Win-win – US budget deficit expands and supports growth and private saving

The Sydney Morning Herald carried an AFP story today (November 14, 2012) – US deficit hits $120b as fiscal cliff nears – which reported the latest US Treasury Department figures which showed that “the US budget deficit rose 22 per cent in October from a year ago, to $US120 billion ($A115.56 billion), as spending far outpaced revenue”. At which point I thought – how lucky the American people are that the Government deficit is still expanding and supporting growth unlike the expanding deficits in Europe which are expanding because of a lack of growth. It is an astounding achievement for the US people. Unfortunately all the signs are that the American polity doesn’t actually understand that their in-fighting, which has allowed the deficits to continue growing, has been good for the nation. Had they actually cut the deficits or failed to pass the debt limit extension, the US economy would be in the doldrums just like Europe. The problem now is that the political debate will reach some conclusion pretty soon and the harbingers of doom are growing stronger. But for the time being with the US budget deficit expanding and supporting growth and private saving it is a win-win.

The article should have stopped at that point. It then had to tell readers “But the sustained deficit continues to push the country’s debt load higher”. Why the use of the word “but”? That shifts the article from being news to opinion and the biases revealed indicate a lack of understanding of what the issues are.

The rest of the report was about how time was running out and not only did the US government have to navigate the “fiscal cliff” but it also would violate the current debt ceiling soon, both events giving the politicians a chance to demonstrate how destructive their ideological leanings might be.

But meanwhile, the substantive information was that the budget deficit rose and supported private saving through continued national income growth.

It is hard to keep track of all the nonsensical articles that are being written at present the desperate need for fiscal consolidation in the US at present.

The Wall Street Journal article (November 13, 2012) – Obama’s Left Flank – claimed that “Everyone talks about Republicans and taxes as an obstacle to bipartisanship, but the liberal delusion that entitlements can be financed by taxes alone is something Mr. Obama needs to address if he wants a successful second term”. To which I muttered – no he doesn’t and no it isn’t. You can match my responses to the appropriate myth, which is an easy task.

On November 12, 2012, a senior IMF official, one David Lipton gave an address at Chatham House, London – Resolving The Crisis And Restoring Healthy Growth: Why Deleveraging Matters? – which rehearsed all the confused narratives that the IMF are presenting to the public as they lose their grip on the national debates in various locations.

The confusion is because the IMF has become a very schizoid organisation with its ideological obsessions being continually confronted with poor predictive performance of their modelling; outright errors in modelling which completely alter the conclusions (the spending multiplier fiasco); and the obvious realisation that their policy recommendations have made matters worse rather than better.

But still they are caught in a vice-like grip by ideology that says one thing while everything else say the opposite. The tension that emerges manifests in statements such as:

… policymakers need the right pace of consolidation in the short term, effective and credible commitments over the medium term time frame, and a willingness to adjust as needed along the way. Deleveraging is necessary, but it should be implemented at a speed and in a way that minimizes the impact on growth.

We read of fiscal consolidation that should be “of quality and as growth-friendly as possible”. Earlier the official admitted that “exiting the crisis requires strong enough demand to restore growth and jobs” and that the private sector needed to reduce its debt levels “which will dampen demand”.

If you decompose the Speech you will quickly find it doesn’t add up. David Lipton said the following:

1. “households need to work off debt, in order to restore their financial position and be ready to cope with the uncertain financial future they now see before them” – which means the household sector will be seeking to spend less than it earns. That means, in Lipton’s words, that this “means higher saving, lower consumption, and other things equal an economic slowdown”.

2. “banks need to deleverage, … [and] … If banks cut back assets by tightening their lending, credit to the private sector will decline, hurting those that are most dependent on bank lending (i.e., SMEs and households), which also undercuts recovery”. So the investment climate will be subdued.

3. This reality would require the “public sector … to be countercyclical … But the high public sector indebtedness in advanced economies, adds a constraint, and requires major, sustained consolidation over the medium term if countries are to restore the soundness of their finances, rebuild fiscal space, and lay a foundation for sustained long-term growth.” Which means he is advocating budget surpluses.

The statement is full of myths. The concept of fiscal space has no meaning in the context of a currency-issuing government.

The IMF defines fiscal space as the:

… room in a government´s budget that allows it to provide resources for a desired purpose without jeopardizing the sustainability of its financial position or the stability of the economy. The idea is that fiscal space must exist or be created if extra resources are to be made available for worthwhile government spending. A government can create fiscal space by raising taxes, securing outside grants, cutting lower priority expenditure, borrowing resources (from citizens or foreign lenders), or borrowing from the banking system (and thereby expanding the money supply). But it must do this without compromising macroeconomic stability and fiscal sustainability – making sure that it has the capacity in the short term and the longer term to finance its desired expenditure programs as well as to service its debt.

They both assume that the government has the same constraints that restricted governments during the gold standard when currencies were convertible and exchange rates were fixed.

In a fiat monetary system, these concepts of fiscal space ignore the main points which are:

• A sovereign government is not revenue-constrained which means that fiscal space cannot be defined in financial terms.
• The capacity of the sovereign government to mobilise resources depends only on the real resources available to the nation.

So a household, for example, as the user of the currency has to save now if it wants to expand its spending possibilities in the future (other things equal). That is because it faces a financial constraint and has to fund all spending.

An equivalent concept for a government that issues its own currency cannot be meaningfully defined. Such a government can spend what it likes in each period irrespective of the budget position in the last period. The claim by Dr Lipton that high public debt ratios “adds a constraint” is without meaning.

He is attempting to reinforce the following claim – that government has match their deficit spending with bond tenders to the private market because they need the funds before they can spend.

In that context, if the debt levels get too high, the private bond markets will become skittish and funds might dry up – hence the claim of a constraint.

However, this claim is never questioned or up for debate but which tumbles down once probed in the right way.

Not only is this practice is voluntary and has only really been such in the last several decades of neo-liberalism but the reality is that the governments just “borrow” back what they have already spent in some prior period – dollar-for-dollar. The assets that the non-government sector has available which allows it to purchase government debt come from prior deficits.

Further, as have seen across many jurisdictions in recent years the practice has broken down anyway. Even with all the institutional practices in place to force governments to act in this way. The US Federal Reserve, for example, has purchased a high proportion of US Treasury debt in recent years. The Swedish central bank altered its internal rules to allow it to generate liquidity at will.

Moreover, for a currency-issuing government, the bond markets are always subservient to the intentions of the consolidated Treasury-Central Bank. The latter can always dictate terms and would do so if the necessity arose.

It is only in situations where the bond-issuing state does not issue its own currency that the power swings to the private bond markets. But even then, the relevant central bank (for example, the ECB) can run the bond markets out of town, which in the ECBs case – it has in the case of Greece and to some extent Spain, Italy and Portugal.

So there is no financial constraint on governments as a result of its debt ratio – whatever level that should be.

The only constraint is whether there is real space for the government to operate in. Real space is about the availability of real productive resources for purchase. With millions of workers currently unemployed there is no way that national governments are up against a real resource constraint.

When a nation is operating at full employment then the government makes space to spend more by taking space of the non-government sector via taxation.

Back to Dr Lipton. His fourth claim was:

… amidst a vibrant global economy, we might expect external demand, perhaps bolstered by currency adjustment, to allow all three parties, households, banks, and public sectors, to de-lever at once without dire growth consequences. But in the current setting, where so many countries find themselves facing similar circumstances, what we have seen is that fiscal consolidation alongside private sector deleveraging, has dampened demand, and the near-term effect on activity has been larger than anticipated in several countries.

That is, the external balance will not be in sufficient surplus to maintain nominal spending growth such that tax revenue will more than offset government spending and households can save even with low investment rates (implying the private domestic sector is saving overall).

This is an admission that export-led growth strategies when the private domestic sector is not contributing to spending growth and the public sector is seeking to reduce its deficit, will fail. En masse such strategies have to fail because export growth requires import growth and the latter dries up when the domestic economy is shrinking.

Please read my blog – Fiscal austerity – the newest fallacy of composition – for more discussion on this point.

That admission makes you wonder why the IMF hasn’t come out and admitted their entire European strategy is doomed to fail. Why are they continuing to impose massive hardships on an increasing pool of unemployed if they know the government and private domestic sectors cannot simultaneously run surpluses when each country attempts to do that?

Such a strategy, as Dr Lipton implies (without teasing out the implication) is doomed to fail because it violates all macroeconomic principles that ultimately spending creates income and the income variations will not allow all balances to be in surplus (as a matter of accounting).

The first part of Dr Lipton’s speech thus sets out in a fairly poor way – but the argument is there nonetheless – that growth is necessary to resolve the crisis and with the private sector deleveraging and the external sector not capable of driving income growth under current circumstances, the process of fiscal consolidation is fraught and if pursued will damage growth further.

But, moreover, he notes that “as Keynes warned with his “paradox of thrift,” in the short-run repairing household balance sheets means higher saving, lower consumption, and other things equal an economic slowdown”, which, in turn, means that attempts to cut public deficits will likely undermine the private households intentions anyway.

Unfortunately, Dr Lipton skims over the impossibility that every sector can save as the ideological position of the Fund re-asserts itself in his speech. His fiscal policy recommendations are largely inconsistent and based on meaningless concepts.

For example:

Where financing conditions permit, fiscal consolidation should be gradual and sustained, guided by structural targets. In case of large negative shocks or growth disappointments, the pace of consolidation should be smoothed in countries that can afford it.

What does “financing conditions permit” mean? As noted above, governments in tandem with their central banks can generate any bond market conditions they like if they so choose.

So these alleged “constraints” only appear if we accept that the government would not choose to engender conditions advantageous to its socio-economic charter. Why would any government voluntarily undermine its own position by playing a charade that it can avoid? The answer is that they play the charade because it doesn’t impede them and when it does start to impact negatively they alter the game very quickly.

Only the non-currency issuing governments are stuck.

What does “afford it” mean? For any currency-issuing government it means nothing. Does Dr Lipton truly believe that a currency-issuing government could not instruct its central bank to credit various accounts to pay the wage to anyone who wanted to take advantage of an unconditional job offer? Does he truly think that the dollars in the accounts would bounce?

The answer is he knows governments could do that. He would then introduce his real objections – about the desirability of public employment etc. Most of which would reflect ideological hang-ups rather than any economic substance.

The reality is that when there are millions of workers idle because there is not enough aggregate demand, a public employment program will always increase efficiency of resource use no matter what the workers really do.

Dr Lipton then claims that:

Fiscal adjustment … should be of quality and as growth-friendly as possible.

Which I noted at the outset.

When the external sector and the private domestic sector cannot support economic growth, fiscal consolidation (meaning cutbacks) can never be “growth-friendly”. That spineless term that has crept into OECD, EU and IMF documents and speeches in the last year or so has no validity at all.

Fiscal consolidation, in that context, will always damage growth. Spending equals income. If the non-government sector cannot drive income growth then there is only one sector left to pick up the slack. It is basic and indisputable.

Conclusion

The IMF and other multilateral organisations know full well that they have advocated policies that have caused the crisis to be deeper and longer than should have been the case.

They have admitted their modelling, which has been used to force governments to deliberately render millions of workers without work, was false and the actual situation was the opposite to what they claimed.

They have bullied governments into adopting highly damaging policy stances using optimistic forecasts that were just unachievable from the day they were published.

They know all that. But their ideological bias is so strong that they have to address that failure with spineless chatter about growth-friendly fiscal cutbacks in the face of highly depressed non-government spending positions.

It is time that the leading governments of the world did do some fiscal trimming by way of altering the composition of their fiscal outlays. And at the top of the list after cutting all support to Wall Street (and similar) bankers around the world and support to companies that manufacture death (the military establishment) should be all funding to the OECD, IMF and World Bank.

Then a new multilateral agency should be formed to reduce inequality and oversee major public works programs in nations suffering widespread unemployment and poverty.

That is enough for today!

(c) Copyright 2012 Bill Mitchell. All Rights Reserved.