RE: New thread: Problems with Godley's recommendations...

[Clifford Poirot <cpoirot@xxxxxxxxxxx>]

My responses to William below in the text of the message.

-----Original Message-----
From: William F. Hummel [mailto:wfhummel@xxxxxxxxxxxx]
Sent: Friday, March 02, 2001 6:15 PM
To: pkt@xxxxxxxxxxxxxxxx
Subject: Re: New thread: Problems with Goodley's recommendations...


I wrote:
>
>As I understand it, the Chartalist view of money is that money need not be
>backed by anything other than government taxation. Money is complete
>endogenous and requires no savings on the part of the public to back money
>creation. Rather, the public needs the government's money to spend. At
>present, the government is not supplying enough of its money due to the too
>high level of taxes as evidenced by the surpluses.

William's Response:
There is no problem of the government not supplying enough money.
The government must supply all the money needed by the public to
pay taxes plus what is needed to provide sufficient reserves to
the banking system.  It is currently taxing more than it is
spending and providing the difference by redeeming T-bonds.  This
reciprocal flow is essentially in balance at all times.

My reply:
I am not sure that the government can just "supply" money. This is a point
where I find Chartalism to be vague. In fairness, I will add that there are
parts about Chartalism I just don't get. My view is that what government
provides, in essence, is an institutional framework of contract enforcement
that makes the public willing to hold fiat currency. The government also
provides stability of the money (sometimes successfully, sometimes not)
through central banks and also the treasury. If I understand it correctly,
Chartalism holds the money supply is backed in the last instance by
government's ability and willingness to accept "its" money in the form of
tax payment.

I wrote:
>Goodley proposes a return
>to a deficit position through a massive tax cut and appears to say this
will
>have no impact on the rate of inflation, nominal or real interest rates
>(though it will stave off a recession).
>
>My problem with this is that it ignores the fact (or what i regard as a
fact
>at any rate) that government debt must be backed by credible promises to
pay
>timely interest and principal. Granted, this government debt can be rolled
>over-but it cannot be rolled over indefinitely.

William replied:
When you say the government cannot roll over its debt
indefinitely, you imply that it must some day be entirely paid
off.  This is simply not true.  In fact there is no reason the
government cannot increase its debt indefinitely as long as the
economy grows indefinitely.

My response:
No-it does not need to be entirely paid off. It simply needs to provide a
credible promise that it will make timely payments of interest and
principal. It cannot "roll over" without cost. Either the tax burden on the
public grows and/or more of the budget is consumed by interest payments. A
permanent debt that grows over time and is not used to finance particular
capital investment projects eats up resources in interest payments. As I
noted below, at the extreme, government piling up of short term debt
undermines the confidence of bondholers and is a strong predictor of
financial crises.

I wrote:

>As I hope I have shown in my
>forthcoming paper on the Russian financial crisis, government debt can
>indeed become effectively a form of Ponzi financing (someone at the PK
>conference I don't remember who, raised the issue as to whether or not this
>can be so but I did not have a chance to follow up this interesting
>comment). Under normal circumstances, I agree that government debt is not
>either speculative or Ponzi financed, though it can be speculated against
by
>bond funds that take long and short positions. However, under abnormal
>circumstances, when governments run persistent BOP deficits, or when they
>are faced with a sudden BOP deficit and a dramatic and unexpected drawdown
>in international reserves, and/or when they must issue more short term debt
>to meet existing debt obligations, then government finance is subject to
>being classified as Ponzi financing.

William replied:
Of course most of the BOP deficit is due to the private sector,
not the government.  But what is meant by drawing down of
international reserves?  The dollar-denominated assets held
abroad can only be used in exchange for other dollar denominated
assets.  They are not "drawn down" in the sense of being taken
away.  If a foreigner wants to sell his US bonds for yen, he must
find someone with yen who wants US bonds, or a suitable
intermediary.

My response:
You are partially correct but you are also making some fairly basic errors.
The BOP records mostly private transactions so it is a measure (primarily)
of the position of the private sector's position vis. the rest of the world.
However, it also includes government transfers and government payments of
principal and interest on debt. So high levels of government debt require
more resources to be committed to payment of principal. This was the
immediate precipitating factor behind the Bulgarian crisis of 1996, 1997
when principal payments came due and forced Bulgaria into a BOP deficit
position and led to a couple fo thousand percent devaluation of the
Bulgarian Lev.

But applying basic national income accounting concepts it is not too
difficult to derive a basic identity:

S+(T-G)=I+CA (where CA is current account). A persistent current account
deficit must be financed  by a government surplus, or CA must remain
negative. And ultimately, it is government that must change IT's reserve
holdings or allow the currency to devalue. A devaluation does not
automatically lead to an improvement in the current account position. So a
flexible exchange rate is not a sufficient condition to bring about
automatic adjustments.

As I noted:
>
>Thus, large and persistent fiscal imbalances are potentially problematic,
>and more so, when accompanied by current account and/or capital account
>deficits. Either the government must resort to higher taxation to retain
>confidence or it must take other steps.

William replied:
Persistent fiscal imbalances really have nothing directly to do
with BOP deficits, and don't depend on them.  Taxes are essential
in maintaining a demand for dollars, but confidence in the dollar
does not depend on the level of taxation.  It depends on the
government controlling the price of dollar-denominated credit, a
task managed by the central bank through the control of bank
reserves.

And as I noted (and emphasize again in contrast to William):
>Thus failure to correct persistent
>fiscal imbalances, or a sudden move from a surplus position to a deficit
>position that might result in long run persistent fiscal imbalances, will
>require 1) higher real and nominal interest rates on government securities
>to fund the fiscal imbalance through international bond sales or 2) a
>massive devaluation of the currency in real terms-a policy that depends on
>Marshall Lerner conditions being met 3) attempts to attract private
>international capital.

A new point I wish to make is this: If you want to challenge standard
national income accounting definitions and equations, by all means, I will
be quite interested. However, as it stands, simple manipulation of national
income accounting concepts yields a quite opposite result and there is
empirical support for it. IMO, the burden is on its critics to show how and
why both the theoretical and empirical evidence is wrong. The private and
public sector transactions (both financial and "real") with the rest of the
world are intrinsically linked together when the government sells bonds to
foreigners and holds international reserves.

Warren asserted:
Fiscal imbalances can safely grow independent of any inflow
foreign capital.  All that really matters is growth of domestic
output/income.

I argue:
No. Absolutely not. Not unless the government offers its bonds only to
domestic residents. Your assertion can only apply in a closed economy.

As I noted before:

>The U.S. has been able to escape some of these problems by credible fiscal
>policies allowing the U.S. government securities to play the role of a
>riskless (or near riskless asset). I am not proposing eliminating this
debt.
>But, the existence of the debt requires taxpayers to pay a portion of taxes
>in payments of interest (effectively a transfer of wealth from taxpayers to
>domestic and foreign bondholders). The second factor behind the U.S. is its
>status as hegemonic power. However, a return on the part of the U.S. to
long
>term structural fiscal imbalances is potentially destabilizing.
>
And William replied:
It's true that the existence of debt causes a redistribution of
financial wealth because of interest payments, though not
necessarily to the net advantage of those receiving payments.
Any spending by the government causes a redistribution, not just
interest payments.   But interest payments are merely a part of a
circular flow of funds between the government and the private
sector, i.e. they are entirely recaptured through taxes, just as
all other government spending is recaptured through taxes and the
sale of debt if necessary.

My response:
Higher levels of debt require higher interest payments. Most bondholders are
wealthier. Interest payments require shifting resources from other
priorities (food stamps, infrastructure) to paying bondholders. It is a
transfer of wealth mostly from lower income households to upper income
households.