Category Archives: Financial Times

Japan- G-7 Statement on Currencies, ‘Concerted Intervention’

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In the context of this ‘everyone’s out of paradigm’ world, it makes sense for Japan’s MOF (Ministry of Finance) to buy dollars vs yen.

But it makes no sense to do this as a coordinated effort with other nations also buying dollars vs yen.

It does make sense for the MOF to ask the G7 for permission to buy dollars, as the ‘out of paradigm’ world considers that kind of thing ‘currency manipulation,’ and brands those nations that do buy fx as currency manipulators and outlaws. And they consider this kind of ‘competitive devaluation’ as a ‘beggar thy neighbor’ policy that robs others of aggregate demand. The last thing they all want to happen is a trade war, where each nation buys the other’s currency trying to weaken his own.

So it’s interesting that the rest of world has agreed to allow Japan to conduct this kind of ’emergency measure.’ It probably means it will be short term and limited.

However the strong yen itself may have only been an initial, temporary phenomena as Japan’s domestic households and businesses move to hoard yen liquidity in anticipation of looming yen expenses. That includes reduced borrowing for the likes of cars and homes as well as widely discussed converting of dollar and other fx deposits to yen deposits. This all works to make the yen ‘harder to get’ and keep it firmly bid.

What follows the initial flight to yen liquidity, however, is the spending of the yen, which makes yen ‘easier to get’. And with that comes more spending on imports, which means those yen spent on net imports are likely to get sold for dollars and other fx by the exporters selling to Japan, to meet their own ongoing liquidity needs.

Additionally, Japan”s budget deficit will rise, which makes yen easier to get by adding yen income and net financial assets to the economy, all of which contributes to a weaker yen. The deficit can rise either proactively, as may be happening with the (relatively modest, but a good start)10 trillion yen govt. rebuilding initiative just now announced, or reactively via increased transfer payments and falling tax revenues due to the fall off in economic activity.

And if they try to contain their deficit spending by implementing the consumption tax hike recently discussed, that will only make things worse, and further increase the reactive deficit spending.

Also, weaker exports and a smaller trade surplus due to supply issues likewise weaken the yen.

As for the BOJ, nothing they do with regards to ‘liquidity injections’ will matter, apart from keeping rates about where they are.

And not to forget that what’s happening in the Middle East, where that pot is still boiling as well.

In my humble opinion this remains a good time to be on the sidelines.

G-7 Statement on Currencies, ‘Concerted Intervention’

March 18 (Bloomberg) — The following is a joint statement
released today by officials from the Group of Seven industrial
nations. The G-7 includes the U.S., Japan, Germany, France, the
U.K., Italy and Canada.

“We, the G-7 Finance Ministers and Central Bank Governors,
discussed the recent dramatic events in Japan and were briefed
by our Japanese colleagues on the current situation and the
economic and financial response put in place by the authorities.


“We express our solidarity with the Japanese people in
these difficult times, our readiness to provide any needed
cooperation and our confidence in the resilience of the Japanese
economy and financial sector.

“In response to recent movements in the exchange rate of
the yen associated with the tragic events in Japan, and at the
request of the Japanese authorities, the authorities of the
United States, the United Kingdom, Canada, and the European
Central Bank will join with Japan, on March 18, 2011, in
concerted intervention in exchange markets. As we have long
stated, excess volatility and disorderly movements in exchange
rates have adverse implications for economic and financial
stability. We will monitor exchange markets closely and will
cooperate as appropriate.”

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UBS Says Faces LIBOR Manipulation Probe

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As previously discussed, the US should outlaw the use of libor by its banking system.
It makes no sense to allow US dollar rate setting for our banks to be set overseas by the BBA.
Setting our banking system’s dollar rates is the Fed’s responsibility.

And, to further make the point, note the word ‘expect’ in this part from below:

“LIBOR is calculated daily by asking contributing banks the rate at which they expect term funding to be offered between prime banks at 11:00 am London time.”

See more of my proposals here.

UBS Says Faces LIBOR Manipulation Probe

March 16 (Reuters) — Swiss bank UBS said it had received subpoenas from U.S. and Japanese regulators regarding whether it made “improper attempts” to manipulate LIBOR rates, the benchmark price for interbank borrowing costs.

“UBS understands that the investigations focus on whether there were improper attempts by UBS, either acting on its own or together with others, to manipulate LIBOR rates at certain times,” the bank said in its annual report on Tuesday.

The Financial Times in its Wednesday edition said regulators, including Britain’s Financial Services Authority, are probing all 16 banks that help the British Bankers’ Association (BBA) set LIBOR rates.

In particular, they are investigating how LIBOR was set for U.S. dollars during 2006-2008, just before and after the financial crisis, the newspaper said, citing sources familiar with the probes.

UBS said it had received subpoenas from the U.S. SEC, Commodity Futures Trading Commission and Department of Justice regarding its submissions to the BBA. It has also been ordered to provide information to the Japan Financial Supervisory Agency concerning similar matters.

UBS said it was conducting an internal review and is cooperating with the investigations. It declined to provide any further details.

The SEC declined to comment.

BBA said LIBOR has a straightforward and transparent calculation method which excludes any rates that are significant outliers.

“We observe rigorous standards in our scrutiny and governance of the LIBOR mechanism, and work with the industry to ensure their continued full confidence in one of its most accurate and reliable benchmarks,” it said in a statement.

LIBOR is calculated daily by asking contributing banks the rate at which they expect term funding to be offered between prime banks at 11:00 am London time. A set number of the highest and lowest contributions are discarded and the remaining rates averaged.

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Excellent post on the MMT controversy

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Straw Men (And Women)

By Peter Cooper

This post is for all the MMT foot soldiers out there in cyberspace, including myself and most readers (prominent MMT economists who are kind enough to drop in from time to time excepted, of course).

Come on, we know who we are. Battling it out in diverse message forums, matching wits with fellow participants who, judging from their arguments, mostly appear to read our posts with their eyes shut and their fingers in their ears to block out the sounds of our linked video presentations. This navel-gazing exercise may seem self-indulgent to the crustier MMT old-timers among us, but, hey, rationalize it, we deserve it!

The post is also for readers who have not yet made up their minds about MMT. Think of this as a small taste of the kind of self-congratulatory back slapping you too will be able to enjoy at heteconomist if you decide to join the ranks of the foot soldiers. Enjoy! You also deserve it!

Straw Men in Cyberspace

On a private message forum I often visit, a regular participant – who is very bright, and a good contributor on many topics – recently posted a criticism of the MMT position on budget deficits that went something like this:

Budget deficits increase demand in some areas and decrease it in others. To illustrate the point I will show an extreme example. Say Honest Annie has $10,000 in savings. Mr Lucky is given $100,000,000 to stimulate the economy. Oh look, now Annie can produce more goods because Mr Lucky can afford to buy them. Of course, look at poor Annie’s real disposition. This new demand comes with the devaluation of her hard-earned savings. What is changing is that now she has to produce more to be able to afford more goods. The government has tricked her into having to work more because her savings have been devalued due to inflation. Sure, Mr Lucky is happy because Annie is producing more goods for him, but there are two sides to the coin.

Clearly the government should not adopt such a ridiculous policy in which it randomly gives one person $100 million in an economy where a typical person has savings of $10,000. But even in terms of the ludicrous example, the poster’s logic is lacking.

If Mr Lucky spent some of the money to buy stuff from Honest Annie, and she had the available time and resources to respond to the additional demand at current prices, she would receive some of Mr Lucky’s money in payment and also have increased spending power to purchase output from Mr Lucky or somebody else. The deficit expenditure can increase demand in some areas without reducing it in others provided the economy is operating below full capacity.

The question is whether there are idle resources that people would willingly put to use if there was demand for the resulting output, and whether this additional output could be supplied in a non-inflationary manner.

No one in the MMT camp is suggesting the government should net spend more than is necessary to enable the purchase of potential output at current prices.

The author of the example is influenced by the Austrian school, so some of his reasoning is defensible within that framework. In particular, as I discussed here and here, the Austrian definition of inflation is different from the one used by other economists. For everyone but the Austrians, inflation means a persistent rise in the general price level (the weighted average of all prices of final goods and services), not an expansion of broader money per se.

This can lead to differences between Austrians and non-Austrians in their assessments of whether inflation is occurring. If there is a rise in general prices, there will typically be an expansion of broader money to accommodate it unless real potential output shrinks due to a supply shock. In this case, both Austrians and non-Austrians alike will observe inflation. But it is possible for the broader money supply to expand (inflation for Austrians) without general prices rising (no inflation for other economists) whenever the economy is operating below full capacity. This means that from the Austrian perspective, it makes sense to suggest deficit expenditure will reduce the value of money even if, for other economists, there is no inflation.

Differences such as this can be discussed as part of a healthy debate. What is more annoying is the practice of creating straw-man arguments, such as the suggestion that MMT economists are advocating mindless spending out of all proportion to the actual demand deficiency or without any thought to the allocation of that net spending. The tactic often appears to be deliberate, in that there is a wilful misinterpretation of the argument to make it easier to ridicule or criticize. No matter how many times the point is clarified, the wilful (and convenient) misinterpretation will be repeated as if nothing has changed. The result is a discussion that fails to advance beyond irrelevant mischaracterizations and attempts to set (reset) the record straight.

As a practical matter for foot soldiers, we need to balance the need to deal with such mischaracterizations with the desire to develop the argument further for those not thrown by the mischaracterizations or to present the same argument elsewhere. At some point, it is probably best to assume that intelligent readers have been provided with enough clarification to make up their own minds about the merits of the straw-man argument, and just get on with advancing the discussion, or if the point has been made, move on to other forums. There is no need to convince every person in every forum.

MMT – and heterodox approaches, in general – seem more susceptible to this kind of straw-man treatment because its proponents have to make the running. In debates with critics or skeptics, the aim of the MMT proponent is usually to explain why the current dominant understanding of the economy is lacking, and why an alternative may offer an improvement in understanding.

A skeptic who is only interested in a better understanding of the economy has no motive to mischaracterize MMT arguments. The motive for engaging in discussion for such a person would be to understand the approach to enable an informed assessment of it. But when a skeptic or critic is more interested in defending a preconceived view of the world – possibly for psychological, political, or careerist reasons – their motive may not be to understand but to obfuscate, sidetrack, or otherwise hold up the discussion in ways that at least muddies the waters enough to make it difficult for others, who may be trying to understand without prejudging positions, to separate nonsense from valid argument, especially if they do not have a training in economics.

Consider journalists who write on economic matters, for example. In a way, it is hard to blame them for erring on the side of the orthodoxy when in doubt if they don’t have sufficient confidence in their own understanding of the subject. When in doubt, it is surely safer to go with the view of a Nobel Prize recipient or Professor from an Ivy League university over the views of a heterodox economist, even if the heterodox position seems to make more sense.

Opponents of the heterodox position can take advantage of this, knowing that they do not have to win arguments, or even engage in them in many cases, provided there is sufficient doubt over the heterodox position, whether because of perception, status, obfuscation or deliberately disruptive tactics, which on the internet can of course be done anonymously.

Straw Men in Academia

Straw-man argumentation is not limited to the orthodoxy or the internet. Heterodox schools use this tactic in disputes among themselves. For example, Marx’s theory of value was widely claimed to be “internally inconsistent” for eighty years on the basis of a straw man (the dominant dual-system, simultaneist interpretation of his theory) before a group of economists were finally able to demonstrate that Marx’s work could be interpreted in a way that not only gave it internal coherence but reproduced all of his results on value, including the long-run tendency of the rate of profit to fall, which had supposedly been “disproved” by Okishio’s theorem.

It wasn’t until the 1980s that papers began to be published by economists adhering to the so-called “temporal single-system interpretation” of Marx, demonstrating the theoretical coherence – validity, not necessarily correctness – of his theory of value when interpreted in a temporal and “single-system” way. It took another twenty-five years of persistence by these economists before Sraffians (who were the most prominent antagonists) and other critics grudgingly stopped dismissing Marx’s theory in pat phrases repeated over and over again without any authority other than the insinuation of authority.

One of the leading protagonists in this debate, Andrew Kliman, has written an accessible book for the generalist reader documenting the history of the debate and summarizing the major findings. For anyone interested in the debate over Marx’s theory of value, it is well worth reading, and eye-opening in bringing to light the extent of intellectual dishonesty in academia, including within the heterodoxy.

The straw-man tactic of the Sraffians served to discredit Marx and help to create a justification for alternative theories (e.g. Sraffianism) to replace or “correct” Marx’s theory. The tactic was also employed by developers of an array of alternative, though short-lived, value theories, such as the New Interpretation, Simultaneous Single-System Interpretation, Value Form theory, etc. A certain career benefit and “respectability” no doubt also comes from distancing oneself from Marx’s theory of value in a capitalist society.

The straw-man attack on Marx’s theory was effective partly because Marxism is outside the orthodoxy and Marxists have little to no presence in academic economics, let alone clout. Another reason for its effectiveness may be that Marxist thought is critical of the capitalist system itself. It is not merely reformist. This is not exactly the most career-savvy research program for an up-and-coming academic.

None of this is to suggest that Sraffianism or any of the other alternative theories are not valid approaches in their own right. It is simply to insist that the developers of these theories were not entitled to assert the invalidity of Marx’s theory almost like a religious mantra when the argument relied on a straw man.

The unjustified but highly successful eighty-year banishment of Marx’s theory can be contrasted with the lack of impact the Cambridge Capital Controversy has had on the dominance of neoclassical economics. This time the position of the Sraffians in theoretical terms was very strong, and their central points were conceded by Paul Samuelson and other leading neoclassical participants in the debate, yet the victory has so far had little impact on the status quo in academic economics.

The strategically effective response of the neoclassical orthodoxy to heterodox critiques drawing on the results of the Cambridge Capital Controversy has been simply not to respond through debate but rather ignore the implications, stop publishing heterodox work in the top journals, and cease hiring heterodox economists in the most prestigious universities or leading policymaking institutions (see Nobel-nomics for a polemical take on the aftermath of the Capital Debates).

When aimed at the orthodoxy, even legitimate criticism struggles to make a dent. For the heterodoxy, the very strongest arguments take a long time to break through.

Eventually, though, as MMT commentator rvm often reminds me, truth will out. Advances in understanding in many areas of human endeavor have faced the same kind of opposition throughout history. Even now, some heterodox advances in economics eventually slip in through the back door of neoclassical economics.

For example, there appears to be an increasing recognition among monetary researchers that some traditional concepts are untenable. Recent notable examples apply to the money-multiplier theory and money endogeneity. Understanding of these points has been well established in Post Keynesian economics for a long time. Now, slowly, some of the ideas are creeping in to mainstream analysis (usually without appropriate credit being given to earlier heterodox work).

All this is a longwinded way of saying that the road is uphill, but the only option is to keep plugging away. Some of the leading proponents of MMT have been grinding away for thirty years now. As internet foot soldiers, we can follow their lead. Sooner or later, perhaps long after we’re all dead, society will wake up to reality, strengthen conceptual understanding, and implement sensible policies.

Ancient historians of twentieth and twenty-first century economic thought will look back and realize that much of the truth was worked out by Kalecki, Keynes, Lerner, CofFEE, UMKC, TCOTU, etc. From their vantage point of 5000 AED (five thousand years After Environmental Destruction), orthodox historians will wonder how the clear and cogent answers of MMT could possibly have been ignored by so many experts of the era, who seemed inexplicably fond of straw men. These orthodox thinkers of the future will know with utter certainty that they could never be so close-minded!

A Comment on MMT Internet Discussions

There is one particular straw man that is repeatedly erected by critics of MMT. I’m sure most foot soldiers reading this will have noticed it. It is one that I find especially grating. The best (i.e. most irritating) phrase I’ve seen to encapsulate the nuances of this particular straw man is the refrain:

MMT claims we can print prosperity.

The phrase “print prosperity” is shorthand for the common message board accusation that MMT ignores real resources and gets bamboozled by money as if it is magic. The accusation is very common. The term “print prosperity” was coined, to the best of my knowledge, by a Math Professor, no less, who happens to be keen on the kind of “fiscal conservatism” advocated by the Concord Coalition.

I consider it a perverse injustice that, in online discussions, MMT sympathizers are frequently reproached for imagining that “we can print prosperity” when in fact it is us who constantly stress as a fundamental point that the only true constraints are resource based, not financial or monetary in nature. We are the ones insisting that if we have the resources, we can put them to use. It is the neoclassical orthodoxy and others who try to make out that we can’t use resources, even if they are available, because of some magical, mysterious monetary or financial constraint. Just who is it that believes in magic here?

MMT shows clearly that if we have the resources, money is no obstacle to a government that issues its own flexible exchange-rate fiat currency. It is not saying that creating money magically creates goods and services. It is saying that it is nonsense – superstitious nonsense – to think affordability for such a government could be about money rather than resources.

Obviously, anyone is entitled to disagree with the MMT position. But they are not entitled purposefully to misrepresent MMT as suggesting that it is oblivious to real resource constraints when it is alternative theories that attempt to obfuscate matters by conjuring up fictitious “financial constraints” (e.g. the neoclassical “government budget constraint” framework).

Take the debate over how to address the aging population for example. It should be obvious – and is obvious in MMT – that the only way to address this issue is to increase future productive capacity. This involves the application of real resources now to research, infrastructure development, education (including in areas relevant to servicing an aging population), etc.

Clearly, MMT is not, as many internet critics claim, saying that creating money solves the problem. It is really the MMT critics who are falling into the trap of thinking money rather than the application of real resources is the solution, despite their frequent protestations to the contrary. They are the ones who think that if the government “saves” money now, this will somehow help to address the needs of the aging population in, let’s say, twenty years time.

Yet, these same people also stress that you can’t “print prosperity”. Well, if you can’t “print prosperity” – and we all agree on that – what good is that money the government supposedly should stash away going to be twenty years from now? It won’t help to provide the infrastructure and technological knowledge that was not developed in the preceding twenty years because governments preferred to “save” money for the future rather than apply resources to the real task of raising productive capacity.

Oh well. We shrug and move on. Such are the trials and tribulations of an internet foot soldier.

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Joe Firestone post on sidestepping the debt ceiling issue with Coin Seigniorage

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Joe Firestone has a new post on Coin Seigniorage, where he gives credit to our own Beowolf’s comment on this website.

As far as I’ve been able to determine, it does work operationally. It seems the US Treasury is already legally empowered to simply mint it’s own platinum coin in any denomination it wants and effectively deposit it in its Fed account, rather than sell bonds to the public to fund its Fed account.

This process doesn’t change actual govt spending, so doing it this way doesn’t add to inflation, nor does it change the fact that govt deficit spending adds income and net financial assets to the other, non govt sectors. It’s just that the new financial assets will simply be new reserve balances at the Fed, rather than new Treasury securities (which are also simply accounts at the Fed).

What issuing these coins does do is remove the legal need for the debt ceiling to be raised, and also reduce the amount of outstanding Treasury securities, which is what is called govt debt. So while both reserves and Treasury securities are, functionally, govt liabilities and differ in name (and sometimes duration) only, the headline rhetoric does make that distinction. So technically, this process eliminates the ‘national debt’ and removes any (misguided) notion of solvency risk:

Links to the post on various websites:

Correntewire

Firedoglake

Our Future

Daily Kos

The most discussion is at Kos.


The best comments are at Correntewire.

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US pressing China to buy tens of billions of dollars in US aircraft, auto parts, agricultural goods and beef “to build goodwill”

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I call it a completely misguided sense of public purpose as a direct consequence of not understanding monetary operations:

U.S. Presses China for Deals

By Bob Davis

January 15 (WSJ) — The U.S. is pressing China to buy tens of billions of dollars in U.S. aircraft, auto parts, agricultural goods and beef to build goodwill when the two countries’ leaders meet Wednesday.

In the run-up to the closely watched event between Chinese President Hu Jintao and President Barack Obama, the two countries are jockeying to set the agenda for the visit, as they haggle over deals. The White House expects the centerpiece of the package to be the sale of Boeing Co. jets.

Leaders of both nations say they want to show that the U.S.-China relationship, which was on the skids last year, is back on track and is mutually beneficial. But they also want to frame the meeting in a way that plays most favorably at home.

“Our relationship is marked by great promise and real achievement,” said Secretary of State Hillary Clinton in a speech on Friday. “And more than ever it will be judged on the outcomes it produces.”

Mr. Hu’s last state visit, in 2006, came before the global financial crisis when the U.S. was clearly a dominant economic power. Since then, China has become the world’s second-largest economy and its state-orchestrated style of development has become a rival to the U.S.’s more market-oriented approach.

Chinese deal-making is part of nearly all of their state visits abroad—it announced $16 billion in deals in India last month. And given a trade gap with China on track to pass $250 billion last year, the U.S. visit will likely be dismissed by China critics as insufficient.

But the White House considers the deals a way to show concrete benefits from the encounter, when many other issues being discussed—including Iran, North Korea and intellectual-property issues—aren’t easily resolved. The Obama administration also wants to show its ability to add jobs during a time of 9.4% U.S. unemployment.

Given tensions in past months between the two powers, China wants the meeting to go off smoothly and to underscore its new world stature. Since Mr. Hu’s last visit to the White House, “China has grown into this strong young man from a teenage boy,” said Zhuang Jianzhong, deputy director of the Center for National Strategic studies at Shanghai’s Jiao Tong University.

The U.S. goal is tangible progress on issues including trade, currency policy, North Korea and Iran.

In her speech, Mrs. Clinton singled out the need for China’s military “to overcome its reluctance at times to join us in building a stable and transparent military-to-military relationship.” She was referring to the Chinese military’s recent rebuff of Secretary of Defense Robert Gates’s bid to re-establish close, regular meetings at top levels.

Mrs. Clinton also said it was vital China join the U.S. “in sending North Korea an unequivocal signal that its recent provocations—including the announced uranium enrichment program—are unacceptable.” The U.S. recently credited Beijing for convincing North Korea to calm tensions after it shelled a South Korean island.

This past week, Undersecretary of State Robert Hormats, Commerce Undersecretary Francisco Sanchez and Deputy U.S. Trade Representative Demetrios Marantis spent three days in Beijing ironing out trade and investment issues. They focused on two Chinese buying trips, headed by senior officials of the Chinese Ministry of Commerce and the China Council for the Promotion of International Trade, that are set to begin Saturday and run through Jan. 21.

The two groups plan to visit half a dozen cities, including Boeing’s home base of Chicago, where Mr. Hu will meet with U.S. and Chinese business executives Friday.

The aircraft purchases are a priority because Boeing is a symbol of U.S. export strength, and it has facilities and subcontractors around the U.S. China also has great purchasing flexibility when it comes to aircraft because carriers’ deals aren’t final until they are approved by the government.A Boeing spokesman declined to comment.

China is also looking to highlight its role as an investor in the U.S. auto industry. SAIC Motor Corp., China’s largest auto maker, recently bought a $500 million stake in General Motors Co., just under 1% of the company. Chinese investors have bought stakes in auto suppliers.

The focus on purchases, said a senior U.S. official is “in part to reduce the trade imbalance, in part to demonstrate to the American public that there are real job benefits to the relationship with China and, in part, to improve the overall tone and to make the trip successful.”

On other commercial issues, the U.S. is pressing China to provide a specific plan for how government agencies and state-owned businesses will buy legitimate software, not knock-off versions. Beijing has already committed to such purchases.

The White House is also seeking commitments that U.S. firms in China won’t be shut out of government-backed projects for high-tech products. The U.S. official said it was unclear at this point how much progress would be made in those areas.

China is looking to use the state visit to compel changes in U.S. policy. Beijing blames the Federal Reserve’s low interest rates and bond purchases for worsening China’s inflation. A delegation of Chinese academics have been visiting Washington, urging the Fed take into account the problems of developing nations when setting policy.

There is little chance the U.S. will agree, said Eswar Prasad, a China scholar at the Brookings Institution, who met with the academics, because of the Fed’s mandate to consider domestic economic concerns when setting policy. The Fed also believes boosting the economy helps the global economy because so many nations rely on the U.S. market.

Foreign-exchange policy is also bound to be a big issue at the Obama-Hu meeting. Since China announced in mid-June that it would lets its currency float somewhat, it has appreciated about 3.6%—with the yuan strengthening in recent days to new heights.

When accounting for the effects of higher inflation in China compared with the U.S., Treasury Secretary Timothy Geithner said the yuan is moving up at a pace of about 10% a year. That is getting closer to the level the U.S. would like to see.

Either China lets the currency rise to fight higher prices, Mr. Geithner argues, or higher prices will make Chinese exports more expensive anyway. In either case, “competitiveness is going is shifting now in our favor,” he said.

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Proposal for Japan and China- buy US state muni bonds!

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My proposal for Japan and China is to announce a plan for each nation to purchase up to $150 billion of US state municipal bonds to help out the US states during these difficult times.

They would be welcomed as rescuers, much like they have been with their announcements to buy securities from troubled euro zone member nations.

While at the same time, buying $US financial assets in the form of state muni debt would work to weaken their currencies vs the dollar and support their export industries.

Doesn’t get any better than that!

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Comments on Robert J. Shiller Article

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Glenn wrote:
Warren – would you care to comment on the ny times article by Robert Shiller?
http://www.nytimes.com/2010/12/26/business/26view.html?_r=1

He’s correct on all counts, including the point that the multiplier might not be 1.

In fact, a 1 multiplier requires all of our demand leakages (pension/ira type contributions, insurance reserves, other corporate reserves, demand for actual cash in circulation, net foreign demand to accumulate $ financial assets, etc. etc. etc.) to be offset by enough non govt sector debt expansion to make up for those ‘savings’ desires.

Sometimes that happens. In the late 90’s the domestic sector was increasing it’s ‘borrowing to spend’ by maybe 7% of gdp per year, more than offsetting the 2% or so govt surplus as well as the foreign sector savings desires. But that was unsustainable as domestic debt is ultimately limited by income, and it all came apart not long after y2k. And a few years ago we had an ok expansion going also driven by private sector debt expansion which also proved unsustainable and came to an abrupt end when the debt turned out to be largely fraudulent mtg lending, etc.

So today, with a highly subdued lending infrastructure, including regulatory over reach by bank regulators, seems to me a balanced budget expansion approach is high risk at best. The outcome could easily be a public sector expansion more than matched by a private sector setback.

However, the larger point is why not just do the spending without a tax increase? That’s sure to increase aggregate demand, and if demand pull inflation does ensue, and unemployment gets ‘too low’ (whatever that means), etc. taxes can always then be raised to cool demand.

The answer can only be that the author either doesn’t understand actual monetary operations and the monetary system fundamentally, or is afraid to say so?

Unfortunately, the ‘headline progressives’ continue to be
THE problem, imho.

A quick read of ‘The 7 Deadly Innocent Frauds’ might help:

https://moslereconomics.com/?p=8662/

I tried to connect with him when I was running for the US Senate in CT with no response.

Also, the economy did pretty well after World War II largely helped by the Marshall plan which was, functionally, a form of govt. deficit spending. We loaned Europe about $15 billion (back when that was a lot of money) to buy stuff from us, if I recall correctly. And enough of the war time deficit spending was held by soldiers coming home and others who spent from their savings for a while.

ECONOMIC VIEW
Stimulus, Without More Debt
 

THE $858 billion tax package signed into law this month provides some stimulus for our ailing economy. With the unemployment rate at 9.8 percent, more will certainly be needed, yet further deficit spending may not be a politically viable option.
 

Instead, we are likely to see a big fight over raising the national debt ceiling, and a push to reverse the stimulus we already have.
 

In that context, here’s some good news extracted from economic theory: We don’t need to go deeper into debt to stimulate the economy more.
 

For economists, of course, this isn’t really news. It has long been known that Keynesian economic stimulus does not require deficit spending. Under certain idealized assumptions, a concept known as the “balanced-budget multiplier theorem” states that national income is raised, dollar for dollar, with any increase in government expenditure on goods and services that is matched by a tax increase.
 

The reasoning is very simple: On average, people’s pretax incomes rise because of the business directly generated by the new government expenditures. If the income increase is equal to the tax increase, people have the same disposable income before and after. So there is no reason for people, taken as a group, to change their economic behavior. But the national income has increased by the amount of government expenditure, and job opportunities have increased in proportion.
 

During the Great Depression, there was a debate about “pump priming” — about whether the government had to go into debt to stimulate the economy. John Maynard Keynes, who originated the Keynesian theory in 1936, liked to emphasize that the deficit-spending multiplier was greater than 1, because the income generated by deficit spending also induces second and third rounds of expenditure. If the government buys more goods and services and there is no tax increase, people will spend much of the income that they earned from these sales, which in turn will generate more income for others, who will spend much of it too, and so on.
 

In contrast, the balanced-budget multiplier theory says that there are no extra rounds of expenditure. You get just one round of spending — meaning that the multiplier is 1.0 — but sometimes that is enough.
 

Paul Samuelson, an economist at M.I.T., first drew national attention to the balanced-budget multiplier in 1943 , seven years after Keynes introduced his theory. The multiplier was an immediate consequence of the Keynes theory, but Keynes didn’t articulate it himself.
 

Economists embraced this multiplier because it seemed to offer a solution to a looming problem: a possible repeat of the Great Depression after wartime stimulus was withdrawn, and when new rounds of deficit spending might be impossible because of the federal government’s huge, war-induced debt.
 

It turns out that this worry was unfounded. The Depression did not return after the war. But in the early 1940s, economists justifiably saw the possibility as their biggest concern. Their discussions have been mostly forgotten because they didn’t have much relevance for public policy — until now, that is, when we again have a huge federal debt and a vulnerable economy.
 

Of course, the balanced-budget theorem is only as good as its assumptions. Other possible repercussions could make its multiplier something other than 1.0. The number could be less, for example, if people cut consumption because of psychological reactions to higher taxes. Alternatively, it could be greater if income-earning people who are taxed more cut their consumption less than newly employed people increase their spending. We can’t be sure what will happen.
 

Researchers haven’t pinned down the deficit-spending multiplier either, even though that has been the focus of their efforts. In fact, a recent survey article on the effects of government stimulus by Alan Auerbach at the University of California, Berkeley, and two of his colleagues has found that “the range of mainstream estimates for multiplier effects is almost embarrassingly large.” Last month, a Congressional Budget Office study revealed similar uncertainty. The trouble comes in estimating how people will react in generating those subsequent rounds of spending.
 

But the balanced-budget multiplier is simpler to judge: If the government spends the money directly on goods and services, that activity goes directly into national income. And with a balanced budget, there is no clear reason to expect further repercussions. People have jobs again: end of story.
 

What kind of jobs? Building highways and improving our schools are just two examples — as cited in 1944 by Henry Wallich, an enthusiast of balanced-budget stimulus who would later become a Yale economist and a Federal Reserve Board governor.
 

AT present, however, political problems could make it hard to use the balanced-budget multiplier to reduce unemployment. People are bound to notice that the benefits of the plan go disproportionately to the minority who are unemployed, while most of the costs are borne by the majority who are working. There is also exaggerated sensitivity to “earmarks,” government expenditures that benefit one group more than another.
 

Another problem is that pursuing balanced-budget stimulus requires raising taxes. And, as we all know, today’s voters are extremely sensitive to the very words “tax increase.”
 

But voters are likely to accept higher taxes eventually, as they have done repeatedly in the past. It would be a mistake to consider the present atmosphere as unchangeable. It’s conceivable that an effective case will be made in the future for a new stimulus package, if more people come to understand that a few years of higher taxes and government expenditures could fix our weak economy and provide benefits like better highways and schools — without increasing the national debt.

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ECB’s Stark: Helping Governments Cannot and Should Not be a Goal of These Operations

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The Fed is conducting it’s QE to lower the risk free term structure of rates for the further purpose of supporting lending in the economy in general.

The ECB is buying member nation debt in the marketplace specifically to help member nations fund the deficits and avoid default.

What the ECB is doing for Greece, Portugal, and Ireland is more analogous to what the Fed did a couple of years ago when it bought corporate debt (commercial paper) from the likes of GE and GM to keep them afloat.

In fact, the ECB can’t ‘expand into US Federal Reserve-style“quantitative easing” ‘ even if it wanted to, because there are no euro equivalents of US Treasury securities. (Not that the Fed’s QE does anything of substance for the US economy, inflation, or the dollar.) About the closest the ECB could come to a ‘Fed style QE’ would be to receive fixed in euribor swap market, which is not even a consideration, as their issue is the solvency of their member nations and not the risk free term structure of rates in general.

Meanwhile, as previously discussed, as long as the ECB keeps buying, it all muddles through.

ECB Increases Intervention in Bond Markets
 

The European Central Bank increased its intervention in government bond markets last week, indicating that the euro’s monetary guardian remained wary of an escalation of the eurozone debt crisis.
 

Purchases under the ECB’s securities market programme rose to €1.1 billion ($1.4 billion) from €603 million in the previous week, according to figures released on Monday.
 

The acceleration highlights how the ECB has been forced into action to prevent governments’ borrowing costs spinning out of control, even though it sees the main responsibility for restoring investor confidence in Europe’s 12-year-old monetary union as lying with political leaders.
 

The previous week’s figures had pointed to a lull in the ECB’s intervention. The rise came in spite of thin trading before the Christmas and new year holidays.
 

The ECB argues its action is aimed simply at correcting malfunctioning markets – and will not be allowed to expand into US Federal Reserve-style“quantitative easing” to support the economy.
 

“Helping governments cannot and should not be a goal of these operations,” Jürgen Stark, an ECB executive and one of its governing council’s more hawkish members, told the German newspaper Stuttgarter Zeitung at the weekend.
 

The latest increase could add to the discomfort of ECB policymakers, however, if it encourages expectations that the ECB will become more aggressive.
 

Because of the increased risks it is bearing, the ECB said this month it would double to €10.76 billion its subscribed capital, which would allow it to increase provisions against losses.
 

The announcement triggered speculation that the ECB was preparing to accelerate its bond purchases. However, Mr Stark said the increase had “nothing to do with the current situation but dates from analysis that we started in 2009”.
 

The ECB began buying bonds in May, at the height of this year’s eurozone crisis. After weekly purchases of €10 bilion or more, the programme was scaled down, with the weekly figures sometimes falling to zero.
 

But in early December the programme was reactivated – although still not up to its initial scale.
 

The ECB does not give precise details but recent purchases are thought to have been concentrated on Portuguese and Irish bonds, where financial market tensions have been focused.
 

Total purchases since the programme started in May have reached €73.5 billion – an amount the ECB will on Tuesday seek to reabsorb from the eurozone financial system to offset the inflationary impact of its action.

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china inflation – ft article

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Sounds like the ‘managing expectations’ they teach at the western universities.

Inflation is under control, says Chinese regulator

By Jamil Anderlini

December 17 (FT) — “The recent inflation is completely different from the periods of very high inflation that China has encountered in the past,” Mr Liu, chairman of the China Banking Regulatory Commission, said on Friday.

“There is overcapacity for most industrial goods in the Chinese market and it’s impossible for upstream inflation to be transmitted downstream.”

The relatively sanguine assessment also partly explains why Beijing appears set to grant Chinese banks a lending quota next year that is roughly the same as this year’s, or even slightly higher, even though the economy is already awash with liquidity.

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Comments on BS2 (Bernanke speech #2)

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Rebalancing the Global Recovery

Chairman Ben S. Bernanke

November 19, 2010

The global economy is now well into its second year of recovery from the deep recession triggered by the most devastating financial crisis since the Great Depression. In the most intense phase of the crisis, as a financial conflagration threatened to engulf the global economy, policymakers in both advanced and emerging market economies found themselves confronting common challenges. Amid this shared sense of urgency, national policy responses were forceful, timely, and mutually reinforcing. This policy collaboration was essential in averting a much deeper global economic contraction and providing a foundation for renewed stability and growth.

The main policy response as the automatic fiscal stabilizers that, fortunately were in place to cut govt revenues and increase transfer payments, automatically raising the federal deficit to levels where it added sufficient income and savings of financial assets to support aggregate demand at current levels. And while the contents selected weren’t my first choice, the fiscal stimulus package added some support as well.

In recent months, however, that sense of common purpose has waned. Tensions among nations over economic policies have emerged and intensified, potentially threatening our ability to find global solutions to global problems. One source of these tensions has been the bifurcated nature of the global economic recovery: Some economies have fully recouped their losses

Those who have sustained adequate domestic aggregate demand through appropriate fiscal policy.

while others have lagged behind.

Those who have not had adequate fiscal responses.

But at a deeper level, the tensions arise from the lack of an agreed-upon framework to ensure that national policies take appropriate account of interdependencies across countries and the interests of the international system as a whole. Accordingly, the essential challenge for policymakers around the world is to work together to achieve a mutually beneficial outcome–namely, a robust global economic expansion that is balanced, sustainable, and less prone to crises.

Unfortunately, that would require an understanding of monetary operations and that a currency is a (simple) public monopoly. And with that comes the understanding that the us, for example, is far better off going it alone.

The Two-Speed Global Recovery
International policy cooperation is especially difficult now because of the two-speed nature of the global recovery. Specifically, as shown in figure 1, since the recovery began, economic growth in the emerging market economies (the dashed blue line) has far outstripped growth in the advanced economies (the solid red line). These differences are partially attributable to longer-term differences in growth potential between the two groups of countries, but to a significant extent they also reflect the relatively weak pace of recovery thus far in the advanced economies. This point is illustrated by figure 2, which shows the levels, as opposed to the growth rates, of real gross domestic product (GDP) for the two groups of countries. As you can see, generally speaking, output in the advanced economies has not returned to the levels prevailing before the crisis, and real GDP in these economies remains far below the levels implied by pre-crisis trends. In contrast, economic activity in the emerging market economies has not only fully made up the losses induced by the global recession, but is also rapidly approaching its pre-crisis trend. To cite some illustrative numbers, if we were to extend forward from the end of 2007 the 10-year trends in output for the two groups of countries, we would find that the level of output in the advanced economies is currently about 8 percent below its longer-term trend, whereas economic activity in the emerging markets is only about 1-1/2 percent below the corresponding (but much steeper) trend line for that group of countries. Indeed, for some emerging market economies, the crisis appears to have left little lasting imprint on growth. Notably, since the beginning of 2005, real output has risen more than 70 percent in China and about 55 percent in India.

No mention of the size of the budget deficits in those nations, not forgetting to include lending by state owned institutions that is, functionally, deficit spending.

In the United States, the recession officially ended in mid-2009, and–as shown in figure 3–real GDP growth was reasonably strong in the fourth quarter of 2009 and the first quarter of this year.

Mainly a bounce from an oversold inventory position due to the prior fear mongering and real risks of systemic failure.

However, much of that growth appears to have stemmed from transitory factors, including inventory adjustments and fiscal stimulus. Since the second quarter of this year, GDP growth has moderated to around 2 percent at an annual rate, less than the Federal Reserve’s estimates of U.S. potential growth and insufficient to meaningfully reduce unemployment. And indeed, as figure 4 shows, the U.S. unemployment rate (the solid black line) has stagnated for about eighteen months near 10 percent of the labor force, up from about 5 percent before the crisis; the increase of 5 percentage points in the U.S. unemployment rate is roughly double that seen in the euro area, the United Kingdom, Japan, or Canada. Of some 8.4 million U.S. jobs lost between the peak of the expansion and the end of 2009, only about 900,000 have been restored thus far. Of course, the jobs gap is presumably even larger if one takes into account the natural increase in the size of the working age population over the past three years.

Of particular concern is the substantial increase in the share of unemployed workers who have been without work for six months or more (the dashed red line in figure 4). Long-term unemployment not only imposes extreme hardship on jobless people and their families, but, by eroding these workers’ skills and weakening their attachment to the labor force, it may also convert what might otherwise be temporary cyclical unemployment into much more intractable long-term structural unemployment. In addition, persistently high unemployment, through its adverse effects on household income and confidence, could threaten the strength and sustainability of the recovery.

Low rates of resource utilization in the United States are creating disinflationary pressures. As shown in figure 5, various measures of underlying inflation have been trending downward and are currently around 1 percent, which is below the rate of 2 percent or a bit less that most Federal Open Market Committee (FOMC) participants judge as being most consistent with the Federal Reserve’s policy objectives in the long run.1 With inflation expectations stable, and with levels of resource slack expected to remain high, inflation trends are expected to be quite subdued for some time.

Yes, the FOMC continues to fear deflation.

Monetary Policy in the United States
Because the genesis of the financial crisis was in the United States and other advanced economies, the much weaker recovery in those economies compared with that in the emerging markets may not be entirely unexpected (although, given their traditional vulnerability to crises, the resilience of the emerging market economies over the past few years is both notable and encouraging). What is clear is that the different cyclical positions of the advanced and emerging market economies call for different policy settings. Although the details of the outlook vary among jurisdictions, most advanced economies still need accommodative policies to continue to lay the groundwork for a strong, durable recovery. Insufficiently supportive policies in the advanced economies could undermine the recovery not only in those economies, but for the world as a whole. In contrast, emerging market economies increasingly face the challenge of maintaining robust growth while avoiding overheating, which may in some cases involve the measured withdrawal of policy stimulus.

Let me address the case of the United States specifically. As I described, the U.S. unemployment rate is high and, given the slow pace of economic growth, likely to remain so for some time. Indeed, although I expect that growth will pick up and unemployment will decline somewhat next year, we cannot rule out the possibility that unemployment might rise further in the near term, creating added risks for the recovery. Inflation has declined noticeably since the business cycle peak, and further disinflation could hinder the recovery. In particular, with shorter-term nominal interest rates close to zero, declines in actual and expected inflation imply both higher realized and expected real interest rates, creating further drags on growth.2 In light of the significant risks to the economic recovery, to the health of the labor market, and to price stability, the FOMC decided that additional policy support was warranted.

Again, fear of deflation, especially via expectations theory.

The Federal Reserve’s policy target for the federal funds rate has been near zero since December 2008,

And not done the trick. And no mention that the interest income channels might be the culprits.

so another means of providing monetary accommodation has been necessary since that time. Accordingly, the FOMC purchased Treasury and agency-backed securities on a large scale from December 2008 through March 2010,

Further reducing interest income earned by the private sector.

a policy that appears to have been quite successful in helping to stabilize the economy and support the recovery during that period.

I attribute the stabilization to the automatic fiscal stabilizers increasing federal deficit spending, adding that much income and savings to the economy.

Following up on this earlier success, the Committee announced this month that it would purchase additional Treasury securities. In taking that action, the Committee seeks to support the economic recovery, promote a faster pace of job creation, and reduce the risk of a further decline in inflation that would prove damaging to the recovery.

Although securities purchases are a different tool for conducting monetary policy than the more familiar approach of managing the overnight interest rate, the goals and transmission mechanisms are very similar. In particular, securities purchases by the central bank affect the economy primarily by lowering interest rates on securities of longer maturities,

Very good! Looks like the officials in monetary operations have finally gotten the point across. It’s been no small effort.

just as conventional monetary policy, by affecting the expected path of short-term rates, also influences longer-term rates. Lower longer-term rates in turn lead to more accommodative financial conditions, which support household and business spending. As I noted, the evidence suggests that asset purchases can be an effective tool; indeed, financial conditions eased notably in anticipation of the Federal Reserve’s policy announcement.

Incidentally, in my view, the use of the term “quantitative easing” to refer to the Federal Reserve’s policies is inappropriate. Quantitative easing typically refers to policies that seek to have effects by changing the quantity of bank reserves, a channel which seems relatively weak, at least in the U.S. context.

While the channel is more than weak- it doesn’t even exist- even here his story has improved.

In contrast, securities purchases work by affecting the yields on the acquired securities and, via substitution effects in investors’ portfolios, on a wider range of assets.

Leaving out that they remove interest income from the private sector.

This policy tool will be used in a manner that is measured and responsive to economic conditions. In particular, the Committee stated that it would review its asset-purchase program regularly in light of incoming information and would adjust the program as needed to meet its objectives. Importantly, the Committee remains unwaveringly committed to price stability and does not seek inflation above the level of 2 percent or a bit less that most FOMC participants see as consistent with the Federal Reserve’s mandate. In that regard, it bears emphasizing that the Federal Reserve has worked hard to ensure that it will not have any problems exiting from this program at the appropriate time. The Fed’s power to pay interest on banks’ reserves held at the Federal Reserve will allow it to manage short-term interest rates effectively and thus to tighten policy when needed, even if bank reserves remain high. Moreover, the Fed has invested considerable effort in developing tools that will allow it to drain or immobilize bank reserves as needed to facilitate the smooth withdrawal of policy accommodation when conditions warrant. If necessary, the Committee could also tighten policy by redeeming or selling securities.

Not bad!

The foreign exchange value of the dollar has fluctuated considerably during the course of the crisis, driven by a range of factors. A significant portion of these fluctuations has reflected changes in investor risk aversion, with the dollar tending to appreciate when risk aversion is high. In particular, much of the decline over the summer in the foreign exchange value of the dollar reflected an unwinding of the increase in the dollar’s value in the spring associated with the European sovereign debt crisis.

Agreed.

The dollar’s role as a safe haven during periods of market stress stems in no small part from the underlying strength and stability that the U.S. economy has exhibited over the years.

Further supported by the desire of foreign govts to support exports to the US, but that is a different matter.

Fully aware of the important role that the dollar plays in the international monetary and financial system, the Committee believes that the best way to continue to deliver the strong economic fundamentals that underpin the value of the dollar, as well as to support the global recovery, is through policies that lead to a resumption of robust growth in a context of price stability in the United States.

This is a bit defensive, as it implies he does believe QE itself weakens the dollar in the near term. If he knew that wasn’t the case he would have stated it all differently.

In sum, on its current economic trajectory the United States runs the risk of seeing millions of workers unemployed or underemployed for many years. As a society, we should find that outcome unacceptable. Monetary policy is working in support of both economic recovery and price stability, but there are limits to what can be achieved by the central bank alone. The Federal Reserve is nonpartisan and does not make recommendations regarding specific tax and spending programs. However, in general terms, a fiscal program that combines near-term measures to enhance growth with strong, confidence-inducing steps to reduce longer-term structural deficits would be an important complement to the policies of the Federal Reserve.

Ok, it’s something.

But how about repeating that operationally, govt spending is not constrained by revenues, and therefore there is no solvency problem? That’s not politics, just monetary operations.

He could also explain how tsy secs are functionally nothing more than time deposits at the Fed, while reserves are overnight deposits, and funding the deficit and paying it down are nothing more than shifting dollar balances from reserve accounts to securities accounts, and from securities accounts to reserve accounts.

And he could spell out the accounting identity that govt deficits add exactly that much to net financial assets of the non govt sectors.

In other words, he could easily dispel the deficit myths that are preventing the policy he is recommending.

So why not???

Global Policy Challenges and Tensions
The two-speed nature of the global recovery implies that different policy stances are appropriate for different groups of countries. As I have noted, advanced economies generally need accommodative policies to sustain economic growth. In the emerging market economies, by contrast, strong growth and incipient concerns about inflation have led to somewhat tighter policies.

Unfortunately, the differences in the cyclical positions and policy stances of the advanced and emerging market economies have intensified the challenges for policymakers around the globe. Notably, in recent months, some officials in emerging market economies and elsewhere have argued that accommodative monetary policies in the advanced economies, especially the United States, have been producing negative spillover effects on their economies. In particular, they are concerned that advanced economy policies are inducing excessive capital inflows to the emerging market economies, inflows that in turn put unwelcome upward pressure on emerging market currencies and threaten to create asset price bubbles. As is evident in figure 6, net private capital flows to a selection of emerging market economies (based on national balance of payments data) have rebounded from the large outflows experienced during the worst of the crisis. Overall, by this broad measure, such inflows through the second quarter of this year were not any larger than in the year before the crisis, but they were nonetheless substantial. A narrower but timelier measure of demand for emerging market assets–net inflows to equity and bond funds investing in emerging markets, shown in figure 7–suggests that inflows of capital to emerging market economies have indeed picked up in recent months.

To a large degree, these capital flows have been driven by perceived return differentials that favor emerging markets, resulting from factors such as stronger expected growth–both in the short term and in the longer run–and higher interest rates, which reflect differences in policy settings as well as other forces. As figures 6 and 7 show, even before the crisis, fast-growing emerging market economies were attractive destinations for cross-border investment. However, beyond these fundamental factors, an important driver of the rapid capital inflows to some emerging markets is incomplete adjustment of exchange rates in those economies, which leads investors to anticipate additional returns arising from expected exchange rate appreciation.

The exchange rate adjustment is incomplete, in part, because the authorities in some emerging market economies have intervened in foreign exchange markets to prevent or slow the appreciation of their currencies. The degree of intervention is illustrated for selected emerging market economies in figure 8. The vertical axis of this graph shows the percent change in the real effective exchange rate in the 12 months through September. The horizontal axis shows the accumulation of foreign exchange reserves as a share of GDP over the same period. The relationship evident in the graph suggests that the economies that have most heavily intervened in foreign exchange markets have succeeded in limiting the appreciation of their currencies. The graph also illustrates that some emerging market economies have intervened at very high levels and others relatively little. Judging from the changes in the real effective exchange rate, the emerging market economies that have largely let market forces determine their exchange rates have seen their competitiveness reduced relative to those emerging market economies that have intervened more aggressively.

It is striking that, amid all the concerns about renewed private capital inflows to the emerging market economies, total capital, on net, is still flowing from relatively labor-abundant emerging market economies to capital-abundant advanced economies. In particular, the current account deficit of the United States implies that it experienced net capital inflows exceeding 3 percent of GDP in the first half of this year. A key driver of this “uphill” flow of capital is official reserve accumulation in the emerging market economies that exceeds private capital inflows to these economies. The total holdings of foreign exchange reserves by selected major emerging market economies, shown in figure 9, have risen sharply since the crisis and now surpass $5 trillion–about six times their level a decade ago. China holds about half of the total reserves of these selected economies, slightly more than $2.6 trillion.

It is instructive to contrast this situation with what would happen in an international system in which exchange rates were allowed to fully reflect market fundamentals. In the current context, advanced economies would pursue accommodative monetary policies as needed to foster recovery and to guard against unwanted disinflation. At the same time, emerging market economies would tighten their own monetary policies to the degree needed to prevent overheating and inflation. The resulting increase in emerging market interest rates relative to those in the advanced economies would naturally lead to increased capital flows from advanced to emerging economies and, consequently, to currency appreciation in emerging market economies. This currency appreciation would in turn tend to reduce net exports and current account surpluses in the emerging markets, thus helping cool these rapidly growing economies while adding to demand in the advanced economies. Moreover, currency appreciation would help shift a greater proportion of domestic output toward satisfying domestic needs in emerging markets. The net result would be more balanced and sustainable global economic growth.

Given these advantages of a system of market-determined exchange rates, why have officials in many emerging markets leaned against appreciation of their currencies toward levels more consistent with market fundamentals? The principal answer is that currency undervaluation on the part of some countries has been part of a long-term export-led strategy for growth and development. This strategy, which allows a country’s producers to operate at a greater scale and to produce a more diverse set of products than domestic demand alone might sustain, has been viewed as promoting economic growth and, more broadly, as making an important contribution to the development of a number of countries. However, increasingly over time, the strategy of currency undervaluation has demonstrated important drawbacks, both for the world system and for the countries using that strategy.

First, as I have described, currency undervaluation inhibits necessary macroeconomic adjustments and creates challenges for policymakers in both advanced and emerging market economies. Globally, both growth and trade are unbalanced, as reflected in the two-speed recovery and in persistent current account surpluses and deficits. Neither situation is sustainable. Because a strong expansion in the emerging market economies will ultimately depend on a recovery in the more advanced economies, this pattern of two-speed growth might very well be resolved in favor of slow growth for everyone if the recovery in the advanced economies falls short. Likewise, large and persistent imbalances in current accounts represent a growing financial and economic risk.

Second, the current system leads to uneven burdens of adjustment among countries, with those countries that allow substantial flexibility in their exchange rates bearing the greatest burden (for example, in having to make potentially large and rapid adjustments in the scale of export-oriented industries) and those that resist appreciation bearing the least.

Third, countries that maintain undervalued currencies may themselves face important costs at the national level, including a reduced ability to use independent monetary policies to stabilize their economies and the risks associated with excessive or volatile capital inflows. The latter can be managed to some extent with a variety of tools, including various forms of capital controls, but such approaches can be difficult to implement or lead to microeconomic distortions. The high levels of reserves associated with currency undervaluation may also imply significant fiscal costs if the liabilities issued to sterilize reserves bear interest rates that exceed those on the reserve assets themselves. Perhaps most important, the ultimate purpose of economic growth is to deliver higher living standards at home; thus, eventually, the benefits of shifting productive resources to satisfying domestic needs must outweigh the development benefits of continued reliance on export-led growth.

Improving the International System
The current international monetary system is not working as well as it should. Currency undervaluation by surplus countries is inhibiting needed international adjustment and creating spillover effects that would not exist if exchange rates better reflected market fundamentals. In addition, differences in the degree of currency flexibility impose unequal burdens of adjustment, penalizing countries with relatively flexible exchange rates. What should be done?

The answers differ depending on whether one is talking about the long term or the short term. In the longer term, significantly greater flexibility in exchange rates to reflect market forces would be desirable and achievable. That flexibility would help facilitate global rebalancing and reduce the problems of policy spillovers that emerging market economies are confronting today. The further liberalization of exchange rate and capital account regimes would be most effective if it were accompanied by complementary financial and structural policies to help achieve better global balance in trade and capital flows. For example, surplus countries could speed adjustment with policies that boost domestic spending, such as strengthening the social safety net, improving retail credit markets to encourage domestic consumption, or other structural reforms. For their part, deficit countries need to do more over time to narrow the gap between investment and national saving. In the United States, putting fiscal policy on a sustainable path is a critical step toward increasing national saving in the longer term. Higher private saving would also help. And resources will need to shift into the production of export- and import-competing goods. Some of these shifts in spending and production are already occurring; for example, China is taking steps to boost domestic demand and the U.S. personal saving rate has risen sharply since 2007.

In the near term, a shift of the international regime toward one in which exchange rates respond flexibly to market forces is, unfortunately, probably not practical for all economies. Some emerging market economies do not have the infrastructure to support a fully convertible, internationally traded currency and to allow unrestricted capital flows. Moreover, the internal rebalancing associated with exchange rate appreciation–that is, the shifting of resources and productive capacity from production for external markets to production for the domestic market–takes time.

That said, in the short term, rebalancing economic growth between the advanced and emerging market economies should remain a common objective, as a two-speed global recovery may not be sustainable. Appropriately accommodative policies in the advanced economies help rather hinder this process. But the rebalancing of growth would also be facilitated if fast-growing countries, especially those with large current account surpluses, would take action to reduce their surpluses, while slow-growing countries, especially those with large current account deficits, take parallel actions to reduce those deficits. Some shift of demand from surplus to deficit countries, which could be compensated for if necessary by actions to strengthen domestic demand in the surplus countries, would accomplish two objectives. First, it would be a down payment toward global rebalancing of trade and current accounts, an essential outcome for long-run economic and financial stability. Second, improving the trade balances of slow-growing countries would help them grow more quickly, perhaps reducing the need for accommodative policies in those countries while enhancing the sustainability of the global recovery. Unfortunately, so long as exchange rate adjustment is incomplete and global growth prospects are markedly uneven, the problem of excessively strong capital inflows to emerging markets may persist.

Conclusion
As currently constituted, the international monetary system has a structural flaw: It lacks a mechanism, market based or otherwise, to induce needed adjustments by surplus countries, which can result in persistent imbalances. This problem is not new. For example, in the somewhat different context of the gold standard in the period prior to the Great Depression, the United States and France ran large current account surpluses, accompanied by large inflows of gold. However, in defiance of the so-called rules of the game of the international gold standard, neither country allowed the higher gold reserves to feed through to their domestic money supplies and price levels, with the result that the real exchange rate in each country remained persistently undervalued. These policies created deflationary pressures in deficit countries that were losing gold, which helped bring on the Great Depression.3 The gold standard was meant to ensure economic and financial stability, but failures of international coordination undermined these very goals. Although the parallels are certainly far from perfect, and I am certainly not predicting a new Depression, some of the lessons from that grim period are applicable today.4 In particular, for large, systemically important countries with persistent current account surpluses, the pursuit of export-led growth cannot ultimately succeed if the implications of that strategy for global growth and stability are not taken into account.

Thus, it would be desirable for the global community, over time, to devise an international monetary system that more consistently aligns the interests of individual countries with the interests of the global economy as a whole. In particular, such a system would provide more effective checks on the tendency for countries to run large and persistent external imbalances, whether surpluses or deficits. Changes to accomplish these goals will take considerable time, effort, and coordination to implement. In the meantime, without such a system in place, the countries of the world must recognize their collective responsibility for bringing about the rebalancing required to preserve global economic stability and prosperity. I hope that policymakers in all countries can work together cooperatively to achieve a stronger, more sustainable, and more balanced global economy.

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