Re: [A-List] US Dollar Standard: Deficits Do Matter

["Leigh Harkness" <Leigh@xxxxxxxxxxxxxxxxxxxx>]

Henry

You wrote:
> Defiicits do matter, but only to the extend of when they occur and how
> the money is raise and spent.  Government debt is not the only source.
>  Government has the power to create money.

Nor does government debt need to cause monetary growth.  Government debt
financed by the issue of bonds to the non-banking sector does not cause
monetary growth.

You continue:
 And as long as the rate of
> money creation is not ahead of economic expansion, even monetarists must
> agree that it is not inflationary.  Even Milton Friedman thinks that
> steady (3%) expansion of the money supply would lead to a 3% steady
> expansion of the economy (with 4% structural unemployment.)

Monetary growth has an effect on economic expansion.  Money generates the
demand that brings about economic expansion.  Even monetary growth of 3% can
be inflationary.

You continue:

 Some who
> are ideologically free from monetarists fixations assert that zero
> unemployment can be achieved with a 6% economic expansion.  To do that
> the government should print and add 7% to the money supply every year,
> running a budget deficit equal to 7% of GDP, whicch in todays terms,
> means $700 billion.

Monetary growth can raise income but it appears to depends on the source of
that money (and there may be some other issues such as the level of loan
repayments to banks).

If the money is created by increasing exports which raises foreign reserves
(either because of a fixed exchange rate or the central bank intervention in
the foreign exchange market), then that money does not appear to be
inflationary.  For the increased exports to exist, there must be an increase
in production (supply).  That monetary growth is associated with a direct
increase in income and the associated monetary growth is related to an
increase in income and is not inflationary.

There appears to be a direct relationship between income and the money
supply.  That is, if income rises 10%, the economy needs a 10% increase in
the money supply.

If the monetary growth was inflationary, rate of monetary growth is much
higher tha the rate of inflation.

The following is an attempt to explain the relationship between money and
inflation.  Please tear it apart because it does not make total sense to me
yet.  But if we start exploring the issue, hopefully someone would shed some
light on the relationship that will make sense.

Monetary growth represents the expansion of entitlements.  Inflation
undermines the value of those entitlemens, such that if E was entitlements,
Ve the value of entitlements and P was the rate of inflation then:

Ve= E/(1+P)

For the economy to have price equilibrium, demand and supply need to be
equal and prices will change to bring about that equilibrium.

The supply side is increased by inflation.  That is not physical supply but
nominal supply.  We could say that the supply side is Vo is given by:

        Vs = S*(1+P)

Where S is the supply of money at the beginning of the period.  It may also
be considered as the supply of products that would have existed without
monetary growth and inflation so that if there were no inflationary monetary
growth there would be no inflation.

For the market to clear:

Ve = Vs

ie  E/(1-P) = S(1+P)

(1+P)^2 = E/S

1+P= (E/S) ^0.5

P = (E/S)^0.5 - 1

That is, the rate of inflation is the square root of the money supply
(created by monetary growth to finance expenditure of government or private
sectors) at the end of the period over the money supply at the beginning of
the period minus 1.

> That is roughly what the US economy is doing, a $400 billlion trade
> deficit and a $300 billion budget deficit.  So why is there 7%
> unemployment?  Because the money is spent on the wrong things.

The $400 billion trade deficit is not any form of monetary stimulus to the
economy.  It cannot be added to the budget deficit to obtain a figure for
the total stimulus to the economy.  Actually, if the $300 billion of the
budget deficit was financed through monetery growth (either from currency or
the banks) then that budget deficit would have contributed to the trade
deficit.  At best you are double counting.  The trade deficit is part of a
current account deficit which is generally finance caused through monetary
growth source from the growth of bank credit and currency.

> Balancing a budget when the economy is contracting is to starve a sick
> patient, to cut taxes for the rich at a time of overcapacity is to pour
> gasoline on fire, and to stimulate an economy with war deficits is to
> burn one's hair to cook an egg.
>
> Tax and spend is a self adjusting formula, not a fiscal sin.  Taxing
> more than spending is simply removing money from the economy.  When
> government does not spend and spend on the right things, it should go
> out of business and let someone else do the necessary.

Taxing more and spending is simply taking money out of the economy and
putting it back in.  Spending on the right things might make thinks better
for those recipients in the right place but it is not going to solve an
unemployment problem.

 Leigh