It is interesting when a local journalist exploits the work of a foreign journalist to perpetuate neo-liberal myths about the way the modern monetary economy works without any critical scrutiny of the underlying ideas that he is mimicking. So we have one US journalist reiterating the views of a so-called “top US policy maker” without critical scrutiny then being copied a few days later by a senior Australian journalist who also doesn’t bother to question whether the underlying economics being fed to his readers makes any sense at all. Pretty poor really – the power of the conservative press!
I refer to an opinion piece in the Wall Street Journal – Don’t Monetize the Debt – which appeared on May 23 and essentially mouthed – in an uncritical manner – the opinions of the the President of the Dallas branch of the US Federal Reserve (one Richard Fisher) about the danger of public debt.
Three days later, today’s Sydney Morning Herald carries the following article – US needs to stop digging hole through to China by its International Editor Peter Hartcher. He also quotes Fisher in an uncritical way with the narrative between quotations appearing to be Hartcher’s opinion. But it is clear that he is just repeating the erroneous neo-liberal discourse offered by Fisher taken directly from the Wall Street Journal article.
When a country is under threat of invasion, it does what it must and it doesn’t count the cost. But when the danger has passed, the debt remains. If big enough, it soon emerges as a serious national problem. This is where the world is at the moment. The worst of the global financial crisis is behind us. Governments have announced enormous stimulus spending, and central banks have issued free money without restraint.
He then starts on the ratings agency line that Standard & Poor’s have “issued an alert that Britain’s rolled-gold AAA-credit rating was in jeopardy, for the first time since it began monitoring British public finances in 1978.”
He goes from that to this: “The question crystallising in a hundred million minds: have governments overdone it? Ireland and Spain have already lost their AAA-credit ratings. But Britain was the first of the world’s big economies to have its creditworthiness challenged in this crisis.” He then claims that the US government debt rating is also being questioned by the agencies.
To make us think this is a big deal he quotes some “financial market player” from London who says:
History shows that government failure to meet debt obligations is the rule, not the exception … Indeed, it is unusual for a country to have a track record longer than three generations for repaying bonds.
I don’t know anything about this “authority” on public finance, he is probably a junior wannabee in an investment fund. But what I do know is that this statement is totally inaccurate in historical terms and moreover misses a fundamental point – modern monetary economies do not have commodity currencies that are convertible into anything but themselves and exchange rates are largely flexible.
Hartcher clearly hasn’t grasped this essential shift in “history” and how it impacts on the operations of the monetary economy. He quotes Fisher (from the WSJ article) who he calls “a top US policy maker”. This is what Hartcher writes and note where the quotation marks are:
Fisher said that on a trip to China, he “wasn’t asked once” about the problem of mortgage-backed securities, the risky debt instruments that abetted America’s financial collapse. “But I was asked at every single meeting about our purchase of Treasurys”
Now this is the WSJ article and you see that Hartcher has cut the quotation marks a little short and wrongly claimed a bit as his own writing:
I wasn’t asked once about mortgage-backed securities. But I was asked at every single meeting about our purchase of Treasurys. That seemed to be the principal preoccupation of those that were invested with their surpluses mostly in the United States. That seems to be the issue people are most worried about.
That is a small issue though. The real point is found in his next question: “What is he talking about?” In response, Hartcher offers this:
Through history, kings desperate to pay for wars have debased their currencies to meet their debts. They added more lead and less gold to coins to make the gold stretch further. The modern equivalent is governments ordering central banks to print more money to finance government debt. Prudent modern governments avoid this.
Why? Because, as many kings discovered, you can win the war and still lose your kingdom. Debased money, money so free and easy that it loses real value, will eventually destroy a kingdom through inflation or financial crisis.
Yet, in responding to the financial crisis, the US Federal Reserve has done exactly this. And America’s biggest creditor, China, is worried.
The way in which he weaves commodity money (gold standard) logic (diluting the intrinsic value of the coins) from the times when the currency was convertible back into something of value – into statements about fiat currencies (modern money which has no instrinsic value and are non-convertible) is misleading and, dangerously so. I doubt Hartcher understands the error of logic that he is committing. If he does then his culpability is reprehensible.
Hartcher is saying that the rise in public debt is posing a greater credit risk than the huge toxic piles of private debt that are as yet unresolved (along with the CDOs that are derivative).
He then chooses to mimick Fisher’s neo-liberal claims that the US “Fed should stop financing the government deficit”.
In a related article by Bloomberg journalist Mark Gilbert – Dollar Is Dirt, Treasuries Are Toast, AAA Is Gone – we read that “The odds on the dollar, Treasury bonds and the U.S. government’s AAA grade all heading for the dumpster are shortening.”
The article suggests that the big public debt purchasers will stop buying government debt because of default fears. The insolvency scare tactic is now spreading among journalists who are being fed by unknown players in the financial markets. Hartcher is doing his bit to push the line in Australia. Soon we will read that the AAA Australian Government rating is under threat.
Well the way the system actually operates in real world land is as follows. The Government sells a bond to the non-government investor and debits the bank account you hold and credits some account within the government reflecting your bond holdings. Numbers just go into ledgers. You get a letter outlining the parameters of the bonds you just bought which includes the maturity date and the interest to be paid on the face value.
On maturity, some operator in the Government reverses these transactions – credits your bank account with the bond repayment plus interest and debits the account recording your bond holdings.
The national government can always do this.
Gilbert then wants us to worry about the size of the deficit – same old same old! He says:
Earlier this month, the U.S. reported the first budget deficit for April in 26 years, with spending exceeding revenue by $20.9 billion, even though that’s the month when taxpayers have to stump up to the Internal Revenue Service and the government’s coffers should be overflowing. So far this fiscal year, the U.S. shortfall is $802.3 billion, more than five times the $153.5 billion gap in the year-earlier period.
The same argument is being used in Australia. All we are seeing here is the automatic stabilisers trashing tax revenue and driving the budget increasingly in deficit as GDP declines. This process actually operates to attenuate the downturn – the deficit increases spending in the economy and helps to “finance” private saving. So the automatic stabilisers help to consolidate the private sector and prepare it for expansion.
Gilbert tries to tie the deficit back to the AAA rating argument. He quotes David Walker who is a rabid critic of any deficit spending in the US:
One could even argue that our government does not deserve a triple A credit rating based on our current financial condition, structural fiscal imbalances and political stalemate …
So we are back to the insolvency issue. The only way the US Government or the Australian Government would ever default on payments in their own currencies would be because they chose to for political reasons. There is no financial constraint on meeting all obligations in their own currencies irrespective of how large these obligations are. Even if the private markets “stop buying the debt” the government will still be able to spend. The debt afterall does not finance the net spending!
Gilbert then tries to moralise:
There’s also a compelling argument that no government should be enjoying the benefits of a top credit grade in the current financial climate.
There is no such compelling argument. Governments (as we read below) just ignore the ratings agencies. As I have written about in the past – Ratings agencies and higher interest rates – when Japan was downgraded several times by the ratings agencies they had a public debt to GDP ratio many multiples of the current US situation and were able to hold their short-term interest rates at around zero for more than 15 years. Their longer term public debt rates were usually wavering between 0.5 and 1.5 per cent during this period. They also ran huge daily budget deficits.
The ratings agencies are largely irrelevant to government. The ratings agencies can do and say what they like but a sovereign government will always be solvent in its own currency and the smart players know that. There is no comparison or analogy between sovereign debt and private debt. One is issued by the monopoly issuer of the currency and the other is issued by the user of the currency. Any analogy is false.
But let us also take a closer look at what Fisher actually said in the WSJ interview. He claims that the “longer-term debt, particularly the Treasurys, is making investors nervous.” The article continued that the challenge is “to reassure markets that the Fed is not going to be “the handmaiden” to fiscal profligacy. The journalist then quotes Fisher:
I think the trick here is to assist the functioning of the private markets without signaling in any way, shape or form that the Federal Reserve will be party to monetizing fiscal largess, deficits or the stimulus program.
So how can someone who is a so-called expert on the way the economy operates and offers commentary along those lines not realise that the concept of “monetisation” or as it is referred to in mainstream textbooks “seignourage” is not applicable to a world where there is a non convertible currency operating in a floating exchange rate regime?
The textbook conception of debt monetisation as it frequently enters discussions of monetary policy in economic text books and the broader public debate is summarised as follows. Debt monetisation is usually referred to as a process whereby the central bank buys government bonds directly from the treasury. In other words, the federal government borrows money from the central bank rather than the public. Debt monetisation is the process usually implied when a government is said to be printing money. Debt monetisation, all else equal, is said to increase the money supply and can lead to severe inflation.
That is the orthodox conception. However, fear of debt monetisation is unfounded, not only because the government doesn’t need money in order to spend but also because the central bank does not have the option to monetise any of the outstanding government debt or newly issued government debt.
As long as the central bank has a mandate to maintain a target short-term interest rate, the size of its purchases and sales of government debt are not discretionary. The central bank’s lack of control over the quantity of reserves underscores the impossibility of debt monetisation. The central bank is unable to monetise the government debt by purchasing government securities at will because to do so would cause the short-term target rate to fall to zero or to any support rate that it might have in place for excess reserves.
Governments spend (introduce net financial assets into the economy) by crediting bank accounts in addition to issuing cheques or tendering cash. Moreover, this spending is not revenue constrained. A currency-issuing government has no financial constraints on its spending, which is not the same thing as acknowledging self imposed (political) constraints.
Fisher also could have easily told the “senior officials of the Chinese government … [who “grilled” him] … about whether or not we are going to monetize the actions of our legislature … I must have been asked about that a hundred times in China” that: (a) bank lending is not reserve constrained; and (b) the causation runs from loans to deposits and reserves rather than from reserves to loans. A simple examination of the way the modern monetary system operates will tell you this.
Fisher then raised the other “budget scare” furphy about intergenerational fears. Hartcher also mimicks these fears in his insipid article. Fisher is “deeply worried” about:
the very deep hole [our political leaders] have dug in incurring unfunded liabilities of retirement and health-care obligations … we at the Dallas Fed believe total over $99 trillion.
I thought immediately that the US is wasting its good minds paying them to calculate this sort of stuff instead of unleashing them onto research into finding a cure for aids or cancer or other major issues.
There is no solvency issue about future pension and health care entitlements that the public sector currently recognises as being their future responsibility. If there is food, shelter and medical supplies on sale in the future then the government will be able to purchase them. It may be that the spending necessary to sustain adequate lifestyles pushes the economy up against the so-called inflation barrier and then fiscal measures will have to be taken to keep nominal demand in line with the real capacity of the economy to meet it. These will involve political choices but to repeat, they are not issues of solvency.
Interestingly, he makes the point that is now common knowledge that the ratings agencies “were paid by the people they rated. I saw that from the inside … [an] … inherent conflict of interest … I never paid attention to the rating agencies … What is clear is that rating agencies always change something after it is obvious to everyone else. That’s why we never relied on them.”
I say interestingly because Hartcher who plunders this article never mentions Fisher’s attitude to the ratings agencies while claiming they are about to close down the US government. Clearly not convenient to his story.
Fisher then commits the error of conflating history – conflating the period when we used commodity money (convertible currencies based on a gold standard) and fixed exchange rates with our modern monetary systems (flexible exchange rates and non-convertible tax-driven currencies). Fisher’s error is just taken on board by Hartcher who also demonstrates the same historical ignorance. This is what Fisher is quoted as saying in the WSJ article:
Throughout history … what the political class has done is they have turned to the central bank to print their way out of an unfunded liability. We can’t let that happen. That’s when you open the floodgates.
Refer back to the paragraphs about monetisation. In a modern monetary system this doesn’t represent the way the central bank and the currency operates. It is all based on the old commodity money (gold standard) logic which is no longer applicable.
The federal deficit in Australia and in the US does not need “financing”. The idea that the actions that accompany net spending increases are “financing” the spending are erroneous but exploited by neo-liberals to question the validity of any government involvement in the private market. These characters know that government involvement will change the playing rules and probably result in greater equity (more equal access to the spoils of the production process – that is, income).
Clearly, tipping the playing field a bit back towards the poor is anathema to the neo-liberals and so they need to debase the efforts by governments to do so. The easiest way to do it is to conflate household budgets with government budgets and to conflate gold standard logic with the logic that faces us in a modern monetary economy. This rhetoric is spectacularly successful as evidenced by the daily domination of the “debt debate” in our public affairs.
Anyway, tonight I play in my band and can forget all this stuff for a while!