Friday, 26 February 2010
Martin Wolf should read this blog.
Two normally reliable U.K. economic commentators went off the rails on Feb 24th: Martin Wolf in the Financial Times and Hamish McRae in The Independent. I’ll deal with the latter in a day or two.
Wolf considers what he calls “successful” and “failed” exits from the recession, and claims that both lead to disaster. He says:
By “success”, I mean recognition of the credit engine in high-income deficit countries. So private sector spending surges anew, fiscal deficits shrink and the economy appears to being going back to normal, at last. By “failure” I mean that the deleveraging continues, private spending fails to pick up with any real vigour and fiscal deficits remain far bigger, for far longer, than almost anybody now dares to imagine. This would be post-bubble Japan on a far wider scale.
Unhappily, the result of what I call success would probably be a still bigger financial crisis in future, while the results of what I call failure would be that the fiscal rope would run out, even though reaching the end might take longer than worrywarts fear. Yet the big point is that either outcome ultimately leads us to a sovereign debt crisis. This, in turn, would surely result in defaults, probably via inflation. In essence, stretched balance sheets threaten mass private sector bankruptcy and a depression, or sovereign bankruptcy and inflation, or some combination of the two.
I can envisage two ways by which the world might grow out of its debt overhangs without such a collapse: a surge in private and public investment in the deficit countries or a surge in demand from the emerging countries. Under the former, higher future income would make today’s borrowing sustainable. Under the latter, the savings generated by the deleveraging private sectors of deficit countries would flow naturally into increased investment in emerging countries.
To the extent that Wolf is right about burgeoning government debt, this just proves the lunacy of Keynsian borrow and spend (B&S), which I dealt with here. To summarise, the big problem with B&S is crowding out: that is, B&S involves government running into debt with a view to boosting the economy. But the extent of the boost is always questionable because crowding out may to some degree stymie it. And there is much disagreement over the extent of crowding out. At worst, governments may be running into debt with ABSOLUTELY NOTHING TO SHOW FOR IT by way of stimulus (though that is an extreme and probably unrealistic view).
More likely, is that some governments are running up relatively large debts with relatively little to show for it. (Kind of rings true that, doesn’t it?).
So why bother with B&S? It’s bonkers. Instead of “borrow and spend” why not just “print and spend”: the effects are much more certain. And if anyone is tempted to scream “Mugabwe” or “Weimar”, the answer is that print and spend was exactly what the U.K. did in 2009: the entire deficit (about £200bn) was quantitatively eased. I.e. the U.K. just printed an extra £200bn, and the sky hasn’t fallen in.
Moreover, print and spend OSTENSIBLY results in as much debt as B&S, but in the case of print and spend, the nature of the debt is a nonsense. It’s not really a debt at all. That is, under print and spend, because of the convoluted way that the “government central bank machine” prints money, for every £X of print and spend the central bank ends up holding government debt worth £X: that is the Treasury supposedly “owes” £X to the central bank.
Well that’s a big nonsense isn’t it? One arm of government owing money to another arm of government: that’s not a debt. Or as Willem Buiter put it, “These monetary base ‘liabilities’ of the central bank are not in any meaningful sense liabilities, because they are irredeemable.”
Thus there is no “sovereign debt crisis” to worry about, as Wolf claims – at least not in the case of the U.K. There IS a potential problem: the increased monetary base. This has occurred because of the private sector’s desire to net save: or put another way because of the private sector’s increased desire for net financial assets.
As long as the private sector wishes to retain this increased amount of “money in the piggy bank”, there will be no inflationary effect. As David Hume in his essay “Of Money” pointed out 250 years ago, a money supply increase cannot be inflationary unless the money comes to market (and even then it’s not necessarily inflationary).
Alternatively, if at some point in the future the private sector attempts to dissave a significant portion of its stock of monetary base, the effect could easily be inflation, unless governments take deflationary countermeasures. Given the slow and inadequate response to the private sector’s recent increased desire to save, governments’ response to the opposite, i.e. a private sector attempt to dissave might be equally slow, and the result could be excess inflation.
And for those still worried about monetary base increases, even in the absence of such increases, there is not much to stop everyone going wild with their credit cards and borrowing up to the hilt to buy larger houses, cars, etc. Inflation would be the result if such an increase in “confidence” or “animal spirits” went too far.
The third para quoted above from Wolf’s article claims that about the only way out of the problem is large scale investment in deficit countries (a conclusion that seems to be endorsed by Krugman)
Given that we are in a recession and have record amounts of plant, machinery and office space lying idle, investment isn’t exactly priority number one. Though industrial capacity has declined by around 1% in the last year, at least in the U.S. So some sort of investment “catch up” is doubtless needed. (See bottom right hand column here.)
Afterthought (27th Feb): Martin Wolf's article is also criticised by Bill Mitchell.