Martin Wolf, the Financial Times’ esteemed economics editor, launches another salvo against misguided austerity measures today. It’s also noteworthy that he argues from a Modern Monetary Theory perspective.
Wolf first stresses that yields on government bonds show that inflationsitas are all wet:
I have a question: do we believe that markets are unable to price anything right, even the public debt of the world’s largest advanced countries, the best understood and most liquid assets in the world? I suggest not. Markets are saying something important…
On Monday, the yield on 10-year government bonds was 1.1 per cent in Japan, 2.6 per cent in Germany, 3 per cent in the US and 3.3 per cent in the UK (see chart) Based on yields on index-linked securities, real interest rates on borrowing by these governments are very low (1.2 per cent, or less, in the US, Germany and UK). Investors are saying that they view the risk of depression and deflation as greater than that of default and inflation.
Wolf next establishes that the private sector in countries all around the world is saving. The OECD forecasts that savings in advanced economies will be 7% of GDP, or roughly $3 trillion. In theory, these savings could go to investments in emerging economies, but the private sector in those countries is projected to be saving too. The Institute for International Finance anticipates a total of $300 billion for 2010.
Wolf then explains how this all plays out:
According to the IIF, the net flow of private funds from advanced countries to emerging countries will be close to $700bn this year. But that will be almost entirely offset by an official outflow, in the form of foreign currency reserves, of close to $600bn. These huge official interventions prevent the emergence of large net capital inflows into emerging countries. Instead, the private sectors of the advanced countries accumulate net claims on the private sectors of emerging countries, while the governments of emerging countries accumulate offsetting claims on the governments of advanced countries.
The bottom line is clear: there exists, at present, a gigantic net flow of funds into the liabilities of the governments of advanced countries. Of course, some countries can still get into difficulties. But it is quite wrong to argue that the difficulties of a Greece or a Spain entail difficulties ahead for the US, or even the UK. The opposite is far more likely: flight from risk entails flight into something less risky. What is the least perilous asset for the investment of gigantic private financial surpluses? The only answer is the public debt of the big advanced countries.
These flows of funds consist only of identities. So what are the causal factors? Maybe, the collapse in private spending in the wake of the financial crisis was caused by terror of the fiscal deficits to come. Maybe, the moon is made of green cheese, too. There is also next to no sign of crowding out in capital markets. The plausible hypothesis, then, is that the fiscal deficits were a response to the collapsing desire to spend of the crisis-hit private sector. Fiscal policy could have been tighter. But the result would have been a depression.
What then of the future? Suppose there is no significant change in policy in emerging economies. Then if a fiscal contraction in advanced countries is not to cause a slowdown, even a second recession, it must be accompanied by an upsurge in private spending.
The argument must be that improved confidence in the long-run sustainability of public finances would lead to greater private consumption and investment spending now, even if there is no significant effects on interest rates or the exchange rate. I am highly sceptical of this argument (see “Why it is right for central banks to keep printing”, Financial Times, June 22, 2010). But grant that this is true. Then the best policy is to slow the long-term growth in spending on age-related programmes. This comes out clearly from the discussion of long-term fiscal trends in the excellent new annual report from the Bank for International Settlements.
Yves here. So Wolf, and the Bank of International Settlement (hardly a bunch of socialists) think keeping old people from having to subsist on pet food would be good for economies around the world. I’d love to see Wolf up against the Social Security fear mongers from the Peterson Foundation. Fur would fly.