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MOSLER'S LAW: There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.

Geithner’s Letter to G-20 on ‘External Imbalances’

Posted by WARREN MOSLER on October 22nd, 2010

They’ve always been completely out of paradigm on domestic federal budgets. But this time around their ignorance has already been costly beyond imagination and looks to only get more so.

Geithner is just symptomatic of all that’s wrong with the mainstream’s understanding of monetary operations.

And I haven’t heard a single mainstream economist who’s got it right on the budget issue or the trade issue.

With the hawks and doves agreeing that federal deficits are a long term problem the obvious fundamental that imports are real benefits and exports real costs gets no consideration.

The trade war is a direct result of not understanding that domestic demand can always be continuously sustained by fiscal adjustments to the direct benefit of that economy.

The rest of the world’s desire to net export to us opens the door for unimagined US prosperity. With a full payroll tax (FICA) suspension we’d probably have enough domestic demand to buy all the goods and services we could produce at full employment plus all we wanted to buy from the rest of the world. And, if not, taxes could be lower still.

Geithner’s Letter to G-20 on ‘External Imbalances’: (Full Text)

Oct. 22 (Bloomberg) — The following is a reformatted
letter dated Oct. 20 from U.S. Treasury Secretary Timothy F.
Geithner to other officials in the Group of 20 industrial and
emerging economies. G-20 finance ministers and central bankers
are meeting today and tomorrow in Gyeongju, South Korea.

Dear G-20 Colleagues:

I am writing to offer some suggestions for our meeting later
this week. We are obviously at a moment where the world is
looking to the G-20 to provide a stronger commitment to work
together to address the major challenges to a sustainable global
recovery. I know that some of you will want to reserve any
substantive agreement until the November Leaders’ Summit, but I
think we should take advantage of the presence of the central
bank governors to try to reach agreement on the broad elements
this weekend, and put those in a report to our Leaders.

Building on Pittsburgh’s Framework for Strong, Sustainable, and
Balanced Growth and Toronto’s commitments on addressing
sovereign debt sustainability, here are three specific
suggestions designed to provide a stronger framework of
cooperation on international financial issues:

First, G-20 countries should commit to undertake policies
consistent with reducing external imbalances below a specified
share of GDP over the next few years, recognizing that some
exceptions may be required for countries that are structurally
large exporters of raw materials. This means that G-20 countries
running persistent deficits should boost national savings by
adopting credible medium-term fiscal targets consistent with
sustainable debt levels and by strengthening export performance.
Conversely, G-20 countries with persistent surpluses should
undertake structural, fiscal, and exchange rate policies to
boost domestic sources of growth and support global demand.
Since our current account balances depend on our own policy
choices as well as on the policies pursued by other G-20
countries, these commitments require a cooperative effort.

Second, to facilitate the orderly rebalancing of global demand,
G-20 countries should commit to refrain from exchange rate
policies designed to achieve competitive advantage by either
weakening their currency or preventing appreciation of an
undervalued currency. G-20 emerging market countries with
significantly undervalued currencies and adequate precautionary
reserves need to allow their exchange rates to adjust fully over
time to levels consistent with economic fundamentals. G-20
advanced countries will work to ensure against excessive
volatility and disorderly movements in exchange rates. Together
these actions should reduce the risk of excessive volatility in
capital flows for emerging economies that have flexible exchange
rates.

Third, the G-20 should call on the IMF to assume a special role
in monitoring progress on our commitments. The IMF should
publish a semiannual report assessing G-20 countries’ progress
toward the agreed objectives on external sustainability and the
consistency of countries’ exchange rate, capital account,
structural, and fiscal policies toward meeting those objectives.

With progress on these fronts, we should reach final agreement
on an ambitious package of reforms to strengthen the IMF’s
financial resources and its financial tools, and to reform the
governance structure to increase the voice and representation of
dynamic emerging economies.

Sincerely,

Timothy F. Geithner

13 Responses to “Geithner’s Letter to G-20 on ‘External Imbalances’”

  1. roger erickson Says:

    So, any trade war boils down to a negotiation between int’l trade lobbies in two countries, at the expense of the domestic lobbies in their respective countries?

    Equivalent to competition between two sets of aristocrats, using peasants as pawns?

    Seems at heart to be a public awareness issue. One that we once fought a Revolution to get away from, only to fall into the same Pareto pattern again.

    Reply

  2. Ramanan Says:

    Disagree ;-)

    It’s a superb step by Tim Geithner. It’s a bit Post Keynesian and can be tremendous for the world economy.

    It boils down to quarreling over whether you are indebted in your own currency or not.

    In the article “Prospects For The United States And The World: A Crisis That Conventional Remedies Cannot Resolve” (Dec 2008) Wynne Godley and Co. wrote this:

    —-
    At the moment, the recovery plans under consideration by the United States and many other countries seem to be concentrated on the possibility of using expansionary fiscal and monetary policies.

    But, however well coordinated, this approach will not be sufficient.

    What must come to pass, perhaps obviously, is a worldwide recovery of output, combined with sustainable balances
    in international trade.

    &

    In this paper we argue, as starkly as we can, that the United States and the rest of the world’s economies
    will not be able to achieve balanced growth and full employment unless they are able to agree upon and implement an entirely new way of running the global economy.
    —-

    Reply

    Paul Reply:

    So we are stuck in a cycle of boom to bust back to boom??? From oil, to real estate to .coms to real estate etc… So what will be the next boom to bust cycle? Are there forces that are purposely engineering the next cycle that we don’t realize as of yet? What can be done to expose it?

    Reply

    WARREN MOSLER Reply:

    I discussed that with Wynne at the time.
    he more than agreed at that time that a 9% federal deficit was needed to do the trick, and that it was operationally sustainable.
    however, he thought it was politically out of the question to even discuss it, and that if he recommended it he wouldn’t be taken seriously, so the only other practical response was for the US to shift net imports by that much, fully recognizing the cost in real terms of trade.

    I tried to appeal to his academic side and I was somewhat successful as evidenced by his subsequent writings, but certainly not fully successful.

    Reply

    beowulf Reply:

    The trouble is, a 9% of GDP federal deficit didn’t do the trick. We’re at about that now, adding your excellent payroll tax holiday proposal and we’d be at 15% or so. Economically, you win the argument, but politically, I’m afraid Wynne was right.

    It wouldn’t be necessary (or even beneficial) for the US to become a net exporter, but as a practical matter, every dollar cut from the trade deficit reduces by like amount the required federal deficit.

    The House overwhelmingly passed a tariff bill last month (the Senate doesn’t have time to take it up this year, but it will be back next year).
    http://www.nytimes.com/2010/09/30/business/30currency.html

    Of course, instead of importers paying tariffs to Tsy, it’d be preferable to simply redistribute the money from importers to exporters via Warren Buffett’s IC market.
    http://en.wikipedia.org/wiki/Import_Certificates

    Reply

    WARREN MOSLER Reply:

    sad but true. although in 07 a proactive hike to 9% might have been sufficient. but maybe not. easy enough to keep cutting taxes until you get it right

    Ramanan Reply:

    I didn’t get the chance to know Wynne and its the greatest regret of my life.

    Emotions apart, its difficult to prove one way or the other, though I completely believe him.

    My interpretation of his stand was that the external debt can go as high as the foreign exchange market allows it but apart from special cases, both the public debt and the external debt rise forever relative to the gdp unless discretionary steps are taken to tackle balance of payments issues. (as can be seen by reading his wonderful book with Marc)

    In the real world, its difficult to verify because governments themselves take austerity measures and take steps to net export before they may run into plausible issues with their currencies.

    Australia seems to have the highest net external debt – 56% (have to check on this – though I haven’t included Euro zone nations such as Spain, Greece whose numbers are 87% and 100% +/-, because its a different case) – lets see how high it goes.

    Putting numbers can be insightful. If there is a limit on the net external debt such as 40%, a differential of 2% between growth and net interest paid on foreign debt just allows a trade balance of 0.8%. Anything above that, will lead to everexpanding public debt and net external debt.

    Empirics is on his side – his articles were full of talks on protectionism measures, need for concerted action, political action on enforcing devaluation of the US exchange rate against Asian nations all of which are happening now! Not to forget his story about a recession following 2000 surpluses and the growth of private sector debt.

    He had put up a great fight against the Monetarists and Thatcherians but his 1983 book going into sectoral balances, stock flow consistency was too late.

    Reply

    WARREN MOSLER Reply:

    the US has no external debt as defined as debt in external currency.

    Ramanan Reply:

    The simplest way to see that indebtedness to foreigners in your currency is actually “debt” is to consider the case where the nation has actually nationalized the banks. If I do not purchase more government bonds using the amount credited because of maturing bonds and make a capital flight, the banking system will be left needing funding in another currency.

    WARREN MOSLER Reply:

    when the banks are nationalized it does not mean the gov owes the uninsured liabilities of that bank.

    beowulf Reply:

    well you did let him know how much you appreciate his work. That puts you one up on David Mamet (who regretted never writing Master and Commander author Patrick O’Brian). That was a very classy email you sent Wynne.
    http://www.multiplier-effect.org/?p=133&cpage=1#comment-18

    As Mamet said, “God bless the straightforward writer, and God bless those with the ability to amuse, provoke, surprise, shock, appall”.
    http://www.nytimes.com/library/books/011700mamet-writing.html

    As to your point about the banking system needing funding in another currency, the government can always inject high powered money. Granted a developing country like India is constrained in ways that the United States is not (for one thing, oil imports are priced in dollars), so long as a nation maintains its seigniorage power it doesn’t need to borrow in another currency.

    Ramanan Reply:

    Beo,

    Yes good to have exchanged something with him. Good to know you saw that at the Levy blog.

    Leaving the debate aside for the moment, Timothy Geithner’s proposal has the potential to put the world economy in a tremendous growth path.

    WARREN MOSLER Reply:

    if he can convince nations holding dollar reserves to spend them there could be quite a bit of agg demand generated and US jobs created for exports.
    but that keeps domestic consumption flat, which means more work and less to buy, usually via higher prices and flat wages. wonderful!

    but as an American, way better for US to cut taxes and fill the spending gap that way

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