Is it Time to Focus on the Value of the Dollar?

Critics of John Maynard Keynes have charged the great man with changing his mind too often. They said that he could not maintain a position for an extended period of time. Keynes countered this criticism with the remark: “When the situation changes, I change my mind. What do you do?”

It seems to me that it is time for Keynesians, and others, to change their minds with respect to policy prescriptions pertaining to employment and the value of the dollar. In this highly integrated world, countries cannot conduct their monetary and fiscal policies independently of one another as the United States has been attempting to do in recent years and did for most of the latter part of the 20th century. The basic philosophy behind this effort is the desire for a county to achieve low rates of unemployment independently of what monetary and fiscal policies are being followed in any other country.

I am not arguing that we should not be in favor of low unemployment. It is just that the philosophy supporting current thinking in the United States emphasizes this one goal over any other and is captured in both The Employment Act of 1946 and the so-called Humphrey-Hawkins Full Employment Act of 1978. There is a long history preceding these “acts” and this history needs to be reviewed to put the current situation into a proper perspective. A good reference is the book by Donald Markwell, “John Maynard Keynes and International Relations: Economic Paths to War and Peace.” (Oxford University Press, 2006)

We pick up the story around 1919 at the Paris Peace Conference. Historically, Keynes had taught and written about the Purchasing Power Parity theory of relative foreign exchange values and had been in favor of flexible foreign exchange rates. However, given the events taking place in the second decade of the 20th century, he changed his mind about how the world economy should be set up in order to save capitalism. At the peace conference, Keynes became a very vocal advocate for fixed exchange rates which would allow countries to seek high rates of employment within their own borders and do this independently of other countries. He worked very hard, both theoretically and practically, to devise a system of exchange rates in which this national independence could be achieved.

The reason for this change of mind was the unrest the Western nations were feeling concerning recent events in Russia and the growing support for the ideas of Marx and Engels. In particular, the Communist movement was gaining ground in most of Europe and the Russian Revolution cemented the idea that a Bolshevik uprising could actually take place. There were legitimate fears that the working classes, if unhappy enough, could rise up and gain control of a nation’s government. This concern supplied the rationale for attempting to develop governmental policies that would help to ensure that a country achieved and then maintained low rates of unemployment. The old ideas had to be revised in the light of new events and new information. The situation had changed so Keynes changed his mind.

Keynes worked for the next twenty-five years or so to create such a system. His efforts were directed along three different paths. First, he attempted to develop the philosophical and scientific foundation for this new way to look at economic policy making. Second, he conducted an almost continuous campaign in the popular press, newspapers and magazines, in an attempt to educate the public along the lines he was thinking as well as to advocate policies. Third, when asked, he devoted time and energy toward the actual creation of such a system; a system that would achieve the integrated world for which he hoped.

The philosophical and scientific work that he did resulted in the publication of his masterpiece, “The General Theory of Employment, Interest, and Money.” This book became the basis for what became known as Keynesian Economics and provided the intellectual rationale in the United States for the passage of The Employment Act of 1946. The Bretton Woods Conference, which began in 1944, produced the world financial system that incorporated much of what Keynes wanted. He was very active in this conference and, in fact, dominated the result. The system included fixed foreign exchange rates that would or could be changed over time as was required. This basis became the operational standard for the world during the next 30-40 years. It was thought that this system “freed-up” national governments so that they could pursue economic policies aimed at full employment in a relatively independent fashion.

Actually, the next 30-40 years saw the system set up at Bretton Woods slowly unravel. The reason…no country could really isolate their economic policies from the economic policies of other countries. The calm of the fixed foreign exchange rate regime was continually punctuated by periodic re-adjustments that had to be made when the currency of a country had to be devalued. The devaluation usually took place after pressure built up on the currency while, at the same time, the government denied that they were going to devalue and the central bank and treasury of the country valiantly made efforts to shore up the value of the currency. Finally, the pressures became so great that the currency had to be devalued.

In the 1960s in the United States, inflation became an issue as the Johnson administration mismanaged the government’s fiscal affairs attempting to pay for both ‘guns and butter’. This era ended as the Nixon administration ‘froze’ wages and prices in 1971 in an effort to gain control over inflation. This government also set free the dollar price of gold (which had been set at $35 per ounce) and let the dollar float in foreign exchange markets. And, as they say, the rest is history.

After this, country after country came up against the inflation dragon as the world continued to give preference in their economic policies to the goal of full employment. Yet, country after country found that they could not independently follow this kind of policy and maintain a strong currency. Country after country came to realize that they must get their fiscal budget under control and make their central bank independent of the central government so that it could follow a policy based upon controlling inflation. More and more central banks adopted ‘inflation targeting’ as their operating goal so as to achieve creditability and trust in world financial markets.

The United States has resisted this trend. As a dying gasp, the Congress enacted the Humphrey-Hawkins Full Employment Act in 1978, but this soon had to be put aside as the Carter administration was forced to confront renewed inflationary pressures and bring in Paul Volcker to lead the Federal Reserve and bring inflation under control. Once inflation was brought under control and some discipline was re-established over the conduct of monetary policy, economic growth was renewed and high levels of employment were attained. With inflation not an issue, businesses tended to concentrate on productivity and not on how to protect themselves from inflation. The unemployment rate dropped to period lows.

However, high employment has continued to be a goal of many politician and intellectuals within the United States. There has been reluctance to establish ‘inflation targeting in the U. S. Every wiggle in the unemployment rate brings cries for new and more effective government stimulus to ensure a low unemployment rate. Yet, reality continues to put holes in the arguments given to support governmental efforts to achieve such a goal. The times are not what they once were. As the times have changed, the politicians and intellectuals that continue to supports such goals need to change their minds.

The United States cannot ‘go-it-alone’. The United States must join the rest of the world and give more attention to the value of the dollar and less to immediate unemployment goals. The ‘revolt of the masses’ is not the threat it was in the 1920s and 1930s (although food issues, particularly in Asia, Africa and Latin America, may have taken over). And, as we saw in the 1990s, fiscal discipline and a non-inflationary monetary policy focused on a strong U. S. dollar, coupled with policies that support private innovation and change, can produce not only low inflation but high employment. It is my belief that Keynes, in the present world environment, would be more supportive of this kind of policy than a ‘Keynesian’ policy based upon achieving full employment, whatever that is. It is time for others to change their minds as well.