Re: [A-List] US Dollar Standard: Deficits Do Matter

[Warren Mosler <mosler@xxxxxxxxxxxxxx>]

Hi Henry!

One more time just for fun...


--- "Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx> wrote:
> Defiicits do matter,

Yes, if spending isn't sufficient to meet the desire
to pay taxes and net save unemployment is the
evidence.


 but only to the extend of when
> they occur and how
> the money is raise and spent.

Sort of, as above.


 Government debt is
> not the only source.

Govt debt is not a 'source.'  It offsets operating
factors mostly caused by deficit spending for the
purpose of supporting the term structure of rates.

>  Government has the power to create money.

For all practical purposes, with a non convertible
currency, govt has only one way to spend:  it credits
a reserve account of a member bank.  Yes, it could
open a 'normal' bank account and act like the
rest of us, etc. but that's a different point
entirely.

 And as
> long as the rate of
> money creation

Depends on how you define 'money.'

 is not ahead of economic expansion,
> even monetarists must
> agree that it

what is 'it?'

 is not inflationary.

No one even agrees on the definition of 'inflation'
with a floating fx policy.

  Even Milton
> Friedman thinks that
> steady (3%) expansion of the money supply

how is 'money supply' defined here?

 would lead
> to a 3% steady
> expansion of the economy (with 4% structural
> unemployment.)

I'd call that an oversimplification.

   Some who
> are ideologically free from monetarists fixations
> assert that zero
> unemployment can be achieved with a 6% economic
> expansion.  To do that
> the government should print

define 'print' please.

 and add 7% to the money
> supply
still undefined.

 every year,
> running a budget deficit equal to 7% of GDP, whicch
> in todays terms,
> means $700 billion.

that adds net financial assets of $700 billion
to the non govt sector.

> That is roughly what the US economy is doing, a $400
> billlion trade
> deficit

That shifts net financial assets from residents to
non residents.

 and a $300 billion budget deficit.

ok.

  So why
> is there 7%
> unemployment?

The deficit is too small.

  Because the money is spent on the
> wrong things.

Which implies unlimited deficit spending on the
wrong things will not drive up demand.

> Balancing a budget when the economy is contracting
> is to starve a sick
> patient, to cut taxes for the rich at a time of
> overcapacity is to pour
> gasoline on fire, and to stimulate an economy with
> war deficits is to
> burn one's hair to cook an egg.
>
> Tax and spend is a self adjusting formula, not a
> fiscal sin.  Taxing
> more than spending is simply removing money from the
> economy.  When
> government does not spend and spend on the right
> things, it should go
> out of business and let someone else do the
> necessary.
>
> Henry C.K. Liu
> annewilliamson wrote:
>
> >                  Deficits Do Matter
> >
> >In their election oratory politicians usually
> stress their love of fiscal
> >discipline and balanced budgets.  But as soon as
> they are elected they tend
> >to discover a great number of exceptions that
> require more funding.

Not nearly enough this time.

> >President Bush clearly made the election pledge to
> avoid budget deficits,
> >but, ever since September 11, 2001, his budget
> proposals built on exceptions
> >project a deficit of more than $300 billion for
> each of the next few years.

ONe way or another the economy will grind its way
to 500+ billion deficits, 5+5 of gdp, as it always
does before coming out of recession.  Maybe a lot
more this time due to the previous savings draining
surpluses.

> >Yet, he also argues for prompt tax reduction, which
> signals a brand-new
> >course of action in the annals of fiscal policy.

Also not nearly enough.

> >
> >The prospect of soaring deficits and simultaneous
> tax reductions alarms a
> >few economists.  On this new fiscal road they
> foresee deficits of $500
> >billion or even $600 billion annually,

That will happen, one way or another.  It's a
'debit system.'

 which in
> time may cast doubt on the
> >credibility of the federal government as debtor.

Not a real issue.  Look at Japan.

> Every few months the
> >Congressional debt ceiling needs to be lifted by a
> few hundred billion
> >dollars. Congress last raised it by $450 billion to
> $6.4 trillion on June
> >30, 2002; it needs to be lifted right now as the
> official Treasury debt
> >again has reached the ceiling.  At the present rate
> of spending it will need
> >to be lifted in June or July of this year and, in
> case of war with Iraq,
> >even earlier.

It should be eliminated.  When congress spends the
$ the new debt ceiling is already implied.

> >
> >The federal deficits are compounded by the budget
> shortfalls of most state
> >governments, estimated at some $105 billion in
> 1992-1993.  State governments
> >are required legally to balance their budgets,
> which forces them either to
> >raise taxes or cut expenditures.

Yes, more procyclical stuff that means the fed
deficit must me that much higher.

  Undoubtedly, most
> prefer to boost their
> >fees and exactions; the proposed federal tax
> reduction, if and when it
> >finally passes the U.S. Congress, may even compound
> their  problems as many
> >state systems are based on the federal tax
> structure.
> >
> >Both deficits, the federal and the state,
> constitute a heavy burden on the
> >capital market which keeps no idle savings
> amounting to hundreds of billions
> >of dollars.

Tsy secs only offset operating factors at the fed.
the concept of a pool of savings has no application.

  They force the Federal Reserve System
> to come to the rescue; it
> >can print any amount of money and create any volume
> of credit.
???  There is no operational counterpart to this
statement.

  The Fed is
> >the financier of last resort, the ultimate source
> of funds that enables the
> >federal government to finance any conceivable
> expenditure and cover any
> >possible deficit.  Without the Fed, fiscal deficits
> of such magnitude would
> >soon depress the American economy and cause serious
> political repercussions.

Govt, taken as a whole, spends by crediting a member
bank account.

> >Its ability to create dollars that enjoy world-wide
> acceptability enables it
> >to distribute the burden of U.S. Government
> deficits to countless millions
> >of dollar holders all over the globe.  They pay for
> the deficits through
> >depreciation of the dollars in their pockets.

????

> Japanese and Chinese, Arabs
> >and Hindus, French and Germans, and all others with
> dollar savings join
> >Americans in bearing the
> >burden of federal deficits.
????  This is a new one!  Yes, they may be making
'bad investment' by holding $ net financial assets,
but what's that got to do with federal deficits?

> >
> >This ability to place the economic cost of
> government spending on millions
> >of trusting victims rests on the extraordinary
> position of the U.S. dollar
> >as the world's primary reserve currency.  The
> dollar acquired this
> >distinction by international agreement reached at
> Bretton Woods in New
> >Hampshire in 1944 which committed the United States
> to provide an anchor for
> >world prices by pegging the dollar at $35 per ounce
> of gold and envisioned a
> >world economy linked by fixed dollar exchange
> rates.  When the United States
> >suffered chronic gold losses and finally faced
> inability to make payments in
> >gold, President Nixon severed the dollar's gold
> link in August 1971,
> >devalued the dollar against major foreign
> currencies in December 1971, and
> >finally floated it in March 1973.  The world has
> been on a floating dollar
> >standard ever since.  It is a fiat standard,
> unbacked and irredeemable,
> >which can be inflated and depreciated at will.

As evidenced by serious declines in purchasing power
in the 70's for example.

> Managed by the Federal
> >Reserve System,

they just set the interbank interest rate.

 it is a useful standard in the
> financial service of the U.S.
> >Government.
> >
> >Other countries are narrowly limited in their
> ability to inflate and create
> >credit;

Not in their own floating fx currencies.

 if they indulge in expansion rates greater
> than those of their
> >neighbors and trade partners, they would soon face
> payment difficulties

Not in their own currencies.

 as
> >imports increase and exports decline.

imports are a benefit, exports a cost.

  They would
> have to reduce the
> >expansion rates and fall in line with their
> neighbors and partners.

Not with floating fx.

 The
> >Federal Reserve System as the manager of the world
> dollar standard has no
> >such narrow limits.  It can inflate and create
> credit as long as its
> >expansion does not exceed the world-wide demand for
> its currency.

All it does is set the interbank rate.


  It may
> >generate trade deficits year after year and
> aggravate its maladjustments as
> >long as foreign banks and investors hoard the
> dollars or invest them in
> >American obligations.

Backwards-  the desire to net save $ financial assets
by non residents is evidenced by the trade deficit.

  It is bound to cause
> world-wide financial upheavals,
> >however, when it depreciates the dollar at
> excessive rates and thereby
> >inflicts painful losses on those foreign investors.

Hold a walkathon to help them out???

> >
> >The floating system based on the U.S. dollar has
> been a precarious structure
> >ever since its inception.  During the 1970s the
> country suffered the worst
> >inflation in decades.  By the end of the decade the
> inflation rate stood at
> >13 percent, the Federal Reserve discount rate at 12
> percent, and the prime
> >lending rate at 15.75 percent, the highest of the
> century.  The dollar had
> >fallen notably in relation to the currencies of
> other trading countries and
> >especially to gold.

Don't forget the oil cartel that jumped oil from
$2 to $40.  All else followed that.

> >
> >The 1980s saw some economic recovery but also
> brought new difficulties and
> >more maladjustments.  They led to an explosion of
> personal, business, and
> >government debt which cast a shadow

What does 'cast a shadow' mean here?

 on the future
> of the financial
> >structure.  Federal government debt soared from
> approximately $950 billion
> >to nearly $3 trillion.

So did non govt savings of net financial assets,
to the penny...

  A growing share of this
> debt was acquired by foreign
> >banks and investors who used the widening imbalance
> of American imports over
> >exports to invest their earnings in the United
> States.

They desired $ 'savings' and were willing to export
real goods and services to us to get them.


> >
> >The 1990s, finally, seemed to defy all rules of
> economic behavior.

Good sign you need to check your theoretical
framework.

  Easy
> >money and credit spurred the most explosive stock
> market boom in U.S.
> >history, creating enormous speculative  wealth and
> spawning new companies.
> >With financial markets booming, the federal
> government even reported a
> >budget surplus,

Yes.  Which drained equal amounts of non govt
'savings.'

 borrowing from Social Security
> trust accounts.

Govt spends by crediting member bank accounts,
and taxes by debiting same.  What does the trust
account have to do with anything real?

  The
> >balance-of-payment deficit became a major concern

Major benefit for the US.

> as imports soared and
> >exports stagnated, which further raised the
> mountain of debt.

The non residents wanted to net save the stuff
and exported to us to get it.

> >
> >Toward the end of the decade, in 1998, the floating
> dollar standard suffered
> >a number of financial shocks

The economy did, not the 'standard'
whatever that is.

 that began in Asia and
> eventually struck
> >fragile economies around the world. American equity
> markets continued to
> >surge until 2000 when an economic slowdown became
> evident also in the United
> >States.  In 2001, finally, the American economy
> slipped into recession for
> >the first time in ten years.  The Federal Reserve
> immediately cut interest
> >rates, a record eleven times in one year;

Each time projecting recovery in 6-9 months.

 the U.S.
> Congress passed a large
> >multi-year tax cut,
Not nearly large enough (see'ten trillion tax cut'
at www.mosler.org from that period)


and the U.S. Treasury even sent
> out tax rebates to boost
> >consumer spending.
Which they did.  And were not nearly enough.

 Yet, the markets continued to
> plunge following the
> >terrorist attacks on September 11, 2001.
> >
> >According to various market analyses, foreign
> investors now own some $7
> >trillion of U.S. assets, 13 percent of American
> corporate stock, 35 percent
> >of U.S. Treasury obligations, 23 percent of
> corporate bonds, and 14 percent
> >of ownership in American companies.

And were willing to net export to us to get it.

  They obviously
> do not take kindly to
> >Federal Reserve policies that depreciate the dollar
> and depress its exchange
> >rate.

Which policies, specifically?

 Last year alone, European investors in the
> S&P 500 lost 38 percent on
> >their property compared to just 24 percent suffered
> by U.S. investors
> >because of the fall of the dollar versus the euro.

I hear the violin music...  And actually the euro
is strong, due to deflationary forces at work there.
the $ is not weak.

> Suffering such losses,
> >their interest in American investments is bound to
> decline.

'Bound to?'  Think they will stop exporting to
keep from earning net $?

  They may even
> >liquidate and withdraw their holdings, which could
> lead to a crushing
> >stampede to the exits.

Whatever that means.

> >
> >We now face a situation that resembles the late
> 1970s when the world began
> >to abandon the dollar and liquidate American
> investments.  It took two years
> >of Federal Reserve inactivity and 20 percent
> interest rates to restore
> >foreign confidence and lure foreigner investors and
> creditors back.
Not what happened.

  Today,
> >the Fed is doing the opposite; it is making every
> effort to stimulate the
> >economy by flooding the money market

Not.  It always supplies the liquidity the banks
demand, to the penny, as a matter of accounting
and a non 0 rate policy.

 while the U.S.
> Treasury is accelerating
> >its deficit spending.

Not nearly enough.

  Both point towards monetary
> upheavals and deep global
> >recession straight ahead,

Yes, but because the deficit isn't yet large enough.

 and both cast a shadow on
> the future of the
> >floating dollar standard.

There isn't one.

Warren Mosler

> >
> >Hans F. Sennholz
> >www.sennholz.com
> >
> >
> >
> >
> >
> >
> >
> >
>
>
>


=====
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