Financial Markets, Money and the Real World
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Financial Markets, Money and the Real World

Paul Davidson

Paul Davidson investigates why the 1990s was a decade of financial crises that almost precipitated a global market crash. He explores the reasons why the global economy still struggles with the aftermath of these crises and discusses the possibility that volatile financial markets in the future will have real impacts on whole industries and national economic systems.
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Chapter 13: The Plumbers’ Solution to Destabilizing International Capital Flows

Paul Davidson

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13. The plumbers’ solution to destabilizing international capital flows A consistent theme throughout this book has been that the logic of classical economic theory assumes away the fundamental economic problems of a market-oriented, money-using entrepreneurial economy. These aspects neglected by classical theory are particularly relevant for understanding the international payments questions involving liquidity, persistent and growing debt obligations, and the importance of instituting stable exchange rates and avoiding a freely flexible exchange rate system. An example of the sanguine classical response to those arguing against freely flexible prices and exchange rates is Professor Milton Friedman’s reply to me in our ‘debate’ in the economic literature. Friedman stated: ‘A price may be flexible . . . yet be relatively stable, because demand and supply are relatively stable over time . . . [Of course] violent instability of prices in terms of a specific money would greatly reduce the usefulness of that money’.1 It is nice to know that as long as prices or exchange rates remain relatively stable, or ‘sticky’ over time, then there is no harm in permitting them to be flexible. The problem arises when there are volatile movements in exchange rates. Should there be a deliberate policy to intervene in the market to maintain relative stability or should a laissez-faire market be permitted to determine the price? Keynes helped design the Bretton Woods agreement to foster action and intervention to fix exchange rates and control international payment flows. Friedman sold the public on the beneficence of government inaction and the free market...

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