Today started off as a usual Sunday – a long-ride on my bike interrupted by two punctures (why do they come in waves). Anyway, then some other things like a visit to the community garden where I have a plot. Then it was down to work and as I read news stories and academic articles I was continually confronted with the tide of hysteria surrounding the impending sovereign defaults (as we are led to believe). My principle conclusion was that these journalists etc have a pretty good job. They get paid for knowing nothing about the topics they purport to be experts about and instead just make stuff up and intersperse it with some mainstream economic ideology taken straight from Mankiw’s macroeconomic textbook. It would be an easy way to make a living. Get the text book out … turn to the chapter on debt this week (last week inflation) and start of with some “large” numbers which are “without precedent” and you are done. Easy pie! Problem is that it influences the readers who do not know these commentators are charlatans.
Off to Portugal and Spain first …
The Associated Press (no link because the news feed is a dynamic site and will disappear) reported on Friday that:
Portuguese opposition parties defeated a government austerity plan on Friday and passed their own bill that lets the country’s autonomous regions rack up even more debt. The move raised new questions about European countries’ ability to control their swollen budget deficits
And note that the opposition was opposing a minority Socialist government and the country is also now starting to experience social unrest with a major street protest on Friday afternoon by workers opposing pay freezes.
A Government Minister was reported as saying:
For (a government) to have credibility in its management of spending, for it to inspire confidence in the country and in international markets, we need to be in charge of budgeting.
The problem is that irrespective of what the opposition did on Friday the Portuguese is not “in charge of budgeting” unless you consider being enslaved by the Maastricht 3 per cent rule and without an independent currency-issuing capacity to be in charge. I don’t consider them to be in charge. They are bound by the common currency rules and a system that allows no fiscal redistribution within the federation.
One commentator described the Portuguese outcome as Bad news in Portugal but then revealed the context – “(t)his can’t be good news for investors already worried about a debt crisis in Europe.”
Paul Krugman waded into this issue (February 5, 2010) in his column – The Spanish Tragedy saying:
As Europe is roiled by sovereign debt fears, it’s important to realize that the crisis in … (Portugal, Ireland, Italy, Greece, Spain) has nothing to do with fiscal irresponsibility. On the eve of the crisis, Spain was running a budget surplus; its debts … were low relative to GDP … If Spain had its own currency, this would be a good time to devalue; but it doesn’t.
So that sounds reasonable … or does it? If Spain had currency sovereignty it would also float it. Devaluation is a term used by economists to refer to a discretionary realignment of parities in a fixed exchange rate system. But under true sovereignty which Spain should have never surrendered, its currency would have been depreciating over the period of the crisis to allow for adjustments between its unit labour costs and those of the nations its trades with.
And while that was happening, the Spanish government would be using its currency sovereignty to keep unemployment down rather than letting it rise above 18 per cent and then face the prospect of it going higher because the mandarins (bullies) in Frankfurt and Brussels want the government to stick to some stupid rules dreamed up by neo-liberals who ultimately think unemployment is a voluntary choice for leisure by individuals (that is, they don’t want to work!).
But Krugman’s use of the term devalue was worrying and suggests he doesn’t really get what true currency sovereignty actually entails.
But I agree with him when he says:
The point is that this has nothing to do with a spendthrift government; what’s happening to Spain reflects the inherent problems with the euro, which now more than ever looks like a monetary union too far.
The point is clear though. With no capacity to set monetary policy, fiscal policy bound by the Maastricht straitjacket, and its exchange rate fixed, the only way Spain, Greece or any of the PIIGS nations can change their competitive position within the EMU is to harshly bash workers’ living conditions. That is not a sensible way to proceed.
A little detour to New York …
Krugman’s employer, the New York Times carried a highly misleading Editorial today (February 7, 2010). It began with an historical account of “how we got there” – the “breathtaking” deficit numbers, that is. It seems that the progressive retaliation to all the deficit terrorism (which tends to be concentrated among Republicans in the US) is to try to argue “well, your lot started it”. Like some schoolyard fracas.
The first point is that the present US administration did inherit an “economy … [that] … was on the brink of another Great Depression” and the “Bush … government had run big deficits for seven straight years”. The editorial doesn’t say that Bush’s deficits followed the sabotage of the Clinton surpluses, which drove the US economy into recession in 2001.
The Editorial also takes us back to school:
So what are the immediate fiscal lessons here? The first lesson is that spending without taxing is a recipe for huge deficits, and that running big deficits when the economy is expanding only sets the country up for bigger deficits when the economy contracts. The second lesson is that once a deep recession takes hold, slashing government spending is not going to solve the problem. It will only make it worse.
First lesson: duh.
Second lesson: definitely.
But the point is that the Bush deficits are immaterial to judging whether the Obama deficits are sustainable or whether the Obama administration has “more” or “less” fiscal space. What defines the amount of fiscal space is not the past fiscal position – surplus or deficit – but the extent to which there are underutilised real resources that can be brought back into production.
And that definition is based on an unchanging public/private mix. A government intent on expanding (or contracting) the public command on resources can make more (or less) space for itself using taxation. Please read my blog – Functional finance and modern monetary theory – for more discussion on this point.
Further, the previous budget stance may influence this space only inasmuch as it influences the level of capacity and labour underutilisation. So a government running surpluses which are imparting fiscal drag into the aggregate demand system and relying on private spending (and increasing indebtedness) to maintain growth (unless there are external surpluses) will typically be associated with emerging productive slack. This may not occur immediately but once the private balance sheets become precarious (as the debt levels rise) then the fiscal drag asserts itself and dominates.
The Editorial then posed the question: “So do we just live with the deficit?” Answer: yes and be thankful you have it and wish that it was bigger. Jobs and businesses are dependent on the deficit. They always will be unless the American economy can conjure up a radical transformation and become a net exporter of significant size. Then the US government will have to explain to its people why they are net shipping valuable resources elsewhere just to accumulate bits of paper denominated in foreign currencies.
That would be a ridiculous strategy but one which the IMF endorses for poor countries – deprive their citizens of use of their own resources and welcome rich industrialists to exploit these resources for the benefits of themselves. If it was a sensible strategy then why are the poorest nations that have been exporting like mad still dirt poor after 30 or so years of IMF programs?
The Editorial’s claim that “Persistently high deficits are harmful to the economy and the country’s long-run security” is highly dependent on the state of the economy, the desires of the private sector, the external position of the economy. In other words, it all depends. Further, the descriptor “high” has no meaning unless you specify a context.
If there is a $US1.3 trillion expenditure leakage from aggregate demand (measured at the full employment output level given current capacity) then is a $US1.3 trillion deficit (the projected US deficit) high? Answer: there is nothing “high” about it. If that is a historically large deficit then it just means that the expenditure leakage from aggregate demand is historically large.
Of-course, the expenditure leakage from aggregate demand in the US is considerably more than $US1.3 trillion because the $US1.3 trillion deficit is leaving around 10 percent of the labour force unemployed (17 per cent if you include those who have given up) and about 30 per cent of capital capacity idle. So in fact, you would conclude that what the NYT editor (and just about everyone else) calls a “large” deficit is in fact a “small” deficit once you consider it relative to its only functional purpose.
The NYT Editorial then opens up Mankiw’s erroneous macroeconomics textbook to continue:
If the government must keep borrowing to make up the difference, it could drive up interest rates and force private companies to compete with the government for investors. That, in turn, would reduce economic growth and, by extension, the potential earnings — and standard of living — of everyone.
Quick letter to editor
The Federal Reserve sets interest rates and can control the yields out along the maturity curve. Budget deficits drive interest rates down for operational reasons relating to the liquidity management operations of the central bank. Further, the government only borrows what it spends and by stimulating growth generates savings which are also available for investment. Finally, bank loans create deposits not the other way around.
Next time you want to write about this please do not consult Mankiw or any other mainstream macroeconomics textbook. I can write that section of the editorial for you. My contact details are attached.
The Editor then moved onto health issues – the smoking guns of the deficit terrorists. My advice to Americans worried about their future health care. Just in case there are insufficient real resources available in the future (which means the US government won’t be able to buy them even though its “cheque book” is at the ready and their cheques will never bounce) I recommend that all US citizens: Stop eating excessive quantities of food and grow vegetables at home after ripping up all your lawns; attend to your children’s obesity immediately; run and jump around a fair bit on a daily basis; and chill out and stop going to analysts. End of gratuitous advice.
So-called Keynesian advises German government …
I am continually tracking the way terminology changes to suit ideological needs. So what used to be called the centrist position in politics is now typically a right-wing position. Progressive parade as deficit terrorists. And … Keynesians are neo-liberals. Go figure!
Today the German paper Der Spiegel ran an interview with one Peter Bofinger who they describe as “a prominent economic adviser to the German government”.
He was asked by Der Spiegel whether the harsh austerity measures imposed on Greece by the EC were “risking a state bankruptcy?” The so-called Keynesian Bofinger said:
To the contrary. The tough stance against Greece is the only correct approach. A cash injection from Brussels would have set a dangerous precedent — it would have signalled to other problem countries like Portugal or Spain that when the going gets tough, the European Union will rescue them.
The picture is from that interview and shows the Greek fire fighters protesting against pay freezes and the austerity plan.
So he clearly thinks that the decision by the EMU not to have a fiscal redistribution capacity, which is the hallmark of any effective federal system was correct. He then also has to think that it is reasonable that asymmetric shocks have to be adjusted to by invoking harsh reductions in standards of living threatening social stability (see picture to the left).
What sort of mad system would be designed in this way? If Germany or any other nation within the EMU didn’t trust other nations, and it is clear from the design of the SGP provisions that they didn’t trust the Club Med nations, then there is very little to be gained from entering the federation.
Boginger went on and said that even if Greece went bankrupt (and presumably faced riots in the streets) then the euro zone would cope because Greece “produces just 2.6 percent of the euro zone’s GDP.”
Okay, once again a clear statement that the nations within the EMU do not share common goals such as advancing public purpose within the zone. As long as Greece doesn’t damage Germany then who cares!
Spiegel then asked him whether his assessment of the euro zone debt to GDP ratio (88 percent) was low? He had indicated in an earlier answer that it was below other nations. Bofinger replied:
It is not low, but it is lower than in the US. There, the national debt is 92 percent of GDP. In Japan, it is even 197 percent. And the United Kingdom’s budget deficit is far worse than that of the euro zone. And as far as a possible loss of confidence is concerned, let me point out that the state of California has been on the verge of bankruptcy for months and its share of the US’s GDP is about 13 percent. Viewed from that perspective, my fear of a domino effect is limited.
So he doesn’t appreciate the context of the monetary system. Any one of the EMU nations could become insolvent because they gave up their currency issuing capacity and the ECB has stated they will not be bailed out under Treaty rules.
However, Japan, the US and the UK are sovereign and have no insolvency risk. Their central banks can control yields if they desire to and the governments can always meet interest servicing payments.
Further, the reference to California is interesting. There is limited fiscal redistribution operating in the US. Not enough as I noted on Friday when talking about Colorado Springs (which is turning off street lights because it has “run out of money”). But at least the US federal system has fiscal redistribution. The EMU system does not have as an ideological position.
Spiegel then said to Bofinger “you’re a follower of Keynesian economics. As such, you believe in stimulating demand in order to increase production and employment and you support the idea of hefty government deficit spending to make that happen. But don’t the exploding deficits make you uneasy?”
Bofinger: After the Lehman bankruptcy, there was no alternative to expensive bank bailout programs and very expansive financial policies. But now the key thing is to organize an exit that is both cautious and rigorous exit strategy. That’s why in our new annual report (editor’s note: provided by the panel of economic advisers to the German federal government), we propose a European consolidation pact under which all EU member states would be obligated in a transparent and credible way to once again achieve balanced budgets. The growing disquiet in the markets shows how important such action is. But equally as bad as the state deficits is the anarchic state of currency policies.
So this is a Keynesian position. Not! There is nothing in Keynes that says that a balanced budget is desirable, achievable or otherwise. It is all about context.
This is straight neo-liberal mainstream ideology. Bofinger is part of the problem not the solution.
The discussion shifted to “currency politics” and Bofinger’s suggestion for a new fixed exchange rate system for the World based around the Euro, the renminbi and the US dollar as reserve currencies. All other countries would peg their currencies to one of the three reserve currencies and the system would be overseen by the IMF. Currency adjustments would reflect interest rate differentials.
I will consider this proposal in detail another day. But the so-called Keynesian (a title that was once considered to be progressive) is advocating a bolted down system where governments would not be able to guarantee full employment for their citizens.
With budgets stuck in balance and having to run monetary policy to defend the “fixed parities” states would be back into the bad old days of the gold standard. The system would collapse under the strain of persistent labour market slack.
Then we read the Sydney Morning Herald and realise …
that it’s economics commentatary is stuck in Mankiw. Senior economics correspondent Ross Gittins is at it again with his latest article If we stay productive, the world’s our oyster (February 6, 2010). You may recall that Gittins tried to tell us that you could learn all you needed to know by studying Mankiw’s 10 Principles of Economics. You can refresh your memories by reading this blog – Do not learn economics from a newspaper. His article was one of the worst from 2009.
Anyway, today Gittins is back on the job talking about the intergenerational challenge. He notes that the Treasury has projected a lower rate of growth in GDP per capita to 1.5 per cent per annum for the next 40 years, compared to 1.9 per cent over the past 40 years. He then sets about explaining how they did it. This is the mainstream nonsense he chose to ape:
… how did Treasury come up with this figure? The economy moves in cycles of boom and bust, so how can Treasury say how the cycle will move over the next 40 years?
It can’t. But it doesn’t think it has to. Economists believe that, over the long term, the economy is driven by supply – the supply of productive resources – rather than the ups and downs in demand.
And here’s the trick: trend growth rates over the longer term are a function of three supply-side variables: population, participation and productivity, otherwise known as “the 3Ps framework”. So let’s see how this framework produces the key projection of average annual growth in GDP per person of 1.5 per cent.
That is the NAIRU-type mantra that comes straight from neo-classical growth theory which was discredited years ago.
It is clear that population growth supports a large economy. It is also clear that the higher the participation rate the more workers are producing. Further, higher productivity is another way of holding the real problems of a rising dependency ratio at bay. All these things are reasonable.
But to think that the evolution of aggregate spending has to impact on what our economy will look like in 40 years time is incorrect. We now have more sophisticated understanding of the way in the productive capacity growth is affected by the business cycle. So a protracted recession such as we are experiencing now typically reduces the growth path and it takes years to work through the persistence and hysteresis that accompanies a recession.
Further, persistently high rates of labour underutilisation (that is, high rates of long-term unemployment) also reduce the capacity of the economy to produce. Not only do idle workers not contribute to income generation but they also develop related pathologies (sickness, substance issues etc) which reduce their productive potential.
And, relatedly, persistently high rates of underemployment and a trend towards part-time casualised labour markets in response to neo-liberal styled deregulations of working conditions reduce the incentive of workers to invest in sophisticated skills. The lower rate of human capital accumulation reduces the potential labour productivity growth.
For all these reasons, aggregate supply movements are intrinsically related to the evolution of aggregate demand. A fully employed, high pressure economy is much more productive and conducive to high rates of investment than an economy that maintains a persistent slack due to deficient aggregate demand.
I covered these issues in this blog – The Great Moderation myth. But Gittins is totally silent on any of this. No surprise though – he has chosen to be a Mankiw-styled mouthpiece.
Then … we read It’s governments’ turn to pay, so we all must pay
Yes, you read that correctly.
Fairfax journalist Malcolm Maiden in his Melbourne Age article Week of non-surprises leaves no one gasping for breath which was entitled It’s governments’ turn to pay, so we all must pay in the Sydney Morning Herald’s version of the same story (February 6, 2010) shows why he should ever call himself a macroeconomics expert.
Sorry to say – the Fairfax press – which is the so-called progressive balance against the rabid right-wing writing you get in The Australian (News Limited) – is also a mouthpiece for the rubbish you will read in Mankiw’s macroeconomics text book. It beats me why these journalists think it is a job to just apply that flawed analysis without any critical scrutiny at all.
As an aside, I can’t wait until Rupert brings in his pay for content model. Then less people will read the Australian and its vituperative and lying message will not be as widely consumed.
Anyway, Maiden’s argument was that all the so-called surprises – RBA’s decision to hold the interest rate constant; a Federal court decision; retail sales were flat because the stimulus is fading and interest rates have been rising; and “global sharemarkets slumped because governments are up to their necks in debt” – were all totally predictable.
On the last “non-surprise” he notes that after large spending injections by governments to save their economies they achieved “debt ratios … that were inconceivable before the crisis”.
Yes, but that is only because the mainstream macroeconomists had all convinced governments that the business cycle was dead and that deregulation was the way to promote untold wealth for the citizenry. There was a widespread denial that we were pursuing unsustainable growth strategies relying on self-regulation of financial markets (which was never going to work) and also increasing private sector indebtedness (which was always a short-term proposition).
So from a modern monetary theory (MMT) perspective the debt ratios are totally expected. In 2001, I wrote in an Op Ed piece – “when this unwinds it is going to be very big – the recession will be not like what we have seen in recent decades”.
Maiden then decides he is an expert on Greece and Portugal and the EMU in general (why stop there – and he doesn’t – as you will see). He goes through the “horror numbers” for Greece and Portugal without any context – but then says:
The real concern is that Greece and Portugal are symptomatic of a much bigger problem.
The United States has just projected a budget deficit this year that will be 10.6 per cent of GDP – more than 3 per cent is undesirable in that and any other economy – and its debts equate to about 94 per cent of GDP. Three-quarters of EU GDP is generated by Germany, Britain, France, Italy and Spain, which are shouldering debts equal to 77 per cent, 71 per cent, 84 per cent, 124 per cent and 74 per cent of GDP respectively. Debt across all the nations in the Organisation of Economic Co-operation and Development is running at 90 per cent of GDP. Australia shines brightly in comparison, with a debt-to-GDP ratio of about 16 per cent.
So cross monetary system comparisons are fine for Maiden. Blind assertions are fine for Maiden. Where, for example, does he derive the analytical result that a deficit of “more than 3 per cent is undesirable in that … [the US] … and any other economy”? Maybe he believed that the Stability and Growth Pact which placed a 3 per cent of GDP rule on deficits was somehow derived from an immutable truth.
This is one of the worst articles you could ever read.
There is no particular budget deficit to GDP figure that is desirable or not independent of knowing about other macroeconomic settings. At present the 10.6 per cent in the US is too small (as discussed above). In a few years time, after a return to growth, that figure would be too big (as unemployment falls). It all depends. The 3 per cent threshold is just Maiden’s ideological imagination at work.
He then says that as governments :
… pay down their debt, countries will have less to spend to keep their economies growing, and they are going to be bidding against private borrowers for funds to service their debt, pushing up on rates, and down on economic growth. There is an added risk of sovereign default itself, although it is still a slight one, in my view.
So all the “horries” in two sentences. First, governments do not have less to spend to keep their economies growing when they are paying down debt. A currency-issuing government can always maintain aggregate demand at the level consistent with full employment and service its debt (which would be included in that spending). There is not finite pot of “money” that the government says “hmm, paying debt this week, so cannot buy some new materials for a public hospital”.
Overall, the government’s net spending decision should only depends on the state of capacity utilisation – its goal is to sustain full employment and ensure there are enough public goods and services available to advance public purpose. Sometimes that might require tax increases to reduce the private command on resources.
Second, I covered the crowding out argument above when discussing the NYT editorial.
Third, there is only risk of sovereign debt default in fixed exchange rate nations with no independent fiscal and monetary capacity. And if he thinks the risk is slight why say it? There is no risk of US government default.
Finally … those who do god’s work have been helping Greece
You will recall that the conservatives who ruled Greece up to the crisis have been accused of lying to the EMU and “cooking their books” – that is, reducing the reported public debt levels.
In today’s Der Spiegel (German version) we learn that Goldman Sachs helped the Greek government in its “embellishments” via the use of “complex financial instruments” – cross-currency swaps. The swaps allowed the Greek government to report a lower Euro debt by exploiting cross-currency exchange rates.
That was my weekend’s flick through the press … not a lot to inspire one’s imagination.
Somewhat more local and of a different nature … I urge everyone to get involved with the Slam Rally, which is fighting the Victorian Government’s anti-live music legislation. SLAM = Save Live Australia’s Music.
There are all sorts of ways you can become involved to put pressure on the government to reverse its nonsensical laws which are forcing the closure of live venues that have kept live bands going in Melbourne (my home town).
That is enough for today!