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

[Clifford Poirot <cpoirot@xxxxxxxxxxx>]

See my responses below

-----Original Message-----
From: Warren Mosler [mailto:mosler@xxxxxxxx]
Sent: Monday, March 05, 2001 12:48 PM
To: pkt@xxxxxxxxxxxxxxxx
Subject: Re: New thread: Problems with Godley's recommendations...


>
I said:

> 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.

And Warren replied:
Taxes need not grow.  The currency can be left
to fluctuate (up or down), for example.  And remember, the interest rate
is selected by the government.  A Japan like 0 rate is an obvious choice
if 'debt service' is objectionable.

My response:
I am not sure if this is representative of Chartalism or not, but it sums up
my uneasiness with Chartalism. While I am cognizant that Randall Wray in his
"Understanding Modern Money" is careful to emphasize that deficits can be
too big and/or could create inflation, it seems (to me) that the costs of
these policies is severely underestimated. At least that is what I think
Warren does here. If the deficit grows over time and is not backed by a
credible tax system, confidence in the debt declines. And here is another
point where my uneasiness with Chartalism lies: I do not think that interest
rate choices can be arbitrary. Sure, the FED could set an overnight Fed
Funds rate of 0, or even offer bonds at 0% interest. But at that point, the
attraction of bonds as an alternative to cash disappears. Even Randall Wray
notes in "Understanding Modern Money" that in the Chartalist scheme the
public chooses to hold bonds as an interest bearing alternative to state
money.

I wrote:
> A
> permanent debt that grows over time and is not used to finance particular
> capital investment projects eats up resources in interest payments.

Warren replied:
I think you are mixing real and notional concepts.  Interest payments are
notional credits at the Fed.

My response:
I do not agree. Interest payments are a real cost. Perhaps the underlying
problem is one of how we view the 1) the level of the endogeneity of money
and 2) whether taxes precede money. If money is not fully endogenous but
depends on some initial supply of financial assets (to the public) and debts
(to the banking system)then money cannot be fully endogenous. It also
follows then that interest payments are not just notional.

I wrote:
> 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.
>

Warren responded:
Not necessarily so.

My reply:
When has this not been the case?

I wrote:
> 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.

Warren replied:
Weren't those payment on $US (external) debt?  That's another story
altogether.

My response:
Perhaps it is another story altogether for the U.S. since the U.S. can
always denominate its external debt in dollars (again-proof that the world
market is far more forgiving of hegemons than of minor states). Nonetheless,
there is a point at which the world economy would no longer wish to hold its
debt in U.S. dollars (fortunately I think we are far from it) thus resulting
in a run on the U.S. dollar. This is at least a logical possibility. If you
owe the money to yourself, you do run the risk of undermining public
confidence in your currency. Another part of the story of the Bulgarian lev
crisis was 1) loss of confidence and extreme currency substitution 2)
capital flight. An overtly fraudulent banking system did not help.

>
I wrote:
> 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.
>

And Warren responds:
You begin with an assumption of a fixed exchange rate, and then say a
flexible
exchange
rate can't automatically bring about adjustments.  I think your statements
are mixing lots of fruits together.

My response:
I am saying that under a fixed rate a BOP disequilibrium (Deficit) can be
resolved by drawing down international currency reserves. But clearly, this
cannot persist forever. If a government chooses to abandon a peg, or we
simply talk about BOP disequilibrium adjustments to a defict under a
floating rate system, then a real devaluation is required. I am just looking
at the model and varying assumptions. Either way, there is a price to be
paid.

Warren wrote:

Yes.  Safe from finance considerations.  Not safe from 'adjustments'
like the price level, fx levels, etc.  Turkey, for example, has never
had a 'finance' problem with lira, despite quadrillions in 'debt.'

My response:
I think you are making my point for me. With enough IMF loans Turkey can
devalue forever and ever amen.

<snip>