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Debt, Deficits and the Cost of Free Lunches
DEBT, DEFICITS AND THE COST OF FREE LUNCHES
It seems that every generation or two, fundamental economic ideas are questioned and challenged. The reasonable and important idea that governments should balance their budgets on an annual basis was challenged in the 1930s by the rise of Keynesian Economics and the counter-argument that deficit spending was desirable, if it was used to maintain full employment. Now it seems that any defense or desire for fiscal restraint and less government spending and borrowing are entirely out the window. Fiscal folly is the watchword of the day.
It is not surprising that politicians care little about annual budget deficits and growing debt, since spending money is their way of buying votes from interest groups wanting to eat at the government trough. In America today, it is all a political game by which Democrats and Republicans pander to their respective voting blocs, especially in an upcoming presidential and congressional election year like 2020.
On the one hand, the danger of a looming political crisis is warned about in the media when they point to the coming budgetary circus that will most likely start playing out toward the end of the summer of 2019, when Congress comes back into full session and the new federal budget year that begins on October 1, 2019, will have to be handled in some way.
Budgetary Brinkmanship and Political Plunder
Will the country be facing another federal government shutdown threat like the one in late 2018 and early 2019? Will the national debt limit be raised to permit the spending of the huge sums of money needed to fulfill all the demands for other people’s money above actual taxes collected through the syphoning off of private sector resources by continued government borrowing in the financial markets?
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Should the Fed Tamper With the Quantity of Money?
SHOULD THE FED TAMPER WITH THE QUANTITY OF MONEY?
Most economists are of the view that a growing economy requires a growing money stock, because economic growth gives rise to a greater demand for money, which must be accommodated.
Failing to do so, it is maintained, will lead to a decline in the prices of goods and services, which in turn will destabilize the economy and lead to an economic recession or, even worse, depression.
For most economists and commentators the main role of the Fed is to keep the supply and the demand for money in equilibrium. Whenever an increase in the demand for money occurs, to maintain the state of equilibrium the accommodation of the demand for money by the Fed is considered a necessary action to keep the economy on a path of economic and price stability.
As long as the growth rate of money supply does not exceed the growth rate of the demand for money, then the accommodation of the increase in the demand for money is not considered as money printing and therefore harmful to the economy.
Note that on this way of thinking the growth rate in the demand for money absorbs the growth rate of the supply of money hence no effective increase in the supply of money occurs. So from this perspective, no harm is inflicted on the economy.
Historically, many different goods have been used as money. On this, Mises observed that, over time,
. . . there would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money[1].
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In Praise of Hayek’s Masterwork
IN PRAISE OF HAYEK’S MASTERWORK
Friedrich von Hayek first published The Road to Serfdom in 1944. His book was subsequently popularised by a condensed version in The Reader’s Digest. This article re-examines Hayek’s theme in the context of today’s economics and politics to see what lessons we can learn from it, and whether personal freedom can survive.
Why personal freedom is important and the treat to it
Destroy personal freedom, and ultimately the state destroys itself. No state succeeds in the long run by taking away freedom from individuals, other than those strictly necessary for guaranteeing individualism. And unless the state recognises this established fact its destruction will be both certain and brutal. Alternatively, a state that steps back from the edge of collectivism and reinstates individual freedoms will survive. This is the theoretical advantage offered by democracy, when the people can peacefully rebel against the state, compared with dictatorships when they cannot.
Nevertheless, democracies are rarely free from the drift into collectivism. They socialise our efforts by taxing profits excessively and limiting free market competition, which is the driving force behind the creation and accumulation of personal wealth and the advancement of the human condition. At least democracies periodically offer the electorate an opportunity to throw out a government sliding into socialism. A Reagan or Thatcher can then materialise to save the nation by reversing or at least stemming the tide of collectivism.
Dictatorships are different, often ending in revolution, the condition in which chaos thrives. If the governed are lucky, out of chaos emerges freedom; much more likely they face more intense suppression and even civil war. We remember dictatorships through a figurehead, a Hitler or Mussolini. But these are just the leaders in a party of like-minded statists.
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Debasing the Baseless–Modern Monetary Theory
DEBASING THE BASELESS – MODERN MONETARY THEORY
- Populist politicians are turning to Modern Monetary Theory
- Fiscal stimulus has not led to significant inflation during the last decade
- MMT is too radical to be adopted in full but the allure of fiscal expansion is great
- Asset markets will benefit over the medium-term
A recent post from the Peterson Institute – Further Thinking on the Costs and Benefits of Deficits – follows on from the Presidential Lecture given by Olivier Blanchard at the annual gathering of the American Economic Association (AEA) Public Debt and Low Interest Rates. The article discusses a number of issues which are linked to Blanchard’s speech: –
- Is the political system so biased towards deficit increases that economists have a responsibility to overemphasize the cost of deficits?
- Do the changing economics of deficits mean that anything goes and we do not need to pay attention to fiscal constraints, as some have inferred from modern monetary theory (MMT)?
- You advocate doing no harm, but is that enough to stabilize the debt at a reasonable level?
- Isn’t action on the deficit urgent in order to reduce the risk of a fiscal crisis?
- Do you think anything about fiscal policy is urgent?
Their answers are 1. Sometimes, although they question whether it is the role of economists to lean against the political wind. 2. No, which is a relief to those of a more puritanical disposition towards debt. The authors’ argument, however, omits any discussion of the function of interest rates in an unfettered market, to act as a signal about the merit of an investment. When interest rates are manipulated, malinvestment flourishes. They propose: –
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Chapter 8: Negotiable Debt, A Bit of History
CHAPTER 8: NEGOTIABLE DEBT, A BIT OF HISTORY
This chapter is a quick summary and clarification of what happens when debt becomes negotiable. The focus is on money, but other aspects are referred to, highlighting the general undesirability of making debt negotiable. There will be some repetition of material previously covered, for the sake of assembling it all in one place.
We all know what money is: a special, universal kind of property whose purpose is to be exchanged for things that are up for sale. Because money can buy almost anything, hijacking the money supply is an obvious objective for any person or class that wishes to become massively wealthy and/or powerful.
Thousands of years ago, when money was valuable metal, a simple way of doing this emerged. Having accumulated a quantity of the metal, a person or institution could issue promises-to pay, and these promises-to-pay could circulate as money. While their promises circulated, nothing needed to be paid out: the promises themselves acted as money. And because the promises were valuable, they could be lent at interest.
The promises were, of course, a form of debt. The issuer owed (in theory) the amount written on the note, or represented by numbers in an account, to anyone owning a ‘promise’.
Debt lent at interest! It’s an idea that still seems strange and unfamiliar, even though it has dominated the world of wealth and power on and off for thousands of years.
This strange hybrid of debt and money is known today as ‘credit’. We are all familiar with ‘credit’; when we have money at the bank, we are ‘in credit’. Legally, the bank owes us money. The bank’s debt circulates as money, so it is best referred to as ‘circulating credit’.
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Chapter 7: Secrets, Ignorance and Lies: Money, Credit and Debt
CHAPTER 7: SECRETS, IGNORANCE AND LIES: MONEY, CREDIT AND DEBT.
“The tyranny of fraud is not less oppressive than that of force.” John Taylor of Caroline, Virginia (1814).
Our money system relies on people not understanding it. If people understood it, they would demand reform.[1]
The most outrageous falsehoods are propagated daily about money and banking. Here are one or two examples:
‘A commercial bank is fundamentally nothing more than a middleman to put these two groups of people (investors and entrepreneurs) together in an efficient way’.[2]
This untruth is repeated regularly in education and the media, and most people believe it. The ‘middleman’ story is denied repeatedly and explicitly by authorities who know about the system, and are honest.
Here are some authoritative denials of the ‘middleman’ narrative:
The Bank of England: “One common misconception is that banks act simply as intermediaries, lending out the deposits that savers place with them…[this] ignores the fact that, in reality in the modern economy, commercial banks are the creators of deposit money. …Rather than banks lending out deposits that are placed with them, the act of lending creates deposits – the reverse of the sequence typically described in textbooks.”[3]
Abbott Payson Usher (20th century banking historian): ‘The essential function of a banking system is the creation of credit, whether in the form of the current accounts of depositors, or in the form of notes. The form of credit is less important than the fact of credit creation.’[4]
Joseph Schumpeter (economist): ‘It is much more realistic to say that the banks ‘create credit’, that is, that they create deposits in their act of lending, than to say they lend the deposits that have been entrusted to them.’[5]
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How Asset Inflation Will End–This Time
HOW ASSET INFLATION WILL END — THIS TIME
Life after death for asset inflation: this is what happens when “speculative fever” remains high even after monetary inflation has paused. This may well have been the situation in global markets during 2019 so far. But history and principle suggest that life after death in this monetary sense is short.
Readers may find it odd to be talking about a pause in monetary inflation at a time when the Fed has cancelled programmed rate rises and the ECB has embarked (March 7) on yet further “radical” policy moves. Moreover, the “core” US inflation rate (as measured by PCE) is still at virtually 2 per cent year-on-year.
Yet we know from past cycles that in the early stages of recession many market participants — and, crucially, central banks — mistakenly view a stall in rate rises or actual rate cuts as stimulatory. Later with the benefit of hindsight these policy moves turn out to be insufficient to prevent a tightening of monetary conditions already in process but unrecognized.
Even had monetary conditions been easing rather than tightening, it is highly dubious whether this difference would have meant the powerful momentum behind the business cycle moving into its recession phase would have lessened substantially.
(As a footnote here: under a gold standard regime there is no claim that monetary conditions will evolve perfectly in line with contracyclical fine-tuning. Both in principle and fact monetary conditions could tighten there at first as recessionary forces gathered. Under sound money, however, contracyclical forces would emerge strongly into the recession as directed by the invisible hand.)
Under a fiat money regime, monetary tightening can occur in the transition of a business cycle into recession, despite the opposite intention of the central bank policy-makers, due to endogenous factors such as an undetected increase in demand for money or a fall in the underlying “money multipliers.”
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Can Expansionary Fiscal and Monetary Policies Counter Recessions?
CAN EXPANSIONARY FISCAL AND MONETARY POLICIES COUNTER RECESSIONS?
When signs of economic weakness emerge, most economics experts are quick to embrace the ideas of John Maynard Keynes.
For most economists the Keynesian remedy is always viewed with positive benefits- if in doubt just push more money and boost government spending to resolve any possible economic crisis.
In this way of thinking, economic activity is presented in terms of the circular flow of money. Spending by one individual becomes a part of the earnings of another individual, and spending by another individual becomes a part of the first individual’s earnings.
So if for some reason people have become less confident about the future and have decided to reduce their spending this is going to weaken the circular flow of money. Once an individual spends less, this worsens the situation of some other individual, who in turn also cuts their spending.
Following this logic, in order to prevent a recession from getting out of hand, the government and the central bank should step in and lift government outlays and monetary pumping, thereby filling the shortfall in the private sector spending.
Once the circular monetary flow is re-established, things should go back to normal and sound economic growth is re-established, so it is held.
Can government really grow an economy?
The whole idea that the government can grow an economy originates from the Keynesian multiplier. On this way of thinking an increase in government outlays gives rise to the economy’s output by a multiple of the initial government increase.
An example will illustrate how initial spending by the government raises the overall output by a multiple of this spending. Let us assume that out of an additional dollar received individuals spend $0.9 and save $0.1. Also, let us assume that consumers have increased their expenditure by $100million. Individuals now have more money to spend because of an increase in government outlays.
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Being and Time (And Central Banks)
BEING AND TIME (AND CENTRAL BANKS)
People value present goods more highly than future goods. For instance, an apple available today is considered more valuable than the same apple available in, say, one month. This is expressive of time preference — which is an undeniable fact, a category of human action.
The sentence “Humans act” is a logically irrefutable truth. It cannot be denied without causing a logical contradiction. By saying “Humans can not act”, you act and thus contradict your very statement.
From the true insight that humans act we can deduce that human action takes place in time. There is no timeless human action. Were it otherwise, people’s goals would be instantaneously reached, and action would be impossible — but we cannot think that we cannot act.
The market interest rate is expressive of time preference, and as such, it is also a category of human action. If determined in an unhampered market, the (natural) market interest rate denotes the discount that future goods are subject to relative to present goods.
If one US-dollar available in a year is trading at, say, 0.95 US-dollar, it means that the market interest rate is 5.0% (the calculation is: [0.95 / 1 – 1]*100).
Should people start valuing present goods more highly than future goods — which is expressive of a rise in time preference —, the discount on future goods vis-à-vis present goods and thus the market interest rate go up.
If peoples’ time preference declines, the discount on future goods vis-à-vis present goods drops, and so does the market interest rate — meaning that people wish to save more and consume less out of their current income.
The interest rate and central banking
In an unhampered market, the market interest rate reflects peoples’ time preference. Nowadays, however, the market interest rate is no longer determined in an unhampered market. It is dictated by the central bank.
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The Problem With Modern Monetary Theory
THE PROBLEM WITH MODERN MONETARY THEORY
According to the Modern Money Theory (MMT), money is a thing that the State decides upon. Following the ideas of the German economist, Georg Knapp, the MMT simply regards money as a token. For instance, when an individual places a coat in the cloakroom of a theatre, he receives a tin disc or a paper receipt. This receipt or a disc is a proof that the individual is entitled to demand the return of his coat. The token was labelled by Knapp as chartal or a pay token.
On this way of thinking money is seen as a chartal means of payments. According to the MMT, the material used to manufacture the tokens is irrelevant – it can be gold, silver, or any other metal or it can even be paper. Hence, the definition of money according to the MMT is what the State decides it is going to be[1].
According to this theory, the value of money is established because the State forces people to pay taxes with the money that the State has decided upon. The State taxes have to be paid with the money tokens issued by the State. The State also has the ability to control the value of money through its declaration of how much it is willing to pay for a certain commodity produced by the private sector. What we have here is a situation wherein the State exchanges empty tokens for goods and services produced by individuals. It then requires them to pay taxes with part of the tokens.
If one dissects the whole process one would discover that it is about an exchange of worthless tokens for real goods and services i.e. nothing for something.
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Chapter 6: American, Won and Lost
CHAPTER 6: AMERICA, WON AND LOST.
After the United States gained its independence from Britain, it became powerful in the world in two very different ways: as an idea, and as a reality.
‘America the idea’ is a land of freedom and democracy, equality and opportunity, promoting these aspirations and values across the world.
‘America the reality’ is an international power. It was built on genocide and slavery. Today, a carefully managed monetary system allots wealth to those who do no productive work. In the wider world, America destabilizes popular governments, promotes tyrannies, creates dollars to purchase foreign resources for corporate exploitation and sponsors foreign wars to establish new bases of military and financial power.
For a long time ‘American the idea’ successfully camouflaged the activities of ‘America the reality’. Today the camouflage is wearing very thin indeed.
‘America the reality’ became stronger than ‘America the idea’ as the powers of money and corporate industry won out over the idealism and the good intentions of many of its ‘founding fathers’[1] and of countless others. Central to this development was the adoption of British banking as a way of creating money.
The adoption of British banking by America has an interesting history. After Independence, the American elite opted for the method favoured by their old colonial masters and rejected homegrown approaches to money-creation, some of which had been both just and efficient (see below).
The new elite liked British banking for the same reason it was loved by the British parliament – because it favoured government power and private wealth. The collusion of finance and government power, via circulating credit, is a very resilient form of concentrated power, because although everyone can see the bad effects, few people understand how it works. Governments across the world have since adopted the method for the same reasons: to augment their own power, and to make it easy for their supporters to increase their own wealth.
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Changes in Government Deposits and Money Supply
CHANGES IN GOVERNMENT DEPOSITS AND MONEY SUPPLY
The US debt ceiling suspension, signed in February 2018, expires at the beginning of March this year. Some commentators are of the view that the US Treasury must carry out special measures if it expects a delay in raising the debt ceiling in March.
The Treasury would have to draw down its deposits at the Fed and deposit the cash in various government department accounts at commercial banks, for future use to pay government salaries and contractors’ fees.
These commentators are of the view that the Treasury deposit withdrawals act like QE (quantitative easing) and the Treasury deposit build-ups like QT (quantitative tightening). However, is it the case?
If in an economy people hold $10,000 in cash, we would say that the money supply in this economy is $10,000. If some individuals then decided to place $2,000 of their money in demand deposits, the total money supply will still remain $10,000, comprising of $8,000 cash and $2,000 in demand deposits.
Now, if government taxes people by $1,000, this amount of money is then transferred from individual’s demand deposits to the government’s deposits. Conventional thinking would view this as if the money supply fell by $1,000. In reality, however, the $1,000 is now available for government expenditure meaning that money supply is still $10,000, comprising of $8,000 in cash, $1000 in individuals demand deposits and $1,000 in government deposits.
If the government were to withdraw $1000 from its deposit with the Fed and buy goods from individuals then the amount of money will be still $10,000 comprising of $8,000 in cash and $2,000 in individuals demand deposits.
From this we can conclude that a large withdrawal of money from the government deposit account with the Fed is not going to strengthen the money supply as suggested by popular thinking.
What are the sources for money expansion?
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Capital Flows–Is a Reckoning Nigh?
CAPITAL FLOWS – IS A RECKONING NIGH?
- Borrowing in Euros continues to rise even as the rate of US borrowing slows
- The BIS has identified an Expansionary Lower Bound for interest rates
- Developed economies might not be immune to the ELB
- Demographic deflation will thwart growth for decades to come
In Macro Letter – No 108 – 18-01-2019 – A world of debt – where are the risks? I looked at the increase in debt globally, however, there has been another trend, since 2009, which is worth investigating as we consider from whence the greatest risk to global growth may hail. The BIS global liquidity indicators at end-September 2018 – released at the end of January, provides an insight: –
The annual growth rate of US dollar credit to non-bank borrowers outside the United States slowed down to 3%, compared with its most recent peak of 7% at end-2017. The outstanding stock stood at $11.5 trillion.
In contrast, euro-denominated credit to non-bank borrowers outside the euro area rose by 9% year on year, taking the outstanding stock to €3.2 trillion (equivalent to $3.7 trillion). Euro-denominated credit to non-bank borrowers located in emerging market and developing economies (EMDEs) grew even more strongly, up by 13%.
The chart below shows the slowing rate of US$ credit growth, while euro credit accelerates: –
Source: BIS global liquidity indicators
The rising demand for Euro denominated borrowing has been in train since the end of the Great Financial Recession in 2009. Lower interest rates in the Eurozone have been a part of this process; a tendency for the Japanese Yen to rise in times of economic and geopolitical concern has no doubt helped European lenders to gain market share. This trend, however, remains over-shadowed by the sheer size of the US credit markets. The US$ has remained preeminent due to structurally higher interest rates and bond yields than Europe or Japan: investors, rather than borrowers, dictate capital flows.
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Don’t Be So Negative
DON’T BE SO NEGATIVE
“FED’S WILLIAMS SAYS IN A DOWNTURN WE COULD CONSIDER QUANTITATIVE EASING, NEGATIVE RATES.”
- Tweet by Reuters’ Jennifer Ablan, reporting on a speech by John Williams of the Federal Reserve Bank of New York at the Economic Club of New York, 6 March 2019.
“Because NIRP worked so well in Europe and Japan ?”
- Response by mac on Twitter.
In February 2016, The Financial Times published an article titled ‘Central Banks: Negative Thinking’, co-authored by Robin Wigglesworth, Leo Lewis and Dan McCrum. The piece in question was atypically sceptical of the received wisdom of QE, i.e., that it works. If it was sceptical as to the efficacy of QE, it was doubly so in relation to the policy of maintaining negative interest rates, or NIRP. Some extracts follow:
Online, the mood has turned to rage. Forums have seen a flood of commentary from Japan’s retirees decrying negative rates and the “torture” that the BoJ’s policy is already inflicting. “Raising commodity prices to overcome deflation, raising consumption taxes, lowering interest rates . . . they are all policies that make us suffer,” wrote one..
The Japanese can be conservative at the best of times, and few think these are the best of times.
But Japan is not the only country affected. A concept once only subject to small-talk among economists is now an uncomfortable reality. With quantitative easing seemingly losing its power to dazzle markets, and many governments either unable or unwilling to countenance raising spending, central banks have felt compelled to try new tools.
Sweden, Switzerland, Denmark, the eurozone and most recently Japan — adding up to almost a quarter of the global economy — have all introduced some form of negative interest rate policy in an attempt to fight deflationary forces, weaken their currencies and stimulate growth.
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Importance of Model Building in Economics
IMPORTANCE OF MODEL BUILDING IN ECONOMICS
In the natural sciences, a laboratory experiment can isolate various elements and their movements. There is no equivalent in the discipline of economics. The employment of model building is an attempt to produce a laboratory where controlled experiments can be conducted.
The idea of having such a laboratory is very appealing to economists and politicians. Once the model is built and endorsed as a good replica of the economy, politicians can evaluate the outcomes of various policies.
This, it is argued, enhances the efficiency of government policies and thus leads to a better and more prosperous economy.
It is also suggested that the model can serve as a referee in assessing the validity of various economic ideas. The other purpose of a model is to provide an indication regarding the future.
By means of mathematical and statistical methods, a model builder establishes relationships between various economic variables.
For example, personal consumer outlays are related to personal disposable income and interest rates, while fixed capital spending is explained by the past stock of capital, interest rates, and economic activity. A collection of such various estimated relations—i.e., equations—constitutes an econometric model.
A comparison of the goodness of fit of the dynamic simulation versus the actual data is an important criterion in assessing the reliability of a model. (In a static simulation, the equations of the model are solved using actual lagged variables. In a dynamic simulation, the equations are solved by employing calculated from the model-lagged variables).
The final test of the model is its response to a policy variable change, such as an increase in taxes or a rise in government outlays. By means of a qualitative assessment, a model builder decides whether the response is reasonable or not. Once the model is successfully constructed, it is ready to be used.
Is the mathematical method valid in economics?
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