Currency-issuing governments have unlimited financial resources to fight recession

The elites are gathering for another junket aka the World Economic Forum, in the frosty, but salubrious surrounds of Davos this week (January 20-23, 2016). The Monday morning temperature there is forecast to be -22°C. According to the Forum’s homePage – Searching for the 21st century dream at Davos – the delegates are going to be reimagining life under the theme “Mastering the Fourth Industrial Revolution”, which is spin for eating a lot of gourmet food, drinking a lot of expensive wine, and, denying the presence of the very large elephant in the conference venue. I suppose it is easy for them to live in denial when the sort of policy regimes they have influenced have categorically failed and will continue to do so with the result that millions remain unemployed and poverty rates are rising. Apparently, the elites have to “‘defetish’ … dialogues about future technologies” and the “onset of a new era of ‘limits’ is a chance we must not miss to imagine and engineer the futures we want”. Here is some gratuitous advice to the elites – forget the robots; forget worrying about the so-called “inflection point … where social, economic and political crises meet rapid technological change, where progress feels like disruption, not promise”; and, instead, more fully understand why this obsession with “a new era of ‘limits'” (by which they mean fiscal limits on governments) has sidetracked any hope of progress and deliberately disrupted people’s lives in a way that dwarf the impacts of technological change.

The Davos theme “Mastering the Fourth Industrial Revolution” would be hilarious if the consequences of the actions that follow these meetings had not been so disastrous for common folk. The idea that these elites have ‘mastered’ anything other than ripping off workers to further their own nests is a sick joke.

I’m not suggesting that the challenges of technological change are not significant. I have done around of radio interviews in the last week discussing the likely impacts of computerisation on patterns of regional employment (following a New South Wales Parliamentary Library report on the topic).

We are likely to miss the boat on dealing with these impacts because they will require significant public-sector involvement in terms of direct employment, targeted industry policy, coherent regional plans, and significant fiscal outlays.

All of which represent the anathema of the current policy orthodoxy, which makes up so-called financial “limits” on necessary public policy initiatives.

Last week (January 6, 2016), the Royal Bank of Scotland issued a report – The bears have killed Goldilocks – which predicted a “cataclysmic year ahead”, which would be:

– bad for global earnings
– bad for global equities
– bad for corporate balance sheets
– bad for global credit spreads
– bad for commodities

Remember, that this is the same bank that failed in 2008 and was mostly nationalised in October of that year when the British government took a majority share holding in exchange for a public money injection of £20 billion. RBS would have collapsed had the British government ‘left it to the market’ to sort out the bank’s management failures.

As an aside, the out-going RBS Chief Executive, who was forced to resign as a consequence of the bank’s failure, pocketed a tidy £2 million payout including a very handsome pension, for his troubles.

In November 2009, the British government via its company – UK Financial Investments – upped its RBS shareholding to 83 per cent. As new issues have occurred since and UKFI have sold some shares, the holding now stands at 73 per cent.

We should also remember that RBS is also liable for massive fines (around £4.5 billion) “in the US over sales of toxic mortgage-backed securities before the financial crisis” (Source).

With all that in mind, trust is not something that runs high when using RBS (predictions or conduct) in the same sentence!

Perhaps, their strategy is engage in some reverse psychology and get everyone thinking it is time to buy financial assets which will boost their own speculative income.

Whatever, what RBS does is less the issue here.

The headlines were that RBS was advising their clients to “Sell (mostly) everything” in the context that trade and credit growth would be negative in the comine period and that:

The world has far too much debt to be able to grow well – global output gap widens

Their conclusion is that with trade and credit in retreat and the “end of the willingness to build up” more debt:

… there is no-one left to take up the baton of growth.

Perhaps the writer should consult their share register and see who owns the company!

To reinforce the RBS claims, the report uses the former president of the Dallas Federal Reserve Bank, Richard Fisher as an authority.

He told the US TV network CNBC on January 5, 2015 (Source) that:

The Federal Reserve is a giant weapon that has no ammunition left. What I do worry about is: It was the Fed, the Fed, the Fed, the Fed for half of my tenure there, which is a decade. Everybody was looking for the Fed to float all boats. In my opinion, they got lazy.

Like the RBS, Fisher hasn’t got a good record himself.

Remember back to January 2008. The – FOMC: Transcript January 29-30 Meeting – attests that Fisher told the Federal Open Market Committee (which sets monetary policy in the US) that:

… none of the 30 CEOs to whom I talked, outside of housing, see the economy trending into negative territory … None of them … see us going into recession … [but on inflation] … That is my major concern besides the additional weakness we are seeing in the economy.

He is on record as rejecting the need to lower interest rates as the housing crisis was unfolding.

His belief that the major fear in 2008 was inflation now stands as a condemnation of his judgement.

The “run out of ammunition” argument is continually rehearsed in the financial and economics media.

Even my journalist friend, Peter Martin, Economics Editor at the Fairfax Melbourne Age, chose to emphasise this sort of myth in the headline of his article (January 15, 2016) – Australia has few tools left to fight recession, warns leading forecaster Stephen Anthony.

He quoted a private industry and consulting economist who claimed that:

In January 2008 gross government debt totalled just $55 billion. It’s now $415 billion, or 25 per cent of GDP, giving the government less room to borrow more without alarming rating agencies

And that is it in a nutshell. The so-called ‘limits’ that the Davos press release claims exist are not limits in any reasonable sense of the concept.

The continued claim that what the ratings agencies might think is important for determining the fiscal choices made by government is one of the worst of the myths that the neo-liberals have created to constrain public intervention into the economy that doesn’t directly benefit the elites.

Just ask Japan what it thinks of the rating agencies! Their sovereign debt has been downgraded several times over the last decades with zero impact on their capacity to issue debt in the private bond markets.

Just ask the United States Treasury what it thought the impact on its yields were following the downgrading recently of its sovereign debt rating. They will answer: no impact.

Please read my blog – Who is in charge? – for more discussion on this point.

In this context, the RBS Report is correct when it says that Richard Fisher:

… is not strictly correct because the Fed has limitless ammunition, it has just chosen to take its bullets home rather than deploy them.

But, then, this is not strictly correct either given that where the US central bank has chosen to direct its policy capacities is not where I would have engaged. By that I mean, the various episodes of quantitative easing, which were based on the flawed belief that the commercial banks would not lend unless they had more reserves.

Please read my blog – Quantitative easing 101 – for more discussion on this point.

The policy impotence of governments was also echoed by the UK Guardian article (January 17, 2016) – Davos delegates with heads in the clouds must tackle financial crisis on the ground – which quoted another investment banker as saying:

… we are teetering on the brink of a fresh crisis, what tools are policymakers left with? When interest rates are at, or close to, record lows, what levers can central bankers possibly pull?

There is that elephant again!

Central to the current negative analysis in the RBS report and other doomsayer predictions is the slight slowdown in the Chinese economy.

The RBS economists claimed the from the World perspective, this slowdown meant that “the game is up. The world is in trouble.”

Why?

In addition to the conservative belief that only monetary policy should be used as a counter-stabilisation measure because fiscal policy has no ‘room to move’, the other myth is that the only sustainable growth engine is via trade.

In other words, if China slows down, world export markets also slow down, given the strong demand in recent years from China for primary commodity and other exports, which means that economic growth stalls.

Which means that external income (spending) will taper somewhat and economic growth will become more reliant on domestic demand. That means that household consumption, private capital formation (investment) and government spending will become more important.

In most nations, household consumption has revived somewhat after falling off during the GFC. The problem is that real wages growth has not returned to any reasonable levels and trails productivity growth by some percentage points, indicating an on-going redistribution of national income to capital (profits).

While the distributional equity issues are one thing, this trend might not be problematic from a macroeconomic spending perspective, if business firms were using that redistributed national income to boost productive infrastructure. That is, increasing investment spending, which not only stimulates current growth, but also boosts potential growth.

The reality is very clear – business investment remains weak in most countries.

So not only is strong business investment unlikely to be the basis of renewed strength in domestic demand, but also household consumption spending is once again, relying on increased access to credit.

In that context, I agree with the RBS report that the world – at least, the non-government sector component of it – “has too much debt”.

I have commented before about how the advanced world seems to be relying again on a massive buildup in private debt to maintain economic growth, just as it did in the period prior to the GFC.

The credit-binge not only maintained growth as real wages were being suppressed by labour market deregulation and national income was being redistributed towards profits, but it also, set in place the conditions for financial market collapse, which manifested openly in 2008.

In Britain, for example, the national government is relying on a repeat of the credit-binge. I noted in several blogs (since 2010) that the fiscal austerity would only work – in the short-term – if the household sector was willing to take on more debt after consolidating its balance sheet somewhat in the post-GFC crash.

Please read my March 2015 blog – British fiscal statement – continues the lie about austerity – for more discussion on this point.

An article in the UK Guardian (January 17, 2016) – Spend, spend, spend – it’s what the chancellor is praying for – provides an updated discussion of this issue.

The journalist notes that “For those who worry about Britain’s recovery being built on a mountain of debt, the situation is getting worse.”

The claim that governments have exhausted their room to move is patently false. As the RBS report noted “the Fed has limitless ammunition”.

I would generalise this observation to say that the consolidated government sector, which includes the central bank and the Treasury, have limitless financial ammunition to stimulate nominal domestic demand.

Note the emphasis in the last sentence on financial and nominal. What is the point here?

First, while the government has unlimited financial resources as long as it issues its own currency, it can only use those resources if there are real resources available for sale in that currency.

Second, if the government tries to push nominal spending (that is, the monetary value of spending) ahead of the capacity of the productive sector to respond in real terms, producing real goods and services, then inflation will result.

Third, a reasonable assessment is that in most countries there are substantial pools of idle real resources available to be brought back into productive use should there be sufficient demand for them. There are millions of unemployed after all.

In other words, one could reasonably conclude there are no foreseeable constraints on fiscal policy in nations where the national governments issue their own currency.

I was reviewing some historical material over the weekend as part of research for one of my current book projects. There was a huge debate in the 1950s which continued into the next decade as to the capacity of currency-issuing governments to take on public debt.

The specific issue in this particular debate was whether growing public debt imposed a burden on future generations – a positive answer to that question is now accepted as a key part of the neo-liberal mythology and a reason for denying that elephant is hovering around Davos.

In 1948, Abba Lerner wrote “The Burden of the National Debt”, which demonstrated that public debt did not impose such a burden because the only burden that was relevant were the real resources that were used in the government spending program associated with the debt issuance.

Lerner wrote (p.256):

Very few economists need to be reminded that if our children or grandchildren repay some of the national debt these payments will be made to our children or grandchildren and to nobody else. Taking them altogether they will no more be impoverished by making the repayments than they will be enriched by receiving them.

In other words, there are distributional consequences within generations but not between them.

In this regard, Lerner noted that (p.261):

The growth of national debt may not only make some people richer and some people poorer, but may increase the inequality of distribution. This is because richer people can buy more government bonds and so get more of the interest payments without incurring a proportionately heavier burden of the taxes. Most people would agree that this is bad. But it is no necessary effect of an increasing national debt. If the additional taxes are more progressive – more concentrated on the rich – than the additional holdings of government bonds, the effect will be to diminish the inequality of income and wealth.

The point Lerner was making was that if an economy is currently at full employment and the government chooses to deploy real resources in some project (for example, to build a new public transport facility), then it has to deprive the non-government sector of those resources.

In a situation of under-full employment, the same project would mean that the government is using idle resources that the private sector could use should it choose.

But at each point in time, it is this real resource usage that constitutes the so-called ‘burden’. Which means, in a temporal sense, that the ‘burden’ exhausts at the time of resource usage and is unable to be transferred to future generations.

Remember that Lerner was writing in the late 1940s. A more contemporary understanding of intergenerational burden shifting would acknowledge that resource usage in the current period, which undermines environmental sustainability, does disadvantage future generations.

But this contemporary view, in no way, provides support for the neo-liberal view that public debt undermines future prosperity.

Further, it was argued in the 1950s, that servicing the public debt (that is, paying interest payments) could be construed as a ‘burden’ on future generations if governments raised taxes in order to pay the interest.

Remember that under the Bretton Woods system, governments were financially constrained, and so the increased taxes to meet future spending commitments was not a far-fetched concern.

Lerner argued, in this context, that those interest payments constituted income for the future generation who might be holding the debt. Once again, he identified distribution issues (transfers from those who might be paying the taxes to those who were receiving the interest payments), but considered these confined to each generation.

[Reference: Lerner, A. (1948) ‘The Burden of the National Debt’, in Metzler, L.A. (ed.) Income, Employment, and Public Policy: Essays in Honor of Alvin H. Hansen, New York, W.W. Norton, 255-75.

Of course, as a result of the collapse of the Bretton Woods system, currency-issuing governments are now free of any financial constraints (unless they voluntary cede their currency sovereignty as in the Eurozone) so any of the distributional arguments relating to tax burden shifts are moot.

The only economic constraint facing governments in this situation are real resource availability. The rest are political (read: ideological).

While it is sensible for governments to increase spending and substitute increased non-government debt with increased cover meant debt, it is even more sensible for governments to refrain from any further debt issuance and draw on the central bank’s unlimited capacity to credit relevant bank accounts in the currency of issue to match its spending program.

Once you understand that it is only real resource availability the constrains government, then all the rest of the discussions about the impacts of computerisation and the room for government to move become clearer.

There is no denying that technological change (for example, robots and computers) are extremely painful processes for individual workers who lose their employment prospects to endure.

But at the macrolevel, there is no reason for total employment to decline as technology changes composition of employment in favour of higher skilled, less routinised jobs.

The responsibility of government is to use its unlimited financial capacity to ensure that there are transitional processes in place to allow workers to maintain income security while employment shifts are ongoing.

These processes should include direct job creation, enhanced education and training, regional industry strategies, investment in best practice technology and deployment, and a safety net Job Guarantee program.

Conclusion

While it appears that the world economy is once again starting to gyrate, there is no reason to believe that the currency-issuing governments have lost their capacity to meet the challenge of a decline in non-government spending.

That is enough for today!

(c) Copyright 2016 William Mitchell. All Rights Reserved.