Submitted by Michael Every of Rabobank
Gresham's Law, Say's Law, and Godwin's Law
It’s Fed day and I honestly can’t bring myself to repeat what was already said on Monday and Tuesday other than “Yes, the Fed will cut but it won’t be enough”. Instead, let us take a moment to contemplate several laws that seem pertinent to our current situation.
First, Gresham’s Law: that bad money drives out good. That used to be the measure of how far a government or a central bank could debase money before everyone hoarded the good stuff and circulated only less valuable coinage. Yet as we contemplate everyone slashing rates again, the opposite appears to be true: everyone is piling into bad and/or directly money-losing assets as benchmark rates decline! One could make the argument for gold, of course, given there is a clear desire to see currencies go lower on the part of central banks, even if they can’t openly say so. (They now leave that to the politicians, of course.) But USD is still, for now, a modern version.
Second, Say’s Law: supply creates its own demand. This is the “Just build and they will come!” hope as we re-embark on monetary policy previously reserved for extreme crisis: Of course, first you have to get them to build, not speculate on money-losing assets. And even then Say’s Law doesn’t hold true – you can and do get over-supply of goods relative to demand both in one market and in aggregate. Then we end up with all vs. all as sluggish economies parasite the consumers of others – all the more so if the central banks nudge-nudge wink-wink their currencies lower too.
Consider those laws and is it any surprise that as the US and China sit down to talk trade we see US President Trump tweet: “China is doing very badly, worst year in 27 - was supposed to start buying our agricultural product now - no signs that they are doing so. That is the problem with China, they just don’t come through. Our Economy has become MUCH larger than the Chinese Economy is last 3 years. My team is negotiating with them now, but they always change the deal in the end to their benefit. They should probably wait out our Election to see if we get one of the Democrat stiffs like Sleepy Joe. Then they could make a GREAT deal, like in past 30 years, and continue to rip-off the USA, even bigger and better than ever before. The problem with them waiting, however, is that if & when I win, the deal that they get will be much tougher than what we are negotiating now...or no deal at all. We have all the cards, our past leaders never got it!”
Meanwhile, a Bloomberg editorial today argues “Hong Kong is running out of time. Signs are building that the city’s political crisis is starting to affect its financial and business prospects…Hong Kong’s reputation for political stability, reliable institutions and effective governance was won over decades. Once lost, it will be hard to regain.” This, as it appears protestors arrested Sunday night are to be charged with rioting (maximum sentence: 10 years) whereas the ‘white-shirts’ who violently attacked protestors the previous Sunday have been released without charge or face much less serious offenses. Bloomberg also reports: “White House Eyeing Chinese Forces Gathered on Hong Kong Border”. That carries implications here that I don’t need to go in to.
But let me now bring in the third law - Godwin’s Law: as an online discussion grows longer, the probability of a comparison involving Nazis or Hitler approaches 1. Indeed, nowadays it usually takes no more than two Tweets to get to that accusation in most online interaction. What’s the relevance? There is a growing swell of anti-China opinion in US policy circles. Seasoned pro-China journeymen have been elbowed aside by younger, hawkish experts who sound even more confrontational that Trump: and some of them use Godwin-esque language. Yes, there are still voices in markets lobbying or pricing for US-China free trade winning out. But let’s rewind the clock and see what the economic debate looked like in the mid-1930s before Godwin.
As a recent Jerusalem Post editorial shows, US President F.D. Roosevelt--the progressive champion of the New Deal--had a pre-WW2 policy to maintain trade and diplomatic relations with Nazi Germany; the Treasury Department even permitted the Nazis to forego a “Made in Germany” label and instead mark goods as having been made in a particular city or region to confuse US consumers. The liberal establishment also shared that stance. Smith College’s president visited Nazi Germany in 1933 and found “no cases of mistreatment” of Jews; Barnard College’s dean toured Germany in 1935 and announced Hitler’s desire to acquire “new land” was “legitimate”; Vassar College’s president saw the boycott as a step toward war, and in 1934, organized a tour of Nazi Germany; and a Bryn Mawr professor similarly denounced the boycott as “simply war without bloodshed.”
Let me make myself abundantly clear: I AM NOT MAKING ANY COMPARISONS OF ANYONE TO HITLER! There is no Godwin goin’ on.
What I am trying to show is that Gresham’s Law matters for markets even in a world without coinage; Say’s Law is a nonsense that will make central banks ignoring Gresham’s Law create worse global imbalances that lead to geopolitical tensions; and hence as US policy hawks start to circle those who think we can avoid a trade rift between the US and China using highfalutin free trade arguments overlook the chequered history of such a principled stance. Anyway, something to think about while we wile away the hours waiting for the Fed.