Professor Mehrling (PhD in Economics from Harvard University, MSc in Econometrics and Mathematical Economics from LSE) is a monetary economist and a historian of economic thought. Lifting useful observations from the financial worlds of the past, such as Bagehot’s or that of Bretton Woods, Professor Mehrling’s research and teaching open a fascinating window onto today’s financial world and make sense of its complexities. His views have influenced policy-makers at central banks, financial regulators and broader financial market participants in the US and beyond. He is the author of several well-received books – including The New Lombard Street: How the Fed became the dealer of last resort – and a number of academic papers while his highly-rated online Coursera course has attracted more than a hundred thousand people from all walks of life.
In October 2018 the MNB Department at the Corvinus University of Budapest was delighted to welcome Professor Mehrling who delivered an enthralling presentation on the challenges of monetary policy and shared additional thoughts, peppered with personal reflections, on broader topics during an interview. This blog post is the second of two covering the interview, and focuses on the global currency system and challenges facing central banks. The first post dived into the basics of the money view and its relationship with economics and finance.
Eszter Baranyai (EB): You argue that the global currency system is and has been a key currency system organised around a dominant national currency. This view is at odds with that expressed in a recent book by Barry Eichengreen et al (covered by our blog here). According to that book, although the dollar has overshadowed all other currencies in recent decades, earlier parts of the 20th century reveal that the dominance of a single currency is not ineluctable. What might be the origin for two contradicting interpretations of history?
Perry Mehring (PM): My money view lens places the payment system at the heart of the issue. Any functional payment system – whether at a national or global level – is facilitated by the use of a single currency. A single global currency supports the division of labour across the globe which in turn fosters growth in the world economy.
Before WWI Sterling was the global currency, whereas after WWII the US Dollar was ready to step into its shoes. An interesting, lesser-known fact is that prior to the Fed’s creation in 1913, the Californian and the New York Dollar did not clear at par. The difference was not large but nonetheless showcases that a single US Dollar only emerged after the Fed’s creation.
The impulse to have multiple global currencies stems from a desire for political sovereignty and is supported by the way economists tend to view the world – serving as advisors to nation states. Whether we like it or not, this is not how money works or will work. While the IMF follows democratic principles, enabling countries to have a say, the significantly-more-important Fed or the US Treasury do not operate on this basis, leaving some frustrated at the global monetary system’s lack of democratisation.
During some of the times when multiple global currencies ostensibly co-existed, co-ordination practices amongst nations of those currencies may reveal more of a global currency aspect than what may meet the eye. One feels less nostalgia for the other times, such as the 1970s marked with huge gyrations in major FX pairs.
EB: What is the main challenge facing the US Dollar as a global currency?
PM: The main challenge facing the global currency is that of political acceptance – both within the borders of the US and beyond. In this respect, I see the role of education as paramount.
Unfortunately, US decision-makers politicise and weaponise the US Dollar – e.g. by punishing banks that trade with Iran – rather than accept that it is a public good and treat it as such. Similarly troubling are the noises France is making on political grounds for the Euro to increase its weight in the global arena.
EB: What are the most important challenges facing central banks, and monetary policy in particular?
PM: Central banks have undoubtedly experienced a steep learning curve during the crisis, leaving us in a better position today than a decade ago. With respect to day-to-day operations, however, we are more ignorant than we would readily acknowledge. Should we understand the transmission mechanism in sufficient depth, we would be able to create a Taylor-like rule and routinize it. Currently, a particular worry of mine concerns the lack of coordination between the Eurozone and the US monetary policy.
Taking a step back, there are three groups of challenges facing monetary policy. First, financial globalization with the dollar assuming the role of the global currency means that US monetary policy – carried out based on US domestic conditions – drives global conditions. Second, given the importance of market-based credit (or shadow banking), dealers’ incentives and market liquidity should not play second fiddle to monetary aggregates in monetary policy decision-making. Finally, the power of central banks is a result of a careful balance – balance vis-à-vis the public fiscal authority, the private global banking system and the civil society. Increased questioning of central banks’ legitimacy, given central bankers are unelected and engage in money-creation which affects all citizens, is a good example of the delicate relationship with civil society.
The first part of the interview can be read here.
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