Professor Stephanie Kelton in the LA Times!!!

Forget the ‘fiscal cliff’

By Stephanie Kelton

Dec 21 (LA Times) — Look, up in the sky! It’s a “fiscal cliff.” It’s a slope. It’s an obstacle course.

The truth is, it doesn’t really matter what we call it. It only matters what it is: a lamebrained package of economic depressants bearing down on a lame-duck Congress.

This hastily concocted mix of across-the-board spending cuts and tax increases for all was supposed to force Congress to get serious about dealing with our nation’s debt and deficit. The question everyone’s asking is this: On whose backs should we balance the federal budget? One side wants higher taxes; the other wants spending cuts. And while that debate rages, the right question is being ignored: Why are we worried about balancing the federal budget at all?

You read that right. We may strive to balance our work and leisure time and to eat a balanced diet. Our Constitution enshrines the principle of balance among our three branches of government. And when it comes to our personal finances, we know that the family checkbook must balance.

So when we hear that the federal government hasn’t balanced its books in more than a decade, it seems sensible to demand a return to that kind of balance in Washington as well. But that would actually be a huge mistake.

History tells the tale. The federal government has achieved fiscal balance (even surpluses) in just seven periods since 1776, bringing in enough revenue to cover all of its spending during 1817-21, 1823-36, 1852-57, 1867-73, 1880-93, 1920-30 and 1998-2001. We have also experienced six depressions. They began in 1819, 1837, 1857, 1873, 1893 and 1929.

Do you see the correlation? The one exception to this pattern occurred in the late 1990s and early 2000s, when the dot-com and housing bubbles fueled a consumption binge that delayed the harmful effects of the Clinton surpluses until the Great Recession of 2007-09.

Why does something that sounds like good economics balancing the budget and paying down debt end up harming the economy? The answers may surprise you.

Spending is the lifeblood of our economy. Without it, there would be no sales, and without sales, no profits and no reason for any private firm to produce anything for the marketplace. We tend to forget that one person’s spending becomes another person’s income. At its most basic level, macroeconomics teaches that spending creates income, income creates sales and sales create jobs.

And creating jobs is what we need to do. Until the fiscal cliff distracted us, we all understood that. Today, we have roughly 3.4 people competing for every available job in America. The unemployment rate is like a macroeconomic thermometer when it registers a high rate, it’s an indication that the deficit is too small.

So in our current circumstance a growing but fragile economy policymakers are wrong to focus on the fact that there is a deficit. It’s just a symptom. Instituting tax increases and spending cuts will pull the rug out from under consumers, thereby disrupting the income-sales-jobs relationship. Slashing trillions from the deficit will only depress spending for year to come, worsening unemployment and setting back economic growth.

Conveying this is an uphill battle. The public has been badly misinformed. We do not have a debt crisis, and our deficit is not a national disgrace. We are not at the mercy of the Chinese, and we’re in no danger of becoming Greece. That’s because the U.S. government is not like a household, or a private business, or a municipality, or a country in the Eurozone. Those entities are all users of currency; the U.S. government is an issuer of currency. It can never run out of its own money or face the kinds of problems we face when our books don’t balance.

The effort to balance the books that’s at the heart of the fiscal cliff is simply misguided. Instead of butting heads over whose taxes to raise and which programs to cut, lawmakers should be haggling over how to use the tool of a federal deficit to boost incomes, employment and growth. That’s the balancing act we need.

Stephanie Kelton is an associate professor of economics at the University of Missouri-Kansas City and the founder and editor of New Economic Perspectives. @deficitowl

Berlusconi comments

As if their problems end with lower borrowing costs.
No mention of needing to run much larger deficits:
Yesterday Berlusconi put it plainly and simply:

Berlusconi says Italy may be forced to leave the euro zone

Silvio Berlusconi said that Italy would be forced to leave the euro zone unless the ECB gets more powers to ensure lower borrowing costs. Berlusconi, who will again lead his People of Freedom party (PDL) in a national election, said that the ECB should become a lender of last resort for the currency bloc. “If Germany doesn’t accept that the ECB must be a real central bank, if interest rates don’t come down, we will be forced to leave the euro and return to our own currency in order to be competitive,” Berlusconi said.Berlusconi is already campaigning hard for the election with a spate of television interviews in an attempt to close the wide gap with the center-left Democratic Party which is polling at above 30 percent, some 14 points above the PDL.

Euro-Area Exports Decline

As previously discussed, the euro has a history of firming when a trade surplus develops, which works to contain net exports. Export friendly policy includes tight fiscal. And for all practical purposes a ‘sustainable’ trade surplus requires fx buying.

Japan is a recent example. When their dollar buying stopped a few years back the yen appreciated to the point where their trade surplus has faded. They are now looking at resuming (or may already have resumed?) fx purchases to reverse this effect.

Euro-Area Exports Decline for a Second Month Amid Recession

By Stefan Riecher

Dec 17 (Bloomberg) — Euro-area exports fell for a second month in October as the economy struggled to pull out of its second recession in four years.

Exports from the 17-nation currency bloc declined a seasonally adjusted 1.4 percent from September, when they fell 1.3 percent, the European Unions statistics office in Luxembourg said today. Imports rose 0.6 percent in October and the trade surplus narrowed to 7.9 billion euros ($10.4 billion) from a revised 11 billion euros in the previous month. Labor- cost growth accelerated to 2 percent in the third quarter from 1.9 percent in the prior three months, a separate report showed.

Koo on reserves time bomb – 500% inflation

So much for yet another legacy.
:(

From Richard Koo’s latest report:

But nightmare scenario awaits when private loan demand recovers. The problem is what happens when private loan demand recovers. Loan books could grow more than tenfold in the US and five fold in Japan and Europe if bank reserves remain at current levels, triggering inflation rates of 500% to over 1,000%.

To avoid this outcome, central banks will have to mop up excessive reserves by raising the statutory reserve ratio, raising the interest rate paid on reserves, and selling government bonds. All of these measures will serve to lift interest rates, sending bond yields sharply higher and triggering a possible crash in the bond markets.

A sharp increase in government bond yields could lead to fiscal collapse in countries with a large national debt. For Japan, where the national debt amounts to 240% of GDP, the results would be catastrophic.

Expanding quantitative easing because it appears to be doing no harm is grievous error. Mr. Abe and his advisors may believe that all they have to do once their anti-deflationary policies succeed and JGB yields start to rise is have the BOJ buy more bonds. However, bank reserves under quantitative easing have risen to a level capable of fueling a 500% inflation rate, in which case the BOJ would have to sell, not buy, JGBs.

Nomura | JPN

BOJ purchases of JGBs in that situation could cause the potential inflation rate to rise from 500% to 600% to 700% and trigger an economic collapse.

I do not know whether the German finance official who was opposed to reckless quantitative easing based his view on this kind of scenario. Nevertheless, it is extremely dangerous to assume that since quantitative easing does no harm in a balance sheet recession, it can be continuously expanded without concern. The real danger posed by this policy will become apparent only after private-sector balance sheets are repaired, and then it will happen suddenly.

BOJs excess reserves could become a time bomb. I would now like to bring some actual numbers into the discussion so that readers may appreciate the implications of this scenario.

Only 7.7 trillion in bank reserves are required to maintain Japans money supply. With the Japanese government now running annual fiscal deficits in excess of 40 trillion, BOJ financing of the entire deficit would require the Bank to supply reserves equal to more than five times the amount needed to maintain the money supply. Over a two-year period, it would have to supply reserves equal to more than ten times the required amount.

In other words, the purchase of one years worth of newly issued government debt by the BOJ has the potential to generate a 500% inflation rate. I suspect few Japanese are willing to accept such a trade-off.

Moreover, the BOJ has already engaged in substantial quantitative easing under heavy pressure from politicians, pushing excess reserves to 29.8 trillion. In my view this represents a time bomb.

Saudi production

A modest drop in demand for Saudi crude, which means they sell a bit less at their posted prices.

Not sure what, if anything, makes them change price at this point.

Supply shocks that could cause demand for their output to fall further include a resumption of output from Iran, an increase from Iraq where development was going full tilt last I checked, and a bit from continued output increases and falling consumption in the US.

On the other hand, if Iran shuts down completely the call on Saudi output could spike beyond their ability to increase production and they’d lose control of prices on the upside.

Fed policy

I wrote this (published) paper on 0 rates 15 years ago.

The trimmed Fed forecasts are confirming the ‘tax’ aspect of QE?

The $80+ billion the fed turns over to the tsy each year would have otherwise been earned by the economy.

It’s all confirming my suspicions that the Fed has been stepping on the brake when it thinks its stepping on the gas.

And when it ‘doesn’t work’ they just step on it that much harder.

Tragically, after all these years and with all the hard evidence in our face we continue to have both fiscal and monetary policy backwards.