Category Archives: Financial Times

ECB monetizing or not ?

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>   
>   (email exchange)
>   
>   On Thu, Apr 15, 2010 at 3:29 PM, John wrote:
>   
>   Warren, I can’t tell from this article if the European Central Bank is
>   issuing new currency in exchange for national government bonds or not?
>   

This in fact is a very good article.

Yes, the ECB is funding its banks, and yes, they do accept the securities of the member nations as collateral.

However that funding is full recourse. If the bonds default the banks that own the securities take the loss.

The reason a bank funds its securities and other assets at the Central Bank is price. Banks fund themselves where they
are charged the lowest rates. And the Central Bank, the ECB in this case, sets the interbank lending rate by offering funds at its
target interest rate, as well as by paying something near it’s target rate on excess funds in the banking system. That is, through its various ‘intervention mechanisms’ the ECB effectively provides a bid and an offer for interbank funds.

In the banking system, however, loans ‘create’ deposits as a matter of accounting, so the total ‘available funds’ are always equal to the total funding needs of the banking system, plus or minus what are called ‘operating factors’ which are relatively small. These include changes in cash in circulation, uncleared checks, changes in various gov. account balances, etc.

This all means the banking system as a whole needs little if any net funding from the ECB. However, any one bank might need substantial funding from the ECB should other banks be keeping excess funds at the ECB. So what is happening is that banks who are having difficulty funding themselves at competitive rates immediately use the ECB for funding by posting ‘acceptable collateral’ to fund at that lower rate.

One reason a bank can’t get ‘competitive funding’ in the market place is its inability to attract depositors, generally due to risk perceptions. While bank deposits are insured, they are insured only by the national govts, which means Greek bank deposits are insured by Greece. So as Greek and other national govt. solvency comes into question, depositors tend to avoid those institutions, which drives them to fund at the ECB. (actually via their national cb’s who have accounts at the ECB, which is functionally the same as funding at the ECB)

As with most of today’s banking systems, liabilities are generally available in virtually unlimited quantities, and therefore regulation falls entirely on bank assets and capital considerations. As long as national govt securities are considered ‘qualifying assets’ and banks are allowed to secure funding via insured deposits of one form or another and the return on equity is competitive there is no numerical limit to how much the banking system can finance.

So in that sense the EU is in fact financially supporting unlimited credit expansion of the national govts. They know this, but don’t like it, as the moral hazard issue is extreme. Left alone, it becomes a race to the bottom where the national govt with the most deficit spending ‘wins’ in real terms even as the value of the euro falls towards 0. When the national govts were making ‘good faith efforts’ to contain deficits, allowing counter cyclical increases through ‘automatic stabilizers’ and not proactive increases, it all held together. However what Greece and others appear to have done is ‘call the bluff’ with outsize and growing deficits and debt to gdp levels, threatening the start (continuation?) of this ‘race to the bottom’ if they are allowed to continue.

The question then becomes how to limit the banking system’s ability to finance unlimited national govt. deficit spending. Hence talk of Greek securities not being accepted at the ECB. Other limits include the threat of downgraded bonds forcing banks to write down their capital and threaten their solvency. And once the banking system reaches ‘hard limits’ to what they can fund a system that’s already/necessarily a form ‘ponzi’ faces a collapse.

The other problem is that when the euro was on the way up due to portfolio shifts out of the dollar, many of those buyers of euro had to own national govt paper, as their is nothing equiv. to US Treasury securities or JGB’s, for example. That helped fund the national govs at lower rates during that period. That portfolio shifting has largely come to an end, making national govt funding more problematic.

The weakening euro and rising oil prices raises the risk of ‘inflation’ flooding in through the import and export channels. With a weak economy and national govt credit worthiness particularly sensitive to rising interest rates, the ECB may find itself in a bind, as it will tend to favor rate hikes as prices firm, yet recognize rate hikes could cause a financial collapse. And should a govt like Greece be allowed to default the next realization could be that Greek depositors will take losses, and, therefore, the entire euro deposit insurance lose credibility, causing depositors to take their funds elsewhere. But where? To national govt. or corporate debt? The problem is there is nowhere to go but actual cash, which has been happening. Selling euro for dollars and other currencies is also happening, weakening the euro, but that doesn’t reduce the quantity of euro deposits, even as it drives the currency down, though the ‘value’ of total deposits does decrease as the currency falls.

It’s all getting very ugly as it all threatens the value of the euro. The only scenario that theoretically helps the value of the euro is a national govt default, which does eliminate the euro denominated financial assets of that nation, but of course can trigger a euro wide deflationary debt collapse. The ‘support’ scenarios all weaken the euro as they support the expansion of euro denominated financial assets, to the point of triggering the inflationary ‘race to the bottom’ of accelerating debt expansion.

Bottom line, it’s all an ‘unstable equilibrium’ as we used to say in engineering classes 40 years ago, that could accelerate in either direction. My proposal for annual ECB distributions to member nations on a per capita basis reverses those dynamics, but it’s not even a distant consideration.

Where are ‘market forces’ taking the euro? Low enough to increase net exports sufficiently to supply the needed net euro financial assets to the euro zone, which will come from a drop in net financial assets of the rest of world net importing from the euro zone. This, too, can be a long, ugly ride.

As a final note, the IMF gets its euros from the euro zone, so using the IMF changes nothing.

Comments welcome!

The Next Global Problem: Portugal

By Peter Boone and Simon Johnson

Peter Boone is chairman of the charity Effective Intervention and a research associate at the Center for Economic Performance at the London School of Economics. He is also a principal in Salute Capital Management Ltd. Simon Johnson, the former chief economist at the International Monetary Fund, is the co-author of 13 Bankers.

April 15 (NYT) — The bailout of Greece, while still not fully consummated, has brought an eerie calm in European financial markets.

It is, for sure, a huge bailout by historical standards. With the planned addition of International Monetary Fund money, the Greeks will receive 18 percent of their gross domestic product in one year at preferential interest rates. This equals 4,000 euros per person, and will be spent in roughly 11 months.

Despite this eye-popping sum, the bailout does nothing to resolve the many problems that persist. Indeed, it probably makes the euro zone a much more dangerous place for the next few years.

Next on the radar will be Portugal. This nation has largely missed the spotlight, if only because Greece spiraled downward. But both are economically on the verge of bankruptcy, and they each look far riskier than Argentina did back in 2001 when it succumbed to default.

Portugal spent too much over the last several years, building its debt up to 78 percent of G.D.P. at the end of 2009 (compared with Greece’s 114 percent of G.D.P. and Argentina’s 62 percent of G.D.P. at default). The debt has been largely financed by foreigners, and as with Greece, the country has not paid interest outright, but instead refinances its interest payments each year by issuing new debt. By 2012 Portugal’s debt-to-G.D.P. ratio should reach 108 percent of G.D.P. if the country meets its planned budget deficit targets. At some point financial markets will simply refuse to finance this Ponzi game.

The main problem that Portugal faces, like Greece, Ireland and Spain, is that it is stuck with a highly overvalued exchange rate when it is in need of far-reaching fiscal adjustment.

For example, just to keep its debt stock constant and pay annual interest on debt at an optimistic 5 percent interest rate, the country would need to run a primary surplus of 5.4 percent of G.D.P. by 2012. With a planned primary deficit of 5.2 percent of G.D.P. this year (i.e., a budget surplus, excluding interest payments), it needs roughly 10 percent of G.D.P. in fiscal tightening.

It is nearly impossible to do this in a fixed exchange-rate regime — i.e., the euro zone — without vast unemployment. The government can expect several years of high unemployment and tough politics, even if it is to extract itself from this mess.

Neither Greek nor Portuguese political leaders are prepared to make the needed cuts. The Greeks have announced minor budget changes, and are now holding out for their 45 billion euro package while implicitly threatening a messy default on the rest of Europe if they do not get what they want — and when they want it.

The Portuguese are not even discussing serious cuts. In their 2010 budget, they plan a budget deficit of 8.3 percent of G.D.P., roughly equal to the 2009 budget deficit (9.4 percent). They are waiting and hoping that they may grow out of this mess — but such growth could come only from an amazing global economic boom.

While these nations delay, the European Union with its bailout programs — assisted by Jean-Claude Trichet’s European Central Bank — provides financing. The governments issue bonds; European commercial banks buy them and then deposit these at the European Central Bank as collateral for freshly printed money. The bank has become the silent facilitator of profligate spending in the euro zone.

Last week the European Central Bank had a chance to dismantle this doom machine when the board of governors announced new rules for determining what debts could be used as collateral at the central bank.

Some anticipated the central bank might plan to tighten the rules gradually, thereby preventing the Greek government from issuing too many new bonds that could be financed at the bank. But the bank did not do that. In fact, the bank’s governors did the opposite: they made it even easier for Greece, Portugal and any other nation to borrow in 2011 and beyond. Indeed, under the new lax rules you need only to convince one rating agency (and we all know how easy that is) that your debt is not junk in order to get financing from the European Central Bank.

Today, despite the clear dangers and huge debts, all three rating agencies are surely scared to take the politically charged step of declaring that Greek debt is junk. They are similarly afraid to touch Portugal.

So what next for Portugal?

Pity the serious Portuguese politician who argues that fiscal probity calls for early belt-tightening. The European Union, the European Central Bank and the Greeks have all proven that the euro zone nations have no threshold for pain, and European Union money will be there for anyone who wants it. The Portuguese politicians can do nothing but wait for the situation to get worse, and then demand their bailout package, too. No doubt Greece will be back next year for more. And the nations that “foolishly” already started their austerity, such as Ireland and Italy, must surely be wondering whether they too should take the less austere path.

There seems to be no logic in the system, but perhaps there is a logical outcome.

Europe will eventually grow tired of bailing out its weaker countries. The Germans will probably pull that plug first. The longer we wait to see fiscal probity established, at the European Central Bank and the European Union, and within each nation, the more debt will be built up, and the more dangerous the situation will get.

When the plug is finally pulled, at least one nation will end up in a painful default; unfortunately, the way we are heading, the problems could be even more widespread.

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Poll Finds Tea Party Backers Wealthier and More Educated

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Poll Finds Tea Party Backers Wealthier and More Educated

By Kate Zernike and Megan Thee-Brenan

April 14 (NYT) — Tea Party supporters are wealthier and more well-educated than the general public, and are no more or less afraid of falling into a lower socioeconomic class, according to the latest New York Times/CBS News poll.

The 18 percent of Americans who identify themselves as Tea Party supporters tend to be Republican, white, male, married and older than 45.

They hold more conservative views on a range of issues than Republicans generally. They are also more likely to describe themselves as “very conservative” and President Obama as “very liberal.”

And while most Republicans say they are “dissatisfied” with Washington, Tea Party supporters are more likely to classify themselves as “angry.”

The Tea Party movement burst onto the scene a year ago in protest of the economic stimulus package, and its supporters have vowed to purge the Republican Party of officials they consider not sufficiently conservative and to block the Democratic agenda on the economy, the environment and health care. But the demographics and attitudes of those in the movement have been known largely anecdotally. The Times/CBS poll offers a detailed look at the profile and attitudes of those supporters.

Their responses are like the general public’s in many ways. Most describe the amount they paid in taxes this year as “fair.” Most send their children to public schools. A plurality do not think Sarah Palin is qualified to be president, and, despite their push for smaller government, they think that Social Security and Medicare are worth the cost to taxpayers. They actually are just as likely as Americans as a whole to have returned their census forms, though some conservative leaders have urged a boycott.

Tea Party supporters’ fierce animosity toward Washington, and the president in particular, is rooted in deep pessimism about the direction of the country and the conviction that the policies of the Obama administration are disproportionately directed at helping the poor rather than the middle class or the rich.

The overwhelming majority of supporters say Mr. Obama does not share the values most Americans live by and that he does not understand the problems of people like themselves. More than half say the policies of the administration favor the poor, and 25 percent think that the administration favors blacks over whites — compared with 11 percent of the general public.

They are more likely than the general public, and Republicans, to say that too much has been made of the problems facing black people.

Asked what they are angry about, Tea Party supporters offered three main concerns: the recent health care overhaul, government spending and a feeling that their opinions are not represented in Washington.

“The only way they will stop the spending is to have a revolt on their hands,” Elwin Thrasher, a 66-year-old semiretired lawyer in Florida, said in an interview after the poll. “I’m sick and tired of them wasting money and doing what our founders never intended to be done with the federal government.”

They are far more pessimistic than Americans in general about the economy. More than 90 percent of Tea Party supporters think the country is headed in the wrong direction, compared with about 60 percent of the general public. About 6 in 10 say “America’s best years are behind us” when it comes to the availability of good jobs for American workers.

Nearly 9 in 10 disapprove of the job Mr. Obama is doing over all, and about the same percentage fault his handling of major issues: health care, the economy and the federal budget deficit. Ninety-two percent believe Mr. Obama is moving the country toward socialism, an opinion shared by more than half of the general public.

“I just feel he’s getting away from what America is,” said Kathy Mayhugh, 67, a retired medical transcriber in Jacksonville. “He’s a socialist. And to tell you the truth, I think he’s a Muslim and trying to head us in that direction, I don’t care what he says. He’s been in office over a year and can’t find a church to go to. That doesn’t say much for him.”

The nationwide telephone poll was conducted April 5 through April 12 with 1,580 adults. For the purposes of analysis, Tea Party supporters were oversampled, for a total of 881, and then weighted to their proper proportion in the poll. The margin of sampling error is plus or minus three percentage points for all adults and for Tea Party supporters.

Of the 18 percent of Americans who identified themselves as supporters, 20 percent, or 4 percent of the general public, said they had given money or attended a Tea Party event, or both. These activists were more likely than supporters generally to describe themselves as very conservative and had more negative views about the economy and Mr. Obama. They were more angry with Washington and intense in their desires for a smaller federal government and deficit.

Tea Party supporters over all are more likely than the general public to say their personal financial situation is fairly good or very good. But 55 percent are concerned that someone in their household will be out of a job in the next year. And more than two-thirds say the recession has been difficult or caused hardship and major life changes. Like most Americans, they think the most pressing problems facing the country today are the economy and jobs.

But while most Americans blame the Bush administration or Wall Street for the current state of the American economy, the greatest number of Tea Party supporters blame Congress.

They do not want a third party and say they usually or almost always vote Republican. The percentage holding a favorable opinion of former President George W. Bush, at 57 percent, almost exactly matches the percentage in the general public that holds an unfavorable view of him.

Dee Close, a 47-year-old homemaker in Memphis, said she was worried about a “drift” in the country. “Over the last three or four years, I’ve realized how immense that drift has been away from what made this country great,” Ms. Close said.

Yet while the Tea Party supporters are more conservative than Republicans on some social issues, they do not want to focus on those issues: about 8 in 10 say that they are more concerned with economic issues, as is the general public.

When talking about the Tea Party movement, the largest number of respondents said that the movement’s goal should be reducing the size of government, more than cutting the budget deficit or lowering taxes.

And nearly three-quarters of those who favor smaller government said they would prefer it even if it meant spending on domestic programs would be cut.

But in follow-up interviews, Tea Party supporters said they did not want to cut Medicare or Social Security — the biggest domestic programs, suggesting instead a focus on “waste.”

Some defended being on Social Security while fighting big government by saying that since they had paid into the system, they deserved the benefits.

Others could not explain the contradiction.

“That’s a conundrum, isn’t it?” asked Jodine White, 62, of Rocklin, Calif. “I don’t know what to say. Maybe I don’t want smaller government. I guess I want smaller government and my Social Security.” She added, “I didn’t look at it from the perspective of losing things I need. I think I’ve changed my mind.”

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NYT on WAMU

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As suggested way back, lender fraud was a large part of the problem (rather than actual lending standards and/or Fed monetary policy)

Largely driven by counterproductive incentives.

It was also an inexcusable failure of regulation that allowed these types of incentives in the first place:

Memos Show Risky Lending at WaMu

By Sewell Chan

April 25 (NYT) — New documents released by a Senate panel show how entrenched Washington Mutual was in fraudulent and risky lending, and highlighted how its top executives received rewards as their institution was hurtling toward disaster.

The problems at WaMu, whose collapse was the largest in American banking history, were well known to company executives, excerpts of e-mail messages and other internal documents show.

The documents were released on Monday by the Senate Permanent Subcommittee on Investigations, which began an inquiry into the financial crisis in November 2008. The panel has summoned seven former WaMu executives to testify at a hearing on Tuesday, including the former chief executive Kerry K. Killinger.

The panel called WaMu illustrative of problems in the origination, sale and securitization of high-risk mortgages by any number of financial institutions from 2004 to 2008.

“Using a toxic mix of high-risk lending, lax controls and compensation policies which rewarded quantity over quality, Washington Mutual flooded the market with shoddy loans that went bad,” the panel’s chairman, Senator Carl Levin, Democrat of Michigan, said.

Mr. Killinger was paid $103.2 million from 2003 to 2008. In WaMu’s final year of existence, he received $25.1 million, including a $15.3 million severance payment.

His pay was not the only compensation under scrutiny.

Loan officers received more money for originating higher-risk loans, and loan processors were rewarded for speed and volume, rather than quality, the Senate panel found. Loan officers and sales associates were paid even more if they overcharged borrowers through points or higher interest rates, or included stiff prepayment penalties in the loans they issued.

The pay structure created “temptation to advise the borrower on means and methods to game the system,” a WaMu internal memo from April 2008 found.

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Interest Rates Have Nowhere to Go but Up – NYTimes.com

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>   
>   (email exchange)
>   
>   On Sun, Apr 11, 2010 at 10:58 AM, wrote:
>   
>   What is your call?
>   

It’s certainly possible, but my suspicion is that we may be going the way of Japan, with interest rates low for very long. With core CPI going negative and the output gap/unemployment remaining very high, especially people who can’t find full time work hitting a new high of 16.9%, the Fed is far from meeting its dual mandate of full employment and price stability (along with low long term rates). And the recent dollar strength, stubbornly high jobless claims numbers, weak loan demand numbers, and not much sign of life in housing has to be a concern about the recovery being more L shaped than V shaped as well.

Seems the Fed would have to have some pretty strong forecasts for CPI and much higher levels of employment to move any time soon apart from perhaps going to what they consider a more ‘normal’ real rate of 1% or so.

And when I look at the euro dollar rates out past 5 years they’re higher than libor got in the last cycle, and this one doesn’t feel like it’s stronger than the last, at least so far. So to discount rates that high (well over 5%) as midpoints of expectations for fed funds looks high to me.

Consumers in U.S. Face the End of an Era of Cheap Credit

By Nelson D. Schwartz

April 10 (NYT) — Even as prospects for the American economy brighten, consumers are about to face a new financial burden: a sustained period of rising interest rates.

That, economists say, is the inevitable outcome of the nation’s ballooning debt and the renewed prospect of inflation as the economy recovers from the depths of the recent recession.

The shift is sure to come as a shock to consumers whose spending habits were shaped by a historic 30-year decline in the cost of borrowing.

“Americans have assumed the roller coaster goes one way,” said Bill Gross, whose investment firm, Pimco, has taken part in a broad sell-off of government debt, which has pushed up interest rates. “It’s been a great thrill as rates descended, but now we face an extended climb.”

The impact of higher rates is likely to be felt first in the housing market, which has only recently begun to rebound from a deep slump. The rate for a 30-year fixed rate mortgage has risen half a point since December, hitting 5.31 last week, the highest level since last summer.

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China Inflation Seen at 15% With Wen Jiabao Losing Boom Control

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More info dripping out regarding an inflation problem which ultimately weakens a currency.

Earlier reports showing US Treasury holdings falling and State dollar debt growing point to the same thing, as does
the reports of govt. efforts to ‘tighten’ policy via reductions in the growth of lending etc.

China Inflation Seen at 15% With Wen Jiabao Losing Boom Control

By Bloomberg News
April 8 (Bloomberg) — “Look at the scale of this,” said
Li Chongyi, an engineer, as he watched a 4-kilometer line of
trucks and earth movers busy quadrupling the size of Chongqing’s
Jiangbei International Airport. “This will take years.”
Jiangbei, which begins work on a third terminal when the
second is done next year, is one of 15 trillion yuan ($2.2
trillion) in projects begun in 2009, almost twice the economy of
India. Most were started by local governments as China’s
stimulus package sparked a record 9.6 trillion yuan of loans.
The projects and their loans are stymieing efforts by
Premier Wen Jiabao to curtail investment as inflation rose to
2.7 percent in February, a 16-month high. Failure to rein in
local government spending could push inflation to 15 percent by
2012, said Victor Shih, a political economist at Northwestern
University who spent months tallying government borrowing.
“Increasingly the choice facing the government is between
inflation or bad loans,” said Shih, author of the book
“Finance and Factions in China,” who teaches political science
at the university in Evanston, Illinois. “The only mechanism
for controlling inflation in China is credit restriction, but if
they use that, this show is over — a gigantic wave of bad loans
will appear on banks’ balance sheets.”
Attempts to curb borrowing by raising interest rates would
boost debt-servicing costs for local governments. At the same
time, tightening credit may stall projects, triggering “a
build-up of bad loans,” the Basel, Switzerland-based Bank for
International Settlements said in a quarterly report in December.

Debt Rising

Nomura Holdings Inc., Japan’s biggest brokerage, estimates
local government projects started last year totaled up to 10
trillion yuan — 2.5 times the official 4 trillion yuan stimulus
plan. The Chongqing Economic Times reported April 6 that the
city plans to spend 1 trillion yuan on another 323 projects.
Construction companies working on projects begun by
provincial governments may be shielded from a wider slowdown in
China’s property market, said Ephraim Fields, a fund manager
with Echo Lake Capital in New York.
“These vital, long-term projects should get the necessary
funding even if the overall economy slows down a bit,” said
Fields, who holds shares of China Advanced Construction
Materials Group Inc., a Nasdaq-listed concrete maker that gets
more than 75 percent of its sales from government infrastructure
projects.

Cement Stocks

Roth Capital Partners also favors Beijing-based CADC. The
company’s stock may rise 52 percent to $8 within a year, the
Newport Beach, California-based fund manager forecast. BOC
International analyst Patrick Li recommends buying Xinjiang
Tianshan Cement Co., which he forecasts may gain more than 15
percent, and Tangshan Jidong Cement Co., which may rise almost
23 percent. The projects begun in 2009 will help China’s cement
output rise 11 percent, or 186 million tons, this year, Li
predicts.
Chongqing, China’s wartime capital on the Yangtze River, is
a prime example of how provincial governments multiplied the
effect of the central government’s stimulus plan. The city had
900 billion yuan in loans and credit lines outstanding at the
end of 2009, said Northwestern’s Shih. Chongqing’s economy
expanded 14.9 percent last year, with investment in factories
and property expanding the most in 13 years.
“Chongqing really stood out,” said Hong Kong-born Shih,
35, who joined Northwestern in 2003 after completing a PhD in
government at Harvard University.

Roads and Rail

Chongqing’s projects include a light rail system that will
receive more than 10 billion yuan in investment this year.
The city will spend at least 8 billion yuan on rail
construction and another 15.5 billion yuan on 288 kilometers
(179 miles) of new expressways. Jiangbei airport said it plans
to raise passenger capacity to an annual 30 million when Phase
II is completed next year, from 14 million in 2009. Phase III,
would raise throughput to 55 million passengers.
The municipality’s construction boom has boosted business
confidence and the property market, said Bruce Yang, managing
director of Australia Eastern Elevators Group (China).
Sales at Eastern Elevators surged 51 percent in 2009, aided
by projects such as a local-government office block in Nan’an
district that needed 20 elevators, Yang said at the company’s
headquarters in Nan’an. He has an order this year to install 23
lifts in a government-sponsored hospital near Chengdu in Sichuan
province.

Macau Bridge

Chongqing isn’t alone. Sun Mingchun, an economist with
Nomura in Hong Kong, estimates local governments have proposed
projects with a value of more than 20 trillion yuan since the
stimulus package was announced in November 2008. They include
high-speed rail links between Wuhan in central China and
Guangzhou in the south, the Hong Kong-Macao-Zhuhai Bridge, and
the construction or upgrading of 35 airports. The economic
planning agency says 5,557 kilometers of railways and 98,000
kilometers of highways opened last year.
The building boom boosted construction and materials stocks,
raising concerns of a bubble. Baoshan Iron & Steel Co. rose
almost 74 percent since the stimulus was announced while Anhui
Conch Cement Co. gained 135 percent. The Shanghai Composite
Index rose 80 percent in the period.
Construction of high-speed rail lines linking Xi’an with
Ankang and Datong in Shaanxi province have pushed CADC’s output
to capacity, President Jeremy Goodwin said in a phone interview.
“The demand is so great we are struggling to keep up,”
said Goodwin.

Burst Bubble

Should the boom end in a property-market collapse, even
those stocks tied to the local government projects will be
affected along with most other industries, said Shanghai-based
independent economist Andy Xie, formerly Morgan Stanley’s chief
Asia economist.
“Corporate profits are very much driven by the property
sector,” said Xie. “The largest sectors will be hit hard,
especially banks and insurance companies.”
A gauge of property stocks has fallen more than 6 percent
this year after more than doubling in 2009 as the government
takes steps to cool rising prices, including raising the deposit
requirement to 20 percent of the minimum price of auctioned land.
Property sales were equivalent to 13 percent of gross domestic
product last year.
“Policy makers may need to start thinking about how to
handle the aftermath of the bust,” said Nomura’s Sun.

Lending Target

Policy makers have also moved to tighten credit. The
central bank is seeking to slow lending growth by 22 percent to
7.5 trillion this year.
China’s local governments set up investment vehicles to
circumvent regulations that prevent them borrowing directly.
These vehicles borrow money against the land injected into them
and guarantees by local governments, said Shih.
Chinese officials have pledged to limit the risks posed by
these vehicles. China plans to nullify guarantees provided by
local governments for some loans, said Yan Qingmin, head of the
banking regulator’s Shanghai branch, March 5.
The World Bank said on March 17 that China, the world’s
third-biggest economy, needs to raise interest rates to help
contain the risk of a property bubble and allow a stronger yuan
to damp inflation.
“Massive monetary stimulus” risks triggering large asset-
price increases, a housing bubble, and bad debts, from financing
local-government projects, the Washington-based World Bank said
in its quarterly report on China. The World Bank raised its
economic growth forecast for China this year to 9.5 percent from
9 percent in January.
The financial burden of those measures on local governments
means that “loose liquidity conditions” will persist for
longer than they should, said Shen Minggao, a Citigroup Inc.
economist in Hong Kong.
Any effort to quickly exit stimulus policies would lead to
“an immediate increase in non-performing loans in the banking
sector,” he said. “To avoid a credit crisis, Chinese
authorities may have to delay a policy exit in the hope that
time remedies the pain.”

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Tom Hickey on MMT

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Tom Hickey Reply:
April 3rd, 2010 at 12:38 am

MDM, the key here is the MMT concept of vertical and horizontal in relation to money creation. This is sometimes called exogenous (outside) and endogenous (inside).

When the government “spends,” the Treasury disburses the funds by crediting bank accounts. Settlement involves transferring reserves from the Treasury’s account at the Fed to the recipient’s bank. The resulting increase in the recipient’s deposit account has no corresponding liability in the banking system. This creation is called “vertical,” or exogenous to the banking system. Since there is no corresponding liability in the banking system, this results in an increase of nongovernment net financial assets.

When banks create money by extending credit (loans create deposits), this occurs completely within the banking system and results in a liability for the bank (the deposit) and a corresponding asset (the loan). The customer has an asset (the deposit) and a corresponding liability (the loan). This nets to zero.

Thus vertical money created by the government affects net financial assets and horizontal money created by banks does not, although its use in the economy as productive capital can increase real assets.

The mistake that is usually made is comparing what happens in the horizontal system with what happens at the level of government accounting. At the horizontal level, debt is the basis for horizontal money creation. Therefore, it is often assumed that debt must be the basis for the creation of money by government currency issuance. This is not the case.

Reserve accounting uses the standard accounting identities, but the meaning of “liability” is not “debt.” The husband-wife analogy for CB-Treasury accounting relationships is apt. Since a husband and wife are responsible for each others debts, neither can be indebted to the other. That is to say, reserve accounting is a fiction that does not represent real relationships, such as exist between a creditor and debtor in the horizontal system.

Moreover, government debt is not true debt either. At the macro level, the reserves that are transferred to banks through government disbursement are used to buy Tsy’s. That is, when a Tsy is bought, this involves a transfer of reserves from the buyer’s bank’s reserve account at the Fed to the government’s account (consolidating CB and Treasury as “government”).

When the Tsy’s are sold or redeemed, the reserves that were “stored” at interest are simply switched back, creating a deposit again. It’s pretty much the same as buying and redeeming a CD. It’s just a switch from demand to time back to demand in a bank account, and a switch between reserves and securities at the government level. That is to say, the government doesn’t have to draw on revenue, borrow, or sell assets to cover its “debt,” as households and firms do. It’s just a matter of crediting and debiting accounts on the (consolidated) government books, even though it may appear that there is a financial relationship occurring between the CB and Treasury due to the accounting. However, it’s just a fiction.

Therefore, the key to understanding MMT is this vertical-horizontal relationship. When one understands this, then Abba Lerner’s principles of functional finance become obvious. (1) Currency issuance through government disbursement is used to increase nongovernment net financial assets, and taxation withdraws net financial assets from nongovernment. (2) Debt issuance by the Treasury is a monetary operation for draining reserves to permit the CB to hit its target rate.

These principles are then applied to Y+C+I+G+NX to balance nominal aggregate demand with real output capacity in order to achieve full capacity utilization, hence, full employment, along with price stability. This is based not on theory requiring assumptions but on operational reality that can be represented using data, standard accounting identities, and stock-flow consistent macro models.

All of this and much more is explained in considerable detail at Bill Mitchell’s billy blog

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yet more on greece

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Gets stranger by the day:

Broke? Buy a few warships, France tells Greece

March 23 (Economic Times) — In a bizarre twist to the Greek debt crisis, France and Germany are pressing Greece to buy their gunboats and warplanes, even as they urge it to
cut public spending and curb its deficit.

Indeed, some Greek officials privately say Paris and Berlin are using the crisis as leverage to advance arms contracts or settle payment disputes, just when the Greeks are trying to reduce defense spending.

“No one is saying ‘Buy our warships or we won’t bail you out’, but the clear implication is that they will be more supportive if we do what they want on the armaments front,” said an adviser to Prime Minister George Papandreou, speaking on condition of anonymity because of the diplomatic sensitivity.

Greece spends more of its gross domestic product on the military than any other European Union country, largely due to long-standing tension with its neighbour, historic rival and NATO ally, Turkey.

“The Germans and the French have them over a barrel now,” said Nick Witney, a former head of the European Defense Agency.

“If you are trying to repair Greek public finances, it’s a ludicrous way to go about things.”

France is pushing to sell six frigates, 15 helicopters and up to 40 top-of-the-range Rafale fighter aircraft.

Greek and French officials said President Nicolas Sarkozy was personally involved and had broached the matter when Papandreou visited France last month to seek support in the financial crisis.

FRIGATE PURCHASE

The Greeks were so sensitive to Sarkozy’s concerns that they announced on the day Papandreou went to Paris that they would go ahead with buying six Fremm frigates worth 2.5 billion euros ($3.38 billion), despite their budget woes.

The ships are made by the state-controlled shipyard DCNS, which is a quarter owned by defense electronics group Thales and may have to lay workers off in the downturn.

Greece is also in talks buy 15 French Super Puma search-and-rescue helicopters made by aerospace giant EADS for an estimated 400 million euros.

The Rafale, made by Dassault Aviation, is a more distant and vastly dearer prospect. There is no published price, but each costs over $100 million, plus weapons.

Germany is meanwhile pressing Athens to pay for a diesel-electric submarine from ThyssenKrupp, of which it refused to take delivery in 2006 because the craft listed during sea trials following a disputed refurbishment in Kiel.

Payment would clear the way for ThyssenKrupp to sell its loss-making Greek unit Hellenic Shipyards, the biggest shipbuilder in the eastern Mediterranean, to Abu Dhabi MAR, industry sources said.

ThyssenKrupp Marine Systems last year canceled a Greek order for four other submarines over the dispute, in which it said Athens’ arrears exceeded 520 million euros.

Witney, now at the European Council on Foreign Relations, said German officials were embittered by Greek behavior in the long-running dispute, as well as previous payment problems over the purchase of German Leopard II tanks.

Greek Deputy Defense Minister Panos Beglitis told Reuters the dispute was on the brink of settlement but denied the timing had anything to do with Athens’ bid to clinch German backing this week for a financial safety net for Greek debt.

“(The submarine) Papanicolis has been carefully inspected by German and Greek experts. It has been greatly improved and declared seaworthy. We will take it, sell it and make a profit,” he said in an interview.

“We are paying 300 million (euros) and we will sell it for 350 million,” Beglitis said. Witney questioned Greece’s chances of turning a profit on a second-hand submarine.

NO LINKAGE?

Asked whether big European suppliers were using the crisis to press arms sales on Athens, he said: “This has always been the case with these countries. It is not because of the crisis, there is no link.”

Beglitis said this year’s defense budget was set at 2.8 per cent of GDP, down from 3.1 per cent in 2009. Non-government sources say the real level of military spending may be higher.

“Our strategy is continuously and steadily to reduce spending. This is also in line with the Greek stability and growth program,” Beglitis said. The program, submitted to the EU, pledges to reduce the budget deficit from 12.9 per cent last year to below 3 per cent by the end of 2012.

Western officials and economists have advocated a radical reduction of the armed forces as a long-term way of reducing structural spending, but Greek officials say that would require a real improvement in relations with Turkey.

Despite warmer ties, the two countries remain in dispute over Cyprus and maritime boundaries and have sporadic aerial incidents over the Aegean Sea.

French economist Jacques Delpla said Greece could reap big savings if it moved jointly with Turkey and Cyprus to settle disputes in the Aegean and Eastern Mediterranean and engaged in mutual disarmament.

“Unlike Portugal or Ireland, Greece could benefit from significant peace dividends to reduce its titanic fiscal deficits,” he said.

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In paradigm Health Care criticism from the left

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This Is Not The Way To Do Healthcare Reform: Democrats Propose Windfall For Insurance Industry

By L. Randall Wray

It is beginning to look like Congress is going to vote to pass health care legislation on Sunday. According to the NYTimes, Democrats are practically celebrating already. here
It is interesting, however, that no one is talking about providing benefits to the currently underserved.
Rather, the “good news” is that the bill is supposed to be “the largest deficit reduction of any bill we have adopted in Congress since 1993,” according to House Democratic leader, Rep.Steny H. Hoyer of Maryland. “We are absolutely giddy over the great news,” said the House’s number three Democrat, Rep. James Clyburn of South Carolina. (Of course, deficit hysteria is nothing new. See here


Who would have thought that health care “reform” would morph into deficit cutting?

As Marshall Auerback and I argue in a new policy brief here
, the proposed legislation is not “reform” and it will not reduce US health care costs. I will not repeat the arguments there. But very briefly, the most significant outcome of this legislation is the windfall gain for insurance companies—who will be able to tap the wages of the huge pool of nearly 50 million Americans who currently do not purchase health insurance. Since many of these are too poor to afford the premiums, the government will kick in hundreds of billions of dollars to line the pockets of health insurers. This legislation has nothing to do with improving health services for the currently underserved—it is all about increasing the insurance sector’s share of the economy.

You might wonder how Democrats can call this a deficit reduction deal? Elementary, dear Watson. They will slash Medicare spending. No wonder—it stands as an alternative to the US’s massively inefficient private insurance system, hence, needs to be downsized in favor of an upsized private system.

There is nothing in the deal that will significantly reduce health care costs. At best, it will simply shift more costs to employers and employees—higher premiums, higher deductibles, higher co-pays, and more exclusions forcing higher out-of-pocket expenses and personal bankruptcies. As we show in our paper, the US’s high health care costs (at 17% of GDP, double or triple the per capita costs in other similarly wealthy nations) are due to three factors. As many commentators have argued (especially those who advocate single-payer) part of the difference is due to the costs of operating a complex payment system that relies on private insurers—resulting in paperwork and overhead costs, plus high profits and executive compensation for insurance executives. This adds about 25% to our health care system costs. Obviously, the proposed legislation is “business as usual”, actually adding more insurance costs to our system.

In addition, Americans spend more for medical supplies and drugs. Since the Democrats ruled out any attempt to constrain Big Pharma through, for example, negotiating lower prices for drugs, there will not be any savings there.

Finally, and most importantly, the biggest contributor to higher US health care costs is our American “lifestyle”: too little exercise, too much bad food, and too much risky behavior (such as smoking). here
 This is why we spend far more on outpatient costs for chronic diseases such as diabetes—40% of healthcare spending and rising rapidly. Ending the subsidies to Big Agriculture that produces the products that make us sick would not only do more to improve US health outcomes than will the proposed legislation, but it would also reduce health care spending—while reducing government spending at the same time. That would be real healthcare reform! But, of course, no one talks about this.

Interestingly, according to the NYTimes article, President Obama likened the legislation to fixing the financial system or passing the economic recovery act. “I knew these things might not be popular, but I was absolutely positive that it was the right thing to do,” he said. That is an apt and scary comparison. This legislation will do as much to “fix” the US healthcare system as the Obama administration has done to “fix” the financial sector and to put the economy on the road to recovery?

Of course, we have not done anything to “fix” the financial sector, or to put Mainstreet on the road to recovery.

I think the President’s comparison is uncannily accurate. So far the main thing his administration has done is to funnel trillions of dollars to the FIRE sector in an attempt to restore money manager capitalism. The current legislation will simply continue that policy—the trillions spent so far to bail-out Wall Street have not been nearly enough. Hence, the effort to funnel billions more to the insurance industry.

But what is the connection between Wall Street and health insurers? As Marshall and I argue in our brief, they are “two peas in a pod” since the deregulation of financial institutions. We threw out the Glass-Steagall Act that separated commercial banking from investment banking and insurance with the Gramm-Leach-Bliley Act of 1999 that let Wall Street form Bank Holding Companies that integrate the full range of “financial services”, that sell toxic waste mortgage securities to your pension funds, that create commodity futures indexes for university endowments to drive up the price of your petrol, and that take bets on the deaths of firms, countries, and your loved ones. See also here


Hence, extension of healthcare insurance represents yet another unwelcome intrusion of finance into every part of our economy and our lives. In other words, the “reforms” envisioned would simply complete the financialization of healthcare that is already sucking money and resources into the same black hole that swallowed residential real estate. here


Just as the bail-out of Wall Street was sold on the argument that we need to save the big banks so that they will increase lending to Main Street, health care “reform” was initially promoted as a way to improve provision of healthcare to the underserved. What we got instead is a bail-out for insurers and cuts to Medicare. Funny how that happens.

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detail for book

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The following, from a 2005 paper of mine, provides a good summary of the argument with quotations and bibliographic citations. Feel free to use for any project of Warren Mosler, as per his instructions. Also, please let me know if you have any further questions or I can provide any additional information. In addition to the information on Colonial Africa, I have added a brief section on Europe and Asia, where the same phenomenon can be found. Also, I refer to a 2006 paper of mine that provides evidence that many of the most famous names in the history of economics were well aware of the phenomenon. Also many political scientists, policy-makers, sociologists, historians, etc. Finally, I have also documented the “tax-driven cowrie shell” from both Africa and Asia, that is, contrary to what has previously been thought (by such economists as Milton Friedman), cowrie currency was not a so-called ‘primitive’ money, but was similarly tax-driven as colonial currency or today’s dollar. Let me know if you would like these references as well.

The economist “Rodney” Warren refers to is Walter Rodney, and his book is in the bibliography. I provide examples from many African colonies, such as Nigeria, German East Africa, French West Africa, British Central Africa, Upper Volta, Southern Rhodesia, and South Africa, but not specifically Ghana. If you need examples specifically from Ghana, let me know and I can provide them.

Once again, please do not hesitate to contact me directly anytime for further assistance. My contact info follows.

Sincerely,

Mathew Forstater

Professor of Economics

University of Missouri—Kansas City

From:

Mathew Forstater, 2005, “Taxation and Primitive Accumulation: The Case of Colonial Africa” in Research in Political Economy, Vol. 22, pp. 51-64.

Direct taxation [and the requirement that tax obligations be settled in colonial currency] was used to force Africans to work as wage laborers, to compel them to grow cash crops, to stimulate labor migration and control labor supply, and to monetize the African economies. Part of this latter was to further incorporate African economies into the larger emerging global capitalist system as purchasers of European goods. If Africans were working as wage laborers or growing cash crops instead of producing their own subsistence, they would be forced to purchase their means of subsistence, and that increasingly meant purchasing European goods, providing European capital with additional markets. It thus also promoted, in various ways, marketization and commoditization. [Direct taxation] appears to have been one of the most powerful policies in terms of both its wide variety of functions, its universality in the African colonial context, and its success in achieving its intended effects. Of course, taxation was not the sole determinant of primitive accumulation [note: “primitive accumulation” or similar terms such as primary accumulation or original accumulation, was a term used by the Classical economists, such as Adam Smith, David Ricardo, and Karl Marx to refer to the process by which subsistence workers became wage-laborers, and the process of early capitalist development in general]. But it has certainly been under-recognized in the literature on primitive accumulation. The history of direct taxation also has some wider theoretical implications. It shows, for example, “that ‘monetization’ did not spring forth from barter; nor did it require ‘trust’—as most stories about the origins of money claim” (Wray, 1998, p. 61). In the colonial context, money was clearly a “creature of the state”. In addition, this phenomenon was in no way unique to the African case. As will be seen following the section on Africa, the same process was also found in Europe, Asia, and elsewhere.

TAXATION AND PRIMITIVE ACCUMULATION IN COLONIAL AFRICA

Colonial administrators at first believed that market incentives and persuasion might result in a forthcoming supply of labor:

Initially the French imagined that if they would only create new needs for the Africans, the indigenous people would go out to work. When this did not happen, the French introduced taxes so as to make Africans earn wages. (Coquery-Vidrovitch, 1969, pp. 170-171)

From the first it was assumed that ample cheap labor was a major asset in Africa…Practical experience soon showed, however, that Africans did not, as a rule, approximate to Indian coolies. Few in sub-Saharan African had experience of working for pay or outside the traditional subsistence economy, and few had any real need to do so. In course of time monetary incentives might generate a voluntary labor force, but during the first decades after pacification neither governments nor private investors could afford to wait indefinitely for the market to work this revolution. (Fieldhouse, 1971, p. 620)

A number of methods were utilized to compel Africans to provide labor and cash crops. Among these were work requirements, pressure for ‘volunteers’, land policy squeezing Africans into ‘reserves’ destroying the subsistence economy, and ‘contracts’ with penal sanctions (Fieldhouse, 1971, pp. 620-621). But the most successful method turned out to be direct taxation.

Direct taxation was used throughout Africa to compel Africans to produce cash crops instead of subsistence crops and to force Africans to work as wage laborers on European farms and mines:

In those parts of Africa where land was still in African hands, colonial governments forced Africans to produce cash crops no matter how low the prices were. The favourite technique was taxation. Money taxes were introduced on numerous items—cattle, land, houses, and the people themselves. Money to pay taxes was got by growing cash crops or working on European farms or in their mines. (Rodney, 1972, p. 165, original emphasis)

The requirement that taxes be paid in colonial currency rather than in-kind was essential to producing the desired outcome, as well as to monetize the African communities, another part of colonial capitalist primitive accumulation and helping to create markets for the sale of European goods:

African economies were monetised by imposing taxes and insisting on payments of taxes with European currency. The experience with paying taxes was not new to Africa. What was new was the requirement that the taxes be paid in European currency. Compulsory payment of taxes in European currency was a critical measure in the monetization of African economies as well as the spread of wage labor. (Ake, 1981, pp. 333-334)

Colonial governors and other administrators were well aware of this ‘secret’ of colonial capitalist primitive accumulation, although they often justified the taxation on other grounds, some ideological and others demonstrating the multiple purposes of taxation from the colonial point of view. “One Governor, Sir Perry Girouard, is reported to say: ‘We consider that taxation is the only possible method of compelling the native to leave his reserve for the purpose of seeking work’” (Buell, 1928, p. 331). First Governor General of the Colony and Protectorate of Nigeria, Sir Frederick Lugard’s Political Memoranda and Political Testimonies are filled with evidence regarding direct taxation: “Experience seems to point to the conclusion that in a country so fertile as this, direct taxation is a moral benefit to the people by stimulating industry and production” (Lugard, 1965a, p. 118). Lugard’s belief that “Direct taxation may be said to be the corollary of the abolition, however, gradual, of forced labour and domestic slavery” (1965a, p. 118), acknowledges the role of direct taxation in forcing Africans to become wage-laborers. Lugard was also clear that the “tax must be collected in cash wherever possible…The tax thus promotes the circulation of currency with its attendant benefits to trade” (1965a, p. 132).

Lugard and other colonial administrators cited a number of other justifications for direct taxation:

Even though the collection of the small tribute from primitive tribes may at first seem to give more trouble than it is worth, it is in my view of great importance as an acknowledgement of British Suzerainty…It is, moreover, a matter of justice that all should pay their share alike, whether civilized or uncivilized, and those who pay are quick to resent the immunity of others. Finally, and in my judgment the most cogent reason, lies in the fact that the contact with officials, which the assessment and collection necessitates, brings these tribes into touch with civilizing influences, and promotes confidence and appreciation of the aims of Government, with the security it affords from slave raids and extortion.” (Lugard, 1965b, pp. 129-130)

The tax affords a means to creating and enforcing native authority, of curbing lawlessness, and assisting in tribal evolution, and hence it becomes a moral benefit, and is justified by the immunity from slave-raids which the people now enjoy.” (p. 173)

Taxation was also justified on grounds that it assisted in ‘civilizing’ African peoples: “For the native,” Ponty stated in 1911, “taxation, far from being the sign of a humiliating servitude, is seen rather as proof that he is beginning to rise on the ladder of humanity, that he has entered upon the path of civilization. To ask him to contribute to our common expenses is, so to speak, to elevate him in the social hierarchy” (Conklin, 1997, p. 144). Colonial tax policies were also introduced in the name of the ‘dignity’ of, and the obligation to, work, where contact with Europeans again was emphasized:

From this need for native labor, the theory of the dignity of labor has developed; this dignity has been chiefly noticeable in connection with labor in the alienated areas. The theory has also developed that it is preferable for the native to have direct contact with the white race so that his advance in civilization should be more rapid than if he remained in his tribal area attending to his own affairs. This is the “inter-penetration” theory in contrast to the “reserve” or “separation” theory. (Dilley, 1937, p. 214)

All of these functions of direct taxation may be seen in some sense as part of colonial capitalist primitive accumulation, whether as assisting in promoting marketization or serving ideological functions in the reproduction of the colonial capitalist mode.

Several points concerning the role of direct taxation in colonial capitalist primitive accumulation need to be made. First, direct taxation means that the tax cannot be, e.g., an income tax. An income tax cannot assure that a population that possesses the means of production to produce their own subsistence will enter wage labor or grow cash crops. If they simply continue to engage in subsistence production, they can avoid the cash economy and thus escape the income tax and any need for colonial currency. The tax must therefore be a direct tax, such as the poll tax, hut tax, head tax, wife tax, and land tax. Second, although taxation was often imposed in the name of securing revenue for the colonial coffers, and the tax was justified in the name of Africans bearing some of the financial burden of running the colonial state, in fact the colonial government did not need the colonial currency held by Africans. What they needed was for the African population to need the currency, and that was the purpose of the direct tax. The colonial government and European settlers must ultimately be the source of the currency, so they did not need it from the Africans. It was a means of compelling the African to sell goods and services, especially labor services for the currency. Despite the claims by the colonial officials that the taxes were a revenue source, there is indication that they understood the working of the system well. For example, often the tax was called a “labor tax” or “prestation.” Under this system, one was relieved of their tax obligation if one could show that one had worked for some stated length of time for Europeans in the previous year (see, e.g., Christopher, 1984, pp. 56-57; Crowder, 1968, p. 185; Davidson, 1974, pp. 256-257; Dilley, 1937, p. 214; Wieschoff, 1944, p. 37). It is clear in this case that the purpose of the tax was not to produce revenue.

To achieve its intended effects, it was also important that the direct tax be enforced, and numerous penalties existed for failing to meet one’s obligation. In German East Africa, “Sanctions against non-payment were severe—huts were burnt and cattle confiscated—so tax defaulters were not numerous” (Gann and Duignan, 1977, pp. 202-203). All kinds of harsh penalties for failing to pay taxes have been documented:

If a man refused to pay his taxes, the Mossi chief was permitted to sequester his goods and sell them. If the man had neither the taxes nor the goods, the chief had to send him and his wife (or wives) to the administrative post to be punished. Sometimes, a man and his wife would be made to look at the sun from sunrise to sunset while intoning the prayer Puennam co mam ligidi (“God, give me money”). Other times a man would be made to run around the administrative post with his wife on his back; if he had several wives, he had to take each one in turn. Then his wife or wives had to carry him around. (Skinner, 1970, p. 127)

Collective punishments were also used widely to enforce the tax. At the very least, failure to “pay could be met, and regularly was met, by visits from the colonial police and spells of ‘prison labour’.” (Davidson, 1974, pp. 256-257)

Another important element in assuring the smooth functioning of the direct tax system was keeping wages low, which had the additional benefit of keeping costs down for private employers. If wages were too high relative to the tax burden, Africans would only work enough to pay off their tax obligation and the labor supply would remain limited:

While taxation is high, wages are very low. It would not do to pay the Natives too much for they would not work a day more than it was absolutely necessary to get tax money. So employers pay the minimum in order to exploit their labourers as long as possible. (Padmore, 1936, p. 67)

Direct taxation was also used to promote and control migration of wage labor. If wage labor and money for cash crops was not available locally, Africans were forced to migrate to plantations and mines to find money wages (see, e.g., Greenberg, 1987; Groves, 1969; Onselan, 1976; although see also Manchulle, 1997, especially p. 8, for a critique).

TAXATION AND PRIMITIVE ACCUMULATION IN EUROPE AND ASIA

In arguing that taxation played an important role in primitive accumulation, this paper has focused on the case of Colonial Africa, but this should in no way imply that the process was limited to Africa. Evidence has already been mentioned in passing with reference to Russia and elsewhere. Vries, in a section entitled “Taxes, the Financial Revolution, War, Primitive Accumulation, and Empire” from his article “Governing Growth: A Comparative Analysis of the Role of the State in the Rise of the West” (Vries, 2002), argues that:

Praising Europe’s state-system and its mercantilist competition implies, whether one likes it or not, praising taxes. The increase of taxation we see in mercantilist countries may also have been a blessing in disguise. Paying them may have been an unpleasant experience, but it need not necessarily have been a bad thing from a macro-economic point of view. It is not farfetched to expect that ever-increasing taxes forced people to work harder and longer. Since the economy of large parts of early modern Europe was characterized by un(der)employment and under-utilization of the available means of production, there was plenty of room for increased production. Moreover, the fact that taxes were collected in money, led to increasing commercialization. Which in turn could increase government income via indirect taxes. (Vries, 2002, p. 75)

Despite Vries’ view of the process as a ‘blessing’, etc., it is clear that the description highlights the ways in which money taxes affected labor supply and monetization in early modern Europe, and even uses the term ‘primitive accumulation’. Later in the article, Vries reports that, in China, “one finds officials proclaiming that taxes ought to be raised to force the populace to work harder” (Vries, 2002, p. 95; for more on China, see Von Glahn, 1996). Vries goes on to report that this development took place throughout Europe and Asia:

When it comes to the way taxes were levied, monetization appears to be the tendency in the entire Eurasian continent. This process had progressed furthest in Europe. All governments preferred to get their income in money and to a very large extent managed to do so. In China an important grain levy continued to exist, but all other important government taxes had gradually been transformed into monetary payments. In India taxes for the central government had to be paid in cash. In the Ottoman Empire monetization made the least progress, but with the increasing weight of cizye, avariz, and tax farming, here too cash payments were on the rise. (Vries, p. 98)

Additional support for Europe and Western Asia is provided by Banaji (2001). Evidence for the notion that money taxes force pressures for increased market activity is provided by the reverse development, namely that a “decline in the exaction of money taxes brought about a decline in trade” (Hopkins, 1980, p. 116, quoted in Banaji, 2001, p. 16). Banaji goes on to report that:

the relentless pressure for taxation in money would also mean that despite the commercial decline which is supposed to have occurred in the Mediterranean of the seventh century, Egyptian landowners and rural communities were undoubtedly forced to meet their monetary obligations through increased production for the market (or participation in it as wage-labourers). (Banaji, 2001, p. 158)

Additional research is necessary to provide a more comprehensive and detailed documentation of the role of monetary taxation in monetization, marketization, and the creation of wage-labor and cash crop production in other regions and time periods, but it is clear that the historical process was in no way confined to Colonial Africa. The fact that various aspects of the phenomenon were recognized by economists as geographically, temporally, and theoretically diverse as Adam Smith, John Stuart Mill, Karl Marx, Fred M. Taylor, Philip Henry Wicksteed, W. Stanley Jevons, Karl Polanyi, and John Maynard Keynes supports the position that it existed with a great deal of generality (see Forstater, 2006).

BIBLIOGRAPHY

Ake, Claude, 1981, A Political Economy of Africa, Essex, England: Longman Press.

Amin, Samir, 1976, Unequal Development, New York: Monthly Review Press.

Banaji, Jairus, 2001, Agrarian Change in Late Antiquity, Oxford: Oxford University Press.

Buell, Raymond Leslie, 1928, The Native Problem in Africa, Vol. 1, New York: Macmillan.

Christopher, A. J., 1984, Colonial Africa, London: Croom Helm.

Conklin, Alice L., 1997, A Mission to Civilize: The Republican Idea of Empire in France and West Africa, 1895-1930, Stanford, CA: Stanford University Press.

Coquery-Vidrovitch, Catherine, 1969, “French Colonization in Africa to 1920: Administration and Economic Development,” in L. H. Gann and P. Duignan (eds.), Colonialism in Africa, 1870-1914, Volume 1: The History and Politics of Colonialism, 1870-1914, Cambridge: Cambridge University Press.

Coquery-Vidrovitch, Catherine, 1986, “French Black Africa,” in A. D. Roberts (ed.), The Cambridge History of Africa, Volume 7, from 1905 to 1940, Cambridge: Cambridge University Press.

Crowder Michael, 1968, West Africa Under Colonial Rule, Evanston, IL: Northwestern University Press.

Crowder, Michael, 1970, “The White Chiefs of Tropical Africa,” in L. H. Gann and P. Duignan (eds.), Colonialism in Africa, 1870-1960, Volume II: The History and Politics of Colonialism, 1914-1960, Cambridge: Cambridge University Press.

Davidson, Basil, 1974, Africa in History, new revised edition, New York: Collier.

Dilley, Marjorie Ruth, 1937, British Policy in Kenya, New York: Barnes and Noble.

Fieldhouse, David K., 1971, “The Economic Exploitation of Africa: Some British and French Comparisons,” in P. Gifford and W. R. Louis (eds.), France and Britain in Africa: Imperial Rivalry and Colonial Rule, New Haven, CT: Yale University Press.

Forstater, Mathew, 2006, “Tax-Driven Money: Additional Evidence from the History of Thought, Economic History, and Economic Policy,” in M. Setterfield, ed., Complexity, Endogenous Money, and Exogenous Interest Rates: Festschrift in Honor of Basil J. Moore, Cheltenham, U.K.: Edward Elgar.

Freund, Bill, 1984, The Making of Contemporary Africa, Bloomington, Indiana University Press.

Gann, L. H. and Peter Duignan, 1977, The Rulers of German Africa, 1884-1914, Stanford, CA: Stanford University Press.

Greenberg, Stanley B., 1987, Legitimating the Illegitimate: State, Markets, and Resistance in South Africa, Berkeley, CA: University of California Press.

Groves, Charles Pelham, 1969, “Missionary and Humanitarian Aspects of Imperialism from 1870 to 1914,” in L. H. Gann and P. Duignan (eds.), Colonialism in Africa, 1870-1914, Volume 1: The History and Politics of Colonialism, 1870-1914, Cambridge: Cambridge University Press.

Lugard, F. D., 1965a [1906, 1918], “Lugard’s Political Memoranda: Taxation, Memo No. 5” in A. H. M. Kirk-Greene (ed.), The Principles of Native Administration in Nigeria: Selected Documents, 1900-1947, London: Oxford University Press.

Lugard, F. D., 1965b [1922], “Lugard’s Political Testimony,” in A. H. M. Kirk-Greene (ed.), The Principles of Native Administration in Nigeria: Selected Documents, 1900-1947, London: Oxford University Press.

Manchulle, François, 1997, Willing Migrants: Soninke Labor Diasporas, 1848-1960, Athens, OH: Ohio University Press.

McCracken, John, 1986, “British Central Africa,” in A. D. Roberts (ed.), The Cambridge History of Africa, Volume 7, from 1905 to 1940, Cambridge: Cambridge University Press.

Onselan, Charles van, 1976, Chibaro: African Mine Labour in Southern Rhodesia, 1900-1933, London: Pluto Press.

Padmore, George, 1936, How Britain Rules Africa, New York: Negro Universities Press.

Rodney, Walter, 1972, How Europe Underdeveloped Africa, Washington, D. C.: Howard University Press.

Skinner, Elliott P., 1970, “French Colonialism and Transformation of Traditional Elites: Case of Upper Volta,” in W. Cartey and M. Kilson (eds.), The Africa Reader: Colonial Africa, New York: Random House.

Temu, A., and B. Swai, 1981, Historians and Africanist History: A Critique, London: Zed Books.

Thomas, Clive Y., 1984, The Rise of the Authoritarian State in Peripheral Societies, New York: Monthly Review Press.

Von Glahn, Richard, 1996, Fountain of Fortune, Berkeley: University of California Press.

Vries, P. H. H., 2002, ““Governing Growth: A Comparative Analysis of the Role of the State in the Rise of the West,” Journal of World History, Vol. 13, No. 1, pp. 67-138.

Wieschoff, H. A., 1944, Colonial Policies in Africa, Philadelphia: University of Pennsylvania Press.

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Dallas address

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This is the text of the address I gave at Dallas.

Will be repeating it in a northern Va meeting next weekend.

Still waiting for the video.

Feel free to distribute.

How tea party democrats can run successfully in the primaries

Honesty in government is a core value of the Tea Party movement and the most basic value in any representative democracy. Accordingly, my first proposal is that all candidates for public office be sworn in: ‘I solemnly swear to tell the truth, the whole truth, and nothing but the truth, so help me God.’ As a consequence, any subsequent lies are perjury, and punishable by law.

I am here to discuss how I believe Tea Party Democrats can win in upcoming Democratic primaries. The answer is to emulate and extend the success of the Tea Party movement by getting back to basics. The Democratic party is the party of Jefferson and Jackson. The founders believed that the public voice should be heard. They believed in limited government. And they never kowtowed to special interests or cowered before purveyors of the conventional wisdom. This means Tea Party Democrats should be running against the Obama administration’s policies which are counter to both traditional Democratic values and Tea Party values.

It is the Washington elite that have moved away from the ideals of Jefferson and Jackson with policies that are, at best, regressive, elitist, and destructive to our quality of life. For example, with unemployment rising, real wage growth falling, and GDP now growing at over 5%, who’s getting all that increase in real goods and services?

Not the millions who voted Democratic who are losing their jobs and their homes, and watching wages fall even as their cost of living goes up. All that real wealth being created is instead rising to the top, due to impossible trickle down policies that would have made even Reagan blush.

The large majority of Americans that elected this administration did not do so to enrich the bankers, insurance executives, drug companies, and union leaders at the expense of the rest of us, in a perversion of true core Democratic values. But it’s clearly happening as even a blind man can see. And all because they don’t understand the monetary system, how and why government spends and taxes, and why we don’t owe China anything more than a bank statement.

I will devote most of the rest of my time talking about the economy. In part, that is because it is my area of expertise, given that I have spent most of my adult life in financial markets. But the most important reason is it is in that arena that the Washington elite have failed us the most. The so-called economic experts have confused themselves and their political masters with contrived explanations for the way the economy works. Their limited vision has limited the range of policy choice. And the result has been a monumental economic disaster and human tragedy.

My first proposal for the economy encompasses both the Tea Party and traditional Democratic values of limited government, fiscal responsibility, and reliance on competitive markets. Working through the logic of this proposal will show both how this straightforward government policy can work, and how convoluted is the elite’s understanding of finance.

I believe that the surest engine for full economic recovery is a full payroll tax holiday. Payroll taxes take away over 15% of everyone’s paycheck, from the very first dollar earned. This is big money- about $1 trillion per year. Half comes from the employee and half from the employer. A payroll tax holiday does not give anyone anything. What it does is stop taking away $1 trillion a year from working people struggling to make their payments and stay in their homes, and businesses struggling to survive. A full payroll tax holiday means a husband and wife earning $50,000 a year each will see their combined take home pay go up by over $650 a month, so they can make their mortgage payments and their car payments and maybe even do a little shopping.

This fixes the banks and fixes the economy, from what I call the bottom up. It fixes the banks without giving them anything more than people who can afford to make their payments. That’s all they need to remain viable.

And what all businesses need most to expand output and employment is people with spending money who can buy their products. Without people to buy goods and services, nothing happens. The payroll tax holiday also means there is also a big reduction in expenses for business. With competitive markets this means lower prices, which also helps consumers, helps keep inflation down, helps businesses compete domestically and in world markets to help optimize our real terms of trade, and helps keep the currency stable as the dollar is ultimately worth what it can buy. So with the payroll tax holiday we get a dramatic increase in economic activity, rising employment in good jobs, and better prices. And we’ll see millions of new jobs, because, again, what business needs most is people with money to buy their products. Then they hire and expand.

What I don’t see is how any self respecting Democrat can allow this tax to stand for a single moment. It is the most regressive, punishing tax we’ve ever had. It starts from the first dollar earned with a cap at $106,800 per year. It’s an utter disgrace to the Democratic party. It should be immediately eliminated. Yet, instead, the Washington Democratic elite are actually discussing increasing it.

Let’s now back up and review how we got to where we are at this moment in time. Headline unemployment is unthinkably high at 10%, and if you count workers who have given up looking for a full time job, it’s over 17%. As you all know, it’s about the financial crisis. The banks got in trouble when their loans went bad. Well, what makes a loan go bad? Only one thing- people who can’t make their payments. If people make their payments, the loans are AAA. If people don’t make their payments the loans are junk and toxic waste. No matter what the security is- a loan, a cmo, cdo, clo, or whatever, it’s all the same. If people are making their loan payments there is no financial crisis. Unfortunately, instead of attacking the problem from the bottom up with a payroll tax holiday, we have an administration that thinks it first needs to fix the financial sector from the top down, before the real economy can improve. This is completely upside down. But the elites believe it, so that’s what they have done to us.

So starting with President Bush, and supported by both Senators McCain and Obama, they funded the financial sector with trillions, while they kept taking away trillions from people working for a living who couldn’t make their payments.

How does that help anyone make their payments, apart from a few bankers? It doesn’t.

What happened for the next year and a half? The banks muddled through, profits and bonuses returned, but unemployment skyrocketed and is still going up, loan delinquencies and defaults and foreclosures skyrocketed and are still going up, and millions of Americans still can’t make their payments and are losing their homes. And a lot of the money the banks are making on federal support is being drained by continuing loan losses. We are getting nowhere as tens of millions of lives are being destroyed by policy makers who simply don’t understand how the monetary system works.

This has been a trickle down policy where nothing has trickled down, because there is no connection between funding the banks, and the incomes of people trying to make their payments. The answer, of course, is instead of giving trillions to the banks, to simply stop taking away trillions from people still working for a living. The government doesn’t even have to give us anything, just stop taking away the trillion dollars a year of payroll taxes with a full payroll tax holiday.

But then there’s the nagging question of ‘how are we going to pay for it? Aren’t we just going to have to borrow more money from China and leave it for our children to pay back? And if it doesn’t work, then where are we, another trillion in debt with nothing to show for it?’
And, in fact the failure to understand that question of ‘how are you going to pay for it’ is exactly what has set the Democratic party, and the nation, on the current path of economic ruin. Therefore, to run successfully against the Democrats who support current policy it is critical you understand what I’m going to say next. This understanding is the basis for achieving our core values of limited government and lower taxes. And what I’m about to tell you is pure, undisputable fact, and not theory or philosophy.

So let me start by examining exactly how government spends at what’s called the operational level. In other words, exactly how does government spend? And this is for the federal government, not the State and local government, who are in much the same position as you and I are. Well, when the federal government spends, it simply changes numbers up in bank accounts. Last May Fed Chairman Bernanke answered Congressman Pelley’s question about where the money comes from that the banks are getting. Bernanke told him the banks have accounts at the Fed and the Fed simply ‘marks them up’- changes the numbers in their bank accounts.

• (PELLEY) Is that tax money that the Fed is spending?
• (BERNANKE) It’s not tax money. The banks have– accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.

The Chairman is exactly right. All government spending is simply a matter of changing numbers upward in our bank accounts. It doesn’t come from anywhere. Just like when you kick a field goal and get 3 points. Where does the stadium get those points? Right, they don’t come from anywhere. It’s just scorekeeping. And that’s exactly how government actually pays for anything.

All it ever does, and ever can do when it spends, is mark up numbers in bank accounts, as the Fed Chairman told us. And with online banking you can actually watch it happen. When a government payment hits your account you can actually watch as the numbers change upward on your computer screen. And notice I’ve never mentioned China or anyone else in this spending process. They are simply not involved. Spending is done by changing numbers higher in our bank accounts. What China does or doesn’t do has nothing to do with this process. Again, this is not some theory or philosophy. It’s simply how it actually works. I’ve been there, I’ve seen it. I grew up on the money desk at Banker’s Trust on Wall St. in the 70’s, and I visit the Fed regularly and discuss monetary operations. I know exactly how it all works.

Now let’s look at how government taxes. And keep in mind what any Congressman will tell you- we have to get money from taxing or borrowing to be able to spend it.
Well, with modern on line banking you can watch what happens when a tax is paid. Suppose you have $5,000 in your bank account and you write a check to the government for $1,000 to pay your taxes. What happens? You can see it on your computer screen. The number 5,000 changes into the number 4,000. The number 5 changes to the number 4. All the government did is change the number in your bank account. They didn’t ‘get’ anything. No gold coins dropped into a box at the Fed. Yes, they account for it, which means they keep track of what they do, but they don’t actually get anything that they give to anyone. The man at the IRS simply changes numbers down in our bank accounts when he collects taxes. And, if you pay your taxes with actual cash, they give you a receipt, and then shred it. How does taking your cash and shredding it pay for anything? It doesn’t. Taxes don’t give the government anything to use to make payments.

So the absolute fact of the matter is, the government never has nor doesn’t have dollars. It taxes by changing numbers down, but doesn’t get anything. It spends by changing numbers up and doesn’t use up anything. Government can’t ‘run out of money’ like our President has repeated many times. There isn’t anything to run out of. It’s just data entry, it’s score keeping. And it has nothing to do with China, which I’ll get to shortly.

So why then does the government tax at all? To control our spending power, which economists call aggregate demand. If the government didn’t tax us at all and let us spend all the money we earn, and government spent all the money it wanted to spend, the result would be a lot of inflation, caused by more spending then there are real goods and services for sale. Too much spending power chasing too few goods and services is a sure way to drive up prices. So the purpose of taxes is to regulate the economy. If the economy is too hot, taxes can be raised to cool it down. If the economy is too cold, as it obviously is today, taxes should be cut to warm it up back to operating temperature.

Taxes are like the thermostat. When it gets too hot or too cold you adjust it. It’s not about collecting revenues, there is no such thing, government never has nor doesn’t have any dollars, it just changes numbers up and down in our bank accounts. It’s all about looking at the economy and deciding whether it’s too hot or too cold, and then making an adjustment.

So, given all this, just what does ‘fiscal responsibility’ mean?
Fiscal responsibility means not overtaxing us to the point we are at today with record unemployment. And Fiscal Responsibility means not spending so much or taxing so little that the economy ‘overheats’ and inflation becomes a problem. That’s what fiscal responsibility means. That’s all it means. The government is responsible for getting the economy right, and the monetary system, including taxation, is a tool for that job.
Taxation is a tool to get the economy right.

So where does China and borrowing come into the picture? To be a successful Tea Party Democrat you will have to understand this and be able to explain it.
So first, how does China get its dollars? It sells things to us and gets paid for them.

And where does China keep its dollars? In a bank account at the Federal Reserve Bank which they call a reserve account. It’s nothing more than a checking account with a fancy name. And why does China buy Treasury securities? To earn a bit more interest.

And what is a Treasury security? It is nothing more than a savings account at the Federal Reserve Bank with a fancy name. And just like any other savings account at any other bank, with a Treasury security you give the Federal Reserve Bank money, and you get it back plus interest. So when China buys a Treasury security, what happens? The Fed moves their funds- the money they earned from selling things to us- from their checking account at the Fed to their savings account at the Fed.

And what happens when those Treasury securities- savings accounts- come due? How do we pay off China? The Fed just moves the funds from China’s savings account at the Fed back to their checking account at the Fed, and makes the number a little higher to include the interest. That’s it. Debt paid. And our children will continue to do this just like our fathers did before us. None of this involves what we call government spending. When government spends to buy something or pay someone else, it just ‘marks up’- as Chairman Bernanke put it- numbers in bank accounts. China’s bank accounts at the Fed are not involved. So why is this administration kowtowing to China on everything from Korea to human rights? And why do we go over there, thinking they are our government’s bankers, worried about getting their money to spend on everything from health care to Afghanistan, when there is no such thing as the US government getting money to spend? Why? There is only one reason. This administration does not understand the monetary system. They reason the Democrats are against a payroll tax holiday is because they think they need those actual revenues to support their spending.

So yes, we are grossly overtaxed and that’s what’s causing the sky high unemployment and the failed economy, as well as the ongoing banking crisis. And fiscal responsibility means setting taxes at the right level to sustain our spending power- not to hot and not too cold, but just right for optimal output and employment and price stability, and a return to prosperity.

And this brings up the next question, which is how to determine the right size of government. First, tax revenues don’t tell us anything about that. Taxing is just changing numbers down. It doesn’t give us anything to spend. Spending is changing numbers up; there is no numerical limit to spending.

So how do we decide how much government we want if the money doesn’t tell us anything? We do it on a very practical level. For example, when it comes to the military we need to ask ourselves, how many soldiers do we need to defend ourselves? How many planes, boats, tanks, and missiles do we need? The more we need, the more people we take who could be in the private sector producing real private sector goods and services, including doctors and nurses, teachers and teaching assistants, scientists and engineers, etc. etc. The military also uses up real resources like oil and steel. That’s the real cost of the military- how many people and resources it takes away from productive private sector activity.

What is the right size for the legal system? That depends on how long you want to wait for a court date, or for a decision. If the process is too slow, we may need more people working there, or we may need better technology. And again, the more people in government, the fewer there are to work in the private sector.

Once we have decided on the ‘right size’ of government, and pay for it by changing numbers up in people’s bank accounts when government spends, we have to decide the right amount to tax to keep the economy not too hot and not too cold, but just right. My educated guess would be, in a normal economy, to start with taxes that are less then spending by about 5% of GDP, if history is any guide. If I’m wrong taxes can either be lowered or raised to get it right. And when government spends more than it taxes- when it changes numbers up more than it changes down- we call that difference the budget deficit.

And when government changes more numbers changed up than down, the economy has exactly that many more dollars in it, which adds exactly that much to the savings of the economy. In fact, in US National Income Accounting, as taught in economics 101, the government deficit equals the total savings of financial assets in the rest of the economy, to the penny. Yes, deficits add to our monetary savings, to the penny. And everyone I’ve talked to in the Congressional Budget Office knows it. And it’s just common sense as well that if government changes numbers up in our bank accounts more than it changes them down, we have exactly that many more dollars.

Let me add one more thing about the size of government. It makes no sense to me to grow the size of the government just because the economy is too cold, if we already have the right sized government. And if we don’t have the right sized government we should immediately get it right, and then adjust taxes if the economy is too hot or too cold.
With this grasp of the fundamentals of taxing, spending, and the size of government, a Tea Party Democrat is well armed to take on the Democratic establishment that’s overtaxing us, driving up unemployment to today’s record levels, destroying our economy and standard of living, and arbitrarily growing government as well.

Conclusions:

Tea Party Democrats have a unique opportunity to be a part of history and overturn the ideas the current administration is employing that are, at best, regressive, elitist, and destructive to our quality of life.

With unemployment rising, real wage growth falling, and GDP now growing at about 4%, who’s getting that increased GDP? Not the millions who voted Democratic who are losing their jobs and their homes, and watching their wages fall. That real wealth being created is instead rising to the top, due to the Obama administration’s impossible trickle down policies. This administration was not elected to enrich the bankers, insurance executives, drug companies, and union leaders at the expense of the rest of us, in a perversion of true core Democratic values. But it’s clearly happening, and all because they don’t understand the monetary system, the don’t understand how and why government spends and taxes, and the don’t understand why we don’t owe China anything more than a bank statement.

The door is wide open for an enlightened, populist Democrat to lead the way to a new era of unsurpassed national prosperity.


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