that. It was not an expensive facility. Having said that, they did roll off, as you point out. But do you think they should be structured in a different way or are you happy with the way that they’re structured?

[00:55:46] Perry

They were structured as 50 basis points around covered interest parity. That was the actual agreement. In the moment of crisis they lowered it to 25, I think to send a signal that we want you to use this, feel free to use this. So you could maybe argue about that. You need to be in contact with the market if you’re too far away. But the other thing to appreciate about this is that that’s the spread for lending between central banks.

This isn’t the spread that private people are getting, because what’s happening is that this is between the Bank of Japan, let’s say, and then the Fed. And then the Bank of Japan is going to add some more on, because all of the credit risk is being taken, not by the Fed, but by its counterparty, by the Bank of Japan. So presumably, they’re not charging just 25 basis points. They’re charging some more. So the effective outside spread that’s facing the market is larger than you might think, looking at the terms of the liquidity swaps.

I haven’t actually looked into the pricing because I think a lot of that is proprietary, but it would be interesting to know that. It might even be that foreign central banks even provided even better financing because they’re trying to help their national champions, but that’s on them. That’s not on the liquidity swap lines arrangements. If they want to subsidize lending, we need to deal with that in some other way. We can’t tell them what to do. But these are large, unlimited swap lines.

In COVID, they blew up very, very rapidly, whereas in the global financial crisis, we were a year into the crisis before these swap lines became clear, this is what we need to put a floor under this crisis. And it was exactly that. That’s exactly when the floor was put, when those swap lines open. So yes, outside spread. I’ll just say one last thing here about this. You’ve got to appreciate that after the global financial crisis, the global north is largely not expanding credit at all.

Even though interest rates are very low, there’s not much credit expansion. The credit expansion is happening in the global south. And the system that we developed to backstop that were these liquidity swap lines because they’re borrowing in dollars long-term from Japanese insurance companies or something, which are trying to balance their exchange exposures in the FX swap market, and also borrowing term from Europe, which are trying to balance their exchange in the eurodollar swap market.

So the liquidity swaps that you ask about, these 50 basis points around CIP, are actually functioning to support global capital markets in this regard, because it’s about the funding of this expansion of the global dollar system to the global south. We circle back to the beginning, this is definitely what Charlie wanted. After World War II, he was a believer in the Hansen Stagnation Hypothesis. He thought, therefore, the only way forward for the global system was development of the global south.

This is going to be the engine of growth, just as the US was a developing country and was an engine of global growth for a period of time. And that means capital flows to the global south. At the time he’s thinking about this, all these capital markets are closed down because of depression and war. So he and his buddies always thought the World Bank was much more important than the IMF, because it was about as a provider of long-term capital until the private markets can kind of get their act together, and they never did get their act together until quite recently.

This expansion of dollar-based credit to private or national champions, put it that way (mostly it is), in the global south, this is really since the global financial crisis. And it comes from the fact that there are zero interest rates in the north, but 10% interest rates in the south. So if you’re looking for yield, that’s where you’re going to find yield. Again, I come back to this point. The dollar system expands, geographically, two steps forward, one step back. There was this two steps forward going on in the last 10 years to the global south.

Now we’re testing that. That seems to be what’s happening right now. So bits of it will break and we will see if we have enough backstops in place to keep that break from spreading. Personally, I’m kind of optimistic about that, but we’ll see. Meanwhile, other stuff is breaking and that’s being tested too, crypto and so forth, and other business models. So we’re in that phase of the one step back, where we get rid of things that weren’t such good ideas in retrospect, and we create a foundation on which we can build again in the next phase.

[00:1:01:14] Kevin

There’s a couple of questions I wanted to end with. One I think is perhaps a little bit out of the blue and maybe too big as an ending question, but I’m going to ask it anyway, which is, how do you think Charlie would have viewed the seizure of the Russian Central Bank reserves after the Ukrainian Invasion?

[01:01:38] Perry

Well, I’m just thinking about historical analogies.

[01:01:42] Kevin

Actually, in the book, you did talk about an episode, I think, where the Czech gold reserves were forcibly given up.

[01:01:52] Perry

To the Germans in World War II, and that the BIS was complicit in this, and that gave the BIS a bad name. Because basically, what happened was some German soldier put a gun to the head of the central bank of Czechoslovakia and said put in that order to transfer it to the German central bank. Everyone knew that that’s what was happening, and they did it anyway. Now, that’s a little bit different because we weren’t at war with Russia. It was actually Europe that was concerned about this.

As I read the news, I have no inside information about this, but it seems to me this was an attempt of the United States to help Europe or to say we’re doing something we can do that doesn’t really cost us anything to show that we’re on your side or something. In general, Charlie is not in favor of those kinds of things. However, politics plays in. One of the reasons for the growth of the eurodollar system was that the Russians did not want to leave deposits in New York City because they knew that they were not safe there. So that was kind of the origins of the eurodollar system before ’71.

So now we’re seeing the same thing, that Russia is holding its reserves in other currencies and swapping them with private counterparties. So they’re trying to evade this. Anyone who knows about money knows that it’s very fungible, that the ability to enforce such a thing, you’re really going to create innovation around the edges. That’s what’s happened. Now, you could make an argument, I think, either way.

But Charlie is very definitely viewing a unified global monetary system as a public good that benefits everyone. And so it’s not a good idea to try to create incentives, to create a parallel system. The notion that that’s going to be a winning move, it’s not a winning move, not a winning move for us even. But the dollar system moves, it’s a seesaw system, and there’s a step back right there. So we’ll see what happens going forward.

[01:04:25] Kevin

Just one final question for people listening and thinking, “I’d like to learn more about Charlie Kindleberger.” What would you recommend people read of his? I think he wrote 15 books, and many, many papers. If you were going to say here are the most relevant works that he’s written for the current system, what would you suggest? For my next holiday, what should I bring along?

[01:04:54] Perry

The World in Depression, I mentioned that before, which is his story about the ’30s. And then I would say maybe he put together a collection of essays called International Economics Collection of Essays, I think it was. Charlie aficionados call it the “big green book”. So it’s a collection of his essays and they’re arranged in money, banking, and finance. So it’s kind of a treatise on money, but it’s a collection of like after dinner talks and fest trips, and so often, they’re quite readable as a matter of fact, but I think that they’re pretty accessible. So I would recommend that.

I think it’s out of print now, but I got a copy from Abe Books for like $3. There may be more of them. I treasure that. A lot of what I have tried to deduce about… I have thought of that as his treatise in money. He never says it is. But the way it’s arranged, it’s structured as if it were a treatise. He was a late bloomer because of the war and depression and everything too. So he’s kind of old by the time this is coming out and he doesn’t really have the energy, I think, to put together an actual treatise.

So he’s really just collecting articles that are the bricks from which you could construct a treatise. And that’s really what I think of myself as doing. That’s why I was interested in Charlie, that I wanted to learn to think the way he did, so that maybe I can write a treatise at some point. Maybe I’ll try to do that as my next book. I have this MOOC, this online course, but it’s really domestic. I was doing Marcia Stigum. I didn’t really know about global money when that was published in 2012. So it’s 10 years later and now I’ve written this book.

So I think extension to international money theory is my next project, on the shoulders of giants, on the shoulders of Charlie. Everyone called him Charlie, by the way. So the fact that you’re calling him Charlie, I’m calling him Charlie, everyone called him Charlie, because I think maybe Kindleberger is a little bit of a mouthful.

[01:07:18] Kevin

Well, listen, I hope you do write that treatise. But in the meantime, listeners should pick up Money and Empire. That’s your most recent book. It’s an excellent read, both for the history of the dollar but also the history of a really fascinating character. So thanks for writing it, and thanks for joining us. I wish you all the best.

[01:07:38] Perry

Thanks very much. It was fun.

[01:07:40] Kevin

\With that, I’m going to pass it back over to Niels.

[01:07:43] Niels

Thank you so much, Perry and Kevin, for a wonderful history lesson about Charles Kindleberger, who ranks as one of the 20th century’s best-known and most influential international economists, but that many people may not have heard about. There were a few key takeaways for me, such as the important difference in the evolution of the traditional US dollar swap lines into this new FIMA Repo Facility, which seems to have been developed very deliberately to deal with the next crisis as and when it comes. Because in reality, it was not really used during COVID when it was first announced.

Of course, the whole issue about the role of the US dollar system and how it’s really like selling liquidity services to the rest of the world and how you don’t need to be a deficit country on the trade account in order to be a key currency provider was quite fascinating. I also found Perry’s view about how he believes that the global currency system was not created at Bretton Wood, and of course, what he thinks that Charles Kindleberger would have said to the confiscation of the Russian currency reserves that we saw after the Ukrainian crisis began.

That’s it for today. Make sure you go and follow Perry’s and Kevin’s work, as well as getting a copy of the books, because as you can tell from today’s conversation, some of these ideas and topics are not being discussed enough on mainstream media. From Kevin and me, thanks so much for listening. We look forward to being back with you in the next episode. In the meantime, take care of yourself and take care of each other.

[01:09:19] Ending

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