Welcome to episode 72 of Activist #MMT. Today I talk with Texas Christian University PhD. economics professor and Cowboy Economist, John Harvey. The topic of our conversation is exchange rate determination. However, be forewarned that this episode is not an introduction but a deep dive into the weeds of John's 2009 textbook, Currencies, Capital Flows, and Crises. For a proper introduction, you'll find links in the show notes to several good recommendations, including two MMT Podcast episodes (December 2020 with John, and October with Steven Hail), John's August 2020 lecture with Modern Money Australia, a 2012 interview on the economics blog Naked Capitalism, and a layperson-friendly 2004 book by psychologist Thomas Oberlechner.

(Here is a link to part two with John.)

This interview took three months of preparation. When I first read John‘s book, I only made it halfway through and, in all honesty, aside from the introduction, I got very little out of it. John's writing has nothing to do with it, it's simply an intense and completely (if you'll forgive the pun) foreign topic. Chapter two, especially, was impenetrable. It's a summary of the major exchange rate models in neoclassical economics and frankly made zero sense. I took a nap after every few paragraphs and watched videos on each type of model, but none of it felt relevant. (John briefly goes over this chapter in his August 2020 lecture.)

I started the book over again and grew fascinated by a five page section in chapter one called Post Keynesian Economics. You'll find it on pages five to nine. The section is an introduction to post Keynesianism and specifically how it contrasts with neoclassicism (the latter of which is currently mainstream economics). Without exaggeration, I read the section around twenty times and wrote pages of notes and questions, several of which I posted on the Facebook group, Intro to MMT (which, I wasn't then, but am now, a moderator of… and I recommend you join it).

I spent the next two months diving into the basics of mainstream economics, starting with a 2019 paper expressing the common concern for the long-term fiscal sustainability of government spending, and its corresponding debt and interest. I then read and interviewed the authors of the 2020 paper responding to it, by German MMT economist Dirk Ehnts and Danish PhD. candidate Asker Voldsgaard. I also read a paper on historical time as recommended by Asker, and a 2006 paper by Scott Fullwiler. The interview inspired a post where I break down the topic in detail: The long-term fiscal sustainability of government spending (is a non-issue)

I then read Steve Keen's 2011 book, Debunking Economics, second edition. I didn't understand much more than I did understand, but it was fascinating and enlightening nonetheless. It also provided excellent background for my next interview with UMKC PhD economics candidate Sam Levey, with whom I discussed the core assumptions of mainstream economics [parts one and two]. Links to all of these papers, posts, and interviews can be found in the show notes.

Before returning to John's book, I read several papers by John and Ilene Grabel, plus the 2004 book by Oberlechner, called The Psychology of the Foreign Exchange Market. I especially recommend Oberlechner's book as a layperson introduction to exchange rate determination. It's particularly easy-to-read and also comes highly recommended by John. As is made clear in Oberlechner's book, one of, if not the, most important determinant in the reality of exchange rates is group psychology.

Finally, I read John‘s book straight through, beginning to end. This time, I was better prepared to distinguish between what to discard and what to focus on. Re-reading chapter two, I now realize that it's less that I didn't understand it and more that it's just not understandable. You would not lose much from skipping the chapter entirely. Its primary benefit is not to learn about foreign exchange but to provide a benchmark for just how far off mainstream is from reality.

The other major lesson I take from John‘s book is that people do not want only to trade – meaning purchase physical goods and services from a company in another country – actual human beings want to accumulate financial assets, and especially, to profit in the short term. Neoclassical economics assumes people only want to purchase stuff (meaning trade), and the only reason they need and want to use money is in order to purchase that stuff. But in the world in which we actually live, only between 1.5 to 8% of all international transactions are for trade. The rest, well over 90%, is for purely-financial assets.

Despite this obvious contradiction by the facts, minstream economics assumes barter for every person, in every country, at all times. In fact, the assumption of barter is required in order for their assumption of balanced trade (either right now or soon to be) to also be true. And that assumption, of balanced trade, is required in order for the assumption of full employment in a single country (any country!) to also be true. In other words, if the myth of barter is indeed a myth (and it is indeed a myth), then mainstream economics falls apart. John and I discuss this in part one, and it inspired me to write a post where I elaborate on the concept, a link to which can be found in the show notes: The neoclassical assumption of full employment requires balanced trade.

If we are to be a civilized society, then we must do what it takes to achieve full employment. Mainstream economics falsely assumes that doing nothing is the only possible avenue to achieving it. MMT demonstrates that full employment can only be attained and maintained, in both good times and bad, by a federally-funded jobs guarantee; one paid for by a currency issuer with a freely-floating currency and little to no debt and other currencies. Despite mainstream's protestations, full employment doesn't and can't happen "naturally." It can only happen with the deliberate and ongoing intervention by the central government – and this will only happen when we stand up and make them do it.

Two notes before we get started: first, a minor correction: I say that "today's" exchange rates are determined by the forecast for next week's exchange rates. I should have said tomorrow. Second, my full question list can be found in the show notes.

And now, onto my conversation with John Harvey.

More resources

• By John:
  • Lecture notes: Exchange Rates and Trade Flows:A Post Keynesian Analysis
  • 1996 paper, Orthodox Approaches to Exchange Rate Determination: A Survey
  • 2001 paper, Exchange Rate Theory and "the Fundamentals"
• By Ilene Grabel (her website):
  • 2016 paper, CAPITAL CONTROLS IN A TIME OF CRISIS
  • 2011 paper, Not your grandfather's IMF: global crisis, ‘productive incoherence' and developmental policy space
  • 2003 paper by Grabel, Gerald Epstein, and Jomo Kwame Sundaram, Capital management techniques in developing countries: An assessment of experiences from the 1990's and lessons for the future
• Other academics recommended by John to learn more about exchange rate determination: Anina Kaltenbrunner, Rogerio Andrade, and Daniela Prates

Full question list

1. First things first! Today is a red letter day in the history of exchange rate determination. (brief Battle of the Bulge summary)
2. Before discovering MMT, I never followed or read about economics. Before discovering your work, I never followed or read about foreign exchange. In my ignorance, coupled with how simplistically it seems to be portrayed in the media (such as "China and the United States trade lots of stuff"), I thought that foreign exchange was only trade (which is the exchange of physical goods and services). I also thought that this trade was mostly done directly between two central governments. But the very existence of exchange rates and currency exchange at all, suggests that exchange actually happens, at least substantially, between companies within two different countries. Governments don't need their own currency! Companies do. So a company in country M (M for import) wants to purchase something from a company in country X (X for export). So company M needs currency from country X, before it can do business with company X. This is not really a question, but I found the opening pages of your book to be pretty eye-opening, and I suspect my ignorance is not unique among the general public.
3. The trading of goods and services is only about 1.5 to 8% of all International transactions. The rest is the trade of financial assets. On page 2 in your book you quote a 2005 BIS survey that says the average daily currency transactions worldwide was about $1.5 trillion. This is around 40 times the value of daily trade. In the show notes, I put a link to a 2019 tweet from Scott Fullwiler that refers to an interview, where it's stated that $5 trillion of settlements are made each day in the Federal Reserve system in the United States. I don't remember which one, unfortunately, but Scott also states in a paper that it may be actually between five and $20 trillion per day. Obviously the data quoted in your book is from 15 years earlier, but I'm shocked that the whole planet is only $1.5 trillion when the US alone is $5 trillion. Are these numbers comparable?
4. Regarding a single nation: A major assumption of mainstream economics is that full employment is here now or soon will be. A critical assumption underlying that is that people (households) are insatiable and will spend every dollar of their income on consumer goods and services. This maximizes aggregate demand, which means companies always need to hire more, hence full employment. A critical assumption underlying this is that all of the spending stays within that country. If even one dollar more leaves the country than comes back in, then total demand is lowered and full employment is put in jeopardy. This is why the assumption of balanced trade, either right now or soon will be, is what you call "one of the legs by which the full employment assumption is maintained." Each country must be a perfectly self-contained, hermetically-sealed bubble, or mainstream theory falls apart. Can you elaborate on this connection, and also briefly describe the other legs that undergirds mainstream's assumption of full employment?
5. One of the most important determinants of exchange rates is group psychology. There's a great moment in your book discussing how the most important determinant of today's exchange rate is today's forecast for next week's rate (or however far into the future). So the idea that your forecast of next week affects next week's actual rate is mostly an illusion. And by the time next week rolls around, you don't care about those actual results anymore! In other words, the expectations are self-fulfilling prophecies. Expectations create the future. Mainstream or neoclassical economics primarily evaluates this situation by comparing those expectations about future values to the actual future values. This is not useful because (A) it pretends the result is unaffected by the expectations (which is called logical time where PK has historical time) (B) Conversely, it suggests that next time maybe we could predict the future. (C) It pretends (I'm not sure how to elegantly say this) that, as if flipping heads five times in a row then makes flipping tails five times in a row more likely and (D) it distracts you from trading and forming expectations in the now! Post Keynesian focuses exclusively on the process of forming those expectations. Can you elaborate on this difference? (I read Oberlechner‘s book. It was very good and in my opinion very layperson friendly. I don't know why it only addressed foreign exchange since it seems to me that almost all its findings apply just as much to traders at any geographic level.)
6. Mainstream acknowledges that it has nothing to say about exchange rate determination in the short run, and only models for the long run. All of those models are wrong, but let's pretend that they're right. So mainstream can predict what will happen, say, 10 years from now, but nothing sooner. So what at all is useful about mainstream economics? 10 years off is always 10 years off. 10 years from now, 10 years from a year from now, 10 years from six years from now. So how is it not just an every-man-for-himself rat race at all times? If I'm correct, then how is mainstream anything more than propaganda for the status quo, which by definition only benefits those already in power. Does that make sense?
7. So much time and energy in foreign exchange is spent on nonsense. Analyzing meaningless charts (chartism) or random economic rules (the fundamentals), pretending that we can somehow predict the future, that we don't affect the future, that we aren't affected by others or the past. So on one hand, because we can't predict the future, what alternative is there? How can it be anything but a big gigantic game? On the other hand, it seems that the vast majority of traders think that neoclassical fantasy world is indeed real. Perhaps a select few that know the reality, deliberately use that knowledge to manipulate and dominate the masses. That seems like a reasonable speculation. Aside from the elite being less elite and neoclassical economists being thrown to the street, what if every trader read your and Oberlechner's books, and Ilene Grabel‘s work, and really got it? What would this alternate foreign exchange universe be like? Trading wouldn't stop! How would it be different?
8. Two meta questions: I'm pretty sure these things are not related, but I'm going to ask them together: (one) I've heard you say that you disagreed with some aspect of MMT but that it's something in the weeds, nothing major. What is your disagreement?
9. (Two) knowing that the book was written well over a decade ago, on page 72 you state, "we [the US] have a fractional reserve banking system…." I can only guess that you would agree that that's no longer the case. So to ask this more broadly: if you were to rewrite the book again today, or update it for a second edition, what would change? How much would each of those changes impact your conclusions, diagrams, and mental models?
10. My ultimate goal, which is clearly impossible to achieve today, is to make a clear connection between your work and that of Fadhel Kaboub. My instinct is that there's something important there. In your late-Mexican-delivery, margarita-fueled, yet very entertaining "horrifically boring" lecture (which was organized by the fine folks at Modern Money Australia and a MMT Podcast), you said the following: "What if I'm a small African nation. Can I follow MMT policies? I don't know. I have always wondered about that." You then clarified that your area of expertise is not developing nations. I believe I understand your specific concern and I'd like to clarify your thinking. First, speaking of MMT in general. We as MMTers know, with total certainty, that the central government's of at least the US, UK, Canada, Australia, and so on, have the capacity to provide dramatically more for public purpose. The challenge is to inform the people and take back control of our government and our money. This may turn out to be unlikely or even impossible, but that's a purely political and social obstacle, not financial. This is analogous to developing nations: although clearly with less bells and whistles than in developed countries, all nations, no matter how developing they are, have the financial capacity to float their currencies and, given enough time, to provide full employment. At that point, they can indeed provide much more for public purpose. The challenge is therefore not financial, but rather to escape out from under the thumb of their colonizing overlords. This may prove unlikely or even impossible, but that's mostly a political and social problem. So when you say "I wonder" and "I don't know," I can only guess (and honestly, hope) that you're referring to those political obstacles, not the financial ones. Is that a fair characterization?
11. A major cause of currency crises is the discrepancy or tension between groupthink (bandwagons and herd behavior) and the underlying conditions in the real world. As the difference grows larger, the tension is more susceptible to smaller and smaller final straws. But often it seems that the final straw is blamed for the years, and sometimes decades, of problems that the final straw merely exposed. An example is the December Surprise which is blamed for the Mexican Currency crisis in 1994, even though it had been building for at least a decade. This is quite analogous it seems, to the false idea that "creating too much money was the cause" of famous historical hyperinflations. As if the war never happened in Weimar, or the decades of terrible circumstances and decisions never happened in Zimbabwe. It even seems appropriate on a personal level, of people spending years in denial, sometimes unknowingly, and then some point years later, the consequences come out all at once – or at least it feels that way. Can you elaborate on this and bring it back to these exchange rate crises?
12. How much does a country need to be concerned about (groups of) individual traders sitting at computer screens on the other side of the planet? Or are problems generally centered around large actors? How did the internet and computer-based trading change things? Were these problems dramatically different before internet/computer based trading?
13. As I understand your book and Ilene Grabel's work, the primary problem regarding exchange rate is, essentially, we've let the mob take over, and their loan sharks have been put in charge of our economies and finances. The mob definitely does not care about public purpose, they care about nothing more than in-and-out, short-term profit. They also push all financial and real costs on to everybody else, who happens to be more vulnerable and farther from the levers of power. And it's all done with little to no consequences. So a country or a company makes a deal with the mob devil (neoliberal devil), and eventually takes out a predatory loan: a cash injection in exchange for control. The country is put into an impossible position and eventually fails to meet that impossible condition. In order to bail themselves out, they must often do something that contradicts with their long-term survival, and give up even more control in the process. It inevitably leads to financial ruin. I believe this analogy is in the ballpark, but you'll correct it as necessary. The major solution according to you and Grabel is to disincentivize short-term profit in order to protect vulnerable countries and companies from predatory loans. But since the mob is in charge of the planet, this is no small task. Can you elaborate on this?
14. Is there anything else you think should be said? Can you recommend related work listeners can look into for more on these topics?