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Central banks are treading on dangerous ground by cutting interest rates and devaluing the currency. This could lead to a new global crisis like that of the 1930s. That's what Judy Shelton, former economic adviser to President Trump, says in an interview with CNBC. Now, as then, there is a risk of a situation in which countries attack each other with trade barriers and competitive devaluations.
"When the Federal Reserve or other central banks talk about stimulus today, it's not to stimulate growth. The effect of 25 basis points is like administering a shock to a motionless body. It doesn't stimulate growth. But it does have an effect on the foreign exchange market and we are in a very dangerous situation.
It's no different from the 1930s, when you had competitive devaluations where one country after another devalues its currency against its trading partners. In those days it was against the gold standard, today you have the European Central Bank, the Bank of Japan, the People's Bank of China, potentially the Bank of England all devaluing against our currency. And that's where the monetary decisions have the most impact."
The big question now is how the United States should deal with this. Are they wise to join the race to the bottom? Or do they have no other choice? Judy Shelton had this to say about it:
"It would be nice if we could be virtuoso in a vacuum, but I don't think we have that luxury. We are doing the right thing right now in the United States because we have a pro-growth economic agenda.
We are making tough policy choices to reduce the regulatory burden and make the tax climate more favourable for entrepreneurs. In Europe, they don't take those hard decisions. But that doesn't mean Americans should subsidize European exports. I do not think we should make it difficult for our own producers who are competing at home against imports from other countries that cheat, for example by manipulating currencies. In doing so, they act as if they can deliver the same thing at a better price."
Central banks are under increasing pressure to influence the value of the currency. That's a worrying development, according to Shelton. According to her, it is now time to create a level monetary playing field, conducive to capital flows and global trade.
"Other countries put a kind of import tax on our goods, when they deliberately devalue their currency. I think we are now at a tipping point in determining what central banks are most effective at. And it's a shame when we come to understand that they are the most effective at influencing exchange rates.
It is a big step to recognise that and to start talking about a level international monetary playing field. I believe that such stability will do much more to improve productivity, free trade and capital flows. We have so many bad investments and distortions caused by the actions of central banks. They've laid the groundwork for negative interest rates and bizarre yield curves, and I think that's very damaging."
According to Shelton, the U.S. central bank will have to intervene at some point to prevent an increase in the value of the dollar. She notes that there are a lot of debts listed in dollars worldwide. If this currency becomes more expensive, the emerging economies with weak currencies will be in trouble.
"I think there is another threat to global financial stability. If it was possible to just ignore what other central banks are doing and let the dollar rise against other currencies, then we have problems too. There are so many debts in the world that are denominated in dollars. If local currencies then depreciate against the dollar, it becomes much more difficult for those debtors to repay that money.
I fear that there is a risk of regional defaults if the value of the dollar rises too much against that of other currencies. That would be dangerous."
