Thursday, 11 December 2014
Deficit “unsustainability” clap-trap.
It would be nice if one of the World’s leading finance and economics publications, the FT, knew something about deficits. Apparently it doesn’t.
First there is this FT 2nd leader article which says in reference to Japan that “Mr Abe’s strategy began with a huge fiscal stimulus followed by a massive dose of quantitative easing. This appeared to jolt Japan out of its deflationary torpor.” Yes quite: deficits bring stimulus. And that makes sense where an economy has excessive spare capacity.
But then the article says “The country needs to put its public finances on a sounder footing. Years of deflation and government borrowing mean that public debt is now approaching an extraordinary 250 per cent of gross domestic product.”
Well there’s an obvious problem there: stimulus is needed, but (so claims the FT) there’s a problem with the resultant high debt. So what’s the FT’s solution?
They haven’t got one!!! So what’s the point of the article, other than to fill up newspaper columns with hot air and waffle? Anyway, I’ve set out the solution below, but first, let’s consider another FT article, because it raises the same alleged problem.The article says:
“But analysts wonder how long the status quo can hold. Many argue that the surplus of household financial assets available to absorb new bonds will dry up within the next five to ten years, meaning that overseas investors – who tend to take a dim view of Japan’s creditworthiness – will hold a casting vote on long-term bond yields.”
There is so much nonsense in that one sentence that it will take me some time to deal with it. But here goes.
First, given that about 95% of Japanese debt is held by the Japanese themselves, it’s going to take a HUGE REDUCTION in those holdings before FOREIGN holders become dominant.
Second, it is PRECISELY THE FACT that the Japanese themselves want to hold large volumes of state liabilities (debt and monetary base) that explains why the Japanese government has to issue so many of those liabilities. I.e. if the Japanese private sector decides to hold fewer bonds/liabilities, that solves the problem: the allegedly excessive volume of bonds issued by the Japanese government!
Third, let’s consider the “disaster” scenario referred to above, namely where foreigners are the main purchasers of bonds.
With a view to explaining the nonsense here, let’s go right back to the original or basic purpose in government issuing liabilities. Governments run deficits (i.e. “print” and issue base money / bonds) because the private sector won’t spend enough to bring full employment unless the private sector’s desire to save that money or bonds is satiated.
But there’s very little point in ACTUALLY PAYING the private sector to hold those liabilities, and in fact Japan currently pays less than 1% on what it borrows. And taking that even further, Milton Friedman and Warren Mosler argued that government should issue NO INTEREST YIELDING liabilities at all: it should issue no bonds – i.e. it should issue just cash or base money, and I agree with them. But that’s an incidental point.
Thus if, in the case of Japan, foreign holders of Japanese government bonds demand a higher rate for holding those bonds, the best course of action for the Japanese government is to simply stick two fingers up at those foreign creditors and repay them, but refuse to roll over the debt.
Of course that could easily mean increased demand. But that solves the problem! That is, the big alleged problem in Japan is how to raise demand (a problem which anyone who has read an introductory economics text book ought to be able to solve).
Alternatively, demand might rise TOO FAR and bring excess inflation. In that case, the Japanese government would need to raise taxes and unprint the money collected. Note that those increased taxes WOULD NOT reduce GDP as long as the inflationary effect of the bond buy back (i.e. QE) equalled the DEFLATIONARY effect of the tax increases.
The only very small fly in the ointment there is that given less scope for getting yield on Japanese assets, international investors would tend to quit the Yen and invest their money elsewhere in the world, and that would depress the Yen relative to other currencies all else equal, which in turn would mean a standard of living hit for the Japanese.
But to repeat, the proportion of Japanese debt held by non Japanese entities is very small, so that’s not a big problem. Moreover, incurring a debt to entities OUTSIDE a particular country inevitably means a temporary rise in living standards for the country concerned, and paying it back inevitably means a temporary decline in living standards. Likewise if you incur debt to your credit card supplier that gives you a temporary boost in you standard of living. And when you abstain from consumption with a view to saving up money and paying back the debt, that involves you in a standard of living hit.
It’s pathetic that I need to spell out this elementary stuff, isn't it?