Dean Baker: Krugman Is Wrong: The United States Could Not End Up Like Greece

Krugman Is Wrong: The United States Could Not End Up Like Greece

By Dean Baker

March 25 — It does not happen often, but it does happen; I have to disagree with Paul Krugman this morning. In an otherwise excellent column criticizing the drive to austerity in the United States and elsewhere, Krugman comments:

“But couldn’t America still end up like Greece? Yes, of course. If investors decide that we’re a banana republic whose politicians can’t or won’t come to grips with long-term problems, they will indeed stop buying our debt.”

Actually this is not right for the simple reason that the United States has its own currency. This is important because even in the worst case scenario, where the deficit in United States spirals out of control, the crisis would not take the form of the crisis in Greece.

Yes, precisely!

Greece is like the state of Ohio. If Ohio has to borrow, it has no choice but to persuade investors to buy its debt. Unless Greece leaves the euro (an option that it probably should be considering, at least to improve its bargaining position), it must pay the rate of interest demanded by private investors or meet the conditions imposed by the European Union/IMF as part of a bailout.

However, because the United States has its own currency it would always have the option to buy its own debt. The Federal Reserve Board could in principle buy an unlimited amount of debt simply by printing more money. This could lead to a serious problem with inflation, but it would not put us in the Greek situation of having to go hat in hand before the bond vigilantes.

This is also true under current institutional arrangements.

However, with regards to inflation, for all practical purposes the fed purchasing us treasury securities vs selling them to the public is inconsequential.

This distinction is important for two reasons. First, the public should be aware that the Fed makes many of the most important political decisions affecting the economy. For example, if the Fed refused to buy the government’s debt even though interest rates had soared, this would be a very important political decision on the Fed’s part to deliberately leave the country at the mercy of the bond market vigilantes. This could be argued as good economic policy, but it is important that the public realize that such a decision would be deliberate policy, not an unalterable economic fact.

True! And, again, for all practical purposes the decision is inconsequential with regards to inflation.

The other reason why the specifics are important is because it provides a clearer framing of the nature of the potential problem created by the debt. The deficit hawks want us to believe that we could lose the confidence of private investors at any moment, therefore we cannot delay making the big cuts to Social Security and Medicare they are demanding. However if we have a clear view of the mechanisms involved, it is easy to see that there is zero truth to the deficit hawks’ story.

Agreed!

Suppose that the bond market vigilantes went wild tomorrow and demanded a 10 percent interest rate on 10-year Treasury bonds, even as there was no change in the fundamentals of the U.S. economy. In this situation, the Fed could simply step in and buy whatever bonds were needed to finance the budget deficit.

Correct.

And this would result in additional member bank reserve balances at the Fed, with the Fed voting on what interest is paid on those balances.

Does anyone believe that this would lead to inflation in the current economic situation? If so, then we should probably have the Fed step in and buy huge amounts of debt even if the bond market vigilantes don’t go on the warpath because the economy would benefit enormously from a somewhat higher rate of inflation. This would reduce the real interest rate that firms and individuals pay to borrow and also alleviate the debt burden faced by tens of millions of homeowners following the collapse of the housing bubble.

However not to forget that the Fed purchases also reduce interest income earned by the economy, as evidenced by the Fed’s ‘profits’ it turns over to the treasury.

The other part of the story is that the dollar would likely fall in this scenario. The deficit hawks warn us of a plunging dollar as part of their nightmare scenario. In fact, if we ever want to get more balanced trade and stop the borrowing from China that the deficit hawks complain about, then we need the dollar to fall. This is the mechanism for adjusting trade imbalances in a system of floating exchange rates. The United States borrows from China because of our trade deficit, not our budget deficit.

True, but with qualifications.

China didn’t start out with any dollars. They get their dollars by selling things to us. When they sell things to us and get paid they get a credit balance in what’s called their reserve account at the Fed.

What we then call borrowing from China- China buying US treasury securities- is nothing more than China shifting its dollar balances from its Fed reserve account to its Fed securities account.

And paying back China is nothing more than shifting balances from their securities account at the Fed to their reserve account at the Fed.

Which account China keeps its balances in is of no further economic consequence,

And poses no funding risk or debt burden to our grandchildren.

Nor does it follow that the US is in any way dependent on China for funding.

Nor is balanced per se trade desirable, as imports are real economic benefits and exports real economic costs.

This also puts the deficit hawks’ nightmare story in a clearer perspective. Ostensibly, the Obama administration has been pleading with China’s government to raise the value of its currency by 15 to 20 percent against the dollar. Can anyone believe that China would suddenly let the yuan rise by 40 percent, 50 percent, or even 60 percent against the dollar? Will the euro rise to be equal to 2 or even 3 dollars per euro?

And, with imports as real economic benefits and exports as real economic costs, in my humble opinion, the Obama administration is negotiating counter to our best interests.

Also, inflation is a continuous change in the value of the currency, and not a ‘one time’ shift which is generally what happens when currencies adjust.

This story is absurd on its face. The U.S. market for imports from these countries would vanish and our exports would suddenly be hyper-competitive in their home markets. As long as we maintain a reasonably healthy industrial base (yes, we still have one), our trading partners have more to fear from a free fall of the dollar than we do. In short, this another case of an empty water pistol pointed at our head.

The deficit hawks want to scare us with Greece in order to push their agenda of cutting Social Security, Medicare and other programs that benefit the poor and middle class. This is part of their larger agenda for upward redistribution of income.

We should be careful to not give their story one iota of credibility more than it deserves. By implying that the United States could ever be Greece, Krugman commits this sin.

Agreed!

Addendum: In response to the Krugman post, which I am not sure is intended as a response to me, I have no quarrel with the idea that large deficits could lead to a serious problem with inflation at a point where the economy is closer to full employment. My point is that the problem with the U.S. would be inflation, not high interest rates, unless the Fed were to decide to allow interest rates to rise as an alternative to higher inflation.

Agreed!

Nor would today’s size deficits necessarily mean inflation should we somehow get to full employment.

It all depends on the ‘demand leakages’ at the time.

This point is important because the deficit hawk story of the bond market vigilantes is irrelevant in either case. In the first case, where we have inflation because we are running large deficits when the economy is already at full employment, the problem is an economy that is running at above full employment levels of output. The bond market vigilantes are obviously irrelevant in this picture.

In the second case, where the Fed allows the bond market vigilantes to jack up interest rates even though the economy is below full employment, the problem is the Fed, not the bond market vigilantes.

We have to keep our eyes on the ball. The deficit hawks pushing the bond market vigilante story are making things up, as Sarah Pallin would say, their arguments do not deserve to be treated seriously.

Agreed.

They should be unceremoniously refutiated!

This entry was posted in 7DIF, China, Currencies, Fed, Government Spending, Inflation, Politics. Bookmark the permalink.

122 Responses to Dean Baker: Krugman Is Wrong: The United States Could Not End Up Like Greece

  1. Pingback: Solvency and Value, Insolvency and Debasement « The Traders Crucible

  2. Tom Hickey says:

    OK, we finally got Ramanan to state his position clearly:

    A current account deficit increases a nation’s indebtedness to the rest of the world. Straightforward accounting.

    Now if there is a dance saying that that debt is not debt, I necessarily have to point out all fallacies used in obtaining that conclusion. To show explicitly that each item in liabilities side of the International Investment Position is debt.

    The movement of exchange rate doesn’t create unemployment. It is the current account deficit which creates unemployment – increases it rather. Now as far as I know MMTers agree with this.

    To compensate the leakage in demand requires deficit spending from some units and if the thesis is that the government runs a higher deficit, you create a situation where demand rises faster than output then it creates a situation in which higher imports cause higher indebtedness to foreigners.
    Here’s the identity connecting stocks and flows

    Closing Stock of Net International Investment Position = Opening Stock + Current Account Balance + Revaluations.

    Its obvious how indebtedness to foreigners increases if you run a current account deficit.

    Is this correct, Ramanan?

    Reply

    Tom Hickey Reply:

    Net International Investment Position – Wikipedia

    IMF Balance of Payments and International Investment Position Statistics

    International Finance Theory and Policy by Stephan Suranovic:

    A country’s net international asset position may either be in surplus, deficit or balance. If in surplus then the value of foreign assets (debt and equity) held by domestic residents exceeds the value of domestic assets held by foreigners. Alternatively we could say that domestic assets exceeds domestic liabilities. This country would then be referred to as a creditor nation. If the reverse is true, so that domestic liabilities to foreigners exceed domestic assets, then the country would be called a debtor nation.

    Suranovic notes that creditor countries face default risk and depreciation risk. He continues:

    For several reasons the debt is not a cause for great worry. First, despite its large numerical size, the US international debt position is still less than 20% of it’s annual GDP. [Now over 20%] Although this is large enough to be worrisome, especially with a trend towards a future increase, it is not nearly as large as some other countries have experienced in the past. In Argentina and Brazil, international debt positions exceeded 60% of GDP. For some less developed countries, international debt has at times exceeded 100% of their annual GDP.

    A second important point is that much of our international obligations are denominated in our own home currency. This means that when international debts (principal + interest) are paid to foreigners they will be paid in US currency rather than foreign currency. This relieves the US from the requirement to sell products abroad to acquire sufficient foreign currency to repay its debts. Many other countries who have experienced international debt crises, have had great problems financing interest and principal repayments especially when bad economic times make it difficult to maintain foreign sales.

    Finally, it is worth noting that, despite the name applied to it, our international “debt” position does not correspond entirely to “debt” in the terms’ common usage. Recall that debt commonly refers to obligations that must be repaid with interest in the future. Although a sizable share of our outstanding obligations is in the form of debt, another component is in equities. That means some of the money “owed” to foreigners is simply the value of their shares of stock in US companies. These equities will either make money or not based on the success of the business, but they do not require a formal obligation for repayment in the future.

    Borrowing without Debt? — Understanding the U.S. International Investment Position by Matthew Higgins, Thomas Klitgaard, and Cédric Tille (Federal Reserve Bank of New York Staff Reports, no. 271 December 2006):
    Sustained large U.S. current account deficits have led some economists and
    policymakers to worry that future current account adjustment could occur through a
    sudden and disruptive depreciation of the dollar and a sharp drop in U.S. consumption.
    Two factors that, to date, have cast doubt on such concerns are the stability of U.S. net
    external liabilities and the minimal net income payments made by the United States on
    these liabilities. We show that the stability of the external position reflects sizable capital
    gains stemming from strong foreign equity markets and a weaker dollar—conditions
    that could be reversed in the future. We also show that while minimal U.S. net income
    payments reflect a much higher measured rate of return on U.S. foreign direct
    investment (FDI) assets than on U.S. FDI liabilities, ongoing borrowing is likely to
    overwhelm this favorable rate of return, pushing the U.S. net income balance more
    deeply into deficit.

    In addition, we review the argument that the United States holds large amounts
    of intangible assets not captured in the data—assets that would bring the true U.S. net
    investment position close to balance. We argue that intangible capital, while a relevant
    dimension of economic analysis, is unlikely to be substantial enough to alter the U.S.
    net liability position.

    Reply

    Oliver Reply:

    Scott Fullwiler writes re Krugman:

    Krugman makes three incorrect assumptions about what MMT policy proposals actually are while also demonstrating a lack of understanding of our modern monetary system (as is generally verified by volumes of empirical research on the monetary system by both MMT’ers and non-MMTer’s). These are the following:

    Assumption A: The size of the monetary base directly (or indirectly, for that matter) affects inflation if we’re not in a “liquidity trap”

    Assumption B: MMT’s preferred fiscal policy approach or strategy—Abba Lerner’s functional finance—is Non-Ricardian

    Assumption C: Bond markets alone set interest rates on the national debt of a sovereign currency issuer operating under flexible exchange rates

    Ramanan writes:

    you create a situation where demand rises faster than output then it creates a situation in which higher imports cause higher indebtedness to foreigners.

    If I read this correctly, Ramanan is questioning assumption B in Scott’s list, i.e. that the fiscal position is not necessarily self-correcting / sustainable in an open economy?

    Bill Mitchell’s comments at the first Krugman post:

    …If there is idle productive capacity (including unemployment) then deficits never matter if they are bringing that capacity back into productive use…

    The bolded bits seem to me the important qualifiers that decide whether assumption B and thus Ramanan’s critique is true or not. Targeting is important, as is an internationally accepted definition of productivity (assuming no protective barriers).

    Devil in the detail? Am I making sense? Should I go read Ricardo :-)?

    Reply

    Ramanan Reply:

    You are unknowingly mixing issues Oliver! I brought the topic because of some comment and not due to PRK v MMT.

    I do not know how to explain this … but try …

    fiscal policy increases output.

    fiscal policy also increases national income and since imports are dependent on income, increases imports as well. So I am talking of this game and nothing about what Paul Robin Krugman raised.

    Reply

    Oliver Reply:

    Ramanan, I may well have mixed issues here, but I was not really posting on what PRK was saying as much as what Scott Fullwiler identified as common points of attack of MMT – straw men in his perception. I thought I had found some congruence between your point and Scott’s straw man, but I may be mistaken.

    regards

    Ramanan Reply:

    Krugman thinks monetized government expenditures leads to high inflation and nothing much about open economy macro.

    Calgacus Reply:

    Fiscal policy will increase imports. It will also tend to depreciate the currency and increase exports. And yes, China’s US dollar holdings are a real debt which can only be paid off by exports from the US. But again, so what?

    As far as I understand your objections, Abba Lerner’s chapters on international trade in his Economics of Employment read like a point-by-point refutation after he used a time machine, read them and returned to 1951. And made in a vocabulary I think you would find congenial.

    From p.354: “Whenever the level of economic activity and of employment in a country is increased, whether this is a result of Functional Finance or of anything else, the increase in employment and prosperity results in an increase in demand for all sorts of goods including imported goods. The additional demand for the additional foreign currency needed to pay for these will tend to depress the rate of exchange. If the country cannot permit its exchange to depreciate, cannot afford to lose gold or use up its foreign exchange holdings and credits in preventing the depreciation, and does not want to resort to tarriffs (perhaps because of fear of retaliation), it must prevent any increase in domestic prosperity. Currency depreciation is the natural concomitant of an increase in prosperity.”

    And if I understand correctly, that Functional Finance is unintentionally Ricardian is essentially in Abba too. And again, I think Oliver’s point was that he was not mixing issues, that open economies are just closed economies with a “foreign trade industry”, as Lerner put it, the Ricardian-ness meaning foreign debt should not explode.

    WARREN MOSLER Reply:

    i would say it this way:

    china can only reduce their pile of dollar denominated financial assets by buying something else.

    it’s not about how the US can retire outstanding govt dollar liabilities.
    the out standing combo of cash, reserves, and tsy secs are tax credits and the quantity goes down when taxes are paid.

    and if you aren’t promoting inflation, your currency depreciation is better called the other guy’s currency appreciation.

    Oliver Reply:

    precisely!

    Ramanan Reply:

    Calgacus,

    Just arguing in circles.

    “it must prevent any increase in domestic prosperity. Currency depreciation is the natural concomitant of an increase in prosperity.”

    Whats the interpretation ? Abba Lerner is saying that if import tariffs are not optional especially given it may lead to retaliation, demand must be deflated ?

    Agree ?

    Else one floats the currency.

    Its true that flexible exchange rates give governments more flexibility in setting the output, but Abba Lerner (at least in the quote) has nothing more to offer.

    Does floating the currency lead to improvement of the external situation ? For a government that means leaving the fate to the currency markets.

    I do not wish to enter into exchanges involving the phrase “Ricardian”. What Ricardian ?

    At any rate, you were the first to interfere. So repeat – Article VIII, Section 4 is about “official convertibility” which means governments have signed agreements which is contradictory to zillions of claims made by MMT about nonconvertibility. Lets not change the topic ;-)

    Ramanan Reply:

    At any rate, I am retiring from this debate :(

    Oliver Reply:

    Shame, Ramanan. I was merely trying to pinpoint your argument as to whether you were trying to describe full capacity output fiscal policy leading to a CA path that is in itself unsustainable (say exponential) or whether the element of non-sustainability enters with the irrationality and power of the currency markets in forcing the demise of a currency believed to be on an unsustainable path.

    The prior is formalistic maths to me and represents what I believe to be the Ricardian argument. The latter is contingent on beliefs of agents with conflicting interests and is ultimately political in that it could be overcome by leadership that itself believes in the long-term benefit of ‘sitting out the attacks come hell or high water’. I think MMT says that if tax enforcement can be maintained, that should be a realistic scenario even for smaller, open economies. I’m saying it might be politically more realistic (and economically indifferent) to choose a different path in some circumstances for some countries.

    Ramanan Reply:

    Really not sure where you are headed at Oliver …

    My point is that there is a big deal made here about the State’s promises and liabilities whereas “operational realities” are something else.

    Now coming back to you sustainability issue, I will again avoid “Ricardian” and any such terminology just for the heck of it.

    Again its difficult to retire from this topic, but since you have used the word “shame” I am a bit compelled to write.

    I have written on this before and but commentators hop in and hop out making it rather difficult for me to explain my viewpoint to everyone.

    The debt sustainability equation links the debt and the end of a period to the debt at the beginning of a period and a term containing the debt times the difference between the interest paid and growth rate and the primary balance.

    This is for the external debt, and I do not worry about the government debt too much.

    Now, this equation should be looked at as a *restriction* rather than a asking to what level the external debt sustains.

    Put simple numbers. A 1% difference between the growth rate and interest rate and a primary balance of 3% leads to the external debt increases toward 300% of GDP!

    Now you can argue that its okay – so what etc… but you are forgetting factors such as while the debt increases, wrong policies lead to increases in income elasticity of imports and exports are dependent on demand abroad! If you ignore, that is bad but if you have policies which promote exports, you are still dependent on demand abroad in addition to increase in competitiveness.

    Do the math! Instead of asking me to do! ..

    Again,

    its important to realize what I am pointing to here. There is a big deal made here on issues such as convertibility or the lack of it. A walk into legal arrangements tells a different story.

    Ramanan Reply:

    “A 1% difference between the growth rate and interest rate and a primary balance of 3% leads to the external debt increases toward 300% of GDP!”

    Sorry didnt frame it right … shoud read ..

    … external debt increasing toward … or converging toward …

    Oliver Reply:

    OK, thanks for engaging, Ramanan. I shan’t press the issue further, I’m probably not up to the maths anyway and so I’d better leave that to you and others to fight out. In any case, as someone else proposed, it would seem like a good idea for you to put down your thoughts in a more comprehensive format and make them accessible to us to understand, comment on or attempt to tear apart (as the case may be).

    Tom Hickey Reply:

    Ramanan: At any rate, you were the first to interfere. So repeat – Article VIII, Section 4 is about “official convertibility” which means governments have signed agreements which is contradictory to zillions of claims made by MMT about nonconvertibility.

    “Convertibility” as used by MMT’ers means convertibility into a fixed rate numeraire like gold, not exchangeability at floating rates. Just because the same term is used does not imply the same meaning. Look at definition and context.

    MamMoTh Reply:

    So you would agree that money and bonds are not the same since they are not convertible to each other, just exchangeable.

    WARREN MOSLER Reply:

    neither is universally academically or otherwise defined.

    popularly,

    money is used for the stuff you use to actually buy things and make payments.

    t bonds are longer maturity accounts you keep your money in.

    both are govt liabilities denominated in dollars

    is there any reason to say any more about it?

    Neil Wilson Reply:

    Yep and a $100 bill is not convertible into $1 bills, only exchangeable.

    So clearly they are not the same as each other.

    WARREN MOSLER Reply:

    i recall it was keynes who defined fiat currency as convertible only into itself

    Tom Hickey Reply:

    cash and bonds cannot be identical because the money price of bonds fluctuates in the market. This is deceptive, however, since bonds reflect currency depreciation (inflationary expectation) and cash does not. Most people don’t watch the value of the USD in the fx markets to see how they are doing.

    Ramanan Reply:

    See my comment @ March 28th, 2011 at 3:26 pm … clearly quoted the sense convertibility has been used.

    MamMoTh Reply:

    Neil, 100$ is convertible to 100 1$ bills, and always will be. So they are exactly the same thing, except for the space they take.

    Tom Hickey Reply:

    Ramanan, the only mention of convertibilty in that previous comment of yours is:

    He [Peter D] also linked to an MMT paper which says”
    “This leads to the second dimension: convertibility. Most modern governments do not promise to convert their IOUs to anything, having long ago abandoned the gold standard. (To be sure, many governments, especially in the developing world, do promise conversion to a foreign currency such as the US dollar. In that case, we can think of the US dollar as the apex of the pyramid.)”

    Is this what you mean? Seems to me to be what I said.

    Neil Wilson Reply:

    “Neil, 100$ is convertible to 100 1$ bills, and always will be”

    You’re right of course there is a mechanism to destroy the $100 and replace it with $1 bills at the central bank.

    MamMoTh Reply:

    WM: is there any reason to say any more about it?

    Don’t know. If we agree that bonds and money are not the same, then I think there is nothing else to say about it.
    Then we could focus on what that difference means wrt to issuing bonds or not when the govt deficit spends.

    Matt Franko Reply:

    Ramanan,

    If I look here:
    http://www.census.gov/foreign-trade/statistics/historical/gands.pdf

    and I total up the collective US BOP deficits going back decades I come up with just short of $8T.

    Then if I look here:

    http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/debta910.html

    it says that total US external debt position is $14T.

    How can US total external debt be more than the cumulative BOP deficits? Where do the foreign entities that loaned the US entities the 14T get it? If the US never net provided it to external entities in the first place? seems like they would come up about 6T short? Any suggestions?

    Reply

    Ramanan Reply:

    Matt,

    The external debt position you quote is gross external debt.

    The more appropriate thing to look at is the international investment position from the BEA or the table L.107 of Fed’s Z.1

    How do they get it ? A person in Belgium can purchase US Treasuries. No need for the US to run trade deficits to have a “gross external debt”

    BEA’s IIP is the more appropriate thing to look at.

    Reply

    Ramanan Reply:

    Further …

    The Net International Investment Position is around minus $3.5-4T, as far as I can remember. So what explains $8T v $4T ?

    The IIP is a stock and one needs to adjust for revaluations. The various US sectors hold assets abroad and due to the devaluation of the dollar they have seen some revaluations (upward). Liabilities are mostly in USDs no effect there. The revaluation has also been due to appreciation of the assets held abroad. e.g., FDI abroad done 20 years ago may have started paying well and hence higher valuations.

    Reply

    Ramanan Reply:

    Btw interesting numbers in the US Treasury tables you linked.

    Monetary Authorities (as opposed to Authority) –

    Currency and deposits** 331,126

    Are these reserves held by foreign banks ?

    Other debt liabilities 54,889 (in Long-term)

    What is this ?

    Reply

    Matt Franko Reply:

    Ramanan,

    Here is the main page at Treasury where I found that page:
    http://www.treasury.gov/resource-center/data-chart-center/tic/Pages/external-debt.aspx

    If you look at Table B, as of the most recent date 9/30/2010, it looks like only 11.3T of the 14T is in USD. So I guess I can see the 8T total BOP deficit “growing” outside the US to 11.3T over the years due to retained interest (probably tax free compounding). (Still seems a little high tho?…)

    Table C has the 331,126 under ‘Immediate Liabilities’ under Monetary Authorities (sic) so that is probably USD deposits of foreign entities at the Fed?

    Quick Question: Where does the person in Belgium get the USD to buy the Treasury Bond if there is no BOP deficit with Belgium?

    Reply

    Neil Wilson Reply:

    “Where does the person in Belgium get the USD to buy the Treasury Bond if there is no BOP deficit with Belgium?”

    There’s a free floating foreign exchange. You can pick up dollars from somebody who does have a BOP deficit but didn’t buy any bonds.

    Ramanan Reply:

    Yes I know most of the US indebtedness to foreigners is in the USD.

    “Where does the person in Belgium get the USD to buy the Treasury Bond if there is no BOP deficit with Belgium?”

    These transactions happen via the correspondent banking channel! Currency is created by banks.

    “Where do the dollars come from ?” is not the way I think :-)

    The only identity in the Balance of Payments accounts is debits = credits.

    Not sure of the other points though.

    “Gross external debt” does not include foreigners’ holding of equities. It also does not include derivative positions.

    Here: this is more complete that gross external debt

    http://www.bea.gov/newsreleases/international/intinv/2010/pdf/intinv09.pdf

    Foreigners hold $21.1T of assets in the United States and sectors in US hold equivalent of $18.4T abroad. (Table 1, line 24 and 4). These are end of 2009 numbers plus direct investment valuation is not at market value (ref: lines 35, 18, 44, 43)

    Matt Franko Reply:

    Ramanan,

    Is it true then that foreign entities that are not members of the US Fed can “create” horizontal “money”? In other words, foreign entities can facilitate the establishment of external USD liabilities sort of “on their own”?

    This would seem like a Ponzi Scheme by definition no?

    Resp,

    WARREN MOSLER Reply:

    anyone can owe other dollars.

    Sergei Reply:

    “Is it true then that foreign entities that are not members of the US Fed can “create” horizontal “money”?”

    Of course not. Any pure fx speculation produces pure fx risk which will be eliminated by your broker should the fx-rate move against you beyond the level secured by your deposit. This is different from when you have “real” dollars in your account due to a loan. No broker or bank can eliminate them because something happens somewhere. Only you, the borrower, have full control over it.

    WARREN MOSLER Reply:

    sort of mixing metaphors there

    depends on your definition of ‘money’.
    foreign entities can create ‘horizontal’ dollar liabilities simply by issuing dollar denominated commercial paper, for example, or any other dollar debt.

    MamMoTh Reply:

    What happens when a foreign bank outside the US makes a loan in dollars? Doesn’t this operation create horizontal money?

    Matt Franko Reply:

    Mamo,

    I’m probably getting this wrong, but it sometimes looks to me that Bernie Madoff’s little computer system where he perpetrated his fraud was creating ‘horizontal money’ only he didnt have a license… when he sent his statements out that had $ signs and numbers next to them, at that point it was technically horizontal money… he was creating USD balances (USD liabilities) just like these external entities that do not have access to the Fed.

    When Bernie’s thing blew up he went to jail, when the external USD system blew up, Bernanke provided a credit line via the FOREX swaps he ran for them.

    Go figure… I could be looking at this wrong… Resp,

    MamMoTh Reply:

    Matt, don’t know about Bernie, but I think he didn’t create any money, he was just giving the money of his latest victims to the older ones.

    My question is about what happens when a farmer in Argentina gets a US$ denominated loan from his local bank. Is there any difference with a farmer in Ohio getting a loan from his local bank?

    Peter D Reply:

    Seems to me that what matters is where the money is spent. For the world-wide economy the Argentinian $US loan is horizontal money denominated in $UD. For the US economy, this money doesn’t exist until spent in the US.

    Sergei Reply:

    Horizontal money requires settlement, i.e. vertical money. US-banks have access to vertical money should they need it. Non-US banks or entities can have luck and be able to settle but only because they had vertical money in the first place. Otherwise, as I said above, it is pure fx-speculation and fx-risk. And in case of Bernie it was a fraud, isn’t it? So why do you mix in money :)

    WARREN MOSLER Reply:

    what you call ‘settlement’ only applies for payments to the govt. which are done by the fed debiting member bank reserve accounts.

    Sergei Reply:

    “foreign entities can create ‘horizontal’ dollar liabilities simply by issuing dollar denominated commercial paper, for example, or any other dollar debt.”

    Horizontal dollars are created not by those who issue liabilities, e.g. dollar denominated commercial paper, but rather by those who purchase it. I can create many horizontal liabilities but if nobody buys them then they do not have a positive dollar price. Buyers set the dollar price of my fresh liabilities, send me the real dollars and thus validate the act of creation of horizontal dollars. But you still need real dollars for all this to happen and this is where foreign/domestic comes into play. Foreigners have to have real dollars in advance or capability to borrow. This is a very strong private condition. Only US-banks can lend “dollars” because this lending create deposits which are convertible into real dollars subject to deposit insurance, capital position of the given bank and other regulatory tricks, i.e. recognized and accepted rules of the game.

    WARREN MOSLER Reply:

    true about buyers.

    but dollar loans create dollar deposits in the euro dollar market just at they do domestically.

    yes, they may or may not be ‘in balance’ and there is a need for ultimate ‘convertibility’ between euro dollars and domestic dollars but it need never get used.

    this is analogous to any futures market. gold futures can trade indefinitely without there ever being a physical delivery, but there does need to be ultimate convertibility to physical gold (which can include ‘cash settlement’ rules) or it doesn’t function.

    see: http://www.moslereconomics.com/mandatory-readings/a-general-analytical-framework-for-the-analysis-of-currencies-and-other-commodities/

    The horizontal component ‘leverages’ the vertical component, etc.

  3. Neil Wilson says:

    BTW I hope everybody has read Scott’s breakdown of the Krugman posts.

    It gets into the operational nitty gritty:

    http://www.nakedcapitalism.com/2011/03/scott-fulwiler-paul-krugman%E2%80%94the-conscience-of-a-neo-liberal.html

    Reply

  4. ESM says:

    I don’t know. I think Dean Baker’s latest musings are more harmful than helpful.

    He’s still not addressing the main points which are that the Fed already controls the short-term interest rate, and by extrapolation, longer-term interest rates, and that Treasury debt issuance is unnecessary except to give investors an alternative risk-free investment and to fashion a risk-free yield curve.

    Saying things like the Fed can buy 10-yr Treasury notes if the bond market turns up its nose is not going to allay fears of runaway inflation. I think it is much better to say that if investors don’t want to buy a 10-yr note, the Treasury should simply offer T-bills instead, and explain why investors will always want to buy T-bills at yields close to the overnight rate. Treasury issuance is a service being provided to investors, and the Treasury should tailor issuance to meet investor needs (assuming the political decision has been taken to provide that service in the first place).

    Also, there needs to be greater focus on the idea that issuance of Treasuries does little to dampen aggregate demand, and that therefore, shortening up the public debt or even cashifying it, is not going to lead to a material increase in aggregate demand.

    People here are very frustrated because they think the mainstream refuses to understand that the government can’t go bankrupt. But I don’t think that’s the source of the disconnect. When mainstream economists talk about bankruptcy/insolvency or a debt crisis, they’re speaking metaphorically. It’s shorthand for the belief that the government will no longer be able to issue bonds to defer private sector consumption and dampen inflation pressures. That latter belief is incorrect, but MMT-ers are not doing a good job about addressing that concern.

    So, for example, when MMT-ers go on TV or write columns and say that it’s stupid to think that the US can go bankrupt, people roll their eyes and think that they’re taking their metaphors too literally. MMT-ers are coming across as shallow nit-pickers.

    The prime focus should be on what the effect on aggregate demand would be if the Treasury stopped issuing bonds above, say, 1 month in duration. Once people start thinking of bonds as money, they’ll begin to see that the Treasury isn’t really borrowing (in the conventional sense) to spend. It is already creating money ex nihilo to spend.

    Reply

    Neil Wilson Reply:

    “Once people start thinking of bonds as money”

    That is a key difference. Bonds can be spent in the same way that bank deposits can be spent – by transferring the value into a checking account and issuing a drawing command against the funds.

    One might be called a ‘sale’ and the other a ‘transfer’, but the effect is the same. There is a fully liquid market in both instruments.

    Reply

    Peter D Reply:

    Absolutely agree, ESM!

    Reply

    MamMoTh Reply:

    Once people start thinking of bonds as money…

    I agree that is a crucial point. Especially because I still don’t think of bonds as money in spite of what I have read on this board but I am afraid we will just never agree. In my opinion:

    * you don’t spend bonds (nor houses), only money. in order to spend you need to sell your bonds (or houses). liquidity of the bond market only means that their price is lower than it would be if it were illiquid like the house market if you were using it as a saving instrument for delayed consumption

    * you can borrow against your bonds. you can also borrow against your house. but houses are not money

    * money has constant nominal value, bonds and houses don’t

    How much this difference affects aggregate demand I cannot tell. Definitely not nearly as much as the hyperinflationists fear, but I would say more than what MMTers seem to believe.

    Reply

    ESM Reply:

    “* you don’t spend bonds (nor houses), only money. in order to spend you need to sell your bonds (or houses).”

    Banks can always borrow against Treasury bonds, with essentially no haircut/margin. For this reason, Treasuries will always be extraordinarily liquid and easy to sell, and become quite interchangeable with reserves.

    The ability to finance a house is more constrained (e.g. large downpayment, higher interest rate, more paperwork and more delay). And when something is more difficult to finance, it’s going to be more difficult to sell too (as we are seeing in today’s housing market).

    In addition, the Fed does not directly lend against houses, so although bank money may increase as a result of mortgage lending, reserves do not unless banks use other collateral to borrow from the Fed or go to the discount window (which they rarely do).

    During more normal times, the expansion of mortgage lending can be quite stimulative, but as we’ve seen over the last 4 years, a house is not always a reliable source of buying power.

    During times of economic stress, Treasuries actually become even more liquid and easy to finance.

    “* money has constant nominal value, bonds and houses don’t”

    Treasury bonds do not deviate from par by all that much, and obviously, the shorter the bond, the less price volatility it will have. In addition, the pull to par effect diminishes the psychological effect of risk even more — if it goes down in price, it starts accreting to par at a faster rate. I don’t think that the volatility of 30-yr bonds is what’s keeping inflation in check, do you? There aren’t even that many Treasuries beyond 10yrs, or even 5yrs.

    Reply

    MamMoTh Reply:

    My point wasn’t that houses and bonds are the same, but that money and bonds are not the same.
    If money and bonds were the same, there would be no bonds, including corporate bonds (or no money).

    beowulf Reply:

    “If money and bonds were the same, there would be no bonds”.

    United States Notes (“Greenbacks”) are both legal tender money tender) and zero-interest bearer bonds (public debt but exempt from statutory debt limit).
    http://en.wikipedia.org/wiki/United_States_Note

    I guess Treasuries aren’t the same as money because you can’t pay taxes by mailing in T-bills instead of a check. Of course, Congress could always add Treasuries to the definition of legal tender. :o)

    MamMoTh Reply:

    They should also add houses while they are at it.

    beowulf Reply:

    Tsy’s Bureau of Engraving and Printing doesn’t build houses (perhaps you’re thinking Habitat for Humanity), they do however print money and Treasuries.

    (a) The Secretary of the Treasury shall engrave and print United States currency and bonds of the United States Government and currency and bonds of United States territories and possessions from intaglio plates on plate printing presses the Secretary selects.
    31 USC 5114

    Neil Wilson Reply:

    “money has constant nominal value, bonds and houses don’t”

    Money doesn’t have a constant value. It appears to be because it is denominated in itself.

    However try buying something priced in a different currency and you will find that it fluctuates quite a bit.

    As somebody who pays in GBP I can tell you that its value in petrol is significantly worse than it was five years ago.

    Reply

    Oliver Reply:

    That seems to be one of the greatest sources of confusion in the mainstream arguments I encounter. And it’s also the initial assumption for all politically motivated ‘hard money’ arguments. In mainstream world, the real value of money seems to be the hinge around which the rest of us had better revolve – mammocentrism.

    MamMoTh Reply:

    Money has constant nominal value, that is 100 dollars will always be 100 dollars. Real value is another thing, and it affects moneys as much as bonds.

    Oliver Reply:

    I think the main idea is that the choice to save precedes – and dominates over – the decision on which vehicle to save in. This order is congruent with the endogenous money story and indeed with demand-side economics. Houses are different from money in that they also provide shelter (look it up), so a better comparison would be between money and other financial assets and/or useless commodities such as gold. If your IRS agent came along and bought up all your blue-chips and your silverware in exchange for cash, would that trigger a binge at the next Prada outlet or would you rather look to buy other ASSETS with your new money? Or, conversely, would the same IRS official selling you savings vehicles at 3% keep you from taking your next holiday or sending your kid to Harvard to study economics if you accepted? In the latter case, we all hope so, but I doubt it :-).

    Reply

    Peter D Reply:

    Guys,I think Randall Wray pretty much settles all the issues about what is money and what is not in this paper.

    Reply

    WARREN MOSLER Reply:

    good points

    Reply

    Mr. E Reply:

    “When mainstream economists talk about bankruptcy/insolvency or a debt crisis, they’re speaking metaphorically. It’s shorthand for the belief that the government will no longer be able to issue bonds to defer private sector consumption and dampen inflation pressures.”

    A hugely important point. It is Krugmans mistake. There is no link between solvency and debasement because governments cannot go insolvent. But the metaphor is widely accepted, and serves to confuse the issue of debasement and insolvency. I just wrote a whole post about this.

    Reply

    Tom Hickey Reply:

    Excellent explanation at Trader’s Crucible, Mr. E. Your distinction between insolvency and debasement clears up the confusion in a very accessible way. It’s a must-read.

    http://traderscrucible.com/2011/03/29/solvency-and-value-insolvency-and-debasement/

    This makes it all the more obvious why no bonds and setting the overnight rate is a good idea. Let the markets assess inflation, get rid of the insolvency bogeyman, and have government balance inflation and employment with fiscal policy, as much as possible with automatic stabilizers including sliding tax rates.

    Reply

    Peter D Reply:

    In the comment on Pragmatic Capitalist, some people dismissed the idea of sliding tax rate as nothing short of delusional. I don’t see it this way. I think it could be presented as something similar to interest rate adjustments, but instead of a few unelected officials deciding on the IR behind closed doors, to have some automatic adjustment of tax rate to inflation/unemployment. This can further be cloaked into something like tax subsidies being withdrawn or restored, as opposed to “tax hikes”, though functionally the same. I am sure Wall Street will promptly come up with tax derivatives for the businesses to hedge the exposure away, just like with IR risk.
    And the tax rate is not constant now as it is – which is why we need to buy TurboTax each year or pay the accountants to get to the nitty gritty of this year’s rules.
    Am I delusional? Is it really an unsellable idea in the US?

    Tom Hickey Reply:

    Warren says that our problems are largely institutional, meaning that major institutional changes are called for. It’s difficult changing major institutions for a variety of reasons, mostly based on momentum. While they are slow moving, their size is huge. Lots of inertia. (hope I haven’t mangled the physics analogy)

    But that doesn’t mean it is impossible. Once we understood physics, technology followed through engineering. Once we understand how the monetary system works, we should be able to use that knowledge to effect positive change in related institutions. Just have to deal with the social inertia of convention.

  5. MamMoTh says:

    I always thought Dean Baker should be your man.
    Ever talked to him or sent him your book Warren?

    Reply

    WARREN MOSLER Reply:

    both.

    he’s a very good scholar, an his writings are coming around to MMT

    we’ve had some good conversations about how to deal with the mainstream inflation arguments he has to contend with

    Reply

    Peter D Reply:

    I remember him commenting on a post by Stephanie Kelton over at New Economic Perspectives but then getting silent. I imagine him reading more and maybe re-thinking things :)

    Reply

    JJTV Reply:

    I think he might of been a little upset about Kelton saying he was going off his rails on social security. Would have been interesting to see his response to her questions.

    Scott Fullwiler Reply:

    Agree. Dean’s an excellent scholar. If he gets on board with MMT, it would be very interesting to see where he could take it.

    Reply

  6. Ramanan says:

    Is China United States’ only Creditor ?

    National/BoP accounting makes it clear who is the creditor and who is the debtor.

    Here’s from the Articles of Agreement of the International Monetary Fund Article VIII, Section 4:


    Section 4. Convertibility of foreign-held balances

    (a) Each member shall buy balances of its currency held by another member if the latter, in requesting the purchase, represents:

    (i) that the balances to be bought have been recently acquired as a result of current transactions; or

    (ii) that their conversion is needed for making payments for current transactions.

    The buying member shall have the option to pay either in special drawing rights, subject to Article XIX, Section 4, or in the currency of the member making the request.

    (b) The obligation in (a) above shall not apply when:

    (i) the convertibility of the balances has been restricted consistently with Section 2 of this Article or Article VI, Section 3;

    (ii) the balances have accumulated as a result of transactions effected before the removal by a member of restrictions maintained or imposed under Article XIV, Section 2;

    (iii) the balances have been acquired contrary to the exchange regulations of the member which is asked to buy them;

    (iv) the currency of the member requesting the purchase has been declared scarce under Article VII, Section 3(a); or

    (v) the member requested to make the purchase is for any reason not entitled to buy currencies of other members from the Fund for its own currency.

    Reply

    Calgacus Reply:

    It is clear that China, like anyone who holds the US government’s dollars in any form, is the US’s creditor. So what?

    Reply

    WARREN MOSLER Reply:

    right, china has dollars, which are defined as the thing that the US govt will accept for payment of taxes. and nothing more

    Reply

    WARREN MOSLER Reply:

    first, the imf isn’t the boss of us

    second, why would we care who/what/why buys sdr’s?

    Reply

    Ramanan Reply:

    The Articles of Agreement is a treaty. The IMF doesn’t impose this on the United States. Nations came together and signed the agreement.

    “Official convertibility” exists.

    The conversion can be in either SDRs or the currency of the member making the request.

    Reply

    Tom Hickey Reply:

    The IMF was set up in the Bretton Woods Agreement, as was the convertible fixed rate system. Nixon that agreement was broken when Nixon unilaterally shut the gold window ending convertible fixed rates. Do you really think that the US will follow “official convertibility” agreements that it deems unfavorable to it based on that precedent?

    WARREN MOSLER Reply:

    that too…

    Ramanan Reply:

    Well, one has to be careful about these things.

    The US undertook conversion to Gold and was under no obligation – it was not forced on the US.

    I believe during that time, lot of nations asked the US to make conversion to their currencies.

    Currencies are not nonconvertible. Currencies are convertible.

    studentee Reply:

    ramanan,

    i just want to get your scenario nailed down: the threat is a us creditor wanting to convert its currency into either the imf ‘currency’ or back into their own? and so the problem is a sudden relative currency depreciation?

    Tom Hickey Reply:

    Let’s just say that China wanted SDR for USD. The SDR are composed of 44% USD, 34% euro, and yen and pound 11% each. That would mean the US perhaps doing cb liquidity swaps with the ECB, BOJ and BOE. They do these swap regularly. What’s the point?

    Ramanan Reply:

    Not just SDRs but foreigners can ask to convert in their own currencies since the aren’t enough SDRs.

    If the US does swaps with FCBs, then the US has debt in foreign currency explicitly in the official sector balance sheet, a strict no-no as per MMT.

    Debt IS debt. Debt is not not Debt.

    Sergei Reply:

    “Debt IS debt. Debt is not not Debt.”

    Debt is financial. it has a nominal price. for foreigners it is called exchange rate.

    Ramanan Reply:

    “for foreigners it is called exchange rate.”

    So is the exchange rate important for residents.

    Neil Wilson Reply:

    “foreigners can ask to convert in their own currencies”

    They can ask, and they will probably get in the majority of cases since it is of no concern.

    However at the edge cases you worry about they won’t get what they ask for.

    That is what you are struggling with – the idea that a country might not “follow the rules”.

    A country will always sacrifice foreigners over its own people first, unless the foreigners have capture over the decision makers.

    Countries fail to follow the rules all the time and get away with it. That’s why Greece is still in the Eurozone.

    Ramanan Reply:

    Its not me who is struggling.

    You cannot start with wrong assumptions such as non-convertibility right ?

    Keynesians failed to understand the constraints due to the external sector in the 70s/80s.

    “A country will always sacrifice foreigners over its own people first, unless the foreigners have capture over the decision makers.”

    Wishful thinking.

    “They can ask, and they will probably get in the majority of cases since it is of no concern.”

    Oh really ?

    Sergei Reply:

    “So is the exchange rate important for residents.”

    You need to make a real (not theoretical) argument why it IS important. Everything behavioural says it is NOT. Everything theoretical says it CAN be.

    I personally do not care much and it is honest. I lived just fine when euro was 0.85 cents and I lived as fine when euro was 1.6 dollars. A 100% (or 50%) swing and why should I care? Nothing changed for me.

    Neil Wilson Reply:

    “You cannot start with wrong assumptions such as non-convertibility right ?”

    Exchangeability isn’t convertibility.

    Ramanan Reply:

    “A 100% (or 50%) swing and why should I care? Nothing changed for me.”

    as if you live in a country with full employment ?

    Certainly you cannot give the Euro (seems you live there, going by your comment) as an exemplary case!

    You can’t complain on the one hand about unemployment and then say “we have been enjoying” !

    Ramanan Reply:

    “Exchangeability isn’t convertibility.”

    It is clear from Article VIII, Section 4 what obligations are. Now you can define something or change the definition but doesn’t change anything.

    Neil Wilson Reply:

    Yes and Bill has already demolished your argument about that.

    Your reliance on the IMF Articles has no more political impact than the ‘debt ceiling’ or the ‘financing acts’.

    They are political constraints, not real ones.

    It can, and will, be repealed, ignored or fudged if it causes a sovereign nation a problem. Suggesting otherwise is naive in the extreme.

    Rob Reply:

    Ramanan –

    You are obsessed about this topic and again and again and again are refuted. Bill directly responded to you. Leave it at that. Every new post with any semblence of this topic, you post the same messages over and over. It’s been addressed by one of MMT’s leading scholars. Let it go, or write a blog post someplace with your arguments as oppossed to constantly bringing it up when you already know the answer from an MMT perspective.

    Ramanan Reply:

    Surely I will let it go Rob.

    But “refuted” ? Not sure.

    “when you already know the answer from an MMT perspective.”

    Yep I know .. just tried to make an attempt to unmuddle the whole thing.

    Rob Reply:

    That said, I do enjoy reading your posts as it brings a fresh perspective about a fascinating topic, I am just trying to point out that it’s hard as a reader to follow your full rationale by piecing together your many posts. I’d definitely read your argument if you posted it someplace.

    Oliver Reply:

    I think the more interesting question than what the IMF rules say, is why national gvts. choose to to abide by them. The ‘free floating’ part of fiat basically says ‘we, the users of this currency, are all in this together’.

    Neil says: A country will always sacrifice foreigners over its own people first, unless the foreigners have capture over the decision makers.

    The problem isn’t necessarily with foreigners. Local elites may share more interests with their foreign counterparts than with the rest of their fellow countrymen. The us vs. them national dichotomy is a bit antiquated.

    Peter D Reply:

    Can somebody supply a link to Billy’s answer to Ramanan?

    Neil Wilson Reply:

    Peter,

    Here: http://bilbo.economicoutlook.net/blog/?p=13787

    and the comment section below.

    MamMoTh Reply:

    A country will always sacrifice foreigners over its own people first, unless the foreigners have capture over the decision makers.

    That’s pretty close to endorsing the bullying of powerful (economically or militarily) countries over not powerful ones.

    How civilized and progressive…

    beowulf Reply:

    The conversion can be in either SDRs or the currency of the member making the request.”

    At the election of the currency buyer (in your hypo the United States):
    The buying member shall have the option to pay either in special drawing rights, subject to Article XIX, Section 4, or in the currency of the member making the request.

    The price of the dollar to SDR is set by treaty at a specific ratio at a specific time at the London market. If the exchange rate for any currency somehow “cannot be obtained” in London (the odds of the UK government cooperating with the US government on this are rather large) then dollar to SDR exchange rate ispriced on the New York market, uh oh. The arbitrage opportunity for the US (and no doubt, the UK as well) is rather enormous, even before Tsy front runs its own transactions on the futures markets.

    IMF Rule O-2(a) defines the value of the U.S. dollar in terms of the SDR as the reciprocal of the sum of the equivalents in U.S. dollars of the amounts of the currencies in the SDR basket, rounded to six significant digits. Each U.S. dollar equivalent is calculated on the basis of the middle rate between the buying and selling exchange rates at noon in the London market. If the exchange rate for any currency cannot be obtained from the London Market, the rate shall be the middle rate between the buying and selling exchange rates at noon in the New York market or, if not available there, the rate shall be determined on the basis of euro reference rates published by the European Central Bank.
    http://www.imf.org/external/np/fin/data/rms_sdrv.aspx

    WARREN MOSLER Reply:

    right, all market based exchange rates, no actual fix fx specified

    beowulf Reply:

    “so the conversion has to be in the currency of the member asking the conversion.”

    I don’t think that’s what the word “option” means (“The buying member shall have the option…”). If buying member chooses SDR conversion but there aren’t enough SDRs in circulation then it looks like the selling member has themselves a problem. Since the buying member stands ready, willing and able to perform its treaty obligation, its excused by impossibility of performance.

    Neil Wilson Reply:

    “That’s pretty close to endorsing the bullying of powerful (economically or militarily) countries over not powerful ones.

    How civilized and progressive…”

    Apologies for describing the world as it is. I appreciate reality is a disappointment for many readers.

    That is what will happen- its basic game theory – regardless of how much the members of the ‘big hug club’ wish it to be otherwise.

    Therefore you need to design the system so that the fallacy of composition neutralises the effects.

    Ramanan Reply:

    “If buying member chooses SDR conversion but there aren’t enough SDRs in circulation then it looks like the selling member has themselves a problem. ”

    Well you can interpret it that way. But thats a nice way of saying the member asking for conversion can declare an event of default. Also makes it clear who the debtor is.

    Plus harsh measures imposed on the debtor nation.

    …is altogether out of proportion to the contribution asked of its creditors … the process of adjustment is compulsory for the debtor and voluntary for the creditor.

    WARREN MOSLER Reply:

    again, what does that mean in practice?

    can japan go to the Fed and demand dollars for yen?
    if so, at what price?
    if at ‘market prices’ as i read it, the entire point is moot.

    Tom Hickey Reply:

    R: Plus harsh measures imposed on the debtor nation.

    That’s boilerplate that applies only to the Third World. Difference between the Asian crisis and this crisis. If it would ever apply to the parties that wrote the agreement, like the US, the agreement would scraped and another agreement written.

    Sergei Reply:

    “You can’t complain on the one hand about unemployment and then say “we have been enjoying””

    Ramanan, what is exactly your thesis? That a 100% swing in the exchange rate can produce a 1 p.p. unemployment rate change?! You are continuously defending a certain thesis but fail to bring any arguments apart from references to some IMF articles and so on. I care even less for IMF articles than a 100% swing in the exchange rate the effect of which is almost like a rounding error given a persistently high unemployment in EZ.

    Ramanan Reply:

    “Ramanan, what is exactly your thesis?”

    Okay some commentator have asked me to stop, but since it seems nobody is sure of what I am talking …

    The Balance of Payments constraint is a superstrong constraint. It is ultrastrong. Wrecks nations. A hemorrhage in the circular flow of national income. Even the United States is not beyond this constraint whatever ha ha hee hee you do about fiscal policy. (I understand fiscal policy is a supremely powerful tool – ultrapowerful tool).

    Peter D acted smart and asked to link a reply. He also linked to an MMT paper which says

    This leads to the second dimension: convertibility. Most modern governments do not promise to convert their IOUs to anything, having long ago abandoned the gold standard. (To be sure, many governments, especially in the developing world, do promise conversion to a foreign currency such as the US dollar. In that case, we can think of the US dollar as the apex of the pyramid.)

    I checked the “Annual Report On Exchange Arrangements And Exchange Restrictions 2010″ from the IMF and it says the United States has been a signatory of Article VIII, Section 4 since ages.

    The reason I brought the IMF into all this is that it has to do with the international nature of money.

    Now the 100% is an exaggerated way to put it. The Euro started from 1 (?) around 1999 went to around 0.8 and came back to 1 and APPRECIATED to 1.6 to come back now to around 1.4.

    At any rate proves that currency adjustment hardly do the trick on balance of payments adjustment. A currency depreciation on the other hand, says something about the acceptability of the currency in international markets. Again you are presenting a currency that APPRECIATED.

    The Euro Zone balance of payments is not so bad (haven’t seen in detail for the whole region) and in fact the balance of payments inside the Euro Area is severest. Why do you think Greece is different from Germany ?

    A current account deficit increases a nation’s indebtedness to the rest of the world. Straightforward accounting.

    Now if there is a dance saying that that debt is not debt, I necessarily have to point out all fallacies used in obtaining that conclusion. To show explicitly that each item in liabilities side of the International Investment Position is debt.

    The movement of exchange rate doesn’t create unemployment. It is the current account deficit which creates unemployment – increases it rather. Now as far as I know MMTers agree with this. Not sure why you don’t.

    To compensate the leakage in demand requires deficit spending from some units and if the thesis is that the government runs a higher deficit, you create a situation where demand rises faster than output then it creates a situation in which higher imports cause higher indebtedness to foreigners.

    Here’s the identity connecting stocks and flows

    Closing Stock of Net International Investment Position = Opening Stock + Current Account Balance + Revaluations.

    Its obvious how indebtedness to foreigners increases if you run a current account deficit.

    At any rate, subtle … no wonder economics is a hard game …

    WARREN MOSLER Reply:

    the balance of payments constraint is that you have to pay for your imports with export revenues, plus/minus non resident desires to hold liabilities denominated in your currency.

    so the US is allowed to import that much more than we export because non residents are willing to net accumulate $US financial assets (and some US real assets- properties, etc.)

    When non residents hold govt. liabilities called US Tsy securities, which are credit balances in securities accounts at the Fed, that is called foreign debt and it is said that the US owes that many dollars to foreigners.

    Functionally that debt means that at maturity we’ve agreed to shift those balances in securities accounts, plus interest, to reserve account balances at the fed.

    And that the US govt stands by to accept those reserve account balances as payment for US federal taxes.

    agreed?

    MamMoTh Reply:

    I wish there was a single post where to discuss these matters, like the balance of payment constraint, the money and bonds, and the govt as a price setter, where there are different positions, instead of these issues popping up here and there…

    WARREN MOSLER Reply:

    how about I post this on the main blog and comments can be directed there?

    http://www.moslereconomics.com/mandatory-readings/a-general-analytical-framework-for-the-analysis-of-currencies-and-other-commodities/

    WARREN MOSLER Reply:

    i don’t think that translates into, for example, japan being able to buy dollars with yen at a predetermined/established fixed exchange rate?

    Ramanan Reply:

    Members hold very little SDRs .. so the conversion has to be in the currency of the member asking the conversion.

    The member asking for conversion can even negotiate to ask other reserve assets.

    It is characteristic of a freely convertible international standard that it throws the main burden of adjustment on the country which is in the debtor position on the international balance of payments. … that is, on the country which is (in this context) by hypothesis the weaker and above all the smaller in comparison with the other side of the scales which (for this purpose) is the rest of the world. … The contribution in terms of the resulting social strains which the debtor country has to make to the restoration of equilibrium by changing its prices and wages is altogether out of proportion to the contribution asked of its creditors … the process of adjustment is compulsory for the debtor and voluntary for the creditor. If the creditor does not choose to make, or allow, his share of the adjustment, he suffers no inconvenience. For whilst a country’s reserve cannot fall below zero, there is no ceiling which sets an upper limit. The same is true if international loans are to be the means of adjustment. The debtor must borrow; the creditor is under no such compulsion
    – Guess who :-)

    Pure double entry book-keeping. If a nation’s net overseas assets position is negative it is a debtor nation how much ever one dances around it.

    Reply

    beowulf Reply:

    Sorry I’d meant to above comment that its at buyer’s option whether to conver into SDR or seller. If buyer picks SDR and there aren’t enough SDRs to convert, the impossibility of performance is not a default.

    But to go back to your Guess who Godley quote above, he and Cripps laid out the solution in “Control of imports as a means to full employment and the expansion of world trade”– you can tackle current accounts deficit with import tariffs, using revenue to cut domestic taxes. If you think trade imbalances are a problem, there’s your silver bullet.

    Tom Hickey Reply:

    And the US would love to pay China of in RMB by buying yuan in the fx market, thereby breaking the peg, which the US has been assiduously pressuring China to do. It woud be tantamount to imposing a tariff.

    As you say, beowulf, China would not commit economic suicide by going this.

    Ramanan Reply:

    Of course… but the muddle continues.

    The member asked to convert can always go to the market.
    That’s the natural route. Its not compulsory to pay in SDRs. The debt can be renegotiated.

    So if you do not want to define it as a default its fine.

    Nonconvertibility is the bosom of the argument that trade deficits are not a problem here. Or assumptions on what the state promises to officials and non-officials holders of the debt (in case someone tries to redefine “official convertibility” or convertibility in general).

    The US is the *only* nation which *seems* to have the ability to run such massive external trade deficits.

    China won’t take this step but gives it tremendous advantage and power.

    China won’t dump Treasuries because it will affect the remainder of the portfolio which is big.

    However China creates a massive deflationary scenario in the US. Its called Death By Renminbi.

    The comments are heading into too big to fail/bail kind of arguments. Not the easiest thing to argue out .. so leave it for now.

    anyways, I take its agreed other nations face issues with the external world :)

    Ramanan Reply:

    “But to go back to your Guess who Godley quote above,”

    Oh that was JMK but Godley was an unrepentant Keynesian so close.

    beowulf Reply:

    Ahh OK, that would have been 2nd or 3rd guess. Just as American politicians can (and do) find any possible sentiment already expressed by Shakespeare, Lincoln or Churchill, there’s an on-point quote by Keynes, Godley or JK Galbraith for just about any economic situation.
    Galbraith, in particular, was a gifted writer. He dabbled in political speechwriting and was first-rate. Although I’m quite the Richard Nixon fan, Galbraith wrote the most brutally awesome putdown for Adlai Stevenson in 1956 (against Eisenhower-Nixon ticket).
    “You roll back the stones, and you find slithering things. That is the world of Richard Nixon”.
    Ha ha, now that’s a gut punch!
    http://www.booknotes.org/fullpage.aspx?sid=60409-1

    beowulf Reply:

    Actually, to clarify, IMF Rule O-2(a) means that the entire basket of currencies can priced in London or in New York or… if its more profitable for the American and British governments, some currencies in London and others a few hours later in New York.
    The reason nobody worries about this ever happening is because fighting a currency war with the United States is like climbing into the water to fight the shark (as Churchill memorably said of land wars in Asia).

    Reply

    WARREN MOSLER Reply:

    and what would a country actually try to do?

    try to buy your currency with theirs at something other than market prices?

    and if it’s done at market prices, either nation could simply broker his side of the trade to a third party.

    beowulf Reply:

    Ramanan’s hypothetical is someone (presumably China) requiring, per WTO rules, the United States to convert all of their currency into either SDR or local currency. Of course the first issue is, why would (assuming China is the selling country) China destroy its own economy? If it can’t export to the US, its economy implodes.

    But for the sake of argument, we’re assuming they go through with it and make their demand for the US to buy back all of the dollars they hold. As the buying nation, the US would have option of choosing to buy SDRs or Yuan. By election to go with SDR, there is another WTO rule (cited above) that sets the value of dollar to SDR currency basket. Whatever the exchange rate is at noon in London (or, perhaps, in New York) is the conversion price regardless of market price at 11:59 or 12:01.

    Only making the point that the US is never going to be forced to buy back its dollars. But there’d no point going so far in the weeds. I’ll amend my quote– making legal arguments based on obscure WTO rules while debating Ramanan is like climbing into the water to fight the shark. :o)

    WARREN MOSLER Reply:

    and china is always allowed to sell its dollars in the market place, but currently only seems to buy more.

    and they can and do buy other currencies, which is the better than the same as owning sdr’s

    and if china did try to ‘pull something’ and demand the US purchase $1T for yuan at a fixed price, odds are the US would simply say no,
    just like Nixon did when France wanted their gold. And Roosevelt did when the US went off gold domestically in 1934, etc.

    Tom Hickey Reply:

    There are two separate issues here. The first is the US as the issuer of the global reserve currency. That pretty much requires the US to supply the necessary currency and the preferred way for nations get USD is exporting to the US. That means that the US has to run a persistent trade deficit, which implies a persistent fiscal deficit to offset, or accept unemployment.

    This is not working for the US now and instead of running the necessary deficit to address unemployment resulting from the leakage, it is accepting depression level unemployment due to the combined trade deficit and increased domestic private saving resulting from delevering. As a result the US is putting pressure on China to remove its peg, on one hand, and on the other, has signaled that it is also open to working on a global reserve currency based on some international arrangement to be brokered, presumably by the G20. This would result in a return toward a fixed rate system.

    Ramanan, I don’t see the issue as one of “convertibility” bout rather as one of floating v. fixed rates. True convertibility involves a non-monetary numeraire like gold. What you are calling “convertibility” is exchanging currency based on floating rates. It’s the floating rates that is the perceived problem, since they allow currency depreciation. The issue now is currency depreciation, specifically of USD as the primary reserve currency, and the push is toward some new fixed rate system without strict convertibility, e.g., gold as numeraire, although some think that some gold might be in the package.

    The second issue is the ROW beside the US, or at least the countries without secondary reserve currencies. They have to obtain foreign reserves for trade and to defend their currencies. This means that they need to be net exporters, which means being put at a disadvantage in real terms of trade.

    So this is not really working for either the primary reserve currency issuer or most of the ROW, especially the emerging nations, which are disadvantaged in real terms of trade and prevented from growing their domestic economies as they might wish, because they don’t want to risk depreciating their currencies.

    The solution is recognizing that this is a demand problem that can be solved by all nations committing to full employment and balanced trade, where imbalances are adjusted through cooperation and coordination. The developed world is going to have to absorb exports while the emerging world is building domestic demand, and the developed nations are going to have to supply investment capital, technology and expertise to the emerging world as well. At the same time, the emerging world is going to have to build domestic demand as quickly as possible. This is what the revolts in MENA are about, more than revolts against repressive regimes. The people there want something more than subsistence living.

    Affordability is not the issue. If there is a monetary issue it is demand-related and distributional.

    The actual issue is husbanding real resources intelligently and cooperatively in order to create a peaceful and prosperous humanity. The presently existing institutions are getting in the way of this and they need to be changed to fit current and anticipated needs.

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