Re: Stiglitz on Soros--question for Leigh

["Leigh Harkness" <Leigh@xxxxxxxxxxxxxxxxxxxx>]

Bill asks:

> Have you looked at the numbers for all economies that perennially run
> deficits?  I would like to know if the relationship you have identified
> holds true universally.

I have only had time and information to look for this relationship in three
countries.  The first was the original country where I found this
relationship and it had a fixed exchange rate system, so the relationship is
more complex.

AUSTRALIA
The Reserve Bank of Australia provides a very comprehensive report so that I
was able to do it for Australia. You need to take out inter-bank loans and
adjust for the formation of new banks, the conversion of savings banks to
commercial/trading banks, etc to find what is the growth of bank credit.

PHILIPPINES
For the Philippines, I happened to be in Manilla and asked the Central Bank
of the Philippines if I could look at their books, and they allowed me.  I
went into the bank and copied their official (ubpublished) records straight
into my computer.

NEW ZEALAND
I tried to get data for New Zealand, but I did not have complete
information. The Reserve Bank of New Zealand treated the data I needed as
confidential.  I did not have NZ data on the growth in loans or deposits
from the conversion of non-bank financial institutions into banks nor
details of interbank loans etc.

However, the growth in the monetary aggregates I was able to gain was
greater than the current account deficit, and there was a very close
correlation.


> As to interpretation, it would seem that bank credit has not financed
> net capital formation in Australia, but has effectively financed capital
> formation in the rest of the world that is exporting to Australia.


The bank credit did finance capital formation or new cars and housing in
Australia.  The way you could think about it is something like this.

THE BIG POOL
Lets say that there is a pool of goods in the economy out of which people
with money are entitle to draw out.  To earn money, you must first provide
goods into the economic pool, and the money you earn entitles you to take
goods out goods to the same value.  So provided the amount of money in
circulation stays the same, no-one can draw out more goods then they have
put in.  In that case there cannot be any excess demand or shortage of goods
relative to money.

But imagine if someone were to print money to entitle people to take goods
out of the pool without putting anything in.  That would cause the pool of
products to be depleted.  It would be depleted by the amount of new money.
Once that new money was incirculation, it would not cause excess demand.
Everyone who subsequently uses it would have contributed to the pool of
goods before they could earn the money.  It is only the initial expenditure
of that money that causes the shortage.

LENDING AND SAVINGS
In our economies, bank lending can create more money and enable people to
deplete the pool of goods and services.  Not all bank lending causes this
problem.  It is only when bank lending is greater than savings.  Savings are
in two forms:
*    repayment of loans (which reduces bank deposits); and
*    increases in foreign reserves (from increased exports).

When bank lending is greater than these forms of savings, then they finance
more entitlements to draw upon products in the pool than have been put into
the pool.  The only way that the pool of products can be replenished is by a
country importing more than it exports.

EXPORTERS AND IMPORTS
Look at it this way.  Exporters earn entitlements to the domestic pool of
products greater than they have contribute to that domestic pool when they
convert their foreign earnings into domestic currency.  They deplete the
domestic stock of products when they spend their earnings.   The economy
imports products to replenishes its pool or depleted stock .  That is not a
problem as the country would have earned foreign entitlments (foreign
reserves) from the exports to pay for those imports.

The economy does not distinguish between money from exports and money from
credit.

When people spend the additional money they gain from the growth of bank
credit, they deplete the domestic stock of goods just like the exporters do.
But when the economy goes to pay for them, it does not have additional
foreign reseves to pay for them.  It must run down existing foreign reserves
or go into debt.  This is what causes the current account deficit.

You wrote:

> I don't see how exchange rate policy has much to do with this

FLOATING EXCHANGE RATE SYSTEM AND CREDIT
Countries using the pure floating exchange rate system don't have the
savings from increases in foreign reserves.  So in these countries the only
savings is loan repayments.

If bank lending equals loan repayments, then there is no growth in bank
credit. When lending is greater than loan repayments, then there is an
increase in bank credit.

The amount that lending exceeds savings is equal to the growth of bank
credit.  When lending exceeds savings it depletes the pool of products by
that same amount.  The amount of additional imports required to make up for
the stock depleted is exactly equal to the growth of bank credit.

Hence, as we have found, the current account deficit is equal to the growth
of bank credit.

This theory fits the facts.  If you have another one that fits the facts, I
would be happy to hear its.

Note that the problem here is not the variable exchange rate part of the
floating exchange rate system.  The problem with the system is that it
requires international receipts and payment to be continuously equal.

Regards

Leigh