Nationalism, Governments and Currency.

The political left has always been suspicious of nationalism. Certainly it is easy to think of examples where nationalism has been taken to extremes with disastrous results. However we do, like it or not, all have to recognise we live in nation states. We might consider ourselves citizens of the world, or citizens of Europe or whatever, but that has to go along with being a citizen of a particular country too.

The traditional model is that we have a country, a government and a currency to go with it which is essentially an IOU of that government. So, for example, we have a country called Vietnam with its own government which issues a currency called the Dong. A neighbouring country, Cambodia, has its own separate government and uses the Riel. You might want to remember these names if you are into pub quizzes!

The people of Cambodia and Vietnam could, if they chose to, unite into a single country, have  a single government and a unified currency. That could make sense, but it would be entirely up to them to decide to do that. What would make much less sense is for them to try to share a currency without unifying their countries. The power of being able to control a currency is very considerable but not easily shareable. If we write our own IOUs as a settlement of a debt we want those IOUs to be unique. We don’t want anyone else writing them out on our behalf. So if Vietnam and Cambodia were to try sharing a currency it probably would not work at all well. There would soon be a dispute over how many IOUs each could create and the two countries would revert to separate currencies very quickly.

This is a similar pattern the world over. Canada has a different dollar from the USA. Australia has a different dollar from New Zealand and so on. There are seemingly some exceptions. Ecuador uses the US dollar. But it cannot create any US dollars of its own. Only the USA can do that, and as many as it likes to stimulate its own economy when needed. That puts Ecuador at a big disadvantage. I would recommend them to introduce their own currency! There is a similar situation in Puerto Rico which also uses the US dollar. But Puerto Rico is not considered part of the USA. If that were to change it would make much more sense for them to use the US dollar. Puerto Rico citizens would become American citizens and pay taxes to the US Federal Govt and receive the benefits of spending by the Federal Government. There would probably be more spending than taxation just as there is in other less affluent US States.  Then they would be truly sharing a currency and not just using someone else’s.

So one way we can define our own feelings of nationalism is by asking ourselves who we would like to share a currency, and a government, with. At present we, in the UK, share a currency, which we call the pound, between the countries of England, Scotland, Wales and Northern Ireland.  Other parts of the world, like Gibraltar and the Channel Islands use the pound but do not share the pound and so are not part of the United Kingdom. If Scotland were to become independent it could not share the pound, it could only use the pound. I am not sure if those Scottish nationalists who argue for a shared currency really appreciate the difference or the potential difficulty.

The big exception in the eurozone. We’ll look at that, and the problems it has, next.

Governments should spend more and tax less to reduce their deficits.

There’s no mistake in the title! To understand economics as it works at the macroeconomic level means we cannot just assume that what works for us as individuals or households also works for currency issuing governments like the UK, the USA and Australia. At first look,  it’s almost as if we have gone down the rabbit hole and we really are in a parallel universe. It is tempting to quote Lewis Carroll’s Queen in “Through the Looking Glass”:

“Why, sometimes I’ve believed as many as six impossible things before breakfast.”

But Alice was quite right in saying:

 “one can’t believe impossible things.” 

We just need to look at the problem from the right perspective to make sense of it all. Any currency issuing government, such as the USA, the UK, or Australia  need never have a Greek type debt problem providing it understands how its own economy works.

The government deficit can be expressed as:

Govt Deficit = Savings of Everyone Else = Private Domestic Savings + International Savings

or

Govt Deficit = Private Domestic Savings + BOP deficit(trade)

In other words, if everyone else in the world wants to save in US dollars, UK Pounds or  Australian dollars which they must if want to sell these countries more stuff than they buy from them, then the governments, or the Private Domestic Sectors in these countries, have to run a deficit.

If the Governments try to reduce their deficits by cutting spending and raising taxes then all they will do is force their economies into recession or even depression.

If they do really want to reduce their deficits, they would have to discourage everyone else saving. In the UK, that would include overseas trading partners who sell to the UK more than they buy from the UK and save the difference.

The way to do that would be to keep interest rates low and engineer some inflation, just a few % should be enough,  into the system – by increasing government spending and reducing taxation. So, perhaps counter intuitively, the way to reduce the government’s deficit in the longer term is for it to spend more and tax less in the shorter term.

Note: I’m not arguing that governments should make deficit reduction a primary object of economic policy. The government’s fiscal policy should always be aimed at steering a sensible middle course between having too much inflation on the one hand and too much unemployment and too many business failures on the other.

But, inevitably, there will always be those neoliberal types  who focus on the government’s deficit. They always seem bewildered that it doesn’t change in the way what they expect it to, and this article is an attempt to explain why.

 

A High Pound, a Healthy Economy, Low Deficits: Pick Any Two from Three!

We all might like to have: 1) A high pound 2) Close to full employment with a healthy growing economy 3) Low government and trade deficits or even surpluses. But, are all three even possible simultaneously? If we have to choose just two which one should we leave out? For most people, there is no simple answer but if we better understand the way our economy works we will at least know what the options are from all political perspectives. Including the second option, of a healthy economy, should be a “no-brainer” for politicians right across the political spectrum. Businesses need a buoyant economy to make profits just as workers need a buoyant economy to find decent and well paid jobs. But is it? The quest for a balanced government budget seems as distant a goal as ever, but the connection to that other largely forgotten deficit, in trade, is rarely made.

Previous generations understood, what we seem to have forgotten, that if any particular country, as a whole, has a net deficit trading position with the rest of the world then either the government of that country, or the inhabitants of that country, has to fund it by borrowing. In other words, the internal deficits run by governments, and the extent of the private sector debts which can accumulate in the economy, are directly related to the external deficits caused by a trade imbalance. We can see that countries such as Germany, Switzerland, Holland and Denmark which run large trading surpluses do not have any of the public or private sector debt problems* which we see in the UK or USA which run large trading deficits. Unfortunately, though, the solution to world debt problems cannot be for everyone to run a trading surplus!

If we do wish to ensure the third option, of low deficits, is included in our choice we need to understand that both government and trade deficits have to be kept low. Transferring the burden of debt, as seems to be the wish of George Osborne, necessary to sustain the current UK trading imbalance, from government to the private sector is going to do less than nothing to solve the economic problems of the country. If he wants to reduce his government’s deficit, without crashing the economy by imposing an unrealistic debt burden on everyone else, he has to acknowledge that this can only be done by reducing the trade deficit too. He has to start to tackle the problem from both ends by nudging down the value of the pound. Including the low deficit option means we have to then choose between having a high pound and a healthy economy.

We can see for ourselves what happens when a country like Greece is stuck with a currency which is too high to suit its economic capabilities and yet it is forced to attempt to balance its books. The economy crashes! Or, we can choose a high pound, a healthy economy and have a more relaxed attitude to the twin deficits. There are many economists who present a good case for selling as much debt (government gilts) as is possible and recycling the proceeds back into the economy with increased deficit spending. Some debt can also be sold to the central bank in what has come to be known as People’s Quantitative Easing. Providing inflation is kept under reasonable control there should be little or no problem.

We can also have a more relaxed attitude to the build up of private debt (if we know what we are doing!), but we should appreciate the difference. Government debt, unless it is in some foreign currency, doesn’t have to be repaid in the same way. The accumulation of too much private debt, though, can lead to economic busts to follow the initial boom created by the increase in bank lending. Tory chancellors starting with Tony Barber and later Nigel Lawson were fond of shifting the debt ‘burden’ from government to everyone else this way. We had the Barber boom, then the Lawson boom. The recession of the early 90’s should have been termed the Lawson bust. Later the supposedly more socialist Gordon Brown boasted of his economic prowess by delivering a government surplus around the turn of the millennium. Simply created by allowing too much private sector borrowing, unfortunately!

Most of this posting, so far, is entirely apolitical in nature. The same economic constraints apply whatever the political complexion of the society or economy involved. It is natural we might have different ideas and opinions over the ideal size of government. It is fair enough to argue for a more socialist approach to the distribution of available wealth and income or a more conservative approach. What is not fair enough, though, is for the political right or neoliberals (who are unfortunately not confined to the Tory Party) to wreck public services like our NHS, and our economy, for some nefarious purpose, or in some misguided attempt to reduce the government’s deficit, by cutting government spending and raising taxation without taking into account everything else that changes when they do that. All they’ll do is crash the economy – again! Judging by the economic storm that is brewing, the powers-that-be haven’t learned from past mistakes and it looks very likely we are seeing the start of yet another very severe financial crisis.

* A country with a large trading surplus is unlikely to have its Private Domestic Sector in overall net deficit. Although this is theoretically possible if Government insists on running an even larger surplus. But the net position can still hide localised high debt problems within the PDS.

Footnote: Some MMT supporters might argue that the tone of this article is more Keynesian than MMT. I accept that criticism but I originally wrote this with the promise from the editor of LabourList, Peter Edwards, that ‘sensible’ articles on economics would be accepted. He’s not explained why but he’s still managed to reject it! So I do accept that I attempted to temper the tone slightly!

Nevertheless I’m posting this up here as the start in a series of articles which are aimed at those who might be immediately turned off by a more strident MMT view  (such as the Govt can never run out of pounds etc) , but at the same time ensuring that the arguments are technically correct.

 

Positive Money : A Fallacy Built on a Little Known Truth. (Part 4)

The proponents of a theory called Positive Money often get their knickers in something of a twist over the ways the banks , as they see it, create money. As the well known economist Minsky said “Anyone can create money. The problem is getting it accepted”.

If I ( or a bank or anyone else)  issue a loan in $ ( or £ ) I’m creating assets for someone denominated in $. But I also have a liability in $ which I have to be able to guarantee by providing $ on demand. Or lose my credibility. So am I (or the bank or anyone else) really creating $ ? In a way yes.

If I (or a bank or anyone else) issue a loan in ounces of gold, I’m creating assets for someone denominated in ounces of gold. But I also have a liability in ounces of gold which I have to be able to guarantee by providing ounces of gold on demand. Or lose my credibility.So am I (or the bank or anyone else) really creating ounces of gold ? In a way yes.

But we wouldn’t have discovered the secret of alchemy any more than we’d discovered a way to create dollars in the way Positive Money suggest is possible!

Is the Chinese Economy a Giant Ponzi Scheme?

There has been quite of lot of justified concern among economics pundits about the Chinese economy with some, like Will Hutton,  likening the problems there to a Ponzi scheme. A Ponzi scheme operates rather like a chain letter where the  earlier entrants into a savings scheme are paid directly from the contributions of later entrants. It is a simple fraud.  It has to break down sooner or later. Whatever the shortcomings of Chinese economic regulation may be we don’t have the evidence to accuse the authorities there of allowing these schemes.

The China situation is better described as one of debt-deflation. Money is created  and then spent in the private sector when banks make loans. This spending stimulates the market: shares and asset prices prices rise, growth spurts, but the newly created money dwindles in the economy as it is spent and respent with the Govt taking its tax cut on every transaction. But the debts remain and accumulate – slowing down the economy. So more bank lending is needed to keep it going and the same thing happens again. Steve Keen has shown that everything looks OK providing the rate of bank lending is accelerating. But as it can’t do that forever, the effect of the bank lending starts to have a net negative effect and then we can have a slump if the level of private sector debt becomes too high.

The immediate fix is for government to  spend, large amounts of cash usually called liquidity, to keep the economy going. Mosler’s Law states that this should always be possible but any crash or   slump is still very disruptive.  A better solution in the longer term is to rely on monetary policy (ie the variation of interest rates and the ease of bank lending) only to a very limited extent in the regulation of the economy.

 

Corbyn’s Calling us Home

I don’t often re-blog. But I’ll make an exception for this!

Turning the Tide

‘Jeremy Corbyn might represent our views, but if we want Labour to return to power he isn’t the right man.’

This was the tweet that broke the camel’s back. After reading it I was faced with two options – either write an article on why it wound me up, or scream long and hard into a cushion – I opted for the former. So here goes.

The argument against the potential electoral success of Jeremy Corbyn as labour leader can often be summed up in three words, ‘Remember Michael Foot.’ So let us remember Foot.

After Michael Foot’s election as leader in November 1980, Labour enjoyed significant poll leads of between 9 and 15%. Understandably, the departure of Roy Jenkins et. al. in March 1981, knocked public confidence in the party, and poll leads dropped to a four or five point average – but labour kept a steady lead, under…

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“Look after the unemployment, and the budget will look after itself ” (Keynes 1933). Is he still right?

(This article was first published in Liberal Democratic Voice)

Keynes was undeniably a genius of his time, but he wasn’t infallible. We should not just assume that he was always correct. As with all prolific writers we can cherry-pick quotations to suit our own political purposes. If we want to argue for more government spending, we can use this:

“For the proposition that supply creates its own demand, I shall substitute the proposition that expenditure creates its own income.”

(Collected Writings of John Maynard Keynes, Volume XXIX, pp 80-81)

Keynes meant that the mere supply of a commodity is not enough to ensure the sale of that commodity, but money from all government spending inevitably ends up in someone’s pocket. This is a statement of the obvious, maybe, but he evidently felt it needed making anyway. On the other hand, if we are suspicious of what sounds like “magic money tree” economics, as many scathingly describe any deviation from their understanding of ‘sound money’, we can find this quotation:

“By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens.”

(Economic Consequences of the Peace, Chapter VI, pp. 235-236)

Rather than play these games we might look at how economics has progressed since his time and interpret his comments in the light of the now available evidence. This Huffington post article makes a good a case, in support of Keynes’s opinion, that a healthy economy will help minimise the government’s budget deficit.

One possible counter argument, from those of a more right wing disposition, would be that it is unclear which is cause and which is effect. Does a healthy economy with low levels of unemployment, and underemployment, naturally produce a small budget deficit or is it the other way around? If we force the budget to balance, by draconian measures, will unemployment fall too? A quick glance at the figures for Greece is enough to eliminate that possibility. It has a relatively modest budget deficit of 3.5% but an unemployment rate of over 25% with no tangible sign that any fall is imminent.

To give an answer to the question posed in the title, we can say “usually yes”, but we must acknowledge there are several, sometimes conflicting, factors involved. It is possible to conceive of a healthy economy with low levels of unemployment at the same time as the government’s budget deficit possibly being a little on what some may consider to be the high side.

To understand why, we need to look at the sectoral balances. To start with, imagine that everyone who issued or used the pound sterling as a currency was separated into either the government or the non-government sector. The assets of the non-government sector have to equal the liabilities, or debts, of the government sector. If money is paid as tax to government the assets of the non-government sector fall exactly as the government debts fall too. We can then divide up the non government sector into domestic and international. So in one year, and using the terminology of internal deficit for the Government’s deficit:

Internal Deficit = Savings of Domestic Sector + External Deficit.

For Keynes to be right on the question of unemployment and the internal deficit it should follow that everyone will save less when unemployment is low. This is a reasonable assumption but there could be exceptions. Everyone is more likely to borrow too, essentially the same as de-saving, when the economy is buoyant and there is confidence that money doesn’t have to be stored for those rainy days ahead. The effect on the external deficit is harder to predict. If the UK reflated its economy, when everyone else was in recession, we could well see that, even as unemployment fell, the external deficit, and so the internal deficit, could increase due to a local upturn sucking in more imports. Exporters could also switch their production to local markets. In that sense, and if we interpret “look after itself” to mean “fall”, Keynes could possibly be wrong! The important thing is that governments should understand these relatively simple relationships to make informed policy choices. The internal and external deficits may not be such a problem as we might be led to believe, if international investors see the UK as a safe place to park their surplus cash. The number one priority for any government, at least in peacetime, should be to ensure the health of the economy, both to offer jobs and business opportunities for all citizens and at the same time maintain the confidence of our external investors.

Ironically, if the UK lost that confidence, no-one would want to lend us any money. The pound would fall. Imports and exports would have to balance. We’d all end up somewhat poorer and we couldn’t then afford to save so much. The internal deficit would have to fall too and maybe even turn into a surplus. But, we have to ask ourselves: “Is this what we really want?”

Is a Happy New Year Possible for 2016?

In April 2014 I wrote:   Stand by for the next UK crash! ETA 2016

I didn’t use my crystal ball which has never proved very reliable, in any case, when it comes to forecasting football scores or racing results. The reasoning was based  on the rate of fall in the financial position of the UK private domestic sector. It was obvious, then, that serious private sector debt problems would start to arise in mid to late 2015 if government policies carried on as they were.

Two recent articles by Owen Jones in the Guardian and Nigel Morris in the Independent  bear this out. Government policies have indeed been carried on as they were.

There is a very real danger of an economic crash as Owen Jones argues although he doesn’t have quite the right explanation. It’s really not much to do with the need for increased industrial productivity. The productivity of  UK and European industry is higher than it has ever been. Yet the economic problems are worse than they have been since the 30’s. Clearly Owen Jones, much as we might admire his political stance,  is barking up the wrong tree.

Simply, if the UK wants to run a 5% of GDP deficit in its Current Account Balance of Payments, someone has to fund that by borrowing. Usually it is government which has assumed that role but increasingly the burden is being shifted onto the Private Domestic sector.

It may work in the short term but soon the private sector will be increasingly unable to raise the necessary loans especially if there is a fear of higher interest rates, and a general credit crunch in the economy. The words ‘credit crunch’ started to become a cliche of all 2008 financial commentary  just prior to the GFC. We are starting to hear them again on a more regular basis.

It’s not looking good!

PS/Edit

The graphical basis of my concern. A modified screen shot from Neil Wilson’s blog “3poken”.

We need to balance the Budget over the Business cycle as Keynes suggested, right?

(This article first appeared in Liberal Democrat Voice)

Firstly, we do need to ask if Keynes did suggest that. There are arguments either way on this point.  Keynes’ view unfolded and developed starting in the bleak 1920’s in Britain. There was no “roaring twenties” for the UK economy as the government deflated the economy to try to fit the Pound back on to its pre war Gold  Standard. Keynes then did argue that governments should run deficits if private spending declined and reduce those deficits when future growth was strong enough. This has been interpreted by many that his intent was that the budget was to be more or less balanced over the business cycle. If anyone is keen to research into his thinking they might like to start with his 1924 publication “A Tract on Monetary Reform”.

A better approach might be to try to understand why Keynes should made a break from tradition and start to advocate that budgets should at times be unbalanced. If we consider an economy which is neither a net exporter nor a net importer and in which everyone spends what they earn within the economy, Government spending and taxation must balance. This is true regardless of the level of taxation imposed (providing it is finite) and so regardless of the level of inflation within the economy. It has to, according to the principle of sectoral balances originally developed in the 60’s and 70’s by the late Prof Wynne Godley at Cambridge University.

If the participants of the economy don’t spend all they earn, ie when private spending declines,  we can have a tendency to recession. Keynesian economists would point out that prices and wages tend to be “sticky” and so don’t respond quickly to changing circumstances as more classically minded economists suggest they should. Therefore, Keynes was quite right to suggest that the Government should spend  more, or tax less,  to prevent recession from occurring. The government needs to borrow money from the savers and spend it on their behalf. Later, when the savers withdraw their money from the bank, or empty their piggy banks, and spend it, the Government needs to run a surplus in its budget to prevent the economy from overheating and inflation occurring. So the budget does indeed end up balanced over the cycle. It ends up being an approximately symmetrical pattern when expressed graphically.

This relatively simple model may have been adequate for the UK economy in the 1920s. However in recent times the extent of saving and desaving hasn’t been symmetrical over the business cycle. When times are good people may borrow and spend more but equally they may put more aside for their retirement. So if the spending/saving/borrowing pattern of the population isn’t symmetric over the business cycle, neither can we  expect the government to run a balanced budget over the business cycle. Instead of imports and exports balancing,  our economy has something like an annual  5% of GDP deficit in its current account. Our trading partners seem happy to supply more real things to us than we supply to them. They take our IOUs in the form of treasury bonds or gilts to make up the difference. In effect they are like a big net saver within the economy. As Keynes pointed out,  if people are saving more, and that includes our trading partners, the Government has to be spending more or taxing less.

The ‘balanced budget over the cycle’ is really just a special case which does not apply to our own 21st century economy. If we try to force the Government budget into balance, at the same time ignoring the trading position and the willingness or otherwise of the economy’s participants to net save then we are courting economic disaster. The budget will not balance, no matter how hard we try, and we will end up like a dog chasing its own tail as the economy spirals ever deeper into recession.

The Job Guarantee. Problems from a Left Perspective.

There’s no doubt that a JG program along the lines we might imagine it to be, and along the lines advocated by the leading names of MMT: Warren Mosler, Bill Mitchell and  others would be highly desirable.

We could have an economy run to ensure almost full employment except for a  JG rate of about 2%. Then maybe there would be another 2% who were in receipt of unemployment pay due to their being temporarily between jobs. We could allow a reasonable period of time for that to occur -say about 3 months. The JG could have a part to play in young people’s apprenticeship schemes too. There could be some relaxation in the principle of “public purpose” if job training was combined with education. The JG could pay a living wage meaning that the wage was more than just enough to stay alive but it was enough to enjoy life too.

The problem, for me, and I suspect others on the left, is that we fear it won’t turn out quite like that. There’s no guarantee, or even likelihood,  that the JG will end poverty. It would depend on the wage the JG pays relative to the cost of living in the locality. If you’re living in London and depending on the rental property market you’d need an income much higher than anything I’ve seen proposed for the JG to be above any reasonable definition of the poverty line.

Incidentally, this posting was prompted by a discussion between Neil Wilson and others (including myself) on his very good blog:

http://www.3spoken.co.uk/2015/11/job-guarantee-jobs-for-people.html

“Very good” doesn’t mean we always agree, BTW,  as this exchange shows.

PM: “We don’t want to get into the situation, for example, where we’re threatening young mothers with loss of benefits for not taking up the JG or getting into disputes with the mentally ill as to their capability for work.”

NW: “I’m afraid that isn’t your choice. That is the choice of the society you live in and how they perceive those individuals”.

Which is a fair enough comment of course, but if it looks, from a left perspective that there are too many devils-in-the-JG-detail for comfort why would the left want to aggressively pursue the concept of a JG? Why not just leave it ” to the society (we) live in ” to come around to the idea ? That’s not likely to happen for a very long time, though. Either the JG is pushed by the left or it just won’t happen at all. Another problem, again at least for me, is the language used to promote the idea of a JG and it being a “buffer stock”. We are real people. Yes we want to work and make a contribution but we don’t want to be a “buffer stock” in the same way as we can have a buffer stock of bales of wool or kilos of butter.

While MMT and concepts like the JG are useful they only go so far. MMT doesn’t say anything about how wealth and incomes should be shared out. If we don’t address that question, and keep on addressing it then we’ll end up with just as much poverty in the future even though society as a whole could well be richer.

There could well be very much higher rates of JG work as the not-so-innocent fraudsters in Government deliberately shift essential work into the JG sector. The JG would be a very powerful weapon and used in the hands of the fraudsters to reduce wages. We could, for example, have a JG now in parts of the EU which paid say €7 ph or whatever was just slightly higher than social benefits. So in Greece we’d have 25% on a JG instead of 25% unemployed.

There’s no way any of us with a leftist perspective would support that. If anyone is contributing to society by working, the old principle of Labour’s Clause 4 applies: “To secure for the workers by hand or by brain the full fruits of their industry and the most equitable distribution thereof that may be possible etc..”

Having a JG, even on a so-called living wage, doesn’t change that one bit!