MMT and External Constraints

Originally posted on February 24, 2014 at the New Economic Perspectives blog.

To Fix or To Float, that is the question.

MMT argues that a sovereign government that issues its own “nonconvertible” currency cannot become insolvent in terms of its own currency. It cannot be forced into involuntary default on its obligations denominated in its own currency. It can “afford” to buy anything for sale that is priced in its own currency. It might be able to buy things for sale in foreign currency by offering up its own currency in exchange—but that is not certain.

If, instead, it promises to convert its currency at a fixed price to something else (gold, foreign currency) then it might not be able to keep that promise. Insolvency and involuntary default become possible.

Generally speaking, the nonconvertible, floating exchange rate currency system provides more policy space. Government can use fiscal and monetary policy to pursue the domestic agenda. Fixing the currency reduces policy space because government must consider its promise to convert. That can conflict with the domestic policy agenda. For example, it is usually (but not always) the case that the government must pursue policy to ensure a positive flow of foreign currency (or gold) to be accumulated as a reserve to maintain the peg.  That usually means domestic unemployment to keep wages and imports down.

So far, this is just logic. Pegging your currency adds a constraint: you need to obtain that-to-which-you-peg in order to ensure you can convert at the pegged price. How binding is the constraint? It depends. In the case of China today, its “managed” exchange rate is not very binding. For example, China has committed to fairly rapid growth of domestic wages. By contrast, in the case of Nepal, the peg against the Indian currency is constraining. If Nepal were to pursue China’s policy of raising wages, her trade deficit with India would grow; unless she could somehow increase remittances from her workers abroad, reserves of Indian currency as well as dollars would be depleted. Her peg would be threatened and a currency crisis would be likely.

Now, would China or Nepal benefit from floating? I have no doubt that China would eventually be in a position where floating would not only be desired, but it would be necessary. China will probably float long before it reaches such a position. China will become too wealthy, too developed, to avoid floating. She will stop net accumulating foreign currency reserves, and will probably begin to run current account deficits. She will gradually relax capital controls. She might never go full-bore Western-style “free market” but she will find it to her advantage to float in order to preserve domestic policy space.

If she did not, she could look forward to a quasi-colonial status, subordinate to the reserve currency issuer. China will not do that.

MMT emphasizes that in “real” terms, imports are a benefit and exports are a cost. Floating the currency and relaxing capital controls allows a nation to enjoy more “benefits” (imports) and fewer “costs” (exports). The nation can “afford” to enjoy all the output it can produce plus whatever output the rest of the world wants to sell to it. It “pays for” those net imports through expansion of its capital account surplus. On the capital account, this is reflected in rest of world accumulation of financial claims denominated in the importer’s currency.

The balances balance. While many say the USA has a “trade imbalance” because the current account is in deficit, there is no imbalance because the capital account is in surplus. Dollar for dollar. There cannot be an imbalance. Foreigners want the dollar assets, and so they sell their output to the USA. Perhaps it is their national interest to do so; perhaps it is not. This is not a matter for me to judge. It is certainly in someone’s interest or they would not do it. Maybe the exporters run policy. Maybe the rich elite do. Or maybe it really is in the national interest.

Brian Romanchuk has a great piece up at his blog: “Why Rich Countries Should Float Their Currencies” (see here). He’s a bond market expert who recognizes that rich, developed countries do not face an “external constraint” so long as they float. I’m not going to repeat his whole argument—you really should read his piece—but here’s the main point: if foreigners want to sell their output to your country, you don’t need to worry about how to get the foreign exchange to finance that.

“There is an accounting relationship that says that foreign entities* have to place financial inflows into a country to match the outflows corresponding to its current account deficit (ignoring small external flows like foreign aid transfers). This seems to imply that foreigners have veto power over a country’s policies, and I have seen arguments that domestics are forced to borrow in foreign currencies as a result of the accounting.

 However, the volume of foreign exchange transactions have been found to be an order of magnitude larger than what is needed to support trade flows. This hyperactivity is partially the result of foreign exchange trading, but it also reflects very large gross cross-border capital market flows. These flows determine the relative value of currencies. The ultimate counterparty to an importer is most likely a foreign investor who wishes to run foreign exchange risk; there is no necessity for domestics to have to borrow in foreign currencies to finance imports.

 It is very possible that a fall in the currency will make a current account worse (as imports become more expensive, and quantities do not immediately adjust), a point that was made in the comments to my previous article. But since the valuation of currencies are driven by capital flows, not trade flows, this cannot go on forever. The domestic wage bill of exporters is being deflated versus international peers, and they become more competitive. (Imported input prices rise in local currency terms, but they pay the same world prices faced by competitors.) Since the exporters are more competitive, expected future profits rise, making domestic equities relatively more attractive. This effect will eventually limit the weakness of the currency. And the empirical reality is that the developed market currencies move around a lot, there appears to be a limit how far they can deviate from a purchasing-power parity fair value estimate.

Although currency volatility is disruptive, companies can use currency hedges to limit the impact of short-term volatility. In a country like Canada, where currency volatility is expected, business managers have learned the hard way that external currency economic exposures need to be controlled. (For example, the next year’s expected foreign currency revenue may be hedged, giving time to react to forex moves.) Conversely, what we we saw in Asia in 1997 was that businesses had come to rely on central banks stabilising the currency, and they engaged in speculative cross-currency exposures (such as borrowing in U.S. dollars because “interest rates were lower”). To paraphrase Minsky, instability is stabilising.

 In any event, I argue that a bid for a developed market currency always exists at some price, because of the potential demand for local currency financial assets. It would require the currency to essentially cease to exist in order for there to be no demand for the currency. This could result from the government repudiating its debt, or regime change (war, revolution). Additionally, it could result from a mass default by the domestic banking system. The latter possibility is very real, and it explains why that it is necessary for regulators to prevent domestic banks from building up foreign currency exposures (as seen in Iceland). This implies that there is a constraint on regulation – banks must be regulated in a fashion that is coherent with a free float in the currency. Many countries have failed to regulate their banks properly (e.g., foreign currency mortgages are commonplace in many countries), but their incompetence does not mean that it is impossible to run a banking system properly.

 Under the assumption that there is always a bid for the currency, it will always be possible to finance a current account deficit. The only question is the price at which the financing occurs”.

To put this as succinctly as possible, if you offer US or Canadian or Australian Dollars, or UK Pounds, or Japanese Yen, or Euroland Euros, you will NEVER find a lack of bidders. The only question is over the price. Heck, I’ve offered Mexican Pesos, and Colombian Pesos, and Turkish Lira and many other currencies  many times, and never found a lack of bidders.

Brian goes on to admit he’s only talking about the situation of “rich” countries. He says he suspects it is better for the developing countries to float, too, but they face difficult problems that he doesn’t feel he knows enough about.

I’m with Brian on that. Frankly, I do not know if Nepal would do better if it floated. I suspect that for many of the world’s poorest countries, the exchange rate regime is not the central issue—and they are probably screwed whether they fix or they float.

Critics of MMT love to point to such cases as proof that MMT is somehow wrong. They challenge us to find a solution to the problems faced by poor countries. If MMT cannot find a simple solution to the complex problems facing developing nations, then somehow MMT is wrong. It is a most bizarre claim.

All we claim is that with a sovereign, floating currency a government of a developing nation can “afford” to employ all its domestic resources that are willing to work for the domestic currency.

Will such a nation be able to import all that it wants? Probably not. Would pegging the exchange rate allow it to import more? Maybe—but then it is very likely that it will have to give up full employment at home. And it will be subject to insolvency and default risk (because it has promised to deliver something it might not be able to deliver).

Is that a trade-off that is in the domestic interest? I doubt it, but I am not sure.

What I observe out in the real world is that pegged exchange rates in developing countries are usually in the interests of the elites—who like their luxury imports and vacations in NYC and Disneyworld. Typically somewhere around half the population is either unemployed or “casually” employed (washing windshields of the luxury imports at stoplights).  Seems like a bad trade-off to me.

The big bogeyman usually raised is “inflation pass-through”. A floating currency opens the possibility of exchange rate depreciation that raises the costs of imports and “passes through” to domestic inflation. As Brian says that inflation impact is usually vastly overstated.

Neil Wilson has a good take on all this, too, in his piece “It’s the Exporters Stupid”:

“The key point is that if a currency moves down so that imports become ‘more expensive’, then the ‘inflation’ that goes off is a distributional response that tries to eliminate some of those imports so that the exchange demands equalise. That also eliminates somebody else’s exports.

The important thing to remember is that when a currency goes down, all the others in the world go up in relation to it and nations that rely upon exports (export led nations) start to lose trade – which depresses their own economy.

Any one of those other economies can intervene in the foreign exchange markets, purchase the ‘spare’ currency and that will halt the slide for everybody. And all exporters to an import nation have a central bank with infinite capacity to do that.

Export-led nations have to constantly provide liquidity into the rest of the world to allow others to buy their goods. Otherwise the rest of the world runs out of the particular money that is needed for the export transaction to complete and the export never happens (UK buyers buy Chinese goods with GBP, but Chinese workers are paid in Yuan. The relative shortage of Yuan due to the export differential has to be provided by the Chinese or Chinese goods become, in absurdum, infinitely expensive).

So the important insight, IMV, is that exporters need to export and the central banks that support that policy with ‘liquidity operations’ will ultimately halt any slide for any important export destination – either explicitly or implicitly through their own banking system….

For me the policy response to sliding currencies is to control the distributional inflation by temporarily banning the import of ‘luxury’ items. That forces the problem onto the exporters, which they can relieve by systemically intervening and fixing the currency imbalance. Forcing them to do what they normally do through the course of trade.”

I agree with Neil that it is better to float and then deal with the pass-through inflation; and it makes sense to force as much of the “pain” of fighting the inflation on the rich as possible. After all, they are the ones importing the BMWs and taking the kids to Disneyworld. As Neil notes in response to Ramanan, I have argued as follows: “the MMT principles apply to all sovereign countries. Yes, they can have full employment at home. Yes, that could lead to trade deficits. Yes that could (possibly) lead to currency depreciation. Yes that could lead to inflation pass-through. But they have lots of policy options available if they do not like those results. Import controls and capital controls are examples of policy options. Directed employment, directed investment, and targeted development are also policy options.”

I am not flippant about the many real constraints faced by a poor, developing nation. At an early stage of development, imports are very hard to get. The national currency faces little external demand. The world doesn’t want the nation’s produce, so it cannot export. Borrowing foreign currency can easily lead to excessive debt service and financial collapse.

Neither floating nor fixing is going to easily resolve these problems. That MMT does not have an easy solution to them does not, in my view, prove that MMT is flawed. My suspicion is that floating the currency and taking advantage of the sovereign’s ability to spend domestically is a step in the right direction. Capital controls are probably necessary—even more so if the country does not float. Foreign aid is probably necessary to finance needed imports.

Full employment of domestic resources is even more important for the developing nation than it is for the rich, developed nation. And yet what we find is precisely the reverse: unemployment is much higher because the government thinks it cannot “afford” to offer jobs. Hence, MMT can offer useful advice even if it cannot offer a magic wand to wish away all the problems faced by developing nations.

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25 RESPONSES TO “MMT AND EXTERNAL CONSTRAINTS”

1. James Cooley | February 24, 2014 at 3:27 pm |“Heck, I’ve offered Mexican Pesos, and Colombian Pesos, and Turkish Lira and many other currencies many times, and never found a lack of bidders.”
   Last night I was watching a C-SPAN program about the history of paper. The author of the book included a photograph of a 100 trillion dollar Zimbabwe note which he said he paid $.5o US for, and which he thought might have been too much. It’s hard to refute the statement that there is ever a lack of bidders for a currency even if only at 1/200,000,000,000,000.
   
   
2. Marley | February 24, 2014 at 3:45 pm |The problem of “poorer” countries (or many “emerging” markets) is that of “original sin”. Unlike the US, UK, Japan, these countries cannot “borrow” in their own currency. Foreign investors want to invest in their own currencies and will seldom do so with a “pure” float – as opposed to say, a “managed” float, the like of which Argentina is doing. The risk is evident if any potential devaluation wipes out of severely diminishes the interest-rate-related return on investment. And so, the drum beats on, with investors ever skittish to have their capital take flight at the first sign of foreign exchange reserve depletion. Of note is the fact that managing a float is akin to maintaining a peg, and requires FX reserves in much the same way. It’s a not a sustainable situation for most developing countries. We must be rid of “original sin” for there to be equitable and stable transfers of capital for the sake of investment. A first step to this, IMO, is to let the currencies of these nations “bottom” out as it were, instead of propping them up.
   
   
3. Deus-DJ | February 24, 2014 at 5:30 pm |I hope the critics especially will pay attention to your last paragraph. That this has to be pointed out shows what they really seem to believe: that developing nations cannot afford full employment.
   
   
4. golfer1john | February 24, 2014 at 5:31 pm |“At an early stage of development, imports are very hard to get. The national currency faces little external demand. The world doesn’t want the nation’s produce, so it cannot export. Borrowing foreign currency can easily lead to excessive debt service and financial collapse.”Is it fair to say that at such an early stage of development a country’s wealth and standard of living is limited to what its people can produce using the local resources? As if it were totally isolated, even as if it were a non-monetary economy? Other than tourism, or foreign aid, or some exportable natural resource like oil or gold, what options are available to compete in world markets and take advantage of the insights of MMT?
   
   
5. Ben Johannson | February 24, 2014 at 8:35 pm |@golfer1johnWe can liken an undeveloped economy to a frontier settlement with little capacity to receive support from more established entities. They live off the land, meaning what they can produce domestically until their productivity and product diversity make them worth the effort and risk to trade with.
   
   
6. Roberto | February 24, 2014 at 9:33 pm |“If MMT cannot find a simple solution to the complex problems facing developing nations, then somehow MMT is wrong”“If General relativity doesn’t show how to build flying saucers then General Relativity is wrong”Some people just hate MMT. I say whatever.
   
   
7. JuneTown | February 25, 2014 at 2:37 pm |“”MMT argues that a sovereign government that issues its own “nonconvertible” currency…………””It seems what needs discussion is about whrther any sovereign government IS actually issuing its own currency, and not whether convertibility is a good or bad thing in differing situations.
   In other words, policies supporting full-employment would work in both convertible and non-convertible currency nations, as long as the government is issuing the currency.
   And, if the government is not issuing the currency, then you do not have “money-use” policies that support full-employment, but return on capital.
   See Dr. Huber’s paper at Real World Economic Forum.
   http://www.paecon.net/PAEReview/issue66/Huber66.pdf
   
   
8. Si1ver1ock | February 25, 2014 at 5:27 pm |What would MMT proponents propose for Venezuela? I hear they have 56% inflation. Anybody know why or how to fix it?
   
   
   • Mark Robertson | February 26, 2014 at 8:22 pm |Venezuela’s inflation is caused by shortages in key consumer goods. The shortages are engineered by the rich, who have been waging an economic war of attrition against the semi-socialist government and against lower classes since Hugo Chavez died on 5 March 2013. The purpose is to cause so much misery for the masses that they blame the government for their pain, and finally join their oppressors (the rich) in overthrowing the government. Then Venezuela can finally return to the way it was before Hugo Chavez, with a savagely repressive government, and an extreme gap between rich and poor.Shortages are maintained by smuggling goods to secret warehouses, many of which are in neighboring Colombia. Meanwhile, foreign companies like Toyota and Ford have almost totally shut down their factories in Venezuela. And since shortages drive up prices, the war is extremely lucrative for the rich.When Chavez was president (1999-2013) the rich tried many times to launch this war of attrition, but Chavez always outwitted them. Eventually, however, cracks appeared within Chavez’ ranks, as (some) politicians within Chavez’ own party became corrupt, and started lining their own pockets. This caused fissures that the rich began exploiting from the moment that Chavez died. Now some politicians in Chavez’ own party are helping the rich to maintain the shortages in consumer goods. It’s very lucrative, and the traitors hope to have places among the oligarchs in the new order. The shortages sustain a black market in various consumer goods, and also sustain a high crime rate. It’s all part of the imperialist / neoliberal plan.
     
     
9. Dan Lieberman | February 25, 2014 at 8:41 pm |Being new to the MMP blog and not having absorbed the previous commentary on MMP, I find myself with questions and need clarifications. Uh, oh, here I go.(1) “The important thing to remember is that when a currency goes down, all the others in the world go up in relation to it and nations that rely upon exports (export led nations) start to lose trade – which depresses their own economy.”
   Is it absolutely true “that when a currency goes down, all the others in the world go up in relation to it?”
   If the dollar goes down in relation to the Euro, can’t the dollar still appreciate in relation to the Yen (Which is what is happening.)?
   If the nation, whose currency depreciates, does not export much or exports a commodity that has no competition, will “nations that rely upon exports (export led nations) start to lose trade – which depresses their own economy?” Nor does it mean the nation will import less. It only means imports will be more costly.I sense these sentences need more clarification or rewording.(2) “If she did not, she could look forward to a quasi-colonial status, subordinate to the reserve currency issuer. China will not do that.”My wording is reverse:
   “If she did not, she could look forward to giving the United States a quasi-colonial status, subordinate to the reserve currency owner. The U.S. will not permit that.”Could not China, which has $4 trillion in foreign reserves, use reserves to purchase U.S. assets other than bonds? This amount could purchase either:• All US Farmland and Buildings – total value $2.332 trillion
   • 1/6 of all homes in the U.S – total value $25.7 trillion
   • All stocks in Dow Jones averages – total value $4.25 trillion(3) MMT emphasizes that in “real” terms, imports are a benefit and exports are a cost. Floating the currency and relaxing capital controls allows a nation to enjoy more “benefits” (imports) and fewer “costs” (exports).This seems to state that debt and capital account surplus are good. If the nation’s entrepreneurs own the factories and pay the laborers, the workers can usually enjoy the same production as the exports. It is mainly surplus production that is exported, and for good reason; it’s the preferred means for making a profit.As for imports, would it not be more beneficial to domestically manufacture the goods and not have to import them?
   Who wants a capital account surplus that leads to foreigners owning our assets and driving up their prices?This concept that China is not a lending nation to the United States baffles me.
   Exports bring purchasing power into the nation.
   Imports deprive the nation of purchasing power.
   In order to sell all goods and make a profit, the lack of purchasing power due to the current account deficit demands more borrowing. If domestic credit is lacking, then foreign credit is required. China supplies the credit that is lacking in the system. Why isn’t it a lending nation?(4) Export-led nations have to constantly provide liquidity into the rest of the world to allow others to buy their goods. Otherwise the rest of the world runs out of the particular money that is needed for the export transaction to complete and the export never happens.Should this read “nations that have a current account surplus have to constantly provide liquidity into the rest of the world to allow others to buy their goods?” Aren’t there many export driven nations, such as United Kingdom, that don’t provide liquidity?
   
   
   • golfer1john | February 26, 2014 at 11:44 am |“Is it absolutely true “that when a currency goes down, all the others in the world go up in relation to it?”
     If the dollar goes down in relation to the Euro, can’t the dollar still appreciate in relation to the Yen (Which is what is happening.)?”1. Yes, it’s a logical identity.
     2. Yes, anything that happens is possible.The reality is that all (floating) currencies fluctuate in value every day, in different amounts. There is no way to isolate the movement of one from the movements of all the others. There are attempts at creating indices that combine the exchange rates of one currency vs. a basket of others, often trade-weighted. They are an approximation of the changes in that one currency, based on the assumption that the movements of the others, on average, will tend to offset each other.
     
     
   • golfer1john | February 26, 2014 at 12:13 pm |“Could not China, which has $4 trillion in foreign reserves, use reserves to purchase U.S. assets other than bonds?”I think there are laws preventing that, at least on a large scale. In addition, governments in general have no interest in owning real property in other countries, even if they own the means of production domestically.What is possible, and happened to some extent involving the Japanese in the 1980’s, is that private citizens and companies in China might make investments in the US, buying property or stocks of US companies. I think the money flows from such transactions would operate just like a reduced trade deficit, the former owners now having cash to spend domestically.
     
     
   • golfer1john | February 26, 2014 at 1:00 pm |“This seems to state that debt and capital account surplus are good.”It’s really not about “good” and “bad”. People trade things for money when they value the money more than the things, and vice verse. Both parties feel better off after the deal. Aggregating all the deals across arbitrary national boundaries does not impart any goodness or badness to the result. If the US and Canada merged, and the people of Canada were suddenly citizens of a country with a trade deficit instead of a trade surplus, would they be any better or worse off because of it?“As for imports, would it not be more beneficial to domestically manufacture the goods and not have to import them?”That depends. If you don’t make them yourself, what do you do with the time and resources not expended? What is the value, domestically, of those resources and that time, compared to the price of the imported goods? Trade happens when it is mutually beneficial. Both parties are better off. Is it more beneficial for you to manufacture your own car than to import one from Detroit (if you don’t live in Detroit)?
     
     
   • golfer1john | February 26, 2014 at 3:29 pm |“This concept that China is not a lending nation to the United States baffles me.
     Exports bring purchasing power into the nation.”Exports remove real (non-financial) wealth from the nation.“Imports deprive the nation of purchasing power.”Imports add real (non-financial) wealth to the nation.“In order to sell all goods and make a profit, the lack of purchasing power due to the current account deficit demands more borrowing.”MMT views the balance of payments, the net savings of dollars by foreigners, as a financial leakage that should be made up by the government adding financial assets to the domestic economy. According to our laws, that involves a series of transactions, one of which looks like borrowing. It didn’t have to be that way. It’s the way we chose to do it.“If domestic credit is lacking, then foreign credit is required. China supplies the credit that is lacking in the system. Why isn’t it a lending nation?”It’s a mercantilist nation. It accumulates financial assets denominated in other nations’ currencies. It acquires them not by lending anything, but by selling things. Whether it hold dollars or swaps them for Treasuries, it acquires them by selling, not by lending. China cannot create dollars to lend.I guess we use the word “lend” to mean different things. When a bank lends, or the Fed lends, it creates an asset – an account balance – for the borrower, out of thin air. When you or I or China buys a Treasury bond, we exchange one asset (dollars) for another (the bond). Nothing is created. They are fundamentally different transactions, and should not be called by the same name.
     
     
     • Dan Lieberman | February 28, 2014 at 7:48 pm |From your response, I gather that MMT is trying to make classical economics a relic of the past and replace it with a modern theory – a significant objective but still not convincing.You say:
       Exports remove real (non-financial) wealth from the nation.
       but don’t show how.
       If a tourist comes to the U.S. (export), how does that remove real wealth from the U.S.?
       If Walt Disney’s films are shown in foreign nations (export), how does that remove real wealth from the U.S.?
       If the U.S. exports surplus agriculture, which will rot in the field, how does that remove real wealth from the U.S.?You say
       Imports add real (non-financial) wealth to the nation.but don’t show how.
       If an American goes touring in Europe (import), how does that add real wealth to the U.S.?
       If a foreign film is shown in the U.S. (import), how does that add real wealth to the U.S.?
       Why has Argentina gone broke – lots of imports?I suspect a lack of recognition that exports are mainly surplus goods, the best means to make profit for reinvestment and to bring purchasing power into a nation, which creates additional demand and stimulates employment.
       Imports do the opposite.There may be specific exports which are not beneficial and specific imports that are beneficial, but in the complete system, current account deficits seem to be ultimately catastrophic and current account surpluses seem to create wonder.You say
       MMT views the balance of payments, the net savings of dollars by foreigners, as a financial leakage that should be made up by the government adding financial assets to the domestic economy. According to our laws, that involves a series of transactions, one of which looks like borrowing. It didn’t have to be that way. It’s the way we chose to do it.Don’t take this as too sarcastic, but from your statements, I can pose a scenario where we can work less.
       Government creates a national bank that allows borrowing of $5,000 each year (Current account deficit/family), if used for imports.
       We take trips around the world, buy goods in China and send them home.
       The government repatriates the dollars by selling Treasuries, deposits them in our National Bank and credits all borrowers with the debt owed to the bank.Come to think of it, that is a good description of what does occur.You say
       China is a mercantilist nation. It accumulates financial assets denominated in other nations’ currencies. It acquires them not by lending anything, but by selling things. Whether it hold dollars or swaps them for Treasuries, it acquires them by selling, not by lending. China cannot create dollars to lend.Don’t all loan sharks (lenders) acquire financial assets by selling things?
       Public banks and “shadow banks” acquire funds by deposits and by investment (not lending). Capital requirements are acquired by selling stock. The means of acquisition of financial assets has nothing to do with its use.I guess we use the word “lend” to mean different things. When a bank lends, or the Fed lends, it creates an asset – an account balance – for the borrower, out of thin air. When you or I or China buys a Treasury bond, we exchange one asset (dollars) for another (the bond). Nothing is created. They are fundamentally different transactions, and should not be called by the same name.Do banks automatically create an asset from a loan? By fractional banking, they create additional reserves, which increases their lending power, and only after the loan is re-deposited in the system. The deposit creates the additional funds. One has nothing to do with the other. Can’t I ask for dollar bills, get it and hold it? Do banks print dollar bills?
       If reserve requirements were 100%, would the transaction not be a loan? No new money out of thin air is created?Definition of a loan:
       Term loan Definition: In general, a transaction in which a legal claim is exchanged for money. The legal claim is typically a contract or promissory note stipulating when and how the money will be repaid.A Treasury Note fits this definition and no exchange of assets is involved.
       To me, it does not matter; purchasing power has left the system and must be returned or goods will be unsold. When domestic borrowing is insufficient then the government is obliged to run debt to keep the economy going. The foreign transaction replaces the domestic borrowing and by equivalence, I consider that to be a loan.
       
       
       • golfer1john | March 1, 2014 at 11:28 am |I don’t think MMT is trying to replace all of Classical economics, whatever that is. It does contradict certain assumptions made by other schools of thought, and reasons differently based on those different assumptions and based on recognizing different facts as being fundamental rather than incidental. And it’s only macroeconomics, I’ve seen nothing in MMT that differs fundamentally from the mainstream view of microeconomics. And I’m not a founder or spokesperson for MMT, just a student of it. I have a BA in economics (taught in the classical style), and I defer to the PhDs here regarding the more obscure theoretical aspects.MMT doesn’t say “real wealth”, it says “real benefit”. Imports and exports don’t necessarily result in transfer of a tangible physical asset, like a car or an iPad. Some of the benefits you mention are things that are immediately consumed.If a tourist comes to the US, he occupies shelter and consumes food and fuel that could otherwise have been used by the local population. He may also consume some entertainment products and other services that were produced by the labor of the local population. Those resources and labor are the real costs. The money is the financial benefit. Even if the local population would not have lived in the same hotel as the tourist, the concrete and steel and labor used to build that hotel could have been put to other uses.Intellectual property doesn’t always fit the model as well. An accountant would allocate part of the cost of making that Disney movie to the foreigners who watched it, but in fact the marginal cost of that “export”, perhaps except for advertising, is essentially negligible, and the movie might have been produced anyway, even if export were impossible. The same goes for things like drugs and software, where the fixed cost of inventing it can be enormous, but the marginal cost of producing another unit is comparatively negligible.“Surplus” agriculture does have a real cost to produce, and if there were not to be exports of it, it may never have been produced in the first place. There is ability to predict demand, and farmers do adjust their production to try to minimize growing something they can’t sell. Supply is harder to predict, since it depends on weather, so prices adjust in order for the market to clear. It only rots in the field when the price becomes so low that it is less than the harvesting cost.When an American goes abroad, he likewise consumes food and lodging that Americans didn’t have to produce, and when he watches a foreign film he enjoys the fruits of the labor of foreign actors and film producers. It’s not a durable tangible thing, but it is consumption, and it is a real benefit.Logically, it can be nothing else. It is not financial, so it is real. It cannot be a cost, or money would not have been exchanged for it. It must be a benefit.I don’t know what you’re referring to in Argentina, but “broke” is a financial term. It can’t be the real benefits of imports that caused it. Perhaps it was debts denominated in a foreign currency?You’re right that exports bring financial assets – which you call “purchasing power” into a country. Exports are a financial benefit, imports are a financial cost. Exports increase employment, as the country must work to produce more than it consumes.It occurs to me that maybe you are not understanding the lingo of real and financial. They are opposites, in this context. Trade is the exchange of a real good or service for a financial asset (“money”). Trade occurs when both parties want what the other has. Both benefit from trade, one in real terms and the other in financial terms. Both incur costs, one real and the other financial. Both feel better off after the exchange. There is no reason to believe that one arbitrary group of humans will collectively desire the same mix of real and financial assets as any other, and their desires are subject to change over time, so I think there will always be trade surpluses and deficits, and I don’t see any inherent problem with either one.“Come to think of it, that is a good description of what does occur.”I’m not sure I follow, but I think you might have the sectoral balance right.“Don’t all loan sharks (lenders) acquire financial assets by selling things?”If you mean commercial banks, not the local mafia – or maybe even if you do mean the local mafia – banks acquire financial assets by lending. The loan, the borrower’s promissory note, is the bank’s asset. So far, the loan shark is the same. The difference is that the bank simply goes to their computer and gives the borrower a deposit in his account. That is money that did not exist before. It can be spent anywhere by the borrower, and spent again by the merchant, and trades at par with government money. The promissory note does not trade at par, but at a discount, if it could trade at all.The loan shark gives the borrower cash, which reduces the cash in his pocket. No new money is created. The loan shark has a different financial asset, the promissory note, but no longer has the cash.Both transactions are purely financial, no real goods or services are involved. It’s not a sale of anything real, like when China sells iPads to us.“Do banks automatically create an asset from a loan?”The loan transaction creates an asset and a liability for both the bank and the borrower. The bank has a new asset, the loan, and a new liability, the deposit. The borrower has a new asset, the deposit, and a new liability, the note. It’s no more complex than that.“By fractional banking, they create additional reserves”As I understand it, MMT thinks the concept of fractional reserve banking is inaccurate in our current system (at least – maybe always). Banks do not create reserves, the Fed creates or destroys reserves by open market operations, or by lending to banks. Banks are not reserve-constrained. They lend whenever they find a creditworthy borrower, and acquire any necessary reserves later. There’s a 2-week lag in the reserve requirement, and in order to maintain its target overnight interest rate, the Fed must supply the required reserves needed by the banking system in the aggregate. It has no choice. Banks borrow them from each other to resolve imbalances, but the aggregate requirement has to come from the Fed.“Can’t I ask for dollar bills, get it and hold it?
         Do banks print dollar bills?
         If reserve requirements were 100%, would the transaction not be a loan?
         No new money out of thin air is created?”Yes.
         No.
         No. (It would still be a loan.)
         No. (Money would still be created.)If the reserve requirement were 100%, the Fed would still have to supply reserves to match the amount of net new loans during the reserve accounting period, assuming that the Fed was maintaining an overnight interest rate by manipulating the quantity of reserves. (QE and interest on reserves changes that. If the Fed is maintaining massively excess reserves in the system, as it is now, then no new reserves would be needed until enough loans were made that all the excess reserves became “required”.)“A Treasury Note fits this definition and no exchange of assets is involved.”Your definition of a loan is fine by me, but that statement is incorrect. When a Treasury Note is created, it is exchanged for a bank balance. Treasury gets a balance in its bank account by issuing Notes. The buyer of the note (the lender) gives up a bank balance (asset) in exchange for it. (It’s all financial assets, no real assets.)“To me, it does not matter; purchasing power has left the system and must be returned or goods will be unsold. When domestic borrowing is insufficient then the government is obliged to run debt to keep the economy going. The foreign transaction replaces the domestic borrowing and by equivalence, I consider that to be a loan.”I’m kind of lost here. Are you talking about imports again? MMT believes the government deficit is largely endogenous, that is, determined by the savings desires of the non-government. That includes the current account deficit (savings by the foreign sector). All things being equal, and given our current laws and institutions, if the trade deficit were to increase, then the budget deficit would increase by the same amount. That doesn’t mean that trade is equivalent to lending.You could say, though, that even if the foreign seller kept the dollar bill in his pocket instead of sending it to his central bank or buying a US Treasury security, what he has is still a promissory note from the US government that is good for paying any tax or fee he might owe. In that sense, the net result could be viewed as if he exchanged real goods for a loan, in the same way that the seller of a house might take back a mortgage. His dollar bill is just a lot more liquid than a note from Joe Blow who bought the house.
         
         
   • joe | February 26, 2014 at 6:32 pm |I look forward to responces to your questions. I’m guessing nothing really is stopping China from swapping 4t in bonds for reserves to buy 4t in “stuff” except for the effects such a large purchase would have on prices? And I suppose if the US did not produce new products for domestic and foreign consumption the dollar would start to devalue. Though new production of more advanced goods (then shoes anf tires) doesn’t mean the trade gap would necessarily be any smaller. I’m just a casual reader of this and may have just made a bunch of dumb comments…
     
     
     • golfer1john | February 26, 2014 at 9:19 pm |Not dumb at all.They wouldn’t buy the stuff all at once. In fact, it is the Chinese Central Bank that holds the Treasuries, they would not be buying stuff at all, just selling their Treasuries for $, and selling the $ for yuan or for some other currency. If they bought yuan, they would drive its fx value up and the dollar down, which is contrary to their mercantilist strategy. They are holding and accumulating those dollars because they want the dollar strong and the yuan weak, so as to enhance their trade surplus. The US is their biggest customer. Contrary to what some say, they would not be terribly concerned about the P&L on their Treasury bond holdings.But, if they did change their mind and sell the dollars, the fx adjustment would make US exports more competitive and Chinese imports less competitive, reducing the bilateral trade deficit, employing more Americans to make more stuff, and fewer Chinese. Until the US gets a lot closer to full employment, the effect on US domestic prices would be minimal, if anything.
       
       
10. PZ | February 26, 2014 at 4:58 am |Poverty is endemic in developing nations. Populations lack wealth to consume, but at the same time producers are missing because of lack of access to finance, and to some extent lacking property rights. If land is in common ownership it cannot be used for collateral for bank loans for example.Public banking seems to be working for China, they have this concept of “development finance”, which presumably means giving access to bank loans for the purpose of economic development. In a monetary production economy, banks are crucial for the production.
    
    
11. Ben Johannson | February 26, 2014 at 3:49 pm |Dan Lieberman,1). All else being equal, if Venezuela devalues its currency then all other currencies rise in relationship to it.2) Congress has refused to allow Chinese purchase of anything of real value. They buy what we let them.3) Countries focusing on trade surpluses restrict domestic demand and tailor production for foreign markets. The wants of working people in the domestic economy is an afterthought at most.4) The UK runs near-continuous trade deficits and is therefore a net importer. It provides liquidity to the world by buying things.
    
    
    • Dan Lieberman | February 27, 2014 at 5:08 pm |1). All else being equal, if Venezuela devalues its currency then all other currencies rise in relationship to it.
      I believe you misinterpreted. The disputed expression did not treat devaluation. It stated “The important thing to remember is that when a currency goes down, all the others in the world go up in relation to it…
      Maybe the intent was meant to say devaluation. I wrote it needed correction.
      2) Congress has refused to allow Chinese purchase of anything of real value. They buy what we let them.
      You may not be up to date.
      Fosun International Ltd bought One Chase Manhattan Plaza and a Chinese consortium bought the General Motors building, also in New York.
      Kiplinger Letter predicts:
      “China is forecast to spend roughly $1 trillion over the next decade buying up foreign assets, including about $15 billion to $20 billion a year on U.S. investments.”
      http://blogs.marketwatch.com/thetell/2013/10/28/what-will-china-buy-beijing-goes-shopping-in-u-s/3) Countries focusing on trade surpluses restrict domestic demand and tailor production for foreign markets. The wants of working people in the domestic economy is an afterthought at most.I’m not sure of this.
      China employs 700 million people and has only a 4% unemployment rate
      Germany does well for its people as does Norway, Qatar, Netherlands, Switzerland, Sweden, South Korea, Japan, etc.
      Trade surpluses support profits and bring purchasing power and investment into a nation. Trade surplus is the life blood of capitalism – without it, the capitalist nation will struggle with recessions and unemployment.
      The wealthiest and most economically successful nations in today’s globe have trade surpluses.4) The UK runs near-continuous trade deficits and is therefore a net importer. It provides liquidity to the world by buying things.I believe you have again misinterpreted.
      Doesn’t every nation that trades “buy things?”
      Exporters that have a current account deficit don’t need to provide liquidity to the system. They need to receive liquidity in order to support their deficits.
      Exporters that have a current account surplus are compelled to provide liquidity to the system so others can continue to purchase their products.
      Supplying liquidity is the function of those with current account surpluses. Naturally a nation cannot have a surplus unless it exports, but this does not mean the nation is specifically geared to exports of goods.
      
      
12. GrkStav | February 26, 2014 at 9:18 pm |The desire of some in Ukraine to join the EU and (if I am not mistaken, to commit to joining) the EMU baffles me, given what is my current understanding of MMT. I cannot fathom why any country that is not currently ‘like’ Germany (mutatis mutandis) would wish to join the EMU, or have to commit to doing so as a condition for entry into the EU. Can anyone explain the possible rationale?
    
    
    • golfer1john | February 27, 2014 at 10:24 am |There are significant advantages to joining the EU. Absent an understanding of monetary sovereignty, they might not know of any disadvantages.
      
      
13. lrwray | February 27, 2014 at 12:44 pm |good discussion here and thx to golfer, ben and pz for fielding questions.
    grk i suspect the main reason for support for joining emu is political, to put some distance from russia. the economic benefits are highly suspect.
    remember when everyone worried that the japanese would use all their dollar reserves to buy up the usa. i always thought that fear was pretty funny. so yes they bought some real estate. ownership subject to usa law. who controls whom. question mark. [sorry my keyboard has lost shift key function so i cannot actually use the question mark or capitals] and look out, here come the canadians. i would worry a lot more about them than about the chinese right now, since they’ve been buying up our natural resources. still, we make the laws. we can choose to let them rape the environment, or we can restrict them. speaking of which, rapacious hedge funds have been buying up our homes. domestic hedge funds, that is. there are enuf real things to worry about that we don’t need to focus on imaginary ones. the solution is not to cut off imports but to put in place laws to protect the public interest.