Och ai Hamish.

As I pointed out yesterday, two defective articles appeared on Feb 24th by normally reliable U.K. economics commentators, Martin Wolf and Hamish McRae. I dealt with the former yesterday. Now for Hamish.

He starts well: “Stand by for a double dip, and a double dip lead by America”. Agreed.

Hamish’s reason is simply that various forms of stimulus are coming to an end in the U.S. He doesn’t identify the reason, which is that Congress has allowed a finite amount of stimulus, but is balking at any more. Reason is that Congressmen think government accounts work like household accounts: the books must balance in the long run, and all that nonsense.

The books haven’t balanced for the last century in the U.S., nor anywhere else. This has not proved a long term problem.

In his concluding paragraphs, Hamish claims:

I know it seems ridiculous that if governments can rescue banks and central banks can pump in so much money that they turn around house prices, that they cannot also ensure that the recovery is solid and sustained. But they can't.

We are this spring seeing the limits of government power, and we are seeing it in the US, here in Britain, in Europe, everywhere. You can pile in additional demand for an economy for a while. That has happened right around the world and it has been successful. But you cannot follow those policies indefinitely, and if you try you reach a tipping point where your actions start to have perverse effects. I suppose that is where Greece is now.

False logic. There is a world of difference between government borrowing AS A SUBSTITUTE FOR TAX which is what Greece has done over the years and the various stimulatory measures which governments can take to escape a recession (which may or may not include increased government debt).

Certainly one of the popular alleged ways of escaping a recession is Keynsian “borrow and spend”. But this is a daft policy, as I point out here.

Or as the German academic Claude Hillinger puts it (p.3).

An aspect of the crisis discussions that has irritated me the most is the implicit, or explicit claim that there is no alternative to governmental borrowing to finance the deficits incurred for stabilization purposes. It baffles me how such nonsense can be so universally accepted. Of course, there is a much better alternative: to finance the deficits with fresh money.

Of course, as I pointed out yesterday, producing “fresh money” involves a nominal increase in the government borrowing. But as I also explained yesterday this form of borrowing is really nothing of the sort.

In short, assuming the recession is dealt with by additional “fresh money”, borrowing (unlike the situation in Greece) is not an obstacle.

This is not to say there are no obstacles. There is an obvious obstacle to “fresh money” or “money printing” at some stage: inflation. (Plus where a relatively small country with its own currency wants to attempt more reflation than other countries, there is the possibility of its currency losing value too quickly relative to other currencies. But this is not really relevant here because Hamish is considering “countries” not an individual country).

Conclusion: government debt is not an obstacle to further stimulation.

Martin Wolf should read this blog.

Two normally reliable U.K. economic commentators went off the rails on Feb 24th: Martin Wolf in the Financial Times and Hamish McRae in The Independent. I’ll deal with the latter in a day or two.

Wolf considers what he calls “successful” and “failed” exits from the recession, and claims that both lead to disaster. He says:

By “success”, I mean recognition of the credit engine in high-income deficit countries. So private sector spending surges anew, fiscal deficits shrink and the economy appears to being going back to normal, at last. By “failure” I mean that the deleveraging continues, private spending fails to pick up with any real vigour and fiscal deficits remain far bigger, for far longer, than almost anybody now dares to imagine. This would be post-bubble Japan on a far wider scale.

Unhappily, the result of what I call success would probably be a still bigger financial crisis in future, while the results of what I call failure would be that the fiscal rope would run out, even though reaching the end might take longer than worrywarts fear. Yet the big point is that either outcome ultimately leads us to a sovereign debt crisis. This, in turn, would surely result in defaults, probably via inflation. In essence, stretched balance sheets threaten mass private sector bankruptcy and a depression, or sovereign bankruptcy and inflation, or some combination of the two.

I can envisage two ways by which the world might grow out of its debt overhangs without such a collapse: a surge in private and public investment in the deficit countries or a surge in demand from the emerging countries. Under the former, higher future income would make today’s borrowing sustainable. Under the latter, the savings generated by the deleveraging private sectors of deficit countries would flow naturally into increased investment in emerging countries.

To the extent that Wolf is right about burgeoning government debt, this just proves the lunacy of Keynsian borrow and spend (B&S), which I dealt with here. To summarise, the big problem with B&S is crowding out: that is, B&S involves government running into debt with a view to boosting the economy. But the extent of the boost is always questionable because crowding out may to some degree stymie it. And there is much disagreement over the extent of crowding out. At worst, governments may be running into debt with ABSOLUTELY NOTHING TO SHOW FOR IT by way of stimulus (though that is an extreme and probably unrealistic view).

More likely, is that some governments are running up relatively large debts with relatively little to show for it. (Kind of rings true that, doesn’t it?).

So why bother with B&S? It’s bonkers. Instead of “borrow and spend” why not just “print and spend”: the effects are much more certain. And if anyone is tempted to scream “Mugabwe” or “Weimar”, the answer is that print and spend was exactly what the U.K. did in 2009: the entire deficit (about £200bn) was quantitatively eased. I.e. the U.K. just printed an extra £200bn, and the sky hasn’t fallen in.

Moreover, print and spend OSTENSIBLY results in as much debt as B&S, but in the case of print and spend, the nature of the debt is a nonsense. It’s not really a debt at all. That is, under print and spend, because of the convoluted way that the “government central bank machine” prints money, for every £X of print and spend the central bank ends up holding government debt worth £X: that is the Treasury supposedly “owes” £X to the central bank.

Well that’s a big nonsense isn’t it? One arm of government owing money to another arm of government: that’s not a debt. Or as Willem Buiter put it, “These monetary base ‘liabilities’ of the central bank are not in any meaningful sense liabilities, because they are irredeemable.”

Thus there is no “sovereign debt crisis” to worry about, as Wolf claims – at least not in the case of the U.K. There IS a potential problem: the increased monetary base. This has occurred because of the private sector’s desire to net save: or put another way because of the private sector’s increased desire for net financial assets.

As long as the private sector wishes to retain this increased amount of “money in the piggy bank”, there will be no inflationary effect. As David Hume in his essay “Of Money” pointed out 250 years ago, a money supply increase cannot be inflationary unless the money comes to market (and even then it’s not necessarily inflationary).

Alternatively, if at some point in the future the private sector attempts to dissave a significant portion of its stock of monetary base, the effect could easily be inflation, unless governments take deflationary countermeasures. Given the slow and inadequate response to the private sector’s recent increased desire to save, governments’ response to the opposite, i.e. a private sector attempt to dissave might be equally slow, and the result could be excess inflation.

And for those still worried about monetary base increases, even in the absence of such increases, there is not much to stop everyone going wild with their credit cards and borrowing up to the hilt to buy larger houses, cars, etc. Inflation would be the result if such an increase in “confidence” or “animal spirits” went too far.


Investment.

The third para quoted above from Wolf’s article claims that about the only way out of the problem is large scale investment in deficit countries (a conclusion that seems to be endorsed by Krugman)

Given that we are in a recession and have record amounts of plant, machinery and office space lying idle, investment isn’t exactly priority number one. Though industrial capacity has declined by around 1% in the last year, at least in the U.S. So some sort of investment “catch up” is doubtless needed. (See bottom right hand column here.)

Afterthought (27th Feb): Martin Wolf's article is also criticised by Bill Mitchell.

Does the U.S.central bank understand economics?

Warren Mosler has produced a wealth of evidence that the U.S. central bank the Federal Reserve or “Fed” does not understand how the banking system works. This is just his latest post on the subject.

In addition to the above, the amount of nonsense emanating from the Fed is disturbing, e.g. see here.

And this from a former Fed staffer.

The latest bit of nonsense is from Gauti B. Eggertsson, of the New York Fed.

This paper sets out an idea which is of less than earth shattering significance: he calls it the “paradox of toil”. Basically the argument is that if more people look for work, this may cut wages, which in turn may cut prices, which given the very low interest rates that currently obtain may mean negative interest rates, which in turn may mean a deflationary effect.

Well if crude oil prices decline one could get the same effect. But I’ve no intention of erecting a “paradox of crude oil price cuts”.

There are a hundred and one deflationary and reflationary effects influencing economies all the time. Governments and central banks SHOULD respond to these by taking appropriate counter measures, though how good governments and central banks are at actually doing this is debatable.

When your car is going uphill it will go slower, other things being equal: shock horror. So assuming you want to go at a constant speed, what’s the solution? Er...Um...I’ve got it: depress the accelerator!

Hypocrisy of the year.

Hypocrisy of the year prize (2009) undoubtedly went to Lloyd Blankfein of Goldman Sachs for his claim to be doing “God’s work”.

It looks very much as though hypocrisy of the year 2010 will also go to Goldmans. Gerald Corrigan, managing director of Goldmans, claimed (according to The Times, Feb 23rd) that “I do have concerns that .....at some point we could see animal spirits beginning to pop up again”.

Now what encourages animal spirits and what causes them to be a problem? It's those morally dubious, casino type activities isn't it? The activities that Goldmans along with fellow Wall Street crooks / banksters (take your pick) have campaigned to have preserved. And this results is the unemployment, poverty and homelessness which are now at unprecedented levels. But let's look on the bright side: Goldman partners, Godly people that they are, will by crying their eyes out over the latter problems.

Did the UK national debt increase in 2009?

Ostensibly the debt increased in 2009 by about £200bn. But the entire lot was quantitatively eased. That is, arguably, there was NO increase in the debt at all. All that happened was that the government central bank machine printed an extra £200bn.

Do you regard the £20 notes in your wallet as a “debt owed by the government to you”? That’s not the way I see the £20 notes in my wallet.

Money, or more accurately, the monetary base appears on the liabilities side of a central bank’s balance sheet. But as former Bank of England Monetary Policy Committee member Willem Buiter put it, “These monetary base ‘liabilities’ of the central bank are not in any meaningful sense liabilities, because they are irredeemable.”

As to the interest paid on this “debt”, this is paid by the Treasury to the Bank of England. But the Bank of England sends all profits it makes at the end of the year back to the Treasury!

This charade does have SOME purpose: it helps maintain a distinction between the Treasury and the central bank. Other than that, it’s a charade. So will everyone please stop worrying about the so called interest paid on the 2009 national debt increase?

Strange ideas on banking at the Fed.

Thanks to Warren Mosler for drawing attention to a recent speech by Narayana Kocherlakota the new president of the Federal Reserve Bank of Minneapolis.

Kocherlakota’s grasp of banking is not what it might be. He claims that

“Deposit institutions are holding over a trillion dollars of excess reserves (that is, over 15 times what they are required to hold given their deposits). These excess reserves create the potential for high inflation. Suppose that households believe that prices will rise. They would then demand more deposits to use for transactions. Banks can readily accommodate this extra demand, because they are holding so many excess reserves. These extra deposits become extra money chasing the same amount of goods and so generate upward pressure on prices. The households’ inflationary expectations would, in fact, become self-fulfilling."

This is nonsense.

Of course there is such a thing as inflationary expectations. If a significant proportion of businesses, households, union leaders etc think prices will rise, then everyone builds inflation into their calculations, and inflation becomes self fulfilling.

But the transmission mechanism proposed by Kocherlakota does not stand inspection and for the following reasons.

First, why are households suddenly going to decide that large reserves might be inflationary, if this is what Kocherlakota is saying? Second, reserves are high mainly because of quantitative easing. I.e. central banks have printed money and bought securities. Owners of said securities have then dumped their cash in commercial banks.

If “households believe that prices will rise” they would certainly WANT additional deposits in proportion. But banks cannot just GIVE any such additional deposits to households. They cannot just pinch “deposit” from the accounts of those who have dumped the above mentioned cash and donate the money to any old household.

If the exceptionally high level of reserves to which Kocherlskota refers somehow boosted GDP, that WOULD increase the viability of loan applications in the eyes of banks. Such loans would boost household deposits. But why should a high level of reserves boost GDP? Neither the theory nor the evidence supports this idea. As to the theory, banks are capital constrained, not reserved constrained.

As to the evidence, reserves have been at record levels for a YEAR, and banks are still cautious about lending. Has Mr Kocherlakota not noticed this?


The Atlanta Fed.

The Atlanta Fed seems to think in similar terms to Minneapolis Fed. See “Steps 1,2 & 3” here.

Having criticised the above two Feds for thinking that increasing reserves increases bank lending, this is not to say expanding bank reserves has absolutely no influence on lending.

If a collection of cash rich customers suddenly increase a bank’s deposits by significant proportion, that makes investing in the bank’s equity more attractive. This may lead to an increase in bank’s capital, which in turn leads to increased lending. But this is an indirect transmission mechanism.

Moreover, in 2009 and 2010, banks know perfectly well that their reserves have increased because of quantitative easing. Potential investors in bank equity also know this. Both of these groups also know that Q.E. will at some stage be partially or wholly reversed. Thus the current large reserves are not much of a basis for long term investment decisions!

Four Solutions for Greece.

This is a modern reproduction of a Trireme (ancient Greek warship). Thanks to the Trireme Trust for permission to reproduce the picture (taken in Greece). Photo by Mary Pridgen.





Solution No. 1.

Cut all wages in Greece by 50% or thereabouts. This would NOT, repeat NOT reduce living standards in Greece by 50% or anywhere near. This solution amounts to the same as devaluing the Drachma in the old days when Greece had its own currency. And that was never a big problem for Greeks.

Unfortunately it would be very difficult to explain this to Greeks. Greeks are even more childish and self-centred than the rest of the human race –which is saying something. And that’s not my opinion: it’s the opinion of Greeks themselves. E.g. see here and here and here.

Solution No. 2.

Re-introduce the Drachma and have it run alongside the Euro, as suggested here. Not a bad idea. Given high unemployment in a particular area, a market opens up for a secondary currency in that area. This has been tried in numerous towns round the World, and it seems to work moderately well. See here.

Solution No 3.

The Warren Mosler suggestion. This involves printing and distributing one trillion extra Euros to Euro countries on a per capita basis.

I don’t understand this solution. Seems to me that the basic problem is the DIFFERENT performance of Euro economies. A measure which treats all countries in a similar fashion may be a temporary solution, but I don’t see how it’s a permanent solution.


Solution No 4.

The rest of the Europe bails Greece out. The big problem here is moral hazard: every PIG country will then want to get its nose in the trough. But on the bright side, the acronym and metaphor align nicely.

And finally please note that my main qualification for pronouncing on matters Greek is that I rowed the Trireme up the river Thames in London (with the help of about 200 others).

Afterthough dated 17th Feb. Fifth solution: Greece leaves the Eurozone and returns after devaluing the Drachma, as proposed by Martin Feldstein.