Today I delve into the world of financial advice by E-mail. There are a growing number of subscription lists that people are exhorted to join to receive the latest in analysis from so-called experts. Most of it would qualify as spam. They seem to follow a formula – stir the emotions, offer great deals (which appear to be the motive – to make money), and spread dangerous half-truths and total fallacies. I get a lot of E-mails myself from readers asking me to comment on some of the claims that they have been reading in these “products”. So today I thought I would meet those requests by focusing on a particular newsletter that is broadly representative of the genre. My advice is to avoid wasting your time on these lists and read billy blog instead!
Several billy blog readers appear to subscribe to an “Austrian” take on macroeconomics provided by one John Mauldin who publishes a weekly E-mail newsletter with the somewhat pretentious title “Thoughts from the frontline”. He calls himself a “recognised financial expert” and talks a lot about inflation and debt default.
He claims in his latest newsletter that the “distribution list is 1.5 million closest friends” – which made we wonder how he has the time to be out on the front-line yet keep up so many close relationships. Okay, lets allow him the license – they are not close friends at all but people who without better advice nominate to receive his newsletter each week.
His latest newsletter begins:
But make no mistake, we are coming close to the end game. Some countries and economies are closer to that point than others, but the entire developed world is lurching, in almost drunken fashion, towards our economic denouement.
Hmm, the end game. Our dénouement.
In literature, the dénouement usually are the things that emerge after some dramatic climax and end the story.
Etymology: French dénouement, literally, untying, from Middle French desnouement, from desnouer to untie, from Old French desnoer, from des- de- + noer to tie, from Latin nodare, from nodus knot – more at node
1 : the final outcome of the main dramatic complication in a literary work
2 : the outcome of a complex sequence of events
Okay, so what is the economic climax of the drama? And what will the end of the story look like?
Once you read the newsletter you realise that it is its “own drama” – rather than being applicable to anything much else. You also realise that it is a hard sell marketing tool for making the author money.
To stir up the emotion he makes the following pronouncement of our impending economic dénouement:
Over the next several months, we are going to start to explore various aspects of the end game. Whither Japan? Are they actually, as I think, a bug in search of a windshield? What does that mean for the world? How safe is the euro? Everyone over here seems to think Germany will bail out Greece. A breakup seems unthinkable to the people I’ve been talking to (so far). But what about Spain? Italy? Can you spell moral hazard?
The Fed has said it will exit quantitative easing (QE) at the end of March. But what if mortgage rates rise? Where do we find $1 trillion (plus!!!) in US savings to fund the deficit, assuming foreigners buy about $400 billion? By definition, savings and foreign investment and the federal deficit must add up to zero. (We will go into that later – just take it as gospel for now.) How can we run 10% of GDP deficits if the Fed does not print money (as they did by buying Fannie and Freddie paper, which became treasuries, as I outlined last week)? That would require almost a 10% savings rate – with it all ending up in treasuries. How can that happen? Really?
From where I sit a financial expert should be someone who knows how the monetary system operates. From these paragraphs I glean that the writer doesn’t really understand the intrinsic nature of the currency systems he is commenting on.
First, Japan is currently beset with a real crisis no doubt but exactly which windshield are we talking about here? The government is sovereign in their own currency and have no foreign currency-denominated debt. There is no risk of insolvency.
Even extending insolvency to inflation – which is a popular ploy by those who detest the government’s use of debt – Japan is mired in deflation. They haven’t had any signs of inflation for 20 years and over that time have often faced a negative inflation rate.
The government bond yields are very low and stable and interest rates have been around zero for years. Budget deficits have typically been used to support the weak domestic spending. When neo-liberalism did force a fiscal contraction in the late 1990s, the economy double-dipped.
So what is exactly going to happen to Japan that is just around the corner – the end game? Please read the following blog – Japan – up against the neo-liberal machine – for more discussion on this point.
Second, the Euro is safe but individual countries within the EMU are not. As I have written in a number of blogs, the intrinsic problem facing the Euro system is not moral hazard. Rather it is the inability of the system to deal with asymmetric shocks in a reasonable manner given that member countries surrender all major policy tools to a non-elected body the European Central Bank. These are tools that a sovereign government (one that issues its own currency) can use readily to reduce the impact of real shocks (a demand collapse) on standards of living.
The requirements specified in the theory of optimal currency areas zones, which was used to justify the creation of the Euro zone, are not present in the existing EMU nations.
Spain and Italy are not particularly gaming the system. They are just victims of an absurd system that should be dissolved forthwith so that the citizens of the individual countries can get reasonable policy outcomes from their governments.
Third, what exactly is the connection between QE and mortgage rates? Quantitative easing may reduce long-maturity rates as it swaps long assets for bank reserves. It does nothing in itself to support aggregate demand (unless there is some rise in investment as long rates decline somewhat, which is unlikely). Please read my blog – Quantitative easing 101 – for more discussion on this point.
The added reserves do not provide the banks with any increased capacity to make loans. They are only constrained (in the main) at present by a dearth of credit-worthy customers.
The added reserves are also not inflationary – because they do not add to nominal aggregate demand. Please read my blog – The complacent students sit and listen to some of that – for more discussion on these last two points.
Further, the central bank sets the term structure of interest rates (by and large) because it exogenously sets the short-term rate. So unless there is something very odd going on (and there is no evidence that there is), mortgage rates will only rise significantly if the central banks decide to push rates up. Presumably that will be at a time that they consider the crisis is over and according to their (flawed) logic believe a return to more neutral monetary policy settings are required.
Where is the climax and dénouement going to come from there?
Fourth, the old faithful that the US is going to run out of money argument again! “Where do we find $1 trillion (plus!!!) in US savings to fund the deficit” – he doesn’t seem to understand that the funds that are borrowed from the non-government sector were provided by the net government spending (the deficits) in the first place – $-for-$ – as a “wash” – so what is the problem?
He also doesn’t seem to understand that there is not a finite pool of saving but a flow of saving that grows with income. So the deficit spending, inasmuch as they stimulate economic growth, are actually the source of finance for non-government savings. If the non-government sector desires to increase saving and withdraws spending in order to pursue that objective then aggregate demand falls.
With output and income in decline, total saving will also fall – the so-called Paradox of Thrift. Please read my blog – When ideology blinds us to the solution – for more discussion on this point.
It is also clear that anyone who understands the basics of national income accounting would not say something like this. Modern monetary theory (MMT) allows you to appreciate that if the non-government sector is spending less than they earn (a spending gap) then the government sector has to be running deficits equal to that gap for GDP (aggregate output and income) to remain stable at full capacity.
If the government does not support the desire to save by the private sector then the spending gap will be positive and GDP will fall as firms realise they are over-producing relative to effective demand. This leads to a spiralling down of output, income and employment, and, ultimately, a recession results.
The budget deficit rises as the economy recesses even if the government leaves its fiscal policy settings unchanged – this is the operation of the automatic stabilisers in force – tax revenue collapses and welfare payments rise.
There is a debate that can be had about the form of the fiscal intervention – but never about the principle that a rising non-government spending gap requires a rising government budget deficit if you don’t want income losses to occur.
Unfortunately, the dominant ideology seeks at every point to disconnect these ideas. That ideology is continually running smokescreens aiming to convince the uneducated masses that fiscal consolidation is a good thing at the same time they are paying their private debt down and saving more. In general, the two ambitions are contradictory and cannot work. But then the neo-liberals have never really been concerned about public purpose. The scam has always been to redistribute as much national income to the profit elites as possible.
Mauldin clearly doesn’t understand how the sectors interact. You can safely conclude that from his statement (repeated from above):
How can we run 10% of GDP deficits if the Fed does not print money (as they did by buying Fannie and Freddie paper, which became treasuries, as I outlined last week)? That would require almost a 10% savings rate – with it all ending up in treasuries. How can that happen? Really?”
First, the government spends in the same way whether it is running surpluses or deficits and independent of the other operations that might accompany the net spending position which appear to the uninformed to be “financing operations”. In all cases, a sovereign government credits bank accounts (or issues cheques) and thus expands bank reserves.
In the case of a budget surplus, the taxation revenue it raises more than drains those added bank reserves and the net position between the government and non-government sector is negative. The opposite is the case with a deficit where net spending is positive.
The taxation is not required to “finance” the spending position. It serves to add or subtract purchasing power from the non-government sector according to the logic of functional finance. Please read my blog – Functional finance and modern monetary theory – for more discussion on this point.
Second, the debt operations are also not required by a sovereign government other than to manage the bank reserves status to ensure the monetary policy of the central bank is coherent (again see Functional finance and modern monetary theory).
But to repeat, the funds that are injected into the non-government sector by the net spending are equivalent to the funds they borrow back given the voluntary constraints they place on themselves (as if they were still in a gold standard) such that they match the net spending $-for-$ with debt issuance. Totally voluntary. But as noted above, its a wash baby!
And if, for example, non-government didn’t want to purchase the government debt but chose to spend the funds elsewhere (say on consumption or private capital formation) then the deficit would fall anyway because at high levels of economic activity the automatic stabilisers push the budget balance towards surplus (and in some cases, into actual surplus).
A 10 per cent deficit/GDP ratio just tells you that at least that much income has been withdrawn from the expenditure stream by the non-government sector. I say that – at least – because even a 10 per cent deficit/GDP ratio might still be associated with a declining economy which means the deficit is too small.
Anyway, what you soon realise is that the newsletter uses a common ploy among these “terrorist” types – ask a lot of pointed questions – make it sound like the sky is falling in, but don’t go into too much detail. The tactic just turns all the emotional knobs that the author knows will exploit the ignorance (in these matters) of the readers. Work on the emotional rather than reasoned and informed plane.
It is a disgusting way of making a living.
Having warmed his readership up with the one-liners (the turning the knobs) and predicting the end, he then launches into his marketing ploy:
But before we get into that, a few housekeeping items … [the first point is some boasting about the size of his readership and how his E-mail list keeps stuffing up – maybe that is the dénouement – his readers get so annoyed with his failing IT systems that they leave and find a better life] … Second, the invitations are starting to go out for our annual Strategic Investment Conference (co-sponsored by my partners …) which will be April … In addition to .. [a host of very conservative speakers] … There are several more rather exciting announcements I will be making in a few weeks. This conference will sell out … This year we are going to focus on “The End Game.” I can guarantee you lively debate, fun times, and over-the-top wines – plus, you will be with people who are simply the coolest ever. The speakers are all friends who “get it.” They called the crisis well in advance. These are the guys who sit and think every day about how this will all end up. The panels are going to be fun. Do not procrastinate. Register now.
Just imagine – if armageddon or the apocalypse was approaching – a.k.a as “The End Game” – would you be planning to hang out with “the coolest people ever” and have “fun times” and listen to all his mates (friends) who “get it” and attending “fun panels”. In his own jargon-ridden manner – where does this guy get off?
Anyway, after that interlude it is back to the hot gospelling otherwise disguised as credible economic commentary and analysis.
Like a lot of commentators at present, he seizes on the recent book by Carmen M. Reinhart and Kenneth Rogoff entitled This Time is Different and calls it a “a very important book, which I will be referring to a lot in the future”. All the deficit terrorists are quoting from this book these days, although I wonder how many have actually read it in detail and understood its applicability.
Here is draft version of This Time is Different that you can read for free.
This is Mauldin’s claim about the book:
Reinhart and Rogoff have catalogued over 250 financial crises in 66 countries over 800 years and then analyzed them for differences and similarities. This is a VERY sobering book. It does not augur well for the developed world to blithely exit from our woes. The book gives evidence to my adamant statement that we have a lot of pain to experience because of the bad choices we have made. This is the entire developed world, and the emerging world will suffer, too, as we go through it. It is not a matter of pain or no pain. There is no way to avoid it. It is simply a matter of when and over how long a period.
In fact, Reinhart and Rogoff’s research suggests that the longer we try to put off the pain, the worse the total pain will be. We have simply overleveraged ourselves, and the deleveraging process is not fun, whether on a personal or a country basis.
Of critical importance, quite apart from the other issues that one might have with Reinhart and Rogoff’s analysis (and I have many), one has to appreciate what they are talking about. Most of the commentators do not spell out the definitions of a sovereign default used in the book. In this way they deliberately (or through ignorance – one or the other) blur the terminology and start claiming or leaving the reader to assume that the analysis applies to all governments everywhere.
It does not. On Page 2 of the draft, Reinhart and Rogoff say:
We begin by discussing sovereign default on external debt (i.e., a government default on its own external debt or private sector debts that were publicly guaranteed.)
How clear is that? They are talking about problems that national governments face when they borrow in a foreign currency. So when so-called experts like Mauldin claim that their analysis applies to the “entire developed world” you realise immediately that they are in deception mode or just don’t get it … full stop.
For a start, the US government has no foreign currency-denominated debt. Remember it has domestic debt owned by foreigners – but that is not remotely like debt that is issued in a foreign currency. Reinhart and Rogoff are only talking about debt that is issued in a foreign jurisdiction typically in that foreign nation’s currency.
Japan has no foreign currency-denominated debt. Many other advanced nations have no foreign currency-denominated debt.
It turns out that many developing nations do have such debt courtesy of the multilateral institutions like the IMF and the World Bank who have made it their job to load poor nations up with debt that is always poised to explode on them. Then they lend them some more.
But it is very clear that there is never a solvency issue on domestic debt whether it is held by foreigners or domestic investors.
Reinhart and Rogoff also pull out examples of sovereign defaults way back in history without any recognition that what happens in a modern monetary system with flexible exchange rates is not commensurate to previous monetary arrangements (gold standards, fixed exchange rates etc). Argentina in 2001 is also not a good example because they surrendered their currency sovereignty courtesy of the US exchange rate peg (currency board).
Further, Reinhart and Rogoff (on page 14 of the draft) qualify their analysis:
Table 1 flags which countries in our sample may be considered default virgins, at least in the narrow sense that they have never failed to meet their debt repayment or rescheduled. One conspicuous grouping of countries includes the high-income Anglophone nations, the United States, Canada, Australia, and New Zealand. (The mother country, England, defaulted in earlier eras as we shall see.) Also included are all of the Scandinavian countries, Norway, Sweden, Finland and Denmark. Also in Europe, there is Belgium. In Asia, there is Hong Kong, Malaysia, Singapore, Taiwan, Thailand and Korea. Admittedly, the latter two countries, especially, managed to avoid default only through massive International Monetary Fund loan packages during the last 1990s debt crisis and otherwise suffered much of the same trauma as a typical defaulting country.
Britain has defaulted only once in its history – during the 1930s – while it was on a gold standard. The Bank of England overseeing an economy ravaged by the Great Depression defaulted on gold payments in September, 1931. The circumstances of that default are not remotely relevant today. There is no gold standard, the sterling floats. Britain has never defaulted when its monetary system was based on a non-convertible currency.
A large number of defaults are associated with wars or insurrections where new regimes refuse to honour the debts of the previous rulers. These are hardly financial motives. Japan defaulted during WW2 by refusing to repay debts to its enemies – a wise move one would have thought and hardly counts as a financial default.
But if you consider the “virgin” list – how much of the World’s GDP does this group of nations represent? Answer: a huge proportion, especially if you include Japan and a host of other European nations that have not defaulted in modern times.
Further, how many nations with non-convertible currencies and flexible exchange rates have ever defaulted? Answer: hardly any and the defaults were either political or because they were given poor advice (for example Russia in 1998).
Reinhart and Rogoff don’t make this distinction – in fact a search of the draft text reveals no “hits” at all for the search string “fixed exchange rates” or “flexible exchange rates” or “convertible” or “non-convertible”, yet from a MMT perspective these are crucial differences in understanding the operations of and the constraints on the monetary system.
Further, if you consider the Latin American crises in the 1980s, as a modern example, you cannot help implicate the IMF and fixed exchange rates in that crisis. The IMF pushed Mexico and other nations to hold parities against the US dollar yet permit creditors to exit the country. For Mexican creditors this meant that interest returns skyrocketed (the interest rate rises were to protect the currency) and the poor Mexicans wore the damage.
It was clear during this crisis that the IMF and the US Federal Reserve were more interested in saving the first-world banks who were exposed than caring about the local citizens who were scorched by harsh austerity programs. Same old, same old.
It is also interesting to recall the recent comment made by former President of the Federal Reserve Bank of Dallas and former member of the Federal Open Market Committee, Bob McTeer who had such strident views that during his tenure the Dallas Fed was known at the “The Free-Enterprise Fed” (Source):
Yesterday, we saw a sharp market reaction when one of the rating agencies that gave AAA ratings to mortgage-backed securities larded with subprime loans called into question the credit worthiness of Britain. As is the case with the United States and the Federal Reserve, Britain and its Bank of England have the ability to create new money if necessary to pay off its debt at maturity. There is no sovereign credit risk. There is no need for credit rating agencies to opine on the credit worthiness of sovereign debt.
Enough said really. What the hell is Mauldin on about?
There was much more in this newsletter along the same lines. Always conflating concepts to the point of false analogy. For example, considering that household debt is equivalent to public debt. Failing to understand the difference between foreign currency-denominated debt and domestic currency debt.
MMT clearly argues that a sovereign government which enters debt arrangements in a foreign currency is compromising its sovereignty and risking insolvency. But Mauldin doesn’t make this distinction.
MMT clearly tells us that growth strategies that rely on ever-increasing levels of non-government debt (say when current account is in deficit and neo-liberal governments are running surpluses) are doomed to fail. In this sense the messages from Mauldin and co about the dangers of household and corporate leverage are partially correct.
But then they expose their ignorance by claiming that all debt is bad and governments have to delever as the private sector does the same.
They never tell you what they expect the outcome of that strategy would be. They never demonstrate an understanding that in a period such as now – what would happen if the government tries to withdraw the fiscal stimulus while at the same time the private sector continues to rebuild its balance sheet (run down debt) and the external sector remains in deficit.
While this would damage GDP growth significantly and risk a further crisis, the deficit would likely increase as the automatic stabilisers overwhelmed the discretionary contraction.
History tells us that over and over again and provide a much more convincing warning for policy makers than the highly selective and sometimes archaic examples proffered by Reinhart and Rogoff.
But for Mauldin, this sort of analysis would be too involved and his readers would have to think rather than emote.
Advice for the day: hang out here – on billy blog – where only the coolest people come to have fun and talk about amazing things …. The gang who hang out here “all get it”. eek! (-:
Quote for today
This was the opening paragraph in an article – How to Squander the Presidency in One Year:
There’s only one political party in the entire world that is so inept, cowardly and bungling that it could manage to simultaneously lick the boots of Wall Street bankers and then get blamed by the voters for being flaming revolutionary socialists.
The so-called progressive parties are the same all over these days.