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MMP Blog #25: Currency Solvency and the Special Case of the US Dollar

Posted on November 20, 2011 by | 3 comments
In recent blogs we’ve been looking at sovereign government issues of bonds. We have argued that this is not really a “borrowing” operation, but rather bond issues offer a (higher) interest-earning alternative than do reserve deposits at the central bank. We also have argued that it makes little practical difference whether the government bonds are held domestically or by foreigners.
However, it is true that in a floating currency regime, it is conceivable that foreigners who hold reserves or government bonds could decide to “run” out of them, impacting the exchange rate. By the same token, countries that want to run net exports with, say, the US, are interested in accumulating Dollar claims—often because their domestic demand is too low to absorb potential output and often because they want to peg their currencies to the Dollar. For that reason, a “run” is unlikely.
This then leads to the objection that the US is surely a special case. Yes, it can run budget deficits that help to fuel current account deficits without worry about government or national insolvency precisely because the rest of the world wants Dollars. But, surely, that cannot be true of any other nation. Today, the US Dollar is the international reserve currency—making the US special. Let us examine this argument.
Isn’t the US special? Yes and no. Accounting identities are identities; they are true for all nations. If a nation runs a current account deficit, by identity there must be a demand for its assets (real or financial) by someone with foreign currency.(A foreigner could either demand the nation’s currency for “direct investment” that includes buying property or plant and equipment,or the foreigner could demand financial assets denominated in that currency.) If that demand for assets declines, then the current account deficit must also decline.
There is little doubt that US dollar-denominated assets are highly desirable around the globe; to a lesser degree, the financial assets denominated in UK Pounds, Japanese Yen, European Euros, and Canadian and Australian dollars are also highly desired. This makes it easier for these nations to run current account deficits by issuing domestic-currency-denominated liabilities. They are thus “special.”
Many developing nations will not find a foreign demand for their domestic currency liabilities. Indeed, some nations could be so constrained that they must issue liabilities denominated in one of these more highly desired currencies in order to import. This can lead to many problems and constraints—for example, once such a nation has issued debt denominated in a foreign currency, it must earn or borrow foreign currency to service that debt. These problems are important and not easily resolved.
If there is no foreign demand for IOUs (government currency or bonds, as well as private financial assets) issued in the currency of a developing nation, then its foreign trade becomes something close to barter: it can obtain foreign produce only to the extent that it can sell something abroad. This could include domestic real assets (real capital or real estate) or, more likely, produced goods and services (perhaps commodities, for example). It could either run a balanced current account (in which case revenues from its exports are available to finance its imports) or its current account deficit could be matched by foreign direct investment.
Alternatively, it can issue foreign currency denominated debt to finance a current account deficit. The problem with that option is that the nation must then generate revenues in the foreign currency in order to service that debt. This is possible if today’s imports allow the country to increase its productive capacity to the point that it can export more in the future—servicing the debt out of foreign currency earned on net exports. However, if such a nation runs a continuous current account deficit without enhancing its ability to export, it will almost certainly run into debt service problems.
The US, of course,does run a persistent trade deficit. This is somewhat offset by a positive flow of net profits and interest (US investments abroad earn more than foreign investments in the US). But the two main reasons why the US can run persistent current account deficits are: a)virtually all its foreign-held debt is in Dollars; and b) external demand for Dollar-denominated assets is high—for a variety of reasons.
The first of these implies that servicing the debt is done in Dollars—easier for indebted American households, firms, and governments to obtain. The second implies that foreigners are willing to export to the US to obtain Dollar-denominated assets, meaning that a trade deficit is sustainable so long as the rest of the world wants Dollar assets.
What about government that “borrows” in foreign currency? What about nations that issue foreign currency denominated assets? Returning to a nation that does issue debt denominated in a foreign currency, what happens if the debtors cannot obtain the foreign currency they need to service the debt?
We have thus far left to the side questions about who is typically issuing foreign currency denominated debt. If it is a firm or household, then failure to earn the foreign currency needed to service the debt can lead to default and bankruptcy. This would be handled in the courts(typically, when debt is issued it is subject to the jurisdiction of a particular court) and by itself poses no insurmountable problem. If the debt is too large, bankruptcy results and the debt must be written-off.
Sometimes, however,governments intervene to protect domestic debtors by taking over the debts. (Ireland is a good example.) Alternatively, governments sometimes issue foreign currency debt directly. In either case,default by government on foreign currency debt is usually more difficult—both because bankruptcy by sovereign government is a legally problematic issue and because sovereign default is apolitically charged issue.
In practice,sovereign default (especially on foreign currency debt) is not uncommon, often chosen as the lower cost alternative to continuing to service debt. Sovereign governments typically choose when to default—they almost always could have continued to service debt (for example, by imposing austerity to increase exports, or by turning to international lenders). Apparently, they decide that the benefits of default outweigh the costs. However, this can lead to political repercussions. Still, history is littered with government defaults on foreign currency debt.
Governments sometimes issue foreign currency debt on the belief that this will lower borrowing costs—since interest rates in, say, the US Dollar,are lower than those in the domestic currency. However, foreign currency debt carries default risk—and if markets price that into interest rates, there may be no advantage. Still, it is not uncommon for governments to try to play the interest differentials, issuing debt in a foreign currency that has a lower interest rate.Unfortunately, this can be a mirage—markets recognise the higher default risk in foreign currency, eliminating any advantage.
Further, as discussed in earlier blogs, for a sovereign government, the domestic interest rate (at least the short term interest rate in the domestic money of account) is a policy variable. If the government is spending domestically in its own currency, it can choose to leave reserves in the banking system or it can offer bonds. In other words, it does not have to pay high domestic interest rates if it does not want to, for it can instead let banks hold low (or zero) interest rate reserves. This option is available to any currency issuing government—so long as its spending is domestic.
As discussed earlier, government will be limited to purchasing what is for sale in its currency—and if it is constrained in its ability to impose and collect taxes then the domestic demand for its currency will be similarly limited. So we do not want to imply that government spending is not constrained—even in a sovereign country that issues its own currency.
But if a national government issues foreign currency denominated IOUs, the interest rate it pays is “market determined” in the sense that markets will take the base interest rate in the foreign currency and add a mark-up to take care of the risk of default on the foreign currency obligations. It is likely that the borrowing costs in foreign currency will turn out to be higher than what government would pay in its own currency to get domestic (and foreign) holders to accept the government’s IOUs.
This is usually not understood because the domestic currency interest rate on government debt is a policy variable—usually set by the central bank—but policy makers believe they must raise domestic rising interest rates when the budget deficit rises. This is done to fight inflation pressures or downward pressure on exchange rates that policy-makers believe to follow on from budget deficits. In truth—as discussed above—if a country tries to peg its exchange rate, then a budget deficit could put pressure on the exchange rate. So, there is some justification for attempting to counteract budget deficits with tighter monetary policy (higher domestic interest rates).
But the point is that government sets the domestic interest rate on overnight funds,which then closely governs the interest rate on short-term government bonds. So, if government wants lower rates on its debt, it can always use domestic monetary policy to achieve that goal. Unfortunately, this is not widely understood—hence—governments issue foreign currency denominated debt and then take on risk of default because they actually must get hold of foreign currency to service the debt. Thus, it is almost always a mistake for government to issue foreign currency bonds.
Conclusion on US exceptionality. So, yes, the US (and other developed nations to varying degrees) is special, but all is not hopeless for the nations that are “less special.” To the extent that the domestic population must pay taxes in the government’s currency, the government will be able to spend its own currency into circulation. And where the foreign demand for domestic currency assets is limited, there still is the possibility of nongovernment borrowing in foreign currency to promote economic development that will increase the ability to export.
There is also the possibility of international aid in the form of foreign currency. Many developing nations also receive foreign currency through remittances (workers in foreign countries sending foreign currency home). And, finally, foreign direct investment provides an additional source of foreign currency.
Next week, we will turn to impacts of government policy in an open economy: trade deficits and exchange rate effects.

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Some Modest Proposals for Reforming the U.S. Financial and Tax System

Posted on November 17, 2011 by | Comments Off on Some Modest Proposals for Reforming the U.S. Financial and Tax System

By Michael Hudson

OnNovember 3, 2011, Alan Minsky interviewed me on KPFK’s program, “Building aPowerful Movement in the United States” in preparation for an Occupy L.A.teach-in. To clarify my points I have edited and expanded my answers from theinterview transcript.
AlanMinsky: I amjoined now by Michael Hudson. He is a distinguished research professor ofeconomics at the University of Missouri-Kansas City, and also is president ofthe Institute for the Study of Long Term Economic Trends. Welcome to the show,Michael.

MichaelHudson: Thankyou very much.

AlanMinsky: MichaelHudson is scheduled to address Occupy L.A. as part of a teach-in that includesWilliam Black and Robert Scheer, who will be moderating the panel that Michaelwill be on this weekend. Michael, I’m familiar with your work and I know thatyou are a big-picture economic thinker. This is definitely a movement that isasking the big questions about how the global economy and the national economyshould be re-organized. What would you say to the movement at large about howbest to organize a high-tech modern industrial economy in a way that wouldproduce more social and economic justice?
Americais being radicalized by coming to realize how radical Wall Street’s power grabis

MichaelHudson: TheOccupy Wall Street movement has many similarities with what used to be calledthe Great Awakening periods in America. Such periods always begin by realizinghow serious the problem is. So diagnosis is the most important tactic.Diagnosing the problem mobilizes power for a solution. Otherwise, solutionswill seem to come out of thin air and people won’t understand why they areneeded, or even the problems that solutions are intended to cure.

Thebasic problem today is that nearly everyone is in debt. This is the problem inEurope too. There are Occupy Berlin meetings, the Greek and Icelandic protest,Spain’s “Indignant” demonstrations and similar ones throughout the world.

Whendebts reach today’s proportions, a basic economic principle is at work: Debtsthat can’t be paid; won’t be. The question is, just how are they not going to be paid? People with student loans arenot permitted to declare bankruptcy to get a fresh start. The government orcollection agencies dock their salaries and go after whatever property they have.Many people’s revenue over and above basic needs is earmarked to pay thebankers. Typical American wage earners pay about 40 percent of their wages onhousing whose price is bid up by easy mortgage credit, and another 10 to 15percent for credit cards and other debt service. FICA takes over 13 percent,and federal, local and sales taxes another 15 percent or so. All this leavesonly about a quarter of many peoples’ paychecks available for spending on goodsand services. This is what is causing today’s debt deflation. And Wall Streetis supporting it, because it extracts income from the bottom 99% to pay the top1%.

Halfa century ago most economists imagined that the problem would be people savingtoo much as they got richer. Saving meant non-spending. But the problem hasturned out to be just the opposite: debt. Overall salaries have not risen indecades, so many people have borrowed just to break even. Instead of an era offree choice, very little of their income is available for discretionaryspending. It is earmarked to pay the financial, insurance and real estatesectors, not the “real” production and consumption economy. And now repaymenttime has arrived. People are squeezed. So when America’s saving rate recentlyrose from zero to 3 percent of national income, it takes the form of peoplepaying down the debts.

Manypeople thought that the way to get rich faster was to borrow money to buy homesand stocks they expected to rise in price. But this has left the economyfinancially strapped. People are feeling depressed. The tendency is to blamethemselves. I think that the Occupy Wall Street movement, at least here in NewYork, is like what has occurred in Greece and also in the Arab Spring. Peopleare coming together, and at first they may simply watch what’s going on. Onlookersmay come by to see what it’s all about. But then they think, “Wait a minute!Other people are having the same problem I’m having. Maybe it is not really myfault.”

Sothey begin to see that all these other people who have a similar problem in notbeing able to pay their debts, they realize that they have been financially crippledby the banks. It is not that they have done something wrong or are sore losers,as Herman Cain says. Something radically wrong with the system.

Fiftyyears ago an old socialist told me that revolutions happen when people just gettired of being afraid. In today’s case the revolution may grow nearer whenpeople get over being depressed and stop blaming themselves. They come to thinkthat we are all in this together – and if this is the case, there must besomething wrong with the way the economy is organized.

Gradually,observers of Occupy Wall Street begin to feel stronger. There is positive peerpressure to reinforce their self-confidence. What they intuitively feel is thatthe Reagan-Clinton-Bush-Obama presidencies have squeezed their lives. Theeconomy has become untracked.

What’sbasically wrong is that the financial system is running the government. Foryears, Republicans and Democrats both have said that a strong government, carefulregulation and progressive taxation is the road to serfdom. The politicians andneoliberal economists who write their patter talk say, “Let’s take planning outof the hands of government and put it in the ‘free market.’” But every marketis planned by someone or other. If governments step aside, then planning passesinto the hands of the bankers, because of their key role in allocating credit.

Theproblem is that they have not created credit to finance industrial investmentand employment. They have lent for speculation on asset price inflation usingdebt leveraging to bid up housing prices, stock and bond prices, and foreignexchange rates. They have convinced borrowers that they can get rich on risinghousing prices. But this merely makes new homebuyers go deeper into debt to buya home. And when banks say that rising stock and bond prices are good for theeconomy, this price rise lowers the dividend or interest yield. This means thatpension funds and individuals have to save much more for retirement. Instead ofimproving their life, it makes them work harder and borrow more just to stay inplace.

Thebanking system’s alternative to “the road to serfdom” thus turns out to be a roadto debt peonage. This financial engineering turns out to be worse thangovernment planning. The banks have taken over the Federal Reserve and Treasuryand put their lobbyists in charge – men such as Tim Geithner and the others withties to Rubinomics dating from the Clinton administration, and especially toGoldman Sachs and other giant Wall Street firms. 
            
Sothe first thing to realize is something that is characteristic of all great reformmovements. Voters are not yet supporting a radical position to restructure thewhole system. But at least they are coming to see that small marginal reformswon’t work, or are simply trick promises, like President Obama’s promise thatbanks would renegotiate mortgages for homes in negative equity as part of the quid pro quo for the bailouts theyreceived from Treasury Secretary Geithner. There’s been no quid pro quo, merely talk.
            
Peoplesee that law enforcement is missing when it comes to the banks and Wall Street.So simply restoring the criminal justice system would be progress. It used tobe that if you ran a fraud, if you cheated people, if you lied on your incometax and falsified statistics, then you would be sent to jail. But the Obamaadministration has appointed Eric Holder to represent Wall Street. He has notthrown any bankers in jail, recognizing that they are the major campaigncontributors of the party, after all.
            
Whatis easiest for most people to accept is the idea of restoring the way theeconomy used to be more in balance – back when people earned income by beingproductive rather than getting rich by transferring other peoples’ savings andpublic giveaways into their own pockets. But what I sensed in New York wasanger not only at this economic problem, but the fact that the political systemis broken. There is no one to vote for as an alternative to pro-bankcandidates. So what began as anger has become a gathering awareness that Mr.Obama was simply fooling voters instead of leading the change he promised.That’s what politicians do, of course. But people hoped that he might bedifferent. That was the gullibility he played on. He has turned into thenightmare they thought they were voting against.
            
Movingto the right of the Republicans, he started his administration by appointingthe Simpson-Bowles Commission staffed by opponents of Social Security. Herecently followed that up by appointing the Congressional Super-committee ofTwelve to come out with an even more anti-Social Security, anti-Medicaid and anti-minorityposition that the Republicans could get away with. If they would have tried topass such a right-wing policy, the Democratic Congress would have refused topass it. But they don’t know how to deal with a Democratic president whoappoints Wall Street lobbyists to his cabinet and acts like Margaret Thatchersaying that There Is No Alternative (TINA) to making Social Securityrecipients, labor and minorities pay for Wall Street’s bad gambles and banklosses. He has helped Wall Street capture the government – on behalf of the 1%.
            
Theman whom Mr. Obama asked to be his mentor when he joined the Senate was Joe Lieberman.He evidently gave Obama expert advice about how to raise funds from thefinancial class by delivering his liberal constituency to his Wall Streetcampaign contributors. So the problem is not that President Obama is wellmeaning but inept – an idealist who just can’t fight the vested interests andinsiders. He’s thrown in his lot with them. In fact, he really seems to believethe right-wing, pro-Wall Street ideology – that the economy can’t functionwithout a financial system that guarantees “savers” (the top 1%) against loss,even when the bottom 99% have to pay more and more.
            
Andon a personal level, Mr. Obama knows that his fund raising comes mainly fromWall Street, and the only way to get this money is to sell out hisconstituency. You’ve got to give him enough credit to recognize this obviousfact.
            
Theupshot is that we now have a political nightmare. Yet Mr. Obama still seems tobe the best that the Democrats can offer! This is why I think the protestors aresaying they are not going to let the Democrats jump in front of the parade totry and mobilize support for their party. Like the Irish say: “Fool me once,shame on you. Fool me twice, shame on me.” They realize that the financialsystem is broken and that neither party is trying to do much about it. So thepolitical system has to be changed as well as the economic system.
            
Supposeyou were going to design a society from scratch. Would you create what we havenow? Or would you start, for instance, by reforming the most egregiousdistortions of campaign finance? As matters stand, Goldman Sachs has been ableto buy the right to name who is going to be Treasury Secretary. They selectedGeithner, who gave them $29 billion from A.I.G. just before he was appointed.It’s like that all down the line – in both parties. Every Democratic congressionalcommittee chairman has to pay to the Party a $150,000 to buy the chairmanship. Thismeans that the campaign donors get to determine who gets committee chairmanships.This is oligarchy, not democracy. So the system is geared to favor whoever cangrab the most money. Wall Street does it by financial siphoning and assetstripping. Politicians do it by getting money from the beneficiaries – the 1%.
            
Oncepeople realize that they’re being screwed, that’s a pre-revolutionarysituation. It’s a situation where they can get a lot of sympathy and support,precisely by not doing what The New York Times and the other paperssay they should do: come up with someneat solutions. They don’t have to propose a solution because right now thereisn’t one – without changing the system with many, many changes. So many thatit’s like a new Constitution. Politics as well as the economy need to berestructured. What’s developing now is how to think about the economic andpolitical problems that are bothering people. It is not radical to realize thatthe economy isn’t working. That is the first stage to realizing that a realalternative is needed. We’ve been under a radical right-wing attack – and needto respond in kind. The next half-year probably will be spent trying to spellout what the best structure would be.
            
Thereis no way to clean up the mess that the Democratic Party has become sincepolitics moved into Wall Street’s pockets. The Republicans also have become aparty of lobbyists. So it looks like there is no solution within the existentsystem. This is a revolutionary, radical situation. The longer that the OWSgroups can spend on diagnosing the problem and explaining how far wrong thesystem has gone, the longer the demonstrators can gain support by showing thatthey share the feelings everybody has these days – a feeling of beingvictimized. This is what is creating a raw material that has to potential toflower into political activism, perhaps by spring or summer next year.
            
Themost important message is that all this impoverishment and indebtedness isunnecessary. There is no inherent economic reason for things to be this way. Itis not really the way that “markets” need to work. There are many kinds ofmarkets, with many different sets of rules. So the important task is to explainto people how many possibilities there are to make things better. And of course,this is what frightens politicians, Wall Street lobbyists and the other membersof the pro-oligarchic army of financial raiders.
AlanMinsky: Well,let me ask you this – and of course, it is something of an intellectualspeculative game. Let’s say that it’s January 2013, and the radical progressivecandidate X, Dennis Kucinich or Bernie Sanders, is miraculously electedpresident, and Michael Hudson is the chief economic advisor. What would you do,given the opportunity with a favorable congress, to transform the Americaneconomy in ways that would produce policies you think would at least start tohelp break the grip that the financial sector has had in devastating theeconomy in terms of its performance for average households?
RestoreAmerica’s past prosperity and rescue the future from the financial grabbers

MichaelHudson: Thereare two stages to any kind of a transformation. The first stage is simply to startre-applying the laws and the taxes that the Bush and Obama administrations havestopped applying. You don’t want Wall Street to be able to put its industrylobbyists in charge of making policy. So the first task is to get rid ofGeithner, Holder and the similar pro-financial administrators whom Obama hasappointed to his cabinet and in key regulatory positions. This kind of clean-uprequires election reform – and that requires a reversal of the Supreme Court’srecent Citizens United ruling that enables a financial oligarchy to lock in itscontrol of American politics.
            
Oneof the first things that is needed – and only a President could do it – wouldbe to demand a new Supreme Court. This is what Roosevelt threatened, and itworked. You make them an offer they can’t refuse. If this can be done only byexpanding the number of court justices, then you nominate ones who are notradicals on the right – judges who will reverse the 19th-centuryruling that corporations are the same as people and indeed have even morerights (and certainly more campaign money) than people have. You then move to cleanup the corruption of the legal system that has protected financial crooks insteadof sending them to jail. Financial fraud has effectively been decriminalized,at least by Wall Street’s largest campaign contributors.
            
Butthis is really Bill Black’s area. I’m only going to talk about financial andtax reforms here, because they are the easiest to understand and ultimately themost immediate task.
Preventmonopoly price gouging. Bring bank charges in line with the real cost of doingbusiness.
            
Whatis needed today is more than just going back to the past ideals. After all, thegood old class warfare was not so rosy either. But at least the Progressive Erahad a program to subordinate finance to serve industry and the rest of theeconomy. The problem is that its reformers never really had a chance to carryout the ideas that classical economists outlined.
            
Theclassical idea of a free market economy was radical in its way – precisely bybeing natural and thus getting rid of unnatural warping by special privilegesfor absentee landlords and banks. This led logically to socialism, which is whythe history of economic thought has been dropped – indeed, excluded – fromtoday’s academic curriculum. What is needed is to complete the direction ofchange that World War I interrupted and that the Cold War further untracked.After 1945 you didn’t hear anything any more about what John Maynard Keynescalled for at the end of his General Theory in 1936: “euthanasia of the rentier.” But this was the great fightfor many centuries of European reform, and it even was the path along whichindustrial capitalism was expected to evolve. So let me begin with what wasdiscussed back in the 1930s, trying to recover the Progressive Era reforms.
            
Settingup a more fair banking and financial system requires changing the taxfavoritism as well, which I will discuss below. There are a number of good proposalsfor reform. One of the easiest and least radical is set up a public option forbanking. Instead of relying on Bank of America or Citibank for credit cards,the government would set up a bank and offer credit cards, check clearing andbank transfers at cost.
            
Theidea throughout the nineteenth century was to create this kind of publicoption. There was a Post Office bank, and that could still be elaborated toprovide banking services at cost or at a subsidized price. After all, in Russiaand Japan the post office banks are the largest of all!
            
Thelogic for a public banking option is the same as for governments providing freeroads: The aim is to minimize the cost of living and doing business. On mywebsite, michael-hudson.com, I have posted an article just published in the American Journal of Economics and Sociologyon Simon Patten. He was the first professor of economics at the Wharton BusinessSchool. He spelled out the logic of public infrastructure as a “fourth” factorof production (alongside, labor, capital and land). Its productivity is to bemeasured not by how much profit it makes, but by how much it lowers theeconomy’s price structure.
            
Providinga public option would limit the ability of banks to charge monopoly prices forcredit cards and loans. It also would not engage in the kind of gambling thathas made today’s financial system so unstable and put depositors’ money atrisk. Ideally, I would like to see banks act more like the old savings banksand S&Ls. In fact, the most radical regulatory proposal I would like to seeis the Chicago Plan promoted in the 1930s by the free marketer Herbert Simon. Thisis what Dennis Kucinich recently proposed in his National Emergency EmploymentDefense Act of 2011 (NEED).
            
Thismay seem radical at first glance, but how else are you going to stop the banksfrom their mad computerized gambling, political lobbying and creating creditfor corporate raiders to borrow and pay their financial backers by emptying outpension funds and cutting back long-term investment, research and development?
            
Theguiding idea is to take away the banks’ privilege of creating credit electronicallyon their computer keyboards. You make banks do what textbooks say they aresupposed to do: take deposits and lend them out in a productive way. If thereare not enough deposits in the economy, the Treasury can create money on itsown computer keyboards and supply it to the banks to lend out. But you wouldrewrite the banking laws so that normal banks are not able to gamble or playthe computerized speculative games they are playing today.
            
Theobvious way to do this is to reinstate the Glass-Steagall Act so that theycan’t gamble with insured deposits. This way, speculators would bear the burdenif they lost, not be in a position to demand “taxpayer liability” bythreatening to collapse the normal vanilla banking system. AbolishingGlass-Steagall opened the way for Wall Street to organize a protection racketby mixing up peoples’ deposits with bad gambles and with the growth of debtsway beyond the ability to be paid.
            
Tosum up, the idea is to shape markets so as to steer the banks to lend foractual capital formation and to finance home ownership without credit inflationthat simply bids up prices for homes as well as for other real estate, stocks,and bonds.
Taxreform needs to back up and reinforce financial reform

Today’seconomic problem is systemic. This is what makes any solution so inherentlyradical. In changing part of the economic system, you have to adjusteverything, just as when a doctor operates on a human body. Financial reformrequires tax reform, because much of the financial problem stems from the tax shiftoff real estate and finance onto labor and industry. Taxes are the business ofCongress, not the President or his advisors, but I assume that  your question really concerns what I thinkthe economy needs.

Themost obvious fiscal task that most people understand – and support – is to restorethe progressive tax system that existed before 1980, and especially before theClinton and Bush tax cuts. It used to be that the rich paid taxes. Now theydon’t. But the key isn’t just income-tax rates as such. What needs to berecognized is the kind of taxes thatshould be levied – or how to shift them back off labor onto property where theywere before the 1980s. You need to restore the land taxes to collect the “freelunch” that is not really “free” if it is pledged to pay the banks in the formof mortgage interest.
            
Overthe past few decades the tax system has been warped more and more by banklobbyists to promote debt financing. Debt is their “product,” after all. Asmatters now stand, earnings and dividends on equity financing must pay muchhigher tax rates than cash flow financed with debt. This distortion needs to bereversed. It not only taxes the top 1% at a much lower rate than the bottom99%, but it also encourages them to make money by lending to the bottom 99%. The result is that the bottom 99% have becomeincreasingly indebted to the top 1%. The enormous bank debt attached to realestate does not reflect rising rents as much as it reflects the tax cuts onproperty. Wall Street lobbyists have backed Congressional leaders who haveshifted taxes onto consumers via sales taxes and income taxes, as well as FICApayroll withholding. This ploy treats Social Security and Medicare as “userfees” rather than paying them out of the overall budget – and financed out ofprogressive taxation on the top 1%. If wage earners pay more in FICA, you canbe sure that the wealthy get a tax cut.
            
Thisanti-progressive tax shift is largely responsible for the richest 1% doublingtheir share of income. It also has led to the 99% having to pay banks what theyused to pay the tax collector. They pay interest rather than taxes. If I wereeconomic advisor, I would explain just how this works – which is what I alreadytry to do on my website. In a nutshell, the tax shifts since World War II haveleft more and more of the land’s site value to be capitalized into interestpayments on bank loans. So the banks have ended up with what used to be takenby landowners. There is no inherent need for this. It doesn’t help the economy;it merely inflates a real estate bubble. Economic growth and employment wouldbe much stronger if income tax rates were lowered for most people. Propertyowners and speculators would pay. There would be less free lunch and more“earned” income.
            
TheObama Administration has proposed the worse of both worlds – getting rid of thetax deductibility of interest for homeowners. This would squeeze them, withoutscaling down the bank debts that have absorbed the cuts in property taxes. SoMr. Obama is sponsoring yet another anti-consumer proposal to make the bottom99% pay for government – while using government funds to subsidize the banksand bail out their bad bets.
            
Whatneeds to be done is to remove the tax deductibility of interest for investorsin general. This tax favoritism is a subsidy for debt financing – and the mainproblem that the U.S. economy faces today is over-indebtedness. A good policywould aim at lowering the debt overhead. Debt leveraging should be discouraged,not encouraged.
            
Speculatorshave borrowed largely to make capital gains. They originally were taxed asnormal income in the 1913 income tax. The logic was that capital gains build upa person’s savings, just as earning an income does. But the financial and realestate interests fought back, and today there is only a tiny tax on capitalgains – a tax that sellers don’t have to pay if they plow their money intoanother property or investment to make yet moregains! So when Wall Street firms, hedge funds, and other speculators avoidpaying normal taxes by saying that they don’t “earn” money but simply makecapital gains, this is where a large part of today’s economic inequality lies.
            
Iwould tax these asset-price gains (mainly land prices) either at the fullincome-tax rate or even higher. The wealthy 1% make their gains in this way,claiming that they don’t really “earn” income, so they shouldn’t have to paytaxes as if they are wages or profits. But that’s precisely the problem: Whywould you want to subsidize not earningincome, but merely making money by speculating – and then demanding that thegovernment bail you out if you make a capital loss when your speculations gobad, on the logic that you have tied up most peoples’ normal bank deposits inthese gambles? This is what exists today. And it is why people think the systemis so unfair. Most of the super-rich families have made their fortunes byinsider dealing and financial extraction, not by being productive. They are not“job creators” these days. They have become job destroyers by demanding austerityto squeeze out more money from a shrinking economy to pay themselves.
            
Manypeople – especially homeowners – are sucked into thinking that low capitalgains taxes make them rich, and that high property prices leave them with lessto spend. But this turns out not to be the case once the process works its waythrough the economy. These workings need to be more widely explained.
            
Formany years families got rich as the price of their home rose. But they also gotmuch deeper in debt. The real estate bubble was debt-financed. A property isworth whatever a bank will lend against it. The end result of “easy lending”and tax distortions to favor interest-bearing debt is that most families own asmaller and smaller proportion of their homes’ value – and have to pay risingmortgage debt service. This doesn’t really make them better off. The job of apresident or economic advisor should be to explain how this game works, sopeople can get off the debt treadmill. The economy will shrink if it doesn’tlower its debt overhead.
            
Iwould close down tax avoidance in offshore banking centers by treating offshoredeposits by Americans as “earned but hoarded” income and tax it at 90%. Yourestore the rates of the Eisenhower administration when the country had themost rapid debt growth that it had. You reinstate criminal penalties forfinancial fraud and tax evasion by misrepresentation. But the tax avoiders areasking the Obama administration to do just the opposite: to declare a “taxholiday” to “induce” them bring this offshore money home – by not taxing it atall! This kind of giveaway should be blocked. Tax avoiders among the top 1%should be penalized, not rewarded.
            
TheBush-Obama administration has promoted “neoliberal” tax and financial policiesthat have reversed a century of Progressive Era reforms. The past 30 years havesuffered a radical transformation of tax policy and financial policy. So ittakes an equally deep response to undo their distortions and put the Americaneconomy back on track. The guiding idea is simply to restore normalcy. TheProgressive Era that emerged from classical economics understood the economicbenefits of taxing unearned wealth (“rent extraction”) at the top of theeconomic pyramid, provide basic infrastructure services at cost rather thancreating fiefdoms for privatizers to install tollbooths and make their gainstax-exempt. Radical neoliberalism has reversed this. It has vastly multipliedthe debts owed by the bottom 99% to the top 1%.
            
Thisis leading to debt peonage and what really is neo-feudalism. We are seeing akind of financial warfare that is as grabbing as the old-style militaryconquests. The aim is the same: the land, basic infrastructure, and use of thegovernment to extract tribute.
Afinancial Clean Slate
            
Torestore the kind of normalcy that made America rich, most important long-termpolicy would be to recognize what is going to be inevitable for every economy. Debtsneed to be written down – and the politically easiest way to cut through thetangle is to write them off altogether. That would free the bottom 99% fromtheir debt bondage to the top 1%. It would be a Clean Slate, starting over –and trying to do things right this time around. The creditors have not used thebanking system to make America more productive and richer. They have used it asa vehicle to reduce the population to debt serfdom.
            
Adebt write-down sounds radical and unworkable, but it’s been done since WorldWar II with great success. It is the program the Allies carried out in theGerman economy in that country’s 1947 currency reform. This was the policy thatcreated Germany’s Economic Miracle. And America could experience a similarmiracle.
            
Anyeconomy would benefit from cancelling the bad debts that have been built up.Keeping them on the books will handcuff the economy and cause debt deflation bydiverting income to pay debt service rather than to spend on goods andservices. We are going into a new economic depression – not just a “GreatRecession” – because most spending is now on finance, insurance and realestate, not on goods and basic services. So markets are shrinking, andunemployment is rising. That is what will happen if debts are not written down.
            
Thiscan be done either by a Clean Slate across the board, or it can be done moreselectively, by applying what’s been New York State law since before the Revolution,going back to when New York was still a colony. I’m referring to the law of fraudulent conveyance. Thislaw says that if a creditor lends to a borrower without having any idea how thedebtor can pay in the normal course of business, without losing property, theloan is deemed to be fraudulent and declared null and void.
            
Applyingthis law to defaulting homeowners would free the homes that are in negativeequity throughout the country. It would undo the fraudulent loans that bankshave made, the trick loans with exploding interest rates, balloon mortgages andso forth. It also would free debt-strapped companies from being forced to selloff their parts to make their corporate raiders rich.
            
Asan associated law, pension funds should be first in line in any bankruptcy, notat the end of the line as they now are. Current practice lets companies replacedefined-benefit programs with defined contribution programs – where all that employeesknow is how much is taken out of their paychecks each month, not what they willbe receiving when they retire. Only the managers have protected their pensionswith special contracts and golden parachutes. This is the reverse of whatpension plans were supposed to do.
            
EmployeeStock Option Plans (ESOPs) also are being looted. This is what has recentlyhappened at the Chicago Tribune by Sam Zell, who borrowed money and repaid itby looting the Tribune’s ESOP. A fraudulent conveyance law applied at thenationwide level would stop this. People like Zell are looters, and so are thebankers behind him. This is the class warfare that is being waged today. Andthe war is being won by the 1% – while pushing the American economy intodepression.
            
Aspart of the rules to define what constitutes “fraudulent” or irresponsiblelending, mortgage debt service should be reduced to the rate that FDIC headSheila Bair recommended: 32 percent. The problem with debt write-downs, ofcourse, is that when you cancel a debt, you also cancel some party’s savings onthe other side of the balance sheet. In this case, the banks would have to giveup their claims. But this is what used to happen in financial crashes. Whendebts go bad, so do the loans. So the government is radical in saying thatAmerica’s debts will be kept on the book, but it will create new public debt togive to Wall Street for its own debts that have gone bad as a result of itsreckless lending.
            
Thebanks obviously would prefer to bankrupt millions of homeowners than to takeeven a penny’s loss. Their fight to make the government pay for their bad debts– while keeping the debts of the bottom 99% on the books – explains why therichest 1% of Americans have doubled their share of income and the returns towealth in the last thirty years. That’s inequitable. Their accumulation offinancial savings has not taken the form of tangible capital investment infactories or other enterprises to employ labor. It’s looted labor’s savings andgot employees so deep into debt that they’re “one paycheck away fromhomelessness.” They’re afraid to go on strike, because they would miss amortgage payment or an electric utility payment, and their credit-card interestrates would jump to 29 percent. They’re even afraid to complain about workingconditions today, because they’re afraid of getting fired.
            
Thiswasn’t formerly the case. It is the result of “financial engineering” thatshould be reversed. There’s no reason to treat the savings that the top 1% havegot in this predatory way as being sacrosanct. Their gain – their increase infinancial wealth, in bonds, savings and ownership of bank loans – equals thedebts that have been imposed on the bottom 99%. This is the basic equation thatneeds to be more widely understood. It is not an equilibrium equation. Atleast, it won’t be political equilibrium when people start to push back.
            
Weare seeing a financial grab for special privilege and for political power touse the government to subsidize the top 1% at the expense of the bottom 99%, byscaling back social spending, Social Security, Medicare, Medicaid and federalrevenue sharing with the states. The Treasury and Federal Reserve have printednew debt to give to Wall Street – some $13 trillion and still counting sinceLehman Brothers went under in September 2008. Tim Geithner and Hank Paulsonused the crisis as an opportunity to give enormous U.S. debt to Wall Street.That’s more radical than reversing this to restore the economy’s financialstructure to the way it used to be. If you don’t restore it, you’ve replacedeconomic democracy with financial oligarchy.
            
Theway to reverse this power grab is to reverse the giveaways by cancelling thebad debts that have been loaded onto the economy. That is the only way torestore balance and prevent the polarization that has occurred. The problem isthat savings by the top 1% have been used in a parasitic, extractive manner. Ithas been lent to the bottom 99 percent to get them deeper and deeper into debt.So they “owe their soul to the company store,” as the song Sixteen Tons put it.“You get a day older, and deeper in debt.”
            
Thegovernment itself has become more indebted, most recently by the $13 trillionin new debt printed and given to the banks to make sure that no financialgambler need surfer a loss. At the same time the Obama administration did this,it claimed that a generation in the future, the Social Security system may be$1 trillion in deficit. And that, Mr. Obama says, would cause a crisis – andnot leave enough to continue subsidizing his leading campaign contributors. Soin view of this new debt creation – while moving debts to consumers and SocialSecurity contributors to the bottom  ofthe list – if you are going to reverse the bad-debt polarization that we’vereached today, it is necessary to do more than simply reinstate progressivetaxation and shift the tax system so that you collect predatory unearned income– what the classical economists call economic rent. The burdensome debts needto be written off.
            
Thisprobably will take half a year to get most people to realize and accept theidea is to reconstitute the system by lending for productive purposes, notspeculation and rent-seeking opportunities. You want to stop the banks fromlobbying for monopolies to create a market for leveraged buy-outs of theseopportunities – and of course also for real estate speculation and outrightgambling.
            
WallStreet has orchestrated and lobbied for a rentieralliance whose wealth is growing at the expense of the economy at large. It isextractive, not productive. But this fact is concealed by the national incomeand product accounts reporting financial and other FIRE sector takings as“earnings” rather than as a transfer payment from the economy at large – from the 99% – to the 1% of Americanswho have got rich by making money off finance, monopolies and absentee realestate rent-seeking.
            
Itis not really radical to resist Wall Street’s financial attack on America.Resistance is natural – and so is a reversal of the savings they have built upby indebting the rest of the economy to themselves. They have taken their moneyand run, stashing it offshore in tax-avoidance islands, in Switzerland, Britainand other havens. Shame on the political hacks who defend this and who attackOccupy Wall Street simply for resisting the financial sector’s own radicalpower grab and shifted taxes off themselves onto the bottom 99%.
Privatizationis an asset grab masquerading as full employment policy

AlanMinsky: I haveone final question for you. Would you support programs that are put forwardsimilar to what Randy Wray, an associate of yours, suggests in terms ofgovernment employment projects to guarantee full employment?

MichaelHudson: Yes, ofcourse I approve. In fact, it was I who introduced Randy, Pavlina Tchernova andothers to Dennis Kucinich’s staff to help write his full-employment proposalalong these lines. My first caveat is to warn against letting the Obamaadministration turn these projects into a military giveaway. I think Randy andI are in agreement with that.
            
Mysecond caveat is to prevent this full-employment program from creating a laterprivatization giveaway to Wall Street – that is, infrastructure that thegovernment will sell off to the ruling party’s major campaign contributors forpennies on the dollar. This is what Public/Private Partnerships have become, aspioneered in England under Margaret Thatcher and Tony Blair. Wall Street isrubbing its metaphoric hands and saying, “That’s a great idea! Let thegovernment pay for infrastructure and spend a billion dollars on a bridge – andthen sell it to us for a dollar.” The “us” may not be the banks themselves, buttheir customers, who will borrow the money and pay the banks an underwritingcommission as well as interest on the money they use to buy what the governmentis privatizing.
            
Thepretense is that privatization is more efficient. But privatizers add oninterest and financial fees, high executive salaries and bonuses, and turn theroads into toll roads and other infrastructure into neofeudal fiefdoms tocharge monopolistic access fees for people to use. This is what has happened inChicago when it sold off its sidewalks to let bankers finance parking meters inexchange for a loan. Chicago needed this loan because the financial lobbyistsdemanded that it cut taxes on commercial real estate and on the rich. So thefinancial sector first creates a problem by loading the economy down with debt,and then “solves” it by demanding privatization sell-offs under distressconditions.
            
Thisis happening not only in America, but in Greece and other countries under theinsistence of Europe’s bank lobbying organization, the European Central Bank.That’s why there are riots in Athens. So the financial war against society isnot only being waged here, but throughout the world.
            
Toanswer your question about how best to promote full employment, the aim shouldbe to invest public money in a way that the Republicans and Democrats cannot laterturn around and privatize the capital investment at a giveaway price. So I amall on favor of public infrastructure spending as long as you have safeguardsagainst the financial fraud and giveaways to insiders of the sort that that thecurrent administration is sponsoring. The privatizers and their banks would liketo install tollbooths on new bridges and get a free ride to turn America into atollbooth economy. But that’s really another story.

AlanMinsky: MichaelHudson, I want to thank you for joining us on KPFK.



Michael Hudson:Thanks a lot, Alan.

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What the eurozone needs is functional finance

Posted on November 17, 2011 by | Comments Off on What the eurozone needs is functional finance

By Fadhel Kaboub.
(Also featured in the Financial Times)

Sir, The eurozone’s obsession with “sound finance” is the root cause of today’s sovereign debt crisis. Austerity measures are not only incapable of solving the sovereign debt problem, but also a major obstacle to increasing aggregate demand in the eurozone. The Maastricht treaty’s “no bail-out, no exit, no default” clauses essentially amount to a joint economic suicide pact for the eurozone countries.

The eurozone needs a functional finance approach to economic policy, which requires that the European Central Bank, as the monopoly issuer of the currency, acts as a lender of last resort to allow the expansion of aggregate demand through government spending. The ECB’s refusal to use its firepower is what is driving eurozone bond yields to unsustainable levels. The ECB can easily purchase Italian debt to lower yields, but such action would constitute a violation of Article 123 of the European Union treaty. Unfortunately, the likelihood of a swift political solution to amend the EU treaty is highly improbable. Therefore, the most likely and least painful scenario for Italy (Greece, Portugal, Spain etc) is an exit from the eurozone combined with partial default and devaluation of a new national currency.It has been fascinating to watch the entire world turned upside down during the past few weeks over the eurozone’s self-inflicted economic pain – the same pain that so many developing countries have suffered under the Washington consensus austerity measures and sound finance principles.

The takeaway lesson is that financial sovereignty and adequate policy co-ordination between fiscal and monetary authorities are the prerequisites for economic prosperity. In the end, what matters is not the level of the deficit or the national debt, but rather their effects on employment, price stability and economic growth.

Dr. Fadhel Kaboub, Assistant Professor of Economics, Denison University, Granville, OH, US

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

Posted on November 16, 2011 by | Comments Off on 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 (heh..as 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 😀 )

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.

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Posted on November 16, 2011 by | Comments Off on

European Debt Crisis

Roundtable Discussion

and

Special Post-Program Workshop for Teachers:
Teaching Applications for the Secondary Classroom
 

Roundtable Panelists
John Keating
Associate Professor, Department of Economics, KU

Stephanie Kelton
Associate Professor, Department of Economics, University of Missouri-Kansas City

Robert Rohrschneider
Sir Robert Worcester Distinguished Professor in Public Opinion and Survey Research, Department of Political Science, KU
Moderator
Victor Bailey
Charles W. Battey Distinguished Professor of Modern British History, Department of History, and Director, Hall Center for the Humanities, KU

Roundtable Discussion

Thursday, Nov. 17, 3:30-4:30
Alderson Auditorium, Kansas Union

 
———————-

Teacher Workshop

 
4:30-5:30, Curry Room, Kansas Union
 Participate in a discussion of the Roundtable and receive
free teaching materials and refreshments.
Sponsored by the KU Center for Economic Education

—————————

Both sessions are free.Roundtable does not require reservations.

To attend the Teacher Workshop, contactNadia Kardash [email protected] to reserve a space.Register early; limited seating and materials available.

 

Eurpean Debt Crisis Roundtable
Sponsored by: 
European Studies Program
Center for Global & International Studies
Hall Center for the Humanities
Departments of Classics, French & Italian, Germanic Languages

& Literatures, Slavic Languages & Literatures, and Spanish & Portuguese

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Fed Under Fire

Posted on November 14, 2011 by | Comments Off on Fed Under Fire

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ECB: Europe’s Last Hope?

Posted on November 14, 2011 by | Comments Off on ECB: Europe’s Last Hope?

Marshall Auerback on the need for the ECB to perform its duties as lender of last resort.

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Iceland’s New Bank Disaster

Posted on November 14, 2011 by | Comments Off on Iceland’s New Bank Disaster

By OlafurArnarson, Michael Hudson and Gunnar Tomasson*

Theproblem of bank loans gone bad, especially those with government-guaranteessuch as U.S. student loans and Fannie Mae mortgages, has thrown into questionjust what should be a “fair value” for these debt obligations. Should “fairvalue” reflect what debtors can pay – that is, pay without going bankrupt? Oris it fair for banks and even vulture funds to get whatever they can squeezeout of debtors? 

Theanswer will depend largely on the degree to which governments back the claimsof creditors. The legal definition of how much can be squeezed out is becominga political issue pulling national governments, the IMF, ECB and otherfinancial agencies into a conflict pitting banks, vulture funds anddebt-strapped populations against each other.
Thispolarizing issue has now broken out especially in Iceland. The country is nowsuffering a second round of economic and financial distress stemming from thecollapse of its banking system in October 2008. That crisis caused a huge lossof savings not only for domestic citizens but also for international creditorssuch as Deutsche Bank, Barclay’s and their institutional clients.
Stuckwith bad loans and bonds from bankrupt issuers, foreign investors in the old bankssold their bonds and other claims for pennies on the dollar to buyers whose websites described themselves as “specializing in distressed assets,” commonlyknown as vulture funds. (Persistent rumors suggest that some of these areworking with the previous owners of thefailed Icelandic banks, operating out of offshore banking and tax havens and currentlyunder investigation by a Special Prosecutor.)
Atthe time when those bonds were sold in the market, Iceland’s government owned100% of all three new banks. Representing the national interest, it intendedfor the banks to pass on to the debtorsthe write-downs at which they discounted the assets they bought from the oldbanks. This was supposed to be what “fair value” meant: the low marketvaluation at that time. It was supposed to take account of the reasonableability of households and businesses to pay back loans that had becomeunpayable as the currency had collapsed and import prices had risenaccordingly.
TheIMF entered the picture in November 2008, advising the government toreconstruct the banking system in a way that “includes measures to ensure fairvaluation of assets [and] maximize asset recovery.” The government createdthree “good” new banks from the ruins of its failed banks, transferring loansfrom the old to the new banks at a discount of up to 70 percent to reflecttheir fair value, based on independent third party valuation.
Thevultures became owners of two out of three new Icelandic banks. On IMF advicethe government negotiated an agreement so loose as to give them a huntinglicense on Icelandic households and businesses. The new banks acted much asU.S. collection agencies do when they buy bad credit-card debts, bank loans orunpaid bills from retailers at 30% offace value and then hound the debtors to squeeze out as much as they can, byhook or by crook.
These scavengers of the financial system arethe bane of many states. But there is now a danger of their rising to the topof the international legal pyramid, to a point where they are in a position tooppress entire national economies.
Iceland’s case has a special twist. By lawIcelandic mortgages and many other consumer loans are linked to the country’ssoaring consumer price index. Owners of these loans not only can demand 100% offace value, but also can add on the increase in debt principal from theindexing. Thousands of households face poverty and loss of propertybecause of loans that, in some cases, have more than doubled as a result of thecurrency crash and subsequent price inflation. But the IMF and Iceland’sGovernment and Supreme Court have affirmed the price-indexation of loan principaland usurious interest rates, lest the restructured banking system come togrief.
Thisis not what was expected. In 2009 the incoming “leftist” government negotiatedan agreement with creditors to relate loan payments to the discounted transfervalue. On IMF advice, the government handedover controlling interest in the new banks to creditors of the old banks. Theaim was to minimize the cost of refinancing the banking system – but not todestroy the economy. Loans that were transferred from the old banks to the newafter the 2008 crash at a discount of up to 70% to reflect their depreciatedmarket value. This discount was to be passed on to borrowers (households and smallbusinesses) faced with ballooning principal and payments due to CPI indexing ofloans.
Butthe economy’s survival is not of paramount interest to the aggressive hedgefunds that have replaced the established banks that originally lent to theIcelandic banks. Instead of passing on the debt write-downs to households andother debtors, the new banks are revaluing these loan principals upward. Theirdemands are keeping the economy in a straight jacket. Instead of debtrestructuring taking place as originally hoped for, the scene is being set fora new banking crisis.
Somethinghas to give. But so far it is Iceland’s economy, not the vulture funds. With theIMF insisting that the government abstain from intervention, the government’sapproval rating has plunged to just 10% of Icelanders for floundering so badlywhile the new owners call the shots.
TheNew Banks have written off claims on major corporate debtors, whose continuedoperations have ensured their role as cash cows for the banks’ new vultureowners. But household debts acquired at 30 to 50 percent of face value havebeen re-valued at up to 100 percent. The value of owners’ share equity hassoared. The Government has not intervened, accepting the banks’ assertion that theylack the resources to grant meaningful debt relief to households. So unpayablyhigh debts are kept on the books, at transfer prices that afford a windfall tofinancial predators, dooming debtors to a decade or more of negative equity.
Withthe preparatory work done, the time has come for the Vultures to cash inthrough re-sale of New Bank equity shares by yearend. The New Banks have kepttheir corporate cash cows afloat while window-dressing owners’ equity withunrealistic valuations of consumer debts that cannot be paid, except at thecost of bankrupting the economy.
Thereis a feeling that Iceland’s government has been disabled from acting as anhonest broker, as bank lobbyists have worked with Althing insiders – now backedby the IMF – to provide a windfall for creditors.
Theproblem becoming a global one. Many European countries and the United States facecollapsed banks and derailed banking systems. How are the IMF and ECB torespond? Will they prescribe the Icelandic-type model of collaboration betweenGovernment and hedge funds? Or should the government be given power to resist driveby vulture funds to profiteer on an international scale, backed byinternational sanctions against their prey?
The policy danger now facing Europe

Aneconomic crisis is the financial equivalent of military conquest. It is anopportunity for financial elites to make their property grab as ForeclosureTime arrives. It also becomes a political grab to make real the financialclaims that had become uncollectible and hence largely fictitious“mark-to-model” accounting. Populist rhetoric is crafted to mobilize thewidespread financial distress and general discontent as an opportunity to turnlosers against each other rather than at the creditors.
This is the point at which all the years offinancial propaganda pay off. Neoliberals have persuaded the public to believethat banks are needed to “oil the wheels of commerce” – that is, provide the creditbloodstream that brings nourishment to the economy’s moving parts. Only undersuch crisis conditions can banks collect what has become a fictitious buildupof debt claims. The overgrowth of mortgage debt, corporate debt, student loans,credit-card debt and other debts are fictitious because under normalcircumstances there is no way for them to be paid.
           
ForeclosureTime is not sufficient, because much property has fallen into negative equity –about a quarter of U.S. real estate. And for Ireland, market value of realestate covers only about 30% of the face value of mortgages. So Bailout Timebecomes necessary. The banks turn over their bad loans to the government inexchange for government debt. The Federal Reserve has arranged over $2 trillionof such bank-friendly swaps. Banks receive government bonds or central bankdeposits in exchange for their bad debts, accepted at face value rather than at“mark-to-market” prices.
Atleast in the United States and Britain, the central bank can print as much domesticcurrency as is necessary to pay interest and keep these government bondsliquid. Public agencies then take on the position of creditor vis-à-vis debtorsthat can’t pay.
Thesepublic agencies then have a choice. They may seek to collect the full amount(or at least, as much as they can get), as in the case of Fannie Mae andFreddie Mac in the United States. Or, the government may sell the bad debts tovulture funds, for a fraction of their face value.
After the September 2008 crash, Iceland’s governmenttook over the old, collapsed, banks and created new ones in their place.Original bondholders of the old banks off-loaded the Icelandic bank bonds inthe market for pennies on the dollar. The buyers were vulture funds. Thesebondholders became the owners of the old banks, as all shareholders were wipedout. In October, the government’s monetary authority appointed new boards tocontrol the banks. Three new banks were set up, and all the deposits, mortgagesand other bank loans were transferred to these new, healthier banks – at asteep discount. These new banks received 80 percent of the assets, the oldbanks 20 percent.
Then,owners of the old banks were given control over two of the new banks (87% and95% respectively). The owners of these new banks were called vultures not onlybecause of the steep discount at which the financial assets and claims of theold banks were transferred, but mainly because they already had bought controlof the old banks at pennies on the dollar.
Theresult is that instead of the government keeping the banks and simply wipingthem out in bankruptcy, the government kept aside and let vulture investorsreap a giant windfall – that now threatens to plunge Iceland’s economy intochronic financial austerity. In retrospect, none of this was necessary. Thequestion is, what can the government do to clean up the mess that it hascreated by so gullibly taking bad IMF advice?
Inthe United States, banks receiving TARP bailout money were supposed tonegotiate with mortgage debtors to write down the debts to market prices and/orthe ability to pay. This was not done. Likewise in Iceland, the vulture fundsthat bought the bad “old bank” loans were supposed to pass on the debtwrite-downs to the debtors. This was not done either. In fact, the loanprincipals continued to be revalued upward in keeping with Iceland’s uniqueindexing designed to save banks from taking a loss – that is, to make sure thatthe economy as a whole suffers, even suffering a fatal austerity attack, sothat bankers will be “made whole.” This means making a windfall fortune for thevultures who buy bad loans on the cheap.
Isthis the future of Europe as well? If so, the present financial crisis willbecome the great windfall for vulture banks, and for banks in general. Whereasthe past few centuries have seen financial crashes wipe out the savings andcreditor claims (bonds, bank loans, etc.) that are the counterpart to baddebts, today we are seeing the bad debts kept on the books, but the banks andbondholders that provided the bad loans being made whole at taxpayer expense.
Thisis not how economic democracy was expected to work during the 19th-centurydrive for Parliamentary reform. And by the early 20th century,social democratic and labor parties were supposed to take the lead in movingbanking and credit along with other basic infrastructure into the publicdomain. But today, from Greece to Iceland, governments are acting as enforcersor even as collection agents on behalf of the financial sector – as the OccupyWall Street movement expresses it, the top “1%,” not the bottom 99%.
Icelandstands as a dress rehearsal for this power grab. The IMF and Iceland’sgovernment held a conference in Reykjavik on October 27 to celebrate theostensible success in their reconstruction of Iceland’s economy and bankingsystem.
Inthe United States, the crisis that Obama Chief of Staff Rahm Emanuel celebratedas “too good to let go to waste” will be capped by scaling back Social Securityand Medicare as soon as the autumn Doomsday Clock runs down and theCongressional Super-Committee of 12 (with President Obama holding the 13thvote in case of a tie) gets to agree to make the working population pay WallStreet for its bad loans. The Greek austerity plan thus serves as a dressrehearsal for the U.S. – with the Democratic Party playing the role ascounterparts to Greece’s Socialist Party that is sponsoring austerity, andexpelling labor union leaders from its ranks if they object to the granddouble-cross.

*Olafur Arnarson is an author and columnist atPressan.is. Michael Hudson is Prof. of Economics at UMKC. Gunnar Tomasson is aretired IMF advisor.

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MMP Blog #24: What if Foreigners Hold Government Bonds?

Posted on November 13, 2011 by | 1 comment

By L. Randall Wray

Previously, we have shown that government deficits lead to an equivalent amount of nongovernment savings. The nongovernment savings created will be held in claims on government. Normally, the nongovernment sector prefers to hold some of that savings in government IOUs that promise interest, rather than in nonearning IOUs like cash. Further, we have shown that budget deficits create an equivalent amount of reserves. And banks prefer to hold higher-earning assets than reserves that pay almost nothing (until recently, they paid zero in the USA). Hence, both savers as well as banks would rather have government bonds. We, thus, find that in normal times government will offer interest earning bonds in an amount almost equal to its deficits (the difference is made up by bank accumulation of reserves and private sector accumulation of currency).

However, when government deficit spends, some of the claims on government will end up in the hands of foreigners. Does this matter? Yes, according to many. At one extreme we have many commentators worrying that the US government might run deficits, but will find that the Chinese desire to “lend to” the US government is insufficient to absorb bond issues. Others argue that while Japan can run up government debt to GDP ratios equal to 200% of GDP this is only because more than 90% of all that debt is held domestically. The US, it is said, cannot run up debts that great because so much of its “borrowing” is from foreigners—who might “go on strike.” Others worry about ability of the US government (for example) to pay interest to foreigners. And what if foreigners demand more interest? And what about effects on exchange rates? This week, we begin to look at such issues.

Foreign holdings of government debt. Government deficit spending creates equivalent nongovernment savings (dollar for dollar). However, some of the savings created will accumulate in the hands of foreigners, since they can also accumulate the government’s domestic currency-denominated debt.

In addition to actually holding the currency including both cash and reserves (indeed, it is possible that foreigners hold most US dollar-denominated paper currency), they can also hold government bonds. These usually just take the form of an electronic entry on the books of the central bank of the issuing government.Interest is paid on these “bonds” in the same manner, whether they are held by foreigners or by domestic residents—simply through a “keystroke” electronic entry that adds to the nominal value of the “bond” (itself an electronic entry). The foreign holder portfolio preferences will determine whether they hold bonds or reserves—with higher interest on the bonds. As discussed in previous weeks, shifting from reserves to bonds is done electronically, and is much like a transfer from a “checking account” (reserves) to a “savings account” (bonds).

There is a common belief that it makes a great deal of difference whether these electronic entries on the books of the central bank are owned by domestic residents versus foreigners. The reasoning is that domestic residents are far less likely to desire to shift to assets denominated in other currencies.

Let us presume that for some reason, foreign holders of a government’s debt decide to shift to debt denominated in some other currency. In that case, they either let the bond mature (refusing to roll over into another instrument) or they sell it. The fear is that this could have interest rate and exchange rate effects—as debt matures government might have to issue new debt at a higher interest rate,and selling pressure could cause the exchange rate to depreciate. Let us look at these two possibilities separately.
                a) Interest rate pressure. Let us presume that sizable amounts of a government’s bonds are held externally, by foreigners. Assume foreigners decide they would rather hold reserves than bonds—perhaps because they are not happy with the low interest rate paid on bonds. Can they pressure the government to raise the interest rate it pays on bonds?

A shift of portfolio preferences by foreigners against this government’s bonds reduces foreign purchases. It would appear that only higher interest rates promised by the government could restore foreign demand.

However,recall from previous discussions that bonds are sold to offer an interest-earning alternative to reserves that pay little or no interest. Foreigners and domestic residents buy government bonds when they are more attractive than reserves. Refusing to “roll over” maturing bonds simply means that banks taken globally will have more reserves (credits at the issuing government’s central bank) and less bonds. Selling bonds that have not yet matured simply shifts reserves about—from the buyer to the seller.

Neither of these activities will force the hand of the issuing government—there is no pressure on it to offer higher interest rates to try to find buyers of its bonds.

From the perspective of government, it is perfectly sensible to let banks hold more reserves while issuing fewer bonds. Or it could offer higher interest rates to sell more bonds (even though there is no need to do so); but this just means that keystrokes are used to credit more interest to the bond holders.

Government can always “afford” larger keystrokes, but markets cannot force the government’s hand because it can simply stop selling bonds and, thereby, let markets accumulate reserves instead.

                b) Exchange rate pressure. The more important issue concerns the case where foreigners decide they do not want to hold either reserves or bonds denominated in some currency.

When foreign holders decide to sell off the government’s bonds, they must find willing buyers. Assume they wish to switch currencies, so they must find holders of other currency-denominated reserve credits willing to exchange these for the bonds offered for sale. It is possible that the potential buyers will purchase bonds only at a lower exchange rate (measured as the value of the currency of the government bonds that are offered for sale relative to the currency desired by the sellers).

For this reason, it is true that foreign sales of a government’s debt can affect the exchange rate. However, so long as a government is willing to let its exchange rate “float” it need not react to prevent a depreciation.

We conclude that shifting portfolio preferences of foreign holders can indeed lead to a currency depreciation. But so long as the currency is floating, the government does not have to take further action if this happens.

Current accounts and foreign accumulation of claims. Just how do foreigners get hold of reserves and bonds denominated in a government’s domestic currency?

As we have shown in previous weeks, our macroeconomic sectoral balance ensures that if the domestic private sector balance is zero, then a government budget deficit equals a current account deficit. That current account deficit will lead to foreign net accumulation of financial assets in the form of the government’s debt. This is why, for example, the US government is running deficits and issuing government debt that is accumulated in China and elsewhere.

Of course,in the case of the US, for many years (during the Clinton and Bush, jr. presidencies) the domestic private sector was also running budget deficits—so foreigners also accumulated net claims on American households and firms. The US current account deficit guarantees—by accounting identity—that dollar claims will be accumulated by foreigners.

After the crisis, the US domestic sector balanced its budget and actually started to run a surplus. However, the current account deficit remained. The US government budget deficit grew—by identity it was equal to the current account deficit plus the private sector surplus. Given that the US government became the only net source of new dollar-denominated financial assets (the US private sector was running a surplus), foreigners must—by accounting identity—have accumulated US government debt.

Some fear—as discussed earlier—that suddenly the Chinese might decide to stop accumulating US government debt. But it must be recognized that we cannot simply change one piece of the accounting identity, and we cannot ignore the stock-flow consistency that follows from it.

For the rest of the world to stop accumulating dollar-denominated assets, it must also stop running current account surpluses against the US. Hence, the other side of a Chinese decision to stop accumulating dollars must be a decision to stop net exporting to the US. It could happen—but the chances are remote.

Further,trying to run a current account surplus against the US while avoiding the accumulation of dollar-denominated assets would require that the Chinese off-load the dollars they earn by exporting to the US—trading them for other currencies. That, of course, requires that they find buyers willing to take the dollars.

This could—as feared by many commentators—lead to a depreciation of the value of the dollar. That, in turn would expose the Chinese to a possible devaluation of the value of their US dollar holdings—reserves plus Treasuries that total over $2trillion.

Depreciation of the dollar  would also increase the dollar cost of their exports, imperilling their ability to continue to export to the US. For these reasons, a sudden run by China out of the dollar is quite unlikely. A slow transition into other currencies is a possibility—and more likely if China can find alternative markets for its exports.

Next week, we will look to the frequent claim that the US is “special”—while it might be able to run persistent government deficits and trade deficits, other countries cannot.

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A Financial Coup d’etat in the Making?

Posted on November 10, 2011 by | Comments Off on A Financial Coup d’etat in the Making?

By Marshall Auerback

It is said that the EuropeanUnion is a remarkably inefficient organization in terms of organizing economicrescue packages, but when it comes to subverting democracy, they are asruthless and efficient as a well-oiled crime syndicate.
Considerthe following:  in the space of less than2 weeks, the eurocrats have managed to eliminate two troublesome electedleaders, whose actions dared to interfere with their broader objectives offinalizing the “European Project” – a project which, to put it bluntly, islooking more and more like a financial coup d’etat.

First,Greece, which has in a sense provided the template:  Prime Minister George Papandreou, had theaudacity toseek the consent of his own people to decisions that would shape their livesvia referendum.  Well, judging from thepetulant reactions of German Chancellor Angela Merkel and French PresidentNicolas Sarkozy, this clearly wouldn’t do. Blatantly interfering with the internal affairs of a fellow democracy(and an ostensible ally), both lobbied (andthreatened) the Greek government, the end result being that Mr. Papandreou wasduly shoved aside after backtracking.
And look who’s the new PM in Greece: LucasPapademos, a former ECB official, (naturally, with the requisite Goldman Sachspedigree), in order to implement the latest set of “structural reforms”, whichwill almost certainly have the effect of deflating the Greek economy evenfurther into the ground.  Of course, theprivatizations will go ahead and Greece’s rapacious tax evading oligarchs willscoop them up at distressed values (presumably with the cash they’ve alreadystashed offshore in the London property market, or Swiss banks), therebyconsolidating their control of an increasingly dysfunctional Greek economy.  The vast majority of Greeks will sufferhorribly.  They have no say, in a sensebeing left with the choice of shooting themselves or a firing squad.  Still, it’s not a total loss:  no doubt Goldman Sachs will reap substantial feesas it helps to auction off these very same state assets.
Across, the Adriatic, itappears as if the “Merkozy” tandem has also played its cards successfully forRound 2, this time successfully eliminating its troublesome nemesis, Italy PM SilvioBerlusconi.  Say what you will about MrBerlusconi, but in this instance he was right to object to a crude political ploy being foisted on him by theECB, the French and Germans to accept an irrational and economicallycounterproductive program fiscal austerity program in exchange for “support”from the likes of the IMF.   Ask any Argentinean what IMF “support”entails.
AllBerlusconi had to do was cast his eyes toward Athens to see the likely effectof a renewed assault on the Italian welfare state. But the markets’ euphoric reactionto his resignation was surreal: akin to turkeys voting for Thanksgiving.
InRome, this Franco-German powerplay is being overseen by a canny ex-Communist,President Giorgio Napolitano, who is in the process of engineering  life-longeurocrat, Mario Monti, as the next PM in Italy.  Look at Monti’sbackground: Impeccable credentials:  a virtual “lifer” within the European Union’stechnocratic governing structures, mingled with some private sector“experience” as a director of entities such as Coca Cola and, of course, an “internationaladvisor” to Goldman Sachs.
What is taking place isnothing less than a financial coup d’etat by the Eurozone’s rentier class.  And it is one of history’s sad ironies that,at least in the case of Italy, this is all being engineered by an ex-Communist,who likely would have been chased out of the Italian Government (a la JuanBerlinguer)  by a Cold War-driven CIA hadthis taken place but 30 years earlier.
How have we come to this passwithin the EU?  It is hard to point toone person.  We have seen this vastproject moved along by a handful of unelected bureaucrats for several decadesor more.  Jacques Delors was a truly seminal figure, but he did not actalone.  The whole of the Europeanproject has been increasingly driven by these unelected  tenured eurocrats, who  have rotated in and out of various positions withinthe EU’s governing structures and spent a few years’ getting the requisiteprivate sector training at a place like GS or JP Morgan. 
You could make the case thatthis started when then French President Francois Mitterrand came to power inthe early 1980s, and tried to implement a genuinely fresh progressive economicdirection for France. He was promptly undermined until he learned to “playball” with the powers behind the throne.  Since then, the game planhas largely remained the same:  EuropeanCommissioners set up multiple diktats, rules, regulations, minus, of course, anyreal kind of democratic recourse when they encounter popular resistance. You start small and build up gradually and create fait accomplis everywhere. 
Whenthere is democratic backlash via a referendum, the setback is onlytemporary.  Countries, such as Ireland,which dare to vote the “wrong” way in a national referendum, do not have theresults respected.   EU officialdom hasgenerally responded, not by reflecting on a popular expression of democraticwill, but ignoring the results until the silly peasants realize the egregiouserrors of their ways and re-vote the right way. 
Ifit takes two, or even three, referenda, so be it. Politically, theinterpretation of any aspect of the Treaties relating to European governancehave always been largely left in the hands of unelected bureaucrats, operatingout of institutions which are devoid of any kind of democraticlegitimacy.  This, in turn, has led to an increasing sense of politicalalienation and a corresponding move toward extremist parties hostile to anykind of political and monetary union in other parts of Europe.  Underpolitically charged circumstances, these extremist parties might become themainstream.

The one figure who emerges as a tragic figure here isGeorge Papandreaou.  However ineffectually, Papandreou had been deeply committedto making the October deal work.  But asHarvard economist (and Greek government advisor) Richard Parker has noted,Papandreou faced a firestorm on multiple fronts: competitors in his own partywho wanted his job; parliamentarians in his party who threatened to bolt overnew austerity measures; the wholesale intransigence of Samaras and NewDemocracy; to say nothing of economy that was deflating into the ground beforeany real help had arrived.  Calling for a referendum became his onlyinstrument to put out multiple fires at once—by forcing Greek politicians andtheir powerful backers to back down and by forcing European leaders back to thetable immediately to finalize a workable rescue plan in final form.

Of course, he was bound tofail, given the powerful opposition behind him. The Greek PM was being punished on the one hand by his”allies” in the EU, who have imposed collective punishment on theGreek people because of decades of embedded corruption in the system, in spiteof the fact that this Prime Minister had come clean. Making Greece a properfunctioning democracy was Papandreou’s raison d’etre for in getting into Greekpolitics. 
And, on the otherside, the parasite Greek oligarchs themselves, who saw his actions asfrontal attack on their control of the Greek economy, fought to destroy himpolitically and in effect moving Greece one step closer to a failed state.
And now Greece has provided aconvenient model.  You’ve now manufactured a crisis (that EASILY could have been solved by the ECB years ago – Greece is around 2.5% ofEurope’s GDP), which is now spreading, but providing ample opportunity to getrid of troublesome politicians who don’t do what they are told (effectivelyembrace this “stability culture” that the Germans bleat on about, butwhich in reality is nothing more than consolidation of the rentiers’ control ofthe various governments). 
Similarly in Italy, theEuropean Central Bank has been buying Italian bonds, but in very half-heartedfashion and certainly not enough to stem the relentless rise in rates.  The ECB’s new chief, Mario Draghi (also anex-Goldman man), kicked off his term with a blunt warning that Europe’s centralbank would not act as a “lender of last resort” (hiding behind dubious legaltechnicalities) and thereby put his fellow countryman in a position where hisresignation was the only course of action to salvage the country from animmediate financial crisis.

Berlusconi was also an easy target, given his colorfuland dubious private history.  And hislikely replacement, Mario Monti, is a perfect bagman for the financialoligarchs of Europe. He is, indeed, part of what one can rightly refer toas a “financial mafia” that has wrecked the world economy since 2008. Thesehatchet men of this murky and opaque financial world are now being appointed toimplement austerity on poor working households to save the financial sectorfrom a debt deflation — an artificial crisis created because of thearchitecture of the Euro system, which as we know these same financial“markets” so much celebrated when the euro was launched in 1999. Sadly, a largenumber of Italians still see the euro as their saviour from a corrupt past,which many associate with the Italian lire and high interest rates, even if thecorrupt Berlusconi has been himself intimately linked to the same Euro elite.
And Draghi himself has a dubious past: as wenoted in a recent post,historically, Italyactively exploited ambiguity in accounting rules for swap transactions in orderto mislead EU institutions, other EU national governments, and its own publicas to the true size of its budget deficit. 
Itseems indeed fitting that Draghi is now the man forced to deal with theconsequences of this national accounting fraud. But it’s hardly just for the people of Europe, all of whom will continueto get crushed under the boot of yet more fiscal austerity, by an increasinglydetached and democratically unaccountable elite.  No wonder the streets of Madrid, Athens, Romeand elsewhere are beginning to burn.

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