Originally published December 8, 2011 on the New Economic Perspectives blog.
Apologies to all, I have just finished a Coffee conference in Newcastle and before that a SHE conference in Sydney so this is late and brief. I will deal with many of these topics in MMP blog #28. But let me deal with just a few of the comments here.
Q1: Can a euro-using nation like Greece issue net financial assets to its nation?
A: Ignore for a second the government and foreign sectors. Within the domestic private sector, many economic units issue IOUs that represent their debt; these are held by other economic units as their assets. Clearly for every debt there is an asset. They net to zero. Now add the government sector. It has claims on the domestic private sector, and it issues claims on itself. The private sector meets its obligations to government by delivering the government’s own IOUs (ie: currency broadly defined, although in practice taxes are ultimately paid using reserves—a transaction performed by banks that have accounts at the central bank). As we know from previous blogs, deficit spending by government leads to net credits. So the private sector will have net financial assets in the form of claims on government. And in practice those net claims will be bank reserves at the central bank. Government can then sell treasuries as a higher interest earning alternative—which are bought through debits to reserve accounts.
Now the question is whether these reserves or treasuries are net financial assets for the domestic private sector. Surely they are.
Add the foreign sector. Presume the government is operating with what amounts to a fixed peg—either it makes its currency convertible one-to-one against a foreign currency, or it actually adopts a foreign currency (say, the euro). Its central bank opens a reserve account at the central bank that issues the currency (say, at the ECB). It accumulates claims on foreign central banks (its financial assets) and foreigners accumulate claims on it (its financial liabilities). It clears its accounts using ECB reserves (the ECB debits its reserves and credits reserves of foreign banks that have claims against it). When it is short reserves needed for clearing, it must borrow them from other banks that have accounts at the ECB, or from the ECB itself.
As the Greek domestic private sector plus government sector purchase foreign goods, services, and assets, foreign central banks will accumulate claims on the Greek central bank. And as foreigners purchases Greek goods, services, and assets, the Greek central bank will accumulate claims on foreign central banks. If Greece runs a current account deficit (which it does), there are net claims against Greece—net Greek debt that represents net financial assets held by foreigners. (Technically, a current account deficit is offset by a capital account surplus—plus official transactions.) These can be claims on the Greek private sector and on the Greek government. All of this can go on so long as foreigners are willing to accumulate claims on Greeks (private plus government debtors) and the ECB is willing to lend reserves to the Greek central bank. But Greece is subject to the “whims of the market”—the “market” might require a higher interest rate to induce it to continue to “lend” to Greece.
Q2: Can a fixed exchange rate ever be beneficial?
A: An advantage of a fixed rate is that uncertainty over exchange rate movement can be removed—so long as you really believe the peg can be maintained. Let us say you believe it. Then the disadvantage is that the nation gives up domestic policy space since it will have to ensure policy is consistent with maintaining the peg. That is a big trade-off. It could be possible that desired domestic policy is consistent with maintaining the peg. For example, let us say that you want to run your country in a manner that maximizes net exports—so that your central bank accumulates foreign exchange. In that case, maintaining the peg is facilitated. Now, exports are a cost while imports are a benefit—in real terms: you work hard to produce goods that will be consumed by foreigners. Again, it is possible that such a policy is consistent with domestic goals. Let us say you want to develop your productive capacity and want to ensure high quality products so need to perform to global standards. That is a big reason why China wanted to become an exporter. But China must realize the drawbacks to such policy: workers produce goods and services they do not get to consume. So, I am not arguing that no country should ever adopt a peg—rather, countries should be aware of the relative costs of doing so. Finally, pegs invite speculators—who bet that you cannot maintain the peg. That is why it is foolish to peg unless you have an unassailable foreign currency reserve.
Q3: What are the causes of inflation?
A: Excess demand is clearly not the only cause of inflation—and I never implied that it is. Indeed, inflation in the US, outside major wars, has always coincided with high unemployment. Assorted other reasons include rising prices of imported commodities (oil, food), bottlenecks (shortages of key resources including skilled labor), wage-led or profits-led inflation (either workers or capitalists insist on excessive increases to incomes), government indexing (increasing prices paid on purchases, indexing government salaries and benefits, indexing transfer payments), and so on. It is no secret that Germany held the line on wages while almost all other euro-using nations allowed wages to rise—making labor in many nations non-competitive with German workers. Where should we point the finger: at Germany or at Greece? Germany chose a race to the bottom strategy and if all others had followed that strategy, all wages would have been pushed toward zero so that Euroland could “enjoy” falling living standards that at the extreme would fall to the lowest common denominator.
Q4: Several questions and comments related to private credit creation and Steve Keen’s work. Frankly, I did not follow. Let me phrase it this way: is a private credit-led expansion possible.
A: Yes. We saw that in the US from 1996-2006. As Sarah Palin might ask: how’s that working out for ya? Not too well. When will such an expansion stop? When private debtors become unwilling to continue to expand borrowing, or private lenders become unwilling to lend. And as soon as growth of debt stops, the expansion is over. It will almost certainly turn downward because much of the borrowing is based on the expectation of growth of incomes or asset prices (since that makes it easier to service the extra debt). These things almost always end in a very ugly manner. Such as a global financial crisis.