This is the second part of my response to an article published by the German-language service Makroskop (March 20, 2018) – Modern Monetary Theory: Einwände eines wohlwollenden Zweiflers (Modern Monetary Theory – Questions from a Friendly Critic) – and written by Martin Höpner, who is a political scientist associated with the Max-Planck-Institut für Gesellschaftsforschung (Max Planck Institute for Social Research – MPIfG) in Cologne. In this part we discuss bond yields and bond issuance. I had originally planned a two-part series but the issues are detailed and to keep each post at a manageable length, I have opted to spread the response over three separate posts. In Part 3 (next week) we will discuss inflation and round up the evaluation of his input to the debate.
The previous parts in this series:
1. My response to a German critic of MMT – Part 1 (March 26, 2018).
Now to detail.
To ensure these blog posts do not become too long, I decided not to quote his original German.
So, when I quote Martin Höpner using quotation marks “”, I am providing my translation, and, given my German to English is not perfect, nuanced errors in translation and interpretation (usage) are possible.
I have in the last two days, though, had my translation checked with a fluent German speaker and writer to minimise possible errors.
Bond yields …
Martin Höpner’s second major issue, which he considers to be “the heart of the problem” is that he claims MMT adopts an “overly optimistic description of political freedom”.
What appears to be his problem is that while MMT is fine in his estimation – in theory – it has limited application in the real world because other (political, practical) issues intervene.
Remember that MMT does not intend to be a ‘theory of everything’ and certainly does not hold itself to provide deep insights into questions that political scientists might concern themselves with.
MMT is about the monetary system – how it works, what opportunities the currency-issuer has to advance well-being, what constraints there are to hinder that quest, and similar foci.
To make his case in this regard, Martin Höpner first explores the question of bond yields, which he rightly notes are under the control of the government should they choose to exercise that capacity.
As I have noted many times, the belief that a currency-issuing government can be put under siege by the private bond markets via bond auctions is false.
The central bank can always control yields on government debt at whatever maturity they choose by standing ready to purchase whatever volume is required to ensure the private bond market desires are subjugated.
If this is prohibited by current laws or regulations then the legislative capacity of the government can easily be amended if it was deemed to be a problem.
Even when the laws do not change, as in the Lisbon Treaty banning bail-outs of Eurozone Member States’ deficits, the ECB has easily found a workaround using its currency-issuing capacity to purchase massive volumes of government debt in secondary markets, and, in doing so, control yields at its will.
Please read my blog post – Operation twist – then and now – for more discussion on this point.
But Martin Höpner’s point is that while governments might be able to do this, political and other considerations would make it undesirable for them to act in this way.
In other words, there is a difference between what can be done “in principle” and what should be done in practice.
Ok! The world is complex.
The question is whether it is desirable for people to understand, initially, that governments do have this capacity or whether keeping them in the dark and believing in the misinformation put out by mainstream economists is preferred.
He uses an example of the pre-Eurozone Member States, when they still had their own currencies, and points out that there were “considerable differences between the government bond spreads”.
Yes, there were. And so?
He then asks:
Did the countries with high risk premiums fail to recognise their basic ability to minimise them?
First, he seems to ignore the fact that these countries were in the Bretton Woods system until 1971 (and beyond until it was officially scrapped when the Smithsonian Agreements failed on February 14, 1973).
After most of the rest of the world decided that floating exchange rates were more desirable as it freed monetary policy from having to defend the agreed parities, the EEC Member States persisted with various dysfunctional fixed exchange rate arrangements – the Snake in the Tunnel, the Snake, the EMS and then the ultimate ‘fixed exchange rate’ system – the common currency.
Each one of these arrangements proved to be unworkable in the sense of allowing the governments to unambiguously advance the well-being of their people.
Here is a graph of the 10-year government bond spreads against the German 10-year bund for France, the Netherlands, Italy (from 1991), and Spain (from 1980) for the period 1960 to January 2018.
There was obviously significant variability especially in the period following the breakdown of the Bretton Woods system and prior to the adoption of the common currency. The variability reentered the picture after the GFC and before the ECB went to work controlling the spreads in May 2012 and onward.
The obsession with fixed exchange rates among the European nations is in no small part due to their decision to introduce the Common Agricultural Policy in 1962.
This complex system of cross border price fixes would have been administratively impossible to manage without relative currency stability. As it was, the currency variations within the Bretton Woods system led the European Commission to introduce a complex system of so-called ‘green exchange rates’ or simply ‘green rates’, which sat underneath the official exchange rates.
These rates were designed to insulate farm prices from the fluctuations in the market exchange rate. They were set at the parities that ruled prior to the realignment of the French and German currencies in 1969, after major instability in World markets occurred and the Bretton Woods system was entering its death throes.
This approach added layers of complexity onto complexity – a typical European Commission action.
The ‘green rates’ were accompanied by the system of Monetary Compensatory Amounts (MCAs), which were introduced to fix competitive departures arising from fluctuations in exchange rate parities – which critics believed constituted a violation of the EEC principle that prohibited any duties being imposed on trade within the common market.
That didn’t stop them of course. Nothing much has changed. Rules are broken in Europe when convenient.
The point is that the spreads on EEC Member State bond yields pre-Eurozone were in no small part due to discretionary decisions taken by the respective central banks nations with external deficits in an attempt to attract capital inflow (mostly away from Germany).
The Bundesbank historically ran a tight monetary policy because of its obsession with low inflation and this forced its trading partners to endure higher unemployment than they desired or which were suitable given the state of domestic demand in their economies.
The weaker currency EEC nations – France, Italy, the United Kingdom (after 1971) – were forced to accept the restrictive Bundesbank monetary policy settings or else face major capital outflows.
But they were continually up against currency pressures to devalue (under the fixed arrangements and with the Bundesbank more or less refusing to intervene symmetrically), so at times they had to push rates up well above the German rates to head of impending currency crises.
The history of the EEC is littered with these episodes.
So it is hardly a demonstration of the practical aspects of MMT to draw attention to this period of European history.
Whether the nations knew their central banks could intervene in the same way the US Federal Reserve intervened during Operation Twist in February 1961 is beside the point. Of course the central bankers knew they could do the same if they wanted to.
But their policy imperative, given their governments had signed them up to an ‘unworkable’ fixed exchange rate system was to drive the spreads up to offset capital outflow.
The logic of their misconceived choice to tie their currency up in this way demanded they do that.
The consequences were obvious – a recession bias, elevated levels of unemployment, and ultimately, increased speculative attacks on their currencies necessitating period devaluations following a currency crisis.
None of that tension has really gone away under the common currency. It is just that ‘internal devaluation’ has replaced the discretionary realignments pre-euro and central bank can no longer control capital flows in the way they did when their governments were sovereign.
So I found this ‘criticism’ of MMT to be rather facile at best.
Martin Höpner’s own assessment is that the governments in question did “recognise their basic ability to minimise” the spreads but:
… the point was that there were, in fact, other constraints in the design of risk premiums, which are insufficiently captured by MMT due to its focus on the unlimited ability of the central banks to raise funds.
This is a non-criticism.
Remember, again, MMT is not a ‘theory of everything’!
MMT proponents fully recognise that governments may choose to deny their own capacities in search of other objectives – political, ideological or whatever.
That insight is repeated throughout our work – the role of voluntary constraints juxtaposed against the intrinsic characteristics of the monetary system.
Which raises an interesting point that Martin Höpner does not seem to appreciate.
Politics is intrinsically a part of the interaction between the citizens and the elected representatives. Where voting occurs to elect the government, ultimately the politicians have to introduce policies that resonate with the expressed desires of the voters.
Clearly, a dislocation can occur, which usually brings down the elected government at the next election.
History shows us that governments can become captured by sectional interests (the ‘few’), whose ambitions are incongruous with the advancement of the well-being of the ‘many’.
In that case, the political message is massaged strongly through framing and language, a topic I have written a lot about (for example, see recent Journal of Post Keynesian economics article written with Dr Louisa Connors).
That framing and language serves to obscure the intrinsic characteristics of the monetary system and thus restrict the awareness in the public debate for what policy options are available and the likely consequences of each alternative.
Please read my blog posts under the – Framing and Language category – for more discussion on this point.
The point is that by, initially focusing on and emphasising the intrinsic characteristics of the monetary system, and no other body of work does that, MMT strips way the veil of neo-liberal ideology that mainstream macroeconomists use to restrict government policies.
We learn that these constraints are purely voluntary and have no intrinsic status.
This allows us to understand that governments lie when they claim, for example, that they have run out of money and therefore are justified in cutting programs that advance the well-being of the general population.
By exposing the voluntary nature of these constraints, MMT pushes these austerity-type statements back into the ideological and political domain and rejects them as financial verities.
I am surprised that Martin Höpner, as a political scientist, seems oblivious to this veil of ideology and the purpose it serves.
MMT thus broadens the understanding of the policy possibilities for those who come into contact with it. It is a body of work that enhances our democracies.
By exposing these intrinsic characteristics and lifting the ideological veil that politicians hide behind, MMT becomes a broadening force in the public debate.
Sure, as Martin Höpner notes, governments have “other constraints in the design of risk premiums”, which may or may not prevent them politically from driving bond yields to zero.
But what are those constraints? An understanding of MMT quickly sorts out the financial considerations from the ideological.
People quickly realise that bond issuance does not fund government deficits, even if the accounting arrangements make it look as though it does.
People quickly realise that the central bank does not need stocks of government debt to manage their liquidity operations (reserve management) as part of their desire to target a specific short-term interest rate.
They can just pay an interest return on excess overnight reserves or take the Japanese route and allow overnight rates to fall to close to zero.
When a government tells the people that the bond markets determine bond yields and so they have to cut spending because the investors are losing confidence in the government’s ability to pay – which is a recurring theme in governments attempting to justify the unnecessary and damaging imposition of austerity – the depoliticisation strategy (blame the bond markets) – an understanding of MMT allows people to recognise this sort of justification as a non-justification.
We quickly recognise it as an ideological statement. A ruse to pursue policies that have no ‘financial’ basis in terms of capacity to pay or whatever.
It allows the population to appreciate that bond issuance is really about corporate welfare – providing a risk free asset upon which private financial assets can be priced (for risk) and which can be used as a safe haven when there is uncertainty in the private financial markets.
An understanding of MMT thus changes the questions that we ask of our politicians. It broadens the debate. It prevents politicians from invoking faux constraints to justify actions which are detrimental to the ‘many’.
That is an empowering thing.
Sure enough, governments might have reasons for preferring a positive spread on their relative bond yields. But those reasons would have to become transparent and the public would be better placed to evaluate the veracity and reasonableness of those justifications as a result of the work by the MMT proponents.
The other issue that Martin Höpner has in relation to the way MMT discusses government bonds is that we allegedly ignore other useful purposes that bond issuance may serve and which would require positive yields on the bonds.
He fully understands that the sale of government bonds do not have a ‘financing’ function.
But there are other useful functions, which we apparently ignore.
Martin Höpner writes that government bonds provide a means by which “citizens can place their savings”.
This point is clearly recognised by all the major MMT proponents. If you go back to our early contributions in the 1990s, you will see we discuss the way in which a government can encourage thrift by issuing a bond rather than leaving excess reserves in the system earning zero returns.
For example, please read the blog posts:
1. A simple business card economy (March 31, 2009).
2. Barnaby, better to walk before we run (February 9, 2010).
3. Some neighbours arrive (February 15, 2010).
Martin Höpner believes that this ‘function’ means that:
… surcharges have to compensate fairly for inflation and also for uncertainty about future inflation changes – for inflation risk. In addition, savers want to preserve the value of the money tied up in the financial asset not only with regard to domestic but also to foreign goods (travel, imported goods). Risk premiums must therefore not only charge inflation risk but also exchange rate risk.
And if the central banks ignored this and “continued to press down interest rates on government bonds” then the “bonds would lose their function as a fair offer to the domestic savers.”
Which is another non-criticism as far as I am concerned.
Think again about what I wrote above about framing and language and exposing the veil of ideology etc.
The same point applies here.
Obviously, longer term financial assets (public and private) will tend to generate yields that ‘price’ in the sort of risks that Martin Höpner is talking about here.
The further we go out along the yield curve – to longer maturities – the greater will be the uncertainty differential demanded by investors.
There is nothing revelatory about that!
But once citizens understand that the bonds they are buying are not required to fund government deficits then a debate opens up as to what function they might actually serve and whether those functions can be better served in other ways.
Again, an enhancement of democratic choices is made possible.
It is easy to demonstrate that government bonds are mostly serving a ‘corporate welfare’ function as noted above.
Please read my blog post – The bond vigilantes saddle up their Shetland ponies – apparently – for more discussion on this point.
See also – There is no need to issue public debt (September 3, 2015).
While I am supportive of workers being able to save (risk manage their futures) in a safe way, that doesn’t justify the massive corporate welfare that accompanies the issuance of public debt.
It is often argued that if superannuation and life insurance companies were unable to purchase government debt then they would struggle to match their long-dated liabilities with appropriate returning assets.
Further, the claim is that eliminating the government bonds market, retirement planning would become highly uncertain and risky.
What is not often understood is that government bonds are in fact government annuities.
Do the proponents of on-going government bonds really want the private sector to have access to government annuities rather than be directing real investment via privately-issued corporate debt, as an example?
This point is also applicable to claims that government bonds facilitate portfolio diversification. Why would we want to provide government annuities to private profit-seeking investors?
This is in the ‘privatise returns, socialise the losses’ terrain.
Further, if the justification for continued government bond issuance is to provide a method of retirement subsidy for workers, what are the relative benefits and costs of this choice against more direct methods involving more generous public health and welfare provision and pension support?
You see here that the questions we ask are very different once we understand MMT.
We break clear of the shackles that the ‘bonds fund deficits’ lie imposes on us and start questioning the status quo.
We would soon realise that there is a much more effective way to provide a risk-free savings vehicle for workers.
The government could create a National Savings Fund, fully guaranteed by the currency-issuing capacity of the government, which could provide competitive returns on savings lodged with the fund.
There would be no public debt issuance (and the associated corporate welfare and government debt management machinery) required.
The government could meet any nominal liabilities that would arise from this system at any time.
We discuss this sort of option in detail in our new book – Reclaiming the State: A Progressive Vision of Sovereignty for a Post-Neoliberal World (Pluto Books, 2017)
In Part 3 of this response we will discuss Martin Höpner’s concerns about inflation.
Reclaiming the State – Big Discount
Pluto Books has gone mad this Easter.
All their stock is being offered at a 50 per cent discount, which is better than the author’s discount I can get normally.
That means you can purchase our new book – Reclaiming the State: A Progressive Vision of Sovereignty for a Post-Neoliberal World – online, for half price (and the Paperback version comes with a free e-Book).
The offer ends on April 9, 2018.
That is enough for today!
(c) Copyright 2018 William Mitchell. All Rights Reserved.