Re: Marxist Fianancial Advice/ Henry C.K. on Money - 3 - end

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Sovereign Credit (Part 1)

By Henry C.K. Liu

Credit drives the economy, not debt.  Debt is the mirror reflection of credit. Even the most accurate mirror does violence to the symmetry of its reflection. Why does a mirror turn an image right to left and not upside down as the lens of a camera does? The scientific answer is that a mirror image transforms front to back rather than left to right as commonly assumed. Yet we often accept this aberrant mirror distortion as uncolored truth and we unthinkingly consider the distorted reflection in the mirror as a perfect representation.

In the language of economics, credit and debt are opposites but not the same.  In fact, credit and debt operate in reverse relations. Credit requires a positive net worth and debt does not. One can have good credit and no debt. High debt lowers credit rating. When one understands credit, one understands the main force behind the modern economy, which is driven by credit and stalled by debt.  Behaviorally, debt distorts marginal utility calculations and rearranges disposable income. Debt turns corporate shares into Giffen goods, demand for which increases when their prices go up, and creates what US Federal Reserve Board Chairman Alan Greenspan calls "irrational exuberance," the economic man gone mad.

 

Most monetary economists view government-issued money as a sovereign debt instrument with zero maturity, historically derived from the bill of exchange in free banking.  This view is valid for specie money, which is a debt certificate that can claim on demand a prescribed amount of gold or other specie of value.  Government-issued fiat money is not a sovereign debt but a sovereign credit instrument.  Sovereign government bonds are sovereign debt while local government bonds are institutional debt, but not sovereign debt because local governments cannot print money.  When money buys bonds, the transaction represents credit canceling debt.  The relationship is rather straightforward, but of fundamental importance.

 

If fiat money is not sovereign debt, then the entire conceptual structure of finance capitalism is subject to reordering, just as physics was subject to reordering when man's worldview changed with the realization that the earth is not stationary nor is it the center of the universe.  For one thing, the need for capital formation for socially useful development will be exposed as a cruel hoax.  With sovereign credit, there is no need for capital formation for socially useful development.  For another, private savings are not necessary to finance socio-economic development, since private savings are not required for the supply of sovereign credit.  Sovereign credit can finance an economy in which unemployment is unknown, and wages constantly rising.  A vibrant economy is one in which there is labor shortage.  Private savings are needed only for private investment that has no intrinsic social purpose or value.  Savings without full employment are deflationary, as savings reduces current consumption to provide investment to increase future supply.  Say's Law of supply creating its own demand is a very special situation that is operative only under full employment.  Say's Law ignores a critical time lag between supply and demand that can be fatal to a fast moving modern economy.   Savings require interest payments, the compounding of which will regressively make any financial system unsustainable. The religions forbade usury for very practical reasons.

 

Fiat money issued by government is now legal tender in all modern national economies since the collapse of the Bretton Woods regime of fixed exchange rates linked to a gold-backed dollar in 1971.  The State Theory of Money (Chartalism) holds that the general acceptance of government-issued fiat currency rests fundamentally on government's authority to tax.  Government's willingness to accept the currency it issues for payment of taxes gives such issuance currency within a national economy.  That currency is sovereign credit for tax liabilities, which are dischargeable by credit instruments issued by government in the form of money.  When issuing fiat money, the government owes no one anything except to make good a promise to accept its money for tax payment.  A central banking regime operates on the notion of government-issued fiat money as sovereign credit. 

 

Thomas Jefferson prophesied: "If the American people allow the banks to control the issuance of their currency, first by inflation, and then by deflation, the banks and corporations that will grow up around them will deprive people of all property until their children will wake up homeless on the continent their fathers occupied ... The issuing power of money should be taken from the banks and restored to Congress and the people to whom it belongs."   This warning applies to the people of the world as well.  (759 words)

 

Sovereign Credit (Part II)

 

By Henry C.K. Liu

 

Government levies taxes not to finance its operations, but to give value to its fiat money as sovereign credit instruments.  If it chooses to, government can finance its operation entirely through user fees, as some fiscal conservatives suggest.  Government needs never be indebted to the public.  It creates a government debt component to anchor the debt market, not because it needs money.  Technically, government needs never borrow.  It issues tax credit in the form of fiat money.   And only government can make fiat money as sovereign credit.

 

Sovereign debt is a pretend game to make private debts tradable. The relationship between assets and liabilities is expressed as credit or debt, with the designation determined by the flow of obligation. A flow from asset to liability is known as credit, the reverse is known as debt.  A creditor is one who reduces his liability to increase his assets, which include the right of collection on the liabilities of his debtors.

 

The state, representing the people, owns all assets of a nation not assigned to the private sector.  Thus the state's assets is the national wealth less that portion of private sector wealth after tax liabilities, and all other claims on the private sector by sovereign rights. Privatization generally reduces state assets.  As long as a state exists, its credit is limited only by the national wealth.  If sovereign credit is used to increase national wealth, then sovereign credit is limitless as long as the growth of national wealth keeps pace with the growth of sovereign credit. 

 

When the state issues money as legal tender, it issues a monetary instrument backed by its sovereign rights, which includes taxation. The state never owes debts except specifically so denoted voluntarily.  When a state borrows in order to avoid levying or raising taxes, it is a political expedience, not a financial necessity.  When a state borrows, through the selling of government bonds denominated in its own currency, it is withdrawing previously-issued sovereign credit from the financial system.  When a state borrows foreign currency, it forfeits its sovereign credit privilege and reduces itself to an ordinary debtor because the state cannot issue foreign currency.

 

Government bonds can act as absorber of credit from the private sector.  US Government bonds, through dollar hegemony, enjoy the highest credit rating, topping a credit risk pyramid in the international debt market.  Dollar hegemony is a geopolitical phenomenon in which the US dollar, a fiat currency, assumes the status of primary reserve currency of the international finance architecture.  Architecture is an art of aesthetics in the moral goodness sense, of which the current international finance architecture is visibly deficient.  Thus dollar hegemony is objectionable not only because the dollar usurps a role it does not deserve, but also because its effect on the world community is devoid of moral goodness, because it destroys the ability of sovereign governments to use sovereign credit to development their economies.

 

Money issued by government fiat is a sovereign monopoly while debt is not.  Anyone with acceptable credit rating can borrow or lend, but only government can issue money as legal tender. When government issues fiat money, it issues certificates of its credit good for discharging tax liabilities imposed by government on its citizens.  Privately issued money can exist only with the grace and permission of the sovereign, and is different from government-issued money in that privately issued money is an IOU from the issuer, with the issuer owing the holder the content of the money's backing.  But government issued fiat money is not an IOU from the government because the money is backed by a potential IOU from the holder in the form of tax liabilities.  Money issued by government by fiat as legal tender is good by law for settling all debts, private and public.  Anyone refusing to accept dollars in the US is in violation of US law.  Instruments used for settling debts are credit instruments.

 

Buying up government bonds with government-issued fiat money is one of the ways government releases more credit into the economy. By logic, the money supply in an economy is not government debt because, if increasing the money supply means increasing the national debt, then monetary easing would contract credit from the economy.  Empirical evidence suggests otherwise: monetary ease increases the supply of credit.  Thus if money creation by government increases credit, money issued by government is a credit instrument, quod erat demonstrandum. (735 words)

 

 

Sovereign Credit (Part III)

 

By

Henry C.K. Liu

 

 

American Economist Hyman Minsky rightly said that whenever credit is issued, money is created.  The issuing of credit creates debt on the part of the counterparty; but debt is not money, credit is.  Debt is negative money, a form of financial antimatter.  Physicists understand the relationship between matter and antimatter.  Einstein theorized that matter results from concentration of energy and Paul Dirac conceptualized the creation of antimatter through the creation of matter out of energy.  The collision of matter and antimatter produces annihilation that returns matter and antimatter to pure energy.  The same is true with credit and debt, which are related but opposite.  They are created in separate forms out of financial energy to produce matter (credit) and antimatter (debt).  The collision of credit and debt will produce an annihilation and return the resultant union to pure financial energy un-harnessed for human benefit.

 

Monetary debt is repayable with money.  Government does not become a debtor by issuing fiat money, which, in the US, takes the form of a Federal Reserve note, not an ordinary bank note. The word "bank" does not appear on US dollars.  Zero maturity money (ZMM) in the dollar economy, which grew from $550 billion in 1971 when President Nixon took the dollar off a gold standard, to $6.333 trillion as of June 2003, is not a federal debt.   It amounts to over 60% of US GDP, roughly equals to the national debt of $6.67 trillion at the same point in time. Sovereign credit is what gives the US economy its strength.

 

A holder of fiat money is a holder of sovereign credit.  The holder of fiat money is not a creditor to the state, as many monetary economists claim.  Fiat money only entitles its holder a replacement of the same money from government, nothing more. The holder of fiat money is acting as a state agent, with the full faith and credit of the state behind the instrument, which is also good for paying taxes.  Fiat money, like a passport, entitles the holder to the protection of the state in enforcing sovereign credit.  It is a certificate of state financial power inherent in sovereignty.

 

The Chartalist theory of money claims that government, by virtual of its power to levy taxes payable with government-designated legal tender, does not need external financing.  Accordingly, sovereign credit enables the government to finance a full-employment economy even in a regulated market economy. The logic of Chartalism reasons that an excessively low tax rate will result in a low demand for currency and that a chronic government budget surplus is economically counterproductive and unsustainable because it drains credit from the economy. The colonial administration in British Africa learned that land taxes were instrumental in inducing the carefree natives into using its currency and engaging in financial productivity.

Thus, according to Chartalist theory, an economy can finance its domestic developmental needs, to achieve full employment and maximize balanced growth with prosperity without any need for sovereign debt or foreign loans or investment, and without the penalty of hyperinflation.  But Chartalist theory is operative only in closed domestic monetary regimes. Countries participating in neo-liberal international âfree tradeâ under the aegis of unregulated global financial and currency markets cannot operate on Chartalist principles because of the foreign-exchange dilemma.  Any government printing its own currency to finance legitimate domestic needs beyond the size of its foreign-exchange reserves will soon find its currency under attack in the foreign-exchange markets, regardless of whether the currency is pegged at a fixed exchanged rate to another currency, or is free-floating.  Thus all non-dollar economies are forced to attract foreign capital denominated in dollars even to meet domestic needs.  But non-dollar economies must accumulate dollars before they can attract foreign capital.  Even then, with capital control, foreign capital will only invest in the export sector where dollar revenue can be earned.  But the dollars that accumulate from trade surpluses can only be invested in dollar assets, depriving non-dollar economies of needed capital. The only protection from such attacks on domestic currency is to suspend full convertibility, which then will keep foreign investment away.   Thus dollar hegemony, the subjugation of all other fiat currencies to the dollar as the key reserve currency, starves the non-dollar economies of needed capital by depriving their governments of the power to issue sovereign credit domestically. (720 words)
 

 

Sovereign Credit (Part IV)

 

By

Henry C.K. Liu

 

Under principles of Chartalism, foreign capital serves no useful domestic purpose outside of an imperialistic agenda. Dollar hegemony essentially taxes away the ability of the trading partners of the United States to finance their own domestic development in their own currencies, and forces them to seek foreign loans and investment denominated in dollars, which the US, and only the US, can print at will.

The Mundell-Fleming thesis, for which Robert Mundell won the 1999 Nobel Prize, states that in international finance, a government has the choice between (1) stable exchange rates, (2) international capital mobility and (3) domestic policy autonomy (full employment/low interest rates, counter-cyclical fiscal spending, etc). With unregulated global financial markets, a government can have only two of the three options.

Through dollar hegemony, the United States is the only country that can defy the Mundell-Fleming thesis.  For more than a decade since the end of the Cold War, the US has kept the fiat dollar significantly above its real economic value, attracted capital account surpluses and exercised unilateral policy autonomy within a globalized financial system dictated by dollar hegemony. The reasons for this are complex but the single most important reason is that all major commodities, most notably oil, are denominated in dollars, mostly as an extension of superpower geopolitics. This fact is the anchor for dollar hegemony. Thus dollar hegemony makes possible US finance hegemony, which makes possible US exceptionalism and unilateralism.

 

China's excessive dependence on foreign trade has significantly distorted the country's economy, as indicated by the percentage of total foreign trade volume to its gross domestic product (GDP), which amounted to 60 per cent in 2003.  Chinaâs economically advanced regions, largely in East and South China, depend heavily on foreign trade.  The average rate of foreign trade dependence of the 12 provinces and municipalities in East and South China was 74.5 per cent in 2000 while the rate in the 19 provinces and autonomous regions in the central and western regions was only 10 per cent.  In 2003, Shenzhen and Shanghai 356.3 and 148.7 per cent of the trade reliance rate respectively.  Much of this trade takes the form of assembly for re-export although the trend is changing toward vertically integrated manufacturing.

China does not have a diversified trade market. The trade volume between China and its three biggest trade partners - the US, Japan and the European Union - accounts for about one half of its total volume. As a result, the economic performance of these major trade partners not only casts a direct influence on their trade with China, but also affects Chinese trade with the rest of the world. The trade volume between China and the United States constituted 5.4 per cent of China's GDP in 1997. The ratio climbed to 8.95 per cent in 2003. The abnormally high reliance on trade with the United States is the fundamental reason for rising Sino-US trade conflicts.  The relatively low growth rate of these matured economies cannot sustain the high growth rate of Chinese export trade.

Trade reliance ratio is determined by many factors, including calculation of GDP, currency exchange rate, methods of trade and trade competence of a nation.  Nevertheless, one fact stands out: Chinaâs dollar denominated trade surplus benefits the dollars economy and not the yuan economy.  It contributes significantly to Chinaâs capital shortage for domestic development.   China needs to activate its domestic market while maintaining its current market share in foreign trade.  The Chinese economy can benefit enormously by the aggressive deployment of sovereign credit for domestic development, particularly the Western and Central regions.  Sovereign credit can be used to improve farmers' income, promote industrial restructure, stimulate domestic demand, build needed infrastructure, promote education and health care, restore the environment and promote a cultural renaissance.   While exchange control continues, China can free its economy from the dictate of dollar hegemony, adopt a strategy of balanced development financed by sovereign credit and wean itself from excess dependence on export for dollars.  Sovereign credit can finance full employment with rising wages in the Chinese economy of 1.4 billion people and project it towards the largest economy in the world in less than a decade.  Much needs to be done to bring China into the 21 century.  Exporting for dollars is not the way to do it. (714 words)

Henry C.K. Liu