Buoyant Economies

Background History  

 

While working as the economist for the treasury of a small Pacific Island country, Leigh Harkness discovered some basic facts about the management of money that has provided a key to understanding how economies work.  He did not discover a new theory.  Rather facts that confirmed an interpretation of existing theory and separated the sound theory from the unsound.  Also, the data revealed a means of converting economic theory to economic policy.

Up until 1974, Tonga did have a bank.  But it had its own currency.  When people brought money into Tonga, the government would convert it into local currency. They would put the foreign exchange in their own account (that of the Commissioners of Currency) and issue their own printed currency instead.  At that time, the Tongan Pa'anga was fixed to equal the Australian dollar.   When people spent their money and bought imports, the government converted their local money back into foreign exchange.  In this way, Tonga always had plenty of foreign currency to pay for its imports. 

When Tonga established a bank, the bank started lending money.  This money was spent on imports, also.  The money from bank lending that was spent on imports depleted foreign reserves.  To ensure that the country had foreign exchange to pay for imports, the Treasury had to advise the bank to regulate itís lending according to the level of foreign reserves.  If foreign reserves were plentiful, they could lend freely.  If reserves were low, the bank had to restrict lending.

This was a very different approach to that applied earlier in America.  In the early 1970ís, President Nixon appointed Arthur Burns to chair the Federal Reserve with instructions to liberalise bank lending so that people would feel that the economy was prosperous and re-elect President Nixon in 1972.  As in Tonga, the growth in bank lending depleted foreign reserves.   This lending was so damaging to the US foreign reserves that in 1971, the Federal Reserves could no longer offer to convert the US dollar into gold.  By 1972, the growth of bank lending had seriously depleted foreign reserves and was threatening the value of the US dollar.  Rather than constraining bank lending, the re-elected President Nixon floated the dollar. 

Floating the dollar did not treat the problem.  It treated the symptoms of the problem: that is, the falling foreign reserves.  Floating the dollar meant that the US Federal Reserve did not have to convert the US dollar into foreign exchange.  Instead, people who wanted to buy foreign currency had to exchange their US dollars with people with foreign exchange who wanted US dollars.  This was hailed as a major economic reform, allowing the economy to conduct independent monetary policy.

Floating dollar benefitted not only the Federal Reserve, it benefitted the banks.  As their lending no longer depleted foreign reserves, the US Federal Reserve had no reason to restrict their lending.  As a result, banks have prospered and become extremely profitable since then.  However, their lending still causes the country to spend more than it has earned and this causes the US economy to build up huge foreign debts.

One side effect of the floating exchange rate system is that it not only protects the foreign reserves from being depleted by the growth of bank lending, it also stops the growth of exports from adding to foreign reserves.  When exports increase, the exchange rate rises to make imports cheaper so that we buy imports instead of domestic products.  This destroys the industries that compete with imports.  As a result, large parts of the US which were highly industrious are now called the rust belt. 

So while the floating exchange rate system has protected the Fedís foreign reserves and allowed the banks to prosper, the US economy is suffering under a mountain of domestic and foreign debt, and many US industries have been destroyed.  This has also contributed to the high level of unemployment and lower wages.

When Leigh Harkness returned Australia, he joined the Australian Treasury and found similar, even stronger data to confirm what he had found in the Pacific Islands. However, the data was not accepted as it did not conform with the accepted economic wisdom. 

After leaving the Australian Treasury, Leigh Harkness formed Buoyant Economies to promote economic theory and policy consistent with the reality of the economic data he had found.   This has included the consideration of a number of issues including the effect of the floating exchange rate system on economic growth and the growth of foreign debt and the presentation of a number of papers.

Click here for a brief description of Buoyant Economies' approach to economics.

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