Monthly Archives: April 2010



By L. Randall Wray

On Wednesday April 28 several New Economic Perspective bloggers participated in a 1960s style “teach-in” in Washington DC to explode some of the myths about Federal Government deficits. Our event was timed to counter the Pete Peterson-funded extravaganza that promoted all of the fallacies used to stoke hysteria and fear of deficits. You can find more information about our event, as well as our power point presentations (here).

Right before the event, we also issued a joint piece examining the nine worst myths, posted at both New Deal 2.0 (here) and at the Huffington Post (here). The flurry and fury of comments to our piece was amazing, nay, shocking. I think these comments demonstrate just how successful the billions of dollars spent in Peterson’s campaign have been at promulgating dangerous falsehoods over the past two decades. Indeed, the level of commentary is notable both for the vitriol and for its sheer ignorance. One wonders whether civil and informed discussion on the topic of money is even possible.

I was reminded of a conversation I once had with the late and great Robert Heilbroner about my book, “Understanding Modern Money”. He warned me that the book was going to scare the living daylights out of readers (actually he used more colorful language—but it was a private conversation, not a public blog fit for family viewing). He went on to explain that money is the scariest thing for most people, sure to result in heated and angry discussion. It is also complex, something everyone talks about but few understand. Hence, it is a topic that must be carefully addressed, and with plenty of reassurances that one is not propounding anything too unsettling. It is also a subject that accumulates more than its fair share of cranks—indeed, “monetary cranks” actually earned an entry in the New Palgrave dictionary of economics. (By the way, most of the “cranks” discussed in that entry actually were less “cranky” than someone like Milton Friedman or Friedrich von Hayek—but that is a topic for another time.) For that reason, new ways of looking at money will (rightly, sometimes) be suspiciously treated.

The reaction to our post on the nine myths also reminded me of an interview Nobel winner Paul Samuelson gave to Mark Blaug (in his film on Keynes, “John Maynard Keynes: Life/Ideas/Legacy 1995”). There Samuelson said:

“I think there is an element of truth in the view that the superstition that the budget must be balanced at all times [is necessary]. Once it is debunked [that] takes away one of the bulwarks that every society must have against expenditure out of control. There must be discipline in the allocation of resources or you will have anarchistic chaos and inefficiency. And one of the functions of old fashioned religion was to scare people by sometimes what might be regarded as myths into behaving in a way that the long-run civilized life requires. We have taken away a belief in the intrinsic necessity of balancing the budget if not in every year, [then] in every short period of time. If Prime Minister Gladstone came back to life he would say “uh, oh what you have done” and James Buchanan argues in those terms. I have to say that I see merit in that view.”
In other words, the need to balance the budget over some time period determined by the movements of celestial objects, or over the course of a business cycle is a myth, an old-fashioned religion. But that superstition is seen as necessary because if everyone realizes that government is not actually constrained by the necessity of balanced budgets, then it might spend “out of control”, taking too large a percent of the nation’s resources. Samuelson sees merit in that view.

It is difficult not to agree with him. But what if the religious belief in budget balance makes it impossible to spend on the necessary scale to achieve the public purpose? In the same film James Buchanan argues that the budget ought to be balanced except in wartime—and while he does not explicitly endorse Samuelson’s argument that this is nothing but a useful myth, he does imply that there is no financial/economic/solvency reason for balancing the budget. Rather, it is to keep government in check, to ensure it does not grow and absorb too many of the nation’s resources. Ironically, Buchanan’s willingness to deficit-spend in wartime seems to imply that the US ought to almost always run deficits since we are almost always at war with someone. Hence, he seems to advocate nearly permanent budget deficits—no doubt unintentionally. Many might question that position on the argument that if it is OK to run deficits to destroy one’s enemy then it surely makes sense to run deficits to build a strong nation. Indeed, older readers of this blog will remember that our nation got interstate hiways on the argument that this is good for national defense, and that many of us got through college on “national defense student loans”. But that is not really the point I am driving at in this blog.

What I am arguing is that discussion of money and budget deficits has simply reached a state in which it has become impossible to address real world problems. I have always thought that honesty is the best policy—even if the truth is scary—but I am in the education business, not in politics or marketing or religion. But even if we concede Samuelson’s point, that old-time deficit religion is not now useful—even if it might have served a useful purpose in the past.

Yes, government must be constrained. That is what elections and budgeting and accounting and accountability are all about. We need more democracy, more understanding, and more transparency. Politicians need to listen to Main Street—not just Wall Street—before deciding where and how much to spend. They need to be controlled by a budgeting process—whose purpose is not to balance the budget, ensuring tax revenues match spending outgo, but rather to give us some idea of the size of the programs (hence, what percent of our nation’s resources will be devoted to their projects) and, equally important, to hold our leaders and project managers accountable. When managers run over budget, it does not threaten our government’s solvency but it should threaten its credibility. Fraud and over-reach are always a threat where government’s spending is unconstrained. And, yes, too much government spending generates competition over resources, bottle-necks, and even excessive aggregate demand, all of which can generate inflation.
We don’t need myths. We need more democracy, more understanding, and more transparency. We do need to constrain our leaders—but not through dysfunctional superstitions.

Greece CAN Go it Alone

By Marshall Auerback and Warren Mosler

Greece can successfully issue and place new debt at low interest rates. The trick is to insert a provision stating that in the event of default, the bearer on demand can use those defaulted securities to pay Greek government taxes. This makes it immediately obvious to investors that those new securities are ‘money good’ and will ultimately redeem for face value for as long as the Greek government levies and enforces taxes. This would not only allow Greece to fund itself at low interest rates, but it would also serve as an example for the rest of the euro zone, and thereby ease the funding pressures on the entire region.  

We recognize, of course, that this proposal would also introduce a ‘moral hazard’ issue. This newly found funding freedom, if abused, could be highly inflationary and further weaken the euro.  In fact, the reason the ECB is prohibited from buying national government debt is to allow ‘market discipline’ to limit member nation fiscal expansion by the threat of default. When that threat is removed, bad behavior is rewarded, as the country that deficit spends the most wins, in an accelerating and inflationary race to the bottom.

It is comparable to a situation where a nation like the US, for example, did not have national insurance regulation.  In this kind of circumstance, the individual states got into a race to the bottom, where the state with the laxest standards stood to attract the most insurance companies, forcing each State to either lower standards or see its tax base flee. And it tends to end badly with AIG style collapses.

Additionally, the ECB or the Economic Council of Finance Ministers (ECOFIN) effectively loses the means to enforce their austerity demands and keep them from being reversed once it’s known they’ve taken the position that it’s too risky to let any one nation fail.   

What Europe’s policy makers would like to do is find a way to isolate Greece and mitigate the contagion effect, while maintaining the market discipline that comes from the member nations being the credit sensitive entities they are today; hence, the mooted “shock and awe” proposals now being leaked, which did engender an 8% jump in the Greek stock market on Thursday.

But these proposals don’t really get to the nub of the problem. Any major package weakens the others who have to fund it in the market place, because the other member nations are also revenue dependent, credit sensitive entities. Much like the US States, they do not control central bank operations, and must have good funds in their accounts or their checks will bounce.

The euro zone nations are all still in a bind, and their mandated austerity measures mean they don’t keep up with a world recovery. And Greek financial restructuring that reduces outstanding debt reduces outstanding euro financial assets, strengthening the euro, and further weakening output and employment, while at the same time the legitimization of restructuring risk weakens the credit worthiness of all the member nations. 

It does not appear that the markets have fully discounted the ramifications of a Greek default.  If you use a Chapter 11 bankruptcy analogy, large parts of the country would be shut down and the “company” (i.e. Greece Inc) could spend only its tax revenues.  But the implied spending cuts represent a further substantial cut in aggregate demand and decreased revenues, in a most un-virtuous spiral that ends only with an increase in exports or privation driven revolt. 

The ability of Greece to use the funds from the rescue package as a means to extinguish Greek state liabilities would improve their financial ratios and stave off financial collapse, at least on a short term basis, with the side effect of a downward spiral in output and employment, while the sovereign risk concerns are concurrently transmitted to Spain, Portugal, Ireland, Italy, and beyond. Those sovereign difficulties also morph into a full-scale private banking crisis which can quickly extend to bank runs at the branch level.

Our suggestion will rescue Greece and the entire euro zone from the dangers of national government insolvencies, and turn the euro zone policy maker’s attention 180 degrees, back to their traditional role of containing the potential moral hazard issue of excessive deficit spending by the national governments through the Stability and Growth Pact. If the member states ultimately decide that the Stability and Growth Pact ratios need to be changed, that’s their decision. But the SGP represents the euro zone’s “national budget”, precisely designed to prevent the hyperinflationary outcome that the “race to the bottom” could potentially create. At the very least, our proposal will mitigate the deflationary impact of markets disciplining credit sensitive national governments and halting the potential spread of global financial contagion, without being inflationary. 

Do Not Confuse Solvency with Sustainability

By Pavlina R. Tcherneva

The Peter G. Peterson foundation held its ‘fiscal summit’ yesterday to address the looming government debt and deficit ‘problem’. According to a TRNN journalist who attended the summit, the conference began with “we know what the problem is, the federal government debt and deficits have become unsustainably large, we need to make hard choices, cut government spending, including on Social Security and Medicare…”
Any sensible person should be scandalized by this purely ideological stance. When it is necessary to go into war, the deficit is never a problem; when we bail out the financial sector, deficit spending is a ‘requirement’, when we build prisons and pack more people in our jails, oh well… But when it comes to paying for the retired and the sick, surely the government can’t afford to do that! Grandma better pull herself by her bootstraps and take responsibility for her retirement or healthcare needs. But even if we get past the propaganda, Peterson and all the deficit hawks are making one fundamental mistake: they are confusing sustainability with solvency.

“A Fed with broad regulatory authority”: Is it a good idea?

According to James Bullard (President and CEO, Federal Reserve Bank of St. Louis), Sandra Pianalto, (President and CEO, Federal Reserve Bank of Cleveland), and  Richard W. Fisher (President and CEO, Federal Reserve Bank of Dallas) the answer is yes.  Recently, they delivered their speeches at the 19th Annual Hyman P. Minsky Conference on the State of the U.S. and World Economies After the Crisis: Planning a New Financial Structure, held at the Ford Fundation on April 14-16, 2010, NY.
The following statements can be found on the conference’s website:

A Fed with appropriately broad regulatory authority provides the nation with the best chance of avoiding a future crisis…Bottom line: Due to its narrow regulatory authority, the Fed had a severely limited view of the financial landscape as the crisis began.” James Bullard, President and CEO, Federal Reserve Bank of St. Louis emphasis in the original

“the Federal Reserve should continue to supervise banking organizations of all sizes and should take on an expanded role in supervising systemically important financial institutions” Sandra Pianalto, President and CEO, Federal Reserve Bank of Cleveland 2010 see here)

“Current proposals being discussed in Congress would shrink the Fed’s regulatory and supervisory responsibilities…leaving us either with no regulatory oversight or solely with regulatory oversight of LFIs. In my view, these proposals are misguided.” (Richard W. Fisher, President and CEO, Federal Reserve Bank of Dallas 2010:4 see here)

On the other hand, Prof. William K. Black, on his testimony on Lehman Bankruptcy (see here and here), opposed to the view that the Fed did not have the appropriate regulatory authority:

“The Fed’s defense of its disgraceful refusal to protect the public is meritless. It argues that it was not there in its regulatory capacity and that it sent only a few staffers that laced the capacity or the leverage to accomplish any supervisory goals. This is either a deliberate obfuscation or a confession of a core failure. As Senior Vice President and General Counsel of the FHLBSF I was always a regulator – even when I was providing involved in credit-side activities. As a lender, the FHLBSF often learned material information about the institutions we regulated because we engaged in effective underwriting of asset quality. My predecessor famously used the leverage of the FHLBSF as lender of last resort for the largest S&L in America, which was in a liquidity crisis, to force out the fraudulent CEO controlling the institution and to enter into a broad array of steps that greatly reduced the institution’s risk exposure and frauds. At its peak, we had roughly 50 FHLBSF credit personnel resident at the S&L. The fact that the FRBNY, which had far more resources than the FHLBSF, chose to send only a token crew to be on-site at a potential global catastrophe is a demonstration of failure, not a valid excuse for their failure to act to protect the public. The FRBNY has vastly greater leverage than the FHLBSF ever had and in the context of the Lehman crisis it had the leverage to force any change it believed was necessary, including an immediate conversion of Lehman to a bank holding company and a commercial bank.

The Fed has inherent problems even in safety & soundness regulation due to its structure. First, the regional FRBs have boards of directors dominated by the industry. Congress already made the policy decision, in removing all regulatory functions from the FHLBs in the 1989 FIRREA legislation, that this is an unacceptable conflict of interest.

Second, supervision is, at best, a tertiary activity at the Fed and regional banks. Monetary policy gets all the emphasis, the credit windows come second, and economic research and safety & soundness regulation vie for a distant third place. (Consumer regulation is a bastard step child at the Fed and most agencies.)

Third, the Fed is far too close to the systemically dangerous institutions. The SDIs are in an ideal position to exploit opportunities for regulatory “capture.”

Fourth, the Fed is dominated by neo-classical economists that have no theory of, experience with, or interest in the complex financial frauds that are the dominant cause of our recurring, intensifying financial crises. Bernanke appointed an economist, Patrick Parkinson, with no examination or supervision experience to head all Fed examination and supervision.

Fifth, the Fed is addicted to opaqueness and its senior ranks believe the bankers when they claim that the people must never be allowed to learn the truth about asset losses. One of the conflicts of interest that a banking regulator must never succumb to is the temptation to encourage or allow the regulated entity to lie about its financial condition for the purported purpose of preventing a run on the bank. Geithner, unfortunately, embraced that temptation and stated it openly to the Bankruptcy Examiner. It is very easy, psychologically, to believe that you are letting a bank lie to the public for a noble reason – protecting the public. The bankers always tell the regulators that the world will end if the banks tell the truth – but that is a lie. Regulators’ greatest asset is their integrity. I was one of the four FHLBSF regulators that met with the “Keating Five.” To this day, I have no idea what political affiliations, if any, my three colleagues hold. We simply insisted on honest disclosures and we always made a referral to our agency to alert the SEC (and the FBI) to any efforts we found to use accounting to deceive the investors or the regulators.”

Prof. William K. Black, has argued elsewhere that “The Fed refused to exercise that authority despite knowing of the fraud epidemic and potential for crisis”. He pointed out that:
“The Fed’s failures were legion, but five are worthy of particular note.
1. Greenspan believed that the Fed should not regulate v. fraud
2. Bernanke believed that the Fed should rely on self-regulation by “the market”
3. (Former) Federal Reserve Bank of New York President Geithner testified that he had never been a regulator (a true statement, but not one he’s supposed to admit)
4. Bernanke gave the key support to the Chamber of Commerce’s effort to gimmick bank accounting rules to cover up their massive losses — allowing them to report fictional profits and “earn” tens of billions of dollars of bonuses
5. Bernanke recently appointed Dr. Patrick Parkinson as the Fed’s top supervisor. He is an economist that has never examined or supervised. He is known for claiming that credit default swaps (CDS, a.k.a the financial derivatives that destroyed AIG) should be unregulated because fraud was impossible among sophisticated parties.
Each error arises from the intersection of ideology and bad economics.
The Fed’s regulatory failures pose severe risks today. Three of the key failed anti-regulators occupy some of the most important regulatory positions in the world. Each was a serial failure as regulator. Each has failed to take accountability for their failures. Last week, Dr. Bernanke asserted that bad regulation caused the crisis — yet he was one of the most senior bad regulators that failed to respond to the fraud epidemic and prevent the crisis. As Dr. Bernanke’s appointment of Dr. Parkinson as the Fed’s top supervisor demonstrates, the Fed’s senior leadership has failed, despite the Great Recession, to learn from the crisis and abandon their faith in the theories and policies that caused the crisis. Worst of all, the Fed is an imperial anti-regulatory seeking vastly greater regulatory scope at the expense of (modestly) more effective sister regulatory agencies. The Fed’s failed leadership is setting us up for repeated, more severe financial crises.” (see here)

A Little Help from Our Friends

By Stephanie Kelton

Next week, four New Economic Perspectives bloggers — Randy Wray, Marshall Auerback, Pavlina Tcherneva and I — will head to Washington, D.C. to participate in a day-long “teach-in” at George Washington University. The event will take place on April 28th, alongside (or in opposition to) the “Fiscal Summit” that is being sponsored by the Peter G. Peterson Foundation (also taking place in Washington, D.C. on the 28th). Click here to learn more about the teach-in.
If you live in the area, we hope you’ll join us for the event (which is free and open to the public). You can also help by spreading the word or by making a donation to help cover the very modest cost of our event. Click here to support us.

“The Fiscal Sustainability Teach-In Counter-conference will be the important event in Washington on April 28. Unlike the other meeting, this one will feature important work by honest scholars. It deserves at least equal attention, and very much more respect.” — Professor James K. Galbraith

We will be “tweeting” updates from the event on the 28th. Stay tuned for details ….

Prof. William K. Black Testimony on Lehman Bankruptcy

“Fed Chairman Ruml got it right in 1946”

Hat tip Warren Mosler’s blog (

On his recent piece “Taxes For Revenue Are Obsolete ” that appeared on the Huffington Post he notes:

April 15th has come and gone, but the issue of taxation remains the course de jour. I was recently forwarded an article entitled Taxes For Revenue Are Obsolete, written in 1946 by Beardsley Ruml, the former Chairman of the Federal Reserve Bank of New York and published in a periodical named American Affairs. While Ruml was writing about the merits of corporate taxes, it is his discussion about how the function of taxes changed after the nation exited the gold standard that make this a must read. As Ruml’s stated, with an “…inconvertible currency, a sovereign national government is finally free of money worries and need no longer levy taxes for the purpose of providing itself with revenue… It follows that our Federal Government has final freedom from the money market in meeting its financial requirements… All federal taxes must meet the test of public policy and practical effect. The public purpose which is served should never be obscured in a tax program under the mask of raising revenue.” He goes on to explain how, with Federal spending not revenue constrained, the first function of taxation is to regulate the value of the dollar, which we know as regulating inflation. The notion of the Federal government ‘running out of money’ and ‘dependence on foreign borrowing’ as well as ‘sustainability’ is categorically inapplicable. The operative CBO ‘scoring’ is the inflationary effect, rather than simply a revenue forecast. And while Social Security and Medicare may turn out to be inflationary, they are not ‘bankrupting the nation’ as most believe, including a Democratic Congress that cut Medicare spending with the recent health care bill and has all entitlements ‘on the table.’

See also here.

19th Annual Hyman P. Minsky Conference on the State of the U.S. and World Economies: After the Crisis: Planning a New Financial Structure

After many requests from media and academics and Wall Street practitioners, we are posting L.Randall Wray’s presentation at the 19th Annual Hyman P. Minsky Conference (Session 7. International Financial Fragility) held at the Ford Foundation.

To download the ppt file click here.

Troubles in the Eurozone: Is a Conflict with the U.S. Far Behind?

By Marshall Auerback

At its most basic, our economy can be divided up into 3 sectors: there is a private sector that includes both households and firms; there is a government sector that includes both the federal government as well as all levels of state and local governments; and there is a foreign sector that includes imports and exports. As my friend Randy Wray notes (.pdf): “At the aggregate level, the dollar spending of all three sectors combined must equal the income received by the three sectors combined. Aggregate spending equals aggregate income. But there is no reason why any one sector must spend an amount exactly equal to its income. One sector can run a surplus (spend less than its income) so long as another runs a deficit (spends more than its income). This applies to households, businesses, net saving nations vs. net “dis-saving” nations, and the government sector.”

How does this work in practice? If households attempt to net save by spending less than they are earning, and businesses attempt to net save (reinvesting less than their retained earnings), then nominal incomes and real output are likely to fall. Money incomes and economic activity will tend to contract until private savings preferences are reduced (with essential goods and services taking up a larger share of household income as incomes fall), or until depreciation leaves businesses and households inclined to invest once again in durable assets. Common sense suggests that a drop in private income flows while private debt loads are high is an invitation to debt defaults and widespread insolvencies – that is, unless creditors are generously willing to renegotiate existing debt contracts en masse. Which is why any particular nation in these circumstances must either run an external surplus on its current account, or experience a rising government deficit or some combination of the two.

Of course, given the prevailing levels of government deficit hysteria in the US right now, one can see the political appeal of focusing on export led growth, along Asian lines, since a sufficiently large trade surplus will facilitate the government’s ability to cut spending and run public sector surpluses. The problem of course comes from the fact that it is impossible for all governments (in all nations) to run public surpluses without impairing growth because not all nations can run external surpluses. There has to be another nation willing to become a net importer. For nations running external deficits (the majority), public surpluses have to be associated with private domestic deficits, which is inherently constraining in a way that government deficits are not.
Historically the US private sector has spent less than its income—that is, it has run a surplus, whereas the government has run deficits. From a straight national accounts identity, then, the paradox of private sector thrift is that it is facilitated by public sector profligacy. Or another way of putting it: every time the government runs a deficit and issues a bond, adding to the financial wealth of the private sector.
Of course, the opposite would also be true. Assume we have a balanced foreign sector and that the government runs a surplus—meaning its tax revenues are greater than government spending. By identity this means the private sector is spending more than its income, in other words, it is deficit spending. The deficit spending means it is going into debt, and at the aggregate level it is reducing its net financial wealth. By extension, a country which runs a large trade deficit (as the US has persistently done for the past quarter century), needs an even greater degree of government fiscal expenditure to offset the potential “deficit” spending by the private sector.
Clearly, this financial balances approach is not well understood by most voters. Indeed, a recent poll by Douglas Schoen and Patrick Caddell suggests that the swing voters, who are key to the fate of the Democratic Party, care most about three things: reigniting the economy, reducing the deficit and creating jobs. But the latter two goals are generally incompatible, especially during major recessions. In times of high unemployment, government deficits are required to underwrite growth, given that the private sector shift to non-government surpluses has left a huge spending gap and firms responded to the failing sales by cutting back production. Employment falls and unemployment rises. Then investment growth declines because the pessimism spreads. Before too long you have a recession. Without any discretionary change in fiscal policy (now referred to in the public media as “stimulus packages”) the government balance will head towards and typically into deficit, unless the US miraculously becomes an export powerhouse along emerging Asia lines, and runs persistent current account surpluses, to a degree which allows the governments to run budget surpluses.

This is not going to happen, particularly when the largest current account surplus nations, notably Germany, cling to a mercantilist export led growth model, an inevitable consequence of that country’s aversion to increased government deficit spending. The German government’s reticence to counter any kind of shift in regard to its current account surplus is particularly significant in light of the ongoing and intensifying strains developing in the EMU nations (see here). Following the inexorable logic of the financial balances approach sketched above, then, I am now more convinced than ever that there is a “Lehman” style event waiting to happen in the euro zone. Last week’s Greek “rescue” is, as we suggested earlier, Europe’s “Bear Stearns event”. The Lehman moment has yet to come. One possible outcome of this could well be significantly larger budget deficits in the US and a substantial increase in America’s external deficit. Let me elaborate below.

In the euro zone, I now see one of two possible outcomes. Scenario 1: the problem of Greece is not contained, and the contagion effect extends to the other “PIIGS” countries, leading to a cascade of defaults and corresponding devaluations as countries exit the EMU. Interestingly enough, the country which could well be affected most adversely in this situation is France, as the country’s industrial base competes largely against countries like Italy and the corresponding competitive devaluation of the Italian currency in the event of a euro zone break-up could well destroy the French economy (by contrast, as a capital goods exporter with few euro zone competitors, Germany’s industrial base will be less adversely affected in our view).
In Scenario 2 (more likely in my opinion) we get some greater fears about other PIIGS nations (discussion is now turning to Spain, Portugal and Ireland). The EMU might well hold together but the corresponding fear of contagion might well provoke capital flight and drive the euro down to parity (or lower) with the dollar. Of course, the euro’s weakness creates other problems: when the euro was strengthening last year due to portfolio shifts out of the dollar, many of those buyers of euro bought euro denominated national government paper (including Greece). The resultant portfolio shifts helped fund the national EMU governments at lower rates during that period. That portfolio shifting has largely come to an end, making national government funding within the euro zone more problematic, as the Greek situation now illustrates.

The weakening euro and rising oil prices raises the risk of ‘inflation’ flooding in through the import and export channels. With a weak economy and national government credit worthiness particularly sensitive to rising interest rates, the ECB may find itself in a bind, as it will tend to favor rate hikes as prices firm, yet recognize rate hikes could cause a financial collapse. And should a government like Greece be allowed to default the next realization could be that Greek depositors will take losses, and, therefore, the entire euro deposit insurance lose credibility, causing depositors to take their funds elsewhere.

It’s all getting very ugly as it all threatens the value of the euro. The only scenario that theoretically helps the value of the euro is a national government default, which does eliminate the euro denominated financial assets of that nation, but of course can trigger a euro wide deflationary debt collapse. The ‘support’ scenarios all weaken the euro as they support the expansion of euro denominated financial assets, to the point of triggering the inflationary ‘race to the bottom’ of accelerating debt expansion.

So timing is very problematic. A rapid decline of the euro would facilitate a competitive advantage in the euro zone’s external sector, but it could also set alarm bells off at the ECB if such a rapid devaluation creates incipient inflationary strains within the euro zone.

What about the US? In the latter scenario, we can envisage a situation in which the combination of panic and corresponding flight to safety to the dollar and US Treasuries, concomitant with the increased accumulation of US financial assets (which arises as the inevitable accounting correlative of increased Euro zone exports) means that America’s external deficits inexorably increase. There will almost certainly be increased protectionist strains, a possible backlash against both Europe and Asia, especially if the deficit hawks begin sounding the alarm on the inexorable rise of the US government deficit (which will almost certainly rise in the scenario we have sketched out).

Assuming that the US does not wish to sustain further job losses, the budget deficit will inevitably deteriorate further, either “virtuously” (via proactive government spending which promotes a full employment policy), or in a bad way , whereby a contracting economy and rising unemployment, produce larger deficits via the automatic stabilisers moving to shore up demand as the economy falters.

How big can these deficits go? Easily to around 10-12% of GDP or higher (versus the current 8% of GDP) should a euro devaluation be of a sufficient magnitude to induce a sharp deterioration of America’s trade deficit.

What will be the response of the Obama Administration? America can sustain economic growth with a private domestic surplus and government surplus if the external surplus is large enough. So a growth strategy can still be consistent with a public surplus, but this becomes virtually impossible if the euro zone’s problems continue, as we suspect that they will.

President Obama, however, has long decried our “out of control” government spending. He clearly gets this nonsense from the manic deficit terrorists who do not understand these accounting relationships that we’ve sketched out. As a result he continues to advocate that the government leads the charge by introducing austerity packages – just when the state of private demand is still stagnant or fragile. By perpetuating these myths, then, the President himself becomes part of the problem. He should be using his position of influence, and his considerable powers of oratory, to change public perceptions and explain why these deficits are not only necessary, but highly desirable in terms of sustaining a full employment economy.
Governments that issue debt in their own currency and do not promise to convert their currency into anything else can always “afford” to run deficits. Indeed, in this context government spending financially helps the private sector by injecting cash flows, providing liquid assets and raising the net worth of some or all private economic agents. In contrast to today’s budget deficit “Chicken Littles”, we maintain that speaking of government budget deficits as far as the eye can see is ludicrous for the simple reason that as the economy recovers, tax revenue rises, the deficit automatically reduces. That’s the whole reason for engaging in deficit spending in the first place. Any projections that show the deficit continuing to climb without limit is misguided–the Pete Peterson projections, for example, will never come to pass. As we near and exceed full employment, inflation will pick-up, which reduces transfer payments and increases tax revenues, automatically pushing the budget toward surpluses. In the 220 year experience of the United States there have only been a few years when we’ve not had deficits and each time the surpluses were immediately followed by a depression or a recession. So the historical evidence here, indicates that we can run nearly permanent deficits and that when we do, it’s better for the economy. The challenge for our side of the debate is to expose these voluntary constraints for what they are and explain why the US is not a Weimar Germany waiting to happen.

William K. Black on the Charges Filled by the SEC against Goldman Sachs