Date: Wed, 15 May 2002 10:49:36 -0400
To: Leigh Harkness <Leigh@xxxxxxxxxxxxxxxxxxxx>
From: Paul Davidson <pdavidson@xxxxxxx>
Subject: Re: Stiglitz on Soros
At 07:31 PM 5/15/2002 +1000, you wrote:
When I say a country has excess demand, I do not mean that a country has
full employment. A country can have excess demand without full employment.
Let me explain.
Sorry Leigh but your explanation does not hold water as I shall briefly
indicate with my comments spaced between your example. (Your problem is
you do not understand the difference between financing and funding -- but
you are not alone.)
Let us assume that a country is initially stable. To remove the
employment/unemployment factor, let us assume that there is 8% unemployment.
For simplicity, let us assume that it has a fixed exchange rate system and
international receipts and payments are equal. We will also assume that it
has no monetary growth. The money people earn from production (both from
local demand and exports) they spend on consumption and capital goods
(supplied from the local economy and from imports). For this economy to be
stable, exports and imports would be equal.
Now let us assume that the counrtry's banks increase their total lending so
that they increased the money supply, thereby increasing current
entitlements in the economy (that is, increase current demand).
Why did the banks in crease their lending? Normally people borrow
because they want to be able to meet a forward contract commitment --e.g.,
they need a commitment from the banks for a mortgage so they can sign a
purchase price ordering a house (to be constructed) with the bank
providing the funds when the house is completed ; or they are buying a
house spot --- i.e., one on the market (alreeady built) and available.
Either (1) people borrow to order goods for forward delivery or to buy out
of existing inventory -- the supply is already available, or
(2) they borrow to buy securities on a well organized orderly securities
market - and hence are not unsing the money to buy goods and services--
you might want to read an article by Davidson and S. Weintraub in 1973
entitled "Money: Cause or Effect?" in the EJ.
In this process the banks incease their deposits (bank liabilities) and also
increase their loans outstanding (bank assets). To the economy, these loans
outstanding represent an obligation to supply goods to the economy.
But note that the timing between the increase in entitlements and the
increased obligation to supply is different. The banks increase current
entitlements but the obligation to supply products to the economy is a
future obligation.
See the timing aspect is dealt with by the use of spot and forward
contracting --- all this was discussed by myself and Sidney Weintraub in
the 1970s in various places. I have now put all this together with some
modern discussion of gthe role of financial markets and the banking system
in an entrepreneurial economy in my forthcoming. book.
Hence in the current period, there is excess demand. That is, the growth in
current entitlements has exceeded the growth in current obligations to
supply.
there is no current excess demand if you understand how loan contracts are
written and what encourages borrowers to ask for loans from the banking system.
In accounting terms, the banks books are balanced. But in the real economic
world, there increase in current entitlements above the increase in current
obligations causes a current account deficit. If the country cannot obtain
foreign goods to make up for this deficit, it is likely to experience
hyper-inflation associated with a rising money supply facing a depleted
supply of products.
Here you are only introducing a very naive version of the quantity theory
of money -- and playing right into the hands of the
neoliberal-conservative philosophy.
It is this definition of excess demand that I take to cause current account
deficit deficits. It does not matter whether the bank credit is used to
finance government or private sector expenditure.
A rose by any other name------
Paul