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.

 

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”.

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!

Is Government Spending Already by PQE?

We can think that all spending by government is already by the creation of new money, which is the general understanding of PQE (otherwise known as  Overt Monetary Financing of Government), using the concept that money is an IOU of a sovereign currency issuing government.

So, just as you or I have no use for our own IOUs, we tear them up when we get them back, neither has government. All money collected  in the form of taxation or in bond sales is simply shredded. Destroyed -either physically or digitally. When govt spends, it does so by issuing new IOUs. ie Issuing new money.

So what is the point of taxation? It’s to prevent high inflation as has already been mentioned in previous posts.

And the point of selling gilts (bonds)? It is to set longer term interest rates. Generally speaking: The more that are sold by auction, the lower their price, and the higher their yield. The higher their yield the higher are longer term interest rates.

If Government wants lower interest rates in the longer term it should sell fewer gilts, yet still create as many new IOUs, as many new ££, as it needs for spending purposes. Its spending decisions have to be such that they won’t produce too much inflation, of course,  which would require the raising of taxes. The balance between spending and taxation remains the subject of political debate as always.

A better idea might be to stop selling gilts completely and allow savers, ie the hitherto bond purchasers, to put their money on account with the BoE ( which is best considered as part of Treasury) and set the interest rate payable just as a high street bank would set the interest to us on our longer term savings. Short term interest rates are already set this way so the concept, and practice, just needs to be extended to include all savings. The interest rate would probably be higher for a longer deposit period, again as we might expect from our own bank.

And what about the exchange rate?

If the government offers lower interest rates the £ might be expected to fall, and higher rates will probably cause it to rise. If we stay with the idea of selling gilts, and stick with the concept that PQE  is somehow different,  we can say there will be less need for the government to ‘borrow’  and therefore less need to pay out interest.

This will have the same effect on the exchange rate as directly reducing interest rates.  It is just looking at the process from a different perspective.

PQE, as is conventionally understood, could be part of the government’s exchange rate strategy. That is if it wants one, and that could be the subject of another discussion! If it wants a lower pound, it does more PQE. A higher £ means less PQE. It depends on what sort of trade deficit we want to run. If we are happy to run a high deficit, and there is no reason why we shouldn’t, we can keep the pound high, but if we want to reduce it we will need a lower £.

German euros and Greek euros. Are they really the same?

Just like the US dollar, the euro is a single currency which is shared by 19 countries of the European Union.

That’s the official fiction. If the powers-that-be in the EU had really wanted it that way they could have had it that way. They would have needed only one central bank. There would have been one design for each of the various banknotes and one design for each type of coin.

Instead there are multiple country based designs for both notes and coins.  Notes carry a serial number including a country code. There is one national central bank (NCB) per country plus we have the European Central Bank (ECB) .  Whereas most currencies can be considered to be a two layer structure, the euro has a three layer structure. It can be best understood as a collection of tightly pegged but slightly different euros. The Bank of Greece (their central bank) can still print and create euros which they normally do with the approval of the ECB. That approval has been recently withdrawn. So what happens if they create euros without the ECB’s approval? The ECB can only refuse to guarantee them on a par with other euros so instantly the Greek euro would float.

All Greek banks whether domestically owned, or foreign owned, rely on the BoG for their liquidity. So the closure of the Greek banks, including all foreign owned ones, has nothing to do with their financial viability, but everything to do with the inability of the BoG to provide the euros they need to function.

If the euro were a truly single currency the ECB would not be able to isolate Greek banks and their account holders in the way they have. The banks could open tomorrow if the BoG started to create euros again. And indeed they should, preferably with the support of the ECB. The ECB has a duty to all Greek euro holders just as the US Fed has an obligation to all holders of US$. It would be inconceivable that any political dispute between the Federal government and , say , the city of Chicago would result in the residents of that city being denied full access to their bank accounts.

If the BoG issued euros without ECB approval then we’d have a new currency. The Greek euro. Just what would be the status of all previously issued euros, both digitally and physically created would depend on the willingness of the ECB to guarantee them. It would be legally messy but it is a quick solution to get that new currency.

In the EZ, bank depositors, except of course in Greece at the time of writing,  can costlessly shift euro deposits from one bank to another anywhere in the zone. Any depositor of an Irish bank, say,  can move their money to a German bank. This requires the Central Bank of Ireland  to obtain reserves that get credited to the Bundesbank, the central bank of Germany. If deposits tend to flow from the poorer nations,  to Germany in particular, their central banks go ever more deeply into debt to the ECB to obtain reserves that accumulate in the account of the Bundesbank.

As recent events in Greece show, it makes no sense at all for anyone to hold any amount of money in the peripheral banks. The sensible thing is to shift it to a German bank for safe keeping. This is not doing the Germans any favours. It is simply the best way of forcing those most in favour of the euro to accept full liability for euros held by all Europeans. So logically nearly all  euros should end up being German euros anyway!

Is this yet another fundamental flaw in the architecture of the eurozone? The ECB has to guarantee the liabilities of the peripheral NCBs to hold the system together but what if  any country defaults? They will be rid of their National debt at a stroke and can then start afresh with a new currency. The ECB ends up with the bill, which means the rest of the eurozone. Ultimately if everyone else defaults it is Germany, or the last country left in the system, which has to pick up the tab for everyone else.

The Germans should be extremely worried at the prospect of Greece defaulting to be followed by whoever may be next, then whoever is next after that. At the first sign of any repetition of the Greek experience,  savers in the less safe regions of the EZ will, if they are sensible, shift the bulk of their savings out of their local bank and into German euros. They should make plans for doing that now, while there is still  time.

Muddled Thinking Watch #7: Chuka Umunna on Labour’s pre-GFC Deficit

Chuka makes some valid points in his recent Guradian article:

http://www.theguardian.com/commentisfree/2015/may/09/labours-first-step-to-regaining-power-is-to-recognise-the-mistakes-we-made

For example he acknowledges that:

” First, we spoke to our core voters but not to aspirational, middle-class ones. We talked about the bottom and top of society, about the minimum wage and zero-hour contracts, about mansions and non-doms. But we had too little to say to the majority of people in the middle.”

Partially right. “The majority of people” are in the middle. So, in a democracy, to win elections, you have to not only speak to, but also win support from,  “the majority of people”. There’s no getting away from that.

Whether Labour spoke to its core voters is a matter of opinion. I’d argue they may have spoken to them, but they didn’t listen, which is slightly different.

He also makes some invalid points. He says:

“Of course, the last Labour government should not have been running (an albeit small and historically unremarkable) deficit before the financial crash. “

The last Labour government certainly made more than a few mistakes. George Brown famously  made the ludicrous claim that he’d abolished “boom and bust”.  The period  of the Labour government  (13 years) consisted of mainly years of boom, which enabled it to achieve electoral success,  except the last 2 years were years of bust, or trying to recover from the 2008 bust, which brought about its downfall.

But did they make a mistake about the government’s deficit? The boom was caused by too much credit being created by the private sector. I don’t believe there is any dispute on that point. That credit inflated asset prices, firstly shares in the dotcom boom and then property prices in the years up to 2008.  With the benefit of hindsight what should they have done to prevent that credit bubble? They, or their so-called “independent” Bank of England,  should have increased interest rates.  If there’s too little saving and too much borrowing then interest rates should rise. Is there any dispute on that point? That would have stopped the credit bubble. No problem.

But if they’d done that there would have been a problem of the £ appreciating in value. Exports would have become uncompetitive. That, and the reduction in domestic borrowing, and therefore, spending, would have led to less economic activity. Business failures and unemployment would have risen.

So what else would the Labour Government have had to do to compensate? Run a tighter fiscal policy, with a lower deficit, or a looser fiscal policy with a higher deficit?

If you think you know the answer, please email it, with an extremely simple to understand explanation,  to:

chuka4streatham {at} gmail(.)com

PS  I’ll ask Chuka if he can provide a small cash prize for the best answer. 🙂

Why not give control of the fiscal deficit to the Bank of England?

In a democratic society, I would argue that decisions regarding interest rates, both long and short term, should be made by the elected government. They used to be. However, for nearly 20 years, short term rates in the UK have been set by the BoE. The level of short term interest rates is important and it can be adjusted to stimulate a slowing economy or slow an overstimulated economy. But there are other adjustments that can be made too.

Just as a pilot has all the control levers at his disposal when he’s flying a plane (if he, or she, does hand over to the co-pilot it would be all the controls not just one) then all the controls need to be either in the hands of government or the hands of the central bank.

But just who has the controls when it comes to controversial policy decisions like QE? Does an  independent Bank of England decide, all on its own, to buy up £375 billion of government securities from the private financial sector? I don’t think so!

QE is no big deal. That’s not a common view, I’ll agree, but from a scientific perspective, there seems to be no reason why the issue of government , or the BoE if you prefer, IOUs in the form of cash should be any more or less inflationary to the economic system than the issue of IOUs in the form of gilts (treasury bonds). If it is necessary to buy back gilts from the private sector to control longer term interest rates then that’s what needs to happen.

So why not give control of the fiscal deficit to the BoE too? The BoE could calculate the best combination of fiscal and monetary policy, including whatever level of QE is needed, and tell the government what it needs to do. Arguably the government could decide to raise income tax a bit here or reduce VAT a bit there , etc, but it would not have complete control of fiscal policy as it now does.

This is not my favoured option BTW. But, if the pilot is going to hand over the (macroeconomic) controls to his or her co-pilot it should be all the controls and not just one.

Never mind the deficit just vote for the recovery!

It’s difficult to know who to back in next month’s UK elections. Europe is a major issue which the most normally sensible parties, or at least the parties who the public normally consider to be the more sensible,  have largely chosen to ignore  in the run up. The events in the eurozone are highly significant, in particular the Greek crisis,  yet those in the most pro-EU parties don’t want to talk about them at all.

There’s next to nothing about it on Labour’s main website, Labourlist, for example.

Funny that!  Those who believe in a united Europe, as many of our more ardent EU advocates clearly do, should feel as strongly about unemployed young people in Spain or poverty in Greece as about hardship in the UK.  Yet, if they ever remember to make a critical comment, it is not because they wish to change anything. The just expired Parliament has seen a complete absence of Labour opposition to any new laws or powers for the EU.

If the UK today had 50% youth unemployment as the south of Euroland currently suffers, Labour would never let us all hear the end of it – and rightly so. If the UK had Greek levels of unemployment, and a Greek cost of living crisis which has depressed average real incomes by almost a quarter since 2007, again we would not hear the end of it, as Labour would rightly think it completely unacceptable. So why is it that these people who believe in pan European solidarity have nothing to say about the scandal of poverty and joblessness in large chunks of Euroland? Why are they not insisting on new policies for the EU?

The situation is far from ideal but it’s probably best to vote for the party who you feel will produce the best recovery. The recovery, when it happens, will fix all deficit problems. Firstly a healthy economy will mean increased taxation revenue. Secondly, if the economy is healthy no-one is going to worry about debts and deficit anyway. The US$ is surging at present as investors buy up $ securities. Are they worried about a $17 trillion (or is it $18 trillion by now?) debt?

I don’t think so. There are those in the USA who can’t make head nor tail of it all and are pushing for a balanced budget. I can’t see them getting anywhere but heaven help us all if they do!