MMT AND ALTERNATIVE EXCHANGE RATE REGIMES: RESPONSES TO MMP BLOG #11

Thanks for comments. Let me stick to the topic: MMT and alternative exchange rate regimes. At one end we have fixed exchange rates—with the currency pegged to gold or to a foreign currency. At the other we have floating rates. No one seemed to question my (obvious) claim that floating rates provide more domestic policy space, in general. Other than that, what are the advantages and disadvantages?

Well the belief is that fixed rates provide more certainty—you know what the dollar will be worth relative to the pound. That makes it easier to write (nonhedged) contracts. However, the uncertainty is shifted to the ability of government to maintain the peg. That is especially problematic in the post-Bretton Woods era in which countries that peg are essentially “going it alone”.

Many also (paradoxically) believe that fixed exchange rates reduce the chance of speculative attacks. That is counterfactual as well as counterintuitive. Remember the pound? George Soros brought it down and supposedly made a billion dollars in a day betting the UK could not defend the fix. Would you rather short a currency that is fixed, or one that floats minute by minute? In which of those two cases could you make a billion a day? Would you rather try to hit a moving target, or one that is stationary?

Now it is true that daily fluctuation of pegged rates might be nil for long periods of time, in contrast to floating rates that might vary all the time. But when pegged rates do move, they can generate currency crises because when the peg is broken, that is equivalent to a default. If I promise to you to convert my dollar IOUs to a foreign currency (or gold) at a fixed rate, and then I tell you that I’ll only give you half the promised amount of foreign currency, I have just defaulted. That causes havoc in markets.

So, yes, fixed rates can in some cases provide greater certainty—until they are abandoned. To ensure the fixed rate will be maintained, the country will need access to substantial foreign currency reserves. A country like China or Taiwan today can provide a believable promise of conversion at fixed exchange rates. Most nations cannot.

How do these countries obtain the foreign exchange reserves? For the most part, they run current account surpluses (selling goods and services abroad, or earning factor incomes in foreign currency) or they borrow them. How do those reserves end up at government? Because the exporters who earn—let us say—US Dollars need to cover their own domestic expenses in the domestic currency. The central bank offers exchange services to its banks—they need domestic currency reserves. The central bank creates domestic currency reserves and buys the foreign currency reserves. The central bank then typically exchanges Dollar reserves at the Fed for Treasuries. It wants to earn interest. That is why there is a very close link between US current account deficits and foreign accumulation of Treasuries. It is not that foreigners are “lending” to the US government so that it can deficit spend. Rather, the US current account allows foreigners to earn Dollars, and they want to earn interest on safe Treasuries.

What about the IMF articles mentioned that require a country to accept its own currency in exchange for Special Drawing Rights or the seller’s own currency? Does that mean that all signatories have abandoned their floating rate currency? Have they lost domestic policy space? Are they then open to speculative attacks, as if they were on a fixed exchange rate system?

First it is important to note that this is a self-imposed constraint. Governments have adopted a wide variety of these. The US government for example has a self-imposed debt limit. We just went through a huge debate about raising it. Clearly, markets did not force that on the US. Similarly, the IMF Articles of Agreement were adopted—not forced by any kind of market forces or logic.

And in practice, they have no material impact on domestic policy space. Let us say the Chinese decide to submit Dollars to the US to demand payment in RMB. Has the US pegged to RMB? No. It will provide RMB at the current exchange rate. Will this pose an affordability problem? No. Assume the US runs out of RMB. It then goes to foreign exchange markets and uses Dollars to buy RMB at the current exchange rate. Will it run out of Dollars? No. It creates as many Dollars as necessary to buy as many RMBs as it needs.  It can meet all demands as they come due.

Now, the great fear is that this will cause the Dollar to depreciate (the RMB to appreciate). So here’s the fear of our deficit hysterians: China might submit $2 trillion in US currency (reserves and Treasuries), demanding RMB, causing the Dollar to collapse. Really? That is what China wants? What happens to Chinese sales to the US? What happens to the value of Dollar assets held by China? Do you really believe China would do this?

China wants to sell some of its output to the US; if the Dollar collapses, it says “bye bye” to sales. It already holds substantial Dollar reserves. If the Dollar collapses, it is stuck holding an asset that falls in value. Now, in truth, no central bank needs to worry about that. So what if it holds worthless assets. (Just ask the Fed—it bought up toxic waste assets that really have no value at all, in order to save the banksters on Wall Street. That is a topic for another day.) But the Chinese do seem to worry about that—indeed, that is why they keep telling the US to maintain the dollar’s value, or else! (Or else what? Well, nothing. It is a lot like holding a gun to your head and demanding ransom before you blow your brains out. Again, a topic for another time.) The point is that the hyperventilator’s scenario is just not plausible. Current external holders of the Dollar have no interest in seeing it collapse.

Further, so far as I can tell, the Articles are designed to allow countries facing their own payment problems to submit their foreign currency holdings to obtain SDRs (or to drain their own currency out of foreign exchange markets—to stabilize the value of their own currency). The purpose of the Articles is NOT to support speculative attacks—but to protect countries from speculative attacks. If China ever did attempt to crash the dollar in the manner imagined by some hysterians, I suspect the Articles would be set aside until the attack ended. In other words, the Articles were adopted to help stabilize international financial markets, not to enhance destabilizing forces.

If you think about the Bretton Woods standard, the Articles imposed discipline. The Dollar was pegged to gold, and all other nations pegged to the Dollar. The Articles forced each nation to carefully manage foreign currency reserves (meaning Dollars) to ensure they could convert on a fixed exchange rate to Dollars. If too much of a country’s domestic currency was held externally, a fear would grow that it could not maintain the peg to the Dollar; foreign holders could present the currency and demand Dollars. With the Dollar and most other important currencies floating, the Articles do not impose discipline on them. But foreign holders can use the Articles to stabilize their own currencies.

There was a question about Russia’s default that Scott Fullwiler answered (directing readers to Warren Mosler’s piece). But then the question was “why” did Russia choose to default. As best I can determine (and I am no expert although I happened to be in the room when Warren was on the phone during the crisis) it was a political decision. We cannot completely ignore politics. Yes, Congress could have decided not to raise the debt limit. We appeared to be quite close. There was no good economic reason to do it—but politics can lead to some crazy results.

We will deal later with the question asking why money MUST be an IOU.

10 Responses to MMT AND ALTERNATIVE EXCHANGE RATE REGIMES: RESPONSES TO MMP BLOG #11

  1. Thank you for the information on how a nation accumulates those foreign exchange reserves! If a nations central bank could use dollars to buy goods from us (thus returning dollars in exchange for a net benefit), or buy treasuries (returning dollars in exchange for a few more dollars in some time), could they also exchange dollars for another currency? What effect does buying U.S. treasuries and converting dollar reserves to another currency have on the value of the dollar?

  2. Ankur: a foreign CB can buy US Treasuries, or foreign currency and treasuries issued by other nations. Of course, it needs to sell the US Treasuries (find buyers) to do that. Some worry about effects on value of dollar if everyone tried to do this at the same time. It is a risk on the same order of magnitude as alien abduction. Of course, a lot of people do worry about that, too.Ramanan: Please take a look at your comments, all 5 of them. Nothing related to MMT here; longer than my original post. You've got one horse to ride, and you ride it to death. Give it a rest. OK, we know you accept the Thirlwall balance of payments constrained growth model. It applies to the gold standard. Yes, the Dollar, the Pound, the Yen are "convertible" in the sense that you can exchange them at the current exchange rate. There are kiosks in most airports. You are surely bright enough to recognize that when we say "noncovertible" we mean there is no government promise to convert at a fixed exchange rate to gold or foreign currencies. The Articles do not change this in any way.

  3. Randy: Yes, ride it to death. But I am done. I was waiting to pick on this and if you see my original comment, I quoted the right thing. Yes, there are qualifiers sometimes, but I believe the percentage is way too less. Yes, the balance of payments constraint applies to Gold Standard … but unfortunately it applies to any regime. I understand you can come up with an argument, that it is central bankers and policy makers who have it in their heads, and behave that way etc and there is no need for them to behave that way etc., but that arguments along those lines may start sounding similar to Kaldor versus Friedman. Only the United States has managed to escape the balance of payments constraint but unfortunately it is bleeding now unable to beat it. I am done on this and no longer will ride it to death but can't see my comments – can you ask your admin to restore my 5 comments ? I refer to my own comments sometimes! Thanks.

  4. Ramanan: I think the aliens you worry about so much abducted your comments. Look for them on Mars.More seriously, can you see how silly that sounds? So you were waiting for the opportunity to beat the dead Thirlwall horse so you could make 7 posts on the MMP about the IMF articles, and now you want your posts so that you can refer to them elsewhere?Suggestion: why don't you create a blog site, title it "Ramanan rides Thirlwall" or "…Kaldor" (as you prefer), present your whole thesis, and then cite that? I know you post all over the internet wherever you can on this topic. Why not just go whole-hog and create the site and push the ideas? Go ahead and try to explain why a theory formulated for the gold standard actually still applies post-Bretton Woods. See if anyone is interested? I have several times outlined the purpose of MMP. Hint: it is NOT to push dead ideas like the Ramanan/Thirlwall/Kaldor gold standard balance of payments constrained growth. You do not conform at all to the stated purpose of the blog.You have no relevant questions or comments. And when I respond, you unleash a flurry of comments, apparently for the purposes of future flurries of comments. I mean no disrespect. I am just trying to lay out the purpose of this blog and to discover why you refuse to conform. OK you reject and dismiss MMT. Fine. Move on. I am quite happy to field your comments and questions related to MMT; anything that helps to clarify and refine the MMP would be appropriate. If you have anything at all to offer, I will respond. I did respond to your comment about the Articles–something you have posted on an uncounted number of blogs. OK? Can we give it a rest?If you want to argue, can you take it somewhere else? Even the front page of NEP is fine. That is not the purpose of the MMP. This is a Primer to teach MMT. You are not interested in MMT. You are interested in pushing Ramanan, and having posts you can cite elsewhere.Is there any way I can make this more clear to you? This portion of the NEP is NOT for arguing about the soundness of MMT. It is NOT for pushing Thirlwall or Ramanan down the throats of others. Those who want that down their throats can go to your blog.To be clear: serious questions are welcomed. You've made it clear that your purpose had nothing to do with that. You wanted to be able to post your comments so that you could cite them elsewhere. This is not the appropriate venue for that. Thanks in advance for your consideration.

  5. Ramanan: I think the aliens you fear abducted your comments; look for them on Mars!Seriously, can you see how silly this looks? You waited for an opportunity to ride a dead horse so you could post 7 comments on MMP about a gold standard theory of balance of payments constrained growth? And all so that you'd have some more posts on this topic that you can then cite when you go to other blogs to ride the dead horse?Why don't you start a blog devoted to the old dead Kaldor/Thirlwall horse, and ride it there? Wouldn't that make much more sense?Look, I am happy to answer real questions or comments about MMP. I did answer the questions about the IMF Articles. OK you are not happy with that, and you reject MMT. Fine, this is not the blog for you. To be clear, this part of the NEP site is only to teach and clarify the MMT. That is why it is called a Primer. It is not to discuss gold standard theory. You can do that on the main page of NEP.Thanks.

  6. Randy,"Seriously, can you see how silly this looks? You waited for an opportunity to ride a dead horse so you could post 7 comments on MMP about a gold standard theory of balance of payments constrained growth? "No, not that way but not going to defend what I said. "Gold-standard" – looks like an escape hatch for the MMT people. Anyways thanks for engaging.

  7. "at? I know you post all over the internet wherever you can on this topic. Why not just go whole-hog and create the site and push the ideas? Go ahead and try to explain why a theory formulated for the gold standard actually still applies post-Bretton Woods. See if anyone is interested? "To be fair, I have this huge set of people adding me on facebook and posting continuously "You are wrong, MMT is right". Maybe the first step is to hide their posts!

  8. Sorry for the double post; I wrote one last night and it disappeared when I hit post–I think the aliens got it, then for some reason they returned it this afternoon. Meanwhile, I had rewritten the shorter version.But Ramanan: can you understand the "rules" here? This page is the Primer. The front page is for debate. If you have a legitimate question or comment about a blog on MMP, post it and I will try to answer it. If you will look back to my response #2 I wrote this:We hope that those who engage with us on this Primer are here because they want to learn and to help improve MMT through the creation of this Primer. We will not argue with those who want to reject it. Yes, there are alternative explanations of the operation of the monetary system. No one has to accept ours…So to conclude: This is a joint project. We are trying to create a primer of MMT. The project will take a year. You are a contributor, not a critic.Let me repeat the goal here: You are a contributor, not a critic.Could you possibly abide by that? So far as your Facebook, establish whatever rules you want. I promise that if I ever come to your Facebook, I will play by your rules.

  9. Okay the rules here. Sorry. But already have a blog – don't advertize it much as its still a few posts with no firm commitment but here it is http://www.concertedaction.com/

  10. "So here’s the fear of our deficit hysterians: China might submit $2 trillion in US currency (reserves and Treasuries), demanding RMB, causing the Dollar to collapse. Really? That is what China wants? What happens to Chinese sales to the US? What happens to the value of Dollar assets held by China? Do you really believe China would do this?"Something like this or similar? Eventually, yes. IMO, they are going to escape their "dollar trap" and decouple some day."We will deal later with the question asking why money MUST be an IOU."I want to know if there can be more than one definition of IOU. For example, is 1 to 1 swapping and going into debt different?Lastly, is there any reason I have to press the "Post Comment" button three times for a post to appear?