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Martin Wolf: Austerity is Risky Business

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Martin Wolf, in today’s Financial Times, uses modern monetary theory (!), also known as the fiscal balances approach, to explain why calls for fiscal belt tightening are premature.

Let’s provide a little background, courtesy Rob Parenteau of the Levy Institute:

…if we divide the economy into three sectors – the domestic private (households and firms), government, and foreign sectors, the following identity must hold true:

Domestic Private Sector Financial Balance + Fiscal Balance + Foreign Financial Balance = 0

Note that it is impossible for all three sectors to net save – that is, to run a financial surplus – at the same time. All three sectors could run a financial balance, but they cannot all accomplish a financial surplus and accumulate financial assets at the same time – some sector has to be issuing liabilities [borrowing].

Since foreigners earn a surplus by selling more exports to their trading partners than they buy in imports, the last term can be replaced by the inverse of the trade or current account balance. This reveals the cunning core of the Asian neo-mercantilist strategy. If a current account surplus can be sustained, then both the private sector and the government can maintain a financial surplus as well. Domestic debt burdens, be they public or private, need not build up over time on household, business, or government balance sheets.

Domestic Private Sector Financial Balance + Fiscal Balance – Current Account Balance = 0

Again, keep in mind this is an accounting identity, not a theory. If it is wrong, then five centuries of double entry book keeping must also be wrong.

Yves here. Many readers reject the message here instinctively. You cannot have the private sector save in aggregate AND have government run a surplus UNLESS you run a trade surplus. And the problem we have is:

1. The private sector in pretty much every advanced economy is deleveraging, as in saving. Most people, yours truly included, think that’s a good idea.

2. If those economies want to run government surpluses too, then they need to run pretty big trade surpluses

3. It is impossible for all countries to run trade surpluses at the same time.

4. Moreover, some countries that have been running large trade surpluses for quite a while (in particular China and Germany) are not willing to change course, at least not in the near future.

5. So if all these new hairshirt-wearers want to shirk public and private debt at the same time, some countries will need to run correspondingly large trade deficits (which also means they will experience rising private or public sector debt levels). There appears to be a dearth of candidates for this role.

Wolf ‘s article today reads as if he is speaking more to fellow economists, particularly those in policy circles, than his typical, more layperson friendly, offering. Be sure to look at his charts at the end.

From the Financial Times:

Let us look at where we now are, courtesy of the financial balance approach of the late Wynne Godley…. In 2010, according to the International Monetary Fund’s latest forecasts, the private sectors of every large high-income country will run a huge excess of income over spending (see chart). This is forecast at 7.8 per cent of gross domestic product for these countries as a group, at 12.6 per cent for Japan, at 9.7 per cent for the UK, at 7.7 per cent for the US and at 6.8 per cent for the eurozone.

What we are seeing, in short, is an epidemic of private sector frugality – just as many economic doctors recommended. Yet such thrift entails either current account surpluses or fiscal deficits. Of these countries, only Germany and Japan have current account surpluses. The rest are capital importers. These countries will duly run fiscal deficits that are bigger than their private surpluses. We have, as the hysterics note, a tide of fiscal red ink.

Which came first – private retrenchment or fiscal deficits? The answer is: the former. In the case of the US, the huge shift in the private balance between the fourth quarter of 2007 and the second quarter of 2009, from a deficit of 2.2 per cent of GDP to a surplus of 6.6 per cent, coincided with the financial crisis (see chart). The fact that aggregate demand and long-term interest rates tumbled at the same time shows that the collapse in private spending “crowded in” the fiscal deficits. Wild private behaviour drove the wild public behaviour.

In his recent FT column, Jeffrey Sachs of Columbia University argued that fiscal stimulus was unnecessary: monetary policy would have been enough. I disagree. Despite the most aggressive monetary policy ever, private sectors moved into huge surpluses. Monetary policy was “pushing on a string”. The fiscal offsets – overwhelmingly due to built-in fiscal stabilisers, not the discretionary stimulus – helped sustain demand in the crisis. But they were insufficient, even with monetary support, to prevent deep recessions. The argument that stimulus was unnecessary is hard to accept. It is easier to believe it was too small, albeit also ill-targeted.

So how quickly should deficits be eliminated? We must recognise the danger here: cutting public spending will not automatically raise private spending. The attempted reduction in the structural deficit might lead, instead, to a rise in cyclical fiscal deficits, which would be running to stand still, or to a reduction in the private surpluses only because income fell even faster than spending. Either outcome would be grim. Yet neither can be ruled out.

As long as output remains depressed, the fiscal support is most unlikely to be inflationary. Nor will it crowd out the private sector: it is more likely to crowd it in. The big question, then, is whether deficits can be financed. My answer is: yes. Remember that so long as the private sector runs financial surpluses it must buy claims on the public sector, unless the developed world as a whole is about to move into huge external surpluses.

True, the private sector can pick and choose among governments. But it is unlikely to abandon the US, at least. It has shown no sign of doing so, so far (see chart). The problem for peripheral Europeans is that they have little chance of an early return to growth. Markets do not trust in the political sustainability of hair-shirt economics. It is not so much fiscal deficits as an inability to grow out of them that is worrying.

The best policy is to put together measures that sustain strong growth in demand in the short run, while constraining the huge deficits in the long run. This is walking and chewing gum at the same time. Why should that be so hard?

Yet it would now be particularly damaging for fiscal austerity to overcome the European economy and so force beggar-my-neighbour outcomes on the hapless US. As Fred Bergsten of the Peterson Institute for International Economics in Washington noted in the FT last week, such policies could be very dangerous. Thus, far from being stabilising, premature fiscal retrenchment threatens destabilisation of the world economy. In this case, a decision to turn the eurozone into a huge Germany would – and should – be seen as an act of mercantilist warfare upon the US. How long would the latter put up with the hypocrisy of surplus countries that blame borrowers for the deficits their own surpluses make inevitable? Not much longer, would be my guess, at least now that the US government has become the world’s borrower of last resort.

Yes, I understand that huge fiscal deficits make people nervous. I understand, too, the desire to make solvency credible. But following fiscal rules blindly, while ignoring what is going on in the private sector or in external balances, is a recipe for disappointment and political conflict. Fiscal stabilisation that supports growth is welcome. Premature fiscal stabilisation that undermines it is yet another folly.

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118 comments

  1. Francois T

    Again, keep in mind this is an accounting identity, not a theory. If it is wrong, then five centuries of double entry book keeping must also be wrong.

    Alright then! How come there are so many deficit hawks now that want the government to shrink the deficit right now or else damn it??

    Didn’t they learn double entry book keeping? Or is it above their IQ?

    My take is this: Big banks have been and continue to be bailed out. We have 2 wars that establishment dems and repubs cannot have enough of. Oh! let’s not forgt all the tax loopholes for corporations and hedgies of all falvors. You just cannot possible hear the D word uttered once. So, they don’t want to touch that.

    OTOH, the same Dems and Repubs never showed any remorse in playing with the lives of the unemployed and the poor by putting off until the last minute, every three months, a possible extension of their benefits. Oh my dear! this social security thingie..it’s going to corrode the foundations of the Republic! A scandal…I’m telling you!

    Suddenly, just at the precise moment it is time to debate this topic Oh! The Horror! Houston! We have an unsustainable deficit! Mommyyyyyyyyyyyyy!

    I cannot wait to see how pervasive and violent would be the pushback against the policy makers and the elites if we get a second financial shock sooner than later.

    Maybe that is why Obama has decided to enshrine and expand even more all the erosions of civil liberties in this country. He wants to have the necessary tools to repress the masses…just in case.

    1. NOTaREALmerican

      Re: Again, keep in mind this is an accounting identity, not a theory. If it is wrong, then five centuries of double entry book keeping must also be wrong.

      Why do I keep seeing this exact sentence so much in the last month, and in so many different article? Are the economics finally starting to realize their own BS is (uh) BS?

      Are they replacing the phrase: “If I pull an assumption out of my ass it follows that.. ” with “Look, I’m not making this up, it’s accounting!”

  2. attempter

    If we consider the Obama/Peterson/WaPo drive to destroy Social Security in conventional terms, it makes no sense at all.

    No sane person really thinks America’s going to find a way to become a trade surplus country under the restored “growth” conditions everyone claims to be seeking. On the contrary it’s supposed to continue importing cheap crap.

    But this is contradicted by the fact on the ground, that the private consumer is deleveraging. So you’d think the only option left to keep US demand going would be fiscal spending. That’s why even Krugman is objecting to the drive for “austerity” in the US. It makes no sense at all according the the proclaimed expectations and intentions of the “leadership”.

    (I’m not sure how the incessant whining about China’s currency manipulation is supposed to fit into this conceptually. On its face it’s absurd that the US consumer is supposed to be zombified in any way other than through continued cheap imports. If you claim to want continued “consumerism”, however impossible and undesirable that is, it follows that you need existing Chimerica currency arrangements.)

    All this deficit terrorism could be coherent if the US was seeking autarchy, that is to pull out of the “growth” death march and globalization completely, bringing the trade account close to zero. In that case fiscal zeroing out could accompany a private sector account balance. But no one claims to seek anything but continued “growth” and therefore, implicitly, trade deficits.

    So that leads us to what must be the real purpose for the austerity drive. If the government deficit is supposed to approach zero, it follows that the private sector, Americans as a whole, are supposed to remain debtors. Since this can’t be sustainably done on the household level, it follows that they’re supposed to be reduced to permanent debt servitude to the banks and, via corporatized government-for-fee, to the government.

    It’ll be like the old crop lien system but on a vaster scale, as the overall basis for the new feudalism.

    That’s why everyone should jubilate system debts and shun the incurring of new ones like the plague.

  3. Brian Hayes

    The Inquisition is a tough lesson. Don’t stretch the truth. Versailles is a lesson too. Status can make us cold. Empire and Presidium seem to blink and die. Imperial and despot surround us. Republic is good. I wonder why we have so few? Isn’t there solvent regions? I’d settle for a prosperous neighborhood. We should never be so desperate. The blame is ours. We are sovereign. We have domain. That’s our chance and it’s always where we live. Isn’t what’s outside our door the most important politics?

    1. alex

      Such a cogent counter-argument. You leave no doubt about the folly of Wolf’s reasoning.

    2. Perfect Stranger

      Maybe so, but I doubt it.

      He belongs to dangerous class of people journalist-enabler- celebrity, promoter of “free market economy”, better known as imperialism and capitalism.

      Yet, he is happily quoted by many blogers/investors, who embraces same ideology. I noticed that owner of this blog like to use the term “advanced economies”, however, that term doesn’t imply economic success and social justice. Most likely, that term is subconscious associations and cultural artifact of the imperial era known as: colonialism.

      When Martin Wolf and the rest from “free market economy” pack advocating some (any) policies they have in mind policies promoted by IMF/World Bank/WTO, City and Wall St., that is, impoverishment and misery of ordinary people. He is front end of: trickle down economy.

      Rupert Murdoch called once Chris Amanpour from CNN a “war whore”. Being the whore might or might not be matter of choice, however, it is far more noble than being journalist-thug which is certainly his choice, especially when one quote villain such as “professor from Columbia University”.

      1. Yves Smith Post author

        You’ve just made it obvious that you didn’t read the post, and are spewing uninformed prejudice. Wolf mentioned Sachs, that Columbia professor, to disagree with him.

  4. Hilary Barnes

    Someone should tell the European Commission, determined that member states of the EU cut deficits to maximum 3% of GDP by 2013 and aim for balance in 2015, to stretch the targets to 2023 and 2025.

  5. Toby

    “Since foreigners earn a surplus by selling more exports to their trading partners than they buy in imports, the last term can be replaced by the inverse of the trade or current account balance.
    [snip]
    “Again, keep in mind this is an accounting identity, not a theory. If it is wrong, then five centuries of double entry book keeping must also be wrong.”

    Time to expose some ignorance on my part and ask some maybe stupid questions, but this really confuses me.

    Being a country with a current account surplus you may subtract that surplus from the pub+priv sum? Yet if you have a current account deficit you add it? As long as the result is zero all’s well? This seems positively slippery to me.

    The bar chart note says “The foreign balance is of the same magnitude as the current account balance but with the signs changed from positive to negative and vice versa” If you have to swap something round from positive to negative to get your zero, why is the zero so accurate/helpful?

    What is zero, what does it really mean? Does zero equal balance? If all finances balance out all the time by definition, what are recessions and depressions? How relevant is this ‘balance’ if underneath it or within it things can be very stormy indeed?

    What value/use does double entry book keeping actually have in the good old wider world? I’m tempted to believe 500 years of it have indeed been wrong, whatever “wrong” really means in this context. It is simply an accounting practice with particular and narrow utility to accountancy, hence pointing out it is not theory is neither here nor there. I fail to see what relevance it has in dealing with growth/recession, the ecology and poverty.

    Wolf’s article is couched in the tacit an unquestionable belief that the current money-creation system is an eternal and unchanging given. The equation that makes most sense to me is that debt-money engenders our addiction to perpetual growth. Perpetual growth is far more of an enemy than notional deficits and surpluses that anyway balance to zero because they have to. And yet this core of economic orthodoxy, that does more harm than anything else looked at in the article, is still off the table in the MSM. Money-as-debt is not the way forward. We need a revolution in money creation as well as in our attitudes to success, wealth, growth and prosperity.

    I believe that in the end the deficit/surplus dichotomy is itself a red herring. Our cultural obsession with this axis stems, in part, from our poor understanding of money generally. With deep monetary reform (and education reform too) perhaps this might change. Judging from what passes as debate on this issue, probably only further and more damaging collapse stands any chance of bringing real reform about.

    (Another issue I believe relevant is that automation of jobs tends to throw more workers into the arms of the state as less and less are needed to produce goods (and recently services), meaning steadily increasing numbers on the state’s payroll and welfare. This is a problem for the velocity of money through the economy, but this whole area appears a no go in terms of MSM ‘analysis’ and debate.)

    1. jdmckay

      If you have to swap something round from positive to negative to get your zero, why is the zero so accurate/helpful?

      A-1: it’s not “accurate”
      A-2: it’s “helpful” in that, when trying to fit a square peg in a round hole, a means is provided to do so in the abstract when reality resists the implementation. It’s also “helpful” in keeping these guys in a job that doesn’t require a valuable work product.

      How relevant is this ‘balance’ if underneath it or within it things can be very stormy indeed?

      Yes, that’s called: accounting… eg. metaphorical “storm” calming technique.

      (Apt questions you ask, Toby)

  6. Tim

    “the following identity must hold true:

    Domestic Private Sector Financial Balance + Fiscal Balance + Foreign Financial Balance = 0″

    If we follow the logic -Since on a global basis the foreign financial balance has to equal zero and furthermore that this equation has always held true then the total private cash = total government debt. An answer far more trivial than it looks, money is only a store of value in as much as the physical & social capital for which it is a medium of exchange actually exists – we all know that printing money on its own doesn’t create wealth (although it doesn’t seem to stop us trying)

    The problem for policy-makers is how to maximize physical & social capital. Sine it is pretty obvious that people doing nothing useful (whether Paris Hilton or unemployed) generate no physical capital and have a negative effect on social capital the policy-maker should be aiming to maximize the number of people usefully employed.

    A further question then has to be what constitutes useful employment. While a snake-oil peddling derivative salesmen is probably not usefully employed, a grandmother telling stories to children almost certainly is.

    In an economy with so many unemployed policies that promote work are needed what we perhaps forget is that the real aim of those policies are aimed at improving social capital it is the same issue we address when we try to prevent crime,discourage useless derivatives, avoid excessive concentrations of wealth.

  7. Simon

    Once you get the simple rules of the deficit surplus equation it is really very easy to understand what is going on. Why on earth was the current situation allowed to creep up on the world? I seems to me stunningly simple to see what has happened and how. Why it happened is another matter all together. Going forward I suspect that in due course a new generation of, potentially sadly, well informed people will get together and put in place the simple measures required to avoid this stupidity.

    Sadly the solution is either hair cuts all round or war which will result in much deeper cuts unfortunately.

    The reality could be that the US might simply renege on it’s debt and invoke tariffs every which way. That would return it’s manufacturing base to it’s home territory, eliminate it’s debt servicing costs, fix it’s unemployment and possibly reduce some of the inequality.

    China would be left in a bit of a fix. So would Japan and Germany.

    Anyway China has likely reached and exceeded critical development mass. If it does not have sufficient political stability now to take a knock excatly who’s problem is that?

    It’s pretty clear by now that the surplus countries having established themselves in their respected elevated perches are not going just throw up their hands and say OK we give up and climb down for a while giving away everything they worked so hard to achieve.

    What is the alternative?

    1. jdmckay

      Going forward I suspect that in due course a new generation of, potentially sadly, well informed people will get together and put in place the simple measures required to avoid this stupidity.

      Nowhere on the horizon that I can see. Malfeasance across the finance world has us in a tail chasing holding pattern, a process currently known as: change.

  8. Cheribibi

    “Again, keep in mind this is an accounting identity, not a theory. If it is wrong, then five centuries of double entry book keeping must also be wrong.”

    I wonder where inflation comes from, if not the meaninglessness of accounting.

    I really wonder why we should not now take into account future sales of our intellectual properties to martians.

    1. aet

      That estimated future values are subject to inaccuracy does not render them “meaningless”.

  9. Simon

    It actually makes me very sad when I reflect on how badly those entrusted with the responsibility of managing these things have done. Undoing the damage is likely to cause even more damage in the process.

    1. aet

      That depends on the competence of the “physician”: IMHO, they ought to hesitate, if there is a chance that the cure would turn out to be worse than the disease.

    2. NOTaREALmerican

      Re: It actually makes me very sad when I reflect on how badly those entrusted with the responsibility of managing these things have done.

      Actually, they’ve do very well for themselves. Which is the only point of owning a government. Steal from the dumbasses and give the loot to your buddies.

  10. agog

    This debate smacks of the one about how many angels can dance on the head of pin. Wolf writes “The best policy is to put together measures that sustain strong growth in demand…” oblivious like nearly all economists to the likelihood that as we bump along the plateau of peak oil economic growth in the developed world is more or less done for.

    Well-managed delevoping economies willing to pay up for the marginal barrel of oil will be able continue to grow for the time being but before this decade is out will face the situation we do now.

    As Toby alludes to above, our misguided obsession with the perpetual growth has been a grievous error. It is turning out to be a self-correcting one, whether the great and the good like it or not.

    1. alex

      “oblivious like nearly all economists to the likelihood that as we bump along the plateau of peak oil economic growth in the developed world is more or less done for”

      Then an obvious way to direct government spending is reducing our dependence on oil.

      1. charcad

        then an obvious way to direct government spending is reducing our dependence on oil.

        It may be obvious to you and me. But it’s not obvious if your own outsize profits come from being a buy low sell high factotum for imported energy (calling Goldman Sachs and George Soros).

        And it’s less obvious still if you derive your outsize income and power by creating and rationing scarcity. That was the stock in trade of both the failed Soviet nomenklatura and our modern failed US analogs. These are Ivy League lawyers like Al Gore, Jr and the many thousands of highly paid 501c3 foundation noisemakers.

        The truth is the dominant groups in NYC and DC benefit greatly from the current state of affairs.

    2. jdmckay

      It is turning out to be a self-correcting one, whether the great and the good like it or not.

      Apt characterization of things IMO, agog.

      To me, $m qestion: what error(s) are being corrected?

      1. aet

        An “error” is a success when it comes to learning.
        People have ever & always learned from their mistakes.

  11. gigi

    The problem I have is not with the accounting identity. It is with the thesis that pointlessly throwing money away is a way out of this mess. Over the past year they have destroyed, and rebuilt a perfectly good road in my neighborhood. It looked prettier before they started then when they finished. This is beyond absurd.

    Look at the impact of increasing government deficits. Governments are too bloated already. Ours is fighting two unnecessary wars, three if you count the never-ending war on terrorism, bailing out banks, and wasting inordinate amounts of money in red tape. Governments are a necessary evil and we need to realize/remember this. How does growing government power via increased government spending solve any problem? The current path is almost guaranteed to make 1984 come true, just not in the way Orwell thought it would happen.

    Our main problem is the compounding nature of debt. It is an exponential function and if you have ever looked at a diode voltage/current curve, you know how that ends. The interest on the debt cannot be paid back since it is not created with the debt and relies on ever increasing debt to be serviced and not on providing additional services in the future to the bond holders (interest). So increased government indebtedness cannot and will not solve the current problems (and explains why Japan never recovered). Default or currency destruction (in excess of the exponential curve) is the only answer. So default already, get the government expenses in control, stop fighting needless wars, and return some sanity to society. Or if we are going to print, we need to get this money in the hand of the indebted (not the banks and not the bond holders) so their debt is payed off, which is a form of default as well.

    The current path of increasing government “GDP” is lunacy as it solves no financial problems while destroying the social fabric.

    1. Eric

      This comment rings emotionally true to me. In aggregate, maybe the public sector needs to provide increased demand in order to get employment on a much better path, but the money doesn’t get spent in aggregate, it gets spent on specifics and many of the potential specifics strike me as useless or, worse, as establishing an expectation of bad government spending into the future. I understand that people who have studied it a lot believe that the multipliers of tax cuts are lower than for spending, but a payroll tax holiday would at least preferentially be steered at people more likely to spend it.

      1. alex

        The problem with a payroll tax holiday is that it takes money from Social Security. Even if SocSec can afford that, it gives ammunition to those who want to destroy it. One of the bedrock principles of SocSec has always been that it is paid for entirely with dedicated taxes. The Peterson’s of the world who want to destroy SocSec are just saying that they don’t want their income taxes increased so that the general fund can pay back SocSec all the money it’s owed. In other words, the want the US government to default on its debt. I’m sure Peterson would be horrified if anyone suggested doing that with the treasuries Peterson holds, but it’s ok if you’re screwing grandma.

        Alternatives to a payroll tax holiday that would have a similar effect include increases in the EITC and more generous unemployment benefits and COBRA assistance (since you can’t get EITC if you’re not working).

    2. VJ Kumar

      I find the glib talk about “net saving” vs “government deficit” worrisome.

      In the first place, the “accounting identity” the mmt crowd keeps throwing around is nothing but a trivial algebraic term shuffling of the original GDB expression: y = c + i + g restated as (y-c-t) – i = g – t, where c is consumpsion, i investment, t taxes and g government spending.

      Therefore, it follows that when mmt folks talk about the private sector “net saving” they mean nothing more but hoarding government paper in the form of currency or T-Bonds, and that the government needs to print such paper therefore running a deficit as expressed in quantity of the printed paper.

      Immediately, two questions come into one’s mind:

      1. Assuming people(the households) can save at all, they
      can however choose to invest into factories, buying private sector bonds, or just hoard gold instead of hoarding public paper thereby not needing the government to run a deficit. So, as opposed to the new dogma “gov. deficit is good”, the reality is: it depends. The decision to “net save” aka put currency under the mattress is just an investment decision which may be good or bad depending on the circumstances.

      2. While stating that the households hoarding the government IOUs either in the shape of currency or T-Bonds is good, the mmt folks never quite spelled out how exactly such currency will turn up under the populace mattresses. There is some vague talk about government guaranteed jobs at Bob Mitchell’s web site, but not much specific about the actual transfer mechanism of the freshly printed currency into the private sector pockets. As described in gigi’s message, very often government funded projects amount to one person digging up a hole and another person filling it up. How can we ensure that government projects can really accomplish something socially useful ? The past experience of the USSR and the other former socialist countries is not very inspiring.

      Parenthetically, we do know about one possible mechanism: transfer of the government deficit into pockets of the Wall Street fauna. The accounting identity worked quite nicely here: the Wall Street “net saved” thanks to the government “deficit spending”.

      Now, theoretically, government funded projects may be good. It is just unclear how exactly the society as a whole can ensure such goodness. The mmt proponents’ accounting talk about identities is dangerous in its very simplicity, them stating that it is enough for government to print paper and the prosperity will happen by magic. It is no better in fact than the talk of those they call “deficit hawks”

      1. jdmckay

        The decision to “net save” aka put currency under the mattress is just an investment decision which may be good or bad depending on the circumstances.

        Exactly. Common sense 101 AFAIC.

        (…) not much specific about the actual transfer mechanism of the freshly printed currency into the private sector pockets.

        As I understood, Big Ben explained doings so might initiate withdrawal of investment in those private sector (TBTF) entities. Then credit would “stop flowing”, thereby inhibiting our ability to buy more Chinese crap and fuel next bubble.

        Transparency is local, opaqueness is global.

        As described in gigi’s message, very often government funded projects amount to one person digging up a hole and another person filling it up.

        Yes… and your point is? This puts people to work, and puts $$ back in hands of consumer, thus fueling the economy and maintaining the illusion of wealth. Holes, roads, picking up garbage on the road… doesn’t really matter as long as people are working!!! See several recent years of Krugman for details.

        I have noticed, however, these holes keep getting bigger.

        How can we ensure that government projects can really accomplish something socially useful?

        Indeed. I wonder though, why do you restrict this to government? Remove the “socially” modifier, and “useful” seems to me, from WS performance this decade, to be (again) a phenomenon local to WS: useful for their surpluses seems to equate to a corresponding, geometrically expanded deficit elsewhere.

        1. aet

          “the illusion of wealth”.

          I am not so certain that it is any more illusory than life itself may seem if for example one is at the threshold of death. the important thing is that it fills people’s times, and lives. Ity really does not matter with whjat activity, so long as it is not war (ie flat-out destruction)!

          I think that it is far far from illusory wealth you’ve described.
          And who fears illusions, anyway?
          So much as to have his neighbour thrown out of his job?

          1. Toby

            That underestimates people’s ability to notice they’re being paid to do nothing useful whatsoever. I think that’s bad for us humans. We need to feel valued, and there’s the challenge MMT (which has much positive to add in my opinion) does not really address. One of the challenges anyway. There are others that have been addressed above. (I keep on mentioning him, but my money’s on Bernard Lietaer right now. He’s there on youtube for those interested.)

            We need a global debate on where value really comes from. Yes it’s different from person to person, but its relativity is the point. To pick out labour or gold as having intrinsic value, or to look for anything at all that has intrinsic value, is a waste of time. There is no such thing as intrinsic value. We need to deal with that. Soon.

            Continuing and accelerating technological developments pretty much guarantee that all drudge work will be automatable (the vast majority already is) before too long (decades). Thus, the types of things left over for humans to do are going to be creative, human-to-human type ‘jobs’ and it may well be totally unnecessary to work more than 15-20 hours a week (to pluck a fresh figure out of my jacksie). This is a Good Thing. Humans have loads of potential that boring, repetitive work only kills.

            So the whole sweat-of-the-brow mythology is old, and needs renewing. This in turn demands a total reworking of how we educate, what school is and how it should operate, and also what kind of money we create, who creates it. We are also obliged to prevent somehow — as far as possible anyway — people making money from money just because being ‘rich’ is so frikkin kool.

            Humans and environment first, money a distant second, ideology can go phuk itself!

      2. Jimbo

        “they can however choose to invest into factories, buying private sector bonds, or just hoard gold instead of hoarding public paper thereby not needing the government to run a deficit. ”

        You are misunderstanding the meaning of the word “net savings” . “Net” means savings in excess of the investment demands of the private sector. When a company borrows money to build a factory, that act of investment creates, on the the other side of the ledger, the financial assets that become savings.

        The conventional notion that your putting your money in the bank then allows the bank to lend it out, thus leading to investment, is precisely wrong; in fact, it is investment that creates the money that you have to put in the bank!

        But while investment creates it’s own savings, savings does not generally create its own investment. If the savings demand of consumers is greater than the investment demand for business (and in a recession one goes up just as the other is going down), you create a gap which can either be filled by a general reduction in economic activity (and thus a decrease in savings), or by the creation of new financial assets by the act of government deficit spending.

        And note: more spending might not (and probably won’t be) the most efficient way to do this. It’s not the spending that’s important; it’s the deficit. Cutting taxes, and thus not draining financial assets from the private sector in the first place, is a much more direct way to do things.

      3. Yves Smith Post author

        Kumar,

        You need to work through this again. You have this wrong.

        The private sector is not just households, it is ALL private (non government) activity, including businesses.

        If the private sector deleverages (which is happening in pretty much all advanced economies, see Wolf’s data), either the government needs to run a deficit or you need a big increase in exports.

        Please revisit the math with the correct definitions of terms.

        1. Gary J

          Yves – I don’t think you understand the identity – it still works with a fall in imports…yes, this route will actually return the system to balance without blowing an even big debt bubble. The piper must be paid sooner or later.

          I think the optimists call this phenomenon “negative growth”…was there ever a better oxymoron!

          1. Yves Smith Post author

            Apologies, I have explained this longer form in posts, including what happens (contraction) if you try public and private sector deleveraging and don’t have a large enough exports. I have to watch losing patience with readers and cutting corners in my own argument (the fact that I type slowly does not help matters).

      4. Tom Hickey

        “the “accounting identity” the mmt crowd keeps throwing around is nothing”

        If course it says nothing, all identities are tautologies. 2 + 2 = 4 says nothing, but it is highly useful if figuring out what’s happening. People that don’t get that 2 + 2 = 4 are considered boobies. People that don’t get national accounting identities?

      5. pebird

        Sometimes trivial algebra is hard to understand.

        Net financial savings is equivalent to the total government debt, as an accounting identify. It does not mean that government debt is the only “valid” net financial savings vehicle, please. I have no idea where you pulled “hoarding government debt” out from, but it is a useful statement in that it signals your intentions.

        Yes, you can net save in lots of financial forms, just note that in the aggregate the accounting of total net financial savings is equivalent to total government debt.

        Clearly, you’ve run across MMT over the past week or so and the surprise of seeing something so counter-intuitive is driving you to post bromides on inflation and half-baked quantity theories of money. How can I know this? Because if you spent an additional few hours looking at the MMT sites, you would see over and over and over again the statements that MMT does NOT say that all government deficits are good and very clearly states that governments can spend poorly. You might think about that prior to spewing easily refutable assertions, or consider changing your screen name because you are quickly losing credibility.

        And when it comes to trivialities and simplifications, try not to use terms such as “printed currency” and “print paper” too much, it’s another giveaway.

    3. NOTaREALmerican

      Re: The current path of increasing government “GDP” is lunacy as it solves no financial problems while destroying the social fabric.

      You are assuming that the role of government is to solve problems.

      The role of government – or ANY large organization with large piles of loot – is the distribute this loot the management and anybody else the management needs to payoff to keep quiet. (In life: you need to be running a scam or participating in one, otherwise you get left behind).

      If you start from the premise that most humans are scumbags, then what is happening right now is inevitable; the system is working perfectly and therefore should NOT be changed.

      Unfortunately, most humans are also self-delusional and “think” they aren’t scumbag and (worse) are dumbasses and can’t see the smart scumbag ripping them off, when it’s being done – in the open – right under their noises.

      But, that’s what makes a truly great scam GREAT. It’s like magic to the dumbass.

  12. Sungam

    Couple of quick things. I believe no government is planning to run a fiscal surplus in the near term. Most governments are shifting from high deficits to lower deficits.

    In the medium to long term there should be a general agreement that bringing the terms of that equation closer to balance is a good thing.

    Btw, with my limited knowledge of book-keeping and accountancy could someone explain how the growth in value of economic activity is expressed in this framework? The world economy isn’t the same “size” as it was, say, 50 years ago. I think that most of the resistance to this simple identity mentioned in several articles now is that it seems to express the world as a zero sum game where for every winner there is a loser.

    1. VJ Kumar

      Sungam,


      think that most of the resistance to this simple identity mentioned in several articles now is that it seems to express the world as a zero sum game where for every winner there is a loser.

      I think your question is interesting. In fact, the “profit puzzle”(zero sum game) is a major modeling problem with the “circuitist” money model ( a MMT/chartalist cousin). Briefly, with endogenous money accounting, profits or even interest repayment is impossible under the circuitist modeling. While there are some attempts by Steve Keen to resolve the puzzle, I did not see an equivalent chartalist response.

      The profit puzzle is not specific to circuitist modeling but arises with any view of the economy as a circular flow.
      See http://mpra.ub.uni-muenchen.de/20371/ for some thoughts on the puzzle in the context Classical, Keynesian and Marxist economies.

      1. greg b

        VJ

        The endogenous money models ignore the vertical money. The NEW money which can ONLY come form the currency issuer……..aka govt. There is always an infusion of new money. Where it goes (distribution) is key but thats where the non zero sumness pf the system lies. At any given time however we are in a zero sum game.

        If there were never any new currency issued we would see the zero sum affects quite clearly. Using only the private banks as credit money issuers. The money would accumulate at the top quite quickly.

        1. greg b

          Meant to have a comma not a period in my last sentence.

          Using only the private banks as credit money issuers, the money would accumulate at the top rather quickly.

        2. VJ Kumar

          Greg,

          Could you elaborate on profit creation, in the accounting sense, with a specific example of profit being reflected through money creation ? I’ve been unable to find one at the typical places mmt is usually discussed.

          Are you saying that profits are covered with newly printed government money ? If so, how does the new money flows into the firm balance sheet ?

          1. Toby

            My take:

            Profit can be thought of as uneven pooling of available money at various nodes in the economy. Because money is always scarce, and anyway a tool for distributing via price scarce goods and services, competition for as large a share as possible of the available money pool necessarily means winners and losers. Winners are those with a big share, losers those with a small share. I think of this as uneven pooling, or uneven money flow.

            When money is only spent into the economy by govt and does not have to be paid back to anyone at interest, I imagine the competition might be less fierce than in a debt-money situation, because money is less scarce. If there are private lending institutions using non-debt govt money to loan out at interest, the game heats up somewhat, adding extra scarcity. This is inflationary in most normal circumstances, but taxes (in theory) might deal with that.

            In the current system the scarcity factor is at its most intense. The pool of money is always too little to pay back the loaned-into-existence money plus interest, but this does not mean people cannot make profits. For example, suppose 5 banks each lend 5 businesses $1000, and each business has to pay back $1100. Obviously there’s a problem. But if say business A is excellently staffed, has an excellent product, and the others suck, it might win way more than $1100 from the available $5000. This is profit, and is ‘new’ money too. Other businesses go bust, not all banks see their hoped for $100 profit (though their reserves aren’t affected), but at least 1 company did well, and at least 1 bank is happy. We go, in this example, from $0 in the economy to whatever Company A successfully won from the pool, which it deposits at Bank A, which can loan out more. I think that’s profit.

            It’s kind of like Baron von Munchhausen pulling himself out of the swamp by his own hair, but it works (for a while). Ultimately a pure debt-money system becomes a ponzi, which is where we are now by my reckoning. We’re drowning in debt and there are not enough willing and able borrowers out there to keep the game going. That and the fact that perpetual growth is impossible, but all ponzi-like schemes must perpetually grow or they collapse.

          2. VJ Kumar

            Tobi:


            We go, in this example, from $0 in the economy to whatever Company A successfully won from the pool, which it deposits at Bank A, which can loan out more. I think that’s profit.

            You are forgetting that a loan default means a loss for the bank (since a loan is an asset on the bank balance sheet) therefore A’s gain will come at the cost of the bank capital depletion. The reserve is not consideration since it is the bank capital, not the reserve, that determines the bank ability to lend( To simplify your example, the Canadian banking system, for example, does not have any reserve requirement).

            Therefore, summing up across the private sector we’ll come to zero profit, at best, assuming all bank losses were distributed to the winners. In other words, you describe a zero sum game at best or a losing proposition at worst.

          3. Yves Smith Post author

            Kumar,

            As I indicated above, you are arbitrarily redefining terms and ignoring the data.

            The private sector is ALL private activity, households and businesses. It is deleveraging in most advanced economies, per the data.

            So to accommodate net savings by ALL private actors IN AGGREGATE, you need either to have a government deficit or net exports.

            You keep trying to make the private sector net zero, that households are funding businesses with no excess. This is counterfactual right now. You can’t make businesses invest. In fact, most big companies are so obsessed even in expansions with cost cutting and preserving their margins that they have been net savers (NBER data showed that pre-crisis for the US).

            Please revisit the equations with assumptions that correspond to current conditions.

          4. VJ Kumar

            Yves:


            As I indicated above, you are arbitrarily redefining terms and ignoring the data.

            Care to point what exact terms I redefine, or is it just a straw-man?


            The private sector is ALL private activity, households and businesses.

            Did I say otherwise ?


            So to accommodate net savings by ALL private actors IN AGGREGATE, you need either to have a government deficit or net exports.

            I covered that in my question 1 (re. investments vs. hoarding cash/t-bonds) to which the mmt’ers did not provide a concise and logical answer.


            You keep trying to make the private sector net zero, that households are funding businesses with no excess.

            Another straw-man — I did not say that. Neither did any mmt’er answer question 2: in what manner should freshly printed money flow into the private sector ? Still hoping to get a reasonable reponse.

          5. Toby

            No, I’m not forgetting that. Loaned money is lent into existence, it does not come out of the vault. When a loan is not repayed in full, the potential profit does not materialize, the reserves are unchanged. The unsuccessful bank does not increase its reserves, but does not lose anything either.

    2. aet

      Yes indeed: the world’s pop has doubled in fifty years….and personally i think that’s great!

  13. Kill All Keynesians

    Klueless Keynesian Klaptrap from Kretins

    Save the global economy – kill Keynesians on sight.

  14. Debra

    Well, well, well, kudos to Martin Wolf for probably unwittingly raising the most interesting issue in this article when he INTRODUCES the question about the validity of those accountancy practices… (He DOES do this, although he might never admit doing it. The simple act of bringing the topic up is an interrogation.)
    And the number of commenters picking up on that question that Martin just asked shows that we are opening up THIS box to take a look at our most basic premises (dating from the Renaissance, Alex…) and seeing if they are STILL applicable to our world.
    Money as a STORE for value ?
    Na. Money is ONLY worth something at the moment when it is exchanged for something else. At transaction time. At other times… it presents the illusion of being a store for value. There is imaginary value within our symbolic systems, and then there is… other value, right ??
    Let’s ask the following question…
    “How much money will it take to repair the Gulf of Mexico ?”…. Have we finished with the illusion yet ??
    After all, think about it. The idea of keeping money for a rainy day shows how the SYMBOLIC INSTRUMENT you have created to allow exchange to take place becomes itself… an object of “value”.
    Bad plan. That’s why the Catholic Church was a little upset over the usury question. That’s why banking itself takes us right to where we are now. (In conjuction with other attitudes, and practices, of course.)
    But even then during the Renaissance… greed and basic human nature got in the way.
    The desire to hoard coupled with the desire to be safe. And the unbelievably human tendancy to inflate symbolic systems out of all proportions.
    THAT takes your economy down.

    1. jdmckay

      Well, well, well, kudos to Martin Wolf for probably unwittingly raising the most interesting issue in this article when he INTRODUCES the question about the validity of those accountancy practices… (He DOES do this, although he might never admit doing it. The simple act of bringing the topic up is an interrogation.)

      Exactly… thanks. My voluminous commenty snark could be distilled into that one statement.

      1. Tom Hickey

        Right. Let’s do away with that pesky double-entry bookkeeping stuff and stock-flow consistent modeling. (snark)

  15. Emma Zahn

    “Domestic Private Sector Financial Balance + Fiscal Balance – Current Account Balance = 0

    Again, keep in mind this is an accounting identity, not a theory. If it is wrong, then five centuries of double entry book keeping must also be wrong.

    Mr. Parenteau seriously misunderstands the significance of the trial balance proof in double-entry bookkeeping (one word, not two). All it proves is that debits = credits and that there is a reasonable probability that posts to accounts are correct. That is all it does. It does not mean that there are no mistakes or, more importantly, that finances are in good shape. For example:

    Assets = $1 (a debit balance)
    Liabilities = $2 (a credit balance)
    Equity = -$1 (a debit balance which is not good)

    Assets – Liabilities – Equity = 0
    Debit – Credit – Debit = 0
    $1 – $2 -(-$1) =0

    What matters in financial statements is not that debits = credits but which accounts have debit balances and which have credits.

  16. ds

    Re Sungam’s comment: The accounting identity Wolf mentions is not saying that output is a zero sum game. GDP is basically a measure of total expenditures in the economy over a period of time. This, of course, is a lot more than zero and is usually growing.

    The accounting identity Wolf mentions comes from the fact that total expenditures must always equal total income when summed over all 3 sectors of the economy (government, private, foreign). So if one sector is taking in more income than it is spending, then, by identity, some other sector or combination thereof must be spending more than it is taking in.

    So what Wolf is saying is that the reason why the government is running a deficit is because the private sector is running a surplus. If the government were to balance its budget, the private sector would lose its source of savings. And since losing savings does not serve to change the desire to save, the private sector would continue to cut its expenditures in a futile cycle which would then reduce total output, or GDP.

    1. Adam

      Which would result in increasing debt to incomes and a more difficult time in servicing those debts and increase private default and bankruptcy. Keep your eye on Greece and watch it play out in real time over the next 2 to 3 years. Oh, and I expect the Greek guillotine business to pick up too.

    2. jdmckay

      So what Wolf is saying is that the reason why the government is running a deficit is because the private sector is running a surplus.

      Agreed (generally). And now… quite recently (last 2-3 months), Wolf and whole lot of (especially) London based econ/finance folks have made this “balance of trade” equilibrium their mantra, demanding NET exporters become -equilibrium- based (eg. “consume” more… buy more “stuff” from NET importers).

      Why now? Seems to me capitalism includes assumption there are winners and losers, right? I’ve been reading that as a condition of global economics throughout the Greenspan years. WSJ used that explanation as a context, dismissively, as capitalism’s law… as long as WS/London was “winning”.

      So again, why is this particular slice of global economic pie, viewed in this manner… why is this becoming the mantra of the day?

      The crowd ringing this bell says over and over, and Yves has posted often as well, that this lack of soveriegn import/export equilibrium threatens “globalization”. Yves has gone so far as to say, based on this view, that globalization is unworkable.

      Circumstances coinciding w/emergence of this mantra…
      * EU stability has been called into question (“PIIGS” problems)
      * EURO has devalued +/- 17% this year
      * global balance sheets, especially western, have been forced to get a bit more real after global flood of junk mortgage bonds popped, leaving banks/balance sheets very, very short of capital for damn near anything: invest, buy, finance purchases… everything.
      * London (finance), in particular, is among the sickest: over 40% of British ’08 GDP from finance… burst in (mostly) mortgage bubble burst.

      In healthy, honest economic times, surplus investment capital would have been sufficient here (US) and London to absorb/correct so that legitimate (eg: real… or NOT illusory mortage bond type “investments”) could reorganize and move forward.

      However, this scam was so large… so encompassing, the concentration of saving/investment giving “comfort” across so many sectors (retirement accounts, housing values, etc.) that, w/the bursting bubble there’s not all that much left.

      So now, with some of dust clearing from financial meltdown… Britain is essentially broke, w/little economic engine. US in similar straights: we have exported the mechanics of our “stuff” (manufacturing, tech development, etc.). We have created an illusory wealth w/value of homes/real estate, while having eviscerated the engine by which US public pays for all this. And the value of this stuff has fallen because, quite obviously, there is not sufficient value generated on US shores to sustain the bubble era values.

      England in similar shape.

      So… Germany largely avoided this path: they did invest in their own economy, they did develop industry with huge value external to their borders, and they did finance infrastructure at home. A number of nordic countries… similar. Germany’s big hit was huge loss of savings in mortgage bond scam, still they are left with meaningful domestic economic engine producing value.

      So here we are… capitalists like Wolf, AEP and host of others, up to their ass in unworkable economies mucked up be fraud and self deception… after several decades of indifferance to the “loser” side of the capitalistic winner/loser mantra… all of a sudden, that evil liberal word: fairness, is invoked in veiled terms of the need for import/export equilibrium.

      But nowhere in this discussion… nowhere, do they discuss or take into account the mechanics that got us/them here: the massive drain of $$ into an Iraq adventure built on lies… which has BTW fortified and given deeper roots to integration of ME into workable global finance.

      They don’t talk about how they will fill the void left by export of their citizen’s work to cheap labor countries… countries which now are not “emerging” 3rd world economies, but have emerged. And they don’t care to revisit their reliance of balance sheets through the bubble years, which they concocted as “increased productivity” on the backs of cheap external labor, w/investment on these shifts going not into meaningful activities the world needs, but rather phony scams responding to “investor’s” demand for greater “return on investment” which meaningful destinations of said investment would not support: infrastructure, more effecient energy, thoughtful water management, public education…

      No… there is no reckoning from these guys. Rather, with eviscerated economies that no longer respond to basic needs in any manner approaching efficacy, with fraud so rampant it boggles the mind, and with dwindling resources for larger populations presenting hard (as in reality based) equilibrium equations that don’t show up in Wolf’s import/export balance model… essentially, Wolf is advocating economies which did things better, built better stuff, invested in what they *needed*… that these economies need to buy more junk from US/Britain (and a few others) because, well gosh darn it, that’s just good o’le global economic fairness!!!

      Oh well…

      If the government were to balance its budget, the private sector would lose its source of savings. And since losing savings does not serve to change the desire to save, the private sector would continue to cut its expenditures in a futile cycle which would then reduce total output, or GDP.

      That’s all well and fine on paper, but start breaking down the pieces and parts and things look a lot different.

      Just as a cursory example, US deficits are largely a product of bailing out WS malfeasance & -0- accounting for Iraq/ME debacle. Or to put it more consicely: under BUSH years, fed. government *was* private industry: it functioned on their behalf, to exclusion of honest economic observation/measurement/metrics etc., ignoring a decade of warning signs under veils of patriotic, airy fairy bull shit.

      Economy is generated by the product of it’s people. What the people know, what they do and how efficiently… and increasingly in world of greater populations with diminishing resources… how they meet these challenges… this is the stuff of economy. Simply put, a culture informs, then trains (educates), then moves to produce based on knowledge.

      The fruits of these efforts come at the end of the process.

      Wealth is the cumulative knowledge and actionable production (one follows the other) of a group of people.

      That is reality.

      Currency is a means by which humans attempt to value a respective work product.

      Everything these guys talk about is the process in reverse: the currency is the value, and the underlying product represented flows from it in their models. There is no accounting for the value of product, no measure of populations defined by national boundaries and their respective effort/knowledge/product, nor the meaningful differences between them.

      Rather, these guys models need to obscure and ignore that stuff in order to have their import/export equilibriums fit models purposed to distort their portions of currency to represent value which doesn’t exist.

      It sounds compelling, and it’s an EZ sell to large populations of like minded people. It’s also a myth.

      We have huge cultural problems: ingrained beliefs driving theories of economics which do not, in any way, reflect on reality. The models are decades old, derived from mechanics relying on abundance of resources and environmental plenty that simply are gone.

      Never in my lifetime has the chasing of $$ as a vocational (all encompassing… eg. professional purpose) so thoroughly distorted human activities. We got huge, huge problems, they arent’ being acknowledge much less addressed, and this (Wolf type stuff) kind of high minded theory does little more then perpetuate chasing our collective tails.

  17. jdmckay

    This “worst financial crisis since the great depression” is near 3 yrs old now, longer to those who saw it coming.

    AFAIC, Wolf does little more than expound upon Krugman “solutions” (gov stimulus), while having absolutely nothing to say about just what kind of activity this stimulus is supposed to stimulate… nothing. Wolf searches for equilibrium, entirely ignoring the forces in play.

    3 years… 3 f**king years, and our captains of finance/economics still burping up the same meaningless s**t going back pre-meltdown.

    Very honestly, I don’t think Wolf (or AEP or any of these other faux statisticians) have the slightest concept of what economy really is.

    1. charcad

      They don’t. And they think they deserve 7-8-9 figure salaries and bonuses for ordering Chinese take-out.

      1. NOTaREALmerican

        Actually, they do (even if only unconsciously).

        They know they are at the top of the scam. The priest class needs to repeat the story the dumbasses NEED to hear.

        They are participating in the “scam of life”. It’s the only way to tell the mature people from the infants.

  18. ds

    And Re: Emma Zahn’s comment — when you talk about assets/liabilities/equity in relation to Mr. Parentau’s argument you are confusing stocks with flows as well as real vs. financial assets.

    1. Emma Zahn

      Mr. Parenteau: “Domestic Private Sector Financial Balance + Fiscal Balance – Current Account Balance = 0″

      So balances are not stocks?

      Mr. Parenteau chose to reference a double-entry bookkeeping proof for stocks. He said nothing about their ratios to flows.

      Now explain how financial assets are not real, and no fair bringing up CDOs, SIVs, etc.

      1. ds

        The sector balance equation Wolf refers to is a representation of income and expenditure flows. Flows are measured over a time-period. Your balance sheet with assets and liabilities is a measure of stocks. Stocks are measured once at a specific time. So what you make over the course of a year is a flow measurement whereas how much money is in your checking account is a stock measurement.

        Over a given time period, and across all sectors, total income must match total expenditures. So if the private sector is running a surplus then the government sector must be running a deficit (excluding the foreign sector of course).

        The reason why the private sector is running such a surplus is because of what you mentioned: private sector balance sheets are terrible. On a micro level, individuals react to poor balance sheets by consuming less and saving more — i.e. spending less that what they earn. But on a macro level, it is impossible for the private sector to net save unless the government runs a deficit. Absent government deficits, all this savings desire would do is lower consumption, which, by identity, would reduce income and output. This is the classic paradox of thrift.

        This is why Wolf is using the sector balances approach. The approach helps demonstrate that government deficits are not always bad, and that, in this case, by accommodating the savings desires of the private sector, government deficits are keeping output at levels that would be impossible otherwise. So any attempt to cut government spending while private sector savings desires are abnormally high would be extremely dangerous.

  19. Edward Lowe

    I guess I am confused. Perhaps someone in this group can help me understand how MMT can work in a system where there is very little “hard currency” (i.e., paper attached to a present store of hard currencies like silver or gold that represent accumulations of past wage/profit surpluses, i.e., true savings) and mostly a system of debt-based currencies (i.e., paper created from nothing and attached to claims against the *future* value of wages, tax receipts, or profits in exchange for present or past consumption).

    In a debt based system there is no fixed and stable *0* at the end of the equation. Because, rather than a fixed supply of accumulated economic value that is attached to a known supply of currency there is a constant dynamic tension between money created as credit-issuance and money destroyed as principal repayment (about 95% of ‘money’ in existence, I am told). If the rate of credit-based money issuance in the system *exceeds* or is equal to the rate of debt-based money destruction plus interest payments, yes we can let the financial types talk about the flows of money between different economic sectors and the appearance of savings in one sector that is offset by deficits in another. But, without taking into account the dynamic of credit-issuance and debt-repayment plus interest in the system, you cannot even begin to figure out policies that make any sense.

    As an example, if the rate of debt-based repayment, or other forms of debt destruction like debt-forgiveness exceeds debt-issuance even by a few percentage points, actual currency begins to evaporate from the system at an alarming rate due to exponential properties (leading to an increasing negative value at the end of the equation) — the resulting deflation can leave all sectors scrambling for the money that remains in the system. I believe that is precisely what we are seeing on a global scale right now. Although, there has been some horribly inefficient attempts to keep some form of credit-creation going through central bank and government actions — the vastly distributed system of credit creation that preceded the current crisis simply dwarfs the ability of centralized agencies to keep up … the number at the end of the equation is very rapidly going negative on a global scale. This will continue until the system can reestablish a form of dynamic-equilibrium that rebalances credit-creation with true value in economic performance and, I think, a better balance among different groups of economic actors.

    Hopefully, Martin Wolf will help us understand the role of the dynamic credit-creation — debt-repayment plus interest where money is created from nothing on claims of the value of future wages/profits/tax receipts. And how this has anything to do with the MMT equations.

    1. VJ Kumar

      Edward,

      There are some attempts at dynamic modelling at the circuitist camp(Steve Keen, http://www.debtdeflation.com/blogs/).

      However, his accounting is unorthodox, i.e. different from the actual practices. Also, the government “vertical” money creation/printing is not in his model. I was unable to find any comparable dynamic work in the mmt camp.

      I am not sure how Mr. Parenteau can offer his recipes in the absence of an even unproven but at least internally consistent credit/debt flow mode other that generic hand-waving.

      1. Edward Lowe

        Thanks VJ

        Hmmm … hand waving sounds like flat earth type policy making to me. AKA … we know there is more to it than this … but adding dynamic equilibria to the models is SO HARD. I like simple algebra myself and closed/fixed system dynamics, and it is so much easier to get published! Yup, it’s simple algebra and flat earth modeling all around!

        I know of Steve Keen’s work, but I am not an economist, so getting into the particulars for a more trenchant critique is not in my tool kit. I do like to think of Steve as one of those John the Baptist types that show up from time to time to try and encourage the messiah to show him/herself or themselves (if the messiah is to be a community of radicals who actually have something right in answer to where the orthodoxy has gone wrong — as they often are historically, with a prominent fall guy if the heat gets to be too much ;)

        Prepare ye the way …. indeed!

    2. Tom Hickey

      Vertical money is created by currency issuance through the Treasury’s sending out checks and crediting deposit accounts. In a fiat system, The government is not financially constrained in currency issuance. That’s what “fiat” means.

      Horizontal money is created by chartered banks when they make loans against capital — loans create deposits.

      The important pont is that vertical money creation adds to nongovernment net financial assets since there is no corresponding liability in nongovernment. Horizontal money creation nets to zero, since everyones asset is someone else’s liability.

      The government increases nongovernment net financial assets through deficit spending, and decrease them by taxation. This is the essence of fiscal policy. In a fiat system the government as currency issuer does not tax to fund itself or issue debt to finance itself. It just issues. Taxation is to reduce the pressure of demand to harness inflation and create disincentives. Debt issuance is a monetary operation that drains excess reserves to allow the CB to hit its target rate.

  20. PDC

    “Again, keep in mind this is an accounting identity, not a theory. If it is wrong, then five centuries of double entry book keeping must also be wrong.”

    Well, what about 6000 years (or more) of Horoscopes?

    Am I the only one to think that Martin Wolf’s logic is often flawed?

    The point should be: is this “model” self consistent? Does it describe reality to some degree of accuracy? Does it enable us to make at least one interesting and falsifiable prediction?

    Personally, I very much doubt that this “bookkeeping” approach is a sufficient instrument to understand the imbalances of the global economy, and I do suspect that MW just uses it as a rhetoric expedient to support his thesis.

    1. Hal Horvath

      I wish you were right, but no, magic won’t save us from reality.

      Net saving must equal net spending, over relatively short time periods, or else….

      If net savings around the world exceed net spending (including investment like building ships, etc.) you get the obvious, inevitable, downward spiral in spending, aka a “depression”.

      Richard Koo could help, if you don’t like to believe one or three explanations, and want more.

      1. aet

        Yes. the economy does not grow, if people are not net spending.

        Piling gold – or any other commodity – up to the rafters won’t help anything in the larger economy, which is likke blood a flow, a circuit: but perhaps the holder’s fears may be assuaged thereby. I suppose that counts as some kind of value – but maybe not an economic one.
        More psychological, IMHO.

      2. George

        Meh. You are talking about savings and deficits in terms of the currency, not in terms of real goods. If people desire to save the currency and the government doesn’t run a deficit, then the prices of everything relative to the currency goes down. This is better than make-work or trying to reinflate collapsed bubbles.

        1. Hal Horvath

          If people save on net, and the government balances it budget, then the nation *must* have an export surplus or…a downward economic spiral. It’s just math.

  21. Hal Horvath

    This is encouraging.

    Martin Wolf has been talking sense for more than a year on this, and perhaps more people that discuss economics will begin to understand what he’s been saying.

  22. Hal Horvath

    Yves, it is surprising to me that people can manage to avoid understanding this.

    Perhaps this is going to take books upon books, years, dozens of columns, endless talk shows, etc., to begin to get across.

    I wonder if the human brain has something inside it that makes it hard to understand that if everyone saves at once, an economy spirals down. It is so elementary from the logical/economics side, but yet people are going to do double backflips to avoid understanding it I fear.

    1. George

      It spirals down in nominal terms, but do houses disappear? Do cars? Do people? Everything is still there. Prices adjust downwards to compensate.

      As long as you don’t do something stupid like burn crops, destroy houses, or prevent prices from adjusting, this is a good thing.

      As prices go down, people with cash will be tempted to spend it, thus picking up spending based on people’s subjective desires, not some cockamanie make-work scheme concocted by a few planners.

      1. pebird

        ” . . . not some cockamanie make-work scheme concocted by a few planners.”

        We are talking here about the sub-prime mortgage and financial securitization industry, right?

    2. Tom Hickey

      “You can lead a horse to water, but you can’t make him drink.” A lot of people seen not to want to understand.

  23. Hal Horvath

    Martin Wolf: “far from being stabilising, premature fiscal retrenchment threatens destabilisation of the world economy. In this case, a decision to turn the eurozone into a huge Germany would – and should – be seen as an act of mercantilist warfare upon the US. How long would the latter put up with the hypocrisy of surplus countries that blame borrowers for the deficits their own surpluses make inevitable? Not much longer, would be my guess,”

    Exactly. Not much longer. “Free Trade” hasn’t much longer, at this rate, in my estimation. It’s a tragedy unfolding (another great depression), and too many big nations (China, Germany) seem unable psychologically to recognize their part in crashing the world economy.

    1. George

      So the producers… you know, those people who actually ADDED to the total amount of real wealth in this world, are to blame? You guys really do have it all backwards.

      1. Hal Horvath

        George, if you and I lived on a mountain and formed an economy, with 10 gold pieces, and you sold me corn, and I sold you fish, and the trade was balanced…but then, one day….one day I decides to start saving, and thus spending less (in order to save), and thus buying *less* from you, you would have *less* income, comprende? Because you had less income, you could not buy as much from me….unless you *borrowed* (had a deficit)comprende? So, when I started saving more, unless you offset it by borrowing more, then *I end up with less income myself*.

        Savers require borrowers to balance them, or else incomes decline *everywhere* at once.

        Declining incomes mean less spending, and that means fewer jobs.

        1. jdmckay

          George, if you and I lived on a mountain and formed an economy, with 10 gold pieces, and you sold me corn, and I sold you fish, and the trade was balanced…but then, one day….one day I decides to start saving, and thus spending less (in order to save), and thus buying *less* from you, you would have *less* income, comprende?

          Right.

          So what did you buy less of? Corn? Are you starving yourself (and family) or just on a diet, or maybe figured out how to grow your own corn? Or maybe found a wheat supplier you prefer?

          So what happens in capitalism? Corn grower accesses, and decides to find new buyer, or grow different (more demand) product), or move off the mountain because environment is (given current technology/knowledge) untenable for growing other than corn.

          Or maybe corn grower builds tram to move goods up/down the mtn, charging small fee so you (fish) can move goods up there. Etc., etc…

          These are dynamic relationships, as are underlying goods/services. Processes begin, flourish and end. Cultures adapt/change/develop new stuff, or they die.

          These equilibriums are not built into any fabric of reality, they are an abstract point-in-time construct.

          Viewed over time (and not that long a span), these dynamics… balance of trade, goods produced, migration patterns… they go up/down, they flourish and burn out. The underlying fundamental is the intelligence, nimbleness and adaptability of a particular group’s production.

          Your (Wolf’s) model attempts to portray this as some kind of static, deterministic law, while taking no account of the underlying production of relative cultures (in this case nations).

          Further, if you subdivide activities w/in a given nation, the patterns/forces/product I describe further stand out and, it seems to me, cast light on folly of using this metric (trade equilibrium) in the manner Wolf suggests (have net exporters import/consume more).

          Immigrant madness, for example: vast majority of ‘em in south western states are migrant farm workers. I wonder how many folks clamoring for Az. type immigration laws have ever done stoop labor (picking squash/strawberries etc.)? I have, and I can tell you most gringos wouldn’t survive 1/2 a day in the fields. Yet most of those folks do the work happily (always amazes me), and cheaper then US’ cheapest legal labor.

          These folks literally provide Americans w/cheap produce… really inexpensive food.

          Most of immigrant violence in southwest is from drug (Cocaine/pot) smuggling. It enters US because people buy it here… lots and lots of ‘em.

          Yet, in our political debates on the issue, no distinctions are made nor any acknowledgment of value delivered by farm workers. Nor does the cost of black market pot/coke/heroin in terms of driving users into the shadows, ensuing crime, not to mention making them harder to reach for rehab because of the isolation… how does this fit Wolf’s model?

          I don’t buy any of this shit. US’ biggest problem is ignorance, increasing self indulgence, and diminishing desire to both see and understand the world we live in and meet the challenges of doing so successfully.

          We are stuck in the mud created by our own indulgences, and our leaders are blaming it on mud.

          1. Hal Horvath

            What happens when most *everyone* begins saving more, all at once?

            Answer mid 2008-early 2010….and we are only in a lull in that excess savings dynamic, since the stimulus will begin fading out in a few months.

            Guess what will happen to employment when savings again begin to massively exceed borrowing, as in early 2009…

          2. jdmckay

            What happens when most *everyone* begins saving more, all at once?

            All manner of understandable things can happen, particularly given global implications of financial economic mess.

            Answer mid 2008-early 2010….and we are only in a lull in that excess savings dynamic, since the stimulus will begin fading out in a few months.

            So I agree w/all you say there generally… except that, as you presented it (eg: gold/corn on a hill) and as Yves argued quoting Wolf, none of this is an reasoned (eg: cause) argument for import/export equilibrium as suggested. If anything, I’d read you as suggesting more Keynesian stimulus.

            But again… none of this explains fundamentals of US/Britain econ problems. The promise of capitalism has always been that it would flow to where it is most needed. In the US, a condition dramatically accelerated under the Bush years, this mantra has gone up in smoke: what is most needed here has not only been barren of investment, we are seemingly unable to have an adult public conversation about it.

            Where that investment has gone is into the pockets of a few, via (mostly) fraud executed by industry controlling government, at the cost of decimating US economy and strangling the fuel for a rebound. That fuel:
            * brains (education… massively deteriorated)
            * R&D… same as above.
            * available capital… gone in puff of libertarian Bushian debt sucked into Iraq/ME, offshoring everything, and dumbing down (lieing) to a public which got comfortable thinking they were “building wealth” flipping houses and investing in Enron type frauds.

            So anyway, sure… we got problems. And we made ‘em. And most of public doesn’t understand them because it’s never been explained to them. In short, US public has been thoroughly ravaged: financially, morally, resources and savings, by crooks.

            And BO has blown his wad on theory that refinancing the crooks would trickle down to a recovery.

            Guess what will happen to employment when savings again begin to massively exceed borrowing, as in early 2009…

            Balance of trade issues will only be solved by a rebuilding of US economy… period. Yes, people will hoard savings (or non currency valuables)… that’s what always happens when a country’s currency goes down the crapper.

            This balance of trade mumbo jumbo is akin to driving a car at breakneck speed towards a cliff, off the cliff if goes, and somewhere on the way down when driver can see bottom, he screams: WE’VE DRIVEN OFF A CLIFF, SOB!!! SOMEBODY GIVE US MORE ROAD.

  24. john

    As the economics profession grew out of the Great Depression, increasingly it grew on the payroll of players in finance. Since the Reagan deregulation and roll back of anti-trust the dominance and centrality of finance to the payrolls of economists has grown. Short term wealth preservation and financial gain have been the increasing focus of both the industry and its economists.

    Finance’s centrality and success has led to a complete regulatory capture, apparently of all the so called liberal democracies. Otherwise finance ministers would not all see the world through the lens of the financial industry and its hired gun economists.

    Yves’ “EConned” covers the corruptions of economics in the US quite well, anyone who hasn’t read it should, what is happening with the EU shows the corruption there is just as deep. What we are witnessing looks to me like an occidental “Great Leap Forward”: an ideological attempt to force the world to be as a fixed belief system requires that it be, consequences be damned. If the attempt is followed through, the results could be just as good as they were in China a half century ago: in another 30 years Europe just might be poised for growth!

    Generally folks in finance are concerned with how to make money, and more and more with how to make money in finance, the larger economy be damned. They understand the economy to the extent that it helps them make money, now. With quarterly results focusing their interests they have very little interest in how the larger flow of the economy works, the vitriol of the negative comments in this thread only highlight the narrowness of the commenter’s focus.

  25. sherparick

    I note that there were riots and protests in Germany last weekend and the news from the German web sites is that the Merkel government may not last the year. 70 years ago Hoover and Bruening implemented the same kind of austerity policies in 1931 as the world was struggling to come out of a deep recession resulting from a financial crisis and international credit bubble. Merkel, Cameron, and the corporate elite seem to want to repeat the experiment and see if they get the same result I guess. For what is is worth to the Austrians and Neo-classicals who believe in Says’ law (supply always create its own demand) and Ricardian free trade in world of chronic, semi-permanent trade deficits (since if trade was truly free, and countries specializing in only things they have comparative advangtage,there would never be any significant trade deficits since no country could import except equal to amount it could export, Nouriel Roubini has written a nuanced column echoing Martin Wolf. http://www.project-syndicate.org/commentary/roubini26/English

  26. NOTaREALmerican

    So, here is the executive summary of this post (so far):

    Martin is a genius|idiot.

    The equation(s) that all economic decisions are based on – world wide – doesn’t take into account: profits, growth, or usefulness.

    Jeez, is it any wonder….

  27. tc

    “4. Moreover, some countries that have been running large trade surpluses for quite a while (in particular China and Germany) are not willing to change course, at least not in the near future.

    Yve, I think you miss the point that US could cut down deficit by curtailing its annual thrillions military and war budgets, without having the trade surplus countries changing course. Every war US enters into and the 14 career fleets and close to a thousand military overseas bases cause deficits and debts for the US. This surely is not a problem for other countries to fix. The responsibility lies with the spender. I could not imagine a world where a country fights wars and thus incurs deficits and debts and the ROW are required to fix it. It seems warped logic to me.

  28. Jamisia

    First of all, I think it’s best to dump ‘economics’ as a science and return to what it really is: political philosophy. As in, what kind of society do we want? Most European countries assume that there is a large public good and that it’s government’s role to advance it. In my opinion, austerity plans come down to decreasing, if not destruction of the public good. Government may sometimes descend into ‘distributing the loot’ and you have to fight that, but I don’t want ‘no public good’ either.

    Whether the identity is written correctly is irrelevant. In the shape it’s presented it says: it takes three to tango. Government in deficit? Then one of the other two (or both) must be in surplus. And vice versa. Sure, households & businesses can save, but then the growth must come from exports (which are a cost, because real goods are traded for worthless paper (it’s not barter)). But then, what if everyone in a currency zone or a trading bloc follows that strategy? Disaster ahead?

    Sources: you’re better off reading both Bill Mitchell and Warren Mosler. Mitchell is a researchprofessor in Australia, who uses his blog to teach. Mosler recented linked to a pdf, for internal use in GS, where hard currency (present) was compared to soft currency (MMT). Googleth and ye shall find.

    Ps. A few weeks ago I used the identity in a Letter to the Editor (local newspaper). The letter got published too. So wrong or right, the identity struck a nerve. (and I’m anything but an ‘economist’!)

  29. Jim

    One of the fascinating things about MMT is how, at its core, it simply replaces one moral vision with another.

    It attacks the idea of “sound” finance (the old ethic of thrift and savings) with a new ethic which argues that government should advance “public purpose” and throw-out any moralizing concept that public deficits are dangerous.

    The new morality of MMT is focused on the results of government actions. Men and women in our “modern” system can be released from constraints (there are really no important limits in a fiat monetary system) and simultaneously maintain a firm belief in progress–due to the wise steering skill of public-sector bureaucrats and their in-depth understanding of how the monetary system actually operates.

    The new morality of MMT reminds me of a statement from Keynes’ memoirs written in the 1940s in which he says that he and his companions had been willing to admit in the confident years before WWI that they were amongst the last of the Utopians who “believe in a continuing moral progress by virtue of which the human race already consists of reliable, rational decent people…who can safely be released from the outward constraints of convention and traditional standards and inflexible rules of conduct.”

    It just may be, as with Keynes, that MMT will come to be increasingly uneasy with such a progressive ideology that seems to endorse an indefinite expansion of desire, a steady rise in the general standard of comfort and the incorporation of everyone into the culture of abundance.

    There is something about “to big to fail” and what is happening in the Gulf of Mexico that seems to throw the wisdom of this alternative morality into serious question.

    1. Jimbo

      MMT, properly understood, has no more “morality” than the laws of physics. It simply describes the way things are. What you do with that knowledge is up to your own values.

    2. attempter

      I agree that it includes a new moral vision to counterattack the aggressive immorality of neoclassicalism and neoliberalism.

      Although, MMT doesn’t blithely say you can run infinite deficts. It says where the economy isn’t running at full productivity, deficits are harmless and probably beneficial.

      On its face it’s obvious that where we have close to 20% unemployment and underemployment, there’s lots of slack to be taken up.

      So anti-deficit, pro-”austerity” arguments in such a context are malevolent, kleptocratic lies.

      I think, but I’m not sure, that MMT also rejects the “natural rate of unemployment” concept as both wrong and evil.

      I suppose many MMTers would disclaim the moral connotations and prefer merely to denote, but to me the moral aspects are the most interesting point.

    3. Marshall Auerback

      There are some things that you can attempt to rebut, but breaking down ignorance and prejudice is pretty tough. Reading some of these comments, I wonder how many of these people want to have a serious debate and how many of are interested in nothing more than demogoguery and misguided personal attacks.

      Jim, why is there something immoral about accounting 101 which, as Rob Parenteau and others on this comment thred have noted, have been in existence for over 500 years? It’s a description, not a normative prescription. Is it immoral to say that you’ve got blonde hair? Is it immoral to say that Deng Xiaoping was Chinese? Why is it wrong to describe an economy using basic accounting identities?

      But it’s interesting to see this fellow conflate the BP oil spill disaster with MMT. Full marks for originality! What’s next? That Keynes was responsible for the hydrogen bomb?
      You have seen this accounting identity for the three sectoral balances before:

      (S – I) = (G – T) + (X – M)

      So total private savings (S) is equal to private investment (I) plus the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)), where net exports represent the net savings of non-residents. That has to hold as a matter of accounting. It is not my opinion or a matter of “morality”

      Thus, when an external deficit (X – M < 0) and public surplus (G – T < 0) coincide, there must be a private deficit. While private spending can persist for a time under these conditions using the net savings of the external sector, the private sector becomes increasingly indebted in the process.

      For my home and native land, Canada, while the current account deficit has fluctuated with the commodity price cycle, it has continued to deteriorate slightly over the longer term. Accordingly, the dramatic shift from budget deficits to surpluses from the mid-1990s onwards was mirrored by a corresponding deterioration in private sector indebtedness, as I pointed out in a piece a few days ago.

      The only way the Canadian economy could keep growing in the period after 1996 was for the private sector to finance increased spending via increased leverage. This is an unsustainable growth strategy. Ultimately the private deficits will become so unstable that bankruptcies and defaults will force a major downturn in aggregate demand. Then the fiscal drag compounds the problem. Hello? Are we still following this?

      The solution is simple. The government balance has to be in deficit for the private balance to be in surplus for a stable external balance.

      In terms of the slightly worsening current account deficit, we can interpret that as signifying an increased desire by foreigners to place their savings in financial assets denominated in Canadian dollars. This desire means that that the foreign sector will allow us to enjoy more real goods and services from them relative to the real goods and services we have to export.

      In Japan, by way of contrast, the sectoral balances reveals that the private sector surplus increased on a par with the long-term increase in budget deficits. In other words, the persistent and substantial fiscal deficits financed the saving desires of the private sector and helped to maintain positive levels of real activity in the economy.

      This stock-flow accounting structure conditions the way modern monetary theorists think. It is ground in the operational reality of the flow of funds within the economy. I fail to understand the immorality of this.

      So you cannot possibly say, for example, that the government can run indefinite surpluses while the current account is in deficit, and expect the domestic private sector to be able to save. It has to be that the only way the economy can grow in these circumstances is for the private domestic sector to be increasingly going into debt.

      You may think that is fine and we can argue about that as a growth strategy and a reasonable way to manage the need for public goods. That is the debate part. But you cannot deny the former.

      The problem is that the Austrians and mainstream economists do deny the accounting statements and demean the rest of their arguments as a consequence. Most of their solutions cannot “add up” in terms of the stock-flow relations, so they construct specious arguments which ultimately expose the incoherence of their position.

      1. VJ Kumar

        I commented on the identity triviality earlier.

        For simplicity. let’s pretend there is no foreign trade imbalance (say, we live in Germany). I assume you understand that the private “net saving” means nothing more but holding government paper in the form of currency or T-Bonds, and that the government needs to print such paper in order to satisfy potential demand, therefore running a deficit as expressed in quantity of the printed paper.

        If you do, then

        a) Why holding the government paper is more beneficial than investing in the private sector assuming S-I >0 ? Do you agree or disagree that buying say S&P 500 index shares may (or may not) be a more reasonable investment strategy thus decreasing the need for government IOUs and as a consequence running a smaller deficit ? As I commented elsewhere, holding government paper is in essence trusting the government with investment choices rather than making such choices on your own which again may be good or bad depending on your investment skills.

        b) How exactly do you propose to transfer freshly printed money into the pockets of the worthy (having S-I <=0) rather than into the WS denizens saving accounts as was and is being done with the ongoing quantitative easing ?

        Thanks.

        1. Tom Hickey

          In the US, the government forces saving by requiring a $-4-$ debt offset for deficits, thus transferring the increase in nongovernment net financial assets of deficits from deposit accounts into time instruments. This is actually unnecessary since the government has no need to finance itself in a fiat regime, and monetary policy could drain excess reserves through the Fed paying a support rate equal to the FF rate. Many MMT advocates would like to see a no bonds policy, since the interest payment constitutes a subsidy to those wealthy enough to purchase tsy’s.

      2. jdmckay

        Jim, why is there something immoral about accounting 101 which, as Rob Parenteau and others on this comment thred have noted, have been in existence for over 500 years?

        I assume you’re referring to another Jim, but I’ll bite.

        It’s a description, not a normative prescription.

        Exactly. A point in time snapshot, relying on currency buy/sell book keeping for assumed underlying value of goods/services.

        But… Wolf (& others) most certainly use this as a prescription: eg. as demand (or whatever term you use) that the NET EXPORTERS move towards import/export equilibrium.

        Is it immoral to say that you’ve got blonde hair? Is it immoral to say that Deng Xiaoping was Chinese? Why is it wrong to describe an economy using basic accounting identities?

        False analogy (although I suspect you’ll think I’m splitting hairs): Deng is Chinese, and a blonde is… ok, maybe not (could change daily… and where did that purple stuff come from)… but let’s run w/your analogy.

        The accounting you describe and seem to hold in such high esteem relies on multiple layers of assumptions: national GDP accounting relies on home based multi-national accounting, which relies on subsidiary accounting… so on & so forth. There is an assumption of accuracy, right?

        Beyond that, where in all that is the measure of value produced, represented by those currencies/balance sheets? And beyond that, at least in my view, there’s far far too much evidence that corp. accounting is as much wishful thinking and marketing as it reflects reality: Enron, WorldCom, Fed’s toxic asset balance sheet (hard to believe)…

        But it’s interesting to see this fellow conflate the BP oil spill disaster with MMT. Full marks for originality! What’s next? That Keynes was responsible for the hydrogen bomb?

        Again, your examples lack distinctions… and in my view, typical of sloppiness which has guided global finance to the precipice.

        I don’t know (the other) Jim meant w/his BP comment, but I sure know what I think: this BP event is a canary-in-the-mine (CITM) moment, indicicative of much multi-national (and smaller) functioning. First of all, they have lied… just plain lied across the board, on many aspects of this disaster. Beyond that, there is now plenty of cumulative evidence that they utterly (and seemingly flippantly) blew off known and well established best practices designed to ensure a safe, reliable product.

        It’s a CITM moment because it’s charactaristic of so much industry:
        a) highly technical
        b) known science/procedures as guide to safe work product
        c) hugely profitable
        d) high public risk if highly technical work not executed w/integrity.

        BP blew off b-d… blew it off. They were an unreliable manager for a hugely complicated task, and lied about it. And they were motivated to blow off all this by profit, a profit which over the long haul would only be marginally affected by having done things right.

        These charactaristics have become endemic (especially in US): they could be accurately applied to key players in finance that brought us recent bubble, same w/Enron & WorldCom, GM and a host of others. And their influence in stomping out competitiors (energy for example) only exacerbates things.

        So again, as I’ve said elsewhere here, we (world) have arrived at a point where huge problems/shortages for the basics (water/energy/food/industrial resources) are staring us in the face unaddressed. Much of what’s put off the day of reckoning is the leaders of finance who, chasing returns rather then needs, have controlled politics/lawmakers with (essentially) bribes to ignore all this stuff at the expense of economic, cultural and social health.

        Chris Whalen has written on exactly the same (eg: ignoring their economic models, not financing tech/computer software to properly monitor the “stuff” which pointed to mortgage bond blowup) WS corp. behavior: putting profit over quality product.

        I’ll use another term: lack of integrity… these guys operate with a lack of integrity, and fuel an entire industry (PR) to mask this moral vacum w/happy faces.

        The NET exporters who are target of Wolf (and others), they have indeed addressed much of these problems. They have built better products (look at Norway’s regs overseeing BP type accident). In short, they’ve done a lot of things right and built a lot of high value products.

        Why, now that US/Britain have bull shitted their way w/phony accounting and decimated econ engines… why the hell should a prescription by these (US/Britain) same crooks, that cultures who did things right should by more of US junk?

        The problem w/your accounting 101 screed is, that accounting has proven to be a non-reliable representation of just about everything it purports to represent. And w/all due respect, you and a bunch of others seem utterly oblivious to this: I read your stuff (both here and your site) all the time, and never… never, do you address the fundamental activities of humans in the given nations at play… eg. THEIR WORK PRODUCT!!!

        If US wants to get back in the game in honest way, it’s time (actually way past) to start talking about what the hell we do here, and get honest about it. Our NET importing is not a consequence of inequities levied upon us by evil 3rd world nations, it is the direct outcome of several decades whereby we’ve exported our production and tech for cheap labor abroad, while filling the vacuum here with all kinds of worthless crap.

        No amount of Renminbi revaluation is going to make US smart. Rather (IMO) doing so would only delay the day of reckoning.

  30. SuperElite

    90% of the economy is make-work.

    Therefore, I am in favor of reducing GDP as much as possible.

    I’m a big fan of Austrian economists because I believe their position will result in less make-work and a smaller economy.

    1. Tom Hickey

      That’s the dumbest thing I’ve heard all day. With a growing population you want to reduce GDP? Don’t you realize that GDP is identical with national income? Reducing national income increases unemployment. No problem?

      1. Toby

        Can national GDPs expand everywhere for all time? Is the finiteness of the planet a problem for the perpetual growth paradigm? Are we at a point where we need to be addressing the growth question? I think so. So, what about reduced work weeks to get people into work? Of course, there also needs to be huge investment into schools etc., so that we have a work force flexible enough to share competently the work load at ~98% employment, but this is a path I equate with weaning ourselves off growth and transitioning to a more sustainable model.

        I certainly see MMT as part of that process, but I also feel growth is something MMT has not properly addressed. I just read “The Ecology of Money”, which is a small booklet about alternatives to the current money system. It addresses how a revolution in the money system could foster a healthier attitude to growth and contraction, which are unvoidable parts of life. I don’t agree with everything the author (Douthwaite, if memory serves) prescribes, but it makes for interesting reading.

      2. pebird

        Tom,

        But you have to admit it’s a pretty good prediction of what would happen if we applied Austrian economic theory.

  31. Reino Ruusu

    Of course there can be net savings. Not all bookkeeping is double. If I make something, say grow a crop of potatoes, I get to put that on my books without a balancing entry. If I don’t eat the potatoes immediately, I will have accumulated savings. If I sell those potatoes to a bank, new financial assets will come into existence. Accounting is only a means for tracking flows. Those flows do have actual sources and sinks.

    1. ds

      That is correct Reino. You underscore what is going on in the private sector and why we need deficit spending. If I take out a 400,000 dollar loan to buy a house, my balance sheet is $400,000 of liabilities from the loan and $400,000 in assets from the house. Note that the house is a real asset and my assets match liabilities so I am solvent.

      But what if housing prices drop 50% over the next 18 months? My loan is still a $400,000 liability but my house is now only worth $200,000. Realizing this, I would scramble to start saving in a desperate attempt to repair my balance sheet. If I found it impossible to save enough money, my only choice would be to default. This default could produce a cascading effect, leading to my bank defaulting on its depositors and the depositors defaulting on other banks, etc. etc….

      Modern governments have a choice — they can either accommodate private savings desires through deficit spending, giving the private sector the time and ability to repair their balance sheets, or they can allow a massive wave of defaults as households, businesses and banks all scramble to sell their now-worthless real assets. Exactly how the government deficit spends does matter, but, all else equal, the former option is much more preferable than the latter.

    2. Tom Hickey

      Uh. Potatoes are not financial assets. Financial assets are invested to expand real assets. That’s what economics is about.

      1. Reino Ruusu

        No, potatoes are not financial assets, but surely checking account balances are. When a bank purchases a hard asset, say a building, from someone, it credits the seller’s account with a new cash balance that did not exist before the transaction. This way financial assets can be created without a balancing financial asset on the other side of the ledger.

        1. Jimbo

          “When a bank purchases a hard asset, say a building, from someone, it credits the seller’s account with a new cash balance that did not exist before the transaction. ”

          Yes – and that balance then becomes an asset to the seller, and a debt to the bank.

          By definition, a financial asset is a relationship – an asset/debt pair.

    3. Emma Zahn

      If I make something, say grow a crop of potatoes, I get to put that on my books without a balancing entry.

      I don’t think so. You will have invested at least your time, some acreage and probably cash plus you likely have estimated the revenue you expect to receive. Just because you have not posted them to your books doesn’t mean they are not there.

      I am not trying to dispute MMTs accuracy but I would appreciate better accounting/bookkeeping explanations. Something somewhere between a simplistic accounting proof and references to arcane stock-flow measures.

      1. Reino Ruusu

        Of course something has to be invested, but the point is that not all that investment is accounted for. Ever hear of “sweat equity”? Some of the created net value simply did not exist before.

        The result of investment is supposed to be something of greater value than the invested assets. Otherwise investment doesn’t make any sense. We can’t all live on pure speculation.

        The purpose of banks is converting existing equity in the form of real assets into financial assets. Thus the balance of financial assets is not zero either. Unfortunately, most financial assets are nowadays created in debt transactions, resulting in a zero-sum game.

  32. JIm

    Marshall

    I’m not be any means calling the MMT perspective immoral. I said at its core, it seems to me, that MMT offers an alternative moral vision.

    What I am asking is whether this alternative moral vision, which I believe is embedded within the MMT perspective, is adequate to the task at hand.

    Absence of restraint and belief in human progress implies, for me, a confidence in our collective ability(through the market or the state) to conquer a more ancient sense of the inescapable limits to human behavior.

    From my perspective both the “sound” finance moral vision, through the market, and the MMT moral vision, through the state, end up sanctioning the status quo.

    Capitalism, as it has evolved, makes a friend of insatiable appetite and the moral vision embedded in state centered fiat money seems to mimic this same insatiable appetite.

    Culturally, what does MMT submit to?

  33. Tom Hickey

    MMT is a description of the modern (post-1971) monetary system under which we are now living and operating. It is a reality-based operational manual to replace the currency myth-based views. It is descriptive, not normative. The present monetary system will support a lot of different policy options and MMT just shows what they are, how to achieve them, and what to expect.

    What MMT does show is that certain policies now in place or being considered will not produce the anticipated results. It also shows how to achieve sustainable growth (considering population increase) and full employment, along with price stability through fiscal policy, thereby reducing or eliminating the foregone opportunity of persistently high unemployment — anything above about 2%.

  34. Hal Horvath

    I suppose what many hope to avoid understanding is the result — the reality — that the *net* private savings in the world must = the net deficit in the aggregate budgets of all governments in the global economy.

    For citizens to save on net (for the private sector to save more than it borrows in a time period) *requires* that government run an equal and offsetting deficit.

    Facing that is an “uh-oh” moment.

    It destroys some ideolgical, political fads of the day.

    Because if government around the world, in aggregate, had altogether an aggregate balanced budget (no net governmental deficit) then it would follow that the net private savings must be zero (all private savers must be equally offset only by private borrowers).

    yikes!

    And that collapses certain value-systems — since most people in the world hope to save money for retirement/emergencies, etc., that *forces* *unconditionally* that governments *must* then run deficits, in aggregate.

    Thus the ideological value system where people belief that families/individuals should save but also demand that the government balance its budget (Germany, the U.S.) — this is ultimately unworkable unless some nations somewhere are borrowing all that excess saving (Greece), which eventually leads to….yes to defaults, and the illusion of saving is blown away like a tuft of cloud on the wind.

    Germany, seeming to have so much savings….doesn’t!

    Because Greece, Spain, etc. cannot pay all that borrowing back.

    And finding out your ideological values are *unrealistic and unworkable* is intolerable. So it will be denied, ignored, discounted.

    Even if its like denying that water runs downhill.

  35. Hal Horvath

    note: “And that collapses certain value-systems — since most people in the world hope to save money for retirement/emergencies, etc., that *forces* *unconditionally* that governments *must* then run deficits, in aggregate.”

    – This is because in a global savings culture (fad or long term), business doesn’t need to borrow much, since much extra goods and services cannot be absorbed, due to all the saving.

    Thus only government is left to do the borrowing that saving requires.

    When less than 100% of the net saving is borrowed (deficit spending by government), then net *income* (what your job depends on) is reduced by *exactly that difference*. This shortfall in borrowing vs savings results in a downward income spiral.

    A downward income spiral causes (unconditionally) that jobs and/or wages are cut in exact proportion to the borrowing shortfall.

    If the US/Chinese/German/etc. governments do not borrow that excess savings, then your own job, yours, is liable to be next on the chopping block.

  36. jdmckay

    I find this discussion maddening in it’s lack of purpose & lack of meaningful distinction. Auerback says MMT is not prescription, yet whole purpose of Yves’ bullet points presents the tenets as such… Just as Wolf, AEP and so many others have in recent months.

    Yves quotes Wolf above:
    The fact that aggregate demand and long-term interest rates tumbled at the same time shows that the collapse in private spending “crowded in” the fiscal deficits.

    I would say that the deficits (debt) was “crowded in” by practices of previous decade… fraud, and on a massive scale. That demand tumbled was the reasonable consequnce. That interest rates tumbled was a monetary policy decision.

    Wild private behaviour drove the wild public behaviour.

    Given US Fed policy this decade, I can’t see the public/private distinction:

    * Feds actively supported the housing bubble and worked to conceal it.
    * Feds set tax policy encouraging off-shoring of US economy, w/no corresponding sovereign value: eg. it was benefit of a few, at cost of the whole.
    * Feds eviscerated oversight over most everything… environment, finance, off shore drilling… everything. They did this, simply, at behest of industry which packed their pockets to look the other way. I have list of 200+ laws written under Bush era where industry reps wrote desired laws, and it was passed ver batem. And these Fed agencies BTW, forever, were tasked with protecting the public good. In this decade, the task they undertook was to undermine the public good.

    US economy is running on fumes. Our largest problems are entirely unaddressed. We do not have initiatives anywhere addressing them in a meaningful way.

    Just how the hell can any intelligent human being delude himself into ignoring all this by some abstract balance of trade formula?

    In his recent FT column, Jeffrey Sachs of Columbia University argued that fiscal stimulus was unnecessary: monetary policy would have been enough. I disagree. Despite the most aggressive monetary policy ever, private sectors moved into huge surpluses. Monetary policy was “pushing on a string”. The fiscal offsets – overwhelmingly due to built-in fiscal stabilisers, not the discretionary stimulus – helped sustain demand in the crisis. But they were insufficient, even with monetary support, to prevent deep recessions.

    They were insufficient because they never identified, nor sought to address, much less targeted meaningful “wanted and needed” development. There’s been talk of growing a green energy sector, of rebuilding infrastructure: yes, there was some of that… a trickle.

    The rest went to put food on the table, and refinance WS crooks who got us in this predicament. And what have WS captains of finance done w/all this taxpayer gifting?

    Yves has posted often of GS’ carry trades, opportunistic FOREX games based not on sound investment, but beating “the market” to the gun and profiting w/mass: lots of $$ on low margin ahead of percieved, small (or sometimes large, and possibly induced) events.

    DOW climbed greatly on US financials, based on what? Balance sheets, still hiding real estate losses w/various gimmickry, w/earnings coming as described above and investment in… foreign/emerging markets.

    How, pray tell, with US energy grid losing < 30% of generation from source to well socket, with dirtiest coal dependence on the planet, w/workforce expertise reduced dramatically in last 5 yrs w/commensurate loss of earning, w/bio-seed production now facing the unforseen consequences of rushing them to market in a very big way, with drought across the country last 2 years and completely undaddressed…

    what kind of mind, purporting to be economic experts, explains all this away with MMT jargon, balance of trade issues, while ignoring the massive fundamental nuts and bolts that make things go?

    The argument that stimulus was unnecessary is hard to accept. It is easier to believe it was too small, albeit also ill-targeted.

    “ill-targeted”… sheesh. it was un targeted… scattershot, targeting was largely undiscussed. Remember, it was Paulsen’s mid-night call which precipitated the bailout, and congress responded w/out ever… every, publicly enumerating the actual mechanics of US econ activity between workers on the ground and WS captains of finance.

    NONE… ZERO. In our system, it was a fait accompli.

    It almost looks feudalistic, it’s sucked the life out of US economy and ingenuity, it’s left us broke… and most of the participants seem to hardly understand what the hell happened.

    Instead of fixing things, we’re visited w/this constant drivel of econ 101 jargon which pretends as though all we need is a little more capitalism or something.

    What we need is a major self examination, an entire re-accessment of priorities, and some kind of finance delivery mechanism which bypasses WS and goes directly to those doing the production. Let WS have it’s say after we get something going, and after we weed out the crooks there and put ‘em away.

    Really people… it’s time to get real. When the captains of world finance bankrupt the planet w/junk mortgage bonds, and throw up there hands and say: “who could have known!!!”, just why the hell are we putting our collective financial resources in these guys hands to fuel recovery?

    And people wonder (literally) why this “recovery” is not so hot. Sheesh, and double sheesh….

    1. VJ Kumar

      jdmkay:


      “what kind of mind, purporting to be economic experts, explains all this away with MMT jargon, balance of trade issues, while ignoring the massive fundamental nuts and bolts that make things go?

      Precisely, “the massive fundamental nuts and bolts that make things go” theme is conspicuously absent from the discussion. It is quite frustrating.

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