Tuesday, July 20, 2010

Update on Krugman Post

I am making a very quick post, as James Galbraith has responded to my last post on the Seeking Alpha version of the post. I have copied the response below:

On the matter of my beliefs. Krugman's quote from me was this:

"So long as U.S. banks are required to accept U.S. government checks — which is to say so long as the Republic exists — then the government can and does spend without borrowing, if it chooses to do so … Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks to this system."

Read it again with the *very next sentence* included:

"So long as U.S. banks are required to accept U.S. government checks — which is to say so long as the Republic exists — then the government can and does spend without borrowing, if it chooses to do so … Insolvency, bankruptcy, or even higher real interest rates are not among the actual risks to this system. The actual risks in this system are (to a minor degree) inflation, and to a larger degree, depreciation of the dollar."

Does this help resolve what I "appear to believe."? I trust so. What I actually believe is now so thoroughly on the record, there really is no excuse for writing about it without getting it right.

Thank you. James Galbraith
I have, of course, copied this over as James Galbraith should be in a position to set the record straight on what his actual views are.

23 comments:

  1. Galbraith has confirmed for us precisely what I have said here myself:

    http://socialdemocracy21stcentury.blogspot.com/2010/07/galbraith-versus-krugman-on-deficit.html

    Modern Monetary Theory says that, even though deficits are not “financially” constrained, they face real constraints in the inflation rate, exchange rate, available resources, capacity utilization, the unemployment level, and external balance.

    Investor confidence might, or might not, be a real factor affecting the exchange rate and foreign exchange reserves.

    In a gross caricature of this carefully qualified theory, suddenly proponents of it are accused of believing that “there is no limit to government deficits and money printing” – which is obviously nonsense.

    Also, Galbraith’s point that government spending does not have to be fully “funded” either by taxes or bond issues is confirmed here in detail:

    Bell, S. 2000. “Do Taxes and Bonds Finance Government Spending?” Journal of Economic Issues 34.3: 603–620.

    It is confirmed empirically by the fact that the US won World War II by having the Fed print money when necessary:

    The Economics of World War II

    And under the 'tap system' of issuing government bonds after WWII, a number of Western countries (like Australia) for many years actually had their central banks purchase government bonds when they weren't all bought by private bondholders. The system is explained by Bill Mitchell of Billyblog:

    [around 1981] the Australian Office of Financial Management was set up as a special part of the Federal Treasury to management federal debt. Previously, bond issues were made using the “tap system”, whereby the government would announce some volume of debt it wanted to issue at a particular rate and then sell whatever was demanded at that yield. Occasionally, given other rates of return in the financial markets the issue would not be fully subscribed – meaning some of the Government’s net spending would be covered in an accounting sense by central bank buying treasury bills (government lending to itself!).
    The neo-liberals hated this system and regarded it providing no fiscal discipline on government. They knew that by linking deficits $-for-$ with private debt they could more easily mount the debt hysteria and maximize their pressure on government to cut deficits and withdraw from the market.


    http://bilbo.economicoutlook.net/blog/?p=3416

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  2. P.S.
    I find it somewhat amusing that you say "James Galbraith should be in a position to set the record straight on what his actual views are."

    If people had bothered to read his testimony in full - or just read the basics of Modern Monetary theory - they would already have properly understood it, since it was all quite clear to begin with.

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  3. The key point for me with MMT is that the government has infinite 'financial' capacity and therefore anything with purely financial characteristics is directly under its control if it chooses to exert that power.

    Its job therefore is to ensure that there is enough 'money' in the economy.

    Then you get into the political prescription. The best way to do that is to skip the financial sector and put the money directly in the economy at the weak points. So no 'quantitative easing' via banks who are only interested in repairing their equity base. No fiddling with interest rates that hit business as much as homeowners.

    Instead prudent direct purchase of value that the private sector doesn't currently want to avoid an 'opportunity cost' to the economy.

    Once we get to a point where people can see that is possible, then we can move the debate onto *how* to do that so that it doesn't require 'Wisdom of Solomon' decisions but that it happens automatically.

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  4. I think we all understand that governments can print money without limit and so on, but isn't it naive to believe that 'the markets' instantly punish unwise behaviour as seems to be being suggested here? When a government prints money, buys its own bonds etc. the participants in the economy receive false signals about the prospects for the economy. The financial world seems to accept QE and massive government borrowing 'in the abstract', but then puts that to one side and reads the runes in GDP growth figures as though that growth has occurred independently. I'm sure the information is there for anyone who wants to find it, but how to interpret it is an open question.

    In reality, bubbles must be inflated and distortions created with much damage being done before the futility of the government intervention filters through.

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  5. China offers vote of confidence in euro:

    http://www.ft.com/cms/s/0/879055fc-90d3-11df-85a7-00144feab49a.html.

    Analysis here:

    http://moslereconomics.com/2010/07/19/eu-2/

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  6. Gareth CheesemanJuly 22, 2010 at 5:10 AM

    Lemming,

    Yeah, MMT is one of those theories that seems to work logical step by logical step, but you still have to stand back, shake your head, and ask how can an economy that has been grossly blown out of proportion not eventually deflate? Deficit spending isn't supporting "value", it's simply maintaining some of the excess (that may have the appearance of value) that has been created.

    It's a bit like those climate change proponents who jump on items of data that support their argument, but can't see the obvious point that mankind is simply incapable of making useful predictive models of complex systems that are themselves based on chaotic subsystems.

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  7. Gareth CheesemanJuly 25, 2010 at 2:12 AM

    The advocates of MMT on here appear to be entertaining two false assumptions:

    i) That all taxes paid to the U.S. Government are paid with real dollars printed by the Federal Reserve.

    ii) That all goods and services imported into the U.S. are paid for with real dollars printed by the Federal Reserve.

    In case ii) it is certainly the case that these can be paid for with PonziDollars created out of thin air by private banks against overvalued collateral such as suburban asteroid-belt housing. In case i) I'm no expert on the U.S. tax system, but presume that taxes don't have to be paid in cold, hard cash directly from wages. If this is indeed the case, again I see no reason why these can't be paid with PonziDollars .

    As such then, the U.S. Government is getting part of its tax income in PonziDollars, and the Chinese, when buying Treasuries, are not simply swapping Dollar-denominated assets, but swapping PonziDollars for a promise of real Fed-printed Dollars in the future.

    Those PonziDollars are then spent by the U.S. Government in creating real social entitlements and real entanglements in pointless, unwinnable wars. These commitments are difficult to back away from even when the PonziDollars return to the oblivion from whence they came, which means that the U.S. Government's scale of operations is itself Ponzified.

    If, as MMT theorists propose, the budget deficit is the exact mirror of the surplus in the private sector, it simply means that deposits and savings accounts are also replete with PonziDollars (and why would they not be?). If it isn't an exact mirror, it means that PonziDollars are disappearing in the private sector even while the Government's debts are increasing.

    As such, there is no way that the U.S. Government can maintain its current scale of operations. It could temporarily maintain them by either hollowing out the private sector, or buy using seignorage to essentially pay off its debts in the same PonziDollars with which they were purchased. This appears to be the method it is choosing.

    Either way, the eventual outcome can only be a painful deflation of Government in line with the deflation of the economy.

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  8. Reply to Gareth

    The belief that government debt is a Ponzi scheme is utterly refuted here:

    http://socialdemocracy21stcentury.blogspot.com/2010/06/rolling-over-government-debt-and-debt.html

    Also, you say:

    it is certainly the case that these can be paid for with PonziDollars created out of thin air by private banks against overvalued collateral such as suburban asteroid-belt housing.

    You ignore the fact that deleveraging is going on in the US and net private debt has gone negative, which also has led to the broad money stock falling.

    The effect you are talking about is no longer happening.

    The term “Ponzidollar” is a ridiculous loaded term . Capitalism has always had the ability to create money out of thin air, whether it was fiduciary media in the 19th century or fiat money by central banks today. As long as you have good financial regulation, it isn’t a problem.

    It could temporarily maintain them by either hollowing out the private sector

    On the contrary, deficit spending and stimulus allow the private sector to grow, and output to increase. The deflationary depression you appear to advocate would devastate production.

    or buy using seignorage to essentially pay off its debts in the same PonziDollars with which they were purchased

    You fall into the trap of taking the quantity theory of money seriously:

    http://socialdemocracy21stcentury.blogspot.com/2010/07/quantity-theory-of-money-critique.html

    If you subscribe to the Austrian theory of inflation, then your view are subject to this critique:

    http://socialdemocracy21stcentury.blogspot.com/2010/04/austrian-theory-of-inflation-myths-and.html

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  9. Gareth CheesemanJuly 26, 2010 at 1:18 AM

    Lord Keynes

    A few points:

    Firstly, I'm not arguing that Government debt is a Ponzi scheme, I'm arguing that Government income has been artificially inflated by Ponzi-type loan activities, and thus the scope of its operations has unsustainably expanded because of this. Whether or not deleveraging is currently going on in the private sector has no retroactive affect on this.

    Secondly, whether capitalism has always had an ability to create credit out of thin air is less important than the quality of the collateral it is created against. If this collateral is grossly overvalued then I think it entirely appropriate to call the resulting unit of credit a "PonziDollar".

    Thirdly, I'm not "advocating" a deflationary depression, but merely saying that one is inevitable. Japan demonstrates that deficit spending and stimulus merely drags out the pain rather than putting the economy back into growth mode.

    MMT appears to be a purely financial model that doesn't take into account such headwinds against growth as ageing populations, increasing entitlements, changing consumer attitudes toward credit and debt, declining resources (especially energy resources), and the changing attitudes and alliances of key supplier and creditor nations. All these will have a huge impact on the U.S.'s ability to recover even before we consider the relative merits or demerits of stimulus and deficit spending.

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  10. I'm arguing that Government income has been artificially inflated by Ponzi-type loan activities, and thus the scope of its operations has unsustainably expanded because of this.

    That tax revenue increased because of excessive debt and the economic activity caused by debt is certainly true. That government spending was “unsustainably expanded” because of it does not follow at all.

    Correcting macroeconomic policies to promote growth and expand output and employment will ALSO increase revenue. Thus the government can easily fix the economy and see its tax revenues boosted again.

    Thirdly, I'm not "advocating" a deflationary depression, but merely saying that one is inevitable.

    It is not inevitable – if it happens it will be a policy choice that could have been avoided.

    Japan demonstrates that deficit spending and stimulus merely drags out the pain rather than putting the economy back into growth mode.

    On the contrary, Japan demonstrates that fiscal stimulus is highly effective. Japan’s real mistake was the ridiculous failure to fix their banks – clean up the bad assets and non-performing loans.
    This is the same mistake the West is making.
    Japan cleaned up its non-performing loans by about 2003 when the economy shot back into growth, along with the depreciation of their currency by QE which boosted Japanese exports.

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  11. @Lord Keynes

    "Correcting macroeconomic policies to promote growth and expand output and employment will ALSO increase revenue. Thus the government can easily fix the economy and see its tax revenues boosted again."

    This I don't understand. Surely if 'incorrect' macroeconomic policies have been pursued for decades then the resulting distortions may be impossible to fix. It certainly will not be "easy".

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  12. Reply to Lemming

    Surely if 'incorrect' macroeconomic policies have been pursued for decades

    The excessive private debt/asset bubble model has been pursued for about 15 years (1990s onwards). So it hasn’t been for “decades.” It’s been a decade and half, basically.

    then the resulting distortions may be impossible to fix

    Your use of the word “impossible” is extraordinary.
    The US and UK economies were radically restructured as wartime command economies in the 1940s (basically as Soviet-style planning systems, without authoritarianism), but then restructured back to private, consumer production economies in about 5 years (1945-1950). Was that far more radical change “impossible”? Manifestly and obviously not…

    The US is the largest manufacturing nation in the world. The UK has fluctuated at the 6th or 7th largest manufacturing nation on earth for the past 20 years. The belief that the UK “makes nothing” or is “impossible to fix” is also utterly ridiculous. The UK needs to increase investment expenditure, substitute domestically produced goods for imports, and develop new high-tech or high value added industries. Trade and industrial policy can do that. Financial regulation fixes prevents asset bubbles. It might take 5 years to adjust, but that is hardly “impossible”.
    You say that it won’t be “easy.” But compared to what exactly?
    Compared with the radical changes the UK economy faced from 1939–1950, I say it will be considerably easier.

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  13. Gareth CheesemanJuly 27, 2010 at 2:08 AM

    @Lord Keynes

    I think that like pretty much all economists you have the belief that economic growth is not an organic process that is dependent on environmental and social (and to a lesser extent political) factors, but is ontological i.e. growth is simply what economies "do".

    As such, like all economists (even the handful of "good" ones who predicted the crash) you see decline as an unnatural abberation. (It is revealing that economists cannot even bring themselves to use the word "decline" but resort to the weasel phrase "negative growth".)

    I think this is the primary delusion from which MMT starts i.e. regardless of such various factors as projected oil reserves, demographic profiles, climate variations, diplomatic strategies, previous malinvestments etc. etc., all that is needed is a bit of tweaking of monetary policy and everything can be fixed. I just cannot share this view and so believe all your analysis to based on a false premise.

    As for Japan, the stimulus was largely prompted by corrupt cabals within the Japanese construction industry, as explained here:

    http://search.japantimes.co.jp/cgi-bin/fl20090421zg.html

    and has not arrested the Nikkei index's 20 year decline (sorry, negative growth).

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  14. I think this is the primary delusion from which MMT starts i.e. regardless of such various factors as projected oil reserves, demographic profiles, climate variations, diplomatic strategies, previous malinvestments etc. etc., all that is needed is a bit of tweaking of monetary policy and everything can be fixed.

    MMT takes account of these, and it is absurd to say that it only thinks “all that is needed is a bit of tweaking of monetary policy and everything can be fixed.” In fact MMT also stress the need for financial regulation and a functioning banking system.

    and has not arrested the Nikkei index's 20 year decline (sorry, negative growth).

    I am astonished that you think the stock market is a measure of wealth or economic health. The economy can be booming even when there is a bear market in financial asset prices.
    The belief that rising stock prices is a measure of wealth or economic growth is a fantasy.

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  15. As for Japan’s infrastructure spending, it is widely acknowledged that there was underinvestment in infrastructure in Japan in the post war era. Although there was certainly wasteful spending (too many unnecessary roads and bridges), a great deal of 1990s spending was quite justified.
    For example, even in 1983 only 58% of Japanese households had flush toilets, and as late as 1990 only 44% of the population lived in houses connected to modern sewage systems.

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  16. Gareth CheesemanJuly 29, 2010 at 8:00 AM

    @Lord Keynes

    For effective financial regulation and an effective banking system you need a political system that is cleanly seperated from the banking oligarchy and not subject to regulatory capture. The USA has neither of these, which again is the kind of awkward socio-historical phenomenon which messes up the smooth models of academic economists.

    I think you've pretty much jumped the shark if you're attempting to make the case that Japan has just been enjoying 20 years of economic rude health, tbh.

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  17. I think you've pretty much jumped the shark if you're attempting to make the case that Japan has just been enjoying 20 years of economic rude health

    I make no such case - you present a straw man argument.
    Japan had a lost decade from 1993-2002. But that was basically a period of very low growth.
    Keynesian stimulus undoubtedly stopped this "lost decade" from being a severe depression, and was vitally necessary.

    Japan came out of its lost decade around 2002/2003. Japan's economic growth since then has been normal by OECD standards. Japan was hit by the downturn of 2007/2008, but then so was every other country.

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  18. @Lord Keynes: Still no sign of you recognising that human beings are free-thinking, sovereign individuals with complex motives and loyalties, and not little units pinging around in a vacuum until an omniscient economist tells them how they should respond to certain stimulii. Your posts would be somewhat more persuasive if you learned the importance of understatement and nuance rather than absolutes; and if they included just a little humility.

    I suspect this is at least partly because MMT is a still only theory, albeit that you can find historical examples which appear to validate certain aspects of it. But although you can cite examples in which some governments have applied aspects of MMT (presumably subconsciously in most cases, as they didn't have The MMT Handbook to work from) it has not yet been applied systemically to a real world economy - and it seems from my limited understanding that it would work well only if applied in multiple economies, and not to one country or bloc in isolation. If/when this happens, it will certainly encounter incidents or situations not previously accounted for by the theory, and it will need modification. (And fFive hundred years on, it is possible that subsequent tinkering will have left it looking as shabby and as contingent as the current system.)

    Until then, it is very easy to be an MMT enthusiast, and to think - or in your case to *know* - that you have all the answers - a bit like being a communist in the 1890s.

    Come to think of it, it's more like Pascal's wager. If MMT is ever applied and it turns out to work, then you will be able to say 'I was right'. If it is applied and it fails, then you don't suffer because you were just an adviser - the politicians take the rap. And if it is never tested, then you've lost nothing and still gained a reputation for being a bit of a maverick. And I bet that impresses the chicks at seminars.

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  19. Reply to Bill Tanner

    The main principle behind MMT is appropriate deficit spending in times of recession or depression.

    This can been widely used in virtually every country on earth since the 1930s, and the empiricial evidence shows its success.

    Moreover, you have a recent and obvious example of the success of stimulus: China.

    China's export-led growth economy collapsed, and what did China do?
    They implemented a massive $586 billion dollar Keynesian stimulus – and then got a very impressive recovery, so impressive in fact that with growth in the first quarter of 2010 at 11.9%, there is talk that they may need to cool down the economy.

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  20. Posting here on this old subject, as nothing later.
    How do any of the MMT people think that giving all the stimulus to the banks is going to allow the private sector to grow?
    No one wants more debt and already we are facing higher taxes and costs and by giving money to the banks the economists expect the consumer to spend more, where all that is happenning is that demand brought forward during the "boom" is being paid off rather than being written off so that we are paying for foolish investments twice! Does anyone really believe that the consumer is going to lead a recovery?
    I am sure the banks want people to borrow money so that they can continue to rip them off but the only way to get people to spend more is to give them the money, directly, and MMT says that makes no difference to a sovereign states actual finances!?
    I believe that Australia tried it and is often cited as an example of the success of MMT.
    Personally I think that all the "state" people have got stuck in their minds and when enough people/voters/citizens have had enough reality will have to be faced.

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  21. Gold bubble pops, Austrians in denial:

    http://blogs.wsj.com/marketbeat/2010/07/27/gold-bugs-in-retreat/

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  22. @anonymous

    I think what most people "get", and what the academic economists/MMT enthusiasts don't get is that the global economy (and the national economies within it) is not a steady-state/equilibrium system that will chug along at a stable rate of growth regardless of environmental, social or historical circumstances, and therefore only needs a monetary fix or two when something goes wrong.

    It's a mentality that is impervious to subtletly, like the energy cornucopians who think that the end of cheap oil can be fixed with "technology"; as though oil and technology have to be interchangeable, because the economy has to keep growing, because decline is, like, impossible dude.

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  23. The banks seem to be doing very well at the moment.

    Here's a quote from the Automatic Earth:

    It’s very hard, when you work at a too-big-to-fail institution, not to make a profit. When you have access to discount window money at an interest rate of 0.25%, money which you can -electronically- carry across the street to purchase US Treasuries that pay, say, 2.75%, you are set for a 1000% profit margin (even "only" 500% is not that shabby either). You try losing money that way; it ain't easy.

    Is this true? Is it possible for the banks to turn a profit at zero risk without having to interact with the real world at all?

    ReplyDelete

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