Flassbeck vs. Krugman on hot money

Below is an excerpt from a theRealNews.com interview today with Heiner Flassbeck

JAY: Now, we’ve talked a bit about this before, and I know this issue of exchange rates is quite complicated. There’s many factors involved. But one of the main factors, it seems to me, if I’m understanding it correctly, is interest rates are so low in the United States because the Fed is making sure they stay as low as possible, but to a large extent because there’s so little real demand in the United States, wages are so stagnant and so low, that they’re doing everything they can to kind of keep, you know, as much as they can, boosting the economy with cheap credit. And then this has global consequences, not just American domestic consequences. Do I have it right?

FLASSBECK: Yeah, that’s one thing, that’s one factor that’s very important. But, as I said before, it’s not only the U.S. We have zero interest rates in Japan. When the U.S. still had higher interest rate, the hedge funds went through Japan, borrowed money in Japan, and carried it to Brazil and other countries. So it’s always–there’s always a low interest rate country. Or it was done through Switzerland. So it’s not important how it is done.

But the crucial thing in here–I fully disagree with Paul Krugman. Paul Krugman said, you had capital controls in the ’50s and the ’60s under the Bretton Woods system. That’s true, but that’s not the whole truth. The much more important thing is that we didn’t have flexible exchange rates. We have flexible exchange rates, and these flexible exchange rates, with these huge flows of money, of hot money, are going in the wrong direction, they’re going definitely the wrong direction, because countries with a rather high inflation rate, like Turkey or Brazil, get an appreciation of their currencies, and everybody knows that’s absolutely untenable. Every good economic textbook will tell you that the country with the high inflation needs a depreciation. But the flexible exchange rate, the markets, the markets are doing exactly the wrong thing. And Krugman also is shying away from saying this very clearly. And this is the problem.

We had attempts in 2011 in the G20 to talk about a new monetary system, but everybody is shying away from touching this hot issue. This is the hot issue. The markets get the prices wrong. And this has to be addressed head-on. And that means you need intervention, international intervention into the market to avoid the misalignment in the first round, the misalignment driven by the market.

JAY: But the pegged exchange rates don’t seem to work either.

FLASSBECK: Well, you’re never prevented from inventing a smarter system than you had before, but you need a system. The system Bretton Woods didn’t work quite well, because it was a system that corrected the exchange rates when it was too late. I have proposed with someone other people in UNCTAD a system when you anticipate, so to say, the changes in the exchange rate that are needed and you do it right away, so that the big imbalances do not have time to build up. And this is a much smarter way to do it. And so why shouldn’t we learn?

But what is absolutely clear but is not mentioned by most economists, not even by a person like Paul Krugman, whom I like very much for many of his assertions, but he is not saying, well, flexible exchange rates do not work. But this is the fact and this is the core of the matter. And this–but if you say this, then it has harsh consequences for Wall Street, and nobody wants to tackle that.