The world economy’s trilemma

Traders at the New York Stock Exchange, on March 9, 2020. “Economists are acutely busy trying to demystify the current mayhem engulfing the world’s markets,” writes Jordan News columnist, Jawad Anani. (Photo: NYTimes)
Economists are acutely busy trying to demystify the current mayhem engulfing the world’s markets. From main street to Wall Street, prices of stocks, securities, gold, oil, and bitcoin are on a crazy swing.اضافة اعلان

Oil has already increased by at least 39 percent over the last two months. Stock indices are flirting with both bullish and bearish speculators. Gold has already taken more than its fair share of a hit, decreasing from $2,050 in mid-2020 to $1,792 on October 24.

In a study recently published by the European Central Bank (ECB), it shows that European financial markets are not responding to major monetary indictors from the USA. Capital assets are moving in the same direction, with a lag in response to changes in the US Fed’s decisions regarding primary loan rates.    

The primary rate on one-year loans in China is 3.85 percent, in contrast with 3.25 percent in the US. Five-year loans are at 4.65 percent in China, while the long-term rate in the US is 6.84 percent. 

The variation in interest rates represents a difference in modality in the US and China. As far as exchange rates are concerned, China’s Renminbi (RMB) increased from 6.74 RMB to the dollar in 2020, to 6.36 on October 22, 2021.

If leading world market prices and rates are showing less responsiveness or sensitivity to changes in the same prices in the US, then we really should pause and rethink the prospects of the world economy. 

Under these circumstances, many economists are sounding the alarm that the world economy is dangerously approaching stagflation, if not depressionary inflation. This is reminiscent of the stage the world economy endured in 1976 and beyond after the oil shock of 1974. Until then, economists believed in the Phillips curve, which stated that there was a trade off between unemployment and change in the price index. Now, they both seem to go in the same direction.

To deal with this upcoming cycle (stagflation), monetary theory is facing many challenges. One of these was cited above: the lack of consistent ripple effects from the US changing its primary rates or its exchange rate. The second is the fact that the Mundell-Fleming Trilemma is not working anymore.

According to the trilemma theory, countries can streamline their economies by making one of the three mutually exclusive choices.

These three potential choices are setting a fixed currency exchange rate, allowing capital to flow freely with no fixed currency agreement, and autonomous monetary policy.

Countries that have chosen to peg their respective currencies to the dollar can not exercise the second and third options. But if the dollar becomes unstable or shows signs of crazy fluctuations, then those pegging countries would run out of options.

The world may soon find out that it has to move from trilemmas to dilemmas, and exercise more autonomy in their monetary polices. A potential exit strategy for this was developed by Robert Mandell, who suggested the creation of three world currency zones: the US dollar, the euro, and the RMB.

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