July 24, 2004

The Ghost of Andrew Mellon

One thing I said at the Reinventing Bretton Woods 60th Anniversary Conference, Rome, July 2004:

Voltaire is famously supposed to have said: "I disagree with what you say, but I will defend to the death your right to say it."

When I hear the great and good say that "crises are overwhelmingly domestic in origin" I find that have an opposite reaction: I agree with what they say, but I am averse to hearing people in their institutional and institutional positions say it.

If domestic policies were perfect--if domestic policies were good--if they left no significant vulnerabilities uncovered--there would be no crises. For example, the Mexican government in 1994 undertook a six-month liquidity goosing of the economy in the runup to its presidential election. The Mexican government also undertook to boost its long-run credibility by offering its creditors the infamous Tesebonos--peso-denominated but dollar-indexed bonds. These two policy missteps produced the Mexican crisis of 1994-5--a crisis that was bad, and that without Camdessus's, Fischer's, Clinton's, and Rubin's willingness to stick their necks *way* out on very short notice would have been horrible.

What this seems to me to miss is that policy is *never* perfect, and I at least certainly did not think before 1994 that it was a *very* bad thing for a government to be willing to offer its creditors inflation-indexed debt, or that a short pre-election monetary goosing was more than a *minor* sin against the gods of monetarism. Yet the gods of monetarism proved to be jealous gods: the punishment was swift and terrible.

To say that "crises are overwhelmingly domestic in origin" seems to direct our attention away from just what it is that makes the gods of monetarism such awful and jealous gods, and what relatively small changes to our international institutions might make the gods of monetarism kinder and gentler ones. Yes: the shocks that generate crises are primarily domestic, or at least the domestic elements are necessary prerequisites. But the propagation mechanisms are global and international.

I feel the icy breath of the ghost of Herbert Hoover's Treasury Secretary Andrew Mellon when we focus on the sins of the bankers and borrowers rather than the workings of the system.

Posted by DeLong at July 24, 2004 12:54 PM | TrackBack | | Other weblogs commenting on this post

Obviously we would need more of your speech, even, perhaps, the second thing you said. But what is the difference between "the workings of the system" and "the [actions] of bankers and borrowers?"

Posted by: Chris Marcil on July 24, 2004 04:12 PM


If I understand things rightly, the Bretton Woods adjustable-peg exchange rate mechanism was designed to encourage international trade flows, to be further implemented through GATT, while precisely discouraging international capital flows. "Reinventing Bretton Woods"- could this be taken to indicate a turning of the tide with respect to recent economic orthodoxy?

Posted by: john c. halasz on July 24, 2004 04:34 PM


Your phrasing makes it seem that you're aware of this, but just to be clear Voltaire is not on record as saying that phrase; it was someone redacting his work who used it as a summation of his views on the matter.

Posted by: carpeicthus on July 24, 2004 05:48 PM


I agree with what I think I hear you saying, that the International Great and Good should not turn away from trying to improve the part of the system they control just because on balance all financial meltdowns are driven by domestic policies (and so by assumption beyond influnence?). I truly hope thats not the case.

Posted by: Dex on July 25, 2004 05:44 AM


OK, so what do you propose? What are other people at the conference proposing? What seems to be gathering support?

Posted by: Martin Bento on July 25, 2004 06:43 PM


OK, so what do you propose? What are other people at the conference proposing? What seems to be gathering support? If you don't want to go through it here, does the conference have a website where such things will be outlined?

Posted by: Martin Bento on July 25, 2004 06:44 PM


Did you really say that at the conference ? I sure hope so. I share your reaction to the great and the good blaming the victims. I'm not so sure that I totally agree with what they are saying. I admit that Mexico, the ASEAN countries, Russia and Argentina might have flirted to much with disaster convincing investors that they were of easy virtue. But what about the crisis/devaluation of the REAL.

The Economist, which also tends to agree with Davos man, couldn't find anything to criticize. As far as I can recall, the only explanation of the crisis was that East Asia spooked investors who lost confidence in Russia which fulfilled their worst fears so they took it out on Cardoso's baby. don't sound to domestic to me. Has to do with 3 continents including North America, but nothing much to do with Brazil.

I'd also be a lot more convinced if the great and the good noticed the domestic errors before the crisis. The general rule seems to be if the great and the good are applauding too loud it's time to sell. More thoughts at my page.

Posted by: Robert Waldmann on July 26, 2004 10:31 AM


Isn't what happens when "domestic policies are good" in a developing country that the international community showers them with so much love, in the form of direct andindirect capital, that the good policies are thrown far off balance to force a crisis? This isn't to exculpate the recipient country, the borrower, but the fact is that talent in managing an economy in a developing country (not to mention our own) is always stretched incredibly thin and always on a political knife edge. Anyone who starts a party with good policies ends up being thrown out as a party pooper if they try to keep it under control.

So what changes to the mechanism could temper the excessive enthusiams for good domestic polices in a developing economy -- one that doesn't have a deep enough economy to ingest the love?

Posted by: paulo on July 26, 2004 11:10 AM


Paulo, I think that's the best description of a catch -22 I have heard in a long time. I am not sure what outsiders can do, the IMF is already really unpopular hard to imagine how unpopular it could get by insisting on limiting foreign investments to countries that have good domestic policies. Clearly capital controls by the countries themselves would be a solution of some kind, but its hard to predict how negatively they will be received by investors and so how badly it would choke off outside investment.

I think it is even more reason to have better disastor policies set up that magically can cushion bust ups without becoming moral hazards.

Is there any hope on this one?

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