#Lukáš Kovanda, Ph. D.

The Fall of the Dollar Will Revive America

“Central and Eastern Europe is still prone to the eruption of a serious crisis,” says KENNETH ROGOFF, the former Chief Economist of the International Monetary Fund.

Paul Samuelson (the author of a world-famous economics textbook, and the 1970 Nobel Prize Laureate in Economics, note by L.K.) told me recently that he was expecting a terrible run on the dollar.  Do you fear the same?

He really said that?  But yes, there is a great risk.  When we look at the present measures, you cannot avoid seeing that, in terms of debt, the US is one big California.  People want the government to spend on all sorts of programmes, but they are not willing to see their taxes go up.  President Obama speaks about taxing the rich, who would then pay for everything.  But that is only a joke.  That would not yield even one-quarter of the money required.

So what do you propose?

The middle class must be taxed more. But that would cost political points and the government would easily panic in taking such a step.  So I think that we can indeed expect the dollar to weaken.  I do not think, however, that it would pose any great danger for the United States.  It would be much worse for Europe and Japan.  The danger for the US consists of high interest rates.  If the rates remain low and the dollar weakens, then the situation would be literally ideal for the States.  There will be unemployment – I do still think that it will exceed ten percent – and overall demand will not grow faster.  A significant decline of the dollar would therefore be extremely helpful for us.  It would be terrible for everyone else, but very helpful for the United States.

Is that why in a recent article of yours, you proposed inflation as a route that would lead the US out of the crisis?

Yes.  If we are unable to resolve the debt surplus, the great surplus of business and consumer indebtedness, and if we are unable to increase taxes, inflation could be the least of the evils.  It is not an optimal solution – it would be better to have efficient bankruptcy procedures, to increase taxes, or to force debt restructuring throughout the economy.  But it does not seem to me that politicians would be courageous enough to take such measures.

Great inflation as the least of the evils?  Many consider it the greatest…

I have stated several times that within the next few years, we could end up with great inflation.  We do not necessarily have to.  But I am sceptical as to politicians finding a way to pull out the money that they provided to the financial system while addressing the crisis, or to pay for the swelling debt, or for Obama’s social programmes.  As I have said, I think that income tax must be increased such that instead of the present nine or ten percent of gross domestic product, it would cover fifteen.  I do not think that this will happen.  At a certain point, this will therefore lead to inflation – that would essentially amount to a partial insolvency.  It is not ideal, but it is very likely.

When will it happen and how many percent will the price level go up?

It will not be next year, and it does not necessarily have to be in 2011, but, simply put, within the next few years.  Around 2012, I expect inflation of five or six percent.

That is not too high a number.  Some expect as much as twenty percent.

Some kind of an unlikely combination of events would have to occur for that to happen.  There is no reason for that.  Although of course, we could have such an inflation level for a month – because thus far, we have had little experience with quantitative easing (central banks directly pouring money into the economy, note by L.K.) and its modelling.  Temporarily, therefore, the inflation level could “skyrocket”, get outside of the control of the US central bank; but it would be more of a statistical anomaly.  Sustained inflation at the level of twenty percent could only be the result of some kind of a not very likely geo-political catastrophe.

Do you expect another wave of stagflation (the unfortunate combination of low growth or stagnation and high inflation, note by L.K.)?  Similar to that of the 1970s?

Yes, within several years.  In the next five to seven years, growth in the US will be at half the pre-crisis level.  The reason will be that consumption is at seventy percent of the gross domestic product and people will cut their expenditures for many years.  They will recover from the drop in real estate prices, which will not rise at any point soon.  Furthermore, the social programmes that Obama wants to introduce will be more expensive than the present estimates show.  Environmental legislation in itself is a tax.  Ultimately, it will be paid for by consumers.  That, too, will slow the economy down.  So that is the first half of stagflation.  The other is, as we have already said, the assumption that politicians will not increase taxes, as would be required, and that in the end the Fed, although it is now pounding its chest and swears that it would never permit that, will have to get us out of the problems through inflation.

Ben Bernanke, the head of the Fed, however, claims that he has an efficient “exit strategy” at hand, for pulling the newly pumped-in money back from circulation, when it is required.

Technically, that is not a great problem.  We know how to do it – by significantly tightening monetary policy.  Our practical problem is not due to the rates being low, but because many entities in the economy keep borrowing from Bernanke.  The Fed has in its balance trillions of dollars in securities tied to mortgages, which it took over in order to relieve the real estate market, but that market will not be able to stand on its feet in the foreseeable future.  So how to get out of that?  Another problem is the agencies, Fannie Mae and Freddie Mac – what “exit strategy” does the government want to invent in that case?  The Fed is holding consumer loans, and I can imagine that it will somehow relieve California of its debt, too.  The Fed would rather have inflation than pull back all those stimulation measures.

If an “exit strategy” is being discussed, does that mean that the worst of the crisis has already passed?

I think that the most profound drops are a matter of the past.  On the other hand, it is very unlikely that we would now be able to have five years of growth in the US and in Europe, like we did before the crisis.  Recession is coming to an end, but it is not entirely behind us.  Many problems still lie ahead of us.

Kenneth Rogoff (56)

Professor of Economics at Harvard University; from 2001 to 2003, he worked as the Chief Economist and Head of Research of the International Monetary Fund.  In 1978, he became a grand master of chess.  His wife Natasha, with whom he has two children, is the producer of the Russian and Mexican version of the children’s television programme Sesame Street; she teaches her husband how to handle himself in public.

What are the most burning ones?

The greatest one is that the crisis was addressed by giving a blank cheque to the financial system.  And related to that are many hidden costs.  The debts of the US government and of European governments have exploded.  They will not be settled quickly.  The next crisis to come will be a fiscal one – primarily in the United States, but also in countries such as Ireland, Italy, and potentially also Germany.  At this point, that difficulty is not as evident, because the Asian economies and oil superpowers willingly lend to us at nearly zero interest.  But that will not go on forever.  In the foreseeable future, we will have to increase taxes significantly.  In the USA, in order to be able to pay for those social programmes, and in Europe to mitigate the impact of the ageing population.

We simply have to come to terms with the ageing of the population.  But why is the US introducing social programmes right now?  It could have hardly chosen a worse time…

They simply want to do it, and if they are serious about it, this is as good a time as any.  But I do think that Obama’s administration is still holding back in terms of increasing state treasury income.  One of the causes of its popularity is that it has not resolved to take any really radical steps – thus far, it has only been spending and handing out guarantees.  But that cannot go on for ever.

For how long will we feel the impact of the crisis?    

Five to seven years.

But you are not expecting a large economic crisis number two.

I have never claimed that something like that is likely.  In normal times, the likelihood of the arrival of a second Great Depression is one or two percent, and I think that at the worst stage of the present crisis – at some point in February or January of this year – it was ten or fifteen percent.  My colleague Robert Barro speculated that that chance was even twenty percent, which is greatly exaggerated in my opinion.  Now, it is about three percent.  It is still greater than is usual, but it is not a large number.  And the risk of a major stagflation number two?  That is high.

Many people think that the critical stage of the crisis is ending.  Would you like to see more regulation, or more market, after it is over?

We need more regulation.  And we need greater autonomy of regulation from politics.  That is why I am a proponent of an international financial regulator.  I do not think that it is possible to create national regulators who would be politically independent.  Perhaps for a year or two.  But the idea that we can have a domestic, truly politically independent regulator, such as the Fed, is simply wrong.  We simply need more financial market regulation.  But I fear that we will not see it very soon.


I think that there will be a lot of talk about that.  But politicians will be afraid to restrict the fragile growth, the fragile revival, so they will not resolve to do anything.  They do not want to disrupt market trust.

Last year, you published an expert study in which you claim that from the historical point of view, the crisis is nothing exceptional.

When we look at the key indicators by which we usually judge crises, for example the growth of unemployment and government debt, it is a very typical deep crisis.  We have focused on the quantitative similarities with other crises and I was surprised to see how close the parallels were.  A typical recession, for example, takes 1.7 years.  The present one started in December 2007 and will probably end at some point during this summer.  Typical growth in the unemployment level is seven percent; now we have six.  We will also “comply with” the doubling of the debt.  The collapse of the real estate market and the present revival of the stock market are also textbook symptoms.

In your study, you show that although inflation is not a new phenomenon, it reached, on average, values of a different order of magnitude in the last century than in the past.  Why is that so?  Because of the departure from the gold standard and the introduction of a system of uncovered money?

Of course, engaging in an inflationary policy with uncovered money is much easier.  With the arrival of that kind of money, the level of inflation did indeed increase rapidly compared to the past.  The gold standard significantly aided the stabilisation of inflation.  But as in the case of fixed exchange rates, it did not help the recovery policy of the given economy.

Certain economists are still saying that we should return to the gold standard.

I think that such attitudes cannot be taken seriously.  One can perhaps joke about it over a drink in the wee hours.  The gold standard: that would be suicide.  It is the same problem as fixed FX rates – ultimately, it cannot be reliable.  It will end with speculative attacks or deflationary periods.  A far better tool for suppressing inflation is a modern, independent central bank.  Especially in the last ten years, central banks have been relatively very successful, but the next ten years will probably not be as good.

Which region will be struck the worst by the crisis?

From the long-term point of view, the United States will be hit the hardest.  The recession here will end sooner, but it also started sooner.  Of course, Europe will also suffer.  The region of Central and Eastern Europe is still prone to the eruption of a serious crisis.  The growth in indebtedness there is very adverse.  The generous rescue funds from the International Monetary Fund (IMF) put out the fires of the most burning problems, but I am afraid that the crisis can flare up again there.  As the conviction of West European countries that the worst has passed increases, the support for Central and Eastern Europe could end.  Countries such as Latvia will certainly be struck by the crisis, and it is a question as to how much the entire region will be affected.

The problem is that investors – and perhaps even certain economists – view the entire region as a single lump.  But there are many differences among the countries: the Czech Republic is simply not the same as Hungary.

Yes, we hope that the markets will make that distinction.  But I expect that in the first wave after insolvency is declared, the markets will simply not distinguish certain countries within the region.  But the IMF will come to the rescue and the region will survive.  And the markets will, in the end, over a span of time, distinguish between the individual countries.  Just remember what happened in South America at the beginning of this decade: the markets also distinguished Brazil, which survived, from Argentina, which collapsed.

In the Czech Republic, a debate has been going on for many years about the adoption of the euro.  What is better, in your opinion, for a small open economy such as we are – the single currency, or the crown?

It is probably better to have the euro.  The euro cannot be viewed in isolation, i.e., taken out of the context of European integration as such – the opening of borders, the liberalisation of trade…  And that overall context, that “package”, is certainly positive.  But as has been said before, distinctions must be made between regions.  For the Czech Republic, the adoption of the euro is probably desirable.  The case of countries such as Sweden or United Kingdom is not as clear.


They are much larger countries compared to the Czech Republic.  The adoption of the euro would allow the Czech Republic to improve the operation of competition among banks, and the functioning of the financial system, and so on.  But I definitely do not think that you should in any way rush it.  It remains to be seen whether, if it were required, the EU would rescue the Czech Republic faster if it were to use the euro or if it were to retain its own currency.  Now, I would definitely not say that the euro would be helpful in any way in this regard.

Do you think – ten years later – that the euro is a successful project?

It is certainly a success, but it is difficult to distinguish the success of the euro as such from the entire process of European integration.  Integration is an excellent thing – and the euro is a major psychological component.  I think that the euro is not as important economically as it is psychologically.

An abbreviated version of this interview, obtained in Boston, was published in Týden No. 34 on 24 August 2009.

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