Monday, 29 March 2010

Where Keynes Went Wrong, by Hunter Lewis.

I just read “Where Keynes Went Wrong” by Hunter Lewis (or parts of it). The chapter entitled “Markets Do Self-Correct” looked interesting, because Keyes’s main point was that they don’t.

The crucial passage reads:

During a slump, people buy less. This reduces business revenues. Because revenues fall first, before expenses, profits fall. Business owners then lay off employees to reduce costs and restore profitability. If, instead, wages fall, profitability can be restored without layoffs.

This is especially necessary if prices start falling throughout the economy. If people buy so much less that almost all prices start to fall, businesses revenues will be especially hard hit. Not only will fewer widgets be sold, but each individual widget will sell for less. Under these circumstances, if wages do not fall with prices, businesses will certainly face bankruptcy. On the other hand, if both prices and wages fall together workers should be no worse off. Although wages are lower, the consumer products workers buy will also cost less. It will be a wash.

Poor old Hunter Lewis just doesn’t get it: if prices, wages (and profits come to that) all fall by X%, everyone is back where they started! The only change is that the value of the monetary base in real terms has risen which would encourage spending (the Pigou effect). Hunter Lewis has evidently not heard of Pigou or the Pigou effect; at least he doesn’t mention them.

The latter effect would certainly work, but we might have to wait rather a long time. It’s far easier to have the central bank continuously create monetary base. That more or less condemns us to inflation, but as long as we’re talking say 2% year, that’s not so bad.

Sunday, 28 March 2010

Mistakes by Yeva Nersisyan and L. Randall Wray.

This is a good article by the above two. It’s about foreign holders of national debt.

However there are a couple of mistakes near the end. In relation to interest paid they claim “We don’t owe China anything more than a bank statement showing the accounts at the Federal Reserve Bank where their funds are recorded.”

Somehow I don’t think the Chinese would be too happy with being told their billions of dollars and Treasuries have been ripped up, but that they can have a “bank statement” if they like.

The interest that non-U.S. entities earn on U.S. national debt is a genuine increase in U.S. indebtedness to those entities. Though for the moment, as the above authors rightly point out, many of these entities have no immediate intention of calling in the debt, and are happy with “bank statements” for the moment.

As regards foreign entities cashing in their Treasuries and turning these into real goods and services purchased in the U.S., the authors claim this “would almost certainly increase US production and hence employment.”

Well, the latter would not be the effect if the U.S. was at that point in time enjoying full employment, which it should be assuming its economy was being properly run. In this scenario, no more demand is possible. Thus demand from U.S. consumers would have be pared back to make room for the demand coming from foreign entities. That means U.S. citizens working just as hard as before, but not consuming so many of the goods produced. That means a real, if only temporary drop in U.S. living standards.

Alternatively, given excess unemployment in the U.S., the additional demand from foreign entities WOULD raise employment. But there would be little or no increase in U.S. living standards because the extra goods being produced are exported, not consumed in the U.S.

Thus to say that this additional demand from foreign entities results in extra “production and employment” is misleading. Extra “production and employment” are normally seen as “good” because they increase living standards. Extra “production and employment” which result in no living standard improvement is not a great deal.

Anyone out there want to work for me for no pay?

Thursday, 25 March 2010

Important people can’t stick ordinary people.

The ultimate source of all demand is households: ordinary people – Mr & Mrs Average. Plus the basic purpose of economic activity is to produce what households want. Thus when an increase in aggregate demand is required it should be pretty obvious who needs to be given extra spending power: households. That is, it is Main Street rather than Wall Street that should get the extra funds.

Give households extra funds and they’d spend more. Businesses would compete for this extra demand. And businesses with healthy order books are a good bet for any bank looking for someone to lend money to. Simple.

But no: this would be TOO simple. Economists cannot while away their hours in academic ivory towers erecting useless mathematical models based on this sort of simple stuff. So there are plenty of economists don’t like the idea.

And smartly dressed Wall Steet and City of London bankers don’t like the above simple idea: they want direct access to the extra money, Goldman Sachs in particular.

Large banks are clearly incompetent. Moreover, ordinary people to a significant extent act as banks: that is, people lend money to each other. I’ve just lent my niece money to buy a house and a friend of mine has just borrowed money off his mother to buy a van for his business. If government is going to help “banks”, there is no justification whatsoever for large banks getting any sort of preferential treatment over “ordinary people acting as banks”.

Politicians (most of whom couldn’t run a MacDonald’s restaurant) are all self appointed experts in running something a thousand times the size of the entire MacDonald’s chain: the entire economy. Moreover, they are apparently able to do this without having accumulated the knowledge of the subject required of those at the end of their first year in a university economics course.

Politicians all have their own pet schemes for “stimulating the economy”: extra investment, “shovel ready” projects, etc. These “shovel ready” projects would of course do all sorts of socially useful things: the sort of things that local and state government employees were already doing before they were sacked because of the recession. Mad or what?

The there is the $2bn “give away” to builders in the U.S. - when there is a surplus of builders and existing houses cannot be sold !!!!

The UK’s finance minister, Alistair Darling has just announced £2.5bn worth of support for small firms, including a scheme to force banks to lend to small firms. That should keep a few thousand bureaucrats and other unproductive paper pushers employed.

And then in the U.S. there is the payroll tax credit which will result in the creation of about as many jobs for foreigners as U.S. citizens.

Next on this list of shambolic schemes is the Home Affordable Foreclosure Alternative (a scheme in the U.S. for helping those in arrears with mortgage payments, and which by the looks of it won’ work). Plus see here and here.

And we mustn’t forget the farce that is cash for clunkers.

Meanwhile, house repossessions skyrocket.

Two mutually exclusive criticisms are normally made by important people of the idea that ordinary people be given stimulus money. First, households will just save the money, and second, they’ll spend too much, which would be inflationary. Well, which is it folks?

Sunday, 21 March 2010

20 hilariously incompetent academics display their ignorance in – where else – The Guardian.

This article is a peach. Signed by 20 academics, it claims that the best way to repay the national debt is via economic growth. And economic growth brought about by expanding the “knowledge economy”.

Now who benefits from expanding the “knowledge” section of the economy? Um . . er. . it’s academics isn’t it? No doubt fish and chip shop owners are all for favourable treatment for fish and chip shops.

Of course economic growth is good (assuming it’s within environmental constraints). But the idea that economic growth is needed to repay a national debt is just nonsense.

Incurring national debt in the first place consists essentially of one lot of people effectively paying taxes early and getting rewarded for this with interest payments. While another lot of citizens are temporarily excused paying taxes, though they have to pay tax to fund the above mentioned interest. (For the sake of brevity, I’ll ignore the complicating factors that arise when it’s foreigners that buy national debt).

As to repaying national debt, well this just consists of reversing the above process. That is, the less well off have to pay a bit more tax, and the money collected gets repaid to those who made the loan in the first place.

Assuming it is considered desirable to keep the relative incomes of debtors and creditors constant throughout this process, then obviously taxes on rich need to be reduced while the debt is outstanding and re-imposed when the debt is repaid.

Economic growth is totally unnecessary so far as repaying national debt goes.

Saturday, 20 March 2010

Bizarre ideas from a former governor of the Bank of England.

For some strange reason two UK newspapers have chosen to report comments made by a former governor of the BoE to the Treasury Select Committee in 2007, yes 2007. I’ve heard of newspapers dressing up old news as “news”, but this is stretching it a bit. Anyway, the “old news” is actually very interesting, so well done the Independent and the Daily Mail.

There a few mysteries surrounding this story. For example, why are these newspapers reporting this storey NOW? What is their source? I’ve looked at old Treasury Select Committee hearings on the Internet and cannot find anything.

My comments below are based just on these press reports. Hopefully the source of these stories will become generally known quite soon. Anyway, according to the Independent and the mail the governor said:

"In the environment of global economic weakness at the beginning of this decade ... external demand was declining and related to that business investment was declining. We only had two alternative ways of sustaining demand and keeping the economy moving forward: One was public spending and the other was consumption. Now of course it's true that taxation and public spending may influence the economic climate, may influence consumer spending. But we knew that we were having to stimulate consumer spending; we knew we had pushed it up to levels which couldn't possibly be sustained into the medium and long term.

But for the time being, if we had not done that the UK economy would have gone into recession just as has the United States. That pushed up house prices, it increased household debt ... my legacy to the MPC if you like has been 'sort that out'."

There is a huge amount of nonsense here.

First, take the phrase “We only had two alternative ways of sustaining demand and keeping the economy moving forward: One was public spending and the other was consumption.”

Well what other elements ARE there to aggregate demand? The only other one is exports, over which government has little control. The fact that the above two are the only ways that government has of influencing demand has been true of every country worldwide for the last hundred years. The governor might as well have announced that water is wet.

Second, take the statement “But we knew that we were having to stimulate consumer spending; we knew we had pushed it up to levels which couldn't possibly be sustained into the medium and long term.” Now why is this a problem?

Given inadequate demand, governments and/or central banks can boost spending: as Keynes and others pointed out long ago, this is what governments NEED to do. It is what the OUGHT to do. To complain about the need to do this is a bit like complaining that growing children consume a lot of food.

Third, take the phrase “That pushed up house prices, it increased household debt ...”. Why do stimulatory measures push up house prices? If demand drops, house prices drop. If government then takes measures to return demand to its previous level, that should not result in an excessive house price boom: prices should simply revert to their previous level.

Low interest rates should not of themselves result in excessive debt because banks ought to lend on the basis that mortgagees can still afford the mortgage if interest rates rise. The REAL problem was that banks started playing silly buggers and offering ninja mortgages. And a ninja mortgage is a disaster waiting to happen whether it is offered during a period of high OR low interest rates.

Tuesday, 16 March 2010

Bank of England realizes that QE boosts share prices, and Mish doesn’t realize that wages are sticky downwards.

Well done the Bank of England for tumbling to the fact that Q.E. boosts share prices. If people and institutions are given cash in exchange for their securities, they are going to diversify into other assets. Some of us predicted this before Q.E. started in early 2009.

And Mish in an unusual lapse from his usual high standards claims that the money supply might as well be left constant in dollar terms because when the money supply is inadequate, prices will fall, i.e. the real value of the money supply will rise, until the real value of the money supply is adequate.

The flaw in this argument was pointed out by Keynes: “wages are sticky downwards”.

Obviously if prices AND wages changed rapidly in sympathy with changes in supply and demand, then the “Mish” theory would hold. But wages just don’t fall fast enough: or don’t fall at all. Churchill tried to cut miners’ wages in the 1920s. The result was a year long miners’ strike. And they are trying to shave a bit of bureaucrats’ salaries in Greece at the moment. Same result: riots, strikes, etc.

Afterthough (20th March): The above criticism of the BoE is unfair - it was not 100% clear in early or mid 2009 WHAT the optimum amount of QE was.

Monday, 15 March 2010

Fed pays interest on bank reserves!

This is sticking plaster to cover up a blunder, isn’t it?

Instead of giving stimulus to Main Street or State or local governments, most of the stimulus has gone to Wall Street.

Put another way, Government – central bank machines have stuffed the pockets of people and institutions who are unlikely to spend the trillions involved, e.g. as part of the quantitative easing program. These trillions just get dumped in commercial banks.

The banks cannot lend much of it because not much demand is coming from Main Street. Thus interest rates plummet. Thus the Fed has to pay interest on bank reserves, unless interest rates are to go negative. Or as the Fed puts it “Recently the Desk has encountered difficulty achieving the operating target for the federal funds rate set by the FOMC....” (See item 3 here.)

Sunday, 14 March 2010

Tax Foundation nonsense.

Most economists have learned something from the 1930s depression. A sizeable proportion of politicians have learned nothing. The “almost a century out of date” views of these politicians are unfortunately backed by a number of ultra conservative publications produced by some vociferous and well funded conservative organisations. The Tax Foundation seems to fall into this category, if it’s latest publication is anything to go by: “Can Income Tax Hikes Close the Deficit?”

The basic claim of this publication is that, taking the U.S. deficit as about 3% of GDP, income tax increases of horrendous proportions will be needed to “close the deficit” as they put it.

Tax specialists and accountants may be good at tax and accountancy law and at adding up columns of numbers. But macroeconomics is a different ball game, and therein lies the mistake in this publication.

The central mistake is that the authors have not cottoned on to something which has been going on for at least the last hundred years: this is that a portion of government spending (as it happens, roughly 3% of GDP) is funded by seigniorage. That is, the deficit is more or less already covered. This takes some explaining, so here goes.

The private sector likes to save a certain amount. Apart from saving in the form of physical assets like houses and cars, the private sector also (quite understandably) likes to have a stock of financial assets, e.g. to fund retirement.

Investing in the stock exchange is one source of “financial assets”, and another is government debt (e.g. Treasuries). This government debt amounts to a large figure in the average Western country: roughly 50% of GDP.

But inflation eats into government debt: a slight problem. That is, assuming the private sector wants to hold an amount of government debt that is a constant proportion of GDP, then this debt will need to be continually expanded in Dollar or Yen or Pound terms. That is, the relevant “government central bank machine” will need to constantly print more currency units just to keep the debt constant in real terms. I’ll illustrate with some figures.

Most economists nowadays recommend an inflation rate of about 2%, rather than 0% or anything much above 2%. So let’s assume 2% inflation. And let’s also assume GDP growth in real terms of 2%. Plus we’ll assume the above “debt relative to GDP” figure of 50%.

On these assumptions, the amount of extra money that government will need to print every year will be 2 x 2 x 50% = 2% of GDP.

So out of the 3% of GDP that the Tax Foundation says needs to be added to income tax a full 2/3rds is not needed. That is, just 1% of GDP needs adding to tax: not a catastrophic figure.

The above, however, are very much “back of the envelope” figures. In particular, the deficit as a proportion of GDP has not been anywhere near a constant 2% since World War II, as the above back of the envelope calculation might seem to imply. There are some charts here and here giving the actual deficit since World War II.

As these charts show, the deficit was round 0% of GDP immediately after WWII: not surprising, since a near record debt had been incurred by the war itself, and the private sector doubtless did not want to hold this much debt on a permanent basis. This 0% gradually rose to around 5% of GDP in about 1985, and then declined back to around 0% and then rose again.

In other words the 2% that results from the above back of the envelope calculation is about right as an AVERAGE for the sixty years or so since WWII.

Paradox of thrift unemployment.

Many politicians have not yet grasped a very simple point made by Keynes and others. This is that if the private sector has what it regards as an inadequate stock of savings (in the form of cash and/or government debt), the private sector will attempt to save in order to build up its stock of savings.

But this necessarily means cutting down on spending. And cutting down on spending means people out of work. Thus the “paradox” is that while saving money is very laudable, it can be self defeating in the sense that it throws people out of work.

So what is the solution? Easy: make sure that government supplies the private sector with its desired stock of savings. And that normally means running a deficit. Not a ludicrously large defict: that would cause hyperinflation. But a deficit, nonetheless.

Thus the above idea put by the Tax Foundation that the deficit should be “closed” is nonsense. Very roughly two thirds of the deficit does not need closing.

Saturday, 13 March 2010

Think tanks that can't think.

Oodles of think tanks are churning out articles and papers on the recession and the deficit right now. A think tank called “Reform” has just published a paper entitled: “Reality check: Fixing the UK's tax system".

One of the central claims of this paper is that we should avoid taxes in incomes and employment, and instead, increase indirect taxes (e.g. sales taxes). Reason is that, allegedly, taxes on incomes and employment discourage work and employment. There is a flaw in this argument, as follows.

If the typical employee has to pay £X a year more in direct tax, while tax on the goods that they buy goes DOWN by £X a year, then the typical employee is back where they started! I.e. their real wage per hour’s work is not affected. It is hard to see why this shuffling of tax burden between direct and indirect taxes should OF ITSELF have much of an influence on the incentive to work.

That’s not to say that various changes to the personal or employment tax system cannot influence employment levels: of course they can. For example a flat “per employee” increase in a payroll tax would increase the cost of employing the least skilled. This would probably have much the same effect as raising the minimum wage: raise unemployment.

But that apart, shuffling money between direct and indirect tax does not OF ITSELF influence the incentive to work.

Moreover, even if this shuffling did influence real incomes, the argument is still nonsense because real income per hour worked has no influence on the number of hours people choose to work. For example, real incomes have doubled over the last thirty years, yet people work pretty much the same number of hours per week (actually they work slightly LONGER hours than they used to, according to the last lot of figures I looked at!). And as to international comparisons, real wages in Sweden are double those in Portugal, yet people work much the same number of hours a week in each country!

As distinct from the incentive for employees or potential employees to work, there is the question as to whether a payroll tax reduces the incentive for employers to take on staff. Obviously there is a reduced incentive in the sense that ANY tax on the private sector matched by an equivalent amount of extra public sector spending will shift employees from the private to the public sector. But there is no effect other than this effect.

To illustrate, suppose government raises employers’ contribution to a payroll tax by £X a week and spends the £X on whatever: say road construction. Obviously the £X a week withdraws spending power from the private sector and this is made up for by the increased spending power of the public sector (on roads). Employees will shift from various private sector firms to road building. But there is no affect on aggregate demand or aggregate employment.

If any employer is stupid enough to think that their business has been hit by the tax (over and above the latter “shift to road building” effect) and abandons their business, or contracts it, this will just leave unmet demand, which some other employer can profitably exploit.

Another bit of nonsense in the Reform publication is the following piece of false logic: 1, government spending must be cut to help deal with the deficit, 2, increased efficiency by government would reduce government spending, 3, therefore increased government efficiency would help deal with the deficit.

There is just one little problem here, as follows. Suppose efficiency throughout the public sector can be raised by X%. That means (given constant output from the public sector) that roughly X% of public sector employees are then unemployed! Shock horror: it’s precisely the “recession” or “unemployment” that we are trying to deal with here isn’t it?

But never mind, those spare employees can always be employed by the well known Keynsian cure for unemployment: increasing the deficit. Oh b*gger! That’s torn it. The whole object of the exercise is to REDUCE the deficit. Now we’re right up shit creek.

Tuesday, 9 March 2010

Considering Q.E. in isolation is pointless.

CentreForum have just published a paper (endorsed by the Financial Times) which claims that quantitative easing (QE) has been profitable for the wealthy with the less well off not benefiting as much as they should have. CentreForum’s solution is to continue with QE, with some rather bureaucractic procedures for ensuring the benefits flow to the less well off.

I suggest CentreForum are wrong, because considering QE in isolation is a bit like trying to forcast the weather just by looking at Sunspot activity, while ignoring other factors that influence the weather.

In particular QE is a reflationary measure and it would be odd if QE were implemented in the absence of other reflationary measures: in particular a budget deficit. Indeed in the UK in 2009 the entire budget deficit of around £200bn was QE’d.

And the effect of QE in isolation is completely different from QE plus deficit which in turn is completely different from deficit in isolation.

Deficit consists of 1, Treasury borrows £X, 2, Treasury gives £X of securities to those it has borrowed from, and 3, Treasury spends £X. Note that the latter sum of money will flow to a wide cross section of the population. That is because government spending flows to a wide cross section of the population: teachers, policemen, highway construction contractors, the unemployed and so on.

QE simply consists of reversing the above items “1” and “2”. Thus the net effect of QE plus deficit is “print money and spend it”. And this money flows, as noted above, to a wide section of the population. There is thus no need for the bureaucratic systems that CentreForum advocates.

That leaves an important question to answer: if, as suggested above, QE plus deficit causes extra government spending to flow to a wide section of the population, why did the wealthy do well from QE?

I cannot prove it, but possibly the reason is that the total amount of QE was more than was needed to prevent the crowding out that accompanies deficits. I’ll expand on that.

When government borrows and spends, this must to some extent drive up interest rates which in turn suppresses private sector borrowing and spending (a phenomenon called “crowding out”). This crowding out can obviously be countered by QE. But it is very hard to say in advance how much QE will be needed to do this (for a given amount of deficit) because it hard to say how much of a problem crowding out is.

But this “ignorance” doesn’t matter! The solution to the problem is simply to implement a deficit and then implement whatever amount of QE is needed to hold interest rates at zero or near zero. Indeed, central banks have been engaged in exactly this sort of operation for decades in that they control interest rates by buying or selling government debt (i.e. QE or "negative QE").

So the explanation for the profit made by the wealthy from QE could simply be that the total amount of QE was more than was needed to counter crowding out.

QE in isolation (or in excess of the amount needed to counter crowding out) is certainly ONE WAY of stimulating an economy. But it’s a daft way of doing it. It is taylor made to boost asset prices. I.e. it is taylor made to benefit Wall Street rather than Main Street. In contrast, a deficit plus just enough QE to make sure there is no crowding out makes a lot of sense.

Monday, 8 March 2010

Monetary base part of the national debt? You’ve got to be joking.

The monetary base is normally counted as part of the national debt. It is supposedly a liability of the central bank: indeed the monetary base appears on the liability side of central bank’s balance sheets.

But wait a moment. Those who hold monetary base have absolutely no right to be repaid their “debt” by the central bank. For example cash ($20 bills or £10 notes) are monetary base. But try going along to your friendly central bank with some of these notes or bills and demand that their “debt” to you is repaid. They’ll tell you to go away.

Not only that, but as a holder of national debt you don’t get to see any of the interest paid of this tranche of the national so called debt. For technical reasons that have to do with the complex way in which governments print money, interest IS PAID on this tranche of the national debt. But it’s paid by the Treasury to the central bank which in turn remits its profits back to the Treasury at the end of the year. YOU don’t get to see any of it.

And third, government has the right to confiscate any monetary base that you hold, and confiscate it at will. Governments do this via an amazing wheeze called “tax”.

To summarise, it’s a very strange sort of “debt” where,1, the “debtor” has the right to extinguish the debt at will, 2, the creditor gets no interest, and 3, there is no way the creditor can be repaid by the debtor.

To count the monetary base as part of the national debt is a bit saying chalk is a type of cheese.

Or as Willem Buiter put it, “These monetary base ‘liabilities’ of the central bank are not in any meaningful sense liabilities, because they are irredeemable."

But if you’re still convinced that monetary base is a debt owed by the central bank to hose holding this debt, I’m prepared to let you in on the deal of a lifetime.

You send me £X. By the way I have a perfect credit record and have ample net assets. I will then immediately undertake to be in “debt” to you to the tune of £2X: that’s an instant 100% profit for you. But there are just a couple of conditions. First you have no right to repayment. And second, I have the right to extinguish the debt at will (that's the whole £2X debt).

How can you lose?

Saturday, 6 March 2010

Bank reform means fewer jobs? Bunk!

This is a poor article by Rolfe Winkler of Reuters. It claims that bank regulation means less credit created by commercial banks which in turn means fewer jobs.

Of course OTHER THINGS BEING EQUAL less credit from commercial banks means fewer jobs. But other things don’t have to be equal; that is, to compensate for the reduced amount of money created by private banks, a central bank can easily create more “central bank money”, i.e. monetary base.

And if this additional monetary base is channelled into the pockets of Main Street rather than Wall Street, then genuine jobs would be created rather than the casino type jobs which is about all that Wall Street creates.

The points in the above two paragraphs are well set out by James Galbraith. As he points out, “Bankers don't like budget deficits because they compete with bank loans as a source of growth.”

The above process of replacing commercial bank created credit with central bank created credit can be taken to an extreme where the ONLY money is central bank created money. This is sometimes known as “hundred percent reserve banking”. Milton Freidman favoured this system. (See p. 247 here.)

The big advantage of it is thus. Commercial banks behave in a pro-cyclical manner. That is, they create more money just when it’s not needed: during a boom. And they destroy money just when they shouldn’t: in a recession. Hundred percent reserve banking would certainly not on its own mean an end to boom and bust, but it would help.


Thanks to Winterspeak for drawing attention to Rolfe Winkler’s article. And thanks to JKH for drawing attention to Galbraith’s article.

Thursday, 4 March 2010

Raise inflation so as to reduce real interest rates? Bonkers!

Greg Manikiw (G.W.Bush’s senior economic advisor) and the IMF have unfortunately decided in favour of targeting higher inflation so as to bring about the option of lower real interest rates. At least that’s the case according to “Beat the Press".

The first problem here is that given negative real interest rate people or firms could, at least in principle, borrow money so as to make investments which make a negative return on capital. I.e. such investments would actually DESTROY REAL WEALTH. Mad or what?

Second, the purpose of negative real interest rates is to encourage borrowing and spending, and this would doubtless work, i.e. raise aggregate demand. But demand can perfectly well be raised at zero interest rates by the means long advocated by modern monetary theorists. This is, to put it bluntly, a helicopter drop. Or to put it in more sophisticated and realistic terminology create more monetary base (and, incidentally, channel it into the pockets of MAIN STREET AND NOT WALL STREET.) That’s what Warren Mosler’s payroll tax holiday would do.

Afterthought. An hour after posting the above I noticed an article in the WSJ expressing similar sentiments. It’s by the president of the Deutsche Bundesbank and chairman of the governing board of the Swiss National Bank.

Wednesday, 3 March 2010

Economists overestimate the importance of their subject.

Recessions and failure by governments to adequately deal with them explain poor economic growth for a few years – perhaps up to five years. But the longer such poor economic growth goes on, the less likely it is that economic policies are to blame.

Reason is that in the long run, economic growth is determined by the pace of technological improvement OTHER THINGS BEING EQUAL. And a large number of factors fall into the “other things being equal” category. That is, I’m assuming, 1, constant population, 2, constant hours per week for those who are in work, 3. Constant levels of “rule of law” versus “corruption” etc etc.

For example Gillian Tett in considering Japan’s economic policies in the Financial Times says “The experience of Tokyo is salutary, not least because Japan has never truly returned to vibrant economic growth in the decade after its banking woes.

I suggest there is another explanation for Japan not “returning to vibrant economic growth”, as follows. Up to very roughly 1990 Japan had the relatively easy job of copying the technology of the US and Europe. Once a country is as technologically competent as other leading countries, it then has to invent and implement technology faster than its rivals: much more difficult.

There is no shortage of Japanese inventors: but the fact remains that inventing is more difficult than copying.

Tuesday, 2 March 2010

Is government debt an asset?

Definition: I’ll use the word bond to refer to government debt (Treasuries in the US and Gilts in the UK).

Advocates of modern monetary theory (MMT) tend to regard bonds (where the latter are held by the private sector) as an asset for the private sector. Indeed it’s not only MMT advocates that hold this view. But there is a problem with this view, as follows.

Bonds have value partially because the bond holder expects to have the original capital sum repaid, and second because of the interest earned. But someone somewhere pays the interest: I’ll assume it’s the taxpayer for the moment (but I’ll examine this assumption below). Thus the “asset” is matched by a liability. This liability is not evidenced in a piece of paper or a book keeping entry as is the case with bonds. But that’s irrelevant.

If someone damages my car, they are liable: they are indebted to me. If no book keeping entry is made to record the fact, that is equally irrelevant: it doesn’t stop the liability being a liability.

Who pays the interest?

It is sometimes assumed that the interest is part of the government deficit, which helps bolster the view that bonds are assets to which there is no corresponding liability. That is, the money with which to pay the interest somehow appears from thin air.

The problem with this view is nicely summed up by the phrase “opportunity cost” (this phrase is defined in any dictionary of economics, for those not acquainted with it). That is, even if the money does appear from thin air, such money could always have been spent on something other than interest, e.g. road repairs. Thus the interest is REAL COST for the community.

Quite apart from that, it just doesn’t make any sense to claim that the interest is part of the deficit, any more than it makes sense to claim that the Army’s pension scheme is financed by the deficit. Likewise it doesn’t make any sense to claim that the army is paid for by taxes on income, whereas the Navy is paid for by sales taxes.

Conclusion so far.

The main reason that bonds a long way from maturity maturity have value is the interest they earn. Counterbalancing this asset is a liability of an almost equal amount, namely the obligation on taxpayers to pay interest (or for those who insist on counting this interest as part of the deficit, there is the opportunity cost point).

In contrast, the main reason that bonds near maturity have value is the cash that is obtained on maturity.


The assumption that bonds are an asset for the private sector to which there is no corresponding private sector liability is not 100% right nor 100% wrong. This assumption just over simplifies the issue.

Monday, 1 March 2010

Reducing the national debt while maintaining the stimulus.

It is popularly believed that stimulus necessitates a rising national debt. Not true! Maintaining, or even increasing the stimulus at the same time as reducing the national debt is perfectly feasible. For a full explanation see here. That’s the new blog “Let’s cut the national debt AND expand the stimulus” – see top of right hand column ----->