Thoughts on S+P action re USA
Posted by WARREN MOSLER on April 19th, 2011
>
> —– Original Message —–
> From: Hadden, Glenn (FID)
> Sent: Monday, April 18, 2011 04:45 PM
> Subject: IMPORTANT – thoughts on S+P action re USA
>
I would like to address the action taken today by S+P in revising the United
States credit outlook to negative.
Simply, I believe the argument behind S+P’s decision is flawed and displays
a misunderstanding of how the monetary system operates. My view is not
predicated on any political ideology. I am merely attempting to demonstrate
the incorrect logic regarding United States credit quality and solvency.
1. FINANCIAL BALANCE FRAMEWORK:
The first fundamental item that must be understood is how financial balances
relate to government indebtedness. In a closed economy (or an economy with a
perpetually balanced current account), government deficits must equal
private savings. If private savings desires increase, a government’s deficit
must increase by precisely the same amount all things equal. There is no
other way.
In the case of the United States, the budget deficit has grown to 10% of gdp
from approximately 4% of gdp because the savings rate has shifted from
approximately negative 2% to approximately positive 6%. Simply stated, the
federal budget isn’t a function of profligate government spending, its a
function of higher desired private savings causing a shortage of aggregate
demand. This shortage of aggregate demand is putting downward pressure on
tax revenues (lower nominal gdp implies lower tax revenues) and upward
pressures on expenditures owing to automatic stabilizers such as UI.
With this example, it is theoretically possible to have much larger
government deficit and debt levels if savings desires grow commensurately.
If private sector savings desires were to fall, which implies higher
aggregate demand (because the spending of a person in the private sector
simply creates another person’s income), the government deficit would fall
commensurately owing to higher tax revenues and possibly lower expenditures.
2. MYTHS REGARDING FOREIGN INVESTORS FUNDING THE UNITED STATES AND EXTERNAL LIABILITIES:
Firstly, the most important item to understand is the USA discharges its
debt in $US. So the entire argument of rating agencies behind ‘external
funding pressures’ is moot. Functionally there is no difference between a
holder of UST’s who is domiciled in USA or abroad, as they are both $US
dominated savers. The only difference is the foreign saver has no ‘need’ to
save in $US (where a USA investors needs $US as a means of exchange and to
pay his taxes).
So, what if foreign now dump their ust’s?
Foreign investors own ust’s and $us because they WANT to own them. By
engaging in fx driven trade policies, foreigners ‘pay up’ to get $US which
allows them greater sales into the USA market. If foreigners didn’t want to
save in $US, they would change their fx policy which would result in less
market share in USA economy. Foreigners can’t be both buyers and sellers
simultaneously. If foreigners wanted to own less $US, the result would be a
smaller current account deficit in USA, which again using a financial
balance framework would either result in more private savings, or a smaller
govt deficit. Bottom line – if foreigners want to have fewer savings in $US,
either private savers must increase savings, or the govt deficit must fall.
3. MYTHS REGARDING FOREIGN INVESTORS FUNDING THE UNITED STATES AND EXTERNAL LIABILITIES part II:
The same way banks offer savers demand deposits and term deposits (ie
chequing accounts versus savings accounts) the USA economy offers savers the
same in the form of $US (demand assets) or UST (term asset). Foreign savers
can therefore keep their $ at their Fed Reserve account and earn basically
zero (functionally a ‘chequing’ or demand account) or buy UST’s
(functionally a ‘savings’ or term account) and earn a coupon. There is no
other way to save in risk free space. As said above, foreigners who engage
in fx driven trade policies must accumulate $US demoninated assets. The only
choice they have is term vs demand assets. So indeed if foreigners declined
to own ust’s and alternatively kept their savings in $US at the Fed, the
result could be a higher and steeper term structure for USA rates. If the
Treasury decided to sell less ust’s and more tbills, this term structure
rise could be negated. Note foreigners actions are never about SOLVENCY, its
merely a function of liquidity preference.
4. THE DEFAULT BY THE SOVEREIGN OPERATING WITHIN A NON-CONVERTABLE EXCHANGE RATE REGIME IS A *FUNCTIONAL* IMPOSSIBILITY:
One must also understand the mechanics of government spending. A government
purchases goods and services from the private sector and then the Federal
Reserve credits the reserve accounts of the commercial banks whom the
sellers of such good and services bank. The Fed then debits the reserve
account of The US Treasury. The Treasury then sells ust’s, where the Fed
then credits the Treasury’s reserve account while debiting the reserve
accounts of the banking system.
So all that has happened is the government has created savings in the
economy by spending (from point 1 above: govt spending = private savings).
So as is illustrated, there is no issue of ‘solvency’ per se. The
government, by spending, is creating the savings to buy the ust’s. The only
issue here is the term gap. Specifically if savers only want demand assets
(ie $us), while the Treasury only wants to sell term assets (ie ust’s), the
resolution will be price and risk premium: ie how much interest rate spread
will a bank or arbitrageur need to intermediate this imbalance. This can all
be negated of course, if the Treasury only issued T-bills.
5. THE DEFAULT BY THE SOVEREIGN OPERATING WITHIN A NON-CONVERTABLE EXCHANGE RATE REGIME IS A *FUNCTIONAL* IMPOSSIBILITY part II:
This is the fundamental flaw of the S+P decision. The basis of their
sovereign rating criteria is as they describe it is: “The capacity and
willingness to pay its debts on time”. As mentioned above, there is
functionally no reason for the USA to ever not pay its debts – the USA’s
debts are and will always be equal to savings desires of the private and
foreign sectors. So ‘CAPACITY’ can never be an issue.
Hence the only reason the USA would ever default was because they ‘wanted’
to default, they never under any circumstance NEED to default so long as the
$US remains a non-convertable currency. The implications for a voluntary
default (again, this is the only kind of default possible by the USA) make
such a default an impossibility. The reason is because the 2nd largest
liability of the federal government is deposit insurance. If the USA decided
it wanted to default to escape its obligations, it would bankrupt its
banking system, who’s holdings of ust’s are greater than system-wide bank
capital of $1.4 Trillion. In fact the contingent liability put the
government has issue via deposit insurance is almost as large as USA debt
held by the public at $6.2 Trillion. So essentially a voluntary default
would actually INCREASE USA indebtedness by almost 100% while
simultaneouslybankrupting its banking system. So if ABILITY to pay is
assured, and a voluntary default actually raises indebtedness while
collapsing the banking system and economy, why would USA ever voluntarily
default? So S+P’s criteria of ‘WILLINGNESS’ to pay is also not applicable.
SUMMARY:
So as demonstrated, the bottom line is ABILITY to pay can never be an issue
in a non-convertable currency system. The only issue is WILLINGNESS to pay.
So if the argument by S+P relates to “the capacity and willingness to pay
its debts on time” as they described on Monday’s call, then their argument
simply isn’t cogent.
The last point I want to make is it would be incorrect to attempt to draw an
analogy to the placement of the UK on credit watch in mid May 2009 relating
to market performance. Yes indeed gilts sold off shortly after this
announcement. However this was more a function of the unhinging of the USA
MBS market. There existed a perception that the Fed via QE1 was attempting
to cap current coupon mortgage rates at 4%. Once this level was breached and
it became clear in mid/late May that this view was incorrect, a convexity
sell event hit the USA rates market which dragged all global bond yields
higher including Gilts.
To conclude – I view the decision today by S+P as having zero impact on
valuations of USA sovereign debt. We continue to engage in trades that
express the correct view that the solvency of the United States can never be
an issue in nominal terms; specifically we are buyers of 30yr assets swaps
at -25bps.
April 19th, 2011 at 9:15 am
Someone needs to convince Bernanke to write off a couple billion of treasuries so that all this debt ceiling bankruptcy talk can go away.
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WARREN MOSLER Reply:
April 19th, 2011 at 11:58 am
and even the imf doesn’t count intergovernmental obligations as debt.
when the fed buys tsy secs the secs are functionally gone.
the fed subsequently selling them is functionally identical as the tsy issuing new secs
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April 19th, 2011 at 9:44 am
Make that trillion instead of billion.
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April 19th, 2011 at 9:50 am
agreed, this is great; thanks to Glenn for singlehandedly outdoing the entire AEI
To build on Glenn’s text, wouldn’t it be better to NOT even let Federal taxes in a fully fiat currency regime be called “revenue”? That’s an oxymoron if ever there was one. By no possible definition of the term can the monopoly issuer of a fully fiat currency either need or derive “revenue” in the form of it’s own currency. Using such language still turns away too many people searching for clarity.
Using the term “revenue” throws a cognitive death-line to deficit thinkers – exactly when the rest of the text provides multiple lifelines to consistent logic. Whenever there is a tug-of-war between confused vs rational thinking, alignment comes soonest when confusing semantics are replaced with appropriately consistent terminology.
How about this instead?
“This shortage of aggregate demand naturally lowers any demanded tax returns (lower nominal gdp implies lower taxes) and increases expenditures on automatic stabilizers such as UI.”
That gets the same point across, and allows less room for “deficit thinking”, i.e., fiscal DTs. Perception inevitably follows terminology, even for those specialists who should recognize semantic divergence, but especially so for everyone else.
Next step is to condition people away from applying the concept of “deficit” in these discussions at all. Just refuse to use inappropriate terminology, and then be more specific.
Allowing confused semantics in fiscal policy statements is exactly how we strayed into this mess even after going off the gold std.
Ultimately, the oxymoron of a fiat currency “deficit” must be more accurately named, or this discussion will continue to irritate newcomers. In any discussion, the smoothest way to lesson the participation burden is to use consistent terminology, and to quickly define any novel terms required.
Anytime bad habits call for the use of fiat currency “deficit”, simply insist on a more accurate term. Currency sector ratio? Net private savings? Altered issuer/user balance? There are many options. Select one, and stick to it consistently – or this harmful fiat confusion will continue to degrade our policy process.
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Dan Kervick Reply:
April 19th, 2011 at 11:51 am
By no possible definition of the term can the monopoly issuer of a fully fiat currency either need or derive “revenue” in the form of it’s own currency.
I don’t get that. Yes, it is true that the monopoly currency issuer doesn’t need to build up its own account balances by receiving revenue. But as a matter of operational fact, that is the way the government does build up some of its account balances. Doesn’t a check to the IRS clear in the same way a check to any other account clears? Your account is debited and the government’s account is credited. You make a payment and the government receives revenue.
They don’t need to do this, I suppose. We could have a tax payment system in which no government account is ever credited. Instead the government could just extinguish the money by issuing some sort of order for the taxpayer’s account to be debited by a certain amount. And then the government could simply create the additional funds it needs by ordering credits to its own accounts.
Similarly, the government doesn’t need to issue debt to raise revenue. It could just credit its accounts by the desired amounts without clearing receiving payments from bond purchasers and without indebting itself to those purchasers. This is the way it could work. But that is not the way it actually does work. Instead, bond purchasers buy bonds, the payments for which are cleared the same way any other payment is cleared. And the government issues legally-binding debt instruments to the purchasers.
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Tom Hickey Reply:
April 19th, 2011 at 12:39 pm
Dan, you are mesmerized by the illusion of finance and are in the wrong paradigm. What is happening is completely different from what you and most others imagine is happening. This is a key point of MMT. Consult the mandatory readings for a full explanation. Warren’s “Soft Currency Economics” is the basis of MMT’s description of monetary/fiscal ops.
The short explanation is that a monetarily sovereign government (like the US, UK, Canada, Japan, Oz, etc) that is the monopoly issuer of a nonconvertible currency with a flexible (floating) exchange rate is not operationally (financially) constrained. As currency issuer, the government neither taxes to fund disbursements, nor borrows to finance them. It simply issues currency, which injects nongovernment net financial assets. Taxation withdraws NFA. Tsy issuance is a monetary operation that drains excess reserves resulting from deficits, so that the Fed can hit its target rate. Tsy issuance simply changes asset composition and term structure of government liabilities. It is saving of NFA created by injection rather than borrowing in order to finance.
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Dan Kervick Reply:
April 19th, 2011 at 5:22 pm
Tom,
I am not really taking issue with the MMT theoretical paradigm. And I am not worried about the deficit hawks and their insolvency bugaboos. I am just taking issue with Neil’s assertion that “by no possible definition of the term can the monopoly issuer of a fully fiat currency either need or derive “revenue” in the form of it’s own currency.”
That statement, it seems to me, is not entirely true. It is entirely true that the monopoly issuer of the fiat currency does not need to take in revenue in the form of the currency it issues, especially given that there is no production cost for the currency. But it is not true that the monopoly issuer of a fiat currency never does derive revenue in the form of its own currency. Whether some monopoly currency issuer does derive revenue from the private sector in the form of its own currency is a matter of political, economic and administrative choice, not theoretical principle.
Any monopoly maker of anything can end up receiving revenue in the form of the stuff it has made, if it so chooses to accept that stuff in exchange for something else it also possesses. I might be the monopoly manufacturer of widgets. That means all the widgets in existence were made and owned by me originally. But I then exchange some widgets for other stuff, and some of my widgets pass into the ownership of others. Later I might then have some safety pins to sell, and I might be willing to accept widgets in payment.
Isn’t it the case that when a taxpayer conveys a check to the federal government, that check is cleared in the same way other checks are cleared? One account is debited and another account is credited. The tax payment is an expense for the taxpayer and revenue for the recipient. The fact that the monopoly currency issuer could have increased the balance in its own account in a more direct way, simply by issuing the currency via directly crediting its account, doesn’t alter the fact that the monopoly currency issuer could choose instead to increase its balance by commanding payments from the private sector and receiving those payments as revenue.
Now you might choose to say that when this tax check clearing happens the money in the private sector account is actually “extinguished”, and then new money is “created” in the government account. But you could say the same thing with respect to any interbank transaction. Suppose my customer writes me a check on his bank’s account, which I deposit in my own account. The check clears; his account is debited and mine is credited. Should we say that I did not actually receive any revenue because the money that was credited to may account is in some philosophical sense not the “same money” as the money that was debited from my customer’s account?
Tom Hickey Reply:
April 19th, 2011 at 7:42 pm
Dan, you are still taken in by the illusion. The government that issues a fiat currency does just that. It can order taxes be correlated with spending but spending can never be depending on taxes. This is the distinction that MMT makes between an operational constraint and a political restraint. Political restraints cannot alter the operational reality of a fiat currency although they can impose political restraints. For example, a debt ceiling does not alter the fact that operationally the US government is able to meet its obligations. The debt ceiling just says that a future Congress may be unwilling to meet them. Similarly, taxing or not taxing has nothing to do with the ability of the government to spend, however it is fixed up to look it.
anon Reply:
April 19th, 2011 at 4:41 pm
this exchange (dan/tom) is a tragedy – a dialogue of the deaf
dan is correct
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Tom Hickey Reply:
April 19th, 2011 at 7:36 pm
Anon, the currency issuer of fiat cannot do anything but issue currency by fiat. This is by definition. Taxes never fund spending because, as Warren says, government does not have or not have money.
Correlation is not causation. Taxation does not fund spending in a fiat system. It may look that way, but it is functionally impossible, just as it may look like government is borrowing when it issues tsys.
Roger Erickson Reply:
April 20th, 2011 at 10:08 am
and Dan is even taken by the illusion that Roger is Neil :)
MamMoTh Reply:
April 20th, 2011 at 10:53 am
I agree anon, although I’d add that who is right is quite irrelevant.
Calgacus Reply:
April 22nd, 2011 at 5:27 pm
I agree with anon & MamMoth; an argument about a not very meaningful point.
Anybody ever see Preston Sturges’ The Palm Beach Story? J. D. Hackensacker III (Rudy Vallee), while wooing Claudette Colbert, meticulously writes down the expenses for the lavish gifts he gives her in a little notebook. Late in the movie, she asks him about it, and he says “Oh, I never add it up.” A sensible government is like that. Sure, it can put its “revenue” (and expenses) in a little note book if it feels like it, but why add it up? Unfortunately, deficit terrorists / numerologists get a hold of the little notebook, add it up and convince everyone that the sum is an unlucky number.
WARREN MOSLER Reply:
April 19th, 2011 at 12:00 pm
and instead of taxation call it subtraction
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April 19th, 2011 at 10:38 am
“Allowing confused semantics in fiscal policy statements is exactly how we strayed into this mess even after going off the gold std.”
well said!!
i’m not an economist, but a linguist instead, and i strongly believe that this is the crux of the problem that you MMT’ers have in counteracting the arguments of the deficit terrorists (apart from the fact that they have a well-oiled, well-funded machine to promulgate the “big lie”).
part of the reason why a lot of what you say appears “counterintuitive” to the lay public is because the ideas you express seem to contradict the terminology you use. so, to some you might come off as being dishonest or, at the very least, confusing.
i think somehow you guys have to make an attempt to frame things differently by explaining how inaccurate the current terminology is.
the problem with that is that could lead to a long drawn-out explanation and given the ever-shrinking attention span of the public you might lose them (a frequent complaint of some here towards bill mitchell).
which reminds me of a interview i heard a long time ago of noam chomsky (another linguist). on the subject of counteracting arguments from the mainstream, he said something to the effect that “they” don’t actually “argue,” they just spout off “slogans” that the public has already been programmed with, so to argue against them, you are forced to go into a long drawn-out discussion exposing their “slogan” for what it is, how it came to be and then how inaccurate it is and then why your view is a more accurate view of reality. and that’s tough to do when you have time contraints as you do on tv interviews.
unfortunate, i don’t have any answers, but i do think, as others here have suggested, that you MMT’ers should do video blogs, with graphics, so that people can come away with a visual representation of how things work. i think that would help a lot.
anyhow, good luck and thanks to all for all the information!
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Tom Hickey Reply:
April 19th, 2011 at 11:52 am
MMT’ers have to develop their own slogans that reinforce their paradigm instead of being drawn out of paradigm by the framing. Just refuse to go there, and when on TV, repeat the slogans forcefully. Then make others respond in paradigm by objecting to the paradigm. That changes the framing from theirs to ours.
Whoever sets the norms of the universe of discourse wins. Slogans are rhetorical expressions of norms that establish framing.
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Neil Wilson Reply:
April 19th, 2011 at 12:43 pm
Yep. And you don’t have to be 100% accurate. You just need to make it difficult for your opponent to frame an answer in 30 seconds.
Regrettably modern PR is the battle of the 30 second attention span. Hence the degradation into emotional manipulation and stereotyping.
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Craig Reply:
April 19th, 2011 at 2:08 pm
hmmm….i think your right “revenue” is a nebulous term that can cause confusion.
how about using “funding” instead of revenue for issuers. currency users require revenue to spend but currency issuers require no funding. currency issuer’s don’t need to earn money or loan money. issuer’s create money when they spend and destroy money when they tax. “funding” for a currency issuer is meaningless.
in other words, credit/debits for currency issuers are accounting identities not operational constraints of finite resources.
what do you guys think? helpful or just adds more confusion?
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Roger Erickson Reply:
April 20th, 2011 at 10:30 am
Close, yet “funding” is no better than “revenue”. Warren’s suggestion of “subtraction” wins so far, even if it’s a bit confusing.
Real point is that a currency-issuing nation needs to generate group alignment to group goals, and execution time always matters.
Public currency issuance and currency recovery in the form of itemized spending & taxation allows a jump start on efficient distribution. However, with the combination of scaling population and fully fiat currency, the entire responsibility shifts faster & faster to intelligent management – something we’re still adjusting to. Once again, we’re simply seeing that we live by our wits, and that all other forms of “currency” are fully nominal. It’s been that way on planet Earth for at least 4 billion years.
All system sciences, and the military too, admit that distributed decision-making trumps all competing approaches. So we need to turn our attention to the methods of improving the quality of distributed decision-making.
That puts all the onus on preparation. Which we’re also failing at.
Good part is that absolute failure clarifies all faults.
Dumb kids falling off their bikes also can’t believe it’s happening – until they actually hit the pavement. Nevertheless, even when they sit up and ask “What truck just hit me?”, their motor/sensory/analysis “automatic stabilizer” systems are already retuning to prepare a different outcome next time around the block.
Smart kids are always watching, and preparing to not make the same mistakes even once.
It’s the ones who can’t learn by either method that are in real trouble.
Craig Reply:
April 20th, 2011 at 10:58 am
okay let me try again and reframe in laymen terms – with a few talking points. like neil says they don’t have to be 100% accurate we just need to make it difficult for our opponent to frame an answer in 30 secs.
A fiat currency issuer (US, Japan, UK but not Greece, Portugal, Ireland) has a privilege position within the economy because the issuer has monopoly control over fiat money. The position comes with unique capabilities:
1. Currency issuers determine interest rates (ie. the interbank overnight lending rate) because as monopolists they are the price setters.
2. Currency issuers don’t need to “raise” money. They are self-funded by government decree. Fiat money (Latin fiat, meaning “let it be done”) is money that has value because of government law. Currency issuers create money when they spend and destroy money when they tax. Taxes for currency issuers serve to regulate the economy (reduce demand) not fund public spending.
3. Currency issuers don’t need to borrow money. Borrowing for a currency issuer only serves to provide risk-free savings for the private/foreign sector. Currency issuer can never default on a loan except by choice (such as a self-imposed debt ceilings) because they are legally self-funding.
Fiat currency issuer’s are essentially the scorekeepers within the economy – not the players (ie. currency users). They are are unlike other participants in the marketplace precisely because they are funded by law and not from earnings or borrowing like other currency users. Deficits and surpluses are accounting identities to currency issuer’s not constraints of finite resources. Government deficits are dollar for dollar equal to private/foreign sector savings.
government deficits = non-government surplus (ie. private & foreign savings)
In the world of sound bites and 30sec interviews, the idea is make a few provocative statements with conviction to give an alternative perspective with a few easy takeaways. strong declarative statements also enables MMT to take the offensive while forcing critics to explain themselves instead of putting MMT on the defense. Any comments or arguments critical of these statements just provide an opportunity to expand on the MMT ideas.
details like the kind Tom spoke of yesterday – “Tsy issuance is a monetary operation that drains excess reserves resulting from deficits, so that the Fed can hit its target rate. Tsy issuance simply changes asset composition and term structure of government liabilities. It is saving of NFA created by injection rather than borrowing in order to finance.”
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WARREN MOSLER Reply:
April 20th, 2011 at 12:11 pm
currencies don’t have value by law. they have value because they can be used to extinguish tax liabilities
Craig Reply:
April 20th, 2011 at 12:53 pm
which may be “functionally” true but for sake of streamlining the MMT talking points it may add confusion. a statement like “currency issuer’s create money by law/government decree” sounds much more authoritative. if a critic disagrees ask them what the definition of fiat money. According to wiki it’s: Fiat money is money that has value only because of government regulation or law” – http://en.wikipedia.org/wiki/Fiat_money
I think selling MMT to joe six-pack requires easy to understand, generalized, talking points without getting bogged down in the details.
Tom Hickey Reply:
April 20th, 2011 at 1:55 pm
I think that there is a lot of sense to this approach, Craig. Article 1, section 8, 10, give the federal government (through Congress) monopoly power over the currency, as well as the taxing power.
I would not emphasize where the value of money comes from, but rather that the Constitution gives the US government a monopoly wrt currency. This is simple to understand and includes the tax issue without relying on it specifically.
Roger Erickson Reply:
April 20th, 2011 at 2:35 pm
To me there’s a consistent issue seen in commentary similar to that from both Ramanan and Craig. To me they’re both indoctrinated in the view that currency-issuers have any obligation to anything thing except explore the options available to their sovereign country and population.
People outside the USA (& even some Americans) think that whomever issues the most commonly used currency should manage it for the equal benefit of foreigners as well as US citizens. That would actually be ceding even more power to existing banksters, and would be continuing in the a disastrous direction we’re already being dragged.
While theoretically laudable (if projected beyond any semblance of predictive power), that’s simply no more possible than me managing my blood volume in order to help those in need of compatible plasma donations! Best I can do is donate some extra. Any attempt to manage my blood for your use quickly gets in the way of all other activities. There are better, more indirect, ways to pursue return-on-coordination.
Anyone who doesn’t want to use $US should work on exploring their own options, not trying to steer the Titanic from a canoe. We have enough confusion on board, & even within the wheel room itself.
Craig Reply:
April 20th, 2011 at 3:20 pm
roger – your exchange with ramanan is beyond my understanding of things. however, i get your point about the dollar should be managed to benefit foreigners as well as US citizens. Maybe it’s my nativity but if more spending is not inflationary and creates more demand whats the harm? especially if it’s spent on R&D and next gen technology that results in commercial applications/products that the rest of the world wants. maybe it’s my lack of understanding but if currency issuer’s grow their deficits gradually and proportionally without causing inflation then no harm is done.
tom – point taken how about this with a little disclaimer on inflation at the bottom:
A fiat currency issuer (US, Japan, UK but not Greece, Portugal, Ireland) has a privilege position within the economy because the issuer has monopoly control over fiat money. The position comes with unique capabilities:
1. Currency issuers determine interest rates (ie. the interbank overnight lending rate) because as monopolists they are the price setters.
2. Currency issuers don’t need to “raise” money. Fiat money (Latin fiat, meaning “let it be done”) is money that has value because of government law (Article 1, section 8, 10). Currency issuers create money when they spend and destroy money when they tax. Taxes for currency issuers serve to regulate the economy (reduce demand) not fund public spending.
3. Currency issuers don’t need to borrow money. Borrowing for a currency issuer only serves to provide risk-free savings for the private/foreign sector. A currency issuer can never default on a loan except by choice (such as a self-imposed debt ceilings) because they have the capacity to create money.
Fiat currency issuer’s are essentially the scorekeepers within the economy – not the players (ie. currency users). They are are unlike other participants in the marketplace precisely because they create money by spending and not from earnings or borrowing like other currency users. Deficits and surpluses are accounting identities to currency issuer’s not constraints of finite resources. Government deficits are dollar for dollar equal to private/foreign sector savings.
government deficits = non-government surplus (ie. private & foreign savings)
Besides the faulty argument that “federal deficits are bad”, the other primary criticism for public spending is inflation. Public spending (aka. printing money) is only inflationary when spending exceeds productive capacities of the private sector (demand pull inflation). The inflation risk we are seeing today is from rising petroleum costs (cost push inflation similar to the oil crisis during the ’80s) not from excess demand (ie. printing money)
Tom Hickey Reply:
April 20th, 2011 at 3:44 pm
Craig: tom – point taken how about this with a little disclaimer on inflation at the bottom:
* A monetarily sovereign government as monopoly currency issuer has the sole prerogative and corresponding responsibility to provide the correct amount of currency to balance spending power (nominal aggregate demand) with goods for sale (real output capacity). If the government issues currency (nongovernment net financial assets) in an amount that results in effective demand in excess of productive potential to expand capacity to meet it, demand-side inflation will occur due to demand exceeding supply. Conversely, if the government falls short in maintaining this balance, so that supply exceeds demand and inventories build up, business contracts. Recession and unemployment result due to insufficient demand relative to supply (like now). Carried to an extreme, deflation results, especially if there is debt destruction (heaven forbid).
Roger Erickson Reply:
April 20th, 2011 at 10:13 am
Thanks Yuu,
Had the same discussion with some military operations people. They listened, said they understood, and simply replied:
“You’re going nowhere until you create a glossary of new terms allowing coherent discussion to proceed. You can’t prepare coherent operations when there is such high margin of error in interpreting statements.”
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April 19th, 2011 at 10:46 am
if this makes you feel any better :)
No risk U.S. will lose AAA credit rating: Geithner
http://www.bnn.ca/News/2011/4/19/No-risk-US-will-lose-AAA-credit-rating-Geithner.aspx
Political, moral & legal credibility are all separate issues
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April 19th, 2011 at 10:57 am
Is this the actual text of an email sent by the head of the Treasury’s desk at Morgan Stanley? Who was the email sent to?
Just want to be clear. If Hadden wrote this, it is huge.
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WARREN MOSLER Reply:
April 19th, 2011 at 12:03 pm
Just a memo from Glenn Hadden, seems. He’s been on my mailing list for quite a while.
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macrosam Reply:
April 19th, 2011 at 6:16 pm
This may have been a tipping point.
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April 19th, 2011 at 11:06 am
Beautiful. It’s encouraging to see this. Warren, are you responsible for the displayed logic?
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April 19th, 2011 at 11:10 am
Warren, thanks! Glenn is global head of FI, huge news
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April 19th, 2011 at 11:36 am
“i think somehow you guys have to make an attempt to frame things differently by explaining how inaccurate the current terminology is.”
yes agreed good point
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April 19th, 2011 at 12:21 pm
Amazing confusions which is the reason Macroeconomics is a difficult subject.
Perhaps “convertibility” is not a concept easy to appreciate. No respect is paid in the above analysis to the fact that the US signed the Article VIII, Section 4 of the Articles of Agreement of the IMF, promising official convertibility of balances.
So the entire argument of rating agencies behind ‘external funding pressures’ is moot.
The confusions start because of arguments such as “where do the foreigners get their dollars from…” and arguments along those lines. Of course, not implying that the dollars are not created in the US – just pointing out the root of the confusions.
The only difference is the foreign saver has no ‘need’ to save in $US (where a USA investors needs $US as a means of exchange and to pay his taxes).
An Australian can pay taxes to the Australian Government in AUDs by exporting to the US and converting the USDs for AUDs.
If foreigners wanted to own less $US, the result would be a smaller current account deficit in USA, which again using a financial balance framework would either result in more private savings, or a smaller govt deficit. Bottom line – if foreigners want to have fewer savings in $US, either private savers must increase savings, or the govt deficit must fall.
In a Tobinesque portfolio preference way of looking at it, foreigners’ reduction in portfolio preference for USD denominated assets will lead to a depreciation of the currency. To some extent, this will reduce imports through price elasticity effects. However income elasticity of imports still has a strong role to play.
Anyways, that a Keynesian way of looking at it, but the above confuses/hides causality. When the US went into a turmoil, imports plummeted, and simultaneously there was a “flight to quality”. The trade imbalance improved instead of deteriorating.
(Just to make sure improved in my language = lessened because here the Attitude (attitude with a capital A) is that higher the deficit, the better.)
To some extent, the chase to get the US Dollars, with the dollar being the reserve currency has made the whole world become more competitive than the US producers. The attitude here is the US dollar will retain the hegemony status whatever the US external sector does.
THE DEFAULT BY THE SOVEREIGN OPERATING WITHIN A NON-CONVERTABLE EXCHANGE RATE REGIME IS A *FUNCTIONAL* IMPOSSIBILITY:
The US dollar is officially convertible, has full current account convertibility and full capital account convertibility.
THE DEFAULT BY THE SOVEREIGN OPERATING WITHIN A NON-CONVERTABLE EXCHANGE RATE REGIME IS A *FUNCTIONAL* IMPOSSIBILITY part II:
Article VIII, Section 4 of the IMF Articles of Agreement ?
Hence the only reason the USA would ever default was because they ‘wanted’ to default, they never under any circumstance NEED to default so long as the $US remains a non-convertable currency.
It IS convertible.
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Tom Hickey Reply:
April 19th, 2011 at 1:09 pm
Ramanan, I don’t understand what you mean by “IS convertible” other than that currencies are exchangeable at the going fx rate. If the Chinese prefer RMB to USD they can convert their dollars. Why would they use the IMF article to do this? (The US has veto power over the IMF anyway.)
As China watcher Michael Pettis observes, the reason China is not doing this is that they evidently prefer to save in USD. No one is forcing them to do this. They know that if they don’t support the US capital account, it will be difficult to maintain their desired volume of exports to the US, since the capital and current accounts have to balance. If China wants to run the model is now running, it has no choice in this regard.
MMT doesn’t deny floating rate fx convertibility but rather fixed rate convertibility, and in his NYT op yesterday, Randy said that the the constraints on a monetarily sovereign government like the US are the inflation rate and the exchange rate.
That said, the US believes that it currency is overpriced and would like to see further depreciation, which is the only way for the US to reach its stated goal of doubling exports in five years. Of course, the ROW is mightily objecting to that but they didn’t like FDR or Nixon going off gold either. They will just get used to lower exports and grow their consumer bases, as the US wishes them to do.
I am not opposing you here. As you know, I have said previously that I am very interested in understanding the external aspects. I am just trying to figure out why you think that this refutes the MMT position. I fail to see that it does. Either I am missing something obvious, or you are not being clear enough for me to get it.
Let me put it this way. As I understand the MMT position, the way the external works is through adjustment (floating rates). In practice this is not seamless, since countries influence the fx market. But it basically works as long as other countries are willing to save in your currency if you are a net importer.
Where problems do arise is in countries that either are not monetarily sovereign or else have to have foreign reserves because their currencies are not stable enough to induce enough confidence for others to save in them.
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Ramanan Reply:
April 19th, 2011 at 2:02 pm
“Ramanan, I don’t understand what you mean by “IS convertible” other than that currencies are exchangeable at the going fx rate. If the Chinese prefer RMB to USD they can convert their dollars. Why would they use the IMF article to do this?”
Of course IS convertible. Better than saying NOT convertible isn’t it ? I notice words such as “IS” “ARE” are conveniently sneaked in here.
Convertibility is a really deep concept.
“No one is forcing them to do this.”
Yes who is arguing about being forced ?
“They know that if they don’t support the US capital account, it will be difficult to maintain their desired volume of exports to the US, since the capital and current accounts have to balance.”
??? Yes they balance so ???
“MMT doesn’t deny floating rate fx convertibility but rather fixed rate convertibility, and in his NYT op yesterday, Randy said that the the constraints on a monetarily sovereign government like the US are the inflation rate and the exchange rate.”
I can just quote numerous articles and papers where it is asserted that the government doesn’t have any obligation to convert.
“That said, the US believes that it currency is overpriced and would like to see further depreciation, which is the only way for the US to reach its stated goal of doubling exports in five years.”
Nope you got the causality wrong. Its by both depreciation and making huge attempts to promote exports. Just depreciation doesn’t do the trick.
“They will just get used to lower exports and grow their consumer bases, as the US wishes them to do.”
Not so easy because they will run into the balance of payments constraint.
“I am just trying to figure out why you think that this refutes the MMT position. I fail to see that it does. Either I am missing something obvious, or you are not being clear enough for me to get it.”
Well the Article VIII, Section 4 is a brilliant weapon of attack, but not the only one. As mentioned above the whole argument is crucially dependent on the supposed non-option of redemption. More generally, as I keep mentioning, there are zillions of causalities involved and the reserve currency status of the dollar simply seems to confuse the hell out of everyone here. Its simply impossible for anyone here to see that a current account deficit implies that local producers have been less successful in selling their products.
Something obvious ? Hmmm… Economics is not easy.
“But it basically works as long as other countries are willing to save in your currency if you are a net importer.”
Only the US imports almost fully in its currency.
“Where problems do arise is in countries that either are not monetarily sovereign or else have to have foreign reserves because their currencies are not stable enough to induce enough confidence for others to save in them.”
Yes a sudden increase in imports or a decrease in exports puts big pressure on the foreign reserves position.
“Reserve” from dictionary.com “something kept back or set aside, esp for future use or contingency”
To really understand the whole thing, one has to appreciate the fact that imports are purchased on credit and ‘money’ has been designed to keep it that way. It cannot be otherwise.
Again, its not easy … I have really thought through this and this is the reason I take so much effort is that I understand the zillion reasons one can go wrong on this one. But this is not a part of the argument, of course. Just making clear my intentions.
Try reading some Nicholas Kaldor … “monetary operations” were trivial for him.
“As I understand the MMT position, the way the external works is through adjustment (floating rates). ”
That Tom is believing in the laissez-faire ideas – as if the fx markets know how to move etc. In practice nations try to improve trade balance by deflating demand or making attempts to increase exports.
Its funny there is an MMT paper accepting the Thirwall Law and arguing “not a problem” at the same time!
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Oliver Reply:
April 20th, 2011 at 3:21 am
Ramanan, you write as though MMTers were all advocating unlimited importing without some sort of vision of how to improve productivity. You’re beginning to sound like the mainstream with their quasi religious dedication to eradicating the symptoms (budget & trade deficits; whether good or bad doesn’t matter) while completely ignoring the denominator, namely worthwhile human endeavours. To me, the idea behind the ‘deficits don’t matter’ and ‘imports are benefits’ mantra is not to actively indulge in or promote any of these – they are, after all mostly passive symptoms of current local and foreign industrial and labour policies – but rather the opposite, namely to divert attention to that side of the equation we actually can influence, namely labour productivity. Seems that communication strategy has failed with you :-). Either there is a way out forward, i.e. it is possible to embrace what is inevitable in an open economy and look for other, worthwhile things to do, or there isn’t, i.e. we must go down the austerity path and beggar our neighbours. I don’t see any sensible middle way you may be getting at, save the odd bit of protectionism and capital controls one might get away with at times. But then, nobody is against that, as far as I can tell. Bill Mitchell regularly says he’s in favour of fair trade, not free trade and he seems to have a fairly clear vision of an active industrial and labour policy. Warren seems somewhat more laissez faire, but I guess he’s fully aware of and content with the outcome that would produce. What exactly do you want and how do you propose to get it without world government?
Ramanan Reply:
April 20th, 2011 at 4:25 am
“You’re beginning to sound like the mainstream with their quasi religious dedication to eradicating the symptoms (budget & trade deficits; whether good or bad doesn’t matter) while completely ignoring the denominator, namely worthwhile human endeavours. ”
Relax, I am not arguing that governments should balance their budgets :-)
“Seems that communication strategy has failed with you :-)”
Seems my communication has failed as well!
I am pointing to the inherent supreme misunderstanding here on international trade. I am quite a fan of Post Keynesian Economics and only read PKE. Have enjoyed the benefits of importing zillions of PKE books.
“i.e. we must go down the austerity path and beggar our neighbours. I don’t see any sensible middle way you may be getting at, save the odd bit of protectionism and capital controls one might get away with at times. ”
No there is no middle way. The only way is a concerted fiscal action by governments with less reliance on market forces and run international trade on fresh principles.
“Bill Mitchell regularly says he’s in favour of fair trade, not free trade and he seems to have a fairly clear vision of an active industrial and labour policy. ”
I am afraid, there is a supreme misunderstanding here on global imbalances. Fair/Free is just a minor point. Australia receives more import invoices in USDs than AUDs. Every analysis starts with the story of foreigners coming in ships with goods and receiving AUDs. Its incorrect.
“To me, the idea behind the ‘deficits don’t matter’ and ‘imports are benefits’ mantra is not to actively indulge in or promote any of these – they are, after all …”
Current account deficits cause hemmorhage in the circular flow of national income. Neoclassicals do not really require balanced trade, they are confused in these matters. In fact neoclassicals had been arguing that it is not a problem and that market mechanisms can take care of it.
One has to be a serious demand-sider Keynesian to see the balance of payments constraint. Your accusations are funny, as I am generally opposed to laissez-faire ideas.
Craig Reply:
April 20th, 2011 at 4:46 am
Just do what we have always done – outsource all the low skilled labor and use public spending to subsidize capital intensive next-gen technology development. Socialize R&D costs and let the business privatize the profits from all the commerical spin off applications.
For a good book giving a broad outline of the public sector’s role in technology development read chapter 13 of George Friedman’s new book “The Next Decade”
He owns Stratfor, evidently the largest private intelligence company in the world –
http://en.wikipedia.org/wiki/Stratfor
http://books.google.com/books?id=y5plTzPTw8YC&pg=PA223&lpg=PA223&dq=%22the+technological+and+demographic+imbalance%22&source=bl&ots=z647m8eUJo&sig=F4mdXCYYCEpjX7OGkvsV9xn4RKs&hl=en&ei=DpuuTdmtI8Sbtwe33qXeAw&sa=X&oi=book_result&ct=result&resnum=1&ved=0CBcQ6AEwAA#v=onepage&q=%22the%20technological%20and%20demographic%20imbalance%22&f=false
Oliver Reply:
April 20th, 2011 at 4:48 am
No there is no middle way. The only way is a concerted fiscal action by governments with less reliance on market forces and run international trade on fresh principles.
A shock to one country can be a blessing to another, such as can be seen between the core European nations their peripheral partners at the moment. So there must be a way for unilateral action on behalf of the ‘victim’. Of course it helps if such action is accepted as ‘good practice’ by others in the sense that markets would react more calmly. And so it seems to me, MMT would work best in a world in which everyone understood its benefits.
Anyway, got to run. Regards
Roger Erickson Reply:
April 20th, 2011 at 10:38 am
Cue Connally. “It’s our currency, but your problem.”
Any country that doesn’t want to use $US is free to show enough initiative to be self-sufficient. That’s a problem of encouraging initiative & regulating fraud – same as here. Don’t mix separable causalities.
All floating Fx currencies are freely convertible, but only to other fiat currencies, which doesn’t give anyone any more direct leverage on hoarding real assets.
That’s like saying 4 field goals (in NFL points) are convertible to two touchdowns & missed point-after kicks. Neither one is convertible into a beer or hot dog at the concession stand.
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April 19th, 2011 at 5:30 pm
Tom – for all your thoughtful engagement with Ramanan, can you explain how he THINKS the US, or the UK (to get away from reserve ccy issues), can suffer a sovereign default or harmful ccy crisis as a result of the current account deficit?
I have long since given up trying to understand his comments – way too elusive and slippery. With his insistence on mentioning the (US-headquartered) IMF, don’t your troll alarm bells come on?
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Tom Hickey Reply:
April 19th, 2011 at 7:46 pm
Anders, Ramanan is a very smart person. He is not an economist by training and I take that as a plus in that he can bring a fresh viewpoint. So I am interested in the point he is trying to make. However, I cannot figure out what it is in simple English.
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Ramanan Reply:
April 20th, 2011 at 12:47 am
Anders I am presenting scenarios which if extrapolated would lead to unbelievable conclusions. If the US government left things to market forces alone, a current account imbalance of the scale that is seen implies that the public debt and the net external debt rises forever to abnormal values. In other words there are no “automatic stabilizers” for open economies.
It is possible that these numbers can go to 300% or something without a problem but I do not think it is likely.
The best way to think about this is how much can the current account deficit go … 20% … 30% ?
Now you can take two stands “not a problem” and “maybe problematic but unlikely”. In case you are open about the latter, start analyzing how 5% or 10% is good (if it is good) but 30% is bad.
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Neil Wilson Reply:
April 20th, 2011 at 6:08 am
R,
” Australia receives more import invoices in USDs than AUDs. Every analysis starts with the story of foreigners coming in ships with goods and receiving AUDs. Its incorrect.”
Isn’t that only an issue where the fx won’t swap the USD for AUD.
As long as the fx is functional it isn’t an issue since the exports in AUD cancel the imports in USD. You have effectively an FX swap.
Can you explain where you think the limit is. At what point can’t a country simply swap in the FX market.
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Ramanan Reply:
April 20th, 2011 at 6:56 am
The fx swap just exchanges one asset for another so Australia hasn’t really made anything out of this.
The swaps still have a rollover risk.
During the crisis, around Oct 2008, Australian banks had issues in the funding markets and the Fed did swap lines with the RBA and RBA did a back-to-back swap with Aussie banks.
Roger Erickson Reply:
April 20th, 2011 at 2:46 pm
> During the crisis, around Oct 2008, Australian banks had issues in the funding
> markets and the Fed did swap lines with the RBA and RBA did a back-to-back
> swap with Aussie banks.
Exactly, and in the process our FED totally manipulated the options available to one population, and encouraged the other population to remain unprepared – while conveniently entrenching their imagined position as indispensable to market function.
Shouldn’t have happened, should never have been necessary to even think of it. Both countries would have been better off using aggressive fiscal actions to stimulate innovation in novel directions.
Instead of adaptive indirection, we let blinked & let Luddite bankers try to stabilize an unstable world. Can’t get much dumber, or suicidal, than this.
Roger Erickson Reply:
April 20th, 2011 at 10:42 am
> I am presenting scenarios which if extrapolated would lead to unbelievable conclusions
so don’t bother extrapolating them beyond our predictive power (which is zero)
anything could theoretically happen, but all that matters is how we adjust to what actually occurs; we have no predictive power but seemingly infinite adaptive power, so restrict your predictions to adaptive routes you think we will actually pursue
seems to me that that’s what investing, personal or national, is all about
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Anders Reply:
April 20th, 2011 at 5:43 am
Ramanan – this seems the clearest you’ve put it that I can recall. Thanks.
1. How far can imbalances go?
First, I would reiterate that the NIIP is the locus of imbalance, ie the cumulation of (i) CADs, (ii) asset valuation and (iii) FX movements, rather than the CADs themselves.
I agree that there are no formal automatic stabilisers for a CAD or NIIP. But it feels like there are various ‘centrifugal forces’:
(i) China shifting over time towards spending rather than accumulating its dollar claims
(ii) shifts in valuation of US vs foreign assets as the US is regarded as a worse place to invest thanks to its appalling NIIP
(iii) shifts in FX rate, similar to (ii)
In short, I would reject your suggestion that market forces by themselves would lead to forever rising NIIP.
2. At what point do imbalances constitute a problem?
The main issue with an excessive NIIP is that the US (or UK) is enjoying an artificially high standard of living (with consumption being in excess of production), and as such would face a ‘shock’ to its standard of living in the event of a sudden shrinkage in the CAD. Countries have been fortunate enough to benefit from the higher standard of living historically; we should be prepared to deal with the ‘correction’ if it comes, but we should not try and hasten the correction.
Some allege a separate issue with an excess NIIP – that it could lead to a currency crisis or default. I still have not seen this fleshed out clearly; it seems to me that market reactions to excess NIIPs for monetarily sovereign issuers are fundamentally not destabilising.
Contrast what happens when the market first starts to correct (either bond prices or FX rate) in a sovereign vs non-sovereign issuer.
* For a non-monetarily sovereign issuer, the further the correction goes, the greater the potential risk of further capital loss, meaning there is a “rush for the exit” ie debt crisis and/or default
* For a monetarily sovereign issuer, the further the correction progresses, the lower the potential risk of further capital loss. As a result, the correction is ‘self-correcting’ – essentially benign.
I struggle to find this “problematic”.
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Ramanan Reply:
April 20th, 2011 at 6:28 am
“First, I would reiterate that the NIIP is the locus of imbalance, ie the cumulation of (i) CADs, (ii) asset valuation and (iii) FX movements, rather than the CADs themselves.”
Very true and I have gone into the details of this many times in my comments.
For example, it may be the case that a nation runs a current account deficit for 20 years and two things combined – currency adjustment and revaluations make this nation a creditor of the rest of the world instead of a debtor.
However, for a policy maker this does not give the license to run higher current account deficits.
“The main issue with an excessive NIIP is that the US (or UK) is enjoying an artificially high standard of living (with consumption being in excess of production)”
Your way of phrasing it. Current account deficits lead to higher unemployment. It is senseless to support one’s argument saying that there is some apparent improvement in the standard of living by consuming useless cheap products…. Breads and Circuses of Imperial Rome … as Nicholas Kaldor would put it…
“Some allege a separate issue with an excess NIIP – that it could lead to a currency crisis or default. ”
Unless you take an empathetic approach to read policy makers’ minds you will fail to see what the problem is. The approach “deficit spend without worry” doesn’t work! The Keynesians completely failed to see this in the 70s.
Here is what Francis Cripps said in 1983:
The conclusion which has to be drawn is that, if a modern economic system is to function properly, a mechanism is required for the management of aggregate demand. Now it happens that the need for management of aggregate demand within a closed national economy can be met rather easily. It is easily met because national economies have an institution called the state which is unique in that it has virtually unlimited powers of credit creation or borrowing (or would have within a closed national economy). Keynesians gave up at this point, thinking that once the need for demand management had been pointed out, and the possibility for demand management by a national government had been understood, the problem of demand management was solved once and for all. Unfortunately, there is no such thing as the state in the contemporary international economy at the international level and the absence of the state as such at the international level is, I believe, a sufficient explanation of why the world economy has run into serious problems of recession….
… The important point is rather that in an international economy the possibilities of national demand management are strictly limited. They are limited by problems or balance or payments adjustment and international finance. Governments that wish to regulate national demand so as to sustain full employment run into problems of increasing trade deficits and, in economics with liberal exchange regimes, loss or confidence and outflows of capital. It is actual or potential balance of payments crises which have been decisive in breaking the habit or Keynesian demand management at the national level. Many national governments are still trying but they are trying under difficulties and they are frightened of balance of payments problems that would result if they tried too hard.
Sorry to be repetitive, but its the reaction to repetition of phrases such as “imports are benefits” (Its an incomplete sentence).
“shifts in valuation of US vs foreign assets as the US is regarded as a worse place to invest thanks to its appalling NIIP”
China can sell goods in the UK and purchase US Treasuries. China exporting to the UK has nothing to do with UK Gilts. Similarly even if China wanted to accumulate other reserve assets such as Euro-denominated debt, it can continue to export to the US.
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Anders Reply:
April 20th, 2011 at 7:20 am
Ramanan
“Current account deficits lead to higher unemployment”: out of context this carries some plausibility, but the whole context here is a CAD being a by-product of an MMT approach designed among other things to fix unemployment via a JG.
Question to you: do you think Francis Cripps, when he was talking about balance of payments crises, was aware/focused on the distinction between a monetarily sovereign and a monetarily non-sovereign issuer?
Matt Franko Reply:
April 20th, 2011 at 8:25 am
Ramanan,
Is it like without tariffs, there is no “automatic” stabilizers for the external balance?
All of this “free trade” stuff prevents the establishment of “automatic” stabilizers in the external sector?
Automatic stabilizers are really only “automatic” after some sort of fiscal law is put in place to facilitate either an increase in govt spending (unemployment insurance/medicaid both established by law) or when the recovery starts a increase in tax (again laws) collections as people get back to being employed…. these ‘automatic’ stabilizers depend on first being established thru law.
This “free trade” stuff has got to go imo….
Resp,
ESM Reply:
April 20th, 2011 at 10:33 am
Matt,
The automatic stabilizer is the FX rate, although Warren would say that the FX rate simply expresses an indifference level for foreigners thinking about saving dollars or purchasing US goods and services.
If a foreign saver in dollars thinks he has enough or is worried that the dollar is too high relative to fundamentals, then he will sell some dollars to somebody else at the prevailing FX rate. Presumably the buyer either thinks the dollar is a fine investment or else he wants to buy some US goods and services. As these transactions occur, you get dollars into the hands of people who either want to buy US goods and services or want to own dollars for some other reason at whatever the prevailing FX rate is. If there are more motivated sellers than buyers, then the FX rate goes down, which then has the effect of making the dollar look more attractive as an investment and US goods and services look cheaper.
This is why having a floating exchange rate (i.e. a free market in your own currency) is more stable than having a fixed one (whether fixed vs gold or fixed vs another currency). At any given moment, the FX rate is at an equilibrium clearing level.
Oliver Reply:
April 20th, 2011 at 10:45 am
Automatic, external stabilizers. I like that.
Roger Erickson Reply:
April 20th, 2011 at 10:54 am
> Unfortunately, there is no such thing as the state in the contemporary
> international economy
This is the whole point. As populations & complexity scale up, if we don’t responsibly ACT like independent states, we’ll have problems. It really is that simple.
Warren says to recognize duty to national Aggregate Demand, not the world’s.
Bill Black says to adequately regulate NATIONALLY DEFINED fraud, regardless of whether innocent/ignorant/willful.
From a systems view, the moment of adaptation in our global adaptive race is still between nation states. Until more nations actually fuse politically, the only responsible thing to do is to improve internal alignment to maximize national aggregate demand. If all electorates simply took 1% more responsibility for running their own countries there would be earthshaking improvement.
That’s a hard enough task to tackle, instead of trying to improve everyone else’s house in addition to your own. The way any complex system is tuned is for all components to simultaneously stay within all their local tolerance limits. Only way to ever scale that up worldwide is to first practice it at national scales. Simultaneously tuning one piston each in 160 different cars gets you nothing but crap.
Ramanan Reply:
April 20th, 2011 at 10:54 am
Anders,
Cripps is the coauthor of a 1983 textbook called Marcoeconomics which clearly shows balance sheets and transaction flows between the Govt/CB, Banks, Private, Foreign sectors. Its the first text to do that and hosts of other things such as stock-flow consistency.
However, sovereignty is a not just the power to take a draft at the central bank. It has to do with all sorts of international treaties involving the IMF/WTO/GATT.
Ramanan Reply:
April 20th, 2011 at 11:00 am
“At any given moment, the FX rate is at an equilibrium clearing level.”
With the stocks of debt rising or falling, the state can hardly be called “equilibrium”.
The clearing is between financial assets, not goods and services. A fall in the goods price has some effect on foreign purchases/sales but this description of exports/imports in neoclassical. This is just price elasticity effect. Post Keynesians on the other hand point out the income elasticity effects.
Roger Erickson Reply:
April 20th, 2011 at 11:02 am
To me at least, it seems that all attempts by banking cartels to manipulate Fx rates ends up fighting the very purpose of letting them float in the first place.
Letting unemployment float in order to support trade or currency flows is about as ass-backwards as you can get, and constitutes treason to nation.
I agree with Warrren that if bankers just stuck to banking instead of trying to influence portfolio “value” through national lobbying, then everything would get a whole lot simpler very quickly. The confluence I see is failure to separate the owners of banks from the banking process. If Warren & Bill Black could work in coordinated unison, I imagine we’d see faster progress in recruiting national alignment to their combined cause.
Every problem in managing human affairs is dominated by human nature itself, not the context or domain they’re working in.
Ramanan Reply:
April 20th, 2011 at 11:04 am
Matt,
To some extent one can take measures to promote consumption of domestically produced goods than imports via tariffs but the argument is that it would featherbed the local producers :-)
So the free marketeers know how to present various arguments, though I tend to somewhat agree with such arguments. But only somewhat.
Anders Reply:
April 20th, 2011 at 11:13 am
Ramanan – for all Cripps’ understanding of stock-flow consistency, it’s not obvious from your response that he appreciated the importance of monetary sovereignty.
It seems that, when pressed, your assertion that the US or the UK could suffer a balance of payments crisis is ultimately founded on international treaties alone.
I would be interested if anyone else reading this believed that the US could be pushed into a balance of payments crisis by the IMF.
Roger Erickson Reply:
April 20th, 2011 at 11:21 am
> However, sovereignty is a not just the power to take a draft at the central bank.
> It has to do with all sorts of international treaties involving the IMF/WTO/GATT.
All those treaties work against efficient regulation of national economies, as time has shown. They’re basically – at best – innocent frauds, foisted by bankowner lobbies and their consistent flaw is that they undermine the resiliency of local economies in a rush to sequester low-hanging fruit by concentrating financial capital.
The methodology of financializing capital has exceeded it’s utility, and is now self destructive to the issuing populations. Capital concentration will soon be trumped by distributed aggregate-demand decisions. Financial concentration simply cannot scale up the distributed agility required by the product of scaling population_X_economy. Owning a bank as a wealth center is becoming a dead albatross, attracting only vultures.
Ramanan Reply:
April 20th, 2011 at 11:38 am
Anders,
That is just a statement “importance of sovereignty” …
Nobody here seems to understand sovereignty .. the IMF knows better … http://www.imf.org/external/np/leg/sem/2004/cdmfl/eng/gianvi.pdf
By becoming members of the Fund, they have accepted these obligations and, to that extent, limited their monetary sovereignty. In exchange they have received certain benefits. One of them is that other members too have agreed to limit their sovereignty for the sake of international cooperation and for the common good of all. Another benefit is that in times of crisis they will have access to financial assistance from the Fund if they meet the required conditions.
As most countries are now members of the Fund, it may be said that full monetary sovereignty exists only in those few countries that are not members of the Fund. In addition to being members of the Fund, some countries are members of regional monetary unions that have limited their monetary sovereignty even beyond the limitations imposed by the Fund’s Articles. For instance, in the European Monetary Union a common currency has replaced the national currencies. Similarly, the West African and the Central African Monetary Unions have their respective common currencies; the member states do not issue separate currencies. These African Unions are even more integrated than the European Monetary Union; for example, they have no national central banks and they have a common system of exchange controls for their financial relations with countries outside each Union. Accordingly, there are today different levels of monetary sovereignty.
“It seems that, when pressed, your assertion that the US or the UK could suffer a balance of payments crisis is ultimately founded on international treaties alone.”
Not at all … my assertion is a counterassertion to the point that currencies are not convertible.
I am talking of the present international setup as opposed to some hypothetical setups…
I have written this at many places to the point that people start pointing out stop writing or something of that sort.
“I would be interested if anyone else reading this believed that the US could be pushed into a balance of payments crisis by the IMF.”
The US is already in it though can’t be called a crisis in that sense – an increase in demand will lead to leakage of demand via current account deficits.
Imagine no foreign sector. A fiscal expansion leads to higher income and higher purchases of domestic products (since there are no foreign products) .. this increases demand further and more consumption and is captured by the fiscal multiplier. In the presence of the external sector, this multiplier is reduced quite a bit, since the US income elasticity for imports is high.
Increase the stimulus further and there is an even higher leakage….
WARREN MOSLER Reply:
April 20th, 2011 at 12:17 pm
I haven’t noticed potential forced convertibility via IMF decree influencing policy lately.
You’d think there might be a headline or two about China threatening to convert all its dollars to yuan tomorrow at noon’s cash price or something like that?
I’ll keep an eye out for it…
Tom Hickey Reply:
April 20th, 2011 at 1:11 pm
Well, I guess we have a test going on right now with the USD crashing, and the gold bugs are going nuts.
I’m betting on the USG (the world’s largest economy and sole superpower).
Ramanan Reply:
April 20th, 2011 at 2:54 pm
You’d think there might be a headline or two about China threatening to convert all its dollars to yuan tomorrow at noon’s cash price or something like that?
I’ll keep an eye out for it…
The option to do that gives China sufficient powers. China will continue to accumulate US dollars and become a greater creditor of the United States.
US-China is special case and cannot be used to extrapolate arguments to other bilateral relations. Most other nations can simply be asked to make the conversion and simply cannot go anyway near what the US has managed to do.
Back to China, no, it won’t dump the US Treasuries either.
.. but we are heading into the territory “I am immortal” … the only way the US can prevent going into that trap is by taking serious steps to address its current account problem.
At any rate, there is nothing preventing the possibility of a slow redemption of dollars to own currency … not necessary to demand immediate conversion of all official balances.
It won’t happen now because the dollar continues to enjoy the “Exhorbitant Privilege” of being the reserve currency of the world but there is no specific reason for this to continue till eternity.
Convertibility also makes clear what “money” is … and who the creditor is and who the debtor is. Straightforward double entry bookkeeping.
WARREN MOSLER Reply:
April 21st, 2011 at 7:06 am
let me suggest that china is fully aware that any attempt to ‘demand immediate conversion of all official balances’ as per an IMF clause would be met much the same way the French demand for gold was met in 1971- ‘sorry, window closed’- and the international gold convertibility guarantee was much stronger/commonly assumed vs the nearly unknown IMF clause you have quoted.
Anders Reply:
April 21st, 2011 at 4:48 am
Ramanan – you have indeed asserted often that currencies are convertible because of treaties, but I just don’t see how the IMF forces convertibility in practice for the US or the UK. Can you spell out how this would happen?
You say “China…won’t dump US Treasurys” but then you say “the only way the US can prevent going into that trap”…WHAT trap?
Neil Wilson Reply:
April 21st, 2011 at 5:44 am
Anders,
I think the IMF have hired Ramanan – who will beat the US and UK into submission by constantly quoting the rules at them and refusing to entertain any suggestion that they might get changed.
Roger Erickson Reply:
April 20th, 2011 at 2:55 pm
> The approach “deficit spend without worry” doesn’t work!
That is incontrovertibly equivalent to saying “refusing to limit public initiative doesn’t work.”
As such, it’s a self-defined oxymoron.
Governments lacking imagination are always fearful to explore adaptive innovations. You’d better get over it, quick. The nuanced explanation is that activity has to be ramped up first, and shaped to adaptive profile second. In practice, initiative & exertion is never limiting. Selection kinetics is limiting, and you can’t select without first generating options! This is so trivial it’s right out of the reverse-entropy of physics and the theory of evolution. Those are both over 100 years old, and presented in every secondary school worldwide.
The solution to any seemingly intractable problem in either physics, biology or software programming is always available, and when it appears it will involve another level of indirection.
There’s no future in projecting from current limitations.
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Tom Hickey Reply:
April 20th, 2011 at 3:22 pm
Ramanan, you are seeing something I am not. From what I can tell from reading Michael Pettis, it is China who has the problem rather than the US. China is hooked into an export model that it cannot extricate itself from and is completely dependent on the US to take its stuff — which the US is willing to do at cheaper and cheaper real cost (dollar depreciation) as China maintains its peg. The US can end this at anytime it wants in a variety of ways that would beggar China. The reason this is not happening is because the US multinationals are happy with the present arrangement. If they would become unhappy for some reason, like rising wages in China, game over and on to Indonesia or somewhere. There is no way that China has any leverage at all over the US. And it’s China that is complaining now, not the US. The US seems to be fine with its real terms of trade and using cheap Chinese labor instead of more expensive US labor.
Ramanan Reply:
April 20th, 2011 at 3:39 pm
“it is China who has the problem rather than the US. ”
Yes China has poverty but US unemployment is 9.2% ?
“The US seems to be fine with its real terms of trade and using cheap Chinese labor instead of more expensive US labor.”
Terms of Trade argument ~ Breads and Circuses of Imperial Rome
“fine” ?
Seasonally not adjusted unemployment rate ~ 9.2% in March 2011 http://bls.gov/news.release/pdf/empsit.pdf
“And it’s China that is complaining now, not the US.”
Which world do you live in ?
Tom Hickey Reply:
April 20th, 2011 at 3:56 pm
The US elite seems to be fine with a “new normal” of 10%. No one in DC is even mentioning it anymore. The official neoliberal line is that there is no unemployment. It is just a lot of lazy people who don’t want work and other who prefer leisure now. In fact, the push is to fire more public workers since they are obviously just overpaid boondogglers. Welcome to the US.
Matt Franko Reply:
April 20th, 2011 at 4:11 pm
Tom,
Just got back from a short family trip to Williamsburg, VA area. Went one day to Busch Gardens (amusement park, havent been there in 5 years), I believe recently bought out by the Peterson people at Blackstone from InBev who bought out BUD, etc… Chinese SWF made $3Bil investment in Blackstone some time back…
I guess youth unemployment in the Tidewater, VA area is nil, as now the Peterson people have young Chinese persons who cannot speak English running some of the amusement games and many other jobs in the park (it’s like an old “James Bond” movie)…. I assume they are here of their own free will…. perhaps they are here to learn the amusement industry from the ground up, or it is another USD grab by some Chinese employment agencies… somewhat disturbing to see..
If I were the US Congressman from that area I’d want to look into it… strange days indeed. Resp,
April 20th, 2011 at 8:35 am
Hello. I had a ‘smart’ question given to me regarding the technical impossiblity for a currency issuer to default, when he is in indebted in its own currency.
“Why did Russia default on its GKO in 1998′?
Any help there, because I cannot find (and I did some serious research on the topic) the reason why they did devaluate AND defaulted on rubles denominated debt…
Many thanks for your view on this!
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Anders Reply:
April 20th, 2011 at 9:35 am
It’s a good question, b/c AFAIK the ruble default is literally the only peacetime default on a sovereign obligation.
Russia certainly didn’t need to default. It was on a dirty peg to the USD and misguidedly felt that defending the peg was more important than honouring its debt obligations – and as such it ran out of foreign currency reserves. Of course the RUR ended up devaluing by 75%(?) anyway.
Also politics – don’t forget this was Boris Yeltsin, who was somewhat opaque in his decision-making.
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The Thaler's Corner Reply:
April 20th, 2011 at 9:58 am
From what i found, itr seems that the CB had traded forward otc contracts with foreigners who bought gko and wanted to hedge currency risk. So the CB could not honour these OTC contracts when it had to abandon the peg (no more foreign reserves). And decided to default on everything then. On top of that, the russian banking system had a significant indebtness in foreign currencies, so had to default too. And there is this issue of GKO swapped with wall street help earlier on in longer terms eurobonds…
that does not explain anyway why they did default on rubles-gko, they could have paidd them in currency. Except if the 1995 FMI rule that the Treasury coudl not tap the CB for cash was paramount?
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Roger Erickson Reply:
April 20th, 2011 at 11:06 am
that question’s been answered at least a dozen times here by Warren;
search through the last 6 months of entries or send an email to Warren
or just Google it; it’s a trivial faq entry by now (answer was that it was institutional collapse, not fiscal; people just walked away from diverse offices in all domains, and the country just dissolved & broke up; that’s voluntary)
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Craig Reply:
April 20th, 2011 at 1:39 pm
here it is – http://moslereconomics.com/2010/06/20/professor-bill-mitchell-on-inflation/
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The Thaler's Corner Reply:
April 21st, 2011 at 9:48 am
@ roger
thanks for your answer. Unfortunately, there not seems to be any special quote from warren about his in archives for the last 2 years, about ‘russia’ or ‘gko’.
Anyway, I had a chat with him and a few other guys, and read about 500 pages of dcouments on this russian defautl for the last week…
And nobody is able to give a credible explanation as to why they decided to default on their rubles denominated GKO once their devaluation was achieved. On top of that they did honour their dollar eurobonds finmin !!!
Incomprehensible.
If anybody can give me some lights.
Thanks.
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MamMoTh Reply:
April 21st, 2011 at 10:34 am
Could one reason be to reign in inflation?
I think Warren mentioned the interest rate on GKOs being 150% at the time of the collapse.
WARREN MOSLER Reply:
April 21st, 2011 at 4:17 pm
exchange rate policy and full employment
roger erickson Reply:
April 22nd, 2011 at 4:27 am
context in Russia was still post soviet, chronicled here
http://en.wikipedia.org/wiki/1998_Russian_financial_crisis
& here
http://en.wikipedia.org/wiki/History_of_the_Soviet_Union_(1982%E2%80%931991)#Unintended_consequences
truly amazing transitions; it could easily have involved mass starvation & violent bloodshed on a 10x scale
this is the telling entry;
“It is estimated that between October 1, 1997 and August 17, 1998, the [Russian] Central Bank expended approximately $27 billion of its U.S. dollar reserves to maintain the floating peg.
It was later revealed that about $5 billion of the international loans provided by the World Bank and International Monetary Fund were stolen upon the funds’ arrival in Russia on the eve of the meltdown.”
Who was benefiting from the original exchange rate and why was it necessary? There were easier options.
Sounds like plutocrats were in charge, trying vainly to protect their own narrow interests, and were dragged kicking & screaming to awareness of how to have both their own interests plus a functioning platform where their interests could eat.
That was the real Russian Awakening. The Russian mob got an education?
Could have been a LOT worse.
April 20th, 2011 at 9:40 am
Even if Joe the plumber understands mmt, he will still equate the government deficit as “printing money” and therefor inflationary. The argument has to address that point to convince the average American or else you all are a bunch of intelectuauls hypothesizing.
Secondly, hadden’s memo illustrates that the serious players on wall street understand mmt and trade off it just like the commodity traders understand the oil market and trade against it, driving the cost of gasoline up to a three high when demand is flat.
The American public’s ignorance on such matters is flat out depressing as we have the power to change this for the better but we are all fooled by smoke and mirrors. We are busy blaming political parties for the deficit and OPEC for the rise in gas prices. :(
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Roger Erickson Reply:
April 20th, 2011 at 11:09 am
Agreed.
1st, It’s not being explained in simple terms to Joe Sixpack.
2nd, traders are going to trade right down to the instance when the ship goes down. There’s an appalling lack of patriotism, common sense, and civic responsibility among “serious players on Wall St”, which makes them as much of a problem as any Deficit Owl, Deficit Hawk, or other innocent fraud.
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john f Reply:
April 20th, 2011 at 3:32 pm
Roger, I agree with your point that this needs to be explained in Joe Sixpack terms. MMT’ers should write a e-mail chain letter something in this style for example,http://www.abovetopsecret.com/forum/thread544407/pg1, to explain MMT principles.
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Craig Reply:
April 20th, 2011 at 11:57 am
your right paul. “printing money” is always followed up with inflation.
maybe a rebuttal could be – Printing money is inflationary when spending exceeds productive capacities (demand pull inflation). However, the inflation risk we are seeing today is from rising petroleum costs similar to the 80′s (cost push inflation) not from too much spending (ie printing money).
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April 20th, 2011 at 10:03 am
Just wanted to point out that David Zervos at Jefferies & Co is another guy who understands this stuff pretty well. I’ve never seen him mention MMT per se, but he understands monetary and fiscal operations.
He wrote today “I would file this latest S&P report in the same bin as the Abacus 2007-AC17 report showing a ‘AAA’ rating, and the Lehman report that had a ‘A’ rating the day before bankruptcy.”
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April 20th, 2011 at 12:23 pm
Ezra Klein has a post that references a post by Jon Bernstein about whether voters understand deficit (I cannot access this last one from work):
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Craig Reply:
April 20th, 2011 at 1:00 pm
yeah i saw that and based on his interview with galbraith and his last few posts he doesn’t seem to get it either.
can he talk any more out of both sides of his mouth “I think Bernstein is probably both wrong and right: My hunch is voters have a basic idea of what the deficit is, but a very wrongheaded idea of when and how it affects them.” enlighten us ezra…what do you think it means?
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April 20th, 2011 at 1:36 pm
Ramanan: The only way is a concerted fiscal action by governments with less reliance on market forces and run international trade on fresh principles.
Agreed. “It’s the demand, stupid.”
Neoliberalism is preoccupied with saving (financial investment) that makes the wealthy wealthier.
The focus needs to be on distributing demand instead, and that requires a shift in share distribution.
Late-stage capitalism is failing owing to rent-seeking eclipsing production, since rent accumulates at the top and crimps income in the middle and bottom, forcing either reduced demand/rising unemployment, or greater indebtedness to maintain lifestyle. Greater indebtedness in the middle and at the bottom means more rent at the top. As Michael Hudson observes, this is the road to serfdom aka debt peonage. “I owe my soul to the company store.”
Add to this global labor arbitrage, and incomes in the middle and at the bottom are suppressed toward subsistence wages. The global elite aim to allow just enough distributed income to keep the rent game going and prevent unrest, although their preference for low tolerance for error make this dicey.
Neoliberalism is based on free markets, free trade, and free capital flows. These are all integral in state and international capture by a global elite. Without revising this framework by replacing “free” with “fair,” the game will go on.
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