There was an article in the UK Guardian (October 29, 2013) – Mainstream economics is in denial: the world has changed, which reported that the economics profession had been “stupidly cocky before the crash” and “had learned no lesson since”. It followed a – report – last week (October 25, 2013) that students at Manchester University had proposed an overhaul of orthodox teachings and economics. The latest Guardian article concludes that the economics profession is in “denial”, that is, “the high priests of economics refuse to recognise the world has changed”. I will come back to that in a moment, but evidence of this denial is swamping the debate about the upcoming Scottish decision on whether to break from Britain. So-called informed policy briefing papers have started to emerge, which will distort the choice available to the Scottish people by perpetuating basic myths about the way monetary systems operate and the choices particular currency arrangements provide government. As I’ve said before, if the medical profession offered the sort of analysis and professional opinion that my own profession offers, then they would be very few practising medics because they would have all been sent broke through malpractice lawsuits.
Before I head to Bonnie Scotland let me deal with the proposition that the “high priest of economic’s refuse to recognise the world has changed”. This, of-course, implies that before the change the mainstream economic theories were reliable basis on which to conduct analysis.
That is not correct. The mainstream macroeconomic approach was shown to be deeply flawed during the Great Depression by Keynes and others and has an improved since.
It is true that prior to 1971 advanced economies worked with a convertible, fixed exchange rate monetary system, which meant that currency-issuing government were financially constrained by dint of the need to manage the fixed parities through monetary policy interventions.
It is also true that after 1971, he same nations abandoned convertibility and operated with Fiat currencies, that is, the currency was empowered by legislative fiat such that the issuing government merely stated that all liabilities to the government (that is, tax etc) would only be resolvable using the currency in question.
After that point (noting that countries did not all immediately adopt the fiat currency, flexible exchange rate system after the Americans abandoned it in 1971 – that is, it took some time), none of the fiat currency-issuing governments faced any financial constraints on their spending.
Yes, they all introduced voluntary restrictions – accounting smokescreens – to make it look as though they had financial constraints. But in reality, at the intrinsic level of the monetary system, they do not have and can vary the legislative rules that they have in place almost whenever they choose.
While the Guardian article wants us to believe that the crisis is the turning point that my profession should recognise, the fundamental changes that most have missed occurred during the Great Depression and in 1971.
In other words, mainstream macroeconomics has never really been an accurate depiction of the way the capitalist monetary system operates and the global financial crisis is just another catastrophe along the way the many failures that the dominant paradigms has produced for us.
But I did love the anecdote from a US university classroom in 2009:
The world was apparently collapsing around them, and what better forum to discuss this in than a macroeconomics class. The response? “The students were curtly informed that it wasn’t on the syllabus, and there was nothing about it in the assigned textbook, and the instructor therefore did not wish to diverge from the set lesson plan. And he didn’t.”
That lesson plan would have been about the glorious advantages of the self-regulated market and how governments had no further macroeconomic roll to play because the business cycle was dead!
The Guardian article then asks – “How do elites remain in charge?”:
If the tale of the economists is any guide, by clearing out the opposition and then blocking their ears to reality. The result is the one we’re all paying for.
This is nothing new it starts on day one of an undergraduate economic’s programme, intensifies by fourth-year (the honours year in stride), dominates postgraduate studies, and mostly defines the appointments, promotion, publication, and research grant processes once the Ph.D. has been obtained.
The brainwashing is as intense as the arrogance of the positions held by the theoreticians. Some sneak through the system, somehow flourishing and reaching more coherent ways of understandings the world. But they are the exception to the rule.
I hope that, in time, Modern Monetary Theory (MMT) provides a basis for curious minds to conduct economic analysis and design policy interventions. But, at present, we are some way from that.
And now to Scotland.
I last wrote about the Scotland decision in this blog – Scotland should vote yes in 2014 but only if ….
The British National Institute of Economic and Social Research released a paper last month (September 17, 2013) – Scotland’s Currency Options. The paper was presented to an – International Conference on the Economics of Constitutional Change – in Edinburgh on September 19-20, 2013. You can find all the papers at the conference link.
All the papers I have read so far (most) reflect the denial that the Guardian article alludes to.
The NIESR paper is no exception. The Institute created a YouTube cartoon, which it thinks is neat. I wouldn’t waste my time watching it (I did and regret it).
Essentially, the paper considers:
… the three currency options for any independent Scotland: being part of a sterling currency union, adopting the euro, or having an independent currency. No currency option is the best when considered against all criteria, they find. Therefore, making the decision requires deciding which criteria are most important. The NIESR researchers puts their emphasis on fiscal solvency; whether a country can honour its debt obligations.
Which immediately alerts you to the fact that the paper is going to be grim reading. Only one of these currency options – having an independent currency – is necessary and sufficient for an independent Scotland.
Using a foreign currency, for example sterling or the euro creates a dependent Scotland and so the essential premise that the researchers begin with is flawed from the outset. It goes downhill from there.
They conclude that “no currency option is best when considered against all criteria”. They believe that the decision will have major ramifications for Scotland’s fiscal position.
We read that:
For an independent Scotland to prosper, it requires a ‘hard’ currency, one in which investors are willing to hold long-dated assets at a reasonable price. A necessary condition for a ‘hard’ currency is that government solvency must be beyond doubt. If this condition is met, then a long-term domestic debt market can develop which supports public finances and financial stability. If it is in doubt, then investors and citizens may choose to hold assets in another currency or simply no longer subscribe to government debt issues.
None of which is true. A truly independent Scotland, issuing its own currency doesn’t need any one to “hold it” other than the residents and others who are forced to pay taxes in that currency.
The link between the currency and other “long-dated assets” (that is, government debt) is erroneous. They make the link because they assume that the Scottish government should maintain the charade of issuing debt to feed the corporate welfare recipients as if, somehow, the Scottish government needs the private sector to give it its own currency before it can spend it.
Have you ever heard of such nonsense!
For a currency-issuing government the bond markets other subjugated ones. Please read my blog – Who is in charge? – for more discussion on this point.
The reality is that government debt-issuance supports the “long-term domestic debt market” not the other way around. That is one of the first myths that needs to be dispelled if the public is ever to understand what has been going on before their eyes for decades.
The NIESR paper then claims that:
Solvency is the ability to repay and service debts determined by the value of assets exceeding liabilities. The value of a nation’s assets is the marketable value of its physical assets and its expected future primary fiscal surpluses plus any seigniorage, while the value of liabilities is its current and likely future debts. Expectations play an important part in judging solvency. In the wake of the financial crisis, the debt burden of many countries has dramatically worsened, leading creditors to question the solvency of even advanced economies much more closely.
There is never a solvency issue for a currency-issuing government no matter how fancy you want to define the condition. Read: never. expectations of the private sector play no role in that condition.
A currency-issuing government can always meet its liabilities as long as they are in its own currency. Its central bank can continuously run with negative capital (in accounting terms) and what we think about the capacity of that type of government to pay up is irrelevant.
Note also the slippage in demarcation in the last sentence. Yes, the outstanding debt for many countries has increased, although it is not a burden for a currency-issuing government.
Using emotional terminology like “dramatically worsened” provides no informational content if we are considering a currency-issuing government.
But note the inexactness of the next statement about “even advanced economies”, which have apparently had their solvency scrutinised by leading creditors.
Which advanced economies are they referring to? And remember, this is in the context that the Scottish government could introduce its own currency and only issue liabilities within that currency.
Well it turns out, not that the NIESR authors care to specify this, that the only nations that have encountered any difficulty in terms of selling their government debt are those in the Eurozone, which do not issue their own currency.
The authors leave it to the reader (who may not have the capacity to differentiate here) to think of advanced nations in terms of the UK, the US, Japan, Australia and then infer somehow that the solvency of these nations has been in doubt and is also something that the bond markets determine.
It is highly likely that the authors do not even understand they are doing that. It is highly likely that it is not so much denial (as in the Guardian article) but just plain, bog ignorance brought on by years of brainwashing as a result of being part of the mainstream economics profession.
But no advanced nation, which issues its own currency, has had any problems issuing its debt in the last five years – and we know why. The bid-to-cover ratios have remained high because bond markets need the debt to feed their parasitic addiction to the corporate welfare that the debt provides.
Recall my example in Australia when the government was running surpluses and retiring debt. The financial markets demanded that the government issue a minimum amount of new debt even though in the mainstream logic there was no reason to. It blew their cover completely.
This loose reasoning is typical of the mainstream profession, which fails to understand the fiat monetary system.
The analysis presented also assumes that Scotland would “join the European Union at the earliest opportunity” and therefore be required to make a “commitment to join the euro, and that timing would be unspecified, but depend on meeting the Maastricht criteria”.
They then spend considerable time estimating that under these conditions, “Scotland would need to run primary surpluses of 3.1% annually order to achieve a Maastricht defined debt to GDP ratio of 60% after 10 years of independence”.
And then compared to its 2000-12 performance – an “average primary fiscal deficit of 2.3% (including taxes from oil and gas)”, the authors claim that this “would represent a fiscal tightening of 5.4%”.
We can conclude one thing from this – their Excel spreadsheet has the correct formulas! But not much else. Scotland would be mad to accept this future.
They do not have to join the Euro, nor join the EU if they choose not to and the conditions of membership mean they have to impose fiscal austerity which will damage the living standards of its people.
The fiscal position it would have to adopt depends on its external performance, the spending and saving decisions of its private domestic sector and the degree of real resource slack that it inherits.
Questions about its “per capita share of UK government debt and a geographic share of oil” that are central to the NIESR analysis are largely irrelevant if it issues its own currency.
First, as an independent nation it can renegotiate the prorated debt into its own currency. Second, the prosperity of the nation will hinge on the real resources it has access to – either within its borders or those it can import.
The government can motivate the maximisation of all real resources that are available for sale in the new currency. The nation as whole would, in the worst-case scenario, have to export to import foreign real resources.
We also read that:
If Scotland chose to issue its own currency … then it could, in theory, create an almost unlimited supply at virtually no cost.
Yes, that is true. So what is all the discussion about the need to pacify financial markets about?
They go on:
To assure citizens that it will not abuse this position and possibly cause inflation, states generally grant the central bank independence to deliver government targets.
No, that is not true. What is required is that the new Scottish government would have to assure its citizens that its fiscal policy aims were to achieve and sustain full employment and no more.
The arrangements regarding the central bank are irrelevant in that regard.
As long as the government spends within the real resource space provided by non-government overall saving (whether it be private domestic sector saving overall or external deficits) – relative to full capacity utilisation – then there is no fear of inflation – irrespective of whether it issues debt to the non-government sector or not.
The inflation risk comes with spending not the monetary arrangements that might accompany it.
You can appreciate how tortured this style of analysis is from the following reasoning:
In periods of financial distress when private agents want to hoard the safest asset, central banks supply of liquidity provides an important safety valve. In the fog of a crisis it is rarely straightforward to distinguish between illiquidity (a central bank responsibility) and insolvency (a fiscal issue). Central banks which provide liquidity can facilitate the transfer onto the fiscal accounts.
That is about as bad as it gets. What this means is that the currency-issuer can always provide the currency-issuer with as much “cash” as it likes to avoid both a banking meltdown and meet all spending ambitions.
Why not just say it – there is no liquidity or solvency risk facing a currency-issuing government (where the latter embraces the consolidated treasury and central bank)?
They later go on to recommend a pegged currency if the government issued its own currency. This is in the context of the fiscal austerity (they call it “fiscal rectitude”) they claim will be required.
The fiscal austerity is not required nor would pegging a currency allow the new nation to be independent. The Scottish government would be advised to float the currency and let it adjust accordingly so that its policy focus can be on maximising the potential of the domestic economy.
The authors fear “capital flight” – which would promote a depreciation in the exchange rate – but no real resources can fly anywhere other than airplanes and they have a habit of flying back again – full of tourists enjoying the increased competitiveness of the nation that would come with the lower exchange rate – enhancing the already beautiful countryside!
The following points are worth remembering.
A sovereign government in a fiat monetary system has specific capacities relating to the conduct of the sovereign currency. It is the only body that can issue this currency. It is a monopoly issuer, which means that the government can never be revenue-constrained in a technical sense (voluntary constraints ignored). This means exactly this – it can spend whenever it wants to and has no imperative to seeks funds to facilitate the spending.
This is in sharp contradistinction with a household (generalising to any non-government entity) which uses the currency of issue. Households have to fund every dollar they spend either by earning income, running down saving, and/or borrowing.
Clearly, a household cannot spend more than its revenue indefinitely because it would imply total asset liquidation then continuously increasing debt. A household cannot sustain permanently increasing debt. So the budget choices facing a household are limited and prevent permanent deficits.
These household dynamics and constraints can never apply intrinsically to a sovereign government in a fiat monetary system.
There is also a sharp distinction between a state within a federal system (which uses the federal currency and has no central banking capacity) and a truly sovereign national government.
A sovereign government does not need to save to spend – in fact, the concept of the currency issuer saving in the currency that it issues is nonsensical.
A sovereign government can sustain deficits indefinitely without destabilising itself or the economy and without establishing conditions which will ultimately undermine the aspiration to achieve public purpose.
Further, the sovereign government is the sole source of net financial assets (created by deficit spending) for the non-government sector. All transactions between agents in the non-government sector net to zero. For every asset created in the non-government sector there is a corresponding liability created $-for-$. No net wealth can be created. It is only through transactions between the government and the non-government sector create (destroy) net financial assets in the non-government sector.
This accounting reality means that if the non-government sector wants to net save overall in the currency of issue then the government has to be in deficit $-for-$. The accumulated wealth in the currency of issue is also the accounting record of the accumulated deficits $-for-$.
So when the government runs a surplus, the non-government sector has to be in deficit. There are distributional possibilities between the foreign and domestic components of the non-government sector but overall that sector’s outcome is the mirror image of the government balance.
If Scotland wants to be truly independent it has to have its own currency.
Then all the issues about what ratings the public debt would get from the bond markets and the rating agencies and all the rest of the nonsense would fade away into irrelevance.
Denial or ignorance – major changes are required within my profession before it starts to serve the people with sound advice that will advance their well-being.
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.