Originally published November 16, 2011 on the New Economic Perspectives blog.
Thanks for comments. I’ll return to posting the questions and my responses this week.
Q1: What about the Chinese or others buying US assets with the dollars they have credited to their accounts. They could have control of US corporations which wouldn’t sit well with the US electorate.
A: I recall the exact same “yellow peril” arguments in the 1980s when the Japanese were “buying up” Hawaii and NYC. Look, once they buy US assets they are subject to US laws. If we don’t like what they are doing with“their” property, we change the laws. In truth, is it worse to be subject to the whims of a convicted criminal like Michael Milken engaged in LBOs that enable him to downsize workers and strip off assets; or to a Japanese or Chinese firm that has a long-term interest in producing autos in Georgia? I guess it is a toss-up. In any case, most of the Chinese “dollars” are safely locked up at the Fed, either in the form of reserves or US Treasuries. They get no obvious advantage from that ownership except whatever advantages Treasury Secretary Geithner wants to give to them.
Q2: What do you make of the idea that a weaker dollar would be good for our economy because it’d make it less attractive to export American jobs and possibly bring some back? Would the positive effects of this offset the negative effects of more expensive oil and imports?
A: Estimates of trade benefits of dollar depreciation are almost certainly overstated. First, many of our trading partners “peg” to the dollar—depreciation has no effect at all on them. Second, those that don’t peg are willing to take lower profits (hold dollar prices steady) to keep market share (this has been the Japanese strategy). Third, exports are a cost, imports a benefit so trying to maximize a trade surplus is a net cost maximizing strategy; ergo: just plain dumb. Fourth, forget those old, 19thcentury factory jobs. They ain’t coming back, and good riddance. Today low wage workers in developing nations will take them; tomorrow they’ll all be done by robots who don’t mind hard work for zip wages. Alternative: create good paying jobs in good working conditions right here in the good ol’ US of A.
Q3: When foreign central banks purchase U.S. dollars, how does the accounting go from their perspective? Do they mark up U.S. dollars on the asset side of their balance sheets and issued money on the liability side? Does this lead to increase of reserves in the domestic banking system, and they have to issue equivalent amount of bonds to accomodate this? So export led growth, with undervalued exchange rate would still lead to increase in public debt even when government’s budget was balanced? And if foreign central banks hold foreign money on the asset side of their balance sheets and domestic currency on their liability, aren’t they exposed to huge losses if exchange rates change?
A: Not sure I got all of this, but let’s give it a go. Typical case: a country (say, China) exports goods to the US. Its exporters earn dollars but need RMB (to pay workers, buy raw materials, service debt). Their bank credits their deposit account with RMB, central bank of China credits the bank’s reserves in RMB. So the dollar reserves end up at Bank of China (asset of Bank of China, liability of Fed). Bank of China says “hey, these suckers earn zero interest; I want Treasuries” so Fed debits their reserves and credits Bank of China with Treasuries. Impact in the US: some US bank’s reserves are debited, Bank of China’s reserves credited. No change of total reserves until Bank of China buys Treasuries. At that point the reserves disappear, Fed’s liability to China reduced, Treasury’s liability to China increased. No necessary impact on the dollar/RMB exchange rate since the exports sold and imports bought were voluntary, and China only exported because she wanted dollars (reserves, then Treasuries). The next question always is: but what if China decides to run out of the dollar and dumps Treasuries? Ok, if that happened there could be depreciation pressure on the dollar; in which case China loses since its dollar assets decline in value relative to RMB. Fortunately, China is not as dumb as those posing the scenario. It will not runout of dollars in part because it does not want dollar depreciation.
Q4: This discussion gets to the heart of another question I have regarding the MMT proposition that tax liability is the main reason users value a fiat currency. As there are considerably more dollars held abroad as a hedge against currency runs and also as banking reserves to underpin intl trade, it would seem that foreigners value the dollar and yet have no tax liability to the US government. How does this square with the MMT claim? This also brings to mind another nagging suspicion that MMT focuses too much on nominal values and not on the real value of the supply of goods and services that underpin the currency. My guess is that Chinese sovereign funds will seek diversification out of dollar reserves by exchanging them for dollar-denominated real assets. Barron’s had an article this week that suggests the Chinese govt. will also promote intl trading in yuan to compete with the dollar. I could see how exchange markets with competing currency bloc issuers could provide the constraints on policy abuse of fiat currency values – a collapsing exchange rate is a highly visible market indicator.
A: Ok: 1. At the extreme, if we impose a $2 trillion tax only on Bill Gates, you can be sure that others will take dollars because poor Bill will work hard for us to pay his tax in dollars. This is a red herring. We do not need to tax all 6 billion people in the world to ensure a global demand for dollars. Tax about 300 million relatively wealthy Americans and you can be sure dollars will be demanded outside the US. Because Americans want them to pay taxes. Ever hear of the “margin”? Here is one place it works. Tax on the margin and you drive a currency. 2. MMT focuses too much on nominal? Hey, MMT is “modern money theory”. Money. So yes, it is focusing on money. Nominal. We could focus instead on the aesthetic value of nose jobs. Then we would call it modern nose jobs theory: MNJT. In any case, like it or not, we live in amonetary economy. Monetary production economy. Capitalist economy. Choose your terms. Money matters. 3. Barron’s? Give me a break. That is your source of analysis? Read more MMP, less Barron’s. More seriously: China will become the biggest economy in the world within 5 years. Its currency will likely replace the dollar in 50. Maybe sooner. Don’t hold your breath.
Q5: To what extent do foreign countries other than China hold US dollars as a way to protect their own currencies? Even if not directly pegged to the dollar, don’t many hold dollars to support their currencies in fx markets? If China suddenly desired to hold fewer dollars and started to dump their US bonds, wouldn’t the weakening of the dollar that might result cause all those other countries to buy more dollars to build back adequate reserves? And wouldn’t that demand tend to support the dollar’s value? In effect won’t every country that uses dollars to protect its own currency automatically act to protect the value of the dollar as well? If the dollar were to be suddenly devalued for whatever reason, is their any other stable currency that could plausibly be used instead by countries that now use US dollars to protect their own? I can’t imagine Euros or Yuan being very attractive …
A: So many questions, so little time. However, much of this answered above. Yes, many hold dollars to enable them to manage or peg their currencies. Holdings increased after the Asian Tigers’ crisis, when nations came to realize you need an unassailable reserve if you are going to peg. China learned it well. Does it increase demand for dollars. As Sarah would say, “you betcha”. Does devaluation lead to capital losses? Yep. Is there any alternative now? Nope. You can’t get safe euro debts in sufficient quantity. Oh, sure you can buy the debts of PIIGS. Go ahead, they need your help. Germany is a net exporter and the model of fiscal rectitude, so you can’t get their euro debt. So euro is a no-go. RMB? No way. Ditto. It is a better Germany than Germany is. Japanese Yen? Exporter. As an exporter it creates sufficient domestic saving to absorb its large government debt. TINA: there is no alternative to the dollar. Today.
Q6: Okay, I’ve been waiting for these posts for some time. I don’t know how much of the below question you will deal with in next weeks post, so maybe its best if you ignore the parts of the questions that will be dealt with. (1) You mention Japanese domestic saving. Can we just confirm once and for all that the high rates of domestic saving in Japan are the result of large government deficits and little of this ‘leaking’ abroad due to their running current account surpluses? And can we surmise from this that Japanese savings rates are largely determined BY the government deficits? — hence, it’s the deficits that ’cause’ the savings and not the savings that ‘allow’ the deficits. Sorry, I know I’ve been pressing this point for while on here. But I’d like it ‘in stone’, as it were. (2) In what way does what you say above tie into the Hudson/Varoufakis ‘dollar hegemony’ argument? I.e. the argument that the US occupies a ‘special position’ due to its post-war status that allows it to have its currency accepted by others to an extent that no other sovereign can? The kicker here would be that, if there is truth to this argument the US might not like the prospect of currency devaluations not just from the perspective of Wall Street, but also for geopolitical and military (read: imperial) reasons.
A: Thanks for the patience! Japanese gov’t deficits +current account surpluses = large domestic savings. By identity. Yes. Yen for Yen. Causation goes from spending to income to saving; or from injections to leakages, in the normal Keynesian way. Some in US would like dollar depreciation (exporters); some would like appreciation (tourists, and yours truly). The US is special. It has more nukes than anyone else and has shown theworld it is willing to use military might. That was not post-war, it was war. That’s real hegemony, not merely dollar hegemony. Nuclear hegemony will trump currency hegemony, I think.
Q6a: Question (1a) — well stated! Let me try to summarize– and add a third alternative: Which view is “best”? * Conventional view — loanable funds: “private savings allow government deficits”
* Philip’s suggestion: “government deficits’ cause’ private saving”, or alternatively “private saving is determined by government deficits”
* Keynes/Godley view (heh..as understood by Hugo): Increased private saving constitutes a demand leakage,since private spending decreases. Private saving decisions thereby ‘lead’ thegovernment into deficit. Because if the government does not go into deficit (toaccomodate for the private saving intentions) the economy will slow down (dueto the decreased private spending). So: “private saving behaviour ’leads’ government deficits” or alternatively “government deficits ‘allow’ private saving” Philip, is that a reasonable way to formulate your question (1a)? (Question (1b) would then be the question on why so few foreigners hold Japanese bonds — is it due to Japanese current account surpluses?)
A: Always takes two to tango. By construction, modern government budgetary outcome is accommodative—taxes fall and spending rises in downturn. The downturn, in turn, can be thought of as resulting from inadequate aggregate demand which leads to a reluctance to spend. That in turn results from a preference for saving and especially in liquid form. Ergo: private sector wantsto net save in government IOUs, so won’t spend, so a deficit results to satisfy the saving desire. To be sure, causation is always complex but that is a rough and ready explanation.
Q7: Pretty much. Randy has said many times before that government spending = private saving dollar for dollar. I just want to know if he thinks the case of Japan is a concrete example of this. Its just a very concrete argument to make against the ’Japan is because of high savings’ types. “No,” you’d respond,”Their savings are DUE TO high deficits coupled with trade surpluses! The government bonds just mop this up. Hence the perpetually low interest rates.”
A: Both. Japan has an inadequate safety net in conjunction with 2 decades of recession. Perfectly rational to save. That generates low growth and hence budget deficit. However, since the saving cannot occur unless the budget deficit occurs (and trade surplus) it makes sense to say the deficits allow the desired saving to be realized.
Q8: Could the government be compelled to raise taxes, after issuing so much bonds, paying so much interest, that bond holders become nervous and suddenly rush to buy actual stuff (mines, power plants, whatever) before inflation and currency depreciation occur? As the US dollar shift away from international reserve currency status, isn’t a harsh inflation to be expected ? How to deal with it? When governments lended to banks in 2008, were they compelled to do so because the massive losses demanded reserves to pay right away (or go bankrupt) to an amount exceeding what central banks had in their balance sheet ? Have we figures saying just that ? Otherwise why would governments act as Lender of Last Resort and humiliating central banks who pretended to be the ultimate guarantee of the monetary system ? (Yep I was the guy sending an e-mail entitled Lender of Penultimate Resort, I hope I”m not too pressing 😀 )
A: In a sovereign country, taxes create a demand for the currency and they drain income and thus reduce demand, which can be useful if there is inflation pressure. Obviously that is not the problem in recent years. So, no, there is no reason to raise taxes after the bail-out. The US dollar is not shifting away from international reserve status. Have you been watching Euroland? There will be a huge euro bond sell-off and a run into US Treasuries. Buy them now before Europe gets all of them. Why did the Fed bail-out Wall Street? Because Bob and Hank and Timmy came from Wall Street to save Government Sachs. Not sure it is humiliating, but it certainly is a scandal. Worst in human history.
Q9: As far as exchange rates go, context matters. Switzerland is actually rather unhappy about the fact that the CHF rose so much relative to EUR in the recent crisis, to the point where their central bank decided to put a limit on how high the CHF can go. They want to protect their tourism and export industries. Similarly, it seems to me that a depreciation of the USD wouldn’t necessarily be bad for the US. At least, I often read US commentators complain about the perceived de-industrialization of the US compared to the rest of the world. A falling USD could certainly help make production inthe US more attractive again, couldn’t it?
A: Again, depends on which American you are. Estimates of positive trade effects are almost certainly overstated for the US. For acountry like Italy, depreciation could have a nontrivial effect within Europe. Of course, it cannot do that until it leaves the euro and returns to the Lira. Noone is going to peg to an Italian Lira. So depreciation does increase exports. Given that most countries constrain demand, exporting is a lot like paying people to dig holes. It provides jobs devoted to waste. Exports mean you produce things you don’t get to consume. Pure waste—might as well just dig the holes, unless workers prefer making Fiats they don’t get to drive. The US would be far better off if it exported nothing, imported loads of stuff, and operatedat full employment. Not digging holes but rather doing useful and fun stuff.