Wednesday, 7 July 2010

US and Euro private sector surplus: $3,000bn this year?

According to Martin Wolf the combined private sector surplus in the US and Eurozone will be $3,000bn this year.

He says “My conclusion, then, is that the advanced countries remain highly short of demand”. Agreed.

His final para says that the G20 countries “may hope that retrenchment now will spur on private spending. But what is their plan if it turns out that it does not?”

Yes, there are a fair number of people who would like an answer to that one (me included). Or to be more blunt, there isn’t a plan (except in the Baldrick “I’ve got a cunning plan” sense of the word plan).

But all is not lost. The answer to the above question, i.e. what alternative plan is there, is in the second last paragraph of a Huffington Post article by Warren Mosler. As Mosler says “.....deficit spending would accumulate as excess reserve balances at the Fed....”. I.e. the answer is: (a) just carry on with deficits, (b) let them accumulate as monetary base, not national debt (why pay interest when you don’t have to?????)

So why aren’t governments doing this or “planning” for this? Probably because they think more monetary base expansions are inflationary. Well they are wrong, and for the following reasons.

1. As David Hume pointed out 250 years ago in his essay “Of Money”, money supply increases are not inflationary till they are spent. I.e. it is SPENDING not the size of the money supply that is inflationary.

2. It is a popular belief that extra monetary base enables banks to lend more. That idea has hardly been born out in the last two years: we’ve had astronomic monetary base increases and politicians are tearing their hair out at the FAILURE of banks to lend. Secondly, banks are capital constrained, not reserve constrained. MB increases do not increase bank capital, therefore they don’t facilitate extra lending.

3. As regards the U.K. with inflation already worryingly high, further deficits and MB increases hardly seem appropriate. Answer: that’s possibly true, but the above points are not supposed to be applicable to EVERY country. They are intended as a general sort of answer to the question, “What should normally be done given a combination of, 1, high unemployment, and 2, the private sector saving as never before.”

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