By Daniel Negreiros Conceição
A global economic winter is coming. The Euro experiment is nearing its total collapse—an entirely avoidable disaster long foretold by MMTheorists. In the US, people’s blind aversion to public deficits and the public debt, fuelled by the alarmist cries of a Republican Party currently controlled by lunatics and economic illiterates, makes it impossible for the government to make use of the stimulating fiscal instruments that are needed to get that country out of its current recession. Even China, the one country that had been seemingly unaffected by the global depression until now, shows signs of slowing down. Brazil better be prepared.
Since 1936, with the publication of Keynes’s The General Theory, economists have known (or should have known) that the key to promoting macroeconomic stability and securing full employment in a capitalist economy is to keep total purchases of domestically produced goods and services from being too low, which would cause a unemployment, or too high, which would cause demand-pull inflation. With falling global demand and because the Brazilian government has been blindly trying to keep its own deficit under control, the Brazilian economy had been able to avoid a recession until recently only because autonomous spending had been kept up by the recent changes in monetary policy.
I cannot stress enough that I am not advocating here against reducing interest rates. I applaud the efforts by the Brazilian government to reduce interest rates, especially its use of publicly owned commercial banks to lower the historically abusive rates that were charged by lending institutions in Brazil. Ceteris paribus, low interest rates are (almost always) better than high interest rates, at least from a macroeconomic point of view. However, the monetary stimulus cannot be the only tool protecting the Brazilian economy against the economic storm coming from the North. In fact, with its combination of an easy-money policy and fiscal conservatism, the Brazilian government may be helping to create a private-debt-bomb set to explode right in the middle of a global recession, when Brazil’s economy can least afford it.
As a growth (or recession-avoiding) strategy, it is possible for monetary policy alone to have stimulating effects in the short-run. By lowering borrowing costs, the Brazilian government was indeed able to stimulate private borrowing. In this case, it was not conventional monetary policy that did the trick (reducing the return on public debt can do little to stimulate private spending), but the use of publicly owned lending institutions to force down the rates for consumers, home-buyers and small and medium-sized businesses. Families responded to the reduction in borrowing costs by increasing their (debt-financed) autonomous consumption (and some real-estate investment). Firms also increased their purchases, not necessarily because the cost of borrowing had fallen, but because the debt-fueled rise in consumption spending created more opportunities to sell commodities for profitable prices. Because more money was being spent, more output was being sold, and because more output was being sold, more jobs were being created.
And now for the bad news: Because of a cruel accounting arithmetic, in the absence of an appropriate fiscal complement or a fortuitous improvement in the current account balance, the private-debt-fueled expansion must unavoidably bring with it an increasingly fragile and eventually unsustainable financial structure (a-la Hyman Minsky).
By going into debt, families and firms can, for as long as credit is being given to them, spend above their incomes. However, the situation can quickly become unsustainable. Because borrowers must repay their debts to banks with interest, and because banks do not ever return as income to families and firms nearly as much as what they earn from them as interest and tariffs, the capacity of all indebted families and firms to meet their financial commitments depends on an ever expanding level of private debt. Allow me to explain why.
In order to meet their financial commitments over the course of any given period (i.e. in order for them to make principal and interest payments, or—at the very least—in order for them to make interest payments and avoid falling behind on their loans), indebted units must earn more money than their non-interest expenditures during that same period. Simply put, indebted units must enjoy positive money balances while they remain indebted. Since one person’s monetary gain is another’s monetary loss, the demand for net money gains of indebted units cannot be satisfied unless other actors in the economy suffer net money losses. Over any given period, these net infusions of money can come from the dissaving by consumers (as rising debt or reduction of financial wealth), the autonomous investment by firms and families (debt-financed or paid for by reducing their accumulated financial wealth), the deficit spending of the government and/or the current account surplus (which reflects the net losses of money by foreign units). Without an increase in the government deficit and/or an increase in the current account surplus, the only way for the demand for money balances of indebted families and firms to be met is for other firms and families to suffer money losses at an increasing rate.
In the US, since real-estate investment was the primary driver of aggregate spending until the 2008 financial disaster, families and firms were able to postpone the exhaustion of their borrowing capacity for a while. As long as the real-estate properties being purchased by borrowers were appreciating at a fast enough rate, indebted units were able to refinance their debts by presenting unrealized capital gains as collateral. Under these conditions, it was possible for the demand for monetary balances of the indebted units to be satisfied not only by the money losses of new borrowers, but also by the additional borrowing by already indebted units.
In Brazil, since most of the expansion in private debt has been associated with autonomous consumption, the borrowing capacity of the private sector has become exhausted much more quickly. On one hand, most of the realizable value of consumable goods is lost at the moment when it is purchased by the consumer, making it impossible for unrealized capital gains to be used as collateral for additional debt by already indebted consumers. On the other hand, the distributional nature of capitalist economies causes the net money losses of indebted wage-earning consumers to be mostly captured by firms, banks and their wealthy owners, while wage-incomes tend to remain stagnant. Thus, although it is claimed that the reduction of interest rates in Brazil has mostly benefited the poorer families, since it has allowed them to purchase previously unaffordable things, in reality it has benefited profit earners the most. For those Brazilian families who have relied on borrowed means to consume, any gain from anticipating the acquisition of expensive durable goods was likely more than offset by the (still extremely high) interest costs.
In the US in 2008, the economic contraction that followed the private-debt-fueled expansion happened because the demand for money balances of indebted units could no longer be satisfied. Once real-estate prices stopped rising at such a fast rate, the rate of new borrowing fell because indebted units could no longer refinance their debts, banks could no longer trust borrowers, and the speculative demand for real-estate properties disappeared. Consequently, money losses were no longer enough for the demand for money gains of indebted units to be met. The result was a recessive spiral almost as bad as the Great Depression of the 1930s.
The mechanism that turns the private-debt-driven expansion into a recession is well known by MMTheorists. With the exhaustion of the private sector’s capacity to borrow, the creation of new debts can no longer provide the positive money balances needed by indebted units. Struggling to meet their financial obligations, these indebted units cut back on spending, but this only adds to their problems (and to everyone else’s). It is the old paradox of thrift in action! Although it is possible for a single individual to increase her saving by cutting back on spending because her income is independent from her own expenditures, it is impossible for society as a whole to increase its saving by cutting back on total spending because a reduction in aggregate spending means a reduction in aggregate income. As we saw just above, the net monetary gains of indebted units who have exhausted their ability to borrow can only come from the total dissaving by other consumers, total autonomous investment, the government’s deficit or the current account surplus. By reducing their own spending, indebted units end up increasing their own financial difficulties by causing overall incomes to fall, thus reducing the incentive for firms to invest (why would entrepreneurs invest more in a shrinking economy?) and for banks to lend (why would banks lend more in a shrinking economy?).
In Brazil, after a brief borrowing frenzy, the capacity of consumers to borrow has quickly become exhausted. This means that we can no longer expect autonomous consumption to keep Brazil out of a recession. The economy has already become stagnant. What is worse, Brazilians must now find ways to provide money gains to the large number of indebted units looking to deleverage. To do so, the government must promptly abandon its conservative stance on fiscal policy. In the absence of growing net exports, only an increase in the government deficit can provide the money gains needed by indebted units to meet their debt commitments and keep incomes from falling. This is just what MMTheorists and advocates of functional finance have been saying all along: government spending should be used to offset fluctuations in private spending so that aggregate spending is kept at the level that produces full employment without demand-pull inflation. In Brazil it is now time for government deficits to rise. *In the US, greater deficits have been needed since 2008.
However, the adoption of functional fiscal policies in Brazil will require that a few myths be dispelled:
(1) The first myth tells us that national governments can use up their borrowing capacity just as families and firms. People actually point to the fiscal crisis in the Eurozone to make their case. However, as long as the money-issuing authority (the Brazilian Central Bank or the Fed) is committed/willing to purchase any amount of federal debt in excess of what private agents are willing to hold, the national government will never face financial constraints on its capacity to spend. This is the case for Brazil and for the US, but it is not the case for the countries in the Eurozone. This is why families, firms, banks and Eurozone governments can go bankrupt, but it is not possible for the Brazilian and American governments to fail to meet any of their debt commitments, as long as they are denominated in their national currencies, unless these governments choose to not service their debts due to the ignorance, stupidity or dishonesty of government officials.
(2) The second myth is linked to the first. Since monetary authorities can always adjust the stocks of reserves and Treasury-debt in the economy, the interest rate paid on national debts is a monetary policy decision and can be set at any level, independently of the size of the national debt. Thus, it is absolutely unnecessary for the government to achieve primary fiscal surpluses in order for interest rates to be reduced. In fact, contrary to popular belief, the causality runs in the opposite way. By increasing the return on Treasury debts, the government causes future deficits to be greater by committing to greater interest payments to the holders of public debt.
(3) The third myth relates to the strange aversion of conservative commentators to government deficits, as if they were somehow more inflationary than rising net-exports, autonomous consumption and/or private investment. There is no logical basis for this fear, unless we are still thinking in terms of a failed monetarist framework according to which increments in aggregate demand can come only from increments in the supply of money. The real world is nothing like the monetarist world. In reality, government deficits increase aggregate demand not because they increase the money supply (which they do, not because governments rely on their “printing presses” to deficit spend, but because the recipients of government payments get credited money-values in their checking accounts), but because they represent purchases of domestic commodities by the government and because they add income to actors with positive propensities to consume. There is no reason to expect that this would be any more inflationary than a rise in investment spending, debt-fueled autonomous consumption or an increase in net exports. In all those cases, more money would be put to circulate in the economy causing the value of total purchases of domestic production to increase, which is all that matters when it comes to rational concerns about demand-pull inflation. In fact, the risk of inflation from a fiscal stimulus may be even lower than from increases in private spending, since public spending could be directed to the elimination of production bottlenecks and other constraints on material production.
By now, economists should know better than to rely on private borrowing alone to keep economies from underperforming. After all, no good can come from a growth dynamic that can only be sustained if private debts continue to grow. Furthermore, while it can accelerate the economic growth during an expansion, a monetary push is unlikely to work for an economy that is already in a recession since it is very hard to tease people into borrowing more money with lower interest rates when their incomes are stagnant or falling. In any case, there is nothing that monetary policy can do for the Brazilian economy at this time. Now that the Brazilian private sector has used up all of its capacity to borrow, avoiding a recession will necessarily require generous government deficits. Thus, it is time for the Brazilian government to challenge all economic delusions that say that public austerity can ever be a way out of recessions and start spending with no concern for its own debt. But wait! Perhaps it has just decided to do exactly that…