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