Thursday, 23 December 2010

Ebenezer Scrooge economics.

I am tired of being told by the BBC and other news organisations that full shops at Xmas is “good thing”. It’s not: it means more consumption, more carbon dioxide emissions and so on.

Full shops are allegedly good because that implies more jobs, and with unemployment too high – well, more jobs must be good outcome surely.

There is actually a far better outcome, as follows. Unemployment is defined as wanting a job and not being able to find one. The better outcome and better way of reducing unemployment would be people choosing to work fewer hours and accepting a lower standard of living.

How often do you see statistics on the latter variable on the news?

And now I’m off to indulge in some unnecessary consumption.

Wednesday, 22 December 2010

Mish criticises Kucinich’s bill.

Mish’s criticisms of Congressman Dennis Kucinich’s “abolish the Fed” bill are a bit harsh in places.

This bill abolishes the Fed and gives Congress the right to create new money. The bill outlaws fractional reserve banking, an aspect of the bill that Mish agrees with. So do I.

Mish says:

“Neither sound money nor the free market comes from printing money into existence. Arguably the only thing worse than the Fed printing money out of thin air is Congress printing money out of thing for the purpose of full employment and/or any other absurd ideas Congress has.

The last thing we need, the very last thing we need is Congress lending money into existence to pay the bills or to do anything it wants for any reason. Those looking for hyperinflation can find the roots of it in that bill.”

Now what does “sound money” actually mean? Like most ultra reasonable sounding phrases, it is near meaningless.

If by “sound money” one means keeping the money supply growth at a level that aims to maximise employment without causing excess inflation, then there is nothing wrong with “printing money into existence”. In fact “printing money into existence” has been going on ever since the Greenback first appeared.

Also, this bill does not give Congress the right to create money to fund any old form of spending proposed by any old politician. It proposes setting up a “Monetary Authority” to control money creation. Now isn’t that the fundamental flaw in the bill? That is, it just replaces the Fed with a “Monetary Authority”.

Mish’s final paragraph reads:

“All things considered, and in spite of horrendous flaws, it may be a plus that someone has actually submitted a bill in Congress to end Fractional Reserve Lending. Now all we to do is throw away the entire rest of the bill and let Ron Paul draft a proper bill ending FRL as the central idea.”


Monday, 20 December 2010

Monetary union requires political union?

I’m tired of that cliché. Hong Kong and various mid American countries use the US dollar or have their currencies pegged to the dollar. Same went for Argentina between 1991 and 2002. To call these countries a political union is obvious nonsense.

As this article in the Financial Times suggests, giving peripheral European countries an easier escape from the Euro might be a better option than forcing them to stay in and endure years of austerity.

Sunday, 19 December 2010

Are Canadians are suckers for moral hazard?

As Walter Bagehot pointed out in “Lombard Street” (published in 1873), booms and recessions are a regular cycle. That is, irrational exuberance goes too far, which leads to a crash, followed by a slow recovery. Memories are short, so after a few years of recovery, no one thinks the inevitable new bout of exuberance can possibly be irrational, so the cycle starts again.

To say that memories are short in Canada looks like being an understatement: they haven’t learned the lessons of the recession WE ARE STILL IN! The Bank of Canada seems to be buying junk mortgages like there’s no tomorrow. See Mish.

Friday, 17 December 2010

Is the natural rate of interest really zero?

There is a widely accepted phrase amongst advocates of Monetary Theory (MMT) that the “natural rate of interest is zero”, e.g. see Mitchell here and here. Or for a more concise exposition of the zero interest rate idea, see Mosler. I support MMT, but I’m not enthusiastic about this natural rate idea.

By the way, the word “government” will be used below to refer to “government and central bank combined”.

One possible sense of the phrase “natural rate of interest” is something like “the free market rate” or “the rate that would prevail assuming no attempt by government to influence the rate”. In other words this is the rate that arises just from the relationship between those who want to be net borrowers and those who want to save up, and be net lenders.

The phrase “natural rate” is used differently in MMT: the phrase is used to help explain what happens when government creates and spends money (i.e. does not borrow or tax to fund the spending). The effect is a drop in interest rates. And the rate can, according to MMTers drop to zero. In the words of Mosler (p. 539), “Our main point is, in nations that include the USA, Japan, and others where interest is not paid on central bank reserves, the “penalty” for deficit spending and not issuing securities is not (apart from various self-imposed constraints) “bounced” government checks but a zero percent interbank rate, as in Japan today.”

I beg to differ: it could be that full employment in some countries is attained (because of the additional spending) BEFORE interest rates reach zero! Of course the above zero interest point may well be valid in Japan. But the Japanese are ultra enthusiastic savers: they are willing to lend their government very large sums at zero or near zero rates of interest. Spendthrift Anglo-Saxons and PIG countries are different.

Now that all might seem to be contradicted by events since the recent credit crunch. That is, interest rates have dropped to near zero even in Anglo-Saxon and some other countries, yet those countries certainly do not have full employment: put another way, in these countries, a zero or near zero rate of interest coexists with a feeble rate of exit from the recession.

The answer to this contradiction is that governments have not JUST being net spending: they have engaged in quantitative easing (QE). And QE is a policy which aims specifically at reducing interest rates, with additional consumer spending being very much of a side show. Another aim of QE is to boost asset prices: nice for the rich and asset owners generally, but this again is not the same as directly putting purchasing power into the hands of the average consumer / citizen.

So which is the better policy: QE or extra net spending? Well the basic purpose of the economy is to produce what consumer / citizens want. Thus the better policy is net spending because this puts more purchasing power into consumer / citizens’ pockets.

Of course additional net spending can mean extra government spending AND/OR reduced taxation. And it is arguable that extra government spending does not equal putting additional purchasing power into consumer / citizens’ pockets. On the other hand, additional purchasing power IS put in their pockets in the sense that citizens vote at election time for government to act as citizens’ agent and do some spending on behalf of citizens: e.g. spend money on schools, the police and so on. So let’s just say the phrase “put purchasing power into consumer / citizens’ pockets” is being used in a broad or “dual” sense here.

To put the latter point another way, and summarise, the distinction being made here is between two policies. The first is to increase both traditional consumer spending (e.g. on cars, houses, etc) plus traditional government spending (e.g. schools, the police, etc). The second policy, that is QE, is to drop interest rates and boost asset prices.
At the time of writing, the weaknesses of putting much of the emphasis on QE have been layed bare: we have (at least in the U.S.) record low interest rates and a feeble recovery from the recession.

So my favoured policy in a recession is to have government do more net spending, and let the market determine the interest rate – or at least have “net spend” as the main anti recessionary tool, with interest rate adjustments being a minor and supplementary tool. That was more or less what Abba Lerner advocated, except that he though bureaucrates and politicians were someow good judges of the optimum the interest rate for the purposes of optimising the total amount of investment.

Keynes also advocated the above “extra net government spending” idea, but not in such a blatant or bold manner as Lerner.

Afterthought (18th Dec). To summarise, “the natural rate of interest is zero” is a bit of a non statement, for the following reasons. Given falling unemployment and no deliberate attempt by government to influence interest rates, full employment may be attained at least in some countries before interest rates reach zero. And if demand is then raised still further, inflation ensues. In this scenario the “zero interest rate” scenario is an irrelevance: it should be avoided.

So perhaps the above quote from Warren Mosler should be rephrased and toned down, and the phrases “natural rate” and “zero” should be avoided. The above quote reads “the “penalty” for deficit spending and not issuing securities is not . . . bounced government checks but a zero percent interbank rate…” . Instead, it should simply read, “the penalty of deficit spending and not issuing securities is not bounced government checks but a reduced interest rate”.

Tuesday, 14 December 2010

What did the Fed do with $9 trillion?

Fed Inspector General can’t explain what happened to $9 trillion. The first two thirds or so of this clip deals with a ONE trillion sum. Then they move on to the nine trillion.

(I got this from Brenda Rosser in the comments section here:

Sunday, 12 December 2010

QE does not equal printing money.

QE is often equated with printing money. This is nonsense.

Let’s start with the QEing of government bonds near maturity. These bonds are widely regarded as, and accepted as a very near equivalent of cash in the world’s financial centres. Thus QEing these bonds is about as earth shatteringly irrelevant as swapping $10 bills for $20 bills. Giving someone two $10 bills in exchange for a $20 bill does not constitute “printing money” and nor does QEing short term government bonds.

As to QEing longer term government bonds or private sector bonds, things are a little more complicated. Let’s start by defining the word money and the phrase “print money”.

There are numerous definitions of the word money, but one definition is “a very liquid asset”: that is, an asset which is readily accepted as a means to pay for less liquid assets like cars, houses, and so on.

As to the phrase “print money”, this is normally understood to mean the creation and distribution of MORE money with no corresponding reduction in the amount of assets which are “near money”. To illustrate (and to use the above example of QEing short term government bonds) creating $X out of thin air and using the $X to buy and tear up $X worth of short term government bonds certainly NOT the same as creating $X out of thin air and distributing the $X to the population (e.g. via a tax reducution or a helidrop).

In the latter case (e.g. a tax reduction), private sector assets RISE by $X. In contrast, in the former case (QEing) the value of private sector assets remain constant, or very nearly CONSTANT. That is a BIG DIFFERENCE! And since the “QE equals money printing” brigade cannot see the difference, the conclusion is that they can’t see an awful lot.

Printing versus printing and distributing.

I said above that money printing equals the creation AND distribution of more money. It could be argued that the distribution element is not a necessary part of the definition. For example, if I print a million tonnes of £20 notes and stash them down a disused coal mine and don’t tell anyone what I’ve done, that is still “money printing” isn’t it? Perhaps it is. But the above senseless “stashing” operation will have no effect whatever on demand, inflation or anything else (apart from temporarily increasing the demand for paper and ink).

QEing private sector bonds.

QEing private sector bonds and longer term government bonds is a little different from QEing short term government bonds, which as noted above is little different to swapping $20 bills for $10 bills.

Assuming a fair price is paid for “long term / private” bonds, then no money printing takes place in the sense that the value of private sector assets remains the same. On the other hand, the liquidity of a portion of those assets certainly IS improved: in the extreme case, hard to dispose of bonds are turned into cash, which is a very definite improvement in liquidity.

The EXTENT of money creation here is hard to estimate. It is certainly nonsense to claim that QEing $Y worth of these bonds equals the printing and distribution of $Y worth of new money. But SOME money HAS been created in that extra liquidity has been created. I’ll leave it to others to quantify this!

Saturday, 11 December 2010

Martin Wolf is wrong to back low interest rates.

Martin Wolf in the Financial Times attacks the idea that low interest rates are unfair to older people (who tend to be lenders / savers). This article is not up to Wolf’s usual high standards.

His first argument is that older people have benefited from “huge capital gains in their houses”. Completely irrelevant! Not everyone owns a house: some rent. And second, the gain in value of one’s house is no benefit, unless one trades down to more humble accommodation. And third, some peoples’ houses are worth far more than others, plus some people have more than one house!

Martin Wolf’s argument above is a bit like arging that men should pay a higher rate of tax than women because men tend to earn more. The way to a more equitable distribution of post tax income is INCOME TAX. The sex of individual taxpayers is irrelevant.

If there is something wrong with large capital gains on large houses or second homes, then fine: introduce a tax on those gains. Though any such tax (and thus Wolf’s point about house price increases) is rendered somewhat irrelevant by the fact that at least in the U.K., capital gains tax is payable on second homes, plus the value of everyone’s main residence is included in estate valuations for inheritance tax purposes when they die.

Wolf then argues that given excess debt, excessive leverage and weak financial sectors, low interest rates will help profligate and irresponsible lenders and borrowers rectify their mistakes. Well it’s not the job of pensioners (or anyone else) to subsidise or come to the rescue of the irresponsible.

Walter Bagehot advocated, quite rightly, that where a bank is in trouble, the central bank should provide TEMPORARY assistance based on QUALITY collateral and at PUNATIVE rates of interest. If the bank cannot produce quality collateral or pay those punative rates, then it does not just have a temporary liquidity problem: it is bust. Bankrupt. It should be closed down.

Of course politicians HATE taking the latter bull by the horns. It means disruption, which might lose them votes (but benefit the country in the long term). “Kicking the can down the road” is so much more appealing for politicians. And there is another bonus, at least in the U.S.: the irresponsible lenders who are rescued with taxpayers’ money then continue contributing to said politicians’ campaign funds.

Subsidies for the irresponsible are themselves irresponsible.

Martin Wolf then claims that “with higher rates, house prices would fall further, unemployment would rise, more loans would default and banks would fall back into difficulties.”

The idea that higher rates of interest have to lead to higher unemployment is nonsense. Of course it is perfectly true that ALL OTHER THINGS BEING EQUAL higher rates MAY lead to higher unemployment: certainly adjusting interest rates is a popular way of supposedly regulating aggregate demand.

However there are plenty of authorities who have questioned the effects of interest rates on demand and hence on employment levels. For example, the Radcliffe Report in the U.K. in 1960 concluded that interest rates were a poor way of regulating demand.

And Scott Sumner, Prof of economics at Bentley University (U.S.A.) thinks likewise.

But more important than the questionable effects of interest rates in regulating demand is the above “other things being equal” point. The flaw in Martin Wolf’s argument here is as follows.

Suppose we were to adopt what might be called the above purist Walter Bagehot approach and keep interest rates relatively high. And let’s also assume that high interest rates DO curtail demand. The result – no question about it – would be raised unemployment.

However, interest rates are not the only factor determining employment levels! That is, there are well known ways of boosting demand (and employment) other than adjusting interest rates. E.g. an unfunded deficit with the additional or new money channelled into household pockets would raise demand: pretty much what Keynes advocated, as did Milton Friedman.

To summarise, we could perfectly well go for higher interest rates, and compensate for any demand reducing effects by boosting demand by other avenues.

Wednesday, 8 December 2010

Would a common fiscal policy solve Europe’s problems?

Note dated 14th Jan 2011. This post has been rather superseded by a post dated 14th Jan 2011.

The current conventional wisdom is that it would. I’m not convinced.

Suppose there had been some sort of centralised European fiscal authority between say 2000 and 20008. Would those running it have nipped PIG type problems in the bud? That is, would they have spotted that anything was wrong before the credit crunch arrived and it was blindingly obvious to everyone that something was wrong? Where ARE these geniuses with better forsight than everyone else?

And even if these geniuses exist, there is another and somewhat technical problem, as follows.

A major problem with common currency areas occurs, as is now widely appreciated, where the competitiveness of constituent countries diverge. Where such countries each have their own currency, those who have lost relative competitiveness can devalue. In a common currency area they allegedly cannot do this.

Well actually they could, though doing so is complicated and messy. The way to do it, assuming an X% devaluation is required, is to cut all wages in the country concerned by X%. As is the case where a country with its own currency does an X% devaluation, the X% wage cut does cut living standards, but not by anything near X%. This is because the wage of natives of the country concerned forms a significant part, and usually the vast bulk, of the cost of goods and services consumed in the country concerned.

Now presumably what is meant by “common fiscal policy” is something resembling what is currently taking place in Ireland, but in slow motion. In other words the minimum wage, social security benefits, and a few other items are cut, allegedly well before the problems we now see materialise.

But cutting those two items plus a few more, is nowhere near the same as cutting ALL wages. Presumably the idea is that cutting the above two items will eventually result in wages drifting downwards (at least relative to wages in more competitive countries). But the “drifting down” is bound to take several years. The relevant country will have to endure a long period of deflation and unnecessary unemployment in the meantime.

A better alternative would be to cut employers’ contribution to any payroll tax (National Insurance contribution in the U.K.). That would reduce the cost of employing people, which in turn would reduce the cost of the relevant country’s exports and possibly rectify the balance of payments position.

Saturday, 4 December 2010

The political right is barking mad.

As Scott Sumner says, when inflation was 4.1% and unemployment below 5% in 2007 the political right favoured stimulus. Now that inflation is 1.2% and unemployment near 10%, they think stimulus will be inflationary.

They really are totally and completely barking mad.

Wednesday, 1 December 2010

The multiplier is totally irrelevant.

There are a thousand articles, chapters in books, papers, etc which discuss the relative merits of different forms of economic stimulus, with particular emphasis on the multiplier effects of each. For example there is the tax cut versus increased public spending debate. An recent article by Prof Michael J.Boskin is just one example.

But the multiplier or “bang per buck” argument is also dragged into other areas, for example the relative merits of different employment subsidies.

However the entire argument over mulitpliers is TOTALLY IRRELEVANT because given a relatively low multiplier, the additional dollars needed to create a given number of jobs is not a REAL cost. That is, producing the extra dollars ex nihilo required by a relatively low multiplier form of stimulus does not cost anything in REAL TERMS. All that is required is a book keeping entry.

For example, the multiplier in the case of tax cuts over the next year or two could be unimpressive because a significant proportion of households have had their fingers burned during the credit crunch. As a result they may NOT want to buy houses, or anything else, with BORROWED money. Instead, they may want to buy stuff with SAVED money.

But where does this additional stock of money come from? There is only one source: a government deficit. But that deficit, assuming it accumulates as extra monetary base rather than extra national debt, does not COST anything in real terms to produce. To put it bluntly, printing money does not cost anything.

This point is intuitively obvious to advocates of Modern Monetary Theory. I would be nice if professors of economics, like Boskin, were similarly clued up.

Sunday, 28 November 2010

Germans don’t support PIGS.

Over the last decade Germany’s competitiveness has improved relative to that of PIGS. If all EU countries had different currencies, this growing disparity could have been dealt with via devaluation of PIG currencies.

But the above countries all use the Euro, so devaluation is impossible. But what IS possible, at least for a while, is for Germany to lend the PIGS enough money to keep them going. But eventually the debts become unsupportable, unless Germany forgives the debts, and starts lending all over again.

Now this process might look like a gift by Germans to PIGS and certainly 99% of Germans see it that way. To put it in illustrative form, the net effect is that Germans sell Mercs to PIGS at let’s say 20,000 Euros each, but then have to reimburse PIG countries to the tune of 1,000 Euros per Merc buyer, which looks like a gift.

But suppose the PIGS had devalued, by let’s say 5%. Germans would than have got 19,000 Euros, or thereabouts for their Mercs, assuming Merc prices in Deutschmark terms remained constant. In both cases Germans get 19,000 Euros per Merc, instead of the 20,000 they were hoping for.

The two strategies are not VASTLY different, though the devaluation option leads to a more efficient allocation of resources. That is, under the “lend and forgive debt” option, Mercedes is encouraged to sell more Mercs to PIGS than it otherwise would: after all, Mercedes still gets 20,000 per Merc – it’s the German taxpayer who funds the 1,000 reimbursement to the PIGS. In contrast, under the devaluation option, fewer Mercs are sold to PIGS. That would initially create unemployment in Germany, but Germany can perfectly well make up for that by increased domestic spending.

Conclusion: the 1,000 Euro reimbursement by Germany to PIGS is not in the nature of a straightforward gift. There IS a cost for Germans in the form of inefficient resource allocation, but PIGS probably take a similar hit from this inefficient resource allocation factor.

Wednesday, 24 November 2010

Inspired comment of the week.

The most succicinct and inspired comment I’ve read so far this week is by Stephanie:

“The cause of the current economic malaise is an over-leveraged consumer – the Fed can’t figure this out?!? They figured it out for the banks when they were all leveraged 40, 50 to 1 and were thereafter de-leveraged by receiving free handouts. De-leveraged the rest of us!! Then things will all go back to hunky-dory. Oh…wait…they can’t do that…that would end up putting the hurt BACK on the banks, wouldn’t it?

Tuesday, 23 November 2010

Republicans love the recession.

It’s been obvious for some time that the Repugnant Party does not want to provide work for the unemployed. But it’s nice to see a senior member of the party admit as much.

As Senate Minority Leader Mitch McConnell put it, if getting rid of Obama “means doing nothing to help 15 million Americans searching for work who can't find it, too bad.” (Source: Fiscal Times.)

Afterthought (1st Dec): One particularly strident opponent of stimulus and advocate of austerity is Thomans Friedman. Though his qualilfications for playing this role are somewhat diminished by the fact that he lives in an 11,000 square foot house worth about $9million. Worse still, it’s not as if he acquired this palacial abode thanks to his own talents: he married into one of the 100 richest families in the U.S.: the Bucksbaums.

It makes Marie Antoinette and her “let them eat cake” remark look like a socialist.

I got the above information on Friedman from Dean Baker.

Monday, 22 November 2010

The Japanese don’t understand why they lost a decade, nor does Krugman.

Krugman’s book, “The Return of Depression Economics” devotes a chapter to Japan’s lost decade. But no solution to the lost decade appears in this chapter. However and strangely enough, a solution is set out in an earlier chapter.

The latter “earlier” solution involves a real “mini-economy” in the 1970s: the Washington DC baby sitting economy. Discovering this econonomy, according to Krugman, “changed my life”. Briefly, this economy consisted of a club which couples with young children could join. The objective was to enable couples with nothing to do on particular evenings to baby sit for couples wanting to go out for the evening and in need of baby sitting services. A those doing baby sitting for an evening earned a token or coupon. For a fuller description of this economy, see here.

But this economy ran into a problem: it suffered a depression or recession. That is the number of couples wanting to baby sit exceeded the number willing to hire baby sitters. As Krugman put it, “Couples who felt their reserves of coupons to be insufficient were anxious to baby-sit and reluctant to go out.. But one couple’s decision to go out was another’s opportunity to baby-sit; so opportunities to baby-sit became hard to find….”

The solution to this recession was simple: distribute more coupons to everyone. It worked.

Now for Krugman’s chapter on Japan. He considers the possibility that money (i.e. “coupons”) can be borrowed and lent (not a feature of the baby-sitting economy). Certainly borrowing and lending will facilitate higher aggregate demand for a given total stock of money/coupons. And reduced interest rates will encourage more borrowing and ought to raise GDP a bit (assuming the relevant economy has some slack, i.e. that additional demand does not result in inflation).

But Japan dropped interest rates to near zero and nothing much happened.

He then notes that Japan tried expanding public works (bridges to nowhere in many cases). But this was financed by BORROWING not by PRINTING and distributing more money (coupons). By now Krugman has forgotten all about the obvious and simple solution: increasing the volume of coupons! He offers no solution to the lost decade.

Doubtless some economists think that lending money at a zero rate of interest rate is the same thing as printing and distributing money. Well assuming the loan and zero rate of interest is guaranteed to last for ever, the the two come to the same thing. But of course in the real world, neither are guaranteed to last for ever: a point which ordinary would be borrowers (households) have spotted, but which allegedly sophisticated economists, bankers and politicians have perhaps not.

Krugman then considers deliberately stoking inflation so as to get those in possession of “coupons/money” to spend the stuff! Well that is just desperation.

The chapter ends by noting that Japan’s problems have been temporarily alleviated by increased exports, but that the supposedly insoluable problem, the dreaded liquidity trap, will re-surface!

Why not just s*dding print and distribute more coupons/money????

Or to quote Mosler’s law: “There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.”

And if anyone tries to tell me that quantitative easing equals printing money, I’ll scream. QE simply involves swapping one asset for another. It does not result in a net increase in private sector net financial assets. And in the case of quantitatively easing short term government bonds (which are little different to cash), you might as well swap $10 bills for $20 bills.

Thursday, 18 November 2010

I thought Martin Feldstein had a brain.

As Dean Baker put it recently, “In elite Washington circles ignorance is a credential.”

This credential is clearly possessed by Greg Mankiw, Rogoff, and others. But till now, I thought Martin Feldstein was free of this dubious credential. Unfortunately a recent article of his in the Wall Street Journal casts doubt on the latter idea.

Feldstein’s first paragraph reads “The stubbornly high unemployment rate is our economy's top problem today, but our exploding national debt is the more serious problem for the future. The recent proposal by Erskine Bowles and Alan Simpson, the chairmen of the bipartisan National Commission on Fiscal Responsibility and Reform, shows how difficult it will be to cut deficits and slow the growth of the national debt.”

First, anyone who takes Bowles and Simpson seriously, has to be economically illiterate, for reasons I spelled out here.

Secondly, why is it so difficult to “cut deficits and slow the growth of the national debt”? Feldstein doesn’t explain. The reality is that a deficit can accumulate EITHER as additional national or debt OR additional monetary base (which is to some extent what has actually happened over the last two years or so, and is what Keynes recommended).

In other words it is perfectly feasible to continue with the deficit and have NO rise in the national debt as a consequence. Got that? I’ll repeat that (in bold and in colour) just to drive the point home.

It is perfectly feasible to continue with the deficit and have NO rise in the national debt as a consequence.
Of course, the “monetary base” option is doubtless more stimulatory, dollar for dollar, (and potentially inflationary) than the national debt option. But what of it? If you use a higher energy fuel in a car engine, but want constant power output, what do you do? The answer is use less fuel. Doh!

Feldstein then trots out the old Ricardian myth that “the mere prospect of persistent high deficits jeopardizes the current recovery by creating the expectation that tax and interest rates will eventually rise substantially.”

The idea that the average household knows what the deficit per household is an idea straight out of la-la land. And the idea that the average household then “saves up” so as to meet the future alleged tax liability is also straight out of la-la land. Moreover, the evidence just does not support this Ricardian idea. That is, the average household does exactly what anyone with an ounce of common sense expects them to do. I.e. given increased income (as a result of a deficit), the average household SPENDS a significant proportion of that increased income in a fairly short space of time, and saves a proportion (and not for the most part to meet some carefully calculated future tax liability).

For the evidence, see here, here, here and here.

Apart from the empirical evidence, there is a whapping great theoretical flaw in the idea that it makes sense for any household to “save up” to meet the alleged future tax liabilities resulting from a deficit plus increased national debt. It’s thus.

The motive for this saving is presumably that the alleged future tax liability will reduce living standards for households, and to mitigate this, households save (i.e.sacrifice living standards NOW) so that they can spend a bit more (or maintain living standards) when the alleged extra tax becomes due.

Now let’s suppose, just to keep things simple, that a deficit has to be run THIS year to maintain full employment, and that NEXT year government has to raise taxes to prevent the economy overheating (while employment stays at the “full” level). Let’s also assume to keep things even more simple (and for the benefit of the simple souls who believe in Ricardian equivalence) that we have constant technology and a constant population.

In this circumstance, living standards or income per household will be EXACTLY THE SAME in each year! There is absolutely NO POINT in households “saving up” to meet the tax liability in the second year. Put another (and figurative) way, the income that government grabs from households in the second year, is income that those households COULD NOT SPEND IT THEY WANTED TO, without causing excess inflation!

It’s a bit like each household having $2,000 worth of obviously forged $10 bills: no use to anyone. They can just be removed from each household and burned.

In short (and this is admittedly a bit far fetched), perhaps the reason why households do NOT save much so as to meet the above alleged future tax liability is that the average household is more clued up than people like Martin Feldstein who teach economics at Harvard!!!!

Cynical conclusion.

It is of course possible that Feldstein is only acting the idiot. When the king is an idiot and is surrounded by idiots, it is necessary to play idiot to be heard at court.

Afterthought (5th May 2011): On the subject of Feldstein's deficiencies, I see someone agrees. And (27th Dec 2014), Paul Krugman.


Tuesday, 16 November 2010

Ireland: exactly who are the bond holders being bailed out?

There is a list here produced by Guido Fawkes. And wouldn’t you know it – Goldman Sachs is one of the institutions whose skin is being saved via the Irish bail out. Yes, when it comes to robbing the poor and stuffing the pockets of the rich, Goldman Sachs usually has something to do with it.

I suspect that the root cause of this farce is that the Euro is what is sometimes called a “debt based system”. I’ll explain (and I’m not 100% sure I’ve got this right).

Where a country issues its own currency (e.g. U.S., U.K., Japan, etc) monetary base is owned or held, free of debt, by a selection of people and institutions (possibly including you). Put another way, there is no debt corresponding to the £Xbn of monetary base in the U.K., for example.

Or to put it a third way, over the last fifty or hundred years, a portion of public spending in these “own currency issuer” countries has consisted of the relevant government / central bank machine spending money which it has simply printed, rather than obtained from tax or borrowing.

That is to be contrasted with the money produced (out of thin air) by the commercial banking system. To illustrate, when a commercial bank grants you a mortgage, it credits £X to your account for you to spend on your new house, but at the same time registers you as a debtor to the bank.

The Euro is similar to the latter commercial bank arrangement rather than the above “own currency issuer” arrangement. That is, the ECB offers Euros to commercial banks, who in turn lend the money to whatever European countries want said money. That explains why Germany, the most solvent country in Europe, is nevertheless heavily in debt.

The commercial banks involved in the above “debt based Euro system” obviously take a cut of the money they shift around. And that is fair enough as long as they are exposed to genuine risk: the risk that some country might go belly up. Problem is, that Europe is not prepared to allow sovereign default.

This effectively means (far as I can see) that the whole Euro system involves a free gift of billions to commercial banks. Europe needs to decide between on the one hand a debt based system combined with the genuine possibility of sovereign default and on the other hand, a “U.S. / U.K.” debt free monetary base system. The latter would not preclude sovereign defaults, but at least it would cut down on the donation of billions to taxpayers’ money to the super rich.

Friday, 12 November 2010

Obama’s Debt Commission is clueless on the basic nature of national debts, deficits, etc.

The Debt Commission, which is trying to produce a plan to reduce the national debt, has just produced a draft report. It’s in nice big bold type, so economic conservatives may be able to understand it. Unfortunately some of the words have more than one syllable: possibly a problem for economic conservatives.

Essentially the report is nothing more than a list of possible government spending cuts and possible tax increases. Well obviously those two will reduce the deficit. And if the spending cuts / tax increases go far enough, the national debt is also reduced.

But there is a problem: spending cuts / tax increases destroy jobs, and that is exactly what is not needed just now. So what to do? Well here’s the answer.

If a government spends more than it collects in tax, obviously that means a deficit. And the deficit can be funded in two basic ways. First, government can borrow, and that increases the national debt. Secondly, it can just let the monetary base increase. Essentially the latter option just consists of the government / central bank machine printing and spending newly created money. Indeed this money printing is exactly what has happened big time in the case of Quantitative Easing (QE).

As regards borrowing, there is a big potential problem, as follows. Borrowing $Xbn from the private sector, and then letting the money flow back into the private sector in the form of $Xbn of government spending means that the amount withdrawn from the private sector equals the amount “given back”, so to speak. It is quite possible that the net effect is ZERO. At least there is certainly some argument as to exactly how big the employment boosting effect is.

A better option (the one favoured by Keynes) is the second one: plain straightforward money printing. Certainly this second option is a good one where the national debt looks like growing too large.

And for those who want to give the usual knee jerk reaction to the money printing idea, i.e. “Weimar”, “Mugabwe” and so on, perhaps they can tell us why the U.S. monetary base has increased by astronomic and unprecedented amounts over the last two years (as a result of QE), yet inflation is at a near record low.

The explanation, of course, is that money printing will not be inflationary UNTILL the private sector decides it has too much money and starts spending excessive amounts. That drives up demand, which in turn creates jobs, and if it goes too far, drives up inflation. And at that point, it may very well be necessary to “unprint” money: i.e. have government raise taxes, rein in money and extinguish it.

Of course money printing is not without inflationary risks. But all governments are constantly caught between a rock and a hard place: too much demand and inflation becomes excessive, while too little demand means excessive unemployment.

Having said that money printing is the way to reduce the deficit while not destroying jobs, it is legitimate to ask why QE has involved money printing big time, yet the employment boosting effect has been pathetic. The answer is simple: the additional money has gone into the pockets of the section of the population least likely to spend it, that is the wealthy.

And there is a second reason why QE has had little effect, as follows. Had there been a straightforward helicopter drop of bundles of $100 bills into the gardens of wealthy, there might have been an effect. But what QE actually involves (to put it figuratively) is taking $X worth of valuable bits of paper called “Treasuries” from the wealthy, and giving them $X worth other other bits of paper called “dollar bills”.

Now why should that have any effect? It’s a bit like confiscating red and green Rolls Royces from the wealthy, and giving them grey and brown Rolls Royces in return. That would produce a lot of yawns, but not much else.

Government spending as a proportion of GDP.

Another mistake the commission makes is to get politics and economics mixed up, in particular, they claim that cutting government spending as a proportion of GDP will reduce the national debt. (See p. 6). They actually advocate cutting the proportion to 21%.

Perhaps they can tell us how come several European countries over the last fifteen years have had government take DOUBLE that amount of GDP, while at the same time keeping national debt CONSTANT as a proportion of GDP over a period of several years.

The answer, of course, is that the deficit has ABSOUTELY NOTHING to do with what proportion of GDP is taken by government. For example if government spends 2% of GDP while its income from taxaton is 1% of GDP, then the deficit will be 1% of GDP. Likewise if government spending is 41% of GDP and its income is 40%, then the deficit will still be 1%!!!!

Moreover, the decision as to what proportion of GDP is taken by government is the basic difference between the political left and the political right. It is not the job of a supposedly apolitical body like the Deficit Commission to have an opinion on this matter.

Thursday, 11 November 2010

Chinese leaders are as daft / devious as Western leaders.

Not for the first time, Wen Jiabao has been wittering on about the factory closures that will occur if the Yuan is revalued. Well, Wen me old mate, if the Yuan IS revalued, you can perfectly well make up for the lost demand from abroad by boosting demand at home. And you know perfectly well how to do this because you did this in response to the credit crunch.

But I suspect that factory closures are not your real concern. Like kings, emporors and every other type of political leader since the world began, you want to throw your weight around on the world stage at the expense of your own hard working and under paid citizens. And having a huge wad of foreign exchange enables you to do just that.

Tuesday, 9 November 2010

Saturday, 30 October 2010

Huerta De Soto and full reserve banking.

Mervyn King, Governor of the Bank of England, said recently: “Of all the many ways of organising banking, the worst is the one we have today.”

Agreed. Question, is: what’s the best alternative?

Huerta Do Soto (DS) proposes an alternative. It’s set out in his book, “Money, Bank Credit, and Economic Cycles”, which is downloadable here. I’ll try to summarise the book: a summary which will doubtless be unfair, inaccurate and biased towards my own views. Anyway, here goes.

Paragraphs in italics below are 100% my own views, not DS’s.

Ch 1 (pages 1 – 37). This sets out the difference between two very different “animals”. First there is a deposit for safe-keeping which is intended to be repayable on demand by the depositor. The depositor may well have to pay the depositee for costs involved in safe-keeping. Second there is a loan for a longer or specific period of time. In this case the depositee normally pays interest to the depositor or lender.

Banks blur the distinction between the two, that is deposits that are supposed to be instantly repayable are not – because about 90% of them have been loaned on to others. De Soto attaches importance throughout the book to the fact that his breaks fundamental legal principles.

I disagree with the “legal” point. The fact an activity breaks a law or basic legal principles is not important. The important question is “what harm is done by the law breaking?” FR certainly does harm in that it amounts to letting commercial banks print money, which they do big time in a boom (exactly when the extra money is not desirable). I.e. FR leads to instability. Put another way, the harm comes from the instability, not from the fact that a legal principle has been broken.

Ch 2 & 3 deal with historical examples of the above illegality and attempts to legally justify fractional reserve.

There is plenty of historical material here. I am grateful to DS for opening my eyes to the extent to which many of the problems relating to money and banking were being discussed by ancient Romans and Spaniards and other mainland Europeans 500 years or so ago: long before Anglos got in on the act.

Another interesting point is that when FR first started, the bankers concerned were aware that they were doing something underhand. I.e. it has taken time, even centuries, for the process to become respectable.

Ch 4. This deals with the credit expansion process. De Soto says in respect of the generating money ex nihilo that “businessmen rush out to launch investment projects as if society’s real saving had increased, when in fact this has not happened. The result is artificial economic expansion or a “boom,” which by processes we will later study in detail, inevitably provokes an adjustment the form of a crisis and economic recession.” That is one of the central messages of the book.

Ch 5. Pages 256-291. An explanation of capital investment involving Robinson Crusoe and his desire to make a stick to collect fruit, and how making the stick involves sacrificing current consumption.

p. 291-341. DS (like many Austrians, I think) attaches importance to what are sometimes called “intermediate goods”. E.g. one firm makes metals, another turns metals into car parts, and finallya car manufacturer puts the parts together.

I just don’t get this. If FR leads to instability, then that is the problem. No doubt the latter problem plays out differently as between an economy where a lot of intermediate production is involved, and in contrast, a simpler economy with relatively little intermediate production. But this strikes me as unimportant. But maybe I’ve missed something here.

Pages 347-95. De Soto claims that FR produces artificially low interest rates which in turn leads to a misallocation of resources. De Soto claims that the above mentioned “intermediate goods” point is central to explaining this misallocation of resources.

I agree that FR leads to artificially low interest rates and a misallocation of resources. As to the intermediate goods point, as I’ve already said, I don’t get it. Seems to me that artificially low rates will clearly lead to a misallocation of resources - end of argument. Period. I don’t see the need for the “intermediate goods” points, but to repeat, maybe I’ve missed something.

DS repeats the classic Austrian idea that recessions are good in that they hasten the destruction of malinvestments made during the preceeding boom.

I’ve always disagreed with the latter point because malinvestments are CONSTANTLY BEING DISPOSED OF, in that hundreds of firms go bust or lay off staff per week and hundreds of new firms start up, or existing firms expand. Do we need two million people unemployed and GDP lower than it could be in order to get rid of malinvestments? Plus if a recession is unnecessarily prolonged, some malinvestments will go bust which given less of a recession may turn out to be viable in the long run given a bit of re-organisation, new management, or whatever.

Chapter 6. More on the history and theory of business cycles.

Chapter 7. Criticism of Keynsianism and Monetarism.

Chapter 8. Arguments for and against central banks. DS (like von Mises and Rothbard) is anti-central bank mainly because in acting as lender of last resort, they encourage recklessness.

Central banks do have that weakness. But at the same time, in an ideal world, a responsible central bank supplies extra monetary base when it is needed. I don’t see an efficient way of doing this in a “no central bank” scenario. DS’s proposed way seems to be prolonged periods of deflation (in both senses of the word). The latter certainly would result in falling prices and hence a rise in the value of the monetary base per unit of currency, but I dread to think what levels of unemployment would need to be endured and for what period to achieve this.

Also, if memory serves, the Bank of England intervened in the 1800s to provide liquidity in various crises between its foundation and WWI. Britain did not suffer rampant inflation at any time in that period.

Ch. 9. DS wants “elimination of legal tender regulations which oblige all citizens, even against their will, to accept the state-issued monetary unit
as a liberatory means of payment in all cases. The revocation
of legal tender laws is therefore an essential part of any
process of deregulation of the financial market. This “denationalization
of money,” in Hayek’s words, would allow economic
agents, who possess far more accurate, first-hand information
on their specific circumstances of time and place, to
decide in each case what type of monetary unit it would most
benefit them to use in their contracts.”

p. 739. De Soto says “Therefore our proposal of free choice in currency is clear. In the transition process which we will examine further on,
money in its current form is to be privatized via its replacement
by that form of money which, in an evolutionary manner,
generation after generation, has prevailed throughout history:
gold. In fact it is pointless to attempt to abruptly
introduce a new, widespread monetary unit in the market
while ignoring thousands of years of evolution in which gold
has spontaneously predominated as money”

I don’t agree that gold has in some way been the “natural” currency for centuries, while (presumably) debt based money has not.

This article by A.Mitchell Innes in the Banking Law Journal shows that if anything, it’s been the other way round.

A.Mitchell Innes article is here.

Indeed, the earliest tally stick dug up by archeologists dated from 30,000 years ago. So we can say that debt based money has been practiced for at least that period of time.

Thus the use of debt as a form of money is natural phenomenon. Thus isn’t DS being naïve in thinking that allowing the market to come up with its own form of money will get rid of debt as a form of money?

Third,the gold standard has big problems, e.g. the following:

i) The price of gold fluctuates. Of course governments can get round this by fixing the price of gold, but in this case, the price of gold is what it is because government says so. That’s not much different to a £20 note being worth something because government says so (or says the note is an acceptable way of paying tax).

ii) There isn’t nearly enough gold in the world to supply the world with an adequate amount of money. On can get round this by having central banks hold only small amounts of gold relative to total money supply, but the further this policy is taken, the nearer the currency becomes to being fiat.

According to de Soto, his system has numerous advantages, one of which is “The Proposed Model Promotes Stable, Sustainable Economic
Growth, and Thus Drastically Reduces Market Transaction Costs
and Specifically the Strains of Labor Negotiations.”

I don’t see Bob Crow, leader of the London Tube workers, and one of the most belligerent union leaders in Britain being all sweetness and light just because we have a De Sote monetary set up!!!

p. 760. De Soto then deals with various possible objections to his system. One of these is that: “The proposed system would largely decrease the amount of available credit, thereby pushing up the interest rate and hindering economic development.”

I quite agree. Essentially DS proposes cutting all commercial bank created money or credit, which leaves just monetary base. Plus the latter is presumably limited to the amount of gold available to back the monetary base. That is a HUGE HUGE reduction in the money supply, isn’t it?

De Soto then says “Hence we conclude that there is absolutely no theoretical basis for the assumption that the interest rate would be
higher in the proposed system than it is now. Quite the reverse
would be true.”

Well, that contradicts earlier parts of the book where he says that one of the main faults of FR is that it brings artificially low interest rates !!!!

Incidental points:

Re insurance companies acting as banks, De Soto is aware of the problem here, but does not think it is serious.

He is happy with a scenario where prices gradually decline (deflation in one sense of the word).

I think there is a problem here. Trade unions are very much wedded to their annual wage increase, even if it is only in nominal terms. I feel he is too optimistic about a scenario where deflation (in both senses) reins supreme. Personally I’d prefer to ban FR and maturity transformation and keep central banks plus aim for 2% inflation. That scenario involves risks, as De Soto rightly points out. But I feel it is the least bad of the various options.

Monday, 25 October 2010

A new way to rob taxpayers and subsidise banks.

This debate between Tim Congdon and Robert Skidelsky is worth a read.

Tim Congdon has long had thing about the monetary aggregates. He has discovered there is a relationship between the money supply and GDP, and in particular that the money supply collapses in recessions. From this he concludes that if the money supply is boosted, that helps us out of the recession.

The big flaw here, as Skidelsky rightly points out, is that it is questionable as to which way the cause effect relationship runs. Commercial bank created money is created when a private sector entity thinks it’s worth their while borrowing from the bank, and the latter condition will tend to obtain when businesses have full order books and/or the economy is at full employment and everyone runs out to get mortgages to fund house purchases. I.e. the cause effect runs from GDP to money supply (at least as far as commercial bank created money goes).

Indeed, what exactly IS the cause effect relationship running from money supply to GDP?

Congdon actually proposes a solution to the recession which we can use to examine the latter question. His proposal is for money to be created by government borrowing from commercial banks. So let’s say government borrows a trillion from commercial banks. What of it? If the mere fact of crediting government with a trillion has an effect, I don’t see it. Of course, as soon as government starts SPENDING that money (a la Skidelsky), then there is an effect. But not before. David Hume made very much the same point 250 years ago when he said in respect of money supply increases “If the coin be locked up in chests, it is the same thing with regard to prices, as if it were annihilated.”

Anyway, moving on, the next question in relation to Congdon’s idea is: what on earth is government doing letting commercial banks create money out of thin air, when the government / central bank machine can perfectly well do this itself? Moreover, this proposal is a stealth subsidy for commercial banks (to add to the various subsidies of this nature already in operation). That is, a 100% reliable debtor (i.e. government) would be added to such bank’s balance sheets. Now that kind of dilutes the toxic debtors on those balance sheets, doesn’t it?

And finally, note that the above argument between Congdon and Skidelsky is one of the many problems that come out in the wash under Modern Monetary Theory (MMT). I drew attention to a couple of other problems that come out in the wash here.

Under MMT, given a recession, government prints money and spends it (and conversely, given an inflationary boom, government raises taxes and/or cuts government spending, reins in money and extinguishes it). In a recession, whether the effect comes the act of spending (as per Skidelsky) or from the money supply increase (as per Congon) doesn’t matter!

Afterthought (26th Oct): Congdon is not the only one to advocate the above “have government borrow from commercial banks” policy. Another advocate of this policy is here:

Wednesday, 20 October 2010

The stimulus was never designed to do much.

The billionaire funded anti stimulus movement in the U.S. is fond of claiming that the original stimulus did not achieve much. Well the answer is that it wasn’t designed to do much, apart from prevent the entire U.S. economy grinding to a halt. It was certainly never designed to bring the U.S. back to full employment in two or three years.

See here, and search for the three or four paras starting:“The most important question facing Obama…”.

Tuesday, 19 October 2010

Let’s re-allocate the bloated monetary base into household pockets.

People are employed when other people wave their dollar bills or credit cards in the air and demand goods and services. It is tragic that this statement of the obvious needs to be made, but as I pointed out here, half the economics profession seems to have forgotten the above point.

The big obstacle to getting more dollars into household pockets is the dreaded deficit. That is, channelling money into household pockets can only be done by increasing the deficit, and Republicans and supposedly liberal Democrats (who largely accept conservative thinking when it comes to deficits, as Bill Mitchell has pointed out time and again) won’t wear any significant increase in the deficit because they think the latter involves increasing the national debt.

The latter idea is nonsense, of course, because deficit can perfectly well accumulate as additional monetary base instead of national debt. (Incidentally, politicians’ failure to get this point is a problem in the UK as much as the US, however there is less scope for stimulus in the UK just at the moment because inflation is around 3%. Thus the real potential benefits from politicians’ grasping the above point are to be had in the US rather than the UK, at the time of writing.)

However there is a solution of sorts to the political log jam which is thwarting economic progress. This solution derives from the fact that there is already a huge amount of monetary base out there doing little or nothing. It derives from quantitative easing. It is now widely accepted that QE is near useless: “pushing on string” to use the popular phrase.

So why not use the money which is already out there doing nothing, to actually DO something? In other words why not reverse QE and channel the money so obtained into household pockets?

When QE was first started, conservatives, like so many Pavlov dogs, started chanting “Weimar . . .Mugabwe”. Well they’ve been proved wrong on that one.

If the excess supply of monetary base already out there is simply re-allocated, they can’t possibly do their “Weimar . . . Mugabwe” chant. No increase in the monetary base is involved. And another beauty of this wheeze is that while the deficit goes up, no increase in the national debt ensues. So conservatives cannot cite their “national debt” argument. They’ll be stumped.

Afterthought (20th Oct). There is a vaguely similar suggestion by David Blanchflower: have the Fed buy the debt of individual states in the U.S. That’s kind of “the Fed doing fiscal policy”.

That rather falls for moral hazard: it encourages reckless behavior by states in the future. But the benefits might outweigh the costs.

Sunday, 17 October 2010

100% reserve banking: lecture at the LSE by de Soto.

Jesus Huerta de Soto, is a Spanish prof who has written an entire book against fractional reserve banking (750 pages!). He goes into the entire history. Seems to me (and don't take my word for it) that we are still all arguing about the points relating to banking that ancient Romans were aware of and that various Europeans were aware of 500 years go.

The book is called "Money, bank credit and economic cycles" and it's available online.

His lecture at the London School of Economics is on Thursday 28th Oct., which I intend going to. Details here:

Friday, 15 October 2010

Conference on Banking, Money, etc in London, 13th & 14th November, 2010.


See here for more details about the Positive Money Campaign:

I think the conference is open to almost anyone who is interested. At least they’re letting me attend, so it must be open to almost anyone! Cost: £10 for students and £20 for non students.

Thursday, 14 October 2010

Ricardian equivalence is nonsense.

At least there is a way in which Ricardian equivalence is applied to the stimulus debate which is nonsense, and as follows.

If government borrows and spends in a recession, so the Ricardian argument goes, it will have to raise taxes and pay back the money sooner or later. Plus households are allegedly aware of this. So given a deficit, households will allegedly start saving now for the above future tax hike. And this in turn renders stimulus ineffective. The flaws in this argument are thus.

First, the idea that the average household has enough knowledge about economics to be able to calculate the “deficit per household” is an idea that comes from “la-la” land, as Bill Mitchell put it in his recent blog post about Ricardian equivalence.

However, let’s proceed on the basis that the average household CAN make the above calculation, and proceed to “flaw No. 2”, which is thus.

Government will not necessarily get the money for the payback from increased tax. It may get the money from public spending cuts. Indeed, govt probably WILL do this, to a greater or lesser extent.

And there is no need for households to “save up” for public spending cuts. When the cuts arrive, govt just spends a bit less on roads, the armed forces, the police and so on, and that’s that.

Third, and assuming the pay back comes from tax increases, there is no point in govt paying back the above debt till the economy looks like overheating. I.e. the debt is paid back in a scenario where households cannot effectively spend any more (on pain of causing inflation). Thus taxes have to rise. However there is no point in “saving up” to pay this extra tax in as far as govt grabs this extra tax before the average household gets its hands on the money.

For example most income tax (i.e. for wage earners) is deducted before wage earners see the money (at least that’s the case in Britain and most Western countries). In that govt grabs extra tax before households get their hands on the relevant money, any household which “saves” to meet the tax liability is engaged in double counting.

Turning now to where households DO get their hands on income before govt confiscates a proportion in the form of tax, there is a paradox or self contradiction in household behaviour here, if the average household “saves up” to meet the alleged future tax liability. The paradox is thus.

As pointed out above, a rational govt will only raise taxes where the economy looks like overheating, that is, where households are attempting to spend too much, i.e. and demand goods and services in such a volume that the economy cannot meet the demand.

Now what is the central objective in “saving so as to meet a future tax liability”? The objective is presumably to be able to meet the liability while leaving the household bank balance undiminished. But the whole cause of the problem (excess demand) is caused by households attempting to RUN DOWN their bank balances too fast (or “dissave”).

Let’s summarise that. If the average household is thrifty and saves to meet some future tax liability, demand will not become excessive, so there’ll be no need for the tax! Alternatively, if the average household becomes too spendthrift, demand will rise too far, thus govt will have to increase taxes so as to damp demand. But in this situation, the average household is clearly not aiming to “leave its bank balance undiminished”!

There is a fourth and less important flaw in the Ricardo argument. This is worth a mention because the mere fact that you never see it mentioned by advocates of the argument illustrates their ignorance. The flaw is thus.

If the monetary base and national debt are to remain constant as a proportion of GDP, they will have to be constantly topped up because they are constantly declining in real terms because of inflation. To illustrate, if nat debt and mon base are say 50% of GDP and inflation is 2%, you need a constant and never ending deficit of 2 x 0.5 = 1% of GDP. That portion of the deficit is NEVER paid back. I.e. it is not “future tax”. To illustrate, the U.S. mon base increased from around $50bn in 1960 to around $2,000bn in 2010. (And you can just imagine the average household being fully conversant with that point, can’t you!)

To reiterate, I’ve never seen advocates of the Ricardo argument mention the point in the above paragraph. That is they never say something like “households will save to meet the cost of deficits, except in as far as there is there is need for a constant and never ending deficit of about 1% of GDP per year”.


Finally, it is always possible that the above mentioned situation where debt has to be paid back to stop the economy overheating may take several years to materialise, during which time a somewhat bloated national debt persists. This may strike some readers as unsatisfactory and I quite agree. That is, I think Keynesian “borrow and spend” has serious flaws. I much prefer what might be called “Modern Monetary Theory / Abba Lerner print and spend”. I’ve set out the reasons here:

Friday, 8 October 2010

There is something wrong at the Federal Reserve.

When one senior person in an organisation talks nonsense, that doesn’t prove much. But when the numbers start rising to significantly above one or two, the suspicion arises that there is something wrong with the organisation itself.

I highlighted some nonsense emanating from two Fed people here.

Plus there is an ex-Fed economist (Arnold Kling) who says on his blog that he is having difficulty understanding Modern Monetary Theory. However his errors were put right by those leaving comments on the blog. Which raises the question: who is the more economically clued up – professional economists or the best bloggers?

That is three individuals. Now there is a fourth. Alan Greenspan (the one person, if there is one person, responsible for the credit crunch) has an article in the Financial Times today. The article is hogwash. Here is the first paragraph.

Although rising moderately this year, US fixed capital investment has fallen far short of the level that history suggests should have occurred given the recent dramatic surge in corporate profitability. Combined with a collapse of long-term illiquid investments by households, they have frustrated economic recovery. These shortfalls, the result of widespread private-sector anxiety over America’s future, have defused much, if not most, of the impact of the administration’s fiscal stimulus. Moreover, the activism embodied in such programmes has itself stoked the degree of anxiety.

“Long term illiquid investments by households”?? Well presumably that’s just a fancy name for houses. At least housing is far and away the biggest “illiquid investment” that the average family makes. Now given that there has been a GROSS OVERINVESTMENT in houses, what on Earth does Greenspan expect or want heavily indebted households to do? Run out and burden themselves with more NINJA mortgages, buy more or bigger houses and go even further underwater?

As to businesses, the main reason they are not investing as these three surveys show, is not, as Greenspan claims “widespread private-sector anxiety over America’s future”. The latter is an important element, but if there is one overriding reason for not investing it is plain simple lack of demand.

1. See here (p.28), 2, See here (page 14), and 3, See here, page 26).

In the next few paras, Greenspan repeats several times that it is an aversion to illiquid risk that “explains a large part of the anaemic recovery”, to quote.

So the basic purpose of an economy is indulge in risk? I thought the basic purpose of an economy is to provide consumers or citizens with what they want. If there is excess unemployment, then there is scope for giving citizens more of that which enables them to have more of what they want and employ the unemployed. And the stuff that kills the latter two birds with one stone is . . . wait for it . . . . money!! I.e. money needs to be fed into household pockets or “Main Street” pockets, not in to the pockets of Greenspan’s friends: the crooks and fraudsters of Wall Street.

As to the amount of investment needed to meet this demand from the consumer, well businesses can decide for themselves what level of investment is appropriate. They don’t need Nanny Greenspan encouraging or discouraging them from making investments.

Greenspan is a classic example of a phenomenon I highlighted here. That is, the tendency to lose sight of what economies are for, and instead mess around with important sounding concepts like “illiquid investments”.

Greenspan also attributes much of the problem to “the widespread major restructuring of our financial system”. What restructuring? The too big to fails have been left alone, i.e. they are the same size as they always were. (With the exception of the U.K. where the merger of Lloyds and HBOS made the “too big to fails” even bigger!!!!)

As to criminal or fraudulent mortgage practices, there has been next to no clamp down. As to Basle III, it’s as weak as water. Basle III won’t cause banks any lost sleep.

Deficits crowd out private sector investment?

Greenspan then makes the bizarre claim that a significant part of the problem is that the deficit has crowded out private sector investment.

I’ve just done a quick Google search for “deficit “crowd out” and investment”. The various articles and papers available seem to be inconclusive on whether deficits do crowd out investment. Indeed, one of them explicitly states in the summary that the jury is still out on this one.

But even asking the question as to whether deficits crowd out investment displays an ignorance of economics. Reasons are thus.

There are two basic reasons for running a deficit. One is as a substitute for tax. That is, government abstains from covering all its spending with tax and funds a portion from borrowing. That involves wading into the markets, and upping interest rates with a view to attracting funds to cover the relevant spending. (BTW, I’m using non Modern Monetary Theory phraseology here, but never mind.)

Now that IS BOUND TO CROWD OUT INVESTMENT! Indeed, crowding out private sector activity in general (including investment) IS THE WHOLE OBJECT OF THE EXERCISE!!!

That is, private sector activity has to damped down to make room for the relevant public sector activity. In this circumstance, anyone who complains about “crowding out” needs to do a basic course in economics and logic.

The second reason for deficits is to counter a recession, i.e. to do a bit of “Keynsian borrow and spend”. Here, obviously if government just borrows and spends period, then interest rates would rise, and crowding out would occur. But governments / central banks don’t do that. That is they certainly do not let interest rates rise in a recession. In fact they do the reverse: cut interest rates, which makes it easier to borrow and invest!

All in all, the question “do deficits cause crowding out?” is a bit like asking “are fires dangerous?” The answer to the latter “fire” question is “the question is so vague, that it’s a useless question, but ultimately the danger depends on who’s in charge of the fire, what the purpose of the fire is, where it is, how big it is, and a dozen other factors.” In short, don’t ask silly questions.

If Greenspan had his way, matches and cigarette lighters would be banned in case they caused another great fire of London.

And finally, Greenspan bemoans the damaging effect that bank regulation will have on “financial innovation”. Yes, we really need those Ninja mortgages up and running again, don’t we? And then there are those fiendishly clever and “innovative” people at hedge funds, Long Term Asset Management being the main culprit, which nearly brought the U.S. economy crashing down before the credit crunch. And then there are those clever clever CDOs the main aim of which is to hid toxic stuff from the innocents buying the CDOs.

We need “financial innovation” like we need a hole in the head.

Afterthought (9th Oct): More critical comments on Greenspan here.

Afterthought (4th Apr 2011): two more people of the view that Greenspan is past his sell by date: here and here.

Tuesday, 5 October 2010

Ben Bernanke thinks that if the national debt rises too far, so will interest rates!!!

So how come Japan’s debt is 200% of GDP, yet interest rates there are around 1%? That’s about three times the U.S. debt to GDP ratio. And as to the U.S. itself, it has the largest national debt for several decades, while interest rates are at a record low!

This speech by Bernanke clearly demonstrates he hasn’t a clue. Much of the rest of the speech is based on the idea that if the deficit continues, the national debt will also rise. It seems Bernanke has never heard of Keynes or Milton Friedman. As both the latter two individuals made clear, a deficit can accumulate as additional national debt OR additional monetary base.

And as to the idea that extra monetary base means inflation, there has been an astronomic and unprecedented increase in the U.S. base in the last two years, with not so much as a tenth of 1% worth of inflation to show for it.

But Bernanke is not the only ignorant duffer at the Federal Reserve. There’s at least one other: Richard Fisher, president of the Dallas Fed.

This speech by Fisher is as hilarious as Bernanke’s.

This speech by Fisher devotes much space to casting doubt on the merits of quantitative easing. He then asks “The vexing question is: Why isn’t this liquidity being utilized to hire new workers and reduce unemployment?” (That’s the liquidity created by QE).

His answer is his own personal impressions gained from business people he has talked to. To quote: “My soundings among those who actually do the work of creating sustainable jobs and making productive capital investments―private businesses big and small―indicate that few are willing to commit to expanding U.S. payrolls or to undertaking significant commitments to expand capital expenditures in the U.S. other than in areas that enhance productivity of the current workforce. Without exception, all the business leaders I interview cite nonmonetary factors―fiscal policy and regulatory constraints or, worse, uncertainty going forward…”

Well, Fisher’s personal impressions, are no substitute for actual surveys of business opinion. And what is truly hilarious here is that Fisher actually cites a survey of employers’ views in his speech according to which the main problem facing businesses (by a substantial margin) are none of the ones he cites, but plain simple lack of demand or “poor sales” as they call it. (See p. 18 of the survey).

The problems he cites are far from being a total irrelevance, but they are not the MAIN problem cited by employers in the above survey.

Another survey shows similar results (See page 4).

The final bit of nonsense in Fisher’s speech is that he wants to see businesses “hiring and training a workforce”. Problem with that idea is that precious little training needs to be done: there are loads of unemployed skilled people just waiting to fill vacancies. Both the above surveys showed that employers regard a shortage of skilled employees as a total non-problem compared to other factors.

Monday, 4 October 2010

National debt reduction for dummies.

The dummies in charge of Britain and several other countries can’t fathom out how to stop their national debts rising. All they plan to do is SLOW DOWN THE RATE OF GROWTH. For example the consensus amongst British politicians is that Britain should halve its deficit in about four years.

Well pay attention dummies. Here’s how to stop the national debt rising as from tomorrow. (This is actually just a move towards a monetary regime advocated by Milton Friedman which involved NO NATIONAL DEBT AT ALL.)

1. Stop all government borrowing tomorrow (apart from rolling over existing debt).

2. Leave public sector spending untouched.

3. That means a large UNFUNDED deficit. That is, the deficit accumulates as extra monetary base instead of extra national debt.

4. Still with me?

5. The effect of “3” above would be excessively stimulatory and probably inflationary. So temper that with a DEFLATIONARY method of deficit reduction, i.e. get some of the money for the deficit reduction by raising taxes and/or cutting public spending: ideally by just enough that the above inflationary and deflationary effects cancel out. That leaves a NEUTRAL EFFECT.

6. Having the above stimulatory and deflationary effects EXACTLY cancel each other is of course difficult. But getting ANYTHING exactly right when running an economy is never easy. The important point about the argument here is that it achieves something that according to conventional thinking is impossible. That is the important point about the argument here is the THEORY.

7. If you think the above tax rises and public spending cuts means “austerity”, then you are wrong. Remember I said “NEUTRAL” just above? That is, there is (ideally) no stimulatory or deflationary effect from the above wheeze. That is aggregate demand, output per head, total numbers employed, etc. etc. etc. etc. etc. etc. remain the same.

8. Still with me?

9. A moderately intelligent question at this stage would be along the lines “You’ve just said no austerity is involved, but you’re advocating tax rises and public spending cuts. Isn’t that a self contradiction?”

Answer: remember that the unfunded deficit or accumulation of monetary base in the hands of the private sector puts extra spending power into the hands of the private sector. Thus the private sector will spend more. If some of that money is then taken away from the private sector in the form of extra tax, the private sector will be approximately back where it started. Ergo . . . . . no austerity!!!!!

As to the public sector spending cuts, these can be immediately cancelled because of the above mentioned increased government income from the above extra tax which can be spent on public sector employment.

10. It would be easy to take the above argument a stage further and actually bring about a REDUCTION IN THE NATIONAL DEBT STARTING AS FROM TOMORROW. But that would be too much of a shock for economic conservatives and adherents to the conventional wisdom. One step at a time when teaching babies to walk!

11. The real bonus of the above policy is that it would enable Britain to stick two metaphorical fingers up at “the markets”. “The markets” are currently desperate to lend to just about anyone willing to take their money, apart from obvious no hopers (e.g. some PIG countries). Yields on U.S. inflation proofed government bonds are currently NEGATIVE*.

If Britain, the U.S. and other major countries all adopted the above “Churchillian salute” policy, I suspect “the markets” would have a collective nervous breakdown and would beg any reasonably responsible country to take their money at a negative real rate of interest.

12. It is worth summarising the changes in the flows of money between households and government that result from the above policy So here goes.

First, those who do not have significant holdings of national debt (roughly speaking the less well off) pay less tax because they do not need to fund so much interest on national debt. Thus extra taxes can be raised on this section of the population: ideally enough tax to put them back where they started.

Second, there are those who DO have significant holdings of national debt (roughly speaking, the well off). The purpose of having government borrow from these people (as Modern Monetary Theory correctly points out) is NOT to fund government. The purpose is to damp private sector demand by enough to make room for proposed increases in government spending.

Under the “no more borrowing” policy advocated here, these people would pay more tax. Ideally the amount of tax needs to be whatever brings the same “damping” effect as would have been occasioned by borrowing, had the deficit been left in place.

The ACTUAL AMOUNT of tax will CERTAINLY NOT be equal to the amount of borrowing that would otherwise have taken place (and any suggestion that the two are or would be equal is to fall for the most popular mistake in economics: applying micro economic ideas at the macroeconomic level).

At a rough guess, the amount of tax that would have to be raised from the wealthy would be a small proportion of the amount that would otherwise have been borrowed, perhaps about a tenth. Reason is that there is a very big difference between government PERMANENTLY CONFISCATING one’s money (tax) and government borrowing one’s money. In the latter scenario (borrowing) one is still the “owner” of the money. Moreover, one gets a receipt from government (Treasuries in the US and “Gilts” in the UK) which are almost as good as money: the “receipts” can readily be used (like money) to transact business. To illustrate if you have $10k of Treasuries, no money, and want to buy a $10k car, all you do is sell the Treasuries and use the cash to buy the car!

Stop press - (6th Oct). Looks like my above suggestion about responsible governments being able to stick two fingers up at their creditors has become slightly nearer a reality. See post by Stefan Karlsson entitled "Please, U.S. Government. Take My Money" (6th Oct).

Afterthought (12th Oct).
Re the amount the amount of extra tax than needs to be raised from the wealthy or Gilt owners, it could easily be less than a tenth of the value of the Gilts concerned. The relevant question is: “what amount of tax leaves a neutral effect?” To illustrate, if I get £X in exchange for £X of Gilts, there will be a finite stimulatory effect: I’ll have excess cash and will channel it to other assets (and presumably a small amount of extra consumption). But suppose I get £0.95X, because I am taxed to the tune of 0.05 of the value of the Gilts. In that case I may well feel poorer and will in consequence not do anything that results in stimulation. I.e. the ratio could easily be 1:20 or less.

* See Stefan Karlsson’s blog post, “Record Low Real U.S. Treasury Yields.” (28th Sept 2010).

Friday, 1 October 2010

Martin Wolf claims “We can only cut debt by borrowing”.

In an article in the Financial Times with the above title, Martin Wolf claims that the currently excessive unemployment is partially “paradox of thrift” unemployment. The solution, as he rightly points out, is for government to supply households with more cash so that households no longer feel poor, or no longer feel they have cash flow problems.

Unfortunately Wolf claims this additional cash can only come from extra government borrowing. That claim is implicit in the title of the article and is spelled out in more detail in the last four paras.

Well as Mugabwe has worked out, governments can simply print money: there is no need for additional government debt. Governments can either physically print money (i.e. produce extra dollar bills, pound notes, etc) or they can do the same thing with book keeping entries, or with cheque books, etc.

Stop press – Martin Wolf moves closer to Modern Monetary Theory (MMT).

A few days after the above article (published on 26th Sept), another one (1st Oct) by Wolf suggests stimulus should take the form of a National Insurance contribution cut, funded by the government borrowing from the Bank of England. Well the latter is plain old money printing, assuming the bank does not sell the relevant bonds on the open market. See in particular the final three paragraphs of the article.

Now that is all very similar to Warren Mosler’s proposed payroll tax cut funded by new money. (National Insurance contribution in the U.K. is a payroll tax supposed to fund social security.)

Wednesday, 29 September 2010

Message to the Fed: this is the modern monetary theory (MMT) transmission mechanism.

It seems a number of Fed and ex-Fed people have at last tumbled to the fact that there are serious problems with traditional ideas on money supply transmission mechanisms.

This Fed paper to which Warren Mosler draws attention points to the fact that there has been a 2,173% rise in bank reserves in the last two years, with (contrary to text book predictions) almost no effect. Yes you read that right: 2,173%.

The authors of the Fed paper also say “if the quantity of reserves is relevant for the transmission of monetary policy, a different mechanism must be found.”

And then there is Arnold Kling, who worked for a time as an economist for the Fed. He says “I am having an equally hard time understanding modern monetary theory.”

In view of the above, it might be helpful to set out the MMT transmission mechanism. It is very simple and it’s thus (as I see it).

1. The government-central bank machine net spends in a recession. Assuming government wants the relative sizes of public and private sectors to remain constant, some of the money will be spent on hiring extra public sector workers and/or making sure that tax shortfalls don’t result in public sector workers being sacked. That creates employment.

2. There is a multiplier effect from “1”, that is, part of the above additional payroll costs will be spent, which in turn employs more people.

3. The above additional public sector workers will probably save some of their income. That boosts private sector savings. Those savings will not expand for ever. The point will come where the private sector thinks it has enough by way of savings, at which point it will cease saving and will spend, or try to spend all its income. That employs yet more people.

4. While the above boost for the public sector boosts the private sector INDIRECTLY, it is probably desirable to give the private sector a DIRECT boost as well. That can be done by, for example, reducing payroll taxes or income tax. That boosts employees’ take home pay, which in turn will boost their spending, which employs more people.

Doubtless some of the above private sector increase in take home pay, will be saved. The consequences are exactly the same as with the above public sector employees. That is, savings will rise to the point where no more savings are required, etc, etc.

Sunday, 26 September 2010

Von Mises and whether U.S. unemployment is structural.

One of the main claims made ad nausiam by the Von Mises brigade is that recessions are needed so as to rid the economy of what they call “malinvestments”.

The first flaw in this idea is that in any medium size or largish economy, even in periods of full employment, thousands of firms go bust per week and thousands of new firms start up per week. That is, there is a continuous process of disposing of “malinvestments”. Thus the mere existence of malinvestments does not justify recessions.

Second, every economy is stuffed full of malinvestments in that about 25% of industrial capacity is normally unused.

Third, it is a bit of a mystery as to why the existence of thousands of empty houses going to rack and ruin should stop a country’s workforce being employed in non construction type activities. Moreover, the construction industry has not DISAPPEARED as a result of excess house building: it just halved in size, or thereabouts.

Fourth, if excess demand results from easy credit, this will result in excess investment in a WIDE RANGE of industries, plus it will result in inflation. Now inflation in the U.S. was a percentage point or two above target just before the credit crunch: a negligible problem. In contrast, the REAL problem was the grotesque inflation in house prices and ludicrous mortgages being offered, like the famous NINJA mortgages.

This leads to a more plausible argument which might be the basis for thinking that the economy cannot bounce straight back to where it was pre-crunch. This is that a large excess supply of former construction employees amongst the ranks of the unemployed might mean that it will take time to retrain those people, hence hindering a return to full employment as quickly as we would like. So does the evidence for this phenomenon stack up? The answer is “possibly, but it’s a bit doubtful”.

First, if the latter were a significant problem, one would expect to find significantly more former construction employees amongst the unemployed (relative the size of the construction industry) than former members of other industries. This does not seem to be the case if this Roosevelt Institute study is anything to go by: see charts on page 8 here.

In contrast to the above study, and study done by “Oregon Business Report”, paints a slightly more gloomy picture. On the other hand, according to this study, the expansion in numbers employed in the Oregon construction sector between 2001 and 2009 was identical to the contraction 2007 – 9. Now if the workforce are flexible enough to move INTO construction from a variety of other sectors of the economy, presumably they are flexible enough to move back again (though admittedly the contraction was faster than the expansion).

In contrast to the Oregon study Also this study claims that construction workers have no more difficulty finding alternative work than the national average. Since the latter study covers the naton as a whole rather than just one state, it is presumaly more reliable.

As to strictly theoretical considerations. Suppose the level of unemployment at which inflation becomes excessive is 4%. Suppose the proportion of the workforce employed in construction at its height two years ago was 6%. Suppose numbers employed in construction halve, and that of those becoming unemployed, a half have serious difficulty finding other jobs without retraining. That means the proportion of the workforce who are seriously difficult to place is (6/2)/2 which is 1.5%. That in turn means the overall level of employment at which inflation becomes a problem rises from 4% to (4 + 1.5) = 5.5%.

That is an insignificant rise compared to the actual rise over the last two years. Conclusion: there isn't a huge "structural" problem.