Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
Tonight (Tuesday Boston time as I write) my very kind and gracious host took me to an early evening Ringo Starr and his All Starrs concert down on the waterfront. I never knew so many Beatles fans from the 1960s had survived the boredom. They were out in force tonight as he sang Yellow Submarine and other pop relics. The highlight of the evening was Edgar Winter (who is one of his all starrs) featuring on Frankenstein which he made a hit in 1972. But where do all these Beatles fans go during the day! Scary. And by the way, Rick Derringer who was in the original Edgar Winter Band was also in Ringo’s band tonight playing some nice guitar (if you like Gibson-motivated pop – I don’t). My host decided to call it an early night and I left with him – while Warren and his partner bopped on. A neat exit you might say! But Ringo at least provided some leadership – poppy and pretty soppy at that. But much better than our leaders of government are providing if the recent G20 declaration is anything to go by. They have just ceded leadership to the IMF – that unelected rabble. Stay tuned for things to get worse.
Another G20 talkfest has ended in Toronto and the final communique suggests that the IMF is now back in charge. If you read the IMF Briefing and the World Bank Briefing to the G20 Summit you will get a sense of deja vu. The line now being pushed is, as always, structural reform of product and labour markets – which you read as deregulation and erosion of worker entitlements.
The IMF is selling the line that:
Credible consolidation plans-designed to be “growth friendly”-would mitigate the dampening effect on domestic demand. Monetary policy accommodation could be maintained for a more extended period to help support activity, since inflation would remain contained as fiscal balances are strengthened.
Their hope is that export surplus nations will rebalance their growth strategies via exchange rate adjustments to stimulate export sectors of the stagnant nations with low interest rates encouraging investment. They also claim that changing tax mixes (from payroll to consumption) will help growth while increasing revenue.
First, monetary policy is an ineffective expansionary tool. Rates are low and have been for some time. Japan failed to grow fast with zero interest rates for years. It was only when fiscal policy reached an adequate level that it started to show signs of life again.
Second, relying on exchange rate adjustments to lead to a major revitalisation of world growth via trade is to seriously underestimate the extent of the demand crisis facing the global economy. The IMF has been pushing export-led growth on to poor nations for decades with little overall shift in the poverty rates at the lowest levels.
All the IMF simulations are based on their GIMF model which is highly flawed. Basically, these models can give whatever result satisfies your ideological disposition. All that needs to be done is ensure the elasticities (the numerical relationships) on key variables – linking policy changes to output and monetary aggregates – are calibrated accordingly. So the GIMF model will always give large real gains when you deregulate the labour market even though there is no credible research literature that would support that conclusion.
In technical terms, the substitution effects are typically much larger than income effects – which means in English, taking a specific example, that the benefits of cutting wages have huge cost effects but the income losses are downplayed. So the supply expands while there are no real demand effects and the world is judged a better place. The empirical research literature by and large does not support the faith in these sorts of models. Please read my blog – GIGO … – for more discussion on this point.
… Building on our achievements in addressing the global economic crisis, we have agreed on the next steps we should take to ensure a full return to growth with quality jobs, to reform and strengthen financial systems, and to create strong, sustainable and balanced global growth …
But serious challenges remain. While growth is returning, the recovery is uneven and fragile, unemployment in many countries remains at unacceptable levels, and the social impact of the crisis is still widely felt. Strengthening the recovery is key. To sustain recovery, we need to follow through on delivering existing stimulus plans, while working to create the conditions for robust private demand. At the same time, recent events highlight the importance of sustainable public finances and the need for our countries to put in place credible, properly phased and growth-friendly plans to deliver fiscal sustainability, differentiated for and tailored to national circumstances. Those countries with serious fiscal challenges need to accelerate the pace of consolidation. This should be combined with efforts to rebalance global demand to help ensure global growth continues on a sustainable path.
This quote is virtually word-for-word from the IMF briefing which says a lot for the independence of our world leaders. They buy, without question the notion that “(s)ound fiscal finances are essential to sustain recovery, provide flexibility to respond to new shocks, ensure the capacity to meet the challenges of aging populations, and avoid leaving future generations with a legacy of deficits and debt.”
But what constitutes “sound fiscal finances” is not spelt out. It is all fudged around what the bond markets will tolerate. But what the bond traders think is a reasonable outcome for their narrow vested interests is unlikely to be remotely what is in the best interests of the overall populace. So what the bond markets will tolerate should not be a gauge by which we judge sound fiscal finance. After all, for most governments the involvement of the bond markets in the decisions to net public spend is voluntary anyway.
A sovereign government is never revenue constrained because it is the monopoly issuer of the currency and so the bond markets are really superfluous to its fiscal operations. What the bond markets think should never be considered. They are after all the recipients of corporate welfare on a large scale and should stand in line as the handouts are being considered. They are mendicants. It is far more important that government get people back into jobs as quickly as possible and when they have achieved high employment levels then they might want to conclude the fiscal position is “sound”.
My summary checklist for determining whether fiscal policy is sustainable is:
- Saying a government can always credit bank accounts and add to bank reserves whenever it sees fit doesn’t mean it should be spending without regard to what the spending is aimed at achieving.
- Governments must aim to advance public purpose.
- Fiscal sustainability is not defined with reference to some level of the public debt/GDP ratio or deficit/GDP ratio.
- Fiscal sustainability is directly related to the extent to which labour resources are utilised in the economy – that is, full employment.
- A sovereign (currency-issuing) government is always financially solvent.
- You cannot deduce anything about government budgets by invoking the fallacious analogy between a household and government.
- Fiscal sustainability will not include any notion of foreign “financing” limits or foreign worries about a sovereign government’s solvency.
So when the G20 says:
The path of adjustment must be carefully calibrated to sustain the recovery in private demand. There is a risk that synchronized fiscal adjustment across several major economies could adversely impact the recovery. There is also a risk that the failure to implement consolidation where necessary would undermine confidence and hamper growth. Reflecting this balance, advanced economies have committed to fiscal plans that will at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016. Recognizing the circumstances of Japan, we welcome the Japanese government’s fiscal consolidation plan announced recently with their growth strategy. Those with serious fiscal challenges need to accelerate the pace of consolidation.
You know that this is being driven by ratio fever and doesn’t reflect the principles that a sovereign government should pursue. The Japanese government’s decision to cut back now will prove to be as bad as its previous tom foolery in 1997.
The G20 statement is full of erroneous claims that budget surpluses “boost national savings” when in fact they reduce national saving by squeezing the spending (and income generating capacity) of the private sector – unless there are very strong net export offsets.
UK Guardian economics correspondent Larry Elliot (June 28, 2010) in his article – G20 accord: you go your way, I’ll go mine says that:
The Toronto summit shows that now the threat of a second Great Depression has passed, it will take another crisis for the G20 to redress global economic imbalances
Born out of necessity in the dark days of late 2008, the cracks are beginning to show in the G20. Developed and developing nations were united when confronted with the collapse of world trade and the shrivelling of industrial output but are finding it harder to keep the show on the road now that the immediate crisis is over.
The communique from the weekend’s meeting is easily summed up: do your own thing. The Americans cannot persuade the Europeans to hold off from fiscal tightening until the recovery is assured; the Germans and the British think the risks of a sovereign debt crisis are far more serious than the possibility of a double-dip recession.
I agree with that assessment. The IMF line has been re-asserted or as Elliot says “normality has returned”. But this normality set in place the conditions that led to the crisis.
Elliot also notes that governments think the harsh outcomes that will accompany the austerity push is a “price worth paying to keep the financial markets happy” but that:
As for the markets, it is certainly true that sovereign debt is their concern this month. But next month they may be getting in a lather about the slow growth caused by the austerity programmes they themselves have necessitated.
The risk is that satisfying the capricious whims of the financial markets leads to policy error and the doomsday scenario. It goes something like this: even before the sovereign debt crisis erupted this spring, there were some tentative signs that the recovery that began in the spring of 2009 was losing momentum. The US has just revised down its growth for the first quarter and has yet to see the pick-up in the labour market that it enjoyed in previous recoveries. Europe’s expansion over the winter was barely perceptible. China has been pounding along but Beijing has been seeking to tighten credit conditions after 2009’s monetary laxity.
So without any credible explanation as to how growth, which depends on aggregate demand growth, will emerge when you cut aggregate demand the most likely scenario is a move back towards or into recession as a result of the G20 stance.
Paul Krugman goes one step further. In his column on Monday (June 27, 2010) entitled – The Third Depression – he says:
We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression than the much more severe Great Depression. But the cost – to the world economy and, above all, to the millions of lives blighted by the absence of jobs – will nonetheless be immense.
And this third depression will be primarily a failure of policy. Around the world – most recently at last weekend’s deeply discouraging G-20 meeting – governments are obsessing about inflation when the real threat is deflation, preaching the need for belt-tightening when the real problem is inadequate spending.
The point Krugman is referring to is that history (1930s, 1990s etc) has taught us that major economic downturns are persistent. The on-going deflationary impact on demand that persistently high unemployment imposes is usually underestimated by the conservatives who only see rising budget ratios and freak out. History tells us that recovery comes in starts and is often interspersed with backstepping usually because governments lose their political nerve under the constant bullying of the Flat Earthers (aka deficit terrorists).
These vandals have always tried to derail government fiscal support and they never learn from their mistakes. The arguments that are being rehearsed daily in the media – the call for austerity etc – were all there in Japan in the 1990s and across the globe in the 1930s. In each historical period, governments bowed to the pressure and the economies slid backwards into recession.
Students of economics never learn about these policy errors and so remain blithe to the fundamental shortcomings of the mainstream policy advice.
But future historians will tell us that this wasn’t the end of the third depression, just as the business upturn that began in 1933 wasn’t the end of the Great Depression. After all, unemployment – especially long-term unemployment – remains at levels that would have been considered catastrophic not long ago, and shows no sign of coming down rapidly. And both the United States and Europe are well on their way toward Japan-style deflationary traps.
In the face of this grim picture, you might have expected policy makers to realize that they haven’t yet done enough to promote recovery. But no: over the last few months there has been a stunning resurgence of hard-money and balanced-budget orthodoxy.
He calls the balanced-budget orthodoxy “the revival of the old-time religion”. While the conservatives have argued that austerity is needed to allow bond markets to continue financing governments, even in the EMU the ECB is doing a pretty good job of that at present.
Further, in yesterday’s blog I noted:
But what is very interesting and unlike the hysteria surrounding the “sovereign debt” crisis part of the story, there hasn’t been much press coverage about what the ECB is now up to. Despite saying there would be no bailouts the ECB is now buying huge amounts of GIPSI debt to ensure the funding crisis in the EMU is contained. While I am happy they are doing that – inasmuch as anything that is done within the context of that flawed system is compromised – there are sinister overtones. The ECB is now an incredibly powerful institution without peer in the EMU. They stand between the system collapsing or muddling through. And they can force austerity onto citizens throughout the member nations but never face the judgement of the voters.
Just to follow up on that today I got some figures of ECB purchases of government bonds for the last 7 weeks. So far they have purchased 55 billion euro which seems to be sufficient to keep borrowing rates down and allow the EMU governments to refinance themselves without having to default. The following Table shows the last 7 weeks of purchases:
I was chatting with Warren Mosler in Boston about this today and we both agreed that there is a sinister element to this. The purchases really amount to a massive fiscal intervention but with the barbs attached that the national governments have to toe the ECB line. This concentration of power within the EMU within an unelected body which can hand out favours at will in return for total compliance is a very dangerous precedent. If anything looks like totalitarianism in the current developments this is it.
On the bond markets, Krugman says:
… it’s true that bond investors have turned on governments with intractable deficits. But there is no evidence that short-run fiscal austerity in the face of a depressed economy reassures investors. On the contrary: Greece has agreed to harsh austerity, only to find its risk spreads growing ever wider; Ireland has imposed savage cuts in public spending, only to be treated by the markets as a worse risk than Spain, which has been far more reluctant to take the hard-liners’ medicine. It’s almost as if the financial markets understand what policy makers seemingly don’t: that while long-term fiscal responsibility is important, slashing spending in the midst of a depression, which deepens that depression and paves the way for deflation, is actually self-defeating.
Whether Krugman is right about another depression remains to be seen. There has been news in the last day or so that does suggest that the public deficits across the EU are propping up demand just enough to stop a depression scenario. Growth in Europe though extremely weak is positive and there is some evidence that the falling euro is helping exporters. I will provide some separate analysis of this at a later date when more data is available.
But the other side of this “optimism” is the growing threat to the banking system. That is a story that has yet to unfold and will affect all the European banks – not just the GIPSIs. But whichever way you look at it the case that has made for austerity by the IMF and several national governments is unconvincing in the extreme and the very likely impact will be for aggregate demand to slow and perhaps head south. This will do nothing to improve the real aspects of the economy that governments should be focused on.
It will also send the financial ratios, that the maintream economists and their media lackeys are obsessed with, further into the hysteria zone.
Thinking about the G20 and the growing threat of deflation, you quickly realise that this is another one of those aspirational inconsistencies that bedevil the mainstream attack on fiscal deficits.
The Flat Earthers (a.k.a deficit terrorists) want to reduce public debt levels. Some also want to reduce private debt levels at the same time. The latter having in general exceeded the sustainable limits in the last credit binge. However, in demanding that we have a general rundown of debt they usually fall into the accounting trap – that they are seeking this dual goal in the context of a country that runs an external deficit and isn’t likely to go into an external surplus anytime soon, certainly not of the magnitude required to provide counter to the domestic surplus ambitions.
But the simplicity of their argument is what they rely on. Most people find it hard getting their head around the nuances of national income accounting. I realise that. But in the end it is just adding up and subtracting although I acknowledge what is being added and subtracted might give people some grief.
So it sounds right to reduce debt across the board. That sounds like a safe strategy because “too much” debt is bad and any public debt is to be avoided because – the simple message they continually pump out – taxes will rise to pay back the debt and we all hate taxes.
All of these statements regarding public debt are largely false – taxes do not rise to pay back debt unless the government actually imposes that on the economy. Further, debt is rarely paid back and when it is the fiscal drag that is required to pay it back is extremely damaging to the fortunes of all of us private individuals – it reduces our purchasing power and further, puts a liquidity squeeze on us so we have to start selling down our wealth to pay our taxes. Most people in the community don’t realise this however. The commentators never focus on the deleterious effects of running budget surpluses because they have been conditioned to mouth “surpluses increase national saving” without thinking.
Budget surpluses do not increase national saving. It makes no senses to say that a national government, which is sovereign in its own currency, can save in that currency. What does that mean when the government can spend whenever it likes and doesn’t need a stockpile of saving, as in the case of a household, to expand future consumption? It means nothing. Households, save, that is, forgo current consumption to improve future consumption possibilities. That is because they are financially constrained and have to finance all their spending in one way or another. That constraint does not apply to a sovereign government unless they voluntarily impose it. It makes no sense to impose a constraint that prevents the government from actually fulfilling its charter to expand social welfare.
So there are layers of deceptions that litter the attack by the Flat Earthers (a.k.a deficit terrorists).
But there is another deception or ignorance that rarely gets attention. Economies around the remain close to recession at the moment. By introducing austerity packages which aim to reduce deficits the Flat Earthers (a.k.a deficit terrorists) are ensuring that the likelihood of a double-dip recession is increased. One consequence of this is that their policies are likely to increase the deficits and the public debt/GDP ratio as economic activity declines. They have some sort of religious belief that economic growth is going to come out of the bowels of despair.
Somehow, they think that the private businesses worrying about the lack of orders and timid about the future will suddenly appreciate the fact that the government is cutting incomes even further and in a fit of free market zealotry will suddenly start investing again in productive infrastructure even though they don’t have the warehouse space available to store the unsold production that would result.
The other scenario that the religious zealots pray for is a net exports led recovery – for everyone. Again, this fervence defies accounting. Not every country can run external surpluses. Further, to reconstruct an economy from one thathas been running persistent current account deficits into a net exporting country with positive invisibles takes a long time because it involves fundamental structural change – major changes in industry composition and given the wage levels in Asia – major reductions in real wages in the advanced nations. It is simply not going to happen anytime soon.
But the other consequence was picked up by UK Guardian economics correspondent Larry Elliot (June 28, 2010) in his article – G20 accord: you go your way, I’ll go mine.
The sluggish recovery has meant that core inflation in the US and eurozone is already below 1%. They are one recession away from deflation, and perhaps not even that. There is so much spare capacity – particularly in European and North American labour markets – that a marked slowdown in activity rather than falling output would do the trick.
Central banks are terrified by the prospect of deflation, not least because none of them – outside of the Bank of Japan – have any experience of coping with it. They would have every right to be worried. Deflation raises the real level of debt; it would hurt consumers, businesses and – crucially – banks.
Deflation – the Japanese problem – arises when aggregate demand deficiency becomes chronic. The only real way out is with a substantial fiscal stimulus of the order that governments are eschewing.
So who is going to be held accountable for all this policy failure when things go backwards again? The IMF cannot be held accountable because they are not elected and have not constituency.
Australia is also heading south
The Australian Bureau of Labour Statistics released its Job Vacancies, Australia for May 2010 today and the results are not looking good. The summary results are:
- Total job vacancies in May 2010 were 164,600, a decrease of 2.8 per cent from February 2010.
- The number of job vacancies in the private sector was 149,600 in May 2010, a decrease of 1.7 per cent from February 2010.
- The number of job vacancies in the public sector was 15,000 in May 2010, a decrease of 12.3 per cent from February 2010.
The following graph shows the vacancy rate (total vacancies as a percent of the labour force) since February 2005 (quarterly seasonally adjusted data). You will clearly excuse the bank economists and others who are claiming we have a red hot economy and the labour market is booming. It is not and this data while retrospective is consistent with a range of indicators that is suggesting the withdrawal of the fiscal stimulus is not being replaced by a renewed surge in private spending.
Our friend Sean Carmody just alerted me to this story – Moody’s Commercial Paper Rating May Be Cut, S&P Says which says that:
Moody’s Corp., owner of the second- largest credit-rating company, may have its commercial paper ranking cut by its bigger competitor Standard & Poor’s.
S&P today placed Moody’s A-1 short-term debt rating on CreditWatch negative, citing reports that a computer error may have caused Moody’s to give Aaa ratings to debt that didn’t deserve them.
Hilarious. Criminals eating each other up. I recommend a major Moody’s retaliation.
I liked Krugman’s conclusion:
So I don’t think this is really about Greece, or indeed about any realistic appreciation of the tradeoffs between deficits and jobs. It is, instead, the victory of an orthodoxy that has little to do with rational analysis, whose main tenet is that imposing suffering on other people is how you show leadership in tough times.
And who will pay the price for this triumph of orthodoxy? The answer is, tens of millions of unemployed workers, many of whom will go jobless for years, and some of whom will never work again.
It is consistent with the sentiments I expressed last Friday in the blog – Something is seriously wrong. It would be hard to distinguish some of these policy makers and so-called leaders from the characteristics that define extreme sociopaths.
Today (Boston time) I am giving a workshop on fiscal sustainability to a group hand-picked by the host investment fund. My host tells me that the group comprises a financial market participants and venture capitalists. It will probably be a tough audience but I am also told they are not hard-core ideologues and are open to persuasion.
So my goal for tomorrow: Have another 37 people join the Modern Monetary Theory camp and start agitating. There are 37 invitees!
That is enough for today!