Economics and politics - comment and analysis
16. January 2015 I Heiner Flassbeck I Economic Policy, Economic Theory, Financial Markets

Market Chaos and the Fatal Silence of Politics

This is the (updated) translation of an article that appeared January 6, 2015 on this site. We intend to publish one article in English every week in the future to allow more readers to follow closely our analysis of global and European events.

The international markets have been in tumult since the beginning of the year. Many commentators lose their bearings and are at a loss to explain what is going on. Indeed, some developments are nothing short of extraordinary. Prices for globally traded commodities are plummeting at a staggering pace. Particularly prices for oil and oil products are in sharp decline. Other commodity prices like the one for copper are also under pressure. Dramatic ups and downs occur in the stock markets, while prices for fixed income securities record historic heights and their yields historic lows.

Instead of having to pay interest on its loans the German government can borrow money for a few years and to receive a premium from investors. Central banks print money as never before – apparently without restraint – with the consequence that price levels are falling almost everywhere. The exchange rates of some major currencies are in a steep decline. The Euro shows massive weakness: it fell from 1.40 to the US Dollar in the spring of 2014 to less than 1.20 to the US Dollar in January 2015 and Switzerland abandoned the three year old peg to the euro yesterday leaving the markets in shock.

It is not surprising that all of this confuses many and that conspiracy theories and speculation are running wild. Some commentators go so far as to suggest a global take-over of the world economy by extremely powerful actors aiming to safeguard their gigantic economic interests and political power. However, most of such conjecture is extremely far from the mark. In reality, there is no conspiracy. Neither is there a global dominance of one country in particular that is pulling the strings in the background.

Rather, we are witnessing a new era of economic development taking shape in the shadow of a widespread failure of orthodox economic policy. This does not mean that we are unable to explain most of the developments that are taking place. The correct economic theories can explain current developments very well. The problem is that these insights are minority views among professional economists and “experts” who are still struggling to explain the world with the “ideal market model”. This, in turn, confuses ordinary citizens and many people with a critical mind. As even policy makers appear to be unable to understand what is happening, all sorts of pseudo explanations that only add misunderstanding and obfuscation come to the fore.

For example, falling oil prices and a strong Dollar are taken by some as evidence that the United States, with the Dollar being the ‘reserve currency’ and oil being traded in Dollar, constitute a potential threat – for example with regards to Russia – that would not exist if the Dollar would not be the key currency. However, the fact that oil is traded in Dollars has mainly historical reasons and does not bring the United States great advantages, especially not at a time when they are a net oil exporter. There is no evidence at all for the widespread suspicions that the United States systematically and secretly intervenes behind the curtains in the foreign exchange market or in the oil markets.

Moreover, there is no doubt that the strength of the US dollar is disadvantageous to the US economy. Low prices for oil have huge negative effects for the new energy producers in the United States because most of them are rapidly reaching the point where production costs are too high. Finally, the strong Dollar exerts major negative effects on American trade. The negotiations of a free trade agreement with Europe within the TTIP framework turn out to be useless if the Euro remains weak. Surprisingly, the US government at this moment of time remains silent on the fatal weakness of the Euro and its detrimental effects on transatlantic trade relations. It seems, the administration does not want to jeopardise the conclusion of the TTIP, which is considered to be crucial for purely political reasons (as a bulwark against China’s power).

It is certainly advantageous to the US that the Dollar is accepted as legal tender worldwide and that the US only borrows in their own currency. But Europe is also indebted in Euros and not in US dollars, because, so far, many investors have been more than willing to buy Euro-bonds. Once there was the potential for the Euro to stand up to the US Dollar and to become a globally recognised currency. That this did not happen is not the result of an American conspiracy, but of narrow-minded, short-sighted (and mercantilist) German politics.

Much of the general confusion can be explained by the fact that we live in an era of deflation – and deflation is not well understood. As we have said hundreds of times during the last two years, the main problem is that the phalanx of experts including the most powerful central banks refuses to give up the view that inflation and deflation are monetary phenomena. The correct and evidence based view holding that inflation and deflation are the result of wage growth overshooting or undershooting the growth rate of productivity is tabooed in mainstream economics as it questions the core idea of the neoclassical-neoliberal paradigm, namely the efficiency of labour markets. While wages during the 1970s were too high compared to productivity causing inflation they are now too low causing deflation. The failure by the vast majority of experts and politicians to accept this is precisely what fuels conspiracy theories in the view of the wider public. The few politicians that are capable of looking at what is really going on (in the German government, for example, there is nobody), do not dare to oppose the economic mainstream and propose constructive policies. This silence could be fatal for the chances of a European, and global, economic recovery.

Translation by W. Denayer