More drivel from the IMF.

I’m referring to a recent article by two IMF authors: Olivier Blanchard and Daniel Leigh.

Bill Mitchell (Australian economics Prof.) has for years claimed that the IMF is not fit for purpose and should be closed down. I agree.

And support of a kind for Bill (thought not actually advocating the abolition of the IMF) comes from Jonathan Portes, director of the UK’s National Institute of Economic and Social Research. He lists a number of organisations which “got it completely wrong” on “economic issues”. And he includes in that list, the “European Department at the IMF”.

In their first sentence, Blanchard and Olivier (B&O) claim, “In many advanced economies, public debt is very high, and fiscal consolidation must take place. Some factors point to doing more now, others to doing more later. Our purpose in this article is to identify these factors.”

Well there is a whapping great piece of false logic in the first sentence, namely the assumption that because something has recently expanded, it must be too large.

Public sector investment in the UK has declined over the last two years. That of itself does not prove that public sector investment is too low (although my guess is that it probably IS TOO low). Anyone with a brain who tries to prove that X is too low (or high) normally sets out formulas, principles or theories which show what the OPTIMUM amount of X is.

For example, it could be argued that investment in roads and rail in the UK should be determined by purely commercial criteria. That is a “formula” or “principle”.  

So what principles, formulas, etc do B&O set out for determining the OPTIMUM level of debt or deficit. The answer is NONE!!!!!

Instead, they set out a series of factors that allegedly influence the decision as to whether to “consolidate” earlier rather than later. But none of that is of any relevance.

The optimum amount of debt.

Anyway, here’s an idea as to what the OPTIMUM amount of debt should be. To be more accurate I’ll set out a suggestion as to what the optimum TOTAL of debt and monetary base should be, because those two are little different in nature: in particular, both are net financial assets as viewed by the private sector. Moreover, one can easily be turned into the other as indeed has occurred on a large scale recently in the guise of QE.

To summarise, its “private sector net financial assets” (PSNFA) that is the central concern (as has long been obvious to advocates of Modern Monetary Theory).

Basic principle:

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

In other words if the private sector thinks it has an inadequate supply of PSNFA it will save, and we get “paradox of thrift” unemployment.  On the other hand if PSNFA is too high, we get excess spending and hence excess inflation.

And that basic principle renders 90% of B&O's arguments superfluous.

To illustrate, if the private sector is going to want to keep its increased stock of PSNFA for the next five years, there is not point in any consolidation for the next five years. And given the way various private sector entities got their fingers burned in the recent crises, it’s quite possible the private sector DOES ADOPT that relatively conservative approach.

Conversely, the private sector may have a fit of irrational exuberance in three years time, in which case it will be necessary for government to confiscate some PSNFA via extra tax (and/or cut public spending). In other words, if we have to use that ghastly word “consolidate”, then government will need to consolidate.

In short, trying to determine in 2013 what consolidation a government ought to do in each of the next ten years, which is what the IMF authors attempt, is a complete waste of time.

Rogoff the liar and Reinhart the idiot.

You’d think R&R would be eating humble pie at the moment. But not a bit of it. They’re fighting back with amongst other things a litany of lies and half truths in the Financial Times yesterday. Their article there was entitled “Austerity is not the only answer to a debt problem”.

Anyway, let’s look at their article in detail – should be fun. In fact the lies, half truths, mistakes and nonsense is so voluminous, that it’s taken me well over a thousand  words to deal with it all below.

 

Debts near wartime peaks?

In their second paragraph they claim that, “the ratios of debt to GDP are at historically high levels in countries, many rising above previus wartime peaks.”

That is a gross mis-representation.

The reality is that the debt in most major countries is nowhere near “wartime peaks”. Charts for  the US and UK are shown below.

Hat tip to The Atlantic for the second chart.

As to countries which are now in the Eurozone, national debt for such countries is a different kettle of fish as compared to the debt of a country which issues its own currency, but for what it’s worth, France’s post WWII debt to gdp ratio was 208% (see p.23 here). That compares with 89% now.

As to Germany in 1944, its ratio was 217%  P.24  source as above. And it’s now 80%.

As to Japan, its debt peaked at 200% at the end of WWII and is slightly above that level now (218%)

So which are the “many countries” referred to by R&R where debt is now above post war levels? A selection of desert islands in the Pacific, probably. But that’s Rogoff “statistics” and spread sheets for you.

The unfunded pensions scare story.

Next (still on their second paragraph) they trott out the scare story about “underfunded old-age security and pension programmes”. The implication here is presumably that those pension liabilities will add to the debt (although when writing propaganda it always pays not to be too specific about what you’re saying: i.e. propagandists often imply rather state clearly what they mean).

Well I have news for R&R: the UK state pensios scheme is not funded. It’s what’s known as “pay as you go” scheme. I.e. the cost of pensions in 2013 is paid for by taxpayers in 2013. And nothing wrong with that. Indeed, there are even private “pay as you go schemes”.

In short, assuming sufficient taxes are collected in the US in say 2030 to pay for pensions in 2030, there won’t be any increased deficit.

Due caution.

R&R then devote about 200 words to saying they are not against more borrowing, particularly in a recession, but that such borrowing should be done “with due caution”.

Well who could possibly be against “due caution”? That’s just waffle and hot air.

Borrowing for investment.

Next, in an attempt to argue that SOME borrowing is justified, they trott out the common misperception that: “Borrowing to finance productive infrastructure raises long-run potential growth…”.

Well actually if you pay for an investment out of income, rather than borrowing you get EXACTLY THE SAME improved “long-run potential growth”. I.e. the productiveness of an investment IS NOT a reason to borrow: it’s a reason to invest. Doh!

E.g. if you have well over £20,000 in the bank, and you want to invest in a new car or small truck costing £20,000 , why borrow? Only numbskull Rogoff and moron Reinhart would borrow in those circumstances.

In fact a Swiss academic (1) some years ago looked at exactly that question, namely whether a government should fund investment from income or from borrowing. The conclusion was that borrowing did not make sense.

The only reservation there is if government can borrow at a near zero rate, there’s probably no difference between paying for an investment out of income and out of borrowing. But in more normal times, the above Swiss paper is probably right.

R&R’s “consistency” lie.

Just after the above point about infrastructure, R&R claim they have “consistently argued” for such investment “since the outset of the crisis”. In fact, according to this Huffington article, they argued no such thing.

Interest rates may rise.

R&R then trott out the old canard that “interest rates can change rapidly”. Well sure they can. And for the economically illiterate that might seem to pose a problem for a heavily indebted country.

But the first flaw in that argument is that interest paid on EXISTING debt does not change one iota when spot rates rise. I.e. it’s only debt about to reach maturity and which may need to be rolled over the might cause a problem.

But is there actually a problem there? The answer is “no”: at least certainly not for a country that issues its own currency. I.e. Eurozone countries are wholly different. But (and wouldn’t you know it) R&R conflate monetarily soverign countries with non-monetary sovereigns.

At any rate, I’ll concentrate on countries which like the US, are monetarily sovereign, since R&R live there, and the US is presumably their main concern.

So . . . is a rising interest rate a problem for an indebted country? Well no: all it has to do is print money instead of borrow it (as pointed out by Keynes and Milton Friedman).

Of course the knee jerk response from R&R and other economicl illiterates will be that printing is inflationary. Well it’s not if the economy is not at capacity, i.e. if it’s in a recession.

David Hume over 200 years ago pointed out that a money supply increase is not inflationary except to the extent that it brings excess demand. It seems that R&R are not very well acquainted with Keynes, Milton Friedman or David Hume.

Let’s cheat our creditors!

R&R’s next daft suggestion is that debtor countries should “write down” their debts. It’s not 100% clear from the phrase “write down” what they mean. But in fact Rogoff spelled out quite clearly what he meant in 2011: he suggested inflating away debts.

So I’ll assume R&R mean that debtor countries simply defalut one way or another their debts.

Well the result of that is totally predictable: no one is going to lend to the country concerned for the next decade other than at a very high rate of interest.

Creditors were cheated by the inflation spike in the 1970s. The result has been a VERY SLOW long term decline in interest rates since then. Creditors have have long memories.

What R&R and every debt-phobe needs to learn.

1. National debt is a net financial ASSET of the private sector. That means it’s very different to some other financial assets. E.g. in the case of money created by commercial banks, for every dollar of money, there is a dollar of debt. That is, money created by commercial banks nets to nothing.

2. The bigger is the private sector’s holding of net financial assets, the more likely it is to go on a spending spree. In other words national debts are self limiting. Put another way, if you carry on expanding private sector net financial assets long enough, the point must come where the private sector starts to significiantly expand its spending, and the recession ends.

In fact the private sector may spend too much and exacerbate inflation: in which case governemnt will need to confiscate private sector net financial assets via extra tax. I.e. government can run a surplus. Ergo debts are not a problem.

That’s not to say it’s easy to guage the right amount of deficit or surplus, or to get the timing right. But the important point is that IN PRINCIPLE, national debts for countries that issue their own currencies just ain’t a problem.

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Reference:

1. Kellermann, K. (2007). Debt financing of public investment: On a popular  misinterpretation of “the golden rule of public sector borrowing”. European Journal of Political Economy, 23 (4): 1088-1104.

http://econpapers.repec.org/article/eeepoleco/v_3a23_3ay_3a2007_3ai_3a4_3ap_3a1088-1104.htm

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P.S. (4^th May 2013). Jonathan Portes (director of the UK’s National Institute of Social and Economic Research) also tried to very R&R’s claim about current debt levels relative to post war levels. He found that the R&R claim seemed to be essentially false for the five countries for which Portes could find figures.

P.S. (6^th May). Here is more evidence of Rogoff’s dishonesty. Looks like he has refused for three years to let anyone see his famous spreasheet: i.e. it was only very recently that he published it.

P.S.(22nd July, 2013). More evidence of Rogoff's dishonsty here.

P.S. (3^rdSept. 2013). Nice to see someone else pretty much in agreement with my above less than flattering take on Rogoff and Reinhart.