Is MMT neutral concerning income equality / inequality?

Now the last of the row of re-posts…

23 Aug 2011 21:46

One of the main points of MMT is that a monetary sovereign government can always spend enough to allow full capacity utilization.

How does this affect equality / inequality?

If deficit spending closes the demand gap, this results in the economy running at full capacity, and this means that all available labor force will find employment, so the economy will as well run at full employment.
What influence has full employment on total and median wages? At full employment, workers can easily find new employment. This gives the workforce significant leverage against companies, and allows them to bid the wage level up. So we should see a strong rise in the median wage, and an even stronger raise in the lower wage segments. Wages above the median wage will have to rise somewhat slower than the average wage, or the general rise of the wage level would lead to a very strong rise in the wage share of GDP. But generally, the wage share will rise, and the profit share will decline. Thus, income distribution will tend towards equality, and the purchasing power of ordinary middle and lower class workers will rise sharply, increasing consumer demand.

Some companies might dislike the falling profit share, and will try to hike their prices significantly. But if they are not in a quasi monopolistic situation – or a cartel – they will lose market share to competitors who sell at lower prices, so their attempt should usually fail.

Of course, under full employment, there will be a significant risk of inflation. So, what should the government do to keep inflation in check? It has to reduce the deficit – either by reductions in spending or by increased taxation. Some of that will happen more or less automatically – in a booming economy, sales and income taxes will go up – and unemployment and other welfare payments should decline.[the so called automatic stabilizers]. But if the previous slump has been large, this will not be enough.

So, what should it be – cut spending – or increase taxes?

Much of the government spending usually happens in fields that should be a natural domain of governments – like the military, public pensions[1], infrastructure, utilities[2], healthcare[3]and education. So, significant cuts in those sectors might undermine the public wellbeing rather soon, and provoke the next recession.

If we don’t want significant cuts, we’ll have to look at tax hikes. General sales taxes, flat-rate income taxes and contributions to pension plans reduce the purchasing power of the middle and lower classes and therefore, work against equality. So they will reduce aggregate demand (if they are hiked), but it’s quite likely that they will not be lowered soon enough to avoid a new recession.

OTOH, taxes on capital gains, corporate profits and very high incomes will not lower demand very fast, but if they are mostly taxed away (above a certain threshold), the incentive for corporations, and potential high income earners to hike prices / top level wages will be low, and this should limit inflation.
So, the most sustainable approach, almost certainly, is, to spend a lot in bad times and then to rise top tax rates / taxes on economic rent – and push for a very egalitarian income distribution.

Austerity, of course, is just the opposite.

The proponents of government austerity intend to widen the demand gap. This results in even more excess capacity, and higher unemployment. As higher unemployment, as weaker the bargaining position of labor. If this goes hand in hand with the dismantling of social safety nets, the effect on the median wages and the general wage level is clear. The median wage will decline, and the lowest wages for workers without special skills or previous experience will drop fastest. If some wages might rise at all, it would only be the top salaries.

Income distribution will get more and more unequal – the wage share of GDP falls, and the profit share rises. With falling wage incomes, (and – may be – falling government transfers), the purchasing power of the middle and lower classes will decline. They might cope for some time by taking on more and more debt – but sooner or later they will be overleveraged. So, the economy should enter a downward spiral – falling prices (to little demand), falling wages (resulting in lower demand), many bankruptcies. Normally – if some automatic stabilizers would still exist, government spending should slow the fall, but this would mean a sharply increasing deficit.

For true austerians, deficits are anathema. So, the government would have to balance the budget by spending cuts (cutting pensions, health care spending, infrastructure, education, and yes, even defense). Thus, the downward spiral will accelerate fast – if the government cuts keep the pace of the shrinking economy, the profit share (as ratio to GDP) might still rise, but for most businesses, absolute profits (in money units) will still fall, and many will go bankrupt.

Can there be full employment without more equality?

If the wage share doesn’t rise again, domestic consumer demand will remain to weak for full employment. So full employment would have to come from an export surplus (but not everyone can be a net exporter) or from a higher government deficit. But if the economy runs at full employment, the bargaining power of workers would rise in any case – the only way to avoid this would be political oppression – Fascism and / or slavery. And the only way such a system could run at full employment under this condition would be deficit spending – either for a huge military, or infrastructure projects.

Where will this all lead to?

If we follow the full employment path, we have to take some other aspects in to consideration – demography, and resource constraints.

Many leading industrialized countries (and soon China as well) have a fast growing share of elderly people. Unless they take in a lot of immigrants, the dependency ratio – and especially the costs for healthcare, will continue to rise sharply. Is this a problem? Not really – as long as there is productivity growth, there can still be growth with a shrinking work force, or at least constant output with a shrinking workforce.

And as many of the elderly don’t consume that much, there should be a shift from consumption expenditures to healthcare. This, of course, requires a rising government share as part of the economy – the savings ratio might go up, (thus the deficit has to rise to keep demand constant), and with pensions and healthcare a rising segment of the economy, most of the growth will have to be absorbed by the government sector.

And then there are the resource constraints – rising prices for raw materials will likely beat up imported inflation in many countries rather soon. So the governments should tax away the economic rent that oil-importers etc might gain, and invest heavily in alternate energy sources, energy saving devices and the like..

What if austerity prevails?

As long as austerity is maintained, shrinking expenditures should lead to a shrinking economy, more inequality, more misery, and more bankruptcies. Eventually, the fabric of society will break down. There might be fascist regimes, or areas where warlords take over, entire nations turning in to failed states, or a combination of the above. If the fascist keep to austerity, there will be no recovery unless the misery will have reduced the surplus workforce (starvation, lack of healthcare, crime, etc), and a significant part of the survivors have returned to subsistence farming. Only then will wage levels be so low that formerly leading industrial countries that neglected their infrastructure will once again be able to become net exporters. Many people might de facto (if not the jure) have fallen back to the status of slaves. Only if the new fascist regimes will deficit spend for a huge military – and some infrastructure – (and thus have ended austerity) will there be a remnant of a growing economy. If they don’t, further disintegration, back to micro fiefs as in the European middle ages, or – in less populated and more open areas, to a culture of warring horse nomads, will finally become inevitable.

Anyhow – austerity – if it rules long enough, will destroy capitalism, and will destroy civilization.

Footnotes:
Why should pensions, utilities, and health care be natural domains of government?

1] Pensions: Private pension schemes try to build a stock of capital at present to pay for pension in the future, but future retirees will need goods and services that are available in the future, there can’t be a transfer of this goods, because there are not part of a finite stock. By increasing present savings, private pension plans reduce aggregate demand at T1(present), and therefore weaken the growth of the economy, so , the future economy is likely to be weaker (the pie is smaller) at T2(future). So, to ensure maximal growth, reliable public pensions systems – without ex ante funding – are required, so that people don’t need to forego consumption at present.

2] Many utilities, like gas, electricity, water, sewage [and public transport] are best operated as a natural monopoly [duplication of infrastructure by competing utilities will just result in higher prices] – while private monopolies will likely result in abuse (high prices, low quality of service, minimal investment) – public monopolies – with tight supervision, should do the trick..

3] Health care is not really a consumer market. Very few consumers pay most treatments out of pocket. Most patients carry insurance, and the insurance pays for (most of the) treatment. So, in a triangular market, no one has a real interest in maximal efficiency – the patients want the best treatment, the doctors want high wages, the pharmaceutical industry wants high profits, and the insurance company would like to pay as little as possible, but earn high premiums. So both providers and payers have not necessarily the best interest of patients in their mind, and most patients can’t do a real quality check. This drives up cost, but not so much effect. So many people can only afford healthcare if the government either pays for the care, or subsidizes the insurance. Therefore, a single payer health care system – where all services are bought by a monopoly intermediary – e.g. the government, which has leverage in price bargaining against suppliers, seems the most effective. And if there is no price bargaining, but just government funding, excessive profits of pharmaceutical companies and super high wages of some specialists should be subject to high taxes, to remove the monopoly rent.

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How to leave the Euro..

Of course, a paralell currency wouldn’t work, unless the government could CREDIBLY declare, that it would never devalue (compared to the Euro), and that it would redeem the New National Currency (NNC) at par in Euro at a future date -OR- indefinitely accept them for tax payments. (at par). Otherwise, everyone wants to get rid of NNC ASAP.
So, if the goverment introduces a NNC without official conversion, without „officially“ leaving the Eurozone, it could succeed only if it made the NNC dual legal tender at par – thus allowing ALL domestic debtors to serve all debt and all contracts (if the choose so) in NNC. Following Gresham’s law, we should expect NNC to replace the Euro in everyday circulation very fast (everyone tries to hold on his Euro-Assets – and pays everyone in NNC – anticipating future devaluation.)Of course, this would likely lead to some severe cases of abuse (banks paying their best customers in Euros, but converting deposits of ordinary citizens in to NNC). Once the peg between NNC and Euros is abandoned, NNC will likely devalue significantly, and the country might still have to default on its Euro denominated debt.

So the most honest approach would be a clean break. Close the banks for a few days, announce that since 12 years (ca.) Euros have been OUR NATIONAL CURRENCY, and therefore, all debt/contracts denominated in Euros have allways been denominated in our national currency. As from today, we have a new NNC, and all assets and liabilities are converted at a fixed rate. (most likely at par). For international transactions, people can buy Euros at a surchange (in limited quantities). But for some time, you likely will have to introduce capital controls.
Of course, once a country leaves the Euro – either by dual legal tender or conversion – everyone will run to the exit (who will be next? – expect the mother of all bank runs).

The only really safe method to dis-assemble the Eurozone would be a joint declaration of most of the countries („We just realized that it can’t really work“) and therefore, they split the Euro in 18 different ‚Euros‘ – (one international, and 17 national). In each country, all domestic contracts (and debts owed by locals) are in national Euros (as are the coins), while international contracts and exiting banknotes are in „international Euros“. Some countries might peg their currencies to each other, but most would float. If you pay in cash (in banksnotes) shops would use an exchange rate – (all payments by card or cheque will be in the local Euros of the shop) – until this becomes unconvienent enough, so that each country introduces it’s own banknotes again – they will then read 100 Euro Italiano – LIRE or 100 Deutsche Euro MARK. (at least the first series would still use the word Euro). That way, you could avoid the blame game.

Unfortunately, I think this is extremely unlikely, as it would require politicans to aknowledge failure.

So, absent a real fiscal union, the EU will try to kick the can still further down the road, although the downward spiral seems to accelerate fast.
And the first country to jump the boat will need a good excuse (blame the others, that is), and shortly thereafter, everyone will blame everyone else (WE never made a mistake, it’s just those criminal others) – so not only the Euro, but the EU and even peace in Europe will most likely be gone.

With the pace downward now accelerating, the collapse might still come in time for your bet, although there might not be a place left standing where to collect the prize at in 19 months time…

Wie weit geht die Abwärtsspirale?

noch ein repost…» Sat Aug 13, 2011 10:42 pm

In der Debatte um die Wirtschaftspolitik gehen oft die einfachsten Tatsachen vergessen:Jede Ausgabe ist für jemanden eine Einnahme!

Alle Schulden sind auch jemanden‘s Guthaben!

Nicht alle können Gewinne machen / Sparen – denn die Summe aller Einnahmen und Ausgaben muss auf 0 aufgehen.

Ein Anstieg der kumulierten privaten Ersparnisse im Land ist daher nur möglich, wenn jemand anders ein Defizit hat. Entweder, wir haben Exportüberschüsse, dann hat der Rest der Welt mit uns ein Handelsdefizit. Oder unsere Regierung hat Budgetdefizite. Oder – in Zeiten von Metallgeld (Gold- und Silber), die Gold- und Silberminen hatten ein „Defizit“ – in dem Sinne dass ihr Vorrat an nicht abgebauten Metallen schrumpfte.

Die meisten Akteure gehen in der Regel von ihrer „Mikro“ökonomischen Sicht aus, und können nicht in grösseren Zusammenhängen denken. D.h. sie „sehen vor lauter Bäumen den Wald nicht“.
Viele Leute wollen sparen – ein Polster für schwierige Zeiten anlegen, usw. Die Unternehmen möchten möglichst grosse Gewinne machen, und sicher keine Verluste. Die Massnahmen, die dabei ergriffen werden, zielen darauf, die Ausgaben so niedrig wie möglich zu halten, und die Einnahmen maximal zu steigern. In der Wirtschaft ist der bevorzugte Ansatz: rationalisieren so viel wie möglich, Löhne tief halten, Personal einsparen – und mehr verkaufen….

Der mikroökonomische Ansatz funktioniert im Weltmassstab nicht!

Wenn alle Unternehmen versuchen, Ihre Kosten zu senken, möglichst wenig Personal zu beschäftigen, und dabei mehr zu verkaufen, werden die meisten von ihnen ihre Ziele nicht erreichen.

Denn die Reduktion der Löhne/der Beschäftigung reduziert die Kaufkraft der Arbeitnehmer, die Verkäufe können also kaum zunehmen. Zwar verschiebt sich die Aufteilung der Erlöse zugunsten des Kapitals (Gewinneanteile steigen, Lohnanteile sinken) – aber viele Betriebe verfehlen ihre Verkaufsziele und erzielen geringere Margen als geplant. Einige gehen pleite – die Überlebenden versuchen das akkumulierte Kapital in weitere Rationalisierungen zu investieren, und damit die Spirale zu beschleunigen. Je länger dies fortschreitet, desto grösser wird der Kapitalanteil (Investitionen) an den Produktionskosten, und desto kleiner wird der Lohnanteil. Dies reduziert die Kaufkraft immer schneller. Der Endzustand müsste eine Welt mit vollautomatischer Produktion sein. Da keine Löhne mehr anfallen, besteht auch keine Kaufkraft – d.h. sowohl Lohnsumme wie Preise können nicht grösser NULL sein.

Lange bevor die Welt auf dieser Abwärtsspirale so weit nach unten kommt, müsste die Entwicklung irgendwie umschlagen. Aber wie?

Wie ist es möglich, dass Produktivitätsgewinne, die mehr Produktion mit derselben Arbeitsmenge oder die gleiche Produktion mit einer geringeren Arbeitsmenge ermöglichen, nicht zu fortschreitender Verelendung (durch steigende Arbeitslosigkeit) führt?

Entweder, a) die Verkäufe müssen mit der steigenden Produktion Schritt halten – oder b)die reduktion der Arbeitsmenge darf nicht zu geringeren Absätzen führen.
Wie ist so was möglich?

Mehr Verkäufe (für alle) sind möglich, falls 1) die Preise genügend sinken, dass die Mehrproduktion mit den bestehenden Löhnen gekauft werden kann – 2) Die Löhne genügend steigen, dass die Mehrproduktion (zu bisherigen Preisen) gekauft werden kann – 3)Die Exporte zunehmen, d.h. das Ausland kauft unsere Mehrproduktion auf – oder 4) der Staat tritt vermehrt als Käufer auf.

Gleichbleibende Verkäufe bei sinkendem Arbeitsaufwand sind möglich, wenn entweder 5) die Wochenarbeitszeit bei gleichbleibendem Lohn gekürzt wird – oder 6) die Lebensarbeitszeit sinkt (frühere Pensionierung, längere Ausbildung, bezahlter Mutterschaftsurlaub, grosszügige Leistungen bei Arbeitslosigkeit – alles bezahlt durch staatliche Sozialnetze.)

Die Optionen 1), 2) (und 5) gehen zu Lasten der Gewinnmargen der Unternehmen, und werden von diesen daher kaum bevorzugt. Option 3) funktioniert höchstens für einzelne Länder, die Welt als ganzes kann keinen Exportüberschuss haben – wohin denn? Option 4) – höherer Staatskonsum – kann 4a) durch höhere Steuern finanziert werden – Unternehmenssteuern reduzieren jedoch die Profite – Konsumsteuern reduzieren dagegen die Netto-Kaufkraft, helfen also nicht wirklich. Was jedoch funktioniert ist ein höheres StaatsDEFIZIT. Auch bei Option 6) ist die DEFIZITfinanzierung der Sozialprogramme die gesamtwirtschaftlich Wirksamste – höhere Beiträge für Sozialversicherungen schöpfen erneut Kaufkraft ab, verfehlen also dass Ziel.

Wie verhält sich das theoretische Modell nun mit der Praxis der Weltwirtschaft der letzten 150 Jahre?

In den ersten Jahrzehnten war die kapitalistische Wirtschaft noch nicht weltweit dominierend, und auch viele Industriestaaten hatten noch einen grossen Landwirtschaftsektor. Dieser diente als gewisser Puffer – Arbeitskräftereservoir – unerschlossener Markt. Einige Staaten hatten Handelsbilanzüberschüsse, andere fanden Gold, einige hatten nicht gedeckte Defizite, und Krisen waren zahlreich.
Ab den 1880/1890 Jahren verschärfte sich die Expansion in die Randregionen / Kolonialgebiete, die als zusätzliche Absatzmärkte gewonnen werden sollten. Der Erste Weltkrieg wurde durch riesige Staatsdefizite finanziert, dies führte in einigen Ländern zu erheblicher Inflation.
Die Rückkehr zum „Business as Usual“ in den 20 Jahren erwies sich als schwierig, verlief aber in den einzelnen Ländern sehr unterschiedlich. Ab 1929 geriet das System jedoch an den Rand des Zusammenbruchs.

Die Abwärtspirale wurde schliesslich durchbrochen, in dem ab den frühen 30 Jahren fast alle wesentliche Staaten grosse Staatsdefizite erlaubten, die die fehlende Nachfrage auffing. Diese Politik wurde im grossen und ganzen auch nach dem zweiten Weltkrieg fortgesetzt (die USA konnten die Defizite jedoch reduzieren, da die extrem hohen Defizite während des Krieges zu hohen Sparguthaben der Bevölkerung geführt hatten, die sich dadurch bedeutend mehr leisten konnte).

Die anhaltenden Defizite erlaubten eine hohe Beschäftigung, und dies wiederum erhöhte die Macht der Gewerkschaften. Dadurch konnten auch Forderungen nach höheren Löhnen, kürzer Arbeitszeit, früherem Renteneintritt (und höheren Renten) durchgesetzt werden. Die Zeit bis ca. 1980 war von zunehmendem Wohlstand und sinkenden sozialen Ungleichgewichten geprägt.

Aus Sicht der Unternehmerschaft blieben die Gewinne allerdings bescheiden, und die Steuern schienen vielen zu hoch. Der hohe Nachfragedruck begünstigte in vielen Ländern auch eine nicht unerhebliche Inflation.

Ab ca. 1980 begann sich das Blatt zu wenden – die Forderungen der Grosskonzerne fanden nun vermehrt Gehör – Öffnung von Märkten – mehr Exportchancen – aber auch die Möglichkeit, die Produktion in Länder mit tieferem Lohnniveau zu verlagern, eröffneten neue Gewinnmöglichkeiten. Die von zahlreichen Staaten gewährten Steuersenkungen verschoben noch grössere Teile des Einkommens zugunsten des Kapitals, und weg von den Arbeitnehmern. Die Gefahr einer Abwärtspirale gewann erneut Realität.

Die nächsten Jahrzehnte wahren geprägt von grösser Ungleichheit in den westlichen Industriestaaten (die Produktiviätsgewinne gingen ausschliesslich an die Unternehmen, und nicht an die Arbeitnehmer), die Macht der Gewerkschaften begann zu bröckeln. Der Kaufkraftverlust fiel zuerst noch nicht so stark ins Gewicht, da billige Importprodukte die teureren einheimischen Waren verdrängten, und viele Leute sich privat verschuldeten, um nicht auf den gewohnten Konsum zu verzichten. Das Wirtschaftswachstum in vielen westlichen Ländern war sehr moderat, die Aussenhandelsbilanz verschlechterte sich, der Staat trug zwar weiterhin durch Defizite zum Überleben des Systems bei, in Anbetracht des geringen Wachstums machten die Staatsschulden allerdings einen steigenden Anteil der Wirtschaftskraft aus, und auch die private Verschuldung stieg zusehends an. Die steigende Staatschulden wurden von bürgerlichen Politikern zusehends als Bedrohung angesehen, und als Vorwand für den Abbau von Sozialleistungen usw. angeführt.

Ab dem Jahr 2008 zeigte sich jedoch, dass der weitere Anstieg der privaten Verschuldung nicht möglich war – zahlreiche Zahlungsausfälle drohten im Herbst/Winter 2008/2009 das ganze Bankensystem in den Abgrund zu reissen. Contre Coeur rafften sich die Politiker zu einer Rettung der Banken und einigen Wirtschaftsankurbelungsprogrammen auf – diese erhöhten natürlich das Staatsdefitzit, verhinderten jedoch den Kollaps des Systems.

Die „Erholung“ ab ca. 2010 blieb jedoch sehr schwach – die Staatsdefizite waren viel zu klein um eine massive Stütze der Wirtschaft zu werden, und statt nach wirksameren Ankurbelungsmassnahmen zu suchen, fokussierte sich die Politik viel mehr auf das angeblich zu grosse (in Wirklichkeit viel zu kleine) Staatsdefizit. Der Ruf nach Einsparungen, inklusive dem Kahlschlag bei den Sozialwerken, wird immer lauter. Diese Politik wird die Welt sehr rasch auf eine sehr abschüssige Bahn bringen.

Das Staatsdefizit ist DAS LEBENSELEXIR des Kapitalismus. Ohne chronische grosse Defizite kann das System nicht überleben. Die Politik in den USA und Europa strebt offensichtlich nach dem kollektiven Massenselbstmord.

The price level – is it explained by the QTM – or is it rather the other way around?

first postet: Fri Jul 22, 2011 10:19 pm

Scott Summner insist that the QTM is a good explanation of the price level.http://www.themoneyillusion.com/?p=10116
He then creates a fictive economy with a fixed amount of currency and states:

„It’s likely that NGDP will end up being roughly 15 to 50 times the value of the stock of currency.“

Of course, 15 to 50 times are not a really precise figure, not even as „ballpark“ – it’s a factor of 3.3 – so the same quantity of money can have a) stable prices, b) 300 % inflation, or c) serious deflation? – So what does it explain?

He further states:

“BTW, prices in Japan are 100 times higher than in the US, and Korean prices are 1000 times higher.”

Are they? AFAIK, all these countries have their own currency, so there is no common denominator. Comparing “Price levels” without noting that they use different units of account is rather pointless – not all currencies are “created equal”. That’s why there are currency exchange rates. Only if you compare prices (in different currency) at their exchange rate can you compare price levels.

The actual price levels (in local currency) are the result of economic history. Comparative price levels are usually explained by the rate of productivity in the tradable goods sector. If productivity in the tradable goods sector in country A) is high, those producers can easily compete on global markets, make a lot of profit and pay good wages. This should create a high demand for labor in this sector (pull workers out of less productive sectors), and (due to the high wages/profits earned in the TGS) more demand for non tradable domestic goods and services (like housing, haircuts, dining out etc.).

So, higher demand for non-tradables, and wage pull from the tradable sector, will pull the wage level up, and with this the general price level. So country A) – due to its higher productivity in the TGS should have a higher price level than country B). (And of course, it has a fair chance to have a trade balance surplus, so money flows in to the country, which expands the quantity of money – but this is an effect – and not the cause).

So – what else causes inflation (and deflation)?

If demand rises, and supply is inelastic, or, if supply falls, and demand is inelastic, supply will fall short of demand, and hence, prices will rise. Now, how can this be, if the quantity of money is stable?

Well, some call it velocity, others call it leverage. Anyhow, people, chasing the rare goods, either liquidate savings, or take credit, to keep buying.

If supply later becomes adequate again, prices should drop somewhat (but not all the way), but the private sector will be more in debt (relative to GDP) than before.

If supply stays inadequate for some time, there are two possibilities. If the net money supply doesn’t increase sufficiently, then credit expansion will come to an end, there will be a demand shock, and recession (and quite possibly, deflation) will follow. If, OTOH, government runs a persistent deficit, which adds to net financial assets of the private sector (that is – increases the net money supply), then the rise in the price level (inflation) might persist, and if supply remains insufficient for quite some time, both deficit and private credit expansion can finally result in hyperinflation.

Or, to put it in other words: an increase in the quantity of money might follow inflation, and an expansion in the net quantity of money (trough new gold mined and minted, a trade balance surplus, or –rather the norm – a government deficit) is a prerequisite for a persistent rise in the price level – but it’s not the cause, it might be an effect.

If – say under a gold standard – the amount of money is fixed, the price level can’t rise persistently – but it will fluctuate wildly – supply shocks will result in higher prices, but those will soon be offset by demand shocks (or just normalization).

Increasing the money supply trough central bank lending to private banks doesn’t increase the NET financial assets of the private sector (both assets and liabilities of the banking sector increase). An increase in net financial assets of the private sector can only derive from a government deficit or a trade balance surplus (or, if the central bank directly buys NON FINANCIAL ASSETS – like houses, roads, commodities, or labor..).

Paying interest on reserves is nothing but a bank subsidy. [In a similar way, paying interest on treasury bonds is a subsidy to bondholders..] And QE is just a special form of subsidy for bondholders – if they can now sell bonds at a market price above parity to the FED, instead of waiting till the bonds are finally redeemed at par at maturity.

Let’s tell the history another way around…

Part II of..From Austrian Economics to MMT – a short guide in 7 steps

Of course, the above tale wouldn’t be the sequence many MMT followers would accept as historically correct.

For Step 1, we have to acknowledge that man is rarely a solitary being, and certainly not in his upbringing. So an accidently isolated person (as Robinson Crusoe) or a person choosing the solitude of a hermit life might encounter such a situation, but he/she would still have grown up in a group.

And therefore, the step 2 situation – barter economy with few participants – never was the historical norm. Hunter-Gatherer societies usually lived in (extended) family groups. The men went hunting as a group, the women collected fruit and fungi, and looked after the children. Some individuals might have special skills – like making pottery or bows – and were allowed to take some time off from other group duties to exercise those crafts – but there was barely private property, and all products were shared among the members of the group. So, within the group, trade didn’t exist, and would have been considered anti-social behavior. There might have been some barter trade between groups – but those were rare, as were the contacts with strangers. If there were any savings, it would be stored stocks of supplies, put away by the group-elders for future consumption.$

So, what happened next? People gathered together in larger groups, attempted bigger joint projects, like building a wall for defense, a temple for worship, or canals for irrigation. As the group grew larger, it became more difficult to assure that everyone would do his fair share of this duties, and of other duties like guarding the town, or keeping records of duties performed. So, the third step was – the introduction of government.

But one of the first task of government was to assure accountability – that everyone did his fair share of the common duties. So they needed a unit of account – to record the amount of duties every resident had performed. So they could either try to establish a central register – or they could find another way of control. The superior method, so it seemed, was to issue tokens of account, that were handed over to those who had performed services, as a proof for their services. And to assure that people would perform duties in exchange for those tokens, the government would periodically re-collect the tokens from the residents, therefore introducing taxation.

Now, not everyone liked to perform those duties, but everyone had to get tax-tokens. So people with special skills agreed to give up some of their products in exchange for those tokens. Those (citizens) who exchanged tokens for goods and services could thus receive more tokens by performing more government duties, and thus buy things. So the tax-tokens had not only become a unit of account, but also a means of exchange, that is – token-money. As people desired more money to facilitate trade, government found it easy to hire people to perform government duties – so the token-money issuance exceeded taxation, or, the government did run a deficit. This left enough money in the hands of the private sector to allow for circulation, and some even used money as a store of value, that is, they saved money instead of storing goods for future consumption. So, we already have a full-blown fiat-money economy, except there are no banks.

But why, then, did metallic money ever see the light of day? Well, there are a few drawbacks of pure token-money, all related to the relative ease of it’s creation.
First: government could get used to the possibility to easily command goods and services by just creating more tokens – and as long as this was easily accepted, they might sometimes have neglected to tax enough – hence inflation showed up – and thus, people became less inclined to accept the government issues tokens.
Second: as no rare raw materials were needed to produce tokens, other people with skill in some crafts could produce tokens that were indistinguishable from government tokens, without much cost. So counterfeiting could become a serious issue.
And Third: Many places initially stayed out of the control of governments, so while there would be things to trade, and desire to get stuff not self produced, and therefore a demand for a means of circulation / this places didn’t need money for taxation, and non-metallic tokens weren’t that durable, so they wouldn’t collect and save them for future taxation – and so the issues one and two further reduced the demand for such money from people outside the control of government.

Thus, minting coins from rare metals, mostly silver, and for higher denominations even the much rarer gold, solved some of those issues. As the cost of producing the coins was high, this severely limited the ability of the government to issue additional money, and therefore to create inflation trough deficit spending. And second, it made the work of counterfeiters more difficult as well, because if the metallic content of their coins was much lower, it would be noticed – and if it was as high as in government money, the margin of profit was not really worth the effort. Thus, money became relatively rare, but durable, and thus it was often also accepted as means of exchange (and store of value) outside the realms of government.

OTOH, the rareness of the (now) precious metals reduced the availability of money, and therefore economic growth was severely hindered, as well as the ability of governments to react to changing needs and desires. Some reverted to paper money – China several times – other governments debased coinage (using cheaper metals instead of gold and silver) – both giving room for renewed inflation. Many, mostly local governments, couldn’t raise taxes in coin, and therefore returned to requiring direct goods and services from their subjects, as collecting tithes and drafted labor.

Only after the discovery of the Americas, with large Silver (and some Gold) deposits, did the amount of available coinage sharply increase. This did lead to some inflation, but also promoted economic growth, and facilitated trade, as standard coins, like the Spanish Dollar, became used and accepted in many places around the world. Trade and economic development were further facilitated trough the widespread development of banks, and the availability of bank credit.

During the 19th century, with fast increasing international trade and rapid industrialization, the volatility in the exchange rate between Silver and Gold (due to the different quantities of each metal that became available for minting in any period of time) seemed problematic for countries using a bi-metallic system. Therefore, major industrial countries, first the United Kingdom, but in the last third of the century, most leading powers, introduced the Gold Standard, that is a peg of their currency to a fixed amount of gold. The Gold Standard did, however, severely limit the capacity of money growth, leading to recurrent depressions and deflation. Not uncommon as well were bank runs, leading to the collapse of private banks, that in some countries were allowed to issue their own banknotes (still (officially) backed by gold). To reduce the risk of bank failures, all countries finally abolished the right of private banks to issue banknotes, and established this as a monopoly function of a Central Bank.

During WW I, governments found it inacceptable to be constraint in War expenditure trough the limit in Gold Money – so all countries sooner or later abandoned convertibility in to gold during the war, introducing fiat currency (again). After WW I, many countries tried to return to the gold standard, but this constraints were one of the main reasons for the Great Depression.

During the recovery from the Great Depression, and during and after WW II, all leading currencies were in fact based on a fiat system, although as part of the Bretton Woods system most countries introduced fixed rates to the US$. But this was not a real return to the Gold-Standard, because most countries wouldn’t dare to demand the Gold in exchange for Dollars (due to the clear dominance of the US within the western world after WW II) – and US citizens couldn’t exchange their Dollars, so domestically the US was still of the Gold Standard. As trade imbalances created problems for many countries, frequent devaluations – that is a default on the promise to convert other Central Bank’s currency at a fixed rate in to Dollars happened. So, while the Bretton Woods System was nominally a hybrid system, most countries issued more money, and could therefore afford to deficit spend.

The post-gold-standard attempt of many CB’s to restrict the money supply as part of ‘inflation targeting’ bears the danger that – similar to the time of early metallic money – or to the time just before the Great Depression – money could come in to short supply. This would especially be the case, if leading nations would actually fall for the fallacy of a balanced budget – or would even try to repay all debt by running a surplus. Back to the stone-age – or at least to the middle ages – seems to be the rallying cry of the austerity freaks.

From Austrian Economics to MMT – a short guide in 7 steps

12 May 2011 19:35

Step 1).One of the classic examples about savings: – Robinson Crusoe collects 10 Coconuts a day, but only consumes 8 every day. So, he is actually saving 2 nuts / day. After a few days, he will have enough coconuts saved so that he can take a day off (only do things entirely unrelated to coconut collection), but will still be able to consume his habitual 8 nuts a day. Ergo: Savings enables future consumption.
This, of course, holds in a micro-economy – only one agent, producing for his own consumption.
From standard modern situations, we just assumed away: Trade, Market, Money, Bank(s), Credit, Central-Bank, and Government. (And of course, no civilization exist were any of the above is absent).
So, we will now, step by step, add the above features, and look if the assumption about savings still holds.

Step 2)
Assume there are two agents, both farmers, mostly self reliant. But farmer Apple has a big apple tree, while farmer Smith has the ability to forge knives. So there might be a mutual desire to exchange some apples against knives. Now, the rate for the first trade would be 10 apples against 1 knife. Will there be further trades? May be – maybe not. If A. would like a second knife, but S. has no use for further apples, there might be no price relation were apples are cheap enough that S. will produce and give up a second knife, because apples are not durable, and therefore, they are not a good store of value, thus S. will only accept some for consumption, but will not invest in apples.
Ergo: both agents have surplus capacity, but part of existing (apples) or potential (knives) supplies will not be exchanged (or produced), because the respective desires of the agent s don’t match.
So there are not much savings, but there already is unused capacity.

Step 3)
Of course, if more agents take part in the game, there would be a chance that someone else would offer things that S. might trade for knives, and there might be people with a desire for apples, and willingness to give some of their products to A. But in an unorganized, chaotic society, it would still be difficult (and time consuming) to find matching trading partners, as long as there is no market, and no generally accepted means of exchange. Now, some people argue, that such a universally accepted means of exchange could be found, that one particular commodity, gold, fulfilled all the qualities needed so serve as means of exchange. There is the little caveat, however, that gold nuggets are much less uniform (in purity, weight and size) than for example, apples and knives, and that exchanging irregular lumps of gold might prove difficult. So, besides the miner who digs the gold out of the ground, there has to be one more agent, the minter, who melts it down and forms it into uniform coins. [Of course, in reality, mints are usually government agencies – but for the sake of argument, let’s assume of perfectly working private mint, producing recognized standard coins.]
In such an economy, goods are usually exchanged against (gold) money – but still step by step. A producer has first to make products for sale, than exchange them for money (in itself a product, initially produced by the gold mine/mint), before he can exchange the money for other products.
With this modus operandi, savings still needs to precede investment, because there is no credit, and therefore, all payments are immediately due. What are now – after step 3 – savings?. Well, all goods that are not consumed – the good which cannot be consumed is money – as money is usually more durable than other commodities, surplus products will usually be sold, and money (gold) will be saved. Ergo – net savings equal the stock of (gold) money.
Of course, there is some uncertainty here – if saving takes the form of money, we can’t know what that money will eventually (in the future) buy. Using the example of the apples again – if in year 1, there is late frost after blooming, the appletree might bear almost now fruit, and therefore, apples might be extremely expensive in year 1 – my saved money buy’s few apples. In year 2, however, the harvest might be super-abundant, (and there might be several suppliers of apples), and therefore, the apple producer will barely be able to get the expected amount of money, because apples are now so cheap. So, whatever amount of money you saved, your ability to consume real goods and services will depend on the availability of those goods and services (and the price level) in the future.

Step 4) the big one – lets introduce a bank.
While gold coins have their advantages, they also have their disadvantages. As they are uniform and relatively small, I might lose some, or they might get stolen, and I will never be able to identify them as mine, so the finder / thieve might use them without problems. So, may be, I’ll find it more convenient to deposit them in a Bank. The Bank will give me a receipt / an account statement, that says that now, the bank owes me (say 100) coins, and that it will repay them on demand. May be the bank will also allow me to draw checks on my account, and will therefore transfer payments to other agent’s, that have sold me goods or services. As long as the bank does nothing else (that is – only serves as a safe deposit, and intermediary of deposits), nothing much changes. (Of course, the bank can’t make a profit, unless it charges me something for its services, which I might accept if I feel saver so).

But in practice, not only I have become a creditor of the bank (by depositing my money in it), but the bank will grant loans and therefore create credit. If the bank only loans out the funds that are deposited in it (as is often assumed), and hands the coins to the borrowers, it will not immediately be able to return me the coins I’ve deposited (it doesn’t have them anymore, because it handed them over to the borrower. It would have to get them back from the borrower to repay me, or it would have to seize an eventual security (say – a piece of land) that the borrower offered, but may be they will not get enough to repay all deposits, and so the bank will break. (Become illiquid, insolvent, and yes – that’s the source of the word – bankrupt (a broken bank)).

Of course, more often than not, the bank doesn’t hand over the coins to the borrower. In exchange for the loan (say a mortgage) it creates another deposit. So the bank now has two sorts of assets – loans and actual money (gold coins), but only one form of liabilities (deposits). And the sum of deposits exceeds the sum of base money. So, if depositors lose confidence in the bank, they might still all try to withdraw their deposits (bank run), and therefore, the bank fails.
There is no change in net financial assets yet – while money in circulation exceeds money in existence, the additional bank liabilities (private bank deposits) are balanced by additional private debt.

But there is one huge change – the ex ante savings constraint has fallen. With credit, it’s now possible that money in circulation exceeds savings. So, to spend, it’s not necessary to earn first, spending can also be enabled by borrowing. If there is excess capacity – and as we have seen in step two – there almost always is some – idle resources can now be mobilized by spending funds that have not yet been earned. This is an inversion of the savings constraint that held until step 3.
Until step 3, you had to put something (goods or money) aside (not consuming it / not spending it on consumption) to be able to spend more in the future – so savings enable investment, and put a constraint on it. But with credit, the inverse is true. As you can spend before you earn, savings are no pre-requisite for investment. Quite the opposite – investment creates savings. Aggregate income is generated by spending, spending on consumption, and spending on investment. Income from consumption and expenditure for consumption cancel each other out, and therefore, the income from spending will remain as residual, as savings. Therefore: Investment = Savings – or rather: Investment creates savings.

Step 5 let’s issue fiat money.
As we have seen, a bank failure is a distinct risk, as long as the bank has to make it’s bank (credit) money convertible in to gold. (Not enough gold in its vaults). OTOH, most people don’t care about gold coins – they are content to hold bank liabilities – either in the form of deposits, or in the form of banknotes, the most common form of cash in modern times. If we assume a single monopolistic bank, the risk of default / bankruptcy could easily be averted by ending the convertibility of bank money in to cold coins. Most people won’t feel a big difference – the always can withdraw banknotes up to the amount on their deposit, and for failed loans, the bank can just create more credit, additional loans. Of course, if she does so excessively, demand backed by money might actually exceed the capacity of the economy to increase supply of goods and services, and thus, inflation could result. But the bank would never default – bank losses would actually increase the net financial assets of the non-banking sector. (Private debt has gone under – but total deposits and cash remain unchanged).

Step 6 – what if there are many banks?
The example above dealt with a single, monopolistic bank. That’s of course, rarely the case. So, if different banks issue credit without co-ordination, what will happen? If both banks issue non-convertible credit money, there might be an imbalance, as Bank A might issue credit more easy than Bank B. In that case, we should expect a flow of money from A to B, because people that borrowed from A. have more money relative to their non monetary assets than people that do business with Bank B. As a result, we should expect the value of A-money to decline relative to B-money – so there will eventually be a floating exchange rate.
If, OTOH, banks want avoid that their money has a volatile value relative to the money issued by other banks, they have to assure convertibility – either in to gold or another stable commodity – or in to currency issued by a hierarchically superior currency issuer. So, Citibank $ are always convertible in to Federal Reserve $.
This currency issuer is usually called a Central Bank. (CB)
The convertibility in to Central Bank money limits the ability of the bank A. to issue credit, because it has to get the bank notes from the CB, and it has to clear payments to bank B via the CB, (via reserve accounts), because only then will B be sure that they can get the necessary funds if they accept payments from clients of A to clients of B’s deposits. Of course, the Banks can lend extra reserves from the CB, but only against collateral, and at a price.
The ability of the CB to grant further reserves to commercial Banks is limited, if the CB promises convertibility of its currency – either in to gold (as used to be under the gold standard) or in to currency issued by a foreign CB, as is sometimes the case with CB’s of smaller countries, that peg their currency to a larger currency, and have a fixed rate (say to US$). CB’s that don’t guarantee convertibility (and that’s all major Central Banks today) will have to accept a floating exchange rate, but OTOH they face no limits on how much of their own currency they may issue – so they can bail out as many private banks as they choose, and finance as much government deficit spending as desired.

Step 7 last but not least – let’s introduce government.
Many people might argue that government is just one economic agent among many – and that it has to be run by the same methods as a private business. There is, of course, something flawed with that argument.
First, government usually – unlike private firms – doesn’t sell its services on a service by service fee on the marketplace. It pretends to raise the revenue needed to finance its services by a system to collect money, called taxes, that are charged on income, property or transactions of the private sector. But taxes usually do not have a direct relation to government services.
So, even if government would tax to finance its services – in a system with gold money, the total amount of net financial assets would be limited to the total of gold money in existence. (Step 3) So, if the government would run a surplus (tax more than spend), it would reduce net private savings, as now the government would hold part of the total available savings, and thus private sector savings would have to decline. And a government deficit / government debt would shift more of the total savings to the private sector. Here, under the Gold Standard, total debt (public and private) might indeed hit a limit, and public debt might crowd out private investment.
But, as we have seen above, all major countries now have fiat currencies, so there is no upper (or lower) constraint on total net financial assets. Therefore, government deficits are the only way to increase aggregate private savings – if the government spends – with the cooperation of the central bank – it creates additional net financial assets – if it taxes, it destroys net financial assets. So, absent a gold standard – total private savings equal accumulated government deficits. If the government would pay back its debt by taxing enough to generate a stable surplus, this would remove purchasing power from the private sector, and would thus bankrupt the economy. And if the government would tax enough to generate a surplus big enough to eliminate debt, all high-powered money would have vanished from the system, no private savings could exist anymore, and therefore, the country would have fallen back in to the stone-age. [Of course, the government could eliminate nominal debt by paying back treasury bonds by just overdrawing it s account at the central bank – here, no adverse effects are to expect]. And, don’t forget it – if the government spends without limits, and taxes very little, nominal private financial assets will increase spectacularly, but such a increase in spending might actually be faster than the ability of the economy to increase supply, and hence result in inflation.

Krugman attacks MMT – a good or a bad sign?

another old post – getting closer

30 Mar 2011 19:03

In two entries on this NYT blog, Paul Krugman has recently claimed that MMT (Modern Monetary Theorie) states that „deficits never matter“.
This was not only a gross misrepresentation of MMT, it has also been clearly refuted by many supporters that understand monetary operations.

There has been some debate about the question why Krugman choose to take this topic, and why he seems so clueless. [He repeatedly stated that their is indeed a „solvency risk“ for the United States – just not right now…]
But he completely fails to explain how a sovereign nation that is indebted only in its own currency, which is issued by it’s own central bank on behalf of that nation, can ever run out of it’s own currency. [The central bank can always „print“ as much of it’s own currency as it deems necessary – although, mostly it doesn’t print them, but creates it by just crediting bank accounts..]
That Krugman shouldn’t be aware about this basic fact in a modern (not commodity or fixed exchange rate based) currency system seems rather unbelieveable. So why does he claim that there „might“ be a solvency risk (beside the criminal intent of some politicans to destroy the middle class and the social safety net, which might lead them to engineer a solvency crisis – by voluntary default..)

There are, IMHO, just two possible explanations:

1) Krugman tries to look „serious“. Despite his frequent attacks on so called „Very serious people“, he is afraid to fall from grace entirely,so that even the New York Times wont take him serious anymore.. Therefore, he deliberately states bullshit, but tries in fact to place himself in the „center“ of a debate (as a centrist, and not a radical) and therefore open the spectrum of the debate (there are not only people to the right of Krugman, but also an entire school of thought to his left…). In that way, he might actually give MMT an opening – and if the position of the austerity freaks has caused sufficient dammage, he will be able to tell „I told you so“ – and claim that he agreed (mostly) with MMT on most issues all the time….

2) Krugman is a neo-liberal and reactionary at heart. He acts as the left wing horse of a „Progressive“ chariot, but it’s a TROYAN HORSE WAGON. The centre stage is taken by President Obama, who was elected on the promise of „Hope“, and was seen as a bringer of hope by many progressives, but turned out as a big disappointment. [A disappointment that Krugman displays himself..] But, as we can easily see by now, Obama is no progressive at all, he could easily be a member of the GOP (he is probably far to the right of Nixon). But instead of a clear break, an attempt to build a progressive alternative, Krugman still gives the impression that Obama is „a hopeless case, but our only hope“. So he is disarming real progressives. And in that line we might as well see his attack on MMT – look progressive, but validate the basic nonsense of the neo-liberal deficit hawks. As a good Troyan horse, cause confusion, disarm your „friends“, so that they might get slaugthered..

There might be hope that it’s more case 1) – but I’m afraid case 2) might be closer to the truth.. – what are you thinking?