Monetary Policy and Economic Nationalism at the Beginning of the 21st Century

Paul R. Koch, Olivet Nazarene University

 In August of 1944, the U.S. Secretary of State, Cordell Hull, and a future occupant of that office, John Foster Dulles, issued a joint statement which indicated that an understanding between the two major American political parties had been reached regarding the manner in which the proposed international security organization – the eventual United Nations - would be discussed in the context of that year’s Presidential campaign. The private papers of U.S. Senator Arthur Vandenberg indicate that “this meeting of minds was an important signpost in the development of unity (in American foreign policy) that begins, as Vandenberg liked to say, ‘at the water’s edge.’ Institutional and political changes around the world over the last three decades, as well as advancements in information and communications technologies, have certainly furthered the degree of international economic integration in all categories of markets, especially in the areas of money and finance. What are the connections between monetary policy, international finance, and the common good? Are there any criteria under which the common good, properly defined, would be advanced through attempts to contain these effects within national boundaries – to keep them from spreading, metaphorically speaking, beyond the water’s edge? Is it even possible to do so in our contemporary global environment of rapid flows of financial capital between nations?

What is the most appropriate definition of “the common good,” particularly with respect to monetary policy? David Hollenbach has observed that the founders of the Jesuit order, such as Ignatius Loyola, drew upon the insights of Aristotle and Thomas Aquinas in order to put forth a vision of the common good that “included obviously religious ministries,” as well as “tasks that might appear more secular in nature.” Hollenbach also maintains that “Ignatius Loyola’s vision of the common good was extraordinarily expansive in scope . . . extending well beyond the city-state envisioned by Aristotle, the medieval kingdoms of Aquinas’s understanding or the Renaissance republics closer to his own time.” Hollenbach notes, however, that “one rarely finds a definition of the common good in these earlier sources, despite the fact that the concept was so central for them.”  He goes on to assert that the concept of a “public good,” defined by Inge Kaul, et. al., as a good that possesses “nonexcludable benefits, nonrival benefits, or both,” represents “the closest contemporary analogue to the idea of the common good in more classical sources.” At the same time, Hollenbach argues that “the concept of public goods . . . lacks an important element in earlier conceptions of the common good,” namely “the relationships that exist among those who form the community or society in question.” Paul Dembinski has expanded upon this point, maintaining “that the common good . . . lies in the relationship between the individual good and the community good; it cannot be reduced to the economists’ concept of general interest (the sum of individual goods) nor to a social good.” Dembinski also asserts that “the common good is not thus a precise institutional project, it is rather a set of principles for life within society.” While this point may be well taken, it bears noting that the conduct of monetary policy and international finance is inseparably linked to the institutional frameworks which define and enforce the rules that govern these processes. The central question of this inquiry, therefore, as posed by Michael Novak, would seem to be: “What sorts of institutions are likely to raise the probabilities of success in identifying and achieving the common good in history?” Dembinski and Marina Ponti make some overtures in this direction by suggesting that “the large-scale development of national, and above all international, financial activities . . . requires redefining the powers and means of action that are available to national, international and supranational public bodies, particularly as regards the supervision and regulation of financial activities.” Dembinski and Ponti also start the process of making a connection between these issues of finance and the common good on the one hand, and the role of the nation state and its policy-making institutions on the other, in the following manner: Exposing national currencies to market forces means submitting public policy to external assessment. There is nothing wrong with such assessment in itself; indeed, it may help to prevent governments from pursuing aberrant policies. It does raise two questions, however. Should policy makers accept the subordinate position to which they have been relegated by the markets? And are financial markets the most appropriate authority to assess public policy? In this connection, one cannot help noting the asymmetry between those who use a national currency on a daily basis as their unique means of payment and those who use it as an asset among others only to maintain or increase their wealth. There is a growing ambiguity about the roles of finance, which is globalised and in private hands, and money, a local means of payment and a symbol of sovereignty, which – in theory at least – is there to serve the overall national interest.

In the monetary realm, the “aberrant” policies that are referenced by Dembinski and Ponti would most likely consist of over-expansion of the money supply by the central bank, which contributes to a higher rate of domestic inflation and a depreciation in the exchange value of the nation’s currency. The former result is generally regarded, by economists and non-economists alike, as harmful to the national common good.  Although there might be some particular beneficiaries from an unanticipated rise in the rate of inflation (debtors, for example) , the corrosive effect of a high and volatile inflation rate on economic and social relationships has been well-documented historically, as well as in our present time with the tragic situation in Zimbabwe. By contrast, the latter outcome, especially if it is gradual in nature and not a “free-fall,” has a more complicated relationship to the common good, for the following reasons:

-Exchange rates are determined by market forces and developments, as well as by policy outcomes, from all over the world. This point reinforces the case for a broad definition of the common good that extends beyond the borders of any single nation-state, and also makes it more difficult to define the kind of institutional responsibilities that were referenced earlier, because of the increase in the number of interested parties.

-A given change in currency values will have differential effects on particular individuals and groups. A depreciation in the exchange value of the U.S. dollar, for example, will lower the value of dollar-denominated assets (and liabilities), reduce the price of American exports in international markets, and increase the cost of traveling abroad for U.S. citizens. From a global standpoint, however, all of these effects will be offset somewhere else. In the words of Nobel Laureate Robert Mundell, “the only closed economy is the world economy.” What is the most appropriate definition of “economic nationalism,” and does this concept, described by István Hont as consisting of “mercantile or commercial jealousy,” have the same implications for the conduct of monetary affairs as it does for other areas of public responsibility, such as trade policy? Robert Gilpin has argued that “economic nationalism is . . . composed of both analytic and normative elements,” as follows: Its analytic core recognizes the anarchic nature of international affairs, the primacy of the state and its interests in international affairs, and the importance of power in interstate relations. However, nationalism is also a normative commitment to the nation-state, state-building, and the moral superiority of one’s own state over all other states.”

In more economic terms, Albert Breton has concluded that “nationalism is both the disposition that leads an individual to favor and to justify investment in nationality and the encouragement which he gives to the investment of present scarce resources for the alteration of the interethnic or inter-national distribution of ownership.” At first glance, a monetary policy consistent with these definitions would appear to consist of an emphasis on one or more of the following points:

1) Independence from the policies of other central banks. The establishment of such a priority would lend itself to an application of what Maurice Obstfeld has termed the “inconsistent trinity . . . If monetary policy is geared toward domestic considerations, either capital mobility or the exchange rate target must go.”

2) The maintenance of a national currency with a strong identity, as opposed to some kind of optimal currency arrangement with other nations. As Nobel Laureate Friedrich von Hayek pointed out in 1937, “monetary nationalism” was the opposite of what he termed “a truly international monetary system,” which he described as “one where the whole world possessed a homogenous currency such as obtains within separate countries and where its flow between regions was left to be determined by the results of the action of all individuals.”

3) A neo-mercantilist emphasis on the promotion of exports and the discouragement of imports through the pursuit of policies that lead to a depreciation in the exchange value of a nation’s currency – a course of action that David Malpass, among others, has referred to as “exchange rate protectionism.”

Some scholars, however, such as Andreas Pickel, would describe the previous scenario as an overly restrictive view of how economic nationalism might manifest itself in this sphere of public responsibility. Pickel has concluded that “economic nationalism is better understood as a generic phenomenon that can accommodate almost any doctrinal content, including economic liberalism.”  In contrast to the idea of a single program or policy agenda, Pickel’s viewpoint is that “the economic dimensions of specific nationalisms make sense only in the context of a particular national discourse, rather than in the context of general debates on economic theory and policy.” As an example of this contextual significance, Klaus Muller has cited the “deutsche mark nationalism” of the Federal Republic of Germany that began with the currency reform of 1948 and ended with the introduction of the euro in 1999 as a common currency for 12 (now 13, with more on the way) member states within the European Union. Muller states that “in the 1990’s not only the Bundesbank’s policy style but also its institutional design was transferred to the European level,” while at the same time, “the independence of the Bundesbank . . . was enshrined into the statute of the European Central Bank.” In the negotiations that led up to European monetary union, Muller has observed that Germany supported a position that was designed to “safeguard” the euro through the enactment of agreements such as the Stability and Growth Pact, “which would limit inflation rates, restrict budget deficits to three percent (of GDP), and reduce public debts to less than 60 percent of GDP.” The paradoxical outcome of this series of events is that the process of European economic integration, in the form of a single currency that is described by the International Monetary Fund as “the world’s second most important international currency,” as well as the establishment of a common monetary policy that transcends national boundaries, was significantly assisted by this particular manifestation of monetary nationalism. Another set of case studies in which nationalist political impulses might also be consistent with support for a multinational currency is provided by the examples of Quebec and Scotland: relatively small political entities that have achieved a certain measure of autonomy within a larger nation-state, but which still contain sizable constituencies that favor outright independence. Eric Helleiner has written that “Quebec nationalists have emerged as the one of the strongest supporters of proposals to create a North American monetary union,” in part because “the creation of the euro is . . . said to demonstrate how the traditional relationship between sovereignty and currency structures is changing.” Meanwhile, the Economist’s “Charlemagne” column has commented that the Scottish Nationalist Party’s slogan of “Scotland in Europe” in the most recent elections to the Scottish Parliament “is a clever phrase: painting a picture of plucky Scotland setting out into the wider world, but within a reassuring European embrace” that would also include the adoption of the euro, in due course. These examples run contrary to the conclusion of Takeshi Nakano that “the national currency is especially important among policy tools from the standpoint of economic nationalism.”

Nakano’s point of view regarding the importance of monetary sovereignty to the agenda of economic nationalism has been supported from an analytic, but not a normative standpoint, by Benn Steil in a recent essay in Foreign Affairs. Steil argues that monetary nationalism, which he defines as “the idea that countries must make and control their own currencies,” is undergoing a resurgence among the world’s emerging economies in response to the financial and currency crises that have occurred over the last 25 years. Steil maintains, however, that this course of action is not sustainable in an era of financial globalization, for the following reasons: Because foreigners are often unwilling to hold the currencies of developing countries, those countries’ local financial systems end up being largely isolated from the global system. Their interest rates tend to be much higher than those in the international markets and their lending operations extremely short – not longer than a few months in most cases. As a result, many developing countries are dependent on U.S. dollars for long-term credit. This is what makes capital flows, however necessary, dangerous; in a developing country, both locals and foreigners will sell off the local currency en masse at the earliest whiff of devaluation, since devaluation makes it more difficult for the country to pay its foreign debts – hence the dangerous instability of today’s international financial system.

In response to this state of affairs, Steil recommends that the governments of emerging market nations “abolish unwanted currencies” and replace them “with the (U.S.) dollar or the euro or, in the case of Asia, collaborate to produce a new multinational currency over a comparably large and economically diversified area.” This prescription is consistent with the perspective of the Quebec nationalists who are enthusiasts for an independent Quebec’s entry into a potential North American monetary union. According to Eric Helleiner, “they argue that in an age of increasingly powerful global financial markets, national monetary sovereignty is a thing of the past. A national currency can even be a liability from a nationalist standpoint, they suggest, because it can become a target of speculation in these global markets.” If current and potential future events in the euro-zone are any indication, however, a broad movement in the direction of a smaller number of major currencies would not be achieved without a certain amount of political tension. In recent months, the newly elected President of France, Nicolas Sarkozy, “has badgered the ECB (European Central Bank) over the euro’s strength,” claiming that its present exchange value relative to other currencies “hurts French exports.” Sarkozy has also “insisted euro-zone governments should have more sway over the bloc’s exchange-rate policy,” which could pose a challenge to “the inflation-focused monetary policy of the ECB.” Additional challenges will also be associated with the coming expansion of the euro-zone to as many as 27 member states. Paul De Grauwe has written that “in such a large group the probability of what economists call ‘asymmetric shocks’ will increase significantly. This means that some countries may experience a boom and inflationary pressures while others experience deflationary forces.” Even an explicitly federal political system that utilizes a single currency, like the United States, can experience conflicts between regions as a result of the differential impact of a particular monetary policy. For example, a restrictive action that results in higher interest rates will probably be most unpopular in areas where interest-sensitive industries, such as automobiles and lumber, comprise a major share of economic activity. Such disparities are likely to be politically magnified when a common currency is shared by sovereign nation-states, especially when those states are at significantly different levels of aggregate economic prosperity. As De Grauwe has observed, “the degree of divergence between the countries forming the Eurozone-27 is quite high.” From the perspective of Robert Mundell’s previously cited observation that “the only closed economy is the world economy,” that might be economically irrelevant, but it is very relevant from a domestic political standpoint.

In a recent column in the Financial Times, Martin Wolf wrote that “the benefit and risk of (global) finance are two sides of one coin. The benefit is the ability to reallocate resources among people at any point of time and over time. The risk is that the resulting pyramids of promises are vulnerable to fraud, deception, and irreducible uncertainty and so to successive fits of optimism and panic.” It would seem that the global common good, in terms of a nonexclusive and nonrival benefit, would be enhanced, therefore, by the establishment of policies and institutions that would, in Wolf’s words, make “it possible to take advantage of the financial brain’s abilities, while limiting its capacity for irresponsible, short-sighted and destructive behavior.” Michael Novak’s previously cited question, in slightly adapted form, bears repeating at this point: What sorts of institutions are likely to raise the probabilities of success in identifying and achieving this particular dimension of the common good in history? While some monetary or economic nationalists have decided that their interests coincide with the movement towards a smaller number of common currencies, major questions regarding the governance of any new attempts to establish an optimal currency area still remain. A key element in this discussion are the human relationships that are established between the parties to any agreement concerning these matters, which, according to Paul Dembinski, also constitutes an essential characteristic of the common good:

In qualifying good by the addition of the adjective common, the expression is focused on the fact that mankind is unable to attain good in total solitude and isolation and that, for an individual and personal being, good of necessity involves the social and the community.

Whatever the precise definition and institutional arrangement, the notion of the common good expresses the desire of a group of people to lead a happy life. It hints at the tension that is possible between the common good’s two poles: that of the group, and that of each individual member.
Alternative strategies for the promotion of what Friedrich von Hayek described earlier as “a truly international monetary system” would be quite likely to have different implications for the relationships between the participating individuals, enterprises, and states. Hayek concluded 70 years ago that “the rational choice would seem to lie between either a system of ‘free banking’ . . . and on the other hand, an international central bank.” Lawrence White, in commenting on Hayek’s work, has maintained that this choice “depends crucially on spelling out the criteria of good monetary policy and comparing the alternative systems’ ability to fulfill them.” Leaving aside, for the time being, the possibilities for a system of “free banking”, how might one structure the choice between an international central bank that was committed to global price stability and Benn Steil’s proposal for a system which involves a smaller number of stable currencies, governed by national or regional central banks that would also be committed to a non-inflationary policy regime? Razeen Sally has observed that one of the viewpoints that has “long dominated the modern liberal paradigm in international political economy” is “an international politics-based ‘neoliberal institutionalism’”. Sally argues that this perspective “places heavy emphasis on mechanisms of intergovernmental cooperation, often with the mediation of international organizations, to achieve liberal economic outcomes while preserving systemic order.” Sally draws a contrast between this approach and that of classical liberalism, which he claims “gives pride of place to policy action at the national, not the international, level to further the progress of a liberal international economic order,” and also “conceives such action in unilateral terms, not predicated on reciprocal bargaining in international organizations and intergovernmental fora.” The call for the establishment of an international central bank would seem to be a manifestation of the former paradigm, while the possible trend towards the elimination of particular currencies would represent an example of the latter approach. At least some forms of currency consolidation, such as the adoption of the dollar and euro by certain nations in Latin America and southeastern Europe (respectively), would appear to constitute case studies of what Sally has defined as the “classical liberal” approach. As was the case with Germany’s role in the introduction of the euro, nations are acting in what they believe to be their own economic interest, while simultaneously advancing, in Sally’s words, “the progress of a liberal international economic order.” Such actions are consistent with an expansive notion of the common good, referenced earlier by David Hollenbach, that is not contained by political boundaries, and also offer the added advantage of being more politically sustainable over time, because they have taken place on a smaller scale of public decision-making that is more likely to generate a broad consensus in support of these institutional arrangements. If Paul Dembinski is correct regarding “the tension that exists between the common good’s two poles: that of the group, and that of each individual member,” this tension is more likely to be reduced in a smaller, as opposed to a larger, group. As Mancur Olson initially observed over 40 years ago, “the larger a group is, the farther it will far short of obtaining an optimal supply of any collective good, and the less likely that it will act to obtain even a minimal amount of such a good.” As a result of the previous discussion, the preliminary conclusion of this inquiry is that the monetary framework that would be most likely to advance the global common good would be one in which the authority to pursue policies that are aimed at the goal of overall price stability are granted, by the individual action of particular nation-states, to a smaller number of central banks than currently exists at the present time. Such an approach would represent an example of what Sally has termed “liberalism from below,” and offers the prospect of reducing the potential appeal of both economic and monetary nationalism, precisely because of “its focus on the national or domestic preconditions of international order.”