Reply To: The "Dutch Disease" as an argument against free market capitalism?


First, the free market economy cannot be blamed for the impositions on it from an international system of pegged exchanged rates among different fiat currencies issued by the world’s central banks. A free market economy would tend to have a single, commodity money everywhere. In such a system, people increase their demands for some goods by decreasing their demands for other goods. Money moves to into the hands of those selling goods for which demand has increased and out of the hands of those who are selling goods for which demand has decreased. It’s not a social problem that production of the goods experiencing falling demand shrinks and production of the goods experiencing rising demand grows. For example, if demand for consumer electronics increases and for automobiles decreases, it’s not a social problem that Silicon Valley prospers and Detroit declines. Put another way, if California used “Golden Bear” currency and Michigan used “Great Lakes” currency, it would be incorrect to say that appreciating exchange rates of the “Golden Bear” against the “Great Lakes” is the cause of the decline in profitability of California producers who sell into Michigan. The problem for those producers is that their customers are earning less income because they are selling goods people no longer want as urgently as other things.

Second, in a world of various fiat currencies movements in exchange rates, just like all other prices, are an effect of changes in underlying preferences people have. If the French increase their demand for Dutch natural gas relative to say vacations in Paris, then they must increase their demand for Dutch guilders relative to French franks. The Dutch producers of natural gas prosper by satisfying this greater demand. French workers in the tourist industry in Paris earn less income and reduce their demand for Dutch wooden shoes, and therefore their demand for Dutch guilders, and the producers of such shoes earn less income. Whether or not the dutch guilder appreciates against other currencies depends on the extent to which the increase demand for guilder by those buying natural gas is offset by the decrease in demand by those not buying other Dutch exports.

Third, in a world of various fiat currencies, each currency will tend to have the same purchasing power everywhere it is traded. For example, if the dollar had greater purchasing power in France than in America, Americans would buy more French goods, which means they would sell dollars for franks leading to a devaluation of the dollar in France. This would continue until the purchasing power of the dollar was roughly the same in America as France. So the Dutch guilder could only appreciate against other currencies if their was a purchasing power disparity of the guilder in different places. This could occur if the world demand for Dutch guilders increased on net from a shift toward buying Dutch natural gas. But, any appreciation would be only temporary if the purchasing power of the guilder in different countries was not changed by the shift of demand toward Dutch natural gas.

Take a look at the New Palgrave Dictionary of Economics entry on the Dutch disease: