How the Fed Causes Booms and Busts in South America
Nicolás Cachanosky, a native of Argentina who recently completed his Ph.D. under Mises Institute Associated Scholar Ben Powell, spoke with us recently about his research on Latin American monetary policy and his new teaching position.
Mises Institute: What led to your initial interest in the Austrian School?
Nicolás Cachanosky: My initial interest in the Austrian School came from my father, who completed his Ph.D. under the supervision of Hans Sennholz on “The Pitfalls of Mathematical Analysis in Economics.”
My interest in economics was sparked midway through high school and my father gave me books by Hazlitt, Hayek, Mises, and Rothbard. The summer I graduated he gave me my first copy of Human Action. I read it for the first time during the summer before going into the Pontificia Universidad Católica Argentina to do my Licentiate in Economics.
When I finished my licentiate studies I went for my Master of Economics and Political Science to ESEADE, the free-market/Austrian graduate institution in Argentina. After two years studying with Martin Krause, Gabriel Zanotti (who was my advisor) and other faculty, I joined Suffolk University and wrote my dissertation under Ben Powell.
Now I’m moving to Metropolitan State University of Denver where I’ll be teaching macroeconomics and money. I’m looking forward to continuing the work of John Cochran (Mises Institute Senior Fellow and retiring MSUD faculty member) and work next to Alex Padilla (Mises Institute Associated Scholar) in his Explore Freedom Project.
MI: Austrians have often looked at how central banks cause the boom-bust cycle domestically. But in recent research, you’re looking at how the Federal Reserve has contributed to unsustainable booms in Latin America.
NC: If we date the first treatment of Austrian business cycle theory (ABCT) to Mises’s Theory of Money and Credit (1912), then a hundred years has gone by. It is to be expected that some of the empirical assumptions that Mises and Hayek were doing at the beginning of the century need revision.
The monetary institution in place is one of those assumptions. The world is not under the gold standard anymore, but under fiat currencies. This means two things. First, because international interest rates are defined by major central banks, major economies have an effect on small open economies.
Second, with fiat currencies we have more than one currency. This means that there is a new price to take into consideration, the foreign exchange rate. If we have a new price, then the market distortions produced by a major central bank are channeled through two variables, not one. Through the interest rate, as is usual in the canonical version of the ABCT, and through the exchange rate, which means a change in the relative price of nontradables to tradables.
For instance, could it be that part of the export-led growth of China is an unsustainable boom that was driven by the Federal Reserve’s loose monetary policy plus China’s central bank’s decision to peg their currency to the U.S. dollar?
MI: What are some specific areas where this has had the greatest impact?
NC: If you look at Latin America’s countries you see that more roundabout (capital-intensive and forward-looking) industries are more sensitive to U.S. monetary policy than less roundabout industries. I don’t think it is a coincidence that the two largest economic crises in Latin America in the last 60 years occurred after the two largest periods of loose monetary policy by the Fed: at the beginning of 1980, and in 2009, after the subprime crisis.
Industries like mining and quarrying, for example, are more sensitive to U.S. monetary policy than, say, real estate intermediation. The pattern predictions of the ABCT hold for Latin America and U.S. monetary policy.
MI: Give us a glimpse into the banking sector in Latin America. Are central banks restrained right now, or are they, like the Bank of Japan and the Federal Reserve, engaging in monetary activism?
NC: It’s hard to say because there’s plenty of variation. What is important is what drives their activism. It is crucial whether a central bank is independent of the Treasury needs. Some central banks in Latin America, like those of Chile, Colombia, and Brazil have been gaining respect in recent times. Others, like the Argentinean and Venezuelan central banks are at the service of the government.
What central banks can’t do is avoid the effects of activism by major central banks. When the Federal Reserve decides to lower their interest rates between 2002 and 2007, the central bank in any of these countries needs to make a decision under such circumstances. Latin American countries that usually have big economic sectors that depend on the export of commodities may very well feel compelled to expand their money supply and keep their exchange rates stable. In this sense, the activism of Latin American countries is dependent of the activism of major central banks.
MI: Of course, American monetary policy is hardly the only challenge faced by Latin American economies. What are some other impediments to sustainable growth faced by the region?
NC: The underlying problem of the region in general is its anti-free-market ideology rooted in political populism, so well represented by Hugo Chavez and the Kirchners. The results of their policies are clear for anyone who wants to see them. Most economic problems ultimately depend on this cultural setting. Populism is a very dangerous road to take with very damaging and long lasting consequences.
MI: Speaking broadly, are free-market ideas gaining traction in the region?
NC: It is not easy to say because some countries have become more prosperous and free, and others less prosperous and less free. Some countries like Argentina, Venezuela, Ecuador, and Bolivia show repressed economic and civil liberties. But other countries like Chile, Colombia, Perú and Paraguay are doing much better.
Still, I remain confident that the outlook of the region will improve in the coming years, especially if the freest countries do not change their course. Countries like Argentina and Venezuela are showing strong manifestations in opposition to their current politicians in power. I can’t say for sure that this is rooted in free market ideas; it is, more likely, against the poor economic performance and the lack of freedom citizens feel every day without a clear connection to free market institutions. However, this situation of civil protest can open the door for some of these countries to follow the Chilean example and get into a more stable road of growth and development.