Bill’s blog, below, as always, is well worth a read.
And note today’s news, where, of all things, the Democrats are trying to position themselves as larger deficit cutters than the Republicans:
“We’re going to try to get the biggest deal possible, a deal that’s best for the economy, not just in the short term,” Geithner said on NBC’s “Meet the Press.”
We are deep into hard-disk crash trauma at CofFEE today with 2 volumes dying at the same time on Friday and a backup drive going down too. At least it was a sympathetic act on their behalf. Combine that with I lost a HDD on an iMAC after only 2 weeks since it was new a few weeks ago – after finally convincing myself that OS X was the way forward with virtual machines. Further another colleague’s back-up HDD crashed last week. It leaves one wondering what is going on. Backup is now a oft-spoken word around here today. But there is one thing I do know the answer to – Greg Mankiw’s latest Examination Question. It is a pity that he doesn’t know the answer himself. Further, it is a pity that one of the higher profiled “progressives” in the US buys into the same nonsense.
In his latest blog (July 3, 2011) – A Good Exam Question – Mankiw pokes fun at so-called progressive Dean Baker who wrote a column recently in The Republic (July 2, 2011) – Ron Paul’s Surprisingly Lucid Solution to the Debt Ceiling Impasse – where as the title suggests he thinks ultra-conservative US Republican politician Ron Paul is onto something good.
The truth is that none of them – Mankiw, Baker, or Paul – understand how the banking system operates.
First, let’s consider what Baker said in detail.
I think Mankiw’s summary of the Baker proposal is valid:
According to Congressman Paul, to deal with the debt-ceiling impasse, we should tell the Federal Reserve to destroy its vast holding of government bonds. Because the Fed might have planned on selling those bonds in open-market operations to drain the banking system of the currently high level of excess reserves, the Fed should (according to Baker) substantially increase reserve requirements.
Mankiw’s reaction is that “(t)his would be a great exam question: What are the effects of this policy? Who wins and who loses if this proposal is adopted?”.
I also agree that it would be an interesting examination question which I suspect all student who had studied macroeconomics using Mankiw’s own textbook would fail to answer correctly.
I will come back to Mankiw’s own answer directly – which suffers the same misgivings as the suggestion by Baker that we listen to Paul and then Baker’s own addendum to the idea.
Baker referred to Paul’s proposal as:
… a remarkably creative way to deal with the impasse over the debt ceiling: have the Federal Reserve Board destroy the $1.6 trillion in government bonds it now holds
He acknowledges that “at first blush this idea may seem crazy” but then claims it is “actually a very reasonable way to deal with the crisis. Furthermore, it provides a way to have lasting savings to the budget”.
So we have two ideas here – one to reduce debt as a way of tricking the pesky conservatives who want to close the US government down (or pretend they do for political purposes) by not approving the expansion of the “debt ceiling”. The debt ceiling is this archaic device that conservatives can use to make trouble for an elected government which has not operational validity. After all, doesn’t the US Congress approve the spending and taxation decisions of the US government anyway?
The second idea that Baker leaks into the debate is that by destroying public debt held by the central bank (as a result of their quantitative easing program) it would save them selling it back to the private sector which in turn would save the US government from paying interest on it. And he seems to think that is a good thing. Spare me!
In his own words:
The basic story is that the Fed has bought roughly $1.6 trillion in government bonds through its various quantitative easing programs over the last two and a half years. This money is part of the $14.3 trillion debt that is subject to the debt ceiling. However, the Fed is an agency of the government. Its assets are in fact assets of the government. Each year, the Fed refunds the interest earned on its assets in excess of the money needed to cover its operating expenses. Last year the Fed refunded almost $80 billion to the Treasury. In this sense, the bonds held by the Fed are literally money that the government owes to itself … As it stands now, the Fed plans to sell off its bond holdings over the next few years. This means that the interest paid on these bonds would go to banks, corporations, pension funds, and individual investors who purchase them from the Fed. In this case, the interest payments would be a burden to the Treasury since the Fed would no longer be collecting (and refunding) the interest.
First, note the recognition that the central bank and treasury are just components of the consolidated government sector – a basic premise of Modern Monetary Theory (MMT) and should dispel the myth of the central bank being independent.
Mankiw also agreed with that saying “Since the Fed is really part of the government, the bonds it holds are liabilities the government owes to itself”. Which makes you wonder why he doesn’t tell his students that in his textbook. Further, why do those textbooks make out that the central bank is independent when it clearly is part of the monetary operations of the government? The answer is that it suits their ideological claim that monetary policy is superior to fiscal policy.
Second, the accounting hoopla by which the treasury gets interest income back from the central bank but lets it keep some funds to pay for its staff etc might be interesting to accountants but is largely meaningless from a monetary operations perspective. It is in the realm of the government lending itself money and paying itself back with some territory.
I agree with Mankiw that Paul’s suggestion which Baker endorses “is just an accounting gimmick”. But then the whole edifice surrounding government spending and bond-issuance is also “just an accounting gimmick”. The mainstream make much of what they call the government budget constraint as if it is an a priori financial constraint when in fact it is just an accounting statement of the monetary operations surrounding government spending and taxation and debt-issuance.
There are political gimmicks too that lead to the US government issuing debt to match their net public spending. These just hide the fact that in terms of the intrinsic characteristics of the monetary system the US government is never revenue constrained because it is the monopoly issuer of the currency. Which makes the whole debt ceiling debate a political and accounting gimmick.
Third, note that Baker then falls into the trap that the mainstream are captured by in thinking that in some way the interest payments made by the government to the non-government sector are a “burden”. A burden is something that carries opportunity costs and is unpleasant with connotations of restricted choices.
From a MMT perspective, one of the “costs” of the quantitative easing has been the lost private income that might have been forthcoming had the central bank left the government bonds in the private sector. Given how little else QE has achieved those costs make it a negative policy intervention.
So the so-called “burden” really falls on the private sector in the form of lost income. Once you accept that there are no financial constraints on the US government (which means that the opportunity costs are all real) then the concept of a burden as it is used by Baker is inapplicable.
And then once we recognise that there is a massive pool of underutilised labour and capital equipment in the US at present contributing nothing productive at all then one’s evaluation of those real opportunity costs should be low. That is, at full employment the interest payments made by government to the non-government sector on outstanding public debt have real resource implications that might require some offsetting policies (lower spending/higher taxation) to defray any inflation risks.
With an unemployment rate of nearly 10 per cent and persistently low capacity utilisation rates overall, every dollar the government can put into the US economy will be beneficial from a real perspective.
But it gets worse.
Baker turns his hand to thinking about the monetary operations involved in the central bank destroying the bonds. He might have saved us the pain. He notes that the reason the Federal Reserve “intends to sell off its bonds in future years” is because they want to:
… reduce the reserves of the banking system, thereby limiting lending and preventing inflation. If the Fed doesn’t have the bonds, however, then it can’t sell them off to soak up reserves.
But as it turns out, there are other mechanisms for restricting lending, most obviously raising the reserve requirements for banks. If banks are forced to keep a larger share of their deposits on reserve (rather than lend them out), it has the same effect as reducing the amount of reserves.
Baker falls head long into the mainstream myth that banks lend out reserves.
I remind you of this piece of analysis by the Bank of International Settlements in – Unconventional monetary policies: an appraisal – it is a very useful way to understanding the implications of the current build-up in bank reserves.
The BIS says:
… we argue that the typical strong emphasis on the role of the expansion of bank reserves in discussions of unconventional monetary policies is misplaced. In our view, the effectiveness of such policies is not much affected by the extent to which they rely on bank reserves as opposed to alternative close substitutes, such as central bank short-term debt. In particular, changes in reserves associated with unconventional monetary policies do not in and of themselves loosen significantly the constraint on bank lending or act as a catalyst for inflation …
In fact, the level of reserves hardly figures in banks’ lending decisions. The amount of credit outstanding is determined by banks’ willingness to supply loans, based on perceived risk-return trade-offs, and by the demand for those loans. The aggregate availability of bank reserves does not constrain the expansion directly.
It is obvious why this is the case. Loans create deposits which can then be drawn upon by the borrower. No reserves are needed at that stage. Then, as the BIS paper says, “in order to avoid extreme volatility in the interest rate, central banks supply reserves as demanded by the system.”
The loan desk of commercial banks have no interaction with the reserve operations of the monetary system as part of their daily tasks. They just take applications from credit worthy customers who seek loans and assess them accordingly and then approve or reject the loans. In approving a loan they instantly create a deposit (a zero net financial asset transaction).
The only thing that constrains the bank loan desks from expanding credit is a lack of credit-worthy applicants, which can originate from the supply side if banks adopt pessimistic assessments or the demand side if credit-worthy customers are loathe to seek loans.
In answering his own “examination question”, Mankiw gets positively angry and says of the plan to raise reserve requirements that it would be:
… a form of financial repression. Assuming the Fed does not pay market interest rates on those newly required reserves, it is like a tax on bank financing. The initial impact is on those small businesses that rely on banks to raise funds for investment. The policy will therefore impede the financial system’s ability to intermediate between savers and investors. As a result, the economy’s capital stock will be allocated less efficiently. In the long run, there will be lower growth in productivity and real wages.
First, if the central bank didn’t use the bonds to drain reserves (via open market operations) then it would have to pay market rates of interest to the banks who held reserves with them or lose control of its target policy rate. So unless the central bank is going to keep short-term rates at zero for an indefinite period (which I recommend) then we would be unwise to assume they will not be paying a return on the reserves (as they are doing now).
Consistent with MMT, there are two broad ways the central bank can manage bank reserves to maintain control over its target rate. First, central banks can buy or sell government debt to control the quantity of reserves to bring about the desired short-term interest rate.
MMT posits exactly the same explanation for public debt issuance – it is not to finance net government spending (outlays above tax revenue) given that the national government does not need to raise revenue in order to spend. Debt issuance is, in fact, a monetary operation to deal with the banks reserves that deficits add and allow central banks to maintain a target rate.
Try finding this explanation for public sector debt issuance in Mankiw’s macroeconomics text book.
Second, a central bank might, instead, provide a return on excess reserve holdings at the policy rate which means the financial opportunity cost of holding reserves for banks becomes zero. A central bank can then supply as many reserves as it likes at that support rate and the banks will be happy to hold them and not seek to rid themselves of the excess in the interbank market. The important point is that the interest rate level set by the central bank is then “delinked” from the volume of bank reserves in the banking system and so this becomes equivalent to the first case when the central bank drains reserves by issuing public debt.
So the build-up of bank reserves has no implication for interest rates which are clearly set solely by the central bank. All the mainstream claims that budget deficits will drive interest rates up misunderstand their impact on reserves and the central bank’s capacity to manage these bank reserves in a “decoupled” fashion.
Second, Mankiw falls prey to the same error that Baker makes – that banks lend out reserves. As noted this is a mainstream myth. The banks could still lend out whatever they liked as long as there were credit-worthy customers queuing up for loans. So no small businesses would be affected in the way Mankiw claims.
Anyway, as to what the debt-ceiling means, I was asked by several readers about the status of the US government (by which they meant the Treasury) in relation to the central bank (the Federal Reserve).
The legal code in the US essentially recognises that the central bank and treasury are part of the government sector.
If you consult the United States Code which reflects the legislative decisions made by the US Congress you find, for example, the section – TITLE 31 – MONEY AND FINANCE § 5301 – which deals with the Buying obligations of the United States Government
The US law stipulates the following:
31 USC § 5301. Buying obligations of the United States Government
(a) The President may direct the Secretary of the Treasury to make an agreement with the Federal reserve banks and the Board of Governors of the Federal Reserve System when the President decides that the foreign commerce of the United States is affected adversely because –
(1) the value of coins and currency of a foreign country compared to the present standard value of gold is depreciating;
(2) action is necessary to regulate and maintain the parity of United States coins and currency;
(3) an economic emergency requires an expansion of credit; or
(4) an expansion of credit is necessary so that the United States Government and the governments of other countries can stabilize the value of coins and currencies of a country.
(b) Under an agreement under subsection (a) of this section, the Board shall permit the banks (and the Board is authorized to permit the banks notwithstanding another law) to agree that the banks will-
(1) conduct through each entire specified period open market operations in obligations of the United States Government or corporations in which the Government is the majority stockholder; and
(2) buy directly and hold an additional $3,000,000,000 of obligations of the Government for each agreed period, unless the Secretary consents to the sale of the obligations before the end of the period.
(c) With the approval of the Secretary, the Board may require Federal reserve banks to take action the Secretary and Board consider necessary to prevent unreasonable credit expansion.
§ 5301. Buying obligations of the United States Government under Title 31 of the US Code as currently published by the US Government reflects the laws passed by Congress as of February 1, 2010.
So it seems the President can never run out of “money”. Can any constitutional lawyers out there who are expert in the USC please clarify if there are exceptions to this law? The law (including the accompanying notes which I didn’t include here) appears to say that an economic emergency can justify the President commanding the Federal Reserve to hand over credit balances in favour of the US Treasury.
Conclusion
I hope you all answered Mankiw’s examination question correctly.
July 8 (CNBC) — The dismal state of employment offers more proof that President Obama’s economic plan isn’t working, Republican presidential candidate Michele Bachmann told CNBC.
Agreed!
Speaking just after the government said unemployment rose to 9.2 percent last month, the firebrand Minnesota congresswoman and Tea Party leader delivered a blistering critique of the White House’s handling of the jobs picture, focusing specifically on the $800 billion stimulus that has failed to drive down the unemployment rate.
“The president’s own policies have clearly failed the American people,” Bachmann said. “The answer is not to double-down and continue to do more of the same. The answer is to work on what went wrong, to reverse course and have a pro-growth job agenda.”
The $800 billion did what it did- it added $800 billion in income and nominal savings to the economy- to the penny. It’s an accounting identity. If it didn’t add exactly $800 billion the accountants at the CBO would have to stay late and find their arithmetic mistake.
In fact, all entire deficit spending adds that much nominal savings to the economy. That’s where all the increased savings has come from. You could change the label of those deficit clocks to ‘world dollar savings’ and leave the numbers alone.
And note that treasury securities are functionally nothing more than savings accounts at the Fed.
Defying consensus estimates that the economy had merely hit a soft patch and was on its road to recovery, the latest jobs news instead shows just 18,000 jobs created in June and the unemployment rate when taking into consideration those not looking for work at 16.2 percent.
Right, the problem is the deficit is too small. I’ve proposed a full FICA suspension, federal revenue distributions to the state govts of $500 per capita, and an $8/hr federally funded transition job to anyone willing and able to work to facilitate the transition from unemployment to private sector employment.
Bachmann’s campaign has caught fire as polls show her in a virtual dead heat in Iowa with presumptive front-runner Mitt Romney.
In her live interview, Bachmann focused on the voices she has heard while campaigning and the angst among business owners about how Washington policies have hindered business growth.
“I have talked to business owners all across the nation,” she said. “They’re really paralyzed with fear right now. This won’t help hearing (the unemployment news) because it shows that Washington doesn’t have the solution.”
Agreed!
She spoke as Congress and the White House are locked in debate over whether to raise the $14.3 trillion debt ceiling. Bachmann dodged a question over whether the failure to increase the borrowing limit while drastically cutting spending would raise unemployment, but she said more taxes certainly aren’t the answer, either.
“We need to fundamentally restructure how government does spending,” she said. “We’re still operating under the principles of FDR and LBJ. We need to move into the 21st century so we embrace pro-growth policies. Unfortunately they’re tone deaf here in Washington, D.C. They think government is the answer, and the American people know it’s not true.”
I watched her explain how if they just do spending cuts to balance the budget that will create jobs in the long term. What she fails to understand is that with all of our ‘demand leakages’ and tighter lending standards, spending cuts have to be at least matched by tax cuts to not add to unemployment, and tax cuts have to be substantially larger than spending cuts to add to demand and reduce unemployment.
It’s a shame, because with the tea party standing for ‘taxed enough already’ the tea party candidates continue to propose balanced budgets that continue to grossly over tax us.
It’s also a shame that no one in the media has the knowledge of actual monetary operations to expose the gaping flaws in her logic. In fact, the have the same fundamental misunderstanding and tend to agree with her, including the entirely inapplicable analogy that we are in danger of becoming the next Greece.
So current odds have to favor her for the presidential nomination.
And only MMT stands between her and the presidency.
This is bad beyond description, as it displays total ignorance of the difference between interest rate determination in fixed vs floating exchange rate regimes, which may be the only thing standing between this disaster of an economy and unimaginable prosperity.
Worse is that it goes unchallenged, apart from the still relatively small MMT community.
Lawmakers and investors shouldn’t take comfort in low U.S. borrowing costs because markets are often “complacent” about the risk from excessive deficit spending, said James Bullard, president of the Federal Reserve Bank of St. Louis.
“When it does blow up it will be too late,” Bullard said in an interview last month in New York. “When markets lose confidence in the U.S. and say that they don’t trust us any more, rates will skyrocket and the crisis will be upon you.”
In fact, no one on the FOMC has called for QE3, so it’s highly unlikely with anything short of actual negative growth.
So the question is, why the unamimous consensus?
I’d say it varies from member to member, with each concerned for his own reason, for better or for worse.
And I do think the odds of their being an understanding with China are high, particularly with China having let their T bill portfolio run off, while directing additions to reserves to currencies other than the $US, as well as evidence of a multitude of other portfolio managers doing much the same thing. This includes buying gold and other commodities, all in response to (misguided notions of) QE2 and monetary and fiscal policy in general. So the Fed may be hoping to reverse the (mistaken) notion that they are ‘printing money and creating inflation’ by making it clear that there are no plans for further QE.
Hence the ‘new’ strong dollar rhetoric: no more ‘monetary stimulus’ and lots of talk about keeping the dollar strong fundamentally via low inflation and pro growth policy. And the tough talk about the long term deficit plays to this theme as well, even as the Chairman recognizes the downside risks to immediate budget cuts, as he continues to see the risks as asymetric. The Fed believes it can deal with inflation, should that happen, but that it’s come to the end of the tool box, for all practical purposes, in their fight against deflation, even as they fail to meet either of their dual mandates of full employment and price stability to their satisfaction.
They also see downside risk to US GDP from China, Japan, and Europe for all the well publicized reasons.
And, with regard to statements warning against immediate budget cuts, I have some reason to believe at least one Fed official has read my book and is aware of MMT in general.
June 7 (Reuters) — Federal Reserve Chairman Ben Bernanke Tuesday acknowledged a slowdown in the U.S. economy but offered no suggestion the central bank is considering any further monetary stimulus to support growth.
He also issued a stern warning to lawmakers in Washington who are considering aggressive budget cuts, saying they have the potential to derail the economic recovery if cuts in government spending take hold too soon.
A recent spate of weak economic data, capped by a report Friday showing U.S. employers expanded payrolls by a meager 54,000 workers last month, has renewed investor speculation the economy could need more help from the Fed.
“U.S. economic growth so far this year looks to have been somewhat slower than expected,” Bernanke told a banking conference. “A number of indicators also suggest some loss in momentum in labor markets in recent weeks.”
He said the recovery was still weak enough to warrant keeping in place the Fed’s strong monetary support, saying the economy was still growing well below its full potential.
At the same time, Bernanke argued that the latest bout of weakness would likely not last very long, and should give way to stronger growth in the second half of the year. He said a recent spike in U.S. inflation, while worrisome, should be similarly transitory. Weak growth in wages and stable inflation expectations suggest few lasting inflation pressures, Bernanke said.
On the budget, Bernanke repeated his call for a long-term plan for a sustainable fiscal path, but warned politicians against massive short-term reductions in spending.
“A sharp fiscal consolidation focused on the very near term could be self-defeating if it were to undercut the still-fragile recovery,” Bernanke said.
“By taking decisions today that lead to fiscal consolidation over a longer horizon, policymakers can avoid a sudden fiscal contraction that could put the recovery at risk,” he said.
All Tapped Out?
The central bank has already slashed overnight interest rates to zero and purchased more than $2 trillion in government bonds in an effort to pull the economy from a deep recession and spur a stronger recovery.
With the central bank’s balance sheet already bloated, officials have made clear the bar is high for any further easing of monetary policy. The Fed’s current $600 billion round of government bond buying, known as QE2, runs its course later this month.
Sharp criticism in the wake of QE2 is one factor likely to make policymakers reluctant to push the limits of unconventional policy. They also may have concerns that more stimulus would face diminishing economic returns, while potentially complicating their effort to return policy to a more normal footing.
But a further worsening of economic conditions, particularly one that is accompanied by a reversal of recent upward pressure on inflation, could change that outlook.
The government’s jobs report Friday was almost uniformly bleak. The pace of hiring was just over a third of what economists had expected and the unemployment rate rose to 9.1 percent, defying predictions for a slight drop.
In a Reuters poll of U.S. primary dealer banks conducted after the employment data, analysts saw only a 10 percent chance for another round of government bond purchases by the central bank over the next two years. Dealers also pushed back the timing of an eventual rate hike further into 2012.
The weakening in the U.S. recovery comes against a backdrop of uncertainty over the course of fiscal policy and bickering over the U.S. debt limit in Congress, with Republicans pushing hard for deep budget cuts.
Fragility is Global
Hurdles to better economic health have emerged from overseas as well. Europe is struggling with a debt crisis, while Japan is still reeling from the effects of a traumatic earthquake and tsunami.
In emerging markets, China is trying to rein in its red-hot growth to prevent inflation.
Fed policymakers have admitted to being surprised by how weak the economy appears, but none have yet called for more stimulus.
In an interview with the Wall Street Journal, Chicago Federal Reserve Bank President Charles Evans, a noted policy dove, said he was not yet ready to support a third round of so-called quantitative easing. His counterpart in Atlanta, Dennis Lockhart, also said the economy was not weak enough to warrant further support.
While Boston Fed President Eric Rosengren told CNBC Monday the economy’s weakness might delay the timing of an eventual monetary tightening, the head of the Dallas Federal Reserve Bank, Richard Fisher, said the Fed may have already done too much.
Evans and Fisher have a policy vote on the Fed this year while Rosengren and Lockhart do not.
MMT will inform a number of economic policies to be presented and debated in a conference entitled “Lessons from the Crisis: Money, Taxes and Saving in a Changing World” co-hosted by Smart Taxes, (Fiscal Policy for Sustainability Network) and TASC (Think Tank for Action on Social Change) on the 9th May 2011 at Croke Park, Dublin. There will be a public lecture at 6pm in the Westwood House Hotel in Galway at 6pm on Wednesday 11th May.
April 30 (CNBC) — Warren Buffett says if Congress fails to raise the U.S. debt limit, it would be its “most asinine act” ever. But he told shareholders today there’s “no chance” lawmakers will fail to do so, despite “waste of time” debates on Capitol Hill.
While Buffett doesn’t want the nation to keep increasing its debt relative to GDP, he says there’s shouldn’t be a legislated debt limit to begin with, because circumstances change.
Buffett says the U.S. will not “have a debt crisis of any kind as long as we keep issuing our notes in our own currency.” Inflation resulting from a “printing press” approach, however, is a serious threat.
Charlie Munger’s view: the political parties are competing with each other to see who can be the most stupid, and they keep topping themselves.
If the debt limit is not raised, the government would run out of money, forcing a significant shutdown.
The current $14.3 trillion limit expires on May 16, although the administration has said it will be able to juggle some funds so that a shutdown would not happen immediately.
L. Randall Wray is a professor of economics at the University of Missouri-Kansas City and a senior scholar at the Levy Economics Institute of Bard College. He is the author of“Understanding Modern Money,” and blogs at New Economic Perspectives.
In what appears to be an attempt to influence the political debate in Washington over federal government deficits, Standards & Poor’s rating firm downgraded U.S. debt to negative from stable. Yes, the raters who blessed virtually every toxic waste subprime security they saw with AAA ratings now see problems with sovereign government debt.
The best thing to do is to ignore the raters — as markets usually do when sovereign debt gets downgraded — but this time stock indexes fell, probably because of the uncertain prospects concerning government budgeting. After all, we barely avoided a government shutdown earlier this month, and with S.&P. joining the fray who knows whether the government will continue to pay its bills?
Mind you, this has nothing to do with economics, government solvency or involuntary default. A sovereign government can always make payments as they come due by crediting bank accounts — something recognized by Chairman Ben Bernanke when he said the Fed spends by marking up the size of the reserve accounts of banks.
Similarly Chairman Alan Greenspan said that Social Security can never go broke because government can meet all its obligations by “creating money.”
Instead, sovereign government spending is constrained by budgeting procedure and by Congressionally imposed debt limits. In other words, by self-imposed constraints rather than by market constraints.
Government needs to be concerned about pressures on inflation and the exchange rate should its spending become excessive. And it should avoid “crowding out” private initiative by moving too many resources to our public sector. However, with high unemployment and idle plant and equipment, no one can reasonably argue that these dangers are imminent.
Strangely enough, the ratings agencies recognized long ago that sovereign currency-issuing governments do not really face solvency constraints. A decade ago Moody’s downgraded Japan to Aaa3, generating a sharp reaction from the government. The raters back-tracked and said they were not rating ability to pay, but rather the prospects for inflation and currency depreciation. After 10 more years of running deficits, Japan’s debt-to-gross-domestic-product ratio is 200 percent, it borrows at nearly zero interest rates, it makes every payment that comes due, its yen remains strong and deflation reigns.
While I certainly hope we do not repeat Japan’s economic experience of the past two decades, I think the impact of downgrades by raters of U.S. sovereign debt will have a similar impact here: zip.
I spoke with Senator Blumenthal for several hours on MMT just over a year ago, before he was elected Senator.
He read my book and asked the right questions.
He knows imports are real benefits, exports real costs.
He knows the trade deficit is a good thing for America.
He knows that his proposals would reduce our real terms of trade and lower our standard of living.
And he knows taxes function to regulate aggregate demand,
and that we can readily sustain full employment by keeping taxes at the right level for a given size of government.
He remarked that it was how he had learned it at Harvard in the 1960’s.
And he called me several times to discuss specific issues in detail.
With this letter he has turned subversive for presumed political gain.
I see it as a clear case of politics over patriotism.
I likewise discussed this with Senator Carl Levin, but maybe 15 years ago, who also seems to have decided to place politics over patriotism.
If I had the authority, I would prosecute for treason.
April 14, 2011
The Honorable Timothy J. Geithner
Secretary of the Treasury
1500 Pennsylvania Ave. NW
Washington, DC 20220
Dear Mr. Secretary,
We write to urge you to make fundamental currency misalignment a central issue at the G-20 meeting in Washington, DC this week. For too long, this issue has festered, harming not only American companies and workers, but also the economy of every country that meets its International Monetary Fund (IMF) commitments to allow the level of its currency to be determined by markets.
The consistent interference of a few countries in currency markets creates an uneven global playing field, perversely encouraging other countries to intervene as well. The resulting currency misalignments distort global markets, creating instability at a time when the world can ill afford it.
While multiple countries are guilty of currency manipulation, China unfortunately stands out from the rest. Its mercantilist policies occur on a grand scale. In the fourth quarter of 2010, China intervened in currency markets by purchasing $2 billion worth of foreign currency a day, adding $199 billion to its foreign currency reserves. Not surprisingly, in its recent 2011 Global Economic Outlook, the IMF calls the RMB “substantially weaker than warranted” and finds a “key motivation for the acquisition of foreign exchange reserves seems to be to prevent nominal exchange rate appreciation and preserve competitiveness.”
China’s policies work as intended: The RMB has had almost no appreciation against the dollar since May 2008. China’s illegal practices make Chinese-produced goods cheaper than similar products made in America, driving up our trade deficit with China and putting Americans out of work. The United States’ trade deficit with China reached a staggering $273 billion last year, costing our country thousands of jobs.
The IMF cites the accumulation of official foreign exchange reserves as “an important obstacle to global demand rebalancing.” Removing this obstacle should be a key U.S. priority. Ironically, China’s refusal to allow the RMB to appreciate in a meaningful way is contrary to its own best interest. Economists agree that China needs to rebalance its economy to rely more on domestic consumption than on export-led growth. This necessary rebalancing would ultimately tame Chinese inflation, improve global economic growth, and remove a key barrier to a more fruitful U.S.-China relationship.
The United States does no one a favor by downplaying this crucial issue. We urge you to work together with all countries harmed by currency manipulation to press China to allow the level of the RMB to be determined by markets, not government interventions. When everyone plays by the same rules, our entrepreneurs and workers can compete and win in the global economy.
