The great discussion of Keynes in 1925 was against the common opinion of the British Treasury, and the politicians, who wanted to restore the Pound Sterling to its parity before the First World War and with this to the Gold Standard. At that time, with the rate of exchange floating at $4.44 per pound, the debate was whether to devalue the pound to $3.60 per pound or to revalue it and re-establish the pre-war parity of $4.86. The reevaluation of 10% involved, for Keynes, a loss of wages if one wanted to keep Great Britain competitive in its exportation. This meant that the wages of coal miners, who determined the cost of energy, would have to fall. For Keynes consequences of this were clear: a great social protest (which was the general strike of 1927) and a deflationary tendency (that happened from 1928 onwards). Less consumption led to lower prices, that prevented an adequate rate of return for capital, or, in other terms, prevented the reproduction of capital.

The impact on the interest rate is immediate. It falls in an attempt to recover economic activity. This problem of deflation, said Keynes, is more dangerous than inflation and it is better to increase consumption through public investment even though it might not be immediately useful. Von Mises argued that lowering the interest rate would have an impact on the increase of productive activity and that this increase would lead to an increase in the prices of capital goods while consumer prices would increase less and interest rates would slowly recover their level when the prices of goods and consumption would reestablish their level. This we were able to observe in Japan after 1999 and is not true. Since 2008 we were able to observe it in other leading countries and it is also not true.

At the present time the revaluation of the dollar over the euro, its principal commercial partner, is about 30%, and the impact of this on consumption in the United States is visible. They have not managed to recover a rate of growth analogous with that of the 1990s, nor have they managed to employ the population in a massive way. The drama is that this is happening with the interest rates at zero in the United States, Great Britain, Europe and Japan; and with the deflationary tendency launched in Europe in 2013, as the result of the austerity policies applied there since 2011 and now in the United States as a result of the increased exchange rate.

The revaluation of the dollar together with the expectation of a rise in the US interest rates has depressed the international prices of commodities and with this mechanism of transmission, deflation is coming to the rest of the world at the same time as exchange rates depreciate with respect to the dollar. Contrary to what was hoped for, internal prices are not rising with the devaluations in the emerging economies due to the weak demand.  Clearly this is generalizing the process of the crisis that began, according to the point of view, in 2000 or 2008.

The consequence of the weakness of dollar prices is that the concept of economic growth led by exports is at risk. It has already been said that this is not possible and it doesn't work. United States has a falling rate of export growth not of commodities but of capital and intermediate goods, which is their strength. If the dynamics of growth of primary commodities is falling and also the dynamic of exports of capital and intermediate goods of the principal exporter of these goods in the world is also falling, that means the dynamics of the growth of the world economy are falling. There is a marked descent of the rhythm of growth of the total trade in goods and services (the blue line) that has fallen 30%, from over 6% before 2006 to less than 4% the year after. There is also a notable deceleration of the growth of the world GDP, that has lost 20%, growing more than an average of 3% before 2008 (the red line) to 2.5% afterwards.

This is divided as follows: Europe and Japan have not grown since 2008 and the United States grows very little at 1.5%. As these countries make up the largest chunk of the world market, through their level of wealth, their stagnation through deflation has forced the world market for commodities to a fall in quantities beyond the speculative aspects that have triggered the variation of prices. Until these recover their dynamism, the quantities imported by them will be progressively smaller. With interest rates on the verge of rising, prices will continue to fall until they find a new equilibrium.

The big consumers of American industrial goods – both of capital and intermediate -- are Europe and Japan which are not growing and do not appear to have perspectives unless there be an end to the policies of austerity. With Germany on the edge of stagnant deflation with growth close to zero, perhaps they may begin to think that something is wrong.

On the other side is the 2.0 version of Keynesian policies of investment in infrastructure as a means of revitalizing the economy. Only this time it is not the State that makes non recoverable investment, injecting demand, but doing it associated with the private sector. This 2.0 version of Keynesian policy that is extending itself through the world, through new regional banks with governments that are promoting their construction industry, is associated with retirement funds that cannot find income in the stock markets and are desperately looking for places to invest.  This at a time when interest rates are held at zero. A return of interest rates in the leading economies to their historic 6% level in this framework does not look imminent. Economic recovery with interest rates at zero per cent is one thing, and with normal rates is quite another. Could there be a solid global economic recovery while the interest rates do not return to their level? Isn't the zero rate an incentive for stock market speculation and financial bubbles?

Japan is a template to understand what is happening. The green line of graph 2 shows that the GDP per capita has not grown for a decade, but if one looks for data from 1990, there are two and a half decades without growth. It is remarkable that the real interest rate is zero since 1999 and that the descent of the interest rate from 6% to 0% had not reactivated the economy between 1991 and 1999, as Keynes predicted.

Meanwhile, consumption in Europe, the United States and Japan remains stagnant with no growth. The bet is that the other Asian economies will increase their capacity of consumption and that through this they may escape this predicament. Increased consumption in Asia will pull the rest of the world. Due to this, English-speaking press only talks about China. They never write about their own stagnation nor their fall in consumption. The worry now is if China consumes at a lower rate, or if it grows, this is their bet and their fear. If China consolidates its position as the leading economy in the world, this has gigantic repercussions for American hegemony and the unquestioned role of Washington. So the English/American analysis is “let’s hope that China grows, but let’s hope not.” The ones stagnant with deflation problems are the G7 countries: the great world market.

Meanwhile the Consumer Price Index of the United States for all the cities and all products stands at 0.2% for the year to August 2015, and in China 2% for the year to August. For Japan and Germany, the number is 0.2%. as in the United States; Great Britain and France 0.0% That is to say there is almost deflation (only when the figure turns negative is it deflation) and interest rates are negative in all these economies. The bet for American recovery is the association of the State with a private partner, in order to wage war, develop infrastructure and whatnot, and it doesn't appear to be working. At least the fiscal multiplier for money spent on defence does not exist, as can be seen with all the wars that the United States engages in and the lack of GDP growth over the last two decades. 

Latin America is immersed in this problem. Export growth is going to lack dynamism and the distorted interest rate will continue to generate ideas of associated public expenditure. If before it was done with international loans, now it is done with associated foreign investment. The difference being that with foreign investment from pension funds they will require a high rate of return in order to justify the investment, which will have a negative impact on balance of payments as bad as the debt. The difference is that it involves little fiscal costs. Is it enough?

Finally, without export growth and with policies of infrastructural development to re-launch growth, with money from foreign investment funds, who benefits from the re-launching of the economy? Whose consumption will be re-launched? Keynes's idea of infrastructure to generate employment with public money was to generate domestic employment. To do this through a deficit in a deflationary moment was a good idea. Do we have deflation in Latin America? In Brazil, annual inflation to August of 2015 was at 9.53% Argentina (there is no information up to date in Trading Statistics), Chile, 5.0%, Peru 4%, Mexico 2.59%, Colombia 4.74%

Two things are certain. Latin America grows slowly but it grows, with the exceptions of Brazil and Venezuela, and there is a healthy low inflation in a global near deflationary sea.  Secondly, the reactivation measures to be taken in Latin America should be different from those taken in Europe, the United States and Japan for these reasons, as well as for the evident structural reasons. The problem is that the Latin American mental frame of reference is geared around export-led growth and faced with the lack of this, there is no distinct new idea, except for Keynesianism 2.0 of infrastructure with private foreign money. An idea might be that private national pension funds invest, but is there such a thing as private national pension funds?

There is a third truth, short-term capital inflows, which have been coming down since Bernanke in 2013 announced the end of the American credit policy introduced in 2008. This has been translated into exchange rates, as was foreseen, and this will compress imported consumption, which will reduce growth rates. If there were industrial export bases, it might offset this, but no one, except Mexico has this, which is the reason why it faces a much lower fall of exports and of GDP between 2014 and 2015. Of course, it had not risen much (0.8% per capita annual average) since the 1980s.  For the United States, the business of NAFTA has been to obtain a market with 120 million Mexican consumers who finance their balance of payments with worker remittances from badly paid Mexican migrant workers (who are not wanted in the United States, as Donald Trump has made evident). For the United States, these are two good deals, a bigger market and precarious cheap labour. For Mexico, it is less clear what has been gained. Nor is it clear it could have been prevented or if there existed real margins of negotiation. The Mexican industrial base is woven into that of the United States so that the tail moves as fast as the dog. And the dog has not moved very fast for three decades, until it has almost stopped moving.

Then how to go about it? 

Keynes faced a relatively healthy fiscal position. In the crisis of 1929, there was no financial rescue, and this was seriously criticized. What happened was a credit crunch that, combined with the deflationary tendency since 1928, resulted in the depression. This time there exist some deflationary tendencies, and there is no growth, but there is no depression. What exists is a monstrous public debt, of over 100% of the GDP for the countries of the G7, which did not involve inflation, as Hayek and von Mises supposed. What is true is that this immense and monstrous public debt, over 100% of GDP in the G7 countries, has happened with zero interest rates. History will change when the rate rises. Each 1% of interest rate rise will be a 1% of GDP transferred as payment of the public debt to the private financial sector. The Government will balance the budget with a symmetric reduction of public expenditure to avoid an increase in the fiscal deficit. If the fiscal deficit does not generate inflation, the movement towards austerity is unclear. The effect of austerity is everything said above in terms of deflation.

The Latin American drama is that the press and common sense are basically on the side of exporting growth and the free market, even in progressive countries. The training of young economists make them closer to the Perfect Market Hypothesis and the thinking of Lucas than to theories related to employment as the centre, which now as in the 1930’s is the main problem. There is no distinct theoretical refuge from which to give a leap forward. In the 1950s when the prices of commodities collapsed, Prebisch was taken with the ideas of Alejandro Bunge on industrialization and integration of markets. Now we know that this industrialization ended with rising inflation and balances of payments bottlenecks in the 1970s. So, that this is not the way.

What is new is that the idea of integration has been dissected into two: those who are on the side of Pan-American integration with the United States (and now with the TPP) and those with MERCOSUR and regional integration. But the latter have member countries with dissimilar economic policies, disrupting the process of integration. There is no way out of this, with dire implications for MERCOSUR. Different from the 1970s, the problem is not inflation with stagnation, and hence credit policies with inflationary goals in the first place; but world deflation through the fall of consumption in the rich economies derived from austerity policies and the appreciation of the dollar. 

Perhaps we should think of policies against deflation not related, either to closing the fiscal deficit nor downward adjustments in consumption. Meanwhile the anemic Latin American growth will continue in a world divorced between the austerity of Brazil and Mexico, which will sink their growth and perhaps their consumer price indices as well; the stagnation of G7 with near deflation; and Asian growth.  To all of this added up Madame Legarde refers as “overcoming the crisis”, with an interesting innovation in the use of the word "overcoming". The crisis is not a point but a process, and we are coming along.

There are some who state that the cycle of the left has ended. The cycle that has ended seems to be of export led growth in Latin America, although the elites persist and will continue to promote investment in natural resources.

15/10/2015

(Translated for ALAI by Jordan Bishop)

- Oscar Ugarteche – Senior researcher at the Instituto de Investigaciones Económicas UNAM, SNI/CONACYT, Coordinator of the Obela Project.

(Version with corrections posted on 20/10/2015)