Tuesday, July 24, 2012

Daniel Gros is clueless on deficits and debts.

Daniel Gros is Director of the Centre for European Policy Studies in Brussels. He argues for austerity in this VoxEu article on the grounds that the present rate of increase in national debts is “unsustainable” (see his last paragraph).

Incidentally, a country in a common currency area like the Eurozone faces a VERY DIFFERENT set of problems to a “monetarily sovereign” country: that is one which issues its own currency. To deal with both types in a short article like Daniel’s is risky if not absurd: something I won’t do here. I’ll keep it simple, and concentrate on monetarily sovereign countries.

The fashionable word: “sustainable”.

You can nearly always identify people who can’t think by their excessive use of fashionable phraseology. Daniel is an example.

The acceleration of a car from 5mph to 10mph is not “sustainable” in that if it carries on accelerating, it will ultimately exceed the speed limit, or its speed will become dangerous. Or its engine power will ultimately place a limit on further acceleration.

Is that an argument for not exceeding 10mph in your car?

Running the taps on your bath is not “sustainable” in that the bath will ultimately over-flow. Now that’s a brilliant argument for having just one inch of water in your bath, isn’t it?

The number of half-witted “sustainability” arguments of the above sort is almost limitless.

And of course, Gros is right in the sense that the size of a national debt relative to GDP cannot carry on increasing FOR EVER. But the latter point is just plain daft.

A more intelligent question is: what’s the OPTIMUM level of debt? (Incidentally, advocates of Modern Monetary Theory probably don’t need to read further, as they’ll already know the answer.)

Likewise, the intelligent question in relation to car speed is: what’s the best speed in any given scenario?

The optimum level of debt is the level that induces the private sector to spend at a rate that brings full employment.

Government debt is an ASSET as viewed by owners of that debt, and those owners are of course sundry private sector entities. And the more of such debt the latter entities hold, the more they are likely to say “I’ve got enough of these assets now”. I.e. the more they are likely to try to divest themselves of said assets.

But government debt and cash are very similar in nature. I.e. the more of such debt the private sector holds, the more the private sector is likely to SPEND. And spending is the solution to the recession.

So what’s the optimum level of debt children? Well it’s the level at which the private sector spends at a rate that brings full employment. And since we are currently nowhere near full employment, there is plenty of scope for letting the debt continue to rise for the moment.

Put another way, the private sector will tend to hoard cash (or near cash equivalents, like government debt) if the private sector thinks it has an inadequate stock of such assets. And that act of saving or hoarding equals Keynes’s paradox of thrift: which leads to excess unemployment.

What if interest rate rise?

The next non-problem that gives the Daniel Groses of this world sleepless nights is: what happens if lenders become reluctant to lend to a heavily indebted country and the rate of interest the country has to pay rises significantly?

No problem!! The solution is to cease borrowing. Doh!

Assuming the relevant economy still has excess unemployment, i.e. excess spare capacity, the relevant government and central bank just need to print and spend money into the economy (and/or cut taxes). As long as there really is spare capacity, no significant inflation will ensue.

Indeed, that leads nicely to the next mistake made by Daniel.

Deficits do not necessarily mean increased debt.

Daniel, like many of the incompetents that make up Europe and America’s elite, thinks that deficits necessarily lead to increased debt.

As Keynes, Milton Friedman and many others pointed out, a deficit can accumulate by expanding the monetary base rather than expanding the debt.

Indeed, this is PRETTY MUCH WHAT HAPPENED in the U.S. in 2011!!!! To be more exact, 77% of the increased debt was QEd in the US in 2011. Daniel seems to have no idea what is going on.

Of course you could argue that “QEd debt” is still there: in the hands of the central bank.

But this debt is simply a debt owed by one part of the “government / central bank machine” to another. Those debts might as well be torn up.

It could also be argued that the resulting increased monetary base will one day prove inflationary. Well OK it might. But if that happens, the relevant central bank just needs to reverse the QE operation. (Or government and central bank between them need to implement some other deflationary measure.)

And if those debts in the hands of the central bank HAVE BEEN torn up, no problem. I.e. if the central bank holds NO GOVERNMENT DEBT, there is nothing to stop the bank wading into the market and offering to borrow at above the going rate.

And if the legislation in the relevant country prevents the central bank doing that, then the legislation needs changing.

And finally, it should be said in Daniel’s favour that at least his incompetence is not as bad as that of the buffoons on Capitol Hill. These people (and this is scarcely believable) have over the last three decades have actually implemented PRO-CYCLICAL fiscal policies: i.e. run surpluses in recessions and deficits during booms. At least that’s the case according to this article by Jeffrey Frankel.

No comments:

Post a Comment