By Marshall Auerback, a fund manager and investment strategist who writes for New Deal 2.0.
Many market analysts, commentators and economists claim to be having a hard time finding a metric in which the US is in better financial shape than Greece. Ken Rogoff, for example, recently warned that a Greek default would usher in a series of sovereign defaults, and suggested recently on NPR that the crisis also had implications for the US. The historian Niall Ferguson made a similar claim a few months ago in the Financial Times. The cries of the deficit hawks grow louder: Repent all ye fiscal profligates, before the “day of reckoning” comes.
Let’s dial down the Biblical hysteria a wee bit while there’s still time for rational debate. The market’s recent response to the intensifying pressures in the euro zone suggests that investors are beginning to differentiate between countries that are sovereign issuers of currency, such as the US or Japan, and non-sovereign issuers, such as Greece or any other nations in the euro zone. The US dollar is rising in value, notwithstanding the federal deficit, while debt distress in the so-called “PIIGS” countries, especially Greece, are intensifying, thereby driving down the euro to fresh 12 month lows against the dollar.
The relative performance of various currencies against the US dollar is highly instructive in this regard. Over the past 3 months, the Australian, New Zealand and Canadian dollars have all registered gains of some 4% against the greenback. The worst performer? Not surprisingly, the euro, down 6.3% over that period. Whether consciously or not, the markets are demonstrating that they understand the distinctions between users of currencies (who face an external funding constraint), and those nations that face no constraint in their deficit spending activities because they are creators of currency.
That the US has the reserve currency is an irrelevant consideration here. The key distinction remains user vs. creator. The euro zone nations are part of the former; Canada, Australia, the UK, Japan and the US are representatives of the latter.
Using “PIIGS” countries as analogues to the US or the UK, as Rogoff, Ferguson and countless other commentators do, is wrong. Their faulty analysis comes as a result of the deficit critics’ failure to distinguish between the monetary arrangements of sovereign and non-sovereign nations. Any sovereign government (none within the EMU enjoy that status any longer) can deal with a collapse in revenue and an increase in outlays from a financial perspective without invoking the sort of deadlocks that are now crippling the EMU zone. That is why, for example, the Japanese yen is not in freefall against the dollar, despite having a public debt to GDP ratio in excess of 200%, almost 2.5 times that of the US. In fact, over the past few days the yen has actually appreciated against the dollar. Now why would that be, if the lesson we were supposed to learn was the evils of “unsustainable” government deficit spending?
Fiscal sustainability has no relevance in a system where there are no operational constraints on the ability of a government to spend. US Social Security checks will not bounce. Nor will the Canadian or Japanese equivalents. Similarly, their bonds will always be able to pay out interest.
Note that this doesn’t mean that there are no real resource constraints on government spending. Let’s be clear: anyone who advances the use of fiscal policy as an effective counter-stabilization tool is always careful to point out that these interventions can come at a cost. That cost could well be inflation if, as a result of the fiscal expansion, we reach full employment, resource constraints begin to appear, but the government continues to spend. But if the economy recovers, tax revenues will increase and safety net spending will fall. In the US, that means we will likely be back to “normal,” with deficits around 2-4% depending on the state of the economy, which is where we’ve been for the past 30 years aside from 1998-2001.
Why won’t these deficits be inflationary? As Professor Scott Fullwiler noted in a recent email correspondence with me, once the recovery is underway and the economy gets to a significantly higher capacity utilization where price pressures could emerge, the deficit will be declining substantially. It will also be at least a partially offset by a fall in discretionary spending on social welfare. It’s axiomatic that the faster the economy grows, the smaller the deficit becomes, unless the government continues to spend recklessly–which we certainly do not advocate.
And by the time we get to a point where we might have inflation, the deficit is back to 2-3%, which again is where we’ve been for the past 30 years, while average inflation has been about 2%. Note: inflation does not equal default. You and I could well buy credit default swaps on any country in the world, but we are unable to collect if any of the relevant countries register a positive rate of inflation — even a double digit rate of inflation — because inflation is not tantamount to default. Nor do the ratings agencies recognize default in this manner. Default is defined as a failure to perform a task or fulfill an obligation, especially failure to meet a financial obligation. Inflation is not incorporated into the definition when it comes to questions of national insolvency.
By contrast, the talk of Greek default is prevalent across the markets, and that is a reasonable concern in the context of the euro zone. The default option is considered a foregone conclusion, even allowing for the massive 110 billion euro bailout, which was designed to inspire “shock and awe” among investors but instead has simply engendered shock. If Greece costs 110 billion euros to bail out, how much next time for Spain, Italy, or even France?
If the markets have concerns about national solvency, they won’t extend credit. And that is the problem facing all of the euro zone countries. Greece, Portugal, Italy, France, and Germany are all users of the euro-not issuers. In that respect, they are more like any American state or municipality, all of which are users of the US federal government’s dollar.
And deficits per se will not create the conditions for default in the US. If the US continues to run net export deficits (all the more likely given the ongoing fall in the value of the euro), and the private domestic sector is to net save, the US government has to net spend–that is, run deficits. That is a basic accounting identity, nothing more, nothing less. If the US government tries under these circumstances to run surpluses, it will first of all force the private domestic sector into deficits (and increasing debt) and ultimately fail because the latter will eventually seek to increase their saving ratio again.
And the same logic applies for Greece. The call is for the IMF/EU package to reduce its budget deficit as a percentage of GDP from the current 13.6% to 8.1% in 2011. How will they achieve that? Trying to engineer a reduction in the deficit via austerity programs (or freezes or whatever else one might like to call them) at a time when private spending is still insufficient to maintain adequate real GDP growth is a recipe for disaster. It will increase the deficit.
Consider Ireland as Exhibit A in this regard. Ireland began cutting back deficit spending in 2008, when its banking crisis began to spread and its budget deficit as a percentage of GDP was 7.3%. The economy promptly contracted by 10% and, surprise, surprise, the deficit exploded to 14.3% of GDP. We would wager heavy odds that a similar fate lies in store for Greece, given the EU’s inability to understand or recognize basic financial balances and the interrelationships among the various sectors of the economy. Neither a government, nor the IMF, can predict with any certainty what the outcome will be–ultimately private saving desires will drive the outcome, as Bill Mitchell has noted repeatedly.
Why do we have huge budget deficits across the globe? It’s not because our officials have all suddenly become Soviet-style apparatchiks. It is largely because the slower global economy has led to lower revenues (less income=less taxes paid, since most tax revenue is based on income, and lower tax brackets) and higher spending on the social safety net. Gutting this social safety net because we extrapolate the wrong lessons from the euro zone’s particular (and self-imposed) predicament constitutes the height of economic ignorance. It also reflects a transparently political agenda, which the US would be ill advised to embrace. The rescue packages, the IMF intervention and all the talk about orderly defaults cannot overcome the EMU’s fundamental design flaw. Let neo-liberalism die with the euro.
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For 30 years we have been growing total debt at a faster rate than real output. Household and corporate (especially financial) debt exploded in the 80s and 90s and the best part of this past decade. Now we have exponential growth in government debt as household and financial debt contract. All we have done is bring forward demand.
The policy of asset inflation to substitute for real wages benefited a few not the majority. It makes no common sense that a problem of excess systemic debt is solved with more debt. But we have all these academic economists and Wall Street mavens with their models running the show that common sense has been thrown out the window.
At some point Fed monetization of the debt will accelerate and that is just a default for all intents and purposes as debtors are paying back with debased currency. History has shown that money printing works briefly and then the fundamentals re-assert with the reset required by kicking the can down the road meaning even more impoverishment of the middle class.
Its time to send the academics back to their ivory tower and common sense businessmen who have actually had to meet a payroll construct policy.
Amen! But the U.S. can get away with the inflating the money supply game for quite a long time.
‘And deficits per se will not create the conditions for default in the US’
No – but if the U.S. is required to pay in something other than dollars for oil from the Middle East, ‘default’ will only be part of the problem – look at the effects of the OPEC oil embargo and the economy of the 1970s.
Friends and I were discussing last night whether we would see Carla Sarkozy wearing a bikini on the new French Franc notes. A voir.
That’s fine, as long as we don’t see Angela Merkel in a bikini on the new Deutsche mark.
Now that’s a currency I would support!!!
So, basically, as long as we keep inflating the bubble there is no problem. When times are good, we borrow and spend a bit more than we earn. When times are bad, we borrow and spend lots more than we earn. Lather, rinse, repeat, as often as required.
I hope you are a good fund manager, because you are not a very good economist.
I suggest you read Irving Fisher’s famous debt deflation paper. The last thing you want with a big debt overhang is deflation. The debts become impossible to pay off because they increase in real terms. If you want to reduce the possibility of defaults and lower the costs of debt restructuring, you need to stay out of deflation.
One gets the impression that Ben Bernanke is well aware of that. If it was necessary to hold off deflation, I can envision the man sitting in McDonald’s eating 400 Happy Meals a day.
Club Meds wanting to avoid deflation = euro exit = new D-Mark going through the roof = German exports slump = German workers unhappy after a decade of salary restraint under the euro and another decade of restraing bcs the European peers can undersell (while not repaying the old euro debt). Right?
Ultimately, it is a trade-off between the frictional costs of debt restructuring and the frictional costs of moral hazard. Beyond that, Economy goes beyond a mere production maximizing exercise, fairness is important too. So important that it is well documented from behavioral economics that there are situation where people (and even chimps !) trade wealth for fairness.
This is my gut feeling.
Nature is not what the Age-of-Reason boys assumed it to be, man is not the rational P-1 maximizer that classical economics asserts he is, and the invisible hand has about as much basis in factual reality as the Garden of Eden.
We simply substituted nature for God, and free-markets for heaven. But the new constructs are just as supernatural as the old ones, and as susceptible to manipulation by TPTB.
Excellent metaphor!!!
That is the wrong way to look at if you are designing a healthy economic system. All you are doing is perpetuating inflationary debt and price levels caused by inflationary credit creation that have distorted the economy and are unsustainable by the real economy.
You need deflation to get back into equilibrium of real supply and demand.
One way to do it and avoid unfair pain to borrowers is simply to index debt to deflation. Then the government has to stop creating credit out of thin air.
If the government needs money, it should have only two choices: 1) tax or 2) borrow. This way the electorate and market can discipline its actions. Back door taxation through infaltion undermines the integrity of the system and efficiency of the economy.
So as a member of the minority saving class in the United States, I should ally with China (fellow victim of mass debasement) and actively seek the destruction of the profligate, parasitical political class in DC – that purchases (increasingly temporary) political power by systemically destroying the purchasing power of my savings.
I mean why not – if not me, then tomorrow’s US victims of today’s fiscal pedophilia will do the same, in spades.
In socialism, you run out of other people’s to steal.
In the US kleptocracy, you run out of savers to betray.
America 1.0 is at its endgame.
We all do the best we can in these trying times, Expat. Thanks for your kind words.
While I agree that we would not see a Greece like explosion in the US , we would see problems associated with the rise in yields as the value of the dollar declines
Um, did you watch the markets today? They don’t agree with your view of the trajectory of the dollar. And basket case Japan, which has been trying to print and spend its way out of deflation, has a super strong currency right now, which is wreaking havoc with its export sector.
Given what’s going on out there, all built on top of vast uncertainty, a few hrs “market” response to yesterday is, IMO, no barometer whatsoever to what tomorrow may bring, let alone lunch hour today.
Well, the moment the markets understand, that not Greece, but Germany, Austria and the Netherlands could leave the Euro, there is just one way for the Euro: down. The debts of those countries leaving the Eurozone would immediately melt away, when their new currencies rise a lot against the Euro.
More snake oil from Marshall Auerback. Tell us what the potential is for monetary financing of government deficits is without high inflation, or by making it meaningless by (a) nationalising deposit money or (b) paying a market rate of interest on reserves. As far as I can see, the stock of currency and reserves (when they are non-interest-bearing) is nowhere near sufficient to support expanded or continued government deficits. Give us some numbers.
And don’t give us “inflation is not default”. Not formally perhaps, but Mr Market can see through that, and as Mrs Thatcher used to say, “you can’t buck the market”. Given the size of the US dollar bond market (tens of trillions of dollars), it would not be possible to do enough QE to hold bond yields down to an acceptable level.
Yves, I am getting tired of this one-sided repetition of dubious claims about monetary financing. If I write a rejoinder post, will you post it on NC?
RebelEconomist,
I’d love to see a rejoinder. Then we could have a proper debate, rather than simple abuse. And I promise not to get personal! Look forward to seeing what you have to say. The idea here is to encourage debate, not shout it down.
My stupid-childish idea is that the simplest way out of this mess (for Europe) would be a few years of shameless protectionist policy, conjugated with a strong increase in salaries and very high taxes on second houses and financial speculative transactions. Oh, and a very aggressive policy on offshore bank accounts and similar amenities.
Actually, no, PDC, my approach would be either to create a supranational fiscal entity, a “United States of Europe”, if you will, or have individual countries leave the euro zone so that they could have full political automony to promote the kinds of fiscal/monetary policies they would like, as opposed to one set at the behest of a few core nations in the EU. I am opposed to the design flaw at the heart of the euro zone and believe in democracy, not rule by eurocrats. That’s my proposal for the euro zone, not protectionism. The only point I made in regard to protectionism is that we were likely to see it as a politically response to a rising euro zone trade surplus coming on the back of a weaker euro.
or have individual states leave the USA so that they could have full political automony to promote the kinds of fiscal/monetary policies they would like, as opposed to one set at the behest of a few core states in the US. I am opposed to the design flaw at the heart of the USA and believe in democracy, not rule by Washingtoncrats .
Isn’t it the same here?
Close enough for empirical work. :)
The distinction you fail to acknowledge, however, is Marshal’s “solution” provides a means for us to fix them. Your model, us to fix us, well…
The paradigm shift, from what I’ve observed: what’s good for your goose is good for your gander. However, my goose does not recognize my gander’s equality in these matters.
I find the attitude to money-the-tool that MMT implies refreshing and helpful. I’m a beginner in this department, but see, through MMT goggles, money more as an economic lubricant than a classical ‘store of value’. True value lies in the health and robustness of the economy, which itself rests on the health of society, which rests ultimately on the health of the environment. The way we use money should reflect this somehow, but sadly the current Invisible Hand mania is obviously not working. Seeing money as a lubricant of economic activity would be a good starting point for setting our priorities straight. Somehow we need to transition away from money-as-wealth to money-as-tool, away from blind, cyclical consumerism to something long-term and sustainable. This is a must we cannot ignore.
That said, slapping an MMT ‘cure’ across the current debt-drenched world strikes me as cavalier in the extreme. Do we really want to print the debt away? What of moral hazard? Shouldn’t we be declawing finance first, encouraging debate globally about how all this debt has come to be, exploring that issue openly and honestly with a financial ‘truth and reconciliation’ process? And why the insistence on growth? And how would we really achieve the full employment that MMT demands? Technological unemployment is an issue that no economic argument can actually dismiss. We need to find things to do for humans that are socially useful and generate self-respect. What are these jobs, and how many of us need to do them? Manufacturing needs humans less and less.
There’s so much wrong with the current system, patchwork fixes can’t work. An MMT patch, minus deeper analysis of the systemic problems we face, will achieve little to nothing, as far as I can work out.
An observation: how can there be a budget surplus in MMT without unemployment? The only money creation that does not net to zero — so the theory — comes from the sovereign. Private sector credit activities do not expand the wealth. Gov spends amount X into existence, creating the pool of money which then spreads through the economy as banks lend it on at whatever ratio. Gov deficit initially = X, an amount unaffected by private sector lending. For there to be a surplus gov must tax >X back out of the economy. If they did this, there would only be debt-money left in the economy (which means “not enough”), which would lead to unemployment as described by MMT. Ergo MMT would mean ever growing deficits, or not much change from the current system at all.
Money is a serious problem one way or another, and has little to nothing to do, functionally at least, with ideology. It’s all numbers in the end, numbers and confidence, anyway, and confidence is wearing dangerously thin.
Excellent post Toby.
A new view of money is certainly in order but getting those rigid thinking Austrians and religious zealot monetarists to revise any part of their paradigm will prove quite difficult.
I hope you realize that nothing Warren Mosler, Randall Wray or Bill Mitchell prescribes can de described as a “patchwork fix”.? Their writing certainly does describe a dismantling and regulation of the current financial/banking institutions. Everyone focuses on what sounds like “money printing” and completely ignores their other ideas, like Warrens proposal to regulate the ASSET side of banking and not the LIABILITY side that has been focused on forever. This is only one of numerous suggestions put forth (and argued convincingly if you read them) by Mr Mitchell, Mosler and Wray. Their solutions are simple (not simplistic) in nature however they are very difficult to enact because of the nature of our political process (and they are the first to acknowledge this).
BTW you are correct about budget surpluses and unemployment. Bill describes that numerous times. He goes further and says there would be no unemployment if there were no government or no money.
I agree wholeheartedly with Gregg: “Excellent post Toby.”
Correct me if I’m wrong, Toby, but I think this captures the spirit of your comment quite eloquently:
[W]ealth is an order and procedure of production and exchange rather than an accumulation of (mostly perishable) goods, and is a trust (the “credit system”) in men and institutions rather than in the intrinsic value of paper money or checks…
–Will & Ariel Durant, The Lessons of History
Toby,
And I wholeheartedly x 2 agree with this statement:
Shouldn’t we be declawing finance first, encouraging debate globally about how all this debt has come to be, exploring that issue openly and honestly with a financial ‘truth and reconciliation’ process?
If we look at the Latin American experience, debt is the Trojan Horse that neoliberals used to pry open the doors of statist bastions. This certainly was the case in Mexico, where the huge debts incurred by the statist regime of Lopez Portillo (1976-1982) triggered the financial crisis of 1982, which was used as a battering ram to knock down the political barriers to liberalization of the economy. But then the pendulum swung too far in the other direction. As Carlos Fuentes observed:
The straightjacket of extreme protectionism, subsidized consumption and production, captive markets, and lack of competitiveness needed to be loosened—-and was. But in its stead came a demonization of national states, a delusional faith in the free play of market forces, and the cruel complacency of social Darwinism in lands of extreme hunger and need.
–Carlos Fuentes, A New Time for Mexico
Thanks for the comments.
I think wealth should be seen as something that necessarily grows out of health. Health is thankfully quite easy to define. A healthy system is one that can operate at or near its optimum, an unhealthy one cannot. I have found John McMurtry’s (“The Cancer Stage of Capitalism”) observations here very helpful, since they give us a base upon which to make helpful measurements and assessments of those socioeconomic models which purport to increase wealth in society. If societies are systems for ensuring the prosperity, health and happiness of as many of their citizens as possible, something is very wrong with the current model.
But boy do we still have a LOOOOONG way to go! The conflation of money with wealth is deeply embedded in our thinking and culture, pretty much globally. Unlearning and relearning this aspect of our lives ain’t going to be easy, vital a process as it is.
I whole heartedly agree w/others… excellent comment!!!
A very apt and meaningful observation. I’ve said the same thing here (and many other places) for a long time now.
There are huge cultural impediments to effectively deconstructing that, however, as the conditions embodied in your observation have largely taken hold, in belief, as the “grease” that turns the economic wheels.
Of course, it’s the “emperor has no clothes”: were we to match currency to value of contribution, there’s a whole lot of emperors who’d have to learn how to sew.
Yep. Your comments read to me like advanced common sense competing with modern economic policy.
I’m channeling you man. That’s what I would have said if I could focus my mind long enough to actually type it all out. But at the very end of that road is just you and the Big Guy Upstairs, face to face, and then just you and Words, and then when the words melt into infinity it’s just You and You, and then the oneness of it all, and by that point you don’t even need money, or anything really, you just ascend. :)
-Lakesh Prandamanatan
Church of the Holy Chakra
Correct and educate me if I am wrong but isn’t money first issued by a private bank and not from the sovereign? That was supposed to be the function of Federal Reserve, a quasi-government entity that works closely with Washington but nonetheless is required to maintain a balance sheet just like any other family bank? Government never has any money to spend to begin with (remember the Continental Army?) except through collection of fund via tax and issuance of debt. Why else would a government even bother if by a fat finger it can generate, electronically or on a piece of paper, all the expenses it needs? Just to give the currency a sense of street cred among the commons? I’m sorry to say this but MMT has the smell of certitude like another Black-Scholes; if the theory were true why does anyone trade sovereign default on the CDS market?
I’m a newcomer to this so please take my answer as such.
We have to distinguish in the first instance between spending and lending money into existence. Right now whenever money is created, it is lent out as an interest bearing loan. This means there can never be enough money in the economy to cover the interest owed. While we might make some old fashioned arguments about carrots and sticks to justify the effect of scarce money as societal incentive to hard work etc, we have with credit-only money a simple mathematical problem, which we are enduring at the moment.
Private banks theoretically could spend money into existence by lending it out at zero interest and not asking for it back, but that’s somewhat against the profit motive and raison d’etre of a bank. And there would be constitutional issues too. So the sovereign has the sole right to spend money into existence, say, to build a new highway, or maglev network, or education reform and so on. Instead, for cultural reasons and effectively out of choice, the gov sells treasuries on the open market to raise funds, which means it borrows money at interest from private investors. Either it borrows to spend, or it taxes to save to spend (from the ever scarce pool of credit-money out there), at least in the popular conception. When the gov “resorts” to something like QE, this is seen as inflationary, or the cunning printing of money by other means. Watch out, here comes Zimbabwe!
MMT sees taxation as a sometimes necessary drain to take heat out of the economy. Money, which is nothing but computer entries, is removed from (taxed out of)) private accounts and “disappears”. It is not “saved”. Gov need not tax to save, since it can spend money into existence, as if by magic. After all, money is a lubricant, not a store of value per se. Deficits are therefore merely records of the amounts of money gov has injected into the economy, not huge interest bearing loans crushing us all. Taxation is merely one way of removing money from the economy (it can also be done with bond issues). Of course this would be very tricky to get just right, but the principle is something like I have described.
If you want to look deeper, I recommend Bill Mitchell’s blog, which has good introductory papers on all this.
Personally I think we first need a system reset and total exposure of the degree of fraud rampant in finance worldwide, then a full-blooded discussion of how to change course. I like Bernard Lietaer’s Terra currency, which would be global, based on a basket of commodities, used for international investment and trade, and suffers from a 3.5-4.0% demurrage fee. Saving/hoarding it makes no sense whatsoever. “Beneath” the Terra would operate some implementation of MMT at the national level, then lower still local currencies to keep communities cohesive. And all that alongside embracing technological unemployment by shortening the work week, so that moving towards full employment has some sort of a chance. And then revolutionizing education from the ground up.
But that’s just my take. Most important of all are full and open discussions, with as many of us hoi polloi as possible being as informed as possible about what is going on.
I believe Auerback is right there is no need to panic due to public deficits in a sovereign nation that issue it’s own currency. But the core problem that have steered the industrial world in to the present times of repeated crisis is the successful right wing revolution of the past three to four decades. Most of the growth that has occurred have landed among the few and created financial bubble and speculation economy. From 1947 – 1973, in USA, the productivity growth was 104% and real family income growth 104 %, 1974 – 2003 productivity growth was 71 % but real family income did only grow 22 %. Graph.
This pattern is probably in large the same all over the industrial world it does of course hamper aggregate demand among the many. Elisabeth Warrens investigation of the American middle class from 1970 – 2006 gives an even bleaker picture of consumption growth.
The core problem is the working class, middle class, call it what you want, inability and incompetence to make a fair barging on the productivity growth. To be able to make a fair deal it has to come to a situation of near real full employment, it will shift power in society. But then you are up for a real class war for the beneficiaries of the prevailing economic order will not give in without a fight. And there is really non of the political parties in the industrial world with real influence that seriously want to change the present order, they might call them self liberals social democrats or what ever they are acolytes to the present order, their “leftist” pose is merely we maybe hand out some more dole to the those who is negative affected by the present system.
Ad to that defunct neoliberal ideas that the world should focus on export orientated growth, pure idotic mercantilism, in a world with fiat currencies, at least in a world with gold standard it made some sense.
As Auerback point to a more normal order of running deficit is 2 – 4 %, that corresponds to a normal level of public investment i society and since when was it any wrong to finance things that make the society better in the feature with credit. In the euro nonsense 3% deficit was allowed but the idea was that surplus was preferred. To finance public investments for better infrastructure education and so on with credit was not really the right way.
European protectionism would end in a disaster. If not the rickets parts of the world could take on the slack in aggregate demand who could. Despite what’s mentioned above USA has for long as “consumer of last resort” dragged the world of every bubble bursting recessions it’s high time Europe dump its defunct economic nonsense and take some global responsibility to get global economy in gear. This time No1 seems to be hit extraordinarily hard and we could probably not expect No1 to drag the world out of this recession to. But it probably as usual rather set the world on fire than to the right and sensible thing.
1. The UK pound has been doing real well of late (mot!).
2. Yesterday the C$ got creamed, yet per an article I read recently Canada is such a good risk that there are not even CDSs on Canadian debt.
3. It is all a beauty contest between paper currencies. The markets swing back and forth depending on the news of the week. Only gold continues to march higher in all currencies. Gold has now hit new highs in all major currencies except the US$ (but is close there too). That is the real story.
4. The US is like Greece, just not yet. The fireplace has been set with logs, kindling, and some gasoline, with a match at the ready. All that is needed is a spark. The very short average term of US debt is a huge issue (now down to something like only 4 years). That makes a huge rollover risk almost every month (and it is the rollover risk that caused most of Greece’s current mess – May redemptions). No the US will not default but all it takes is one failed auction – or another clear wiff of monetization – and rates will climb pretty quick/or printing presses will be running overtime.
True, the CAD and AUD were weaker yesterday (the piece was actually written the day before), but the yen appreciated significantly, and the Japanese economy has an even higher debt to GDP ratio than the US. The same kinds of warnings you indicate about the US have been made about Japan for over 20 years. We’re still waiting for the day of reckoning there. Where’s the inflation? Where’s the Japanese version of Zimbabwe? Externally held debt vs internally held debt is irrelevant. The key distinction is between user and issuer of currency. That’s also why the UK economy, despite all the bloviating from the commentariat, is performing significantly better than any of the euro zone economies.
And if debased savers and betrayed entrepreneurs decide to switch allegiance to another currency/nation because of your cavalier dismissal that “it can’t happen – because it hasn’t happened yet!”
Which sounds similar to every self-justifying abusive spouse, just before they are set on fire in their bed.
Look, whistle past the ovens on your own and leave my nation’s currency out of it.
Entrepreneurs can’t change countries easily, you are off on a libertarian fantasy. Moving to a new country if you aren’t in the employ of a big corp. is an exercise in downward mobility. How do you have the contacts, the knowledge of how things work, to get anywhere? Yes, there are some isolated successes, but they are rare indeed.
Capital flight can take place only if you have a better store of value. What currency do you recommend? Even with the devaluation of the dollar (50% in gold terms in the 1970s) we didn’t see capital flight. The dollar isn’t pretty, but the alternatives are not looking good right now.
‘That’s also why the UK economy … is performing significantly better than any of the euro zone economies.’
Helps to be an oil producer, too. Because really, apart from oil, the UK doesn’t really do much in the way of making anything real at this point.
OK, Marshall, we get it:
The creator of a currency never…and I mean NEVER…has live under the constraints of a defined predicate.
But, please, spare me the BS about MMT. This monetary theory is nothing but an inversion of The Sorites Paradox. [No small amount of irony, either, that “Sorites” is Greek for “heaped up”.]
A refresher on The Sorites Paradox (and a primer on MMT):
The Sorites Paradox (σωρός sōros being Greek for “heap” and σωρείτης sōreitēs a derived adjective meaning “heaped up”) is a paradox that arises from vague predicates.
The paradox of the heap is an example of this paradox— which arises when one considers a heap of sand, from which grains are individually removed. Is it still a heap when only one grain remains? If not, when did it change from a heap to a non-heap?
One (specifically, an MMT Economist) might construct the argument, using premises, as follows:
1,000,000 grains of sand is a heap of sand (Premise 1)
A heap of sand minus one grain is still a heap. (Premise 2)
Repeated applications of Premise 2 (each time starting with one less grain), eventually forces one to accept the conclusion that a heap may be composed of just one grain of sand (and consequently, if one grain of sand is still a heap, then removing that one grain of sand to leave no grains at all still leaves a heap of sand, and indeed a negative number of grains also form a heap).
_____
Marshall simply inverts the paradox. Instead of asking “when will a heap no longer still be a heap” by removing grains…Marshall simply asks, “When does a heap of shitty debt become an unscalable mountain of shitty debt? If we add one more billion? No. OK, How about another? No. OK, let’s keep adding, and when we get to the point where a billion more turns this shitty heap into a shitty mountain, then we’ll stop!
Only, in the MMT’s sordid-sorites-heap-of-shit-worldview, we never get there.
MMT is to government finances what LTCM was to hedge fund finances. “The probability that we are wrong is 1 in 10^24. (Yes, Virginia–that’s 24 zeroes after that 10!). There are no worries…so….Lever up, up, up!”
Exactly.
I’d extrapolate that metaphor to acknowledge MMT allows the accounting abstraction which replicates the 1 diminishing heap heap into multiple non-existent heaps, which, while grains are being drained from the “reserve” heap, the “accounting” shows un-diminished reserves with # of heaps seemingly increasing proportional to removed grains from “reserve”.
The problem with The Sorites Paradox in this situation is that it creates confusion between something that is REAL (sand) with something that is VIRTUAL (money).
It is the classic stock vs. flow problem. Money is used to keep score: if you don’t have enough money, you lose.
Since score can be changed “at will” (by the scorekeepers) – you can have 1 grain of sand and still have a heap – it is a commonplace error to confuse real with virtual, but it is comforting to think of money as real, since it intermediates between real interactions, but it is also dangerous – it is easy to be manipulated by those who know better.
We have a fixed game, a game where the players knew what they were doing and what the possible outcomes were. The solution is to add more score so they will be “repaid” with “lower value” points.
The classic “let the players fail and god/market will sort it out” will not happen, or will only occur on an inconsistent basis – designed such that most of the pain will fall on those who were not responsible for getting us in this situation.
During a deflation, prices decline – putting downward pressure on incomes. Private debt obligations do not decline. If we agree that debt obligations are unsustainable, the question is how to get them restructured.
One way is to let institutions fail – this is happening with small banks today – they are in the classic position of not having a chair when the music stopped – so restructuring is creating greater industry consolidation – not the final outcome many of us think is stable.
Remember that institutions don’t fail quickly – financial firms theoretically can be restructured quickly, but other firms that go bankrupt can take years to work through – even full liquidations. Lets not even talk about bankruptcy courts being over worked and less and less qualified judges available to make equitable decisions.
Another way is for government to spend – effectively putting more money in that hands of those who need to repay and reducing their private debt burden.
Might this reduce the value of the currency?
It depends on what outcome you value.
Hi Marshall,
I wish to point out that the MMT’ers views are different from the economists at Levy who use the New Cambridge approach as far as the external sector is concerned. I actually fully understood this only recently – though I had tried to do that many times in the last many months or so. One may argue that the differences in views are minor, but I think they are deeply different. I, in fact think they have a deep point and I think they are right.
Recently – in fact – over the last 10 years or so they have been arguing about sectoral imbalances with the rest of the world and that the US Government should do something about it. Don’t think I can be as accurate as them but here is what they seem to suggest: Work with various countries to devaluate the US dollar and encourage them to pursue fiscal expansion so that the US becomes a net exporter to the rest of the world. There is no mechanism for the exchange rate to become devalued and experience has suggested it will resist doing so on its own through market forces.
There is one objection one may take to such a view: expansionary fiscal policy of the rest of the world will increase US exports. However, I think this is not sufficient. An increase in exports will lead to a higher aggregate demand of the US as they increase production for exporting and and this will lead to higher imports in nominal value, with the current account still in deficit. I am quite sure that they have used the stock flow consistent models to arrive at this result.
The reason they do not like the current account being in deficit is that the US is a net debtor nation as one can see from the Flow of Funds. Of course important things are the flow of income, interest etc. but in fact some of these things have become intractable according to Godley, Zezza and Dos Santos.
An even higher fiscal stance is of course important, but the solution is not as easy. Of course this is my understanding of their work, so there are bound to be errors on my part, but I see a crucial difference and wish to point this out.
Would be interested in reading a post discussing sovereign default vs repudiation.
I think California is a better comparison to Greece. California’s gaping budget crisis was caused by irresponsible planning and will require similar solutions. For example: Tax hikes, gov’t worker cuts, a possible federal bail out, ect.
The difference is that California had thriving & robust real economic production which has been largely decimated by financial meltdown: eg. massively disappeared markets. Add to that the water problems, long masked by abnormally warm Pacific >> rain (almost ten years), the fraudulent Enron/Ca. “energy crisis” scam ($30b + ripoff)… all exacerbating their portion of real estate bubble…
Good point. However, both California and Greece financed their budgets on the unrealistic expectation that their bubble driven economies would never stall. California certainly has a more diverse economy and a stronger foundation, but it was overvalued nonetheless. The biggest difference I see is that California never made an attempt hide it’s debt…hopefully. Now the bills are coming due but there is not enough revenue. Where will it come from? Stronger states? Central Banks? California will drag on our union just as Greece, Spain, Portugal will drag on the European Union.
An MMT solution to the California fiscal crisis would be for the state to apply and receive “Emergency Fund” from the US, ad-infinitum, knowing our dollar is sourced from the sovereign within and “deficits don’t matter”. We’ll then apply the same elixir to all 50 states and will have finally achieved the goal of full-employment from coast to coast, with the economy kicking in on all 400 gears.
Also Marshall, 3% of annual growth roughly equals to double the amount in 20+ years. Assuming this is the (modest) pace for which you’d envisioned a healthy economy should target the growth of its national debt, at this rate we are going to accumulate $~23 trillions by 2030, and $46 trillions by 2050. But we’ve heard the word “trillions” so many times over the air and the internet media already it really doesn’t sound too bad afterall even as I’m typing this.
Brannon,
California has infrastructure, Hollywood and Silicon Valley full of brilliant engineers. Greece has no infrastructure, and a population of street wise Middle Eastern mentality people who thought they could live forever from tourism and selling overpriced homes to Germans.
Vinny
The difference between us and Greece is that they aren’t parking their fat butts in front of American Idol and pretending that things are okay. Casino gambling in the stock and commodity markets have caused world-wide misery, but you’d never know it via our news media. The only way we know the difference between reality and this feel-good crap is when we have a pile of bills we can’t pay.
Great post. Makes a lot of sense.
Next week I’m converting more of my Euros to gold. And, by seeing how quickly this country (Greece) is turning into an unruly Third World nation, it’s likely I’ll be spending winter on the beach… in Florida (yes, my friends, there are clear benefits to having dual citizenship :)
Vinny
You are right, the US is not like Greece. California and Michigan are like Greece.
As for the US, it’s more like Portugal or Spain.
Marshall. All seems to rest on Fulwillers assumption–“when the economy recovers” or “when the recovery comes”. Indeed, the recovery may happen next year or guess what, in a decade or never…..Also, budget accounting terms such as percent GDP are thrown around very carelessly. To their credit the EU are somewhat more honest than the U.S. on their national accounts. We don’t count Fannie and Freddie or even SS. You can quible on the definitions but alas those are bureacratic contrivances and the economic reality and effects remain the same……Oh the magic time when the recovery comes! The music man cometh! Here comes Frosty the snowman! War to end all wars. Long essay, to bad its fundamentally flawed–the narrative fallacy at work.
The thing that puzzles me a great deal is that while people talk about the sub national debt (states) in the U.S. it is never really properly accounted for. Also the EU set up for this varies across nations. It really is perculiar how people who should know better compare the U.S. and EU using data which measures somewhat different things. Very peculiar such reliance on such disparate government measures–and assuming they measure some common reality like weight or temperature.
COMPLEX SYSTEMS ARE NOT REDUCIBLE. STOP WITH ALL THE SPECIFICS AND FOCUS ON THE GENERAL. TOO MUCH DEBT TOO MUCH STATE SPONSERED RISK TAKING TOO MANY LARGE FINANCIAL INSTITUONS.
Auerbach please. Not more of this nonsense. The ace in the hole for the USA is that it borrows in it’s own currency, therefore it’s insulated from debt crisis, and chronic deficit disease. Well if that’s the case, why not have a deficit of 20 trillion? We can just print up money, more money, and everything will be ok. Tell Bernanke that Auerbach. Why not Bernanke just say the US will have a zero interest rate policy forever, even hint that? You seem to emphasize a lot on the differences, instead of the similarities. US is dependent on the eagerness of the creditor. Why is short term treasuries dominating over long term? There is no correlation between debt, and depreciating currency? Surely G.W. Bush proved that, and certainly continued on with Obama. Depreciating currency doesn’t mean that sovereign currency can’t be depreciated away, and unvalued by creditors? What about the reason for the price of gold which has been on a uptrend for most of the past decade? The US dollar is strong right now, because of the Euro crisis. What if creditors see that the USA has too much debt, and don’t want to lend to the USA anymore? You seem to be under the impression that Greece would be better off with sovereign currency, the drachma, because it could just print more money to pay it’s creditors. USA wouldn’t default, because that’s the honest way of saying you can’t pay back the debt. Inflation is the most likely direction, which means creditors would be slapped in the face, the question is, how many slaps to the face creditors will take? So Auerback is essentially saying the USA has no problem financing it’s spending, that debt can be infinitely rolled under under a sovereign currency system. It’s pretty simple if you can’t pay it back honestly, you just can’t pay back. Auerbach said that default is not possible, it’s possible, just highly impossible, because inflation an another option. He also said that borrowing at worst with sovereign currency just leads to a run out of resources. Of course with resources sapped, how do you expect to fund a ponzi scheme like Social Security, and other government spending? Auerbach even suggested massive tax cuts as the best economic stimulus. Fact is Greece could of always minimized it’s debt with the Euro, but Greek politicians refused too until their backs were against the wall. Of course you get bunch of riots, and chaos as a result. So the result is debt credited something seemingly prosperous, everybody getting entitlements, pensions, etc then you have a “deflation” of such entitled environment, and stimulus, which includes government housing operating at a continual loss, which is clearly a huge mal-investment. Of course printing money to pay back creditors means the currency will be further debased, and even dumped. What Auerbach is suggesting is one hell of a rollcoaster ride of large proportions.
Samuel,
I suggest you look at Japan, Sweden and the Norwegian countries during their early 1990s fiscal crisis, versus Latin America.
Japan show that massive stimulus and “printing” does not lead to inflation if you have a lot of economic slack and an undercapitalized banking system.
Sweden had a serious crisis in the early 1990s and depreciated its currency. This helped stimulate its economy.
Latin American countries in the 1990s went with IMF imposed austerity. The result was a decade of stagnation and a transfer of income from citizens to foreign banks.
You also seem to forget that a country that issues its own currency does not need to issue debt to fund its government expenditures. The constraint is inflation, that the “printing” creates economic dislocations. We’ve had the Fed expand its balance sheet massively and the inflation indicators here show were are on the verge of deflation (the CPI numbers might be low by a percent, but they are not low to the degree that the inflationistas like to allege).
Yves,
Why didn’t this work for Weimar Germany in the 1920’s?
How did the debased savings class respond?
SC127
There have been multiple posts on this blog that have discussed, in some detail, what it takes to produce hyperinflation, analyzing both the Weimar and Zimbabwe examples. I suggest you familiarize yourself with them. Bottom line: mere expansion of money supply is not sufficient to produce it. It also requires the loss of a huge amount of domestic production capacity. Your analogy here is superficial and incorrect.
And a huge amount of productive capacity has not been dismantled in the US and shipped over to planned-debasee China? Who can of course be counted on to respond in manner entirely suited to US needs, irrespective of domestic Chinese consequences?
If you wish to “educate” us as to the “superficiality” of our hyperinflationary concerns, why not supply a link or two (internet, you know) to the aforementioned exhaustive refutations that supply actual specifics (your site and your invited authors, you know).
SC127
Considering that Japan is a export economy, an economy very different than the US economy, which is consumer based, I don’t see the parallel. So printing money doesn’t lead to inflation in a “consumer” economy? Argentina was faced with inflation when the austral currency couldn’t pay interest, real wages decreased. USA doesn’t need to issue debt? Well if it doesn’t need to issue debt, and instead inflate the money supply, what would make the US dollar valued internationally? The austral was sovereign currency system, and the peso was rejected as money. Let’s not say that Argentina only began to have problems because of IMF imposed austerity. The fight against inflation did improve the economy, however Argentina had large debts to pay, thus continued borrowing. Depreciation leads to inflation, Argentina showed this. Completely contradictory to your statement that inflation in money supply doesn’t create inflation. Depreciation is inflation, one in the same. Argentina had a time where had quasi-currencies, complementary currency were in large scale. Ironic you bring up Argentina as a way to try to credit your argument.
Samuel Morales Jr.,
Your take on Argentina has little, if any, basis in factual reality.
The financial “reforms” initiated by the dictatorship of 1976-1983 shifted the country away from policies that favored industrial development towards those that favored “finance, promoted financial speculation, and created an atmosphere conducive to lax financial controls and capital flight.”
As a result of these policy changes—-all made at the prodding of the IMF and la patria financiera, the country’s wealthy financial elite—-the country’s production capacity imploded:
Between 1975 and 1981, the manufacturing share of the GDP declined from 29 to 22%, industrial employment declined by more than 36%, and industrial production as a whole went down by 17%.
http://www.sep.org.br/artigo/xcongresso32.pdf
Argentina’s experience was thus entirely consistent with Yves’ claim above:
Bottom line: mere expansion of money supply is not sufficient to produce it (hyperinflation). It also requires the loss of a huge amount of domestic production capacity.
Besides the paper cited above by Paul Cooney, there’s another by Miguel Teubal that is worth the read:
http://www.hawaii.edu/hivandaids/Rise_and_Collapse_of_Neoliberalism_in_Argentina__The_Role_of_Economic_Groups.pdf
So sovereign issuance of debt without sovereign control over money supply is a peculiarity of the euro system that may appear paradoxical, even contradictory. I know economists enjoy spotting such perceived systemic flaws. After all, those flaws offer an opportunity to justify their models.
In itself that would be a rather harmless, perhaps even productive intellectual exercise. But most, if not all, economists subsequently succumb to the temptation of predicting the demise of the ‘inherently flawed’ system. The demise will, of course, always appear ‘inevitable’ to the economist.
Now, the eurosystem may or may not have inherent flaws that will ultimately lead to its breakup. But these flaws can not be extrapolated from the Greek situation, for the simple reason that the Greek government subverted and sabotaged that system.
[On a side note: I can understand why this fact is particularly hard to grasp for Americans. A system that does not hedge, balance or minimize the opportunities for freeriding, deception, and subversion to them appears already fundamentally flawed. Their Constitution reflects this tendency. Sets up a system so profoundly misanthropic it’s designed to survive the most tyrannical of evil men. And the same minimalistic approach characterizes the legal system. It’s a radically rule-based society, rational to the point where legality and morality converge.]
Anyway, for historic reasons, European society, legal system and systems of power distribution could never be so rational. They are informed and sometimes distorted by traditions and implicit rules. The informal or non-formalized nature of these arrangements however, is assumed not to diminish the limitations they pose on the behaviour of partners.
Europeans tend to rely on this implicit trust and solidarity as much as on legal rules and enforcement. That’s one of the two major assumptions of the eurosystem that Americans just don’t get. The other is the seperation of monetary policy from politics, a seperation so strict it would instantly transform your Trias Politica in a Quadratus.
The axiom here is a belief that sound monetary policy is not (or should not be) informed by politics. Rather, it should be based strictly on ‘technical’ considerations. (Yes, that’s a typically German idea. Historic inflation neurosis combined with that very German desire for purity and perfection, I guess.)
The ECB is so technocratic, if someone discovers an algorithm to systematically adjust interest rates to match a desired level of inflation, its job could be entirely automated. This is why the ECB is both the world’s most autonomous central bank, and its dullest, most predictable and least activist. (Still, it showed pragmatism and flexibility in this week’s decision to accept Greek ‘junk’ bonds as collateral).
This separation of powers is exactly why the currency union worked for almost two decades, without any meaningful political integration of its members.
Maybe this separation of monetary policy and politics will prove impossible. Maybe the implicit trust on which the stability pact rests will prove to be not just naive but ineffective as well. So far, however, I have not read or heard a single convincing arguments as to why the euro must fail. Which is remarkable considering the amount of arguments thrown at this particular prediction, especially in the anglophone media.
To reiterate, for such an argument to be convincing, it can not contain the case of Greece. The canary in the coal mine may be every economist’s favourite logical fallacy. But it’s still a fallacy, Greece being a case in point (if not quite a canary), because its behaviour and the specific problems that behaviour generated have so far proved to be an anomaly within the eurozone.
Despite its shortcomings, the euro has some smart mechanisms that address the problem of current account deficits and surpluses. The massive wealth transfers to deficit countries is one of them. So-called ESFs explicitly exist in order to improve the competitiveness of deficit countries.
Another part of the mechanism is the pooling of trust. Yes, deficit countries profit from lower borrowing costs. But the other side of the coin is that surplus countries profit from the devaluation of the currency when those debts become problematic. I don’t know about the Germans, but here in Holland everybody welcomes the recent devaluation of the euro.
“Sweden had a serious crisis in the early 1990s and depreciated its currency. This helped stimulate its economy.”
It did, depreciated one might say but it was from a ridiculous high peg, in practice Sweden just dropped the defense of a misguided peg after the market had beat the crap out of the central banks nonsensical defense of the peg. Basically there were a few major things that occurred a real estate speculation bubble busted, fueled by currency arbitrage then there was a right wing neo-liberal indoctrinated government that did everything to conduct pro cyclical policy’s. the major unemployment crisis was in the homeland economy more than 60 thousand small and medium sized companies did go bankrupt. Despite the misguided peg the advanced industrial export sector basically did followed the pattern of the international crisis and wasn’t the cause of the record unemployment, if not the peg had burst they would of course have had more problem.
As one of Sweden’s prominent economist concluded in a report the beginning of the situation was a severely indebted private sector vs a public sector balance sheet in “good” shape, with real estate values dropping on average 30% the situation come untenable. All in all over the period the final result was that one trillion Swedish crowns was moved from the private balance sheet to the public balance sheet.
The depreciated did result in a exceptional boom for the export sector, the relative share to BNP of the export sector did go beyond 50% and the export surplus have remained unprecedented. The internal Swedish economy alas the consumption did hardly see any growth the following decade. The unemployment remained very high albeit moved of the official unemployment record.
seems like marshall makes a great point regarding soverign issuers of currency vs. non soverign issuers.
the problem is more that this is a global financial economy….and the fact that there are non soverign issuers of currency having a crisis and that this actually does impact the financial markets of soverign issuers.
Also the banks seem to run the show here in the usa where we yes…issue are soverign currency. I don’t see inflation an issue no matter the monetization (circle jerk) going on by the fed-treasury..as there is higher intrest being paid on excess reseves so less and less lending to private sector shoud continue despite monetization. ONE potential problem i see is if the financial PTB decide to shift moderate amounts of capital from there long positions in equities and chase higher yields in commoditys…or simply not be eager to keep the stock market afloat.
then a rift between washington and wall street could occur..because the gov’t is trying it’s damdest to keep consumers spending and keeping the fiction alive that a healthy stock market is a mirror of our healthy economy. Strained non sovering issuers of currency could put an end to OUR stock market run and plunge the us back into a debt deflation…..because monetize all you want…..but with a for profit wall street and a federal reserve who has there back…being an issues of soverign currency has it’s benny’s for sure but is not a magick bullet for all that is weak and threatening in our asset market dependent economy that is tied to global finance…..and run by do what’s best for them …(wall street)
“the problem is more that this is a global financial economy….and the fact that there are non soverign issuers of currency having a crisis and that this actually does impact the financial markets of soverign issuers.”
Your operative phrase here should be “financial markets of sovereign issuers”!
You are correct but too often we are letting the “perception” that the financial markets are having trouble lead us to thinking that therefore the REAL economy needs to adjust to keep the financial markets happy. This is BACKWARDS. Or should be backwards.
This is the “class war” that we should be waging. Bond traders making a bulk of their money with no effort (“Oh let me check my account and see if my interest payment arrived on time”) should not be allowed to push WORKING people onto the unemployment rolls because they are unhappy with their future prospects for further gain.
This is why MMT is so powerful to me, because it tells the financial markets, “screw you, WE issue the currency YOU USE IT!!, As long as you use it and dont disrupt our societal needs fine, but as soon as you try to hold us hostage, the game is over and YOU LOSE”