Why the EU won’t fix anything this weekend

Yes, the Germans are concerned that ECB bond buying and direct funding might be inflationary,
but there is something even more fundamental supporting their to objection to ECB support.

The problem is,
the EU leaders believe the high rates, failed auctions, and related funding and liquidity issues
are caused by the national government budget deficits being too high.

And therefore the fundamental solution is deficit reduction.
That is, only by reducing deficits,
will the ability to independently fund return to where it was before the 2008 financial crisis hit.

So while they recognize that ECB funding can keep them muddling through,
though with some perceived inflation risk,
they firmly believe it is deficit reduction that will allow them to return to pre 2008 funding dynamics,
where each member nation could independently fund itself in the market place at reasonable rates.

Unfortunately, that’s a bit like saying that by adjusting his financial ratios,
Bernie Madoff’s fund could return to pre crisis business as usual.

And just like Bernie could only be back in business if somehow he got
the Fed to guarantee his investors against loss,
the way I see it (but, unfortunately, not the way they see it),
the euro member nations now require ECB backing, directly or indirectly,
to be back in business.

As previously discussed, spending and deficits for currency issuers like the US, Japan, UK,
and the euro members when they had their own currencies are not constrained by income or
market forces. Observed debt to GDP levels for currency issuers can be anywhere from
50% to maybe 200%, as they serve to provide the net financial assets demanded by the
various institutional structures of those nations. And regardless of debt ratios, interest rates
are necessarily set by the Central Banks, and not market forces.

Spending and deficits for currency users, including the US states, businesses, households, and the euro member nations since
adopting the euro, are, however, necessarily constrained by income and market forces.
That’s why observed deficits for currency users are far lower than currency issuers.
California, for example, has seen its financing difficulties even though it’s debt to GDP ratio is under 5%.

Luxembourg’s debt to GDP ratio of about 15% when it adopted the euro was by far the lowest of the euro member nations.
And that’s because Luxembourg never did have it’s own currency. It was always a currency user,
and so market forces never let it’s debt get any higher than that. And even with the current financial crisis
Luxembourg’s debt is only about 20% of GDP.

So what happened about 13 lucky years ago is that the currency issuers of mainland Europe decided to turn themselves into currency users.
And at the same time, now as currency users rather than currency issuers,
simply waltz into the euro zone with their suddenly/absurdly too high existing debt ratios they incurred as currency issuers.

The ‘right’ way to do it back then would have been to have the ECB guarantee their debt from the inception of the euro,
and use the Growth and Stability Pact to avoid moral hazard issues and enforce compliance.
But that would not have worked politically.
The only way they would all come together is the way they did all come together.
The priority was union first, and work out subsequent problems as needed.

So now they have two problems-
a solvency problem where they can’t fund themselves without ECB support,
and a bad economy, now further deteriorating as evidenced by negative growth and rising unemployment.

And while the Germans aren’t entirely wrong in their belief that lower deficits would restore funding capacity,
I don’t think they recognize that as currency users debt to GDP ratios may need to be under 30% to get to that point.

Nor do they recognize that given current private sector credit conditions, deficits and debt ratios need to be higher
to offset the demand leakages (unspent income) inherent in their institutional structures. These include pension contributions,
insurance reserves, corporate reserves, individual retirement plans, and the demand for actual cash in circulation.
This means that what they call austerity- pro active tax increases and spending cuts- will slow the economy and therefore cause
tax revenue to fall and transfer payments to rise to the point where deficits increase rather than decrease.
The only remaining hope for growth is exports, but with all the world doing much the same that channel is not currently open.

So back to the present.

(And yes, without the 2008 financial crisis all of this may not yet have happened.
But it all did happen, and here we are.)

The firm belief is that deficit reduction is what is needed to return to independent funding.
And while funding by the ECB can allow things to muddle through, and hopefully not prove inflationary,
there is no exit from ECB funding and the inherent inflation risk it carries apart from deficit reduction.

Therefore I expect the upcoming discussions to focus entirely around deficit reduction, with little if any discussion of funding.
And, as is currently the case, funding assistance will only come conditionally with accelerated austerity.

That is, all options on the table will only cause a bad economy to get worse.
And all options on the table will tend to drive deficits higher,
which both makes matters worse, and,
as recent history has shown,
triggers demands for more austerity.

The chart, below, shows how the financial crisis of 2008 caused what seemed to be working just fine on the way up
to come apart when private sector credit expansion faltered, and the economy took a dive, driving up national government
debt to GDP ratios, and causing it all to go bad in typical ponzi fashion.

eu debt gdp

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81 Responses to Why the EU won’t fix anything this weekend

  1. Gary says:

    If Europeans agree on the austerity, then ECB should be able step in and buy the bonds until the rates are reasonable (or until they get scared by the sums and discontinue buying). If ECB will buy enough – governments should be able to acquire enough funding at reasonable rates. Also – banks and other investors should be relieved and there should be less fear in the news. Although – since deficits are limited, the interest payments on the debt will increasingly weight more on them.
    Then everything will be up to how much they adhere to austerity… The less – the better for the economy. However, the level of austerity will be determined by protests and “blood in the street”.

    Reply

  2. Ron T says:

    They should take a hint from US: debt as high as Greece and happily selling 4-week bonds offering ZERO in interest. Zero!
    8x as many buyers as bonds for sale, why, oh why???

    http://mikenormaneconomics.blogspot.com/2011/12/phony-debt-crisis.html

    Reply

  3. Paul Palmer says:

    I wonder what the debt/GDP of the old Soviet Union was.

    Reply

    Gary Reply:

    @Paul Palmer,

    it was a different kind of economy. There was no debt. Neither private nor government. Wages were determined by government, prices as well. There were basic items in the stores – but they were produced according to “plan” and not demand. It was economy dictated by supply and not demand. Since it was difficult to find anything nicer in the stores – people were “appropriating” produce from their workplaces and then using it either as gifts, bribes or were selling it on black market (which was illegal). So it mattered a lot what items the workplace produced and whether it was possible to attain a position in the workplace where “appropriation” (stealing) was possible.
    In any case – the necessities were cheap and available to everyone, and debt was pretty much unknown.

    Reply

  4. wh10 says:

    Sorry Warren, the analogy is a bit unclear in how it relates to the state of US monetary operations. Are you saying holding your hand behind your back is like the self-imposed constraints, and getting hurt is default? Because as I see it we rly haven’t held our hands behind our back as long as the Fed is willing to set prices if it ever needs to. Of course, if Congress prevents the Fed from doing that, then we’ll be at the mercy of the market like the EZ and have held our hands.

    Another way of looking at is, does the mkt view the US as riskfree bc they think Congress will allow the Tsy direct access to the Fed or bc they think the central bank can run its “printing presses” in the secondary mkt? I’d say they think the latter is more likely, which is why I like the “defense of interest rates” story more than the “govt spends first story,” though I suppose it effectively doesn’t matter, and I recognize it’s all up to Congress anyways. @wh10,

    Reply

    WARREN MOSLER Reply:

    right, markets seem to realize Congress is the boss of the tsy and the fed and therefore isn’t revenue constrained.

    also, reserves and tsy secs are both govt liabilities, etc.

    Reply

    wh10 Reply:

    @WARREN MOSLER,

    Got it. Thanks for your time.

    Reply

  5. jonf says:

    So if appears that a currency user will have to stay under 30% debt to GDP to be in a safe zone while a currency issuer can go up to 200%. That is an interesting comparison. Sooner or later everyone runs afoul of the bond vigilantes who can cut off your options. Beware the limit.

    Reply

    wh10 Reply:

    False. He is just saying 200 is the highest observed. The risk is inflation or worse hyperinflation. @jonf,

    Reply

    jonf Reply:

    @wh10,

    But we now have an inconsistency. It is said that taxes function to regulate demand. If there is a supposed limit of debt to GDP of 200%, then taxes also function to raise revenue and bring down the debt. That is debt may be unsustainable. Could it be that Germany got it right or is the 200% mularky? Or are we unsure and just saying “mind the limit there”.

    Reply

    wh10 Reply:

    @jonf,

    You are misreading Warren. He is not saying 200% is the limit. There is no theoretical limit. He is saying the highest observed in monetarily sovereign countries is 200%, which is Japan’s, and they have no problem. They could exceed this. The issue remains just inflation and at worst hyperinflation, but not formal default.

    WARREN MOSLER Reply:

    there is no nominal limit. See ‘the 7 deadly innocent frauds of economic policy’ on this website

  6. PG says:

    Sovereign currency issuers have no debt: their bonds are saving certificates on the currency. The ratio of savings to GDP has no special meaning except for the interest paid to bondholders.

    17 sovereign currency issuers jointly decided to downgrade themselves as users of a currency they enforce but do not control. Debt exists for currency users, wrong words are used to denote things, so it is not to admire that the once happy people with 17 national currencies are in a quagmire of debt and their creditors are concerned and stressed.

    The most promising solution for debts being repaid is for the economies of the EZ to grow and for this they must change to another monetary arrangement. Anyone who thinks that countries in the EZ can use the same currency in a win/win situation would have better to assess own judgment or emigrate to Fantasy Land.

    Unwinding the EZ so that renewed national currencies will enable national economies grow maximally is the best hope for creditors. The first basic principle is that any country is liable for its public and private debt. The second principle is that terms of discharging the liabilities are to be agreed on a viable basis for each case.

    The notional unit for counting out-EZ liabilities for each country would be the EUR value at the date of departure, EUR_DD. Public debt would be turned into the more safe savings into the national currency valued at the inverse rate of the renewed currency. This would damp national currencies depreciation and would reward countries with currency appreciation, without impairing the capability of governments for net spending the necessary to get economies growing again.

    The question here is how one determines the real value to be repaid of nominal debt denominated in EUR.

    Reply

    jonf Reply:

    @PG,

    Wait, I thought there was a practical limit of debt for currency issuers? How do we get from that to “no debt”?

    Reply

    PG Reply:

    @jonf,

    Think of yourself as a fiat currency issuer.

    Can you imagine being in debt in your own currency?

    How can you owe to somebody something that you are the only one to produce and you can produce in unlimited quantities??

    What is the operational meaning for you of borrowing in your currency? You mark some bits of someone in a computer as interest receiving bits, on the condition that that those bits are not spent unto you cease to pay interest at a pre-agreed time in the future. This for me is a description of offering a saving deposit.

    Being a fiat currency issuer you cannot borrow in your currency even if you want to :-)

    Or, for the matter, can you imagine to save in your own currency? :-)

    b) You go to the computer, you mark up an account and you tell yourself: these are my savings, I’m going to keep them for a rainy day.

    Or, what be a rendition more in accord with MSM economics: you begin by destroying / extracting money out of the private sector by running negative government net spending or a private deficit (more taxes paid than money received from government). You go to the computer and you can go for b) above by marking up the account on the exact amount of money destroyed.

    As an alternative, you can “pay” some “debt” by marking savers accounts as normal deposit accounts on the exact amount of money destroyed. In this way, it is possible – but not guaranteed – that they put back the money in the economy by spending it.

    Being a fiat currency issuer you cannot save in your currency even if you want to :-)

    But you can very easily make currency users save or disave in the currency.

    Reply

    Neil Wilson Reply:

    @PG,

    Or if you can’t get your head around that, simply imagine that you own (or can direct and receive the income from) a bank.

    If you owned a bank, why would you borrow from anywhere else? Anything the bank charges you in interest comes back to you as a bank dividend. The cost of money to you is effectively zero.

    If you were in that situation you would just borrow from your bank.

    So why should the government be any different?

    WARREN MOSLER Reply:

    yes, that too!

    WARREN MOSLER Reply:

    good thoughts!

    wh10 Reply:

    @PG,

    Neil, nice!

    Djp Reply:

    @PG,

    @Neil

    Can I hire your banking staff for some odd jobs?
    They evidently have very low wages.
    ;)

    Neil Wilson Reply:

    @DJP,

    Or the bank lends very, very large amounts of money.

    ;)

    beowulf Reply:

    @PG,
    Or your loan officers are robots.

    In an office in St John’s Wood in London, not far from Lord’s Cricket Ground, samedaycash.co.uk was about to spring to life. Within ten minutes of the site going live, a customer logged on an took out a loan for around £100. With just a £50 investment in Google Adwords, samedaycash.co.uk had attracted its first customer. And without ever realising it, that person had just become the net’s first recipient of a fully automated loan: no human had approved the transaction.
    http://www.wired.co.uk/magazine/archive/2011/06/features/wonga?page=all

    Djp Reply:

    @PG,

    @Neil
    http://www.hulu.com/watch/4253/saturday-night-live-first-citywide-change-bank-2

    @Beowulf
    Interesting!

    Hepionkeppi Reply:

    @PG,

    What the government really wants is to transfer some resources – real resources – from those who have tax liabilities to those who receive government’s payments.

    Those who have tax liabilities are in this sense indebted to those who have/receive government’s money. Debtor is not the actual government itself, in this sense.

  7. Walter says:

    Warren,

    I think they know that current high rates are not just because of too high deficits:

    1. they are well aware of the damage from the Greek haircuts. See your post of Dec 5 about Maria Fekter’s (austr minfin) comments.

    I fully agree with you that saying that GR was an exception is not enough to restore confidence. Looks like mkts now demand explicit ecb backing. Something that no currency issuer even does. Not even Jap that openly discussed last winter whether BoJ should underwrite govt bonds.

    2. they also see that UK, US and Jap have higher deficit and debt ratios, but somehow lower interest rates.

    It is amazing to see how Germany each time gets away with stating that eurobonds would be bad for Germany and only good for others because the yield will always be higher than Germany’s. Kind of weighted average of the member states’ current yields.
    But somehow nobody of the member states stands up.
    Let’s call this the first German innocent fraud.

    With regards to your remark ‘I don’t think they recognize that as currency users debt to gdp ratios may need to be under 30%..’ the following:
    Each time when discussing with advocates of the Austrian school they claim full 100% independence of the cb. When they talk about the govt they mean tsy. When MMT talks about govt it is about tsy+cb, the consolidated govt. We saw this recently again in your interview with Peter Schiff.
    So, Germany simply states they always have been merely currency user, under Bundesbank or ecb.
    Therefor they permit themsleves to avoid any discussion about ecb. We saw this perfectly demonstrated again today during the press conference of Schauble with Geithner.
    Consequently they therefor wipe a whole range of possible solutions for other member states’ problems from the table.
    It is clear that this goes all the way to the false analogy of govt debt before and after eurozone entry.
    Let’s call this the second German innocent fraud.
    And somehow again nobody from the other member states stands up.

    Ignorance or naivity? What do you think?

    Reply

    WARREN MOSLER Reply:

    good point on germany believing they’ve always been currency users!

    Reply

    Aitor Reply:

    @Walter, From a Spanish point of view. We were so eager to be part of Europe that almost everything coming from there seems to be fine for us. Massive amounts of funds have been used to foster growth and infrastructures. Now it seems that we are fearing the possibility to get out of the game. Unfortunatelly it seems to me that the game is already over :(

    Reply

    Walter Reply:

    @Aitor,
    In Spain youth unemployment is very high at the moment, I believe around 50% or so.
    At the same time the minimum salaries for youth seem to be relatively high in Spain, for instance higher than currently in The Netherlands.
    Do you see this as a possible cause of the high youth unemployment in Spain?

    Reply

    Neil Wilson Reply:

    @Walter,

    The lack of aggregate demand is the cause of youth employment.

    Removing a minimum wage in a work deficient economy simply causes a chase to the bottom.

    For there to be a market in anything ‘no’ has to be one of the options. No choice is a monopoly situation.

    WARREN MOSLER Reply:

    agreed, though the minimum wage can be a factor if it’s too high, though in general it isn’t too high to be restrictive the way most think.

    for example, set the minimum wage at $1000 per hour, including govt. employees, and you’ll see a ratcheting up of the general price level

    D. Carnegie Reply:

    @Walter,

    What are you hearing from employers? Are they keen to hire or are they cutting back?

    MamMoTh Reply:

    @Walter,

    For there to be a market in anything ‘no’ has to be one of the options.

    Not hiring young people is the option chosen in Spain.

    In the meantime, the Netherlands have one of the lowest unemployment levels in Europe, and the world.

    Unforgiven Reply:

    @Walter,

    What is the sentiment of the employers there? Are they saying they can’t find help or are they saying they can’t find customers?

    BFG Reply:

    @Unforgiven,

    I’d say they can’t find profits.

    Unforgiven Reply:

    @BFG,

    Well, you could turn to your supply chain and say you need a better price and ask the same of your workforce, but then you face the specter of a deflationary spiral.

    BFG Reply:

    @Unforgiven,

    True, but as it stands now unless profits are increasing there won’t be any meaningful employment. David Levy from the Levy Forecast, said that there is a very strong correlation between increasing profits and increasing employment. And this correlation has broken down in the US, the first time since the Great Depression. So unless profits are being generated I don’t know how Spain are going to solve this problem with the tools it has now.

    WARREN MOSLER Reply:

    could be, but seems more aggregate demand would help a lot?

    Unforgiven Reply:

    @BFG,

    Who knows. Maybe they’ll deflate a bit and maybe the EU will ease up on the deficit mania some. Exports could give a boost as long as deflation doesn’t affect potential customers. So much in flux right now.

    Reply

  8. jonf says:

    For the most part this stuff is beyond me, but I do need to ask a question. Why do you reference a debt rate of 200% of GDP for a currency issuer like the U.S.? Is there any empirical or other evidence to say that is a practical limit? What is the ratio for Japan?

    Thanks.

    Reply

    WARREN MOSLER Reply:

    just reflecting observed ratios. japan is around 200% depending on how you count it

    Reply

    roger erickson Reply:

    @WARREN MOSLER, Isn’t that about what we reached during our peak US mobilization & growth years, during WWII?

    Reply

  9. roger erickson says:

    they still think tthe math works – somehow

    “Monti to Parliament: no alternative”
    Premier Mario Monti was briefing both Parliament chambers Monday on the package, which includes euro30 billion ($40.5 billion) in spending cuts and tax hikes and euro10 billion ($13.5 billion) to boost Italy’s anemic growth.
    http://www.businessweek.com/ap/financialnews/D9REE4S02.htm

    the Italian 2-step? 3 steps back, then one forward; Tina’s progresso recipe! Featuring the Goon Walk. Can’t wait to see the video.

    Reply

  10. Jim Thomson says:

    A vaguely analogous formation of a monetary union occurred when the American states adopted the constitution and formed the US federal government in 1789. A key requirement to adopt the constitution was that the states rev war debts be assumed by the new federal government and that the states enter the union debt-free. Under the Articles of Confederation there was monetary chaos.
    Excellent article, thanks for the insights.

    Reply

  11. Roger says:

    Warren,

    Thanks for the insights. I wonder what you think about how the marginal tax rates of the member states, whether it is the U.S. or Europe, impacts the funding dynamics.

    For example, Illinois had a tax rate of 3% (just raised to 5%), which is a fraction of the effective federal tax rate. For entities that aren’t guaranteed or funded by the monopoly issuer of the currency, shouldn’t we be thinking about the “coverage ratio”. If the effective federal rate is 20%, while a state has an effective rate of 2%, wouldn’t we expect corresponding proportions in the funding dynamics?

    Since we are basically addressing self-imposed constraints and dynamics that are “out of paradigm”, I tend not to think about it, but this isn’t the first time you brought it up, so I was interested in your thoughts.

    I’m inclined toward thinking in terms of coverage ratios. As you once pointed out, the government already owns a proportion of economic profit equal to the effective tax rate.

    Thanks,
    Roger

    Reply

    WARREN MOSLER Reply:

    yes, lots of cross currents, lots of tax deferred buyers buying taxable debt,
    hard to determine the marginal after tax rate that clears it all

    Reply

  12. Geoff says:

    At least there is talk that private bondholders won’t be taking any more haircuts, like they did in Greece.

    Reply

  13. The only light at the end of the tunnel is that the austerity imposed on periphery countries will cause wage and price reductions there, which amounts to devaluing their currency. (Or at least wages and prices will rise more slowly than in core countries, hopefully.) But that could take years.

    That’s why I said on this site a few days ago, that if I was economic dictator of Europe, I’d enforce a 30% or so overnight cut in wages and prices in periphery countries. That gets it over and done with.

    The UK (where I live) devalued its currency by 25% in 2008. At the time, half the population didn’t know it had happened. The process is almost entirely painless.

    Reply

    Neil Wilson Reply:

    @Ralph Musgrave,

    “revalued” its currency. The UK had previously forced it up by 33% by running the stupidest asset bubble in history.

    The Sterling index is pretty much back where it was around the end of the last recession in the mid 1990s.

    Reply

    Hugo Heden Reply:

    @Ralph Musgrave,

    > “That’s why I said on this site a few days ago, that if I was economic dictator of Europe, I’d enforce a 30% or so overnight cut in wages and prices in periphery countries. That gets it over and done with.”

    What about private debt levels though? Cut them too, or let them remain as is?

    Reply

    Ralph Musgrave Reply:

    @Hugo Heden,

    Leave debts as they are: which makes it harder for debtors in the “devaluing” country to repay creditors in non-devaluing countries. But conversely, it’s easier for debtors in non-devaluing counties to repay creditors in devaluing countries – though there won’t be so many of those.

    The moral is: enter into a debtor / creditor relationship across borders at your own risk. I believe lots of Hungarians took out mortgages denominated in Swiss Francs a few years ago and got their fingers burned. It’s no one else’s job to bail them out.

    Reply

    Art Reply:

    @Ralph Musgrave,

    “The moral is: enter into a debtor / creditor relationship across borders at your own risk. I believe lots of Hungarians took out mortgages denominated in Swiss Francs a few years ago and got their fingers burned. It’s no one else’s job to bail them out.”

    Financial arrangements can impose involuntary suffering on people who had absolutely nothing to do with them. Should they be forced to bear the cost(s) too?

    Hugo Heden Reply:

    @Ralph Musgrave,

    Hrmpf. If I were a dictator, I’d just do the Job Guarantee thing, financed by ECB. That’s pretty much it.

    jonf Reply:

    @Hugo Heden, 30% cut in wages sounds harsh. Why not break up the euro?

    Reply

    Ralph Musgrave Reply:

    @jonf,

    Jonf, Remember that I said cut prices AS WELL AS wages by about 30%. I.e. REAL living standards are not much affected. Or to be more accurate, wages would need to be cut by a BIT more than prices. Devaluation is a fairly painless process because the bulk of the cost of stuff sold in a country is accounted for by the cost of labour in that country. It’s only the price of imported stuff that rises (e.g. by about 30% if it’s a 30% devaluation).

    WARREN MOSLER Reply:

    as before, don’t forget about the option to raise everyone else’s wages by 30%, and then let prices adjust rather than raising them

    WARREN MOSLER Reply:

    not 30% increases in the others?
    ;(

    Reply

    Ralph Musgrave Reply:

    @WARREN MOSLER,

    Yes, that’s probably the better option, except that Germans won’t wear inflation.

    Stop press: Martin Wolf in the Financial Times says that external deficits of periphery countries is their crucial weakness, not their fiscal balances or their debt. See:

    http://www.ft.com/cms/s/0/396ff020-1ffd-11e1-8662-00144feabdc0.html#axzz1fqxA3JMn

    Reply

    Hugo Heden Reply:

    @Ralph Musgrave,

    The Germans won’t wear inflation? So if you were a dictator, you’d push deflation onto the periphery instead?

    What’s the point of being a dictator if you’re going to run the same crappy policies as they do today already?

    PZ Reply:

    @Ralph Musgrave,
    >The only light at the end of the tunnel is that the austerity imposed on periphery countries will cause wage and price reductions there, which amounts to devaluing their currency. (Or at least wages and prices will rise more slowly than in core countries, hopefully.) But that could take years.

    That’s why I said on this site a few days ago, that if I was economic dictator of Europe, I’d enforce a 30% or so overnight cut in wages and prices in periphery countries. That gets it over and done with.>

    What would it help, tough? You still would have situation where germany’s pensions savings were too high compared to new money coming to existence trough either private sector’s credit expansion or deficit spending. No amount of devaluation would get you out of that. And exports can’t be solution, as euro-area as a whole has never been able to generate export surpluses.

    >The UK (where I live) devalued its currency by 25% in 2008. At the time, half the population didn’t know it had happened. The process is almost entirely painless.>

    Yes, and what were the results? No export boom. No current account surpluses. Only deteraiting terms of trade and falling living standars as a result. Complete failure.

    Reply

    Neil Wilson Reply:

    @PZ,

    “Yes, and what were the results? No export boom. No current account surpluses. Only deteraiting terms of trade and falling living standars as a result. Complete failure.”

    No. That’s not correct.

    Firstly the devaluation came about because of the end of the ponzi asset boom – which clearly had to end

    Secondly it was a re-rating down to the value GBP was at in the mid 1990s.

    During the intervening period an awful lot of sound factories were turned into crappy rabbit hutches for people.

    Exports have gone up but so have imports. The trade balance has not improved and therefore there has been no cash injection into the economy. And that’s entirely due to the domestic economy being trashed by the government.

    Reply

    PZ Reply:

    @Neil Wilson,

    It it is not failure where is the success? Wasn’t falling pound supposed to discourage imports and encourage exports?

    There is simple accounting identity to explain this situation

    current account + capital accout + change in reserves = 0.

    Presumambly Pound is still reserve currency so ‘reserve account’ would be in surplus. In absense of capital account outflows, current account has to be in balance or negative, by accounting identity.

    So it seems to me there have been no force to generate capital account deficits so Britain has been incabable of generating current account surpluses. And it will be, unless there is some sorf of a ‘capital flight’, or bank of england starts to accumulate foreign currency reserves.

    Is this ‘devaluation leads to export boom’ dogma just pushing the fantasy barrow? In the old days, when you devalued, CB would always intervene in the currency markets and start selling domestic currency. Easy to seen why that would have effect on current account. But nowadays pound is floating and interventions are limited.

    Neil Wilson Reply:

    PZ,

    Did you write that before reading today’s trade figures?

    Trade deficit down to £1.6bn from £4.3bn – mostly due to increased exports to the EU!

    What do we know…

  14. wh10 says:

    BTW, what does Arthur Laffer think of MMT? He advised you on Soft Currency Economics…

    Reply

    WARREN MOSLER Reply:

    he says it’s right, but that its not the way he tells the story, which is wrong, but that he tells it that way anyway. seriously!

    Reply

    wh10 Reply:

    @WARREN MOSLER,

    Unbelievable.

    Is it the same story everyone else says, or is his more right?

    Reply

  15. wh10 says:

    Warren,

    Curious why you actually state that “Observed debt to GDP levels for currency issuers can be anywhere from 50% to maybe 200%.”

    Why the approximate limit around 200%? You feel higher debt:GDP ratios would imply too much deficit spending universally? Or do you just mean 200% is the highest we’ve seen in recent times?

    Reply

    WARREN MOSLER Reply:

    japan has been observed at about 200%, depending on how you count it.

    Reply

  16. wh10 says:

    Warren, this is brilliant.

    Your Madoff analogy is incredibly apt.

    It helps solidify recent thoughts I have had, which is that govt financing *is* a ponzi scheme *unless* the govt is willing to use its sovereign powers in its own currency to act as a lender of last resort/set interest rates (via the central bank or whatever institution). So Rick Perry is sort of right about Social Security being a Ponzi scheme, except that, in the US, the Fed supposedly commits to defending interest rates and being a lender of last resort if need be. As long as that’s the case, and Congress doesn’t arbitrarily block debt issuance (like with the debt ceiling), then the Ponzi scheme shouldn’t fail.

    Would you agree?

    Reply

    wh10 Reply:

    @wh10,

    Also, the US also has the choice to allow the Fed to provide overdrafts/allow the Fed to buy in primary mkts, but I don’t invoke that, since even those constraints aren’t real as long as we allow the Fed to use all its power to set interest rates / buy debt in secondary mkts.

    Reply

    John O'Connell Reply:

    @wh10,

    It depends on what you think is the essence of what Ponzi did. If you think the essence of a Ponzi scheme is that it is a fraud, then, no, government debt (nor Social Security and Medicare) is not a Ponzi scheme.

    But there are many types of fraud. What makes the Ponzi fraud unique is that he did indeed pay off early investors, using money collected from later investors. If you think that financing method, and not the fact that Ponzi was defrauding people, is the essence of Ponzi, then the way Social Security is advertised is indeed the same financing methods that Ponzi (and Madoff) used. Beneficiaries are not paid from earnings on their contributions (can’t be, because there are none), they are paid from new contributions from newer entrants into the system.

    If a private pension plan were run that way, it would be considered fraudulent as well as insolvent. Thankfully, the US government can always pay Social Security benefits regardless of the level of Social Security taxes, now and in the future, forever.

    Greece can’t do that, nor can the State of Arizona or General Motors.

    Reply

    wh10 Reply:

    @John O’Connell,

    John,

    Perhaps my selection of SS and Perry was not the best to make my point, but I think we roughly agree.

    What I meant was US deficit spending in general. In a system where the Govt isn’t allowed overdrafts from the Fed or the Fed cannot purchase bonds in the primary mkt, what seems to guarantee govt debt investors to always return to the auction is that the Fed can always set interest rates on the debt. Yes, we rely on bond investors to continually make the Treasury’s deposit account at the Fed positive, but they will always return because the Fed can set the interest rate.

    The operational difference b/w the Eurozone and the US is that the ECB is politically constrained from buying in secondary mkts. IE, it’s constrained to set the interest rate where it wants. At that point, the Ponzi scheme unravels, and investors are afraid there is real default risk.

    This seems to be the crux of the matter and is more specific than saying the US is a currency issuer and Greece or Arizona is a currency user. The Eurozone could work just like the US, with Greece as a currency user, as long as the ECB is willing to back the debt, it seems to me. And it seems to me that’s what Mosler has said as well.

    Reply

    wh10 Reply:

    @wh10,

    Here’s another angle. Greg Mankiw just posted this article, which states, with regards to the US debt situation, “At some point, however, investors will recognize this behavior for the Ponzi scheme it is.”

    As long as the Fed commits to defending the interest rate, which it has infinite power to do, investors shouldn’t recognize the Ponzi behavior. This is even precluding Treasury overdrafts or Fed buying in the primary mkt, or claiming that ‘spending comes first.’

    Politics prevented the ECB from making this commitment, and thus you see the Ponzi scheme unravel.

    http://www.theglobalist.com/printStoryId.aspx?StoryId=9461

    WARREN MOSLER Reply:

    hopefully the soon recognize M for what he is

    jonf Reply:

    Why do we need to have a fund at all for SS? Can’t we fund it from general revenue?

    Reply

    wh10 Reply:

    @jonf,

    Yes. Anything can be funded that way.

    Reply

    WARREN MOSLER Reply:

    yes, in that it isn’t ponzi if you don’t have to rely on borrowing to make payments, which the fed doesn’t

    Reply

    wh10 Reply:

    @WARREN MOSLER,

    Warren, one further question on this, to make sure I understand your perspective.

    Do you not think it is okay to say, if we’re in a world where overdrafts or Fed purchases in the primary mkt will *never be allowed,* that the Treasury does rely on “borrowing” to mark up its account at the Fed before it spends, but that this will not be an issue as long as investors believe the Fed will use its powers to set interest rates in the secondary mkt, which is impetus enough for investors to always meet the needs of govt bond auctions (putting aside Congressional blockage of debt issuance)?

    The key there is, of course, the Fed not having to borrow, but I want to make sure you think it is reasonable to state it that way under current institutional self-imposed constraints (which are not really constraints if the Fed can still set rates via unlimited purchases in secondary mkts).

    Reply

    WARREN MOSLER Reply:

    I suppose, but Congress is the boss of the fed and the boss of the tsy.

    so it’s like asking if can get hurt in a fight if you decide to keep one hand behind your back, so seems the answer to that is yes

  17. Pierce Inverarity says:

    I remember reading in your “7 Deadly Innocent Frauds” how you were able to convince the Italian finance minister, back when they were on the venerable lira, to continue meeting their interest obligations. Is there any way you can do the same thing with Merkel/Merkozy? For the love of God, they need your understanding of these matters!!

    Reply

    wh10 Reply:

    @Pierce Inverarity,
    Good point!

    Reply

    WARREN MOSLER Reply:

    don’t have the intro this time around, unfortunately

    Reply

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