When markets fail

A repeating narrative during this crisis is that fiscal austerity is required in order to satisfy the “markets”, that amorphous collective of bond traders, gamblers, speculators, crooks and whatever else. The regular threats coming from the ratings agencies (those crooks who lied to investors in order to make profits via cosy deals with the originators of the “assets”) reinforce the idea that markets are the “regulators” of good judgement. Economics students are taught that one of the imperatives of government is to deregulate in order to allow the market signals to be clear and strong so we can act in accordance with the “markets” judgement of prudence. It is a paradigm built on a myth. Markets fail and easily become corrupted and arenas where criminals dominate. The signals they send are also deeply flawed and should not be acted upon. One of the lessons of this crisis is that our agents – the governments we elect – have to make markets work for us not the other way around. When markets fail to establish benchmarks that we do not consider to be in our best interests then it is time to reform them.

Think about what is going on at present. Around the world there are millions of people without jobs and most of them are eking out an existence on diminished incomes via public transfers. Many have no income at all and when their savings evaporate and they have sold their remaining assets – poverty beckons. The crisis is impoverishing millions who had previously enjoyed secure, middle-class lives.

And then what about the less developed countries – they didn’t even get to “middle-class” status and the World Bank research shows that poverty rates rose sharply in the poorest countries as a result of the crisis.

Meanwhile, the financial sector is still paying huge bonuses while at the same time governments are claiming that they have to invoke harsh austerity which will kill growth for the next decade.

And all of this damage and loss – which is totally unnecessary from an economics perspective – is being justified by the claim that the we have to adopt “fiscal conservatism” which:

… simply means that those from whom the state borrows can have absolute confidence that it will meet its obligations to repay, come what may.

Come what may? For non-native English readers out there “come what may” is a cute English expression which means in this context “at whatever cost”. It will surprise you when I reveal the source of that quote.

But the message is very clear – the “markets” have to be obeyed at whatever “real cost” to the economy. When those real costs are massive – as they are now and will continue to be for the next decade or more – wouldn’t it be sensible to ask whether the “markets” have actually got it right?

There is also the small issue of which market signal to take into account. How do we interpret the “market” judgement in Japan over the last two decades in relation to “fiscal conservatism”?

One could hardly say that the Japanese government has imposed fiscal austerity on its people over that time and it now has the highest public debt ratios. Yet the “markets” continue to soak up yen-denominated government paper at very low yields. What signal is being sent there?

The US government has expanded its public debt ratio considerably in recent years but yields remain low and when the ratings agencies downgraded their assessment of the US sovereign debt the demand for it rose. How do we interpret that signal from the “markets”.

The Euro governments are in a different camp altogether. All those who actually understand that the member governments are using a foreign currency and thus are not at all like Japan, the US or the UK governments, appreciate that their is default risk attached to the paper issued from the EMU governments.

They also appreciate that with the Euro bosses insisting on a decade or more of austerity and implementing fiscal rules that will ensure there is a crisis every time there is a serious downturn in aggregate demand, the risk of default with government debt has risen.

But the signals that are being sent can only reasonably be interpreted as saying that the Eurozone is a mistake rather than that governments should impose further austerity.

So there is nothing clear about the signals that the “markets” send anyway other than they seem to be able to distinguish between a sovereign government and a government that uses a foreign currency.

Notwithstanding all this uncertainty, the general point is that if the governments are deliberately imposing a period of recession or entrenched unemployment on its citizens because they think that is what the “markets” want, then it is clear that what the “markets” want is unacceptable and should be ignored. Suitable policy interventions could then be designed to render the “market” impact benign.

For example, how much national income has to be lost to austerity before the obvious question is asked – which is, if a nation issues its own currency why would it accept the dictates of a narrowly-focused sectoral interest group in the economy (the bond markets) which uses that currency?

Another way of saying that is – why pretend that our governments have to borrow before they can spend (thus empowering the “markets”) when in fact – in an operational sense – the government only borrows back what it has already spent anyway?

There is never a reason to impose harsh real losses on people in the name of the markets. That is a neo-liberal (right-wing) construct. There is no need ever to devolve influence to the bond markets. They use the currency and desire government bonds as a risk-free asset upon which to benchmark (price risk) other derivative (risky) assets that they seek to gamble with.

Most of the assets they deal in (and make huge profits from) do nothing at all to advance real welfare gains in the society. Most of the financial market transactions (overwhelmingly) are unproductive and just amount to wealth shuffling. The financial markets are just a huge casino. We invoke pejorative overtones when we think of a low-income worker spending all his/her income on poker machines in dingy casinos or clubs. But we seem to ignore the “suits” who do exactly the same thing, albeit in more salubrious surrounds in the “City” or on “Wall Street”. Of-course, in the latter case, the stakes are multiples of the pennies that workers gamble with.

Larry Elliot touches on these themes in the UK Guardian article (December 12, 2011) – Eurozone crisis: hopes of recovery recede while recession looms. He quotes the head of the Bundesbank who in justifying the tight monetary policy position of the ECB said that:

… central banks risk diluting “the incentives that come from the market” when they intervene.

But Larry Elliot also suggests (quoting another commentator) that the markets get it wrong:

… there is strong evidence that the signals are wrong – or at least, exaggerated. It follows that any policy taking its cue from the market will also be wrong or exaggerated. Specifically, if governments are compelled to impose austerity to regain an irrational loss of investor confidence, then the market would needlessly turn Europe’s incipient recession into something very nasty.

With forecasts suggesting the Eurozone will go back into recession through 2012, Britain close behind and the growth engines of Asia faltering (via their trade channels with the advanced world) surely it is time that new ideas to emerge that challenge this mainstream view.

The mainstream austerity line is trapping the world in a dangerous downward spiral of lost income and increased unemployment. Larry Elliot says our principle policy tools which we should use to advance prosperity and deploy in a counter-cyclical manner (“macro-economic and regulatory policies”) are now becoming:

… pro-cyclical, the tendency of those in charge to carry on digging when they are in a hole. So in the eurozone, countries already suffering a deficiency of demand are told to deflate their economies still further, making it impossible for them to hit deficit reduction targets. Similarly, banks are being told by the regulators to build up much bigger capital buffers to make them safer, a policy that would have had great merit during the boom but, by restricting credit flows to firms, makes another downturn more likely.

So are there any challenges to this orthodoxy? Well, you would not start looking for any new ideas emanating from the British Labour Party – that is for sure.

In this UK Guardian article (December 12, 2011) – EU veto a ‘diplomatic disaster’, claims Miliband – we learn that the Labour leader in the UK thinks that the British government should have signed up for the proposed Treaty change in Europe (aka We won the War!).

Apparently, Ed Miliband said that the British Prime Minister had made:

… the worst mistake by Britain in Europe for a generation after abandoning the country’s place at the top table.

He was quoted as saying “Many people feared an outcome of 17 countries going it alone. Few could have anticipated the diplomatic disaster of 26 going ahead and one country – Britain – being left behind.”‘

What? The Eurozone (and its 9 other hangers-on) have voted to leave themselves behind by imposing impossible fiscal rules on themselves. The rules will fail but the attempt to impose them will be extremely damaging.

As I noted in yesterday’s blog – It became necessary to destroy Europe to save it – the only reason that Britain will follow Europe down the recession “gurgler” is if they continue with their misguided (and unnecessary) austerity plan.

Even if Britain’s trade sector slows as a result of the European fiscal austerity it has the capacity to generate domestic growth via fiscal expansion. David Cameron’s decision to avoid the new fiscal austerity rules in the EU was sound.

Larry Elliot (in the article previously mentioned) made the excellent observation in this regard:

The real reason for objecting to the creation of the Herbert Hoover Appreciation Society (or fiscal stability pact) created by Angela Merkel and Nicolas Sarkozy is that it condemns Europe to permanent deflation and high unemployment, so the prime minister may well have made the right decision for the wrong reasons.

That accords with what I concluded in yesterday’s blog.

Which brings me to “Black Labour” or “in the black labour”, which is presumably influencing Miliband and the political arm of the British Labour Party.

Black Labour is not a progressive movement

Regular readers will know that I occasionally run a series – When you’ve got friends like this … Part X – where I discuss the ideas proposed by commentators which have progressive motivations but often fall back in erroneous neo-liberal macroeconomic thinking.’

I get a lot of criticism via E-mail about those blogs, mostly along the lines that the differences between MMT and these so-called progressive ideas are not large and so solidarity is better than not so as to focus on the enemy.

I have some sympathy with that view but ultimately when ideas can be reduced back to neo-liberal constructs or are just an inaccurate depiction of the way the system operates then I think the record should be set straight.

I acknowledge though that the motivations of these “friends” is usually close to the values that I share.

However, sometimes I read work from self-styled centre-left commentators who I consider to be neither progressive nor “friendly”. Black Labour fit into that category.

So what is this emerging “in the black” approach that seems to be getting supported in the “progressive” media and is claiming to stake out the progressive response to the financial crisis.

At this stage, let’s get a bit scientific and invoke the famous Duck Test which goes like this:

If it looks like a duck, swims like a duck, and quacks like a duck, then it probably is a duck.

The variant is the “neo-liberal disguised as a progressive” test which says – when an organisation tells you it is progressive but then says that fiscal conservatism simply means that those from whom the state borrows can have absolute confidence that it will meet its obligations to repay, come what may – then that organisation is right-wing and neo-liberal in orientation”.

Which means – it is not progressive!

The UK Policy-Network recently published (December 2, 2011) a policy brief – In the Black Labour – which “aims to start a debate in the Labour movement on how to achieve fiscal sustainability”.

The title of the Policy-Network document says it all – they want budgets to be in surplus and claim that Labour should “embrace fiscal conservatism” and that “Labour’s ability to advance social justice can go hand-in-hand with a clear, fiscally conservative stance”.

It is clearly a UK-centric document but the way of thinking advanced is consistent with what is happening to “labour-type” political parties throughout the World.

In Australia, the Labor government is already embracing this “in the black” approach and are destroying their electoral prospects and will become a minority party in the coming years unable to govern in their own right.

They fail to understand that by embracing the key agendas of the conservative parties and offering so-called “light versions” of neo-liberalism the electorate will always prefer the real thing – that is, the conservatives.

I think the politics of this approach is deeply flawed. But I also acknowledge that politics is a matter of opinion and ideology. Further, I am not a political scientist so it is always better to stick to what you know – which in my case is macroeconomics.

On that terrain we can discuss some “facts”. I consider the proponents of the “in the black” approach do not even understand some basic macroeconomic facts which leads them to propose an economic framework that undermines the capacity of the national government to pursue progressive public purpose programs (5Ps).

A progressive position has to start from a sound macroeconomics footing which excludes the neo-liberal concepts of fiscal conservatism.

Fiscal policy has to serve public purpose which includes ensuring there are enough jobs available for all those who desire them

Under some circumstances (rarely found) that use of fiscal policy may produce financial aggregates and ratios that a “fiscal conservative” would be happy with.

In normal times (with external deficits and private domestic saving) budget deficits will be required which horrify the “fiscal conservatives”.

The point is that “in the black” presumes that a certain fiscal outcome – a surplus – is desirable independent of what else is happening in the economy. The focus on the financial ratios etc diverts attention away from what matters and promotes concepts and measures that are largely irrelevant.

The “Black Labour” discussion paper asserts that:

There is nothing right wing about fiscal conservatism. It simply means that those from whom the state borrows can have absolute confidence that it will meet its obligations to repay, come what may.

Often I get E-mails which claim that MMT is a left-wing approach which will always run up against the taint of socialism etc. The claims say more about the irrational paranoia (and misconstruction) of socialism in the US and elsewhere than the validity of the claims.

MMT is neither left- or right-wing in terms of their usual meanings which relate to how much “market-allocation” occurs.

MMT, in part, describe how monetary systems operate and what the macroeconomic consequences will be of certain actions.

I might advocate a certain policy mix which is skewed towards equity, for example, which might suggest I lean to the left.

But I could equally advocate austerity and redistribution of national to profits and the reduction in government activity which would suggest I leaned to the right.

Whichever way I leant, if I understood MMT, I would be able to predict the consequences of my ideological poicy choices.

In the “right-wing” case – I would realise that harsh cuts in public spending without a commensurate increase in private spending would lead to higher unemployment and rising poverty. I might be happy with that outcome but at least I would not have the temerity to claim that a “fiscal contraction expansion” was likely.

So in that sense, MMT is neither left- or right-wing.

However, fiscal conservatism – as a “fiscal rule” – leans to the right because it suggests under most circumstances there will be less public sector activity and more private activity.

But it becomes firmly “right-wing” when you realise that “Black Labour” is advocating sovereign governments continuing to borrow from bond markets as if the causality runs from the preferences and judgements of the bond markets to the capacity of the government to spend.

That is a firmly “right-wing” construct. It assumes that the “market signals” are appropriate to the well-being of the people. As discussed above – if austerity is really what the “markets” wanted then, given the massive real damage of that policy approach which will extend for years to come – we would be sensible to challenge the wisdom of the “markets”.

The reality is that a sovereign government never needs to borrow to spend. In fact, it only borrows at present what it has already spent.

To fully understand that point, the following suite of blogs – Deficit spending 101 – Part 1 – Deficit spending 101 – Part 2 – Deficit spending 101 – Part 3 – provides some guidance.

Bond markets are essentially parasitic institutions who seek risk-free annuities (government bonds) which they then use as a benchmark to price riskier private debt instruments. There are other reasons why the private sector seeks government bonds but they don’t change the argument.

As I explained in this blog – Who is in charge? – the sovereign government is always able to control the terms at which it issues debt to the bond market.

My view is that a truly progressive position would eliminate debt issuance leaving central banks to control its target interest rate via liquidity management via the offer of a return on excess reserves should a non-positive overnight interest rate be seen as being desirable.

A progressive view would never argue that a democratically-elected government should manage its fiscal position to the satisfaction of a narrow-interested sector in the economy (bond markets) when there is no reason to issue debt in the first place.

So in this opening gambit by Black Labour, which is aiming to challenge stereotypes, you see the right-wing ideology inherent in their approach.

The situation is of-course more complicated than a simple right-left dichotomy. In that regard, I recommend a visit to the The Political Compass which explores some of these complexities.

The Black Labour discussion paper continued to argue that:

This means adopting an approach which is careful, risk averse, and cautious.

As if the government budget is a time bomb? That is also a neo-liberal right-wing construct. The only macroeconomic risk associated with the use of fiscal policy in inflation. That risk is associated with any component of spending – public or private.

But the Black Labour argument is that governments have to make sure that bond markets are happy and thus cannot afford to take decisions that would put the bond markets off-side.

What do they think the bond markets would do?

1. They cannot drive up yields on government debt unless the government allows them to.

2. They cannot stop governments from spending in its own currency unless the government allows them to.

3. They cannot cause a recession unless the government concedes to that direction.

So what is it that the government has to be cautious about in relation to the bond markets? Answer – a progressive position would understand that the bond markets operate at the behest of the government not the other way around.

Thus, governments should adopt an approach – first and foremost – that maximises public purpose. That is neither risky or non-risky. There is certainly a need for governments to design policy interventions that do not waste the real resources they engage. But that is a different point.

Then we get the further assertion from the Black Labour discussion paper:

More importantly, Labour’s ability to advance social justice can go hand-in-hand with a clear, fiscally conservative stance.

That is one of the myths that is being circulated by these “progressives” – that you can have your cake and eat it. The evidence is patently obvious – fiscal austerity is only possible if the government cuts into public spending. It is very difficult to advance social justice when the public sector is being cut back and private demand is collapsing and unemployment is rising.

Rising unemployment is the anathema of social justice. Deliberately maintaining high unemployment in the name of “fiscal consolidation” is to deny social justice.

The Black Labour discussion paper rehearses all the standard neo-liberal arguments. They adopt the “deficit-dove” position by saying that when “there is a major absence of private sector demand, the government must fill the gap; not just to keep the economy growing but to protect long term fiscal sustainability” but:

… being in a position to respond to a crisis requires preparation, usually by avoiding deficits in the good times. As Ed Balls said “left-of-centre governments need to favour tough fiscal policy because from time to time, if economic crises occur, you may have to relax that. But you have to build up the credibility and the means to do so”. In other words, effective Keynesianism requires fiscal conservatism.

That is nonsense.

In technical terms, the government’s balance will be the mirror image of the non-government. So if the non-government sector is in deficit the government sector can run a surplus.

The non-government sector is the sum of the external and private domestic sectors. If the current account is in deficit (external sector) then the private domestic sector will also be in deficit (that is, accumulating debt) if the government runs a balanced budget. These are national accounting outcomes rather than opinions.

The crisis was brought on by excessive private sector debt accumulation. The growth that preceded the crisis was largely driven by credit. It was unsustainable.

So to argue that it is desirable for the government to balance its budget over the business cycle is equivalent to saying (for external deficit nations such as Britain) that you want the private sector to be continually accumulating debt and driving growth via credit (exploiting foreign savings).

That is the sort of thinking that created the crisis in the first place.

It is rare that a nation is in a position to sustain growth and sustainable private sector debt positions with government surpluses. It is more typical for budget deficits to support the desire by the non-government sector to save overall.

The point is that a progressive position should not dictate “fiscal rules” other than that the government should use its fiscal capacity to ensure there is full employment. If that requires continuous budget deficits given the behaviour of the other sectors then so be it. That would be a responsible fiscal position to adopt.

Moreover, it is technically incorrect to claim that running a budget surplus today gives the sovereign government more capacity to respond to a crisis tomorrow. A sovereign government can always run a discretionary deficit irrespective of its fiscal stance in previous years.

There is no more or less capacity (fiscal space) today from running surpluses yesterday. The (non-inflationary) fiscal space is determined by the state of private (non-government) spending vis-a-vis the real capacity of the economy.

If there is a spending gap then the government can always and should always fill it to prevent a loss of income and output.

The Black Labour discussion paper continues down its neo-liberal path by introducing the ageing society myth:

The debate about this government’s current fiscal policy may be raging but far less attention has been paid to what comes next. The Office for Budget Responsibility (OBR) has made clear that even if the structural deficit is closed, Britain faces a major fiscal challenge over the coming decades as a consequence of demographic pressures and falling tax revenues. All the parties need to calibrate their plans to this reality, including Labour.

This is the classic myth that is used by neo-liberals to constrain public sector activity.

This proposition is based on the erroneous ageing society debate which tries to reconstruct a real challenge into a financial problem. The constraint that the ageing society will place on us is one of – the availability of real resources.

As long as we don’t use up all the real resources now it will be possible for any sovereign government to deploy them (by government spending) for use in the future. There will never be a financial constraint preventing the government from purchasing whatever is for sale in the currency of issue.

The question about what will be made available in the future and to whom, assuming there are real resources, is a political one and will be resolved accordingly.

The rising dependency ratios that will accompany the ageing society present a productivity challenge – how to ensure there are enough products available to meet the demands of the population.

Running surpluses now will also undermine the capacity of the future generations. Real investment in capacity building now is the best thing our national governments can do for the next generations.

Fiscal austerity which entrenches unemployment – which denies the younger workers the opportunity to acquire work skills – is the anathema of a plan for the future. By deliberately refusing to create full employment, out governments undermine our future prosperity.

The ageing society is not a fiscal challenge.

Please read my blogs – Democracy, accountability and more intergenerational nonsense and Another intergenerational report – another waste of time – for more discussion on this point.

The Black Labour discussion paper then introduces what it thinks are three key insights:

First, extra resources spent by the government must be backed by tax revenues and the fruits of economic growth. If we want to collectively fund something, we’ve got to collectively pay for it.

Second, spending is not the only way to secure improvements in our country and the lives of its people. In fact it is often the least good way to do so. Structural or institutional reforms, which affect the causes of inequality and injustice, are often better – and invariably more enduring.

And third, confronting the reality of limited resources reveals priorities as the true currency of politics. In the coming years, the central distinctions will be about what the political parties choose to spend scarce funds on as much as the total they plan to spend.

None of these statements provide any insights at all that could guide a progressive position.

First, governments do not spend “resources”. The currency comes from no-where and government spending does not have to be “backed” by tax revenue. The correct emphasis is on the real resources that government spending brings into use (or in times of full employment – diverts from other uses).

The financial details that surround these real actions are largely irrelevant.

At full employment, society “pays” for government resource deployment by giving up the private use of those resources. That becomes a political issue – do we want that mix of public and private activity?

Below full employment – there is very little “real” cost of providing a public sector job to a worker who cannot find a job elsewhere. Such a worker is at zero bid in the private markets.

Second, no-one considers that government spending is the panacea for everything. But from a macroeconomic perspective, aggregate demand has to match the supply potential of the economy if we are to have full employment. Government spending must ensure that this equation is maintained over time irrespective of what else it does in a compositional sense (alternating different sectoral (or individual) claims on real output).

Third, political parties (in government) do not spend “scarce funds”. Real resources might be scarce from time to time (and certainly are at full employment). But government spending is not “scarce”. A sovereign government can spend whenever they like and have unlimited (minus a cent) capacity to do so.

That doesn’t mean that government spending is not constrained. The relevant constraint is the spending gap left by the non-government sector.

Conclusion

Overall, the Black Labour discussion paper presumes without comment, critique or justification that the current neo-liberal obsession about public debt ratio and deficits will set the constraints into the future for all governments.

It implicitly assumes that the “market” judgement should be the guide when it is clear that markets become corrupted and fail dramatically.

If that is the best the “centre-left” can come up with in Britain – in the face of a massive failure of the mainstream to explain or manage the crisis – then Gxd help us!

Modern Monetary Theory (MMT) demonstrates the errors that arise when we become obsessed with financial ratios. For example, by trying to reduce the budget deficit via austerity to reduce public debt ratios, it is clear that under most circumstances, the strategy ends up reducing growth and the financial ratios move in the opposite direction to that desired (even if that desire is erroneous).

MMT presents a strong alternative way of thinking about the economy which then gives scope for progressive or even right-wing ideas to be applied – with the necessary consequences being clear.

But a progressive position surely should emphasise renewed leadership which includes public education and the resistance to the idea that the “market” judgements (signals) are worth following – come what may?

I have to catch a flight now (sorry for flying again).

That is enough for today!