Response to MMP Blog #24: Foreign Holdings of Government Blogs

Thanks for comments. I’ll return to posting the questionsand my responses this week.
Q1: What about the Chinese or others buying US assets withthe dollars they have credited to their accounts.  They could have controlof US corporations which wouldn’t sit well with the US electorate.
A: I recall the exact same “yellow peril” arguments in the1980s when the Japanese were “buying up” Hawaii and NYC. Look, once they buy USassets they are subject to US laws. If we don’t like what they are doing with“their” property, we change the laws. In truth, is it worse to be subject tothe whims of a convicted criminal like Michael Milken engaged in LBOs thatenable him to downsize workers and strip off assets; or to a Japanese orChinese firm that has a long-term interest in producing autos in Georgia? Iguess it is a toss-up. In any case, most of the Chinese “dollars” are safelylocked up at the Fed, either in the form of reserves or US Treasuries. They getno obvious advantage from that ownership except whatever advantages TreasurySecretary Geithner wants to give to them.
Q2: What do you make of the idea that a weaker dollar would be good for oureconomy because it’d make it less attractive to export American jobs andpossibly bring some back? Would the positive effects of this offset thenegative effects of more expensive oil and imports?
A: Estimates of trade benefits of dollar depreciation arealmost certainly overstated. First, many of our trading partners “peg” to thedollar—depreciation has no effect at all on them. Second, those that don’t peg arewilling to take lower profits (hold dollar prices steady) to keep market share(this has been the Japanese strategy). Third, exports are a cost, imports abenefit so trying to maximize a trade surplus is a net cost maximizingstrategy; ergo: just plain dumb. Fourth, forget those old, 19thcentury factory jobs. They ain’t coming back, and good riddance. Today low wageworkers in developing nations will take them; tomorrow they’ll all be done byrobots who don’t mind hard work for zip wages. Alternative: create good payingjobs in good working conditions right here in the good ol’ US of A.
Q3: When foreign central banks purchase U.S. dollars, howdoes the accounting go from their perspective? Do they mark up U.S. dollars onthe asset side of their balance sheets and issued money on the liability side?Does this lead to increase of reserves in the domestic banking system, and theyhave to issue equivalent amount of bonds to accomodate this? So export ledgrowth, with undervalued exchange rate would still lead to increase in publicdebt even when government’s budget was balanced? And if foreign central bankshold foreign money on the asset side of their balance sheets and domesticcurrency on their liability, aren’t they exposed to huge losses if exchangerates change?
A: Not sure I got all of this, but let’s give it a go.Typical case: a country (say, China) exports goods to the US. Its exportersearn dollars but need RMB (to pay workers, buy raw materials, service debt).Their bank credits their deposit account with RMB, central bank of Chinacredits the bank’s reserves in RMB. So the dollar reserves end up at Bank ofChina (asset of Bank of China, liability of Fed). Bank of China says “hey,these suckers earn zero interest; I want Treasuries” so Fed debits theirreserves and credits Bank of China with Treasuries. Impact in the US: some USbank’s reserves are debited, Bank of China’s reserves credited. No change oftotal reserves until Bank of China buys Treasuries. At that point the reservesdisappear, Fed’s liability to China reduced, Treasury’s liability to Chinaincreased. No necessary impact on the dollar/RMB exchange rate since theexports sold and imports bought were voluntary, and China only exported becauseshe wanted dollars (reserves, then Treasuries). The next question always is:but what if China decides to run out of the dollar and dumps Treasuries? Ok, ifthat happened there could be depreciation pressure on the dollar; in which caseChina loses since its dollar assets decline in value relative to RMB.Fortunately, China is not as dumb as those posing the scenario. It will not runout of dollars in part because it does not want dollar depreciation.
Q4: This discussion gets to the heart of another question Ihave regarding the MMT proposition that tax liability is the main reason usersvalue a fiat currency. As there are considerably more dollars held abroad as ahedge against currency runs and also as banking reserves to underpin intltrade, it would seem that foreigners value the dollar and yet have no taxliability to the US government. How does this square with the MMT claim? Thisalso brings to mind another nagging suspicion that MMT focuses too much onnominal values and not on the real value of the supply of goods and servicesthat underpin the currency. My guess is that Chinese sovereign funds will seekdiversification out of dollar reserves by exchanging them fordollar-denominated real assets.  Barron’shad an article this week that suggests the Chinese govt. will also promote intltrading in yuan to compete with the dollar.  I could see how exchangemarkets with competing currency bloc issuers could provide the constraints onpolicy abuse of fiat currency values – a collapsing exchange rate is a highlyvisible market indicator.
A: Ok: 1. At the extreme, if we impose a $2 trillion taxonly on Bill Gates, you can be sure that others will take dollars because poorBill will work hard for us to pay his tax in dollars. This is a red herring. Wedo not need to tax all 6 billion people in the world to ensure a global demandfor dollars. Tax about 300 million relatively wealthy Americans and you can besure dollars will be demanded outside the US. Because Americans want them topay taxes. Ever hear of the “margin”? Here is one place it works. Tax on themargin and you drive a currency. 2. MMT focuses too much on nominal? Hey, MMTis “modern money theory”. Money. So yes, it is focusing on money. Nominal. Wecould focus instead on the aesthetic value of nose jobs. Then we would call itmodern nose jobs theory: MNJT. In any case, like it or not, we live in amonetary economy. Monetary production economy. Capitalist economy. Choose yourterms. Money matters. 3. Barron’s? Give me a break. That is your source ofanalysis? Read more MMP, less Barron’s. More seriously: China will become thebiggest economy in the world within 5 years. Its currency will likely replacethe dollar in 50. Maybe sooner. Don’t hold your breath.
Q5: To what extent do foreign countries other than Chinahold US dollars as a way to protect their own currencies? Even if not directlypegged to the dollar, don’t many hold dollars to support their currencies in fxmarkets? If China suddenly desired to hold fewer dollars and started to dumptheir US bonds, wouldn’t the weakening of the dollar that might result causeall those other countries to buy more dollars to build back adequate reserves?And wouldn’t that demand tend to support the dollar’s value? In effect won’tevery country that uses dollars to protect its own currency automatically actto protect the value of the dollar as well? If the dollar were to be suddenlydevalued for whatever reason, is their any other stable currency that couldplausibly be used instead by countries that now use US dollars to protect theirown? I can’t imagine Euros or Yuan being very attractive …
A: So many questions, so little time. However, much of thisanswered above. Yes, many hold dollars to enable them to manage or peg theircurrencies. Holdings increased after the Asian Tigers’ crisis, when nationscame to realize you need an unassailable reserve if you are going to peg. Chinalearned it well. Does it increase demand for dollars. As Sarah would say, “youbetcha”. Does devaluation lead to capital losses? Yep. Is there any alternativenow? Nope. You can’t get safe euro debts in sufficient quantity. Oh, sure youcan buy the debts of PIIGS. Go ahead, they need your help. Germany is a netexporter and the model of fiscal rectitude, so you can’t get their euro debt.So euro is a no-go. RMB? No way. Ditto. It is a better Germany than Germany is.Japanese Yen? Exporter. As an exporter it creates sufficient domestic saving toabsorb its large government debt. TINA: there is no alternative to the dollar.Today.
Q6: Okay, I’ve been waiting for these posts for some time. Idon’t know how much of the below question you will deal with in next weekspost, so maybe its best if you ignore the parts of the questions that will bedealt with. (1) You mention Japanese domestic saving. Can we just confirm onceand for all that the high rates of domestic saving in Japan are the result oflarge government deficits and little of this ‘leaking’ abroad due to theirrunning current account surpluses? And can we surmise from this that Japanesesavings rates are largely determined BY the government deficits? — hence, it’sthe deficits that ’cause’ the savings and not the savings that ‘allow’ thedeficits. Sorry, I know I’ve been pressing this point for  while on here.But I’d like it ‘in stone’, as it were. (2) In what way does what you say abovetie into the Hudson/Varoufakis ‘dollar hegemony’ argument? I.e. the argumentthat the US occupies a ‘special position’ due to its post-war status thatallows it to have its currency accepted by others to an extent that no othersovereign can? The kicker here would be that, if there is truth to thisargument the US might not like the prospect of currency devaluations not justfrom the perspective of Wall Street, but also for geopolitical and military(read: imperial) reasons.
A: Thanks for the patience! Japanese gov’t deficits +current account surpluses = large domestic savings. By identity. Yes. Yen forYen. Causation goes from spending to income to saving; or from injections toleakages, in the normal Keynesian way. Some in US would like dollardepreciation (exporters); some would like appreciation (tourists, and yourstruly). The US is special. It has more nukes than anyone else and has shown theworld it is willing to use military might. That was not post-war, it was war. That’sreal hegemony, not merely dollar hegemony. Nuclear hegemony will trump currencyhegemony, I think.
Q6a: Question (1a) — well stated! Let me try to summarize– and add a third alternative: Which view is “best”? * Conventionalview — loanable funds: “private savings allow governmentdeficits” * Philip’s suggestion: “government deficits’cause’ private saving”, or alternatively “private saving isdetermined by government deficits” * Keynes/Godley view ( understood by Hugo): Increased private saving constitutes a demand leakage,since private spending decreases. Private saving decisions thereby ‘lead’ thegovernment into deficit. Because if the government does not go into deficit (toaccomodate for the private saving intentions) the economy will slow down (dueto the decreased private spending). So: “private saving behaviour’leads’ government deficits” or alternatively “governmentdeficits ‘allow’ private saving” Philip, is that a reasonable way toformulate your question (1a)? (Question (1b) would then be the question on whyso few foreigners hold Japanese bonds — is it due to Japanese current accountsurpluses?)

A: Always takes two to tango. By construction, modern government budgetaryoutcome is accommodative—taxes fall and spending rises in downturn. Thedownturn, in turn, can be thought of as resulting from inadequate aggregatedemand which leads to a reluctance to spend. That in turn results from apreference for saving and especially in liquid form. Ergo: private sector wantsto net save in government IOUs, so won’t spend, so a deficit results to satisfythe saving desire. To be sure, causation is always complex but that is a roughand ready explanation.

 Q7: Pretty much.Randy has said many times before that government spending = private savingdollar for dollar. I just want to know if he thinks the case of Japan is aconcrete example of this. Its just a very concrete argument to make against the’Japan is because of high savings’ types. “No,” you’d respond,”Their savings are DUE TO high deficits coupled with trade surpluses! Thegovernment bonds just mop this up. Hence the perpetually low interestrates.”
A: Both. Japan has an inadequate safety net in conjunctionwith 2 decades of recession. Perfectly rational to save. That generates lowgrowth and hence budget deficit. However, since the saving cannot occur unlessthe budget deficit occurs (and trade surplus) it makes sense to say thedeficits allow the desired saving to be realized.
Q8: Could the government be compelled to raise taxes, afterissuing so much bonds, paying so much interest, that bond holders becomenervous and suddenly rush to buy actual stuff (mines power plants, whatever)before inflation and currency depreciation occur ? As the US dollar shift awayfrom international reserve currency status, isn’t a harsh inflation to beexpected ? How to deal with it? When governments lended to banks in 2008, werethey compelled to do so because the massive losses demanded reserves to payright away (or go bankrupt) to an amount exceeding what central banks had intheir balance sheet ? Have we figures saying just that ? Otherwise why wouldgovernments act as Lender of Last Resort and humiliating central banks whopretended to be the ultimate guarantee of the monetary system ? (Yep I was theguy sending an e-mail entitled Lender of Penultimate Resort, I hope I”m nottoo pressing :D )

A: In a sovereign country, taxes create a demand for thecurrency and they drain income and thus reduce demand, which can be useful ifthere is inflation pressure. Obviously that is not the problem in recent years.So, no, there is no reason to raise taxes after the bail-out. The US dollar isnot shifting away from international reserve status. Have you been watchingEuroland? There will be a huge euro bond sell-off and a run into US Treasuries.Buy them now before Europe gets all of them. Why did the Fed bail-out WallStreet? Because Bob and Hank and Timmy came from Wall Street to save GovernmentSachs. Not sure it is humiliating, but it certainly is a scandal. Worst inhuman history.
Q9: As far as exchange rates go, context matters.Switzerland is actually rather unhappy about the fact that the CHF rose so muchrelative to EUR in the recent crisis, to the point where their central bankdecided to put a limit on how high the CHF can go. They want to protect theirtourism and export industries. Similarly, it seems to me that a depreciation ofthe USD wouldn’t necessarily be bad for the US. At least, I often read UScommentators complain about the perceived de-industrialization of the US comparedto the rest of the world. A falling USD could certainly help make production inthe US more attractive again, couldn’t it?
A: Again, depends on which American you are. Estimates ofpositive trade effects are almost certainly overstated for the US. For acountry like Italy, depreciation could have a nontrivial effect within Europe.Of course, it cannot do that until it leaves the euro and returns to the Lira. Noone is going to peg to an Italian Lira. So depreciation does increase exports.Given that most countries constrain demand, exporting is a lot like payingpeople to dig holes. It provides jobs devoted to waste. Exports mean youproduce things you don’t get to consume. Pure waste—might as well just dig theholes, unless workers prefer making Fiats they don’t get to drive. The US wouldbe far better off if it exported nothing, imported loads of stuff, and operatedat full employment. Not digging holes but rather doing useful and fun stuff.

Comments are closed.