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Mine’s Bigger than Yours: Notes on Optimal Size of Govt.

By L. Randall Wray

For most of my career—going on 30 years–I’ve been accused of advocating Big Government. That is mostly because I adopted Hyman Minsky’s views—which I won’t go through here. Of course, those claims came from the right. I’ve always been proud of it, to some extent, even if I’ve always been critical of what my government actually does with its spending. And if I don’t piss-off at least one person every day, I’ve failed.

For the past 20 years as we developed the MMT approach and the JG/ELR proposal, we’ve faced all manner of ridiculous accusations: we advocate slavery (offering a job to someone who wants to work is no different from chaining him and whipping him and forcing him to pick cotton in the hot sun from sunrise to sunset) or communism (proposing full employment as a policy goal is the same thing as forcing everyone to share their undergarments) or fascism (noting that taxes-drive-money is equated to herding Jews into gas chambers).

Of course, those claims came mostly from the left—indeed, all three were proclaimed in the same sentence by a prominent Post Keynesian, and repeated at every opportunity by him and all his followers.

And now there is a whole website devoted to an “alternative” modern money view (called MMR—which I’ve not been able to decipher; it either stands for Measles, Mumps, and Rubella, or Monetarily Mentally Retarded—neither is very PC as an identity, I must say) insisting that the MMT approach embraces Nazi authoritarianism, since as we all know, no democratic government would ever impose taxes, much less use them to drive money (nay, according to MMR everyone would sit around leaderless campfires and barter with seashells whilst singing Kumbaya).

Oh and then there is the guilt by association: some financial markets people as well as Austrians agree with some of MMT, thus, MMT has to be an evil plan developed by Goldman Sachs to take over the world. This is the view of both right and left critics.

And now we find ourselves accused of advocating Small Government. The ultimate insult!
In a bizarre twist, the critics have been able to combine the guilt-by-association (some MMTers actually are willing to discuss Austrians views! Oh my, what has the world come to?), ad hominem attacks (a hedge fund manager must be against government!), and faulty logic (explaining how a JG is an automatic stabilizer must mean you are against discretionary fiscal stimulus!) to come up with yet another attack—and, again by Progressives (obviously—since Austerians want smaller government, so presumably they welcome us to the Small Government fold!).

I don’t think either our Austerian friends or our Progressives have the foggiest notion how big the federal government now is, what it spends on, and how much greater spending would need to be to fund all the programs Progressives want (and that Austrians fear).

I don’t know if this is going to make me more of a Big Government type or enhance my newly found Small Government reputation. But let’s see what the Federal government actually spends, using 2010 data (latest more-or-less actual data from the 2012 Economic Report of the President). The total is $3.5 Trillion, which is 24% of GDP that reached $14.66 Trillion.

Note that this is unusually high compared to trends due to the “big spending Democrats in the White House”.
No, actually it is big because GDP was depressed by the deep recession while government spending rose mostly automatically to deal with unemployment, poverty, and medical problems brought on by the crash.
But let’s take 24% of GDP as a rough approximation of the size of our “Big Government”. Note I am not including state and local governments—these are users, not issuers of the currency. Their spending is “paid for” by taxes, fees, fines, and some funding from Washington. I can see arguments either way for including them in our measure of the size of “Big Government” but I think that from the MMT perspective it makes more sense to leave them to the side.

I have added in parentheses the percent of GDP for the biggest items: defense (5%), Education and so on (1%), Health (2.5%), Medicare (3%), Income Security (4%), and Social Security (5%). Nothing else really matters much individually. Note there are well-known problems with the defense number—the reported figure significantly understates actual spending because a lot of “defense” activities are secret; some of the spending is hidden in other categories. Some is probably not reported anywhere.

Total: On-budget and off-budget …………………………………. 3,456,213    (24%)
National defense …………………………………………………………….. 693,586     (5%)
International affairs ……………………………………………………….. …45,195
General science, space and technology ………………………… ….31,047
Energy ………………………………………………………………………. ……..11,613
Natural resources and environment ……………………………… ….43,662
Agriculture ………………………………………………………………… …….21,356
Commerce and housing credit ……………………………………  ….–82,298
Transportation ………………………………………………………………… 91,972
Community and regional development …………………………. …23,804
Education, training, employment, and social services ……..127,710      (1%)
Health ………………………………………………………………………. ……369,054      (2.5%)
Medicare ………………………………………………………………….. ……451,636      (3%)
Income security ……………………………………………………………….622,210      (4%)
Social security …………………………………………………………… …..706,737      (5%)
Veterans benefits and services …………………………………….. .108,384
Administration of justice …………………………………………….. ….53,436
General government …………………………………………………… ……23,031
Net interest ………………………………………………………………….. ..196,194
Undistributed offsetting receipts ……………………………………–82,116
OK for our conservative and Austrian Austerians, a government that is almost 25% of our economy is far too big. For our progressive friends it is far too small. Let’s focus on the big things.
At least a fifth of all government spending goes to “defense”—and the actual figure is probably double that (say, 10% of GDP). Judging from libertarian support for Ron Paul and from the traditional progressive opposition to US imperialism abroad, I suspect we can agree that “defense” spending is far too big. Personally, I have opposed all US invasions of other nations with the exception of our participation in WWII. I’d bring all troops home, close all foreign bases, and prohibit further military adventures abroad; as our Republican friends say, “starve the beast” by cutting all military spending down to what is necessary to maintain a purely defensive force within our borders. The only foreign intervention I would support would be to air drop food and medical supplies wherever they are needed.
I know I won’t get my way. I would not call this a Big Government or Small Government preference—it is anti-war. But let us presume we scale back “defense” spending to a scale that makes it hard to mount sustained invasions abroad—to, say, 2% of GDP. (That should be sufficient to put a tank into the hands of every gun-loving and motherland-protecting patriot to ward-off attack.) We’ve thereby reduced the reported size of government by 3% of GDP (and perhaps actual size by 8% of GDP—but we will ignore that in calculations below). So, a 3% reduction of Big Government.
MMTers want a universal Job Guarantee program at a living wage. Various calculations have put that at about 1% of GDP, with net cost close to zero (due to savings on anti-poverty programs, unemployment compensation, and so on). Let’s say that is off by an order of a three hundred percent—true cost turns out to be 3% of GDP. That just replaces the reduction of defense spending, getting us back to 24% of GDP.
Now it is unreasonable to presume there is absolutely no reduction of “welfare” spending—in the form of “income security” that is 4% of GDP. We’ll offer a job to all who want to work, creating somewhere between 10 million and 30 million new jobs at a living wage (note that not all of the new jobs will be in the JG program—that depends on “multiplier” job creation in the private sector, but those jobs will also pay living wages or otherwise workers cannot be recruited out of the JG). Unemployment compensation, food stamps, and even some “tax expenditures” on the earned income tax credit will all decline.
Stephanie Kelton and I have replicated earlier work done by Hyman Minsky showing that a JG program will eliminate most poverty (defined as those below the official poverty line) just by providing one minimum wage job per household. At a higher wage, and by offering more than one job to households that want more work, the JG would raise most families well above the poverty line. Let us say that income security spending falls by a couple of percentage points (2% reduction). That offsets two-thirds of the JG program spending.
Note also there will be a bit of saving in the “education, training, employment, and social services” category that currently prepares workers for jobs that do not exist. But let’s keep the 1% devoted to that spending but instead prepare workers for jobs that will exist. So I won’t count any reduction here.
So we are down to 22% of GDP. Now let’s replace our failing US healthcare system with a universal and free, federally paid-for program that offers the range of services that are provided in the average rich nation. That will run about 7-8% of GDP. We already devote an amount equal to 5.5% of GDP to “health” and “Medicare”. Then there’s another 10% of GDP spent by consumers either out-of-pocket, through their state and local governments (“taxpayers”) and through private insurers. So we can cut total spending if we ramped up federal spending by a couple of percentage points. We’ll presume that extraordinary health spending (vanity nose jobs, anatomical augmentation, hair transplants from hairy backs to shiny scalps, etc) is taken care of by the private sector, while all the important stuff is covered by the federal government.
Let’s leave the savings to the nongovernment sector spending to the side and focus on the government’s portion: we go from 5.5% of GDP to, say, 8% of GDP for an increase of federal spending equal to 2.5% of GDP.
The remaining big category is Social Security—about three-quarters of which goes to retirees. That is the main income support for the majority of our seniors. Progressives believe benefits are too small—especially for retirees who had low earnings, and also for many who receive disabilities as well as for dependents and spouses of workers who die. Let’s ramp that up by 2% of GDP.
Note that with the JG program discussed above, that offers a living wage to all who want to work, seniors and their dependents will already have the option of earning more income from work. We should let them “double dip”—no reduction in work opportunity due to retirement onto Social Security benefits, nor in Social Security benefits should they choose to work. Living standards should be significantly higher with the boost to benefits plus the enhanced jobs prospects.
Our net impact on federal government spending so far: net increase of 2.5% of GDP. We’ve gone from a Big Government of 24% to 26.5%.
But we aren’t done yet. Let’s look to our progressive wish list for more. Public infrastructure is deficient—a point made by President Obama, and by our society of engineers that finds a deficit in our public infrastructure amounting to trillions of dollars. Yes we need bullet trains, cleaner water, better airports, bridges and hiways, and more dependable sewage treatment. And we need to join the developed world in getting our darned electrical wires safely underground so that power isn’t knocked out in every ice storm.
How much? Let’s look to the estimates provided by the progressive PERI report. They found that the rate of growth of public infrastructure spending fell by about half over the past decades; they project a needed “baseline” annual increase of $87 billion to make up for the shortfall, of which $54 billion would come from all levels of government.
Their “wish list” high end estimate would be for the public sector to spend even more, an additional $93 billion annually. However our state and local governments are broke—so let’s put the full burden on the federal government, and ramp up its spending by 1% of GDP (make it a nice round $150 billion per year). That is well above the PERI dreams—which will go beyond traditional projects and make a dent in our sustainability problems with insulation retrofitting and so on. (There is a nice synergy here as our JG workers will be doing these sorts of projects.)
So we add another percentage point to government spending.
Our Big Government is now 27.5% of GDP. We’ve got true full employment at a living wage. We’ve got universal and free healthcare. We’ve got a more generous retirement system, and better care for survivors and those with disabilities. We’ve got bullet trains and bridges that don’t fall into rivers. And we’re reducing our foreign entanglements.
All for 3.5% of GDP additional spending.
And we’ve avoided “dynamic budgeting”—we have not counted potential savings in terms of reduced incarceration for the young jobless males who turn to a life of crime. We haven’t counted health benefits; we didn’t reduce spending very significantly on income support that will face fewer demands. We didn’t count multiplier effects on private sector spending—that would reduce government spending in some areas. And so on.
All of us, progressives and Austrians alike, know we can “afford it” because a sovereign government cannot run out of its own currency. Three point five percent.
I do not know if that will comfort our Austerians, who think 24% is already far too big. Nor do I know if it will comfort our Progressives, who are now sure that MMTers have become advocates for Small Government.
To be sure, I can add some more items to the list above: more federal funding for education, federal support for sustainable agriculture (but less support for corporate farming—so that probably balances), more foreign aid, and good wine flowing from every water fountain in America.
All that might add one or two or three more percent—and get us to a 30% government. Will that horrify our Austrians, and still dissatisfy our Progressives?
Probably. Both.
What should government do?
I think reasonable people can disagree when it comes to what government ought to do. I think it is worth discussing. Lay it out on the table. Forget the silly arguments about deficits and hyperinflations and taxation by dictatorships and JG slavery and bankrupting our grandkids and associating with Austerians and Hedge Fundarians.
And about arbitrary government-to-GDP ratios. We don’t need to argue about whose is bigger. What matters is what you do with government.
What should government do? It’s a mostly political question. A 24% government (US) can do most of what most people seem to want government to do. And more than what others want. And so can a 50% government (France). The jury is still out on a 15% government (Mexico)—it would be hard to point to Mexico as either a case of a successful government doing what people want it to do, or as an Austrian Austerian utopian Small Government.
What do you want government to do? 

Confederacy-lite: The Oklahoma’s AG’s Civil War against the United States of America

By William K. Black
(Cross-posted from

The fact that only 49 State Attorneys General (“AG”) entered into the mortgage fraud foreclosure fraud settlement focused attention briefly on Oklahoma’s AG, E. Scott Pruitt. The Oklahoma Republican Party bills Oklahoma as the reddest state, and Pruitt is beet red. He refused to enter into the settlement not because it was too weak, but because it provided any reduction in the principal amount of the debt of distressed Oklahoma homeowners.

The distinguishing characteristic about Pruitt is that he was elected on the promise to launch a litigation war against the federal government, particularly federal regulation. Pruitt and his counterparts in Virginia (Ken Cuccinelli) and Florida (Pam Bondi) claim that their principal function is protecting their citizens from the depredations of – the United States of America. Pruitt, ala South Carolina in 1860, expressly politicized the cause as opposition to the elected President of the United States. He asserts that regulation is inherently illegitimate because it is done by “unelected bureaucrats.” (So is policing and firefighting and service in the military.)

“Oklahomans deserve an Attorney General who will stand up to the Obama Administration that seeks greater and greater control your life. Oklahomans deserve and Attorney General who will stand unapologetically for the truths of the Constitution.


I will serve as Attorney General of the State of Oklahoma for one fundamental reason — to advance your freedom.

Washington DC tells us that we possess freedom, yet the federal government defines the extent of that freedom through the regulations of unelected bureaucrats.”

“What is your reason for running?

“I truly believe this election is unlike any other election that any of us have ever experienced. Right now, all across Oklahoma, our families and businesses are besieged by a Congress, an Administration and its federal agencies that are hostile to our most cherished values and ideals. Furthermore, I believe that what is at stake in this election is whether we are going to live consistent with what our Constitution stands for – whether we will live with the freedoms for which we were intended. I am seeking to serve as Attorney General of the State of Oklahoma to advance your freedom….”

It is no coincidence that the three AGs represent states (a territory in the case of Oklahoma) that supported the Confederacy and use phrases and arguments made famous by secessionists. They represent the resurgence of the old, sad embrace of the great lie. The United State of America, the greatest democracy in world history, is supposedly the great evil threatening Virginia, Florida, and Oklahoma. The Confederacy viewed the great evil as the threat to the “state right” to “our way of life” – enslaving black slaves. One hundred and fifty years ago the worst disaster in U.S. history was brought on by proponents of this monstrous system. It took 150 years of massive bailouts from the Northern and Western states to the states and territories that supported the Confederacy to make it possible for them to overcome the damage their racism did to their economies.

The new Confederacy-lite has no “noble cause” akin to slavery, but the cry is still the need to preserve “our way of life.” Pruitt, during his election campaign, highlighted what he described as the epitome of federal tyranny destroying the freedom of Oklahomans. Listen to the full horror of the federal regulatory assault on the cherished “way of life” of Oklahomans.

(Aug 27 [2010]) Republican candidate for attorney general, Scott Pruitt, said today the recent petition filed by the Center for Biological Diversity and several other groups with the US Environmental Protection Agency (EPA) to ban lead in ammunition and fishing tackle is a direct assault on the freedoms guaranteed Oklahomans under the Second Amendment.

While visiting the Lawton area today, Pruitt said, “The attempts to ban lead in ammunition and fishing tackle is a back-door attack on basic freedoms we enjoy as Oklahomans and our way of life. Should the Environmental Protection Agency pursue this ban, as attorney general, I will do all I can to stop Washington bureaucrats like the EPA.”

Lead is highly toxic, so removing lead from ammunition would be exceptionally good for waterfowl (who feed in a way that can fatally concentrate lead pellets) and for hunters who eat waterfowl. Non-toxic ammunition is now readily available. I do not know why Pruitt thinks that preventing the poisoning of waterfowl “is a[n] attack on basic freedoms” and Oklahomans’ “way of life.” The Oklahoma “way of life” is to shoot waterfowl and eat them. You cannot shoot or eat waterfowl that die from poisoning themselves by ingesting lead shot in a marsh along the migratory flyway six hundred miles north of Oklahoma. Waterfowl are big believers in interstate commerce.

We adopted the U.S. constitution in great part because under the Articles of Confederation the States interfered with interstate commerce in ways that harmed the national interest and because the States could not protect their citizens’ interests when protecting those interests depended on actions taken in other states. [EPA denied the petitions asking it to regulate lead ammunition and sinkers.]

It isn’t fair, of course, to characterize Pruitt’s passion to defend the right to poison ducks as typical of his basis for making his assault on federal regulation his office’s top priority. Pruitt wants to sue to stop most federal regulations that protect Americans. Oklahoma is a huge energy producer, so Pruitt’s real hate is any rule that restricts pollution or increases energy efficiency. Under Pruitt’s ideology, it is tyrannical for the EPA to protect Americans from pollution or for Congress to require NHTSA to adopt rules requiring that vehicle manufacturers improve the fuel efficiency. Providing health care to Oklahomans who cannot afford health care is tyrannical.

“Limited Government:

The passage of President Obama’s healthcare legislation in Washington fundamentally alters the relationship of citizen to government in America. Rather than government serving the citizen, it seeks to become master, controlling, dictating and utilizing power it does not possess.

Our founding documents are legal documents, not suggestions. They exist to control the impulses of men, and counteract the temptation toward tyranny; where elected individuals think they know better than the people they serve, that they are somehow more enlightened. The Founders defeated a monarchy that believed such things. We must in our generation now do the same.

I will, on behalf of Oklahomans, initiate a constitutional challenge to the legislation in its entirety, with a goal of rendering the legislation null and void in the State of Oklahoma.”

Pruitt has a self-inflicted problem with candor when it comes to his openly partisan attack on what he repeatedly labeled “Obamacare.” He now repeatedly denies that he has made such references.

“Pruitt, who was elected attorney general last year, said his office has filed two lawsuits against the federal government’s Affordable Care Act, also known as Obamacare. However, Pruitt said he does not refer to the controversial health care legislation as Obamacare because the issue is not about politics for him.”

Pruitt gently chided those who refer to the law as “Obamacare,” saying, “You will never hear me say ‘Obamacare.’ This is too important of an issue to make it partisan. It’s not about health care. It’s about the Constitution.”

In the face of budget cuts that have greatly reduced the already grossly inadequate ability of State AGs to protect their citizens from elite white-collar criminals, Pruitt redirected the scarce resources of his office away from protecting the citizens from the elite criminals.

“As part of keeping one of my primary commitments during the campaign, I formed a special federalism unit dedicated to the purity of constitutional balance of power, enforcing the plain meaning of the founders’ directive that the federal government be one of specific and enumerated powers, and conversely preserving to Oklahoma and its citizens reserved powers, all with an aim of preserving individual liberty. The Office of Federalism is under the direction and leadership of my Solicitor General, who constantly monitors the actions of the federal government and works as my top appellant litigator.”

“Office of Federalism

Inside the Office of Federalism I will assign attorneys in the A.G.’s office whose primary responsibility is to determine how the office can and should push back against Washington. Whether it’s related to property rights, the right to keep and bear arms, the right to educate our children, or related to the first amendment, the attorney general must have resources and leaders internal to the office fighting those battles every day.

In addition to bringing suit against the Obama Administration’s newly passed health care mandates, the new Office of Federalism will defend Oklahomans against agencies such as the Environmental Protection Agency when its regulations seek to establish climate and energy policy absent congressional action, and the Nat’l Highway Traffic & Safety Administration in setting new fuel-economy standards.”

The federal government is a massive enterprise, yet Pruitt has prioritized his inadequate resources to “constantly monitor[] the actions of the federal government” in an effort to achieve “purity” of the constitutional balance of power. His office brings suits designed to allow elites to become even wealthier by maiming or killing others through their pollution.

“This week, we also saw the EPA delay the announcement of draconian ozone standards they seek to put in place to advance a leftist-environmental agenda until after the November elections. This is the politics of Washington bureaucrats trying to hide their intentions from the people of Oklahoma, and it’s got to be stopped.”Pruitt said as attorney general one of the first initiatives of his administration will be to prioritize resources in the AG’s office, and dedicate a team to defend against abuses of power by the federal government that impact Oklahomans, “I will assign attorneys in the AG’s office whose primary responsibility is to determine how the office can and should push back against Washington. Whether its related to property rights, the right to keep and bear arms, the right to educate our children, or related to the first amendment, the attorney general must have resources and leaders internal to the office fighting those battles every day,” said Pruitt.

“I will be a new type of Attorney General. I will be an activist Attorney General, but from the conservative side of the political spectrum. I will shift existing resources to create an ‘Office of Federalism’ whose task it will be to keep the federal government from unduly burdening Oklahomans and Oklahoma businesses.”

In his election campaign, Pruitt used “battle” metaphors to describe his “activist” role and that of his new federalism office.

Issue Position: Office of Federalism

“I will establish an Office of Federalism with the Attorney General’s office. I will assign attorneys in the A.G.’s office whose primary responsibility is to determine how the office can and should push back against Washington. Whether its [sic] related to property rights, the right to keep and bear arms, the right to educate our children, or related to the first amendment, the attorney general must have resources and leaders internal to the office fighting those battles every day.”

Pruitt campaigned on the basis that he would protect the freedom to exercise one’s religion in the public space. In office, he has made clear that there is only one exception to that rule – Muslims are not welcome to seek to exercise their religion in the public sphere. Pruitt has continued to defend the constitutionality of an Oklahoma law that blatantly singles out Muslim religious tenets for discrimination in a manner that is inescapably unconstitutional under the U.S. and Oklahoma constitutions.

Pruitt’s twin objections to the national foreclosure fraud settlement with five massive financial institutions were that it sought reforms to their foreclosure practices to prevent the resumption of the endemic fraud and modestly reduced the principal on some underwater loans to borrowers. He is the perfect embodiment of Confederacy-lite – he runs his office to protect his elite contributors at the expense of Oklahomans.

Of course, he claims that he is doing the opposite – protecting little banks by going after the largest banks that the Obama administration refuses to go after. Indeed, he asserts that the federal government intentionally destroys small banks through regulation in order to ensure systemically dangerous institutions’ (SDIs) dominance.

“Sixty-eight percent of all money in this country is deposited into seven banks,” Pruitt said. “The regulatory environment is strangling the life out of community banks and I will tell you it’s intentional because the (federal government) can better manage an economy when you have all your money in just seven banks.”

When push came to shove, Pruitt sought to weaken the reforms that the Obama administration (reluctantly) imposed on the gigantic and fraudulent financial institutions. He worked against the interests of small, honest banks. Pruitt stresses that he will sue to force federal government “accountability”but he gives the big banks a pass from criminal liability or even serious civil liability.

“Pruitt has announced that he intends to establish an office to deal with federalism in the attorney general’s office with the intention of protecting Oklahoma’s rights against federal encroachment. The office would also deal with issues such as federal regulation of health care, financial business and immigration.

“I will look at options to make sure we take whatever steps necessary to hold the federal government accountable,” he said.

Pruitt previously announced that he plans on reviewing and taking some sort of action to hold the federal government responsible for securing the border. He said several states have considered such action as an alternative to enacting immigration laws such as those recently passed in Arizona.”

Bill Black is the author of ;The Best Way to Rob a Bank is to Own One and an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog New Economic Perspectives

Follow him on Twitter: @WilliamKBlack

Greece: A Default is a Better Outcome Than the Deal on Offer

By Marshall Auerback

Pick your poison. In the words of Greek Finance Minister Evangelos Venizelos, the choice facing Greece today in the wake of its deal with the so-called “Troika” (the ECB, IMF, and EU) is “to choose between difficult decisions and decisions even more difficult. We unfortunately have to choose between sacrifice and even greater sacrifices in incomparably more dearly.”  Of course, Venizelos implied that failure to accept the latest offer by the Troika is the lesser of two sacrifices.  And the markets appeared to agree, selling off on news that the deal struck between the two parties was coming unstuck after weeks of building up expectations of an imminent conclusion. 
In our view, the market’s judgment is wrong:   an outright default might ultimately prove the better tonic for both Greece and the euro zone. 

The only questions that remain to be resolved are these: have all of the parties begun preparations to mitigate the ultimate impact of an outright default by Athens?  And will the ECB be sufficiently aggressive in combating the inevitable speculative attacks on the other members of the euro zone periphery, which are almost certain to ensue, once Greece is “resolved” one way or the other.
Within the Troika, the Germans in particular have been the champions of taking the toughest line possible against the Greeks and other “Mediterranean profligates”. But however stubborn Berlin appears to be, the Merkel Administration is certainly not stupid. At this juncture, it seems more rational to view their  ongoing promotion of fiscal austerity as a political smokescreen: In reality, what Germany likely wants to do in the case of Greece is trigger is an involuntary default so that the other PIIGS don’t get the wrong idea and ask for a similarly large haircut on their debts.  They realize the consequences that might follow, as the others gear up for similar treatment.  Far easier were Greece to move toward involuntary default, in the eyes of Berlin.
Politically, of course, the Merkel government can’t actually come out and advocate a Greek default or, indeed, outright expulsion from the euro zone. Far more politically astute to promote fiscal austerity on top of yet more fiscal austerity, (even though that is certainly not winning Mrs. Merkel any popularity points in Greece), until the Greeks themselves scream “Uncle!” and default outright.
It helps domestically as well. According to polls Angela Merkel is now the most popular politician in Germany, which is why she persists with this pernicious narrative that the problems of Greece all stem from fiscal profligacy and laziness, in contrast to the responsible and hard-working German people.
Ultimately, though an involuntary default carries risks for the stability of the euro payments system, a deal, per the terms outlined in the press, is bad for Greece.  And probably even worse for global markets, especially the bond markets.
Either eventuality creates problems but default is probably the less bad option longer term. Let me elaborate:
Greece is a hopelessly uncompetitive economy that probably shouldn’t be in the euro zone. But can you surgically detach Greece if it defaults, without some sort of impact on the entire euro payments system?

And what will the impact be on Greece itself?  The country currently runs a primary budget deficit (excluding interest payments on debt) of around 5% of GDP. Were it to default, Athens would be forced to go cold turkey (“cold Greece”?) until the primary fiscal deficit (now around 5% of GDP) is balanced. Maybe the government could suspend all military expenditures as a first pass? At the very least, they can stop buying German military equipment!
No question, that under a default, a lot of public sector employees will be sacked, pensions will be at risk, and unemployment will almost certainly go higher.  But that is certainly going to occur under the deal now being struck.   Were the country to revert to the drachma, however, they would likely be left with a substantially weaker currency, which could ultimately provide the country with the wherewithal to compete in the global economy. With a super-cheap exchange rate, Greece could become a Mecca for retirement homes, research hospitals, trans-European liberal arts colleges, and maybe low-overhead software startups. Plus, a permanent home for the Olympics. It could live happily ever after, as Florida does, on the pension income of the elderly and the beer money of the young.
This would be the source of the foreign transfers that the private banking sector won’t make anymore. In Greece’s case that credit went to the public sector and a lot of it built useful infrastructure, so it’s not a waste, but the first step is surely to cancel the debts and stop the illusion that they can be paid. And it would end the “death by 1000 cuts” currently being imposed on the Troika, which will serve no useful economic, political or social purpose.
Of course, there will be a slew of defaults and an endless series of court cases, litigation, etc., much as there was when Argentina defaulted in 2001.  But it would force the issue of debt restructuring on the table in a meaningful way and at least provide Greece with light at the end of the tunnel.
To ensure some sort of viability of the drachma, the Greek government would have to find a more credible means of ensuring tax compliance. Most Greeks with money have presumably already moved it beyond the reach of the Greek banking system, so that savings would not be wiped out. As the tide of repossessions begins, many of these oligarchs would likely start to buy back the Greek assets on the cheap, as it is doubtful that the euro banks will want anything to with them.
Beyond that, it would be important for Athens to establish a new tax system that minimises tax evasion, so as to create demand for the new drachma immediately, and mitigate the formation of an extensive parallel transactions currency. After all, it is possible that many Greeks might prefer to use the existing stock of euros in the country and there is very little the EU authorities could do to stop this (much as the US government could not prevent Panama from dollarising its economy). But in order to establish a long-lasting demand for drachmas, two things would have to happen: 
  1. The Greek government would announce that it will begin taxing exclusively in the new currency.
  2. The Greek government would announce that it will make all payments in the new currency. 

Given the country’s history of tax evasion on income tax, a national real estate tax would likely work better than a new income tax.
(See here for more details:)

On the other hand, the challenge for the European Union authorities is to ensure that speculative capital is not unleashed on the next weakest link in the chain – say, Portugal – to ensure that there is an adequate firewall established and to minimise disruptions to the entire euro payments system. It’s unclear to me whether the euro zone authorities have truly thought this aspect through and considered the best means to prevent a major disruption of the EMU payments system. Then again, perhaps this is what the ECB’s new programs are really all about.

On the other hand, I happen to think a rescue of the sort that is now being publicly mooted is worse for both sides. The imposition of yet more fiscal austerity on Greece will exacerbate the debt deflation dynamics which are destroying the country and will provide Greece with ZERO means of servicing even the reduced levels of debt. The country will still remain uncompetitive and depression like conditions will continue, with the ongoing burden of more euro denominated debt servicing.
More dangerous is the risk that comes if there is a “successful” deal: It come with the pending question- ‘if Greece doesn’t have to pay, why do I’- The Irish are asking that question already, and I’m sure the Portuguese and Spanish will soon be asking the same thing. As my friend Warren Mosler has noted: 

Possible immediate consequences of that discussion include a sharp spike in gold, silver, and other commodities in a flight from currency, falling equity and debt valuations, a banking crisis, and a tightening of ‘financial conditions’ in general from portfolio shifting, even as it’s fundamentally highly deflationary. And while it probably won’t last all that long, it will be long enough to seriously shake things up.

Longer term, a Greek default could well provoke the question, “What on earth do governments issue bonds for anyway?” That might well provoke a far more provocative debate on the nature of modern money and the self-imposed legal constraints with which sovereign governments bind themselves in their conduct of fiscal policy. But that’s probably best left to the pages of another blog post!

MMP Blog #36 What Government Ought to Do: An Introduction

By L. Randall Wray

In the nextseries of blogs we will turn to whatgovernment ought to do. This serieswill specifically treat only sovereign government—one that issues its owncurrency. From the earlier blogs, that will make it clear that we areaddressing only a government that does not face an affordability constraint.

In theseupcoming blogs we will examine alternative views about the proper role forgovernment—given that it can “afford” anything for sale in its own currency. Wefirst look at four reasons why government spending ought to be constrained. Wethen compare and contrast a typical “conservative” versus “liberal” view aboutthe scope of government. (These terms are used in the American sense—that are somewhatidiosyncratic. In America, conservative is closer to what is called “liberal”or “neoliberal” abroad. Liberal in America is closer to “social democratic” orto “labor party” abroad.)

We willwork toward developing an example of a government program that is consistentwith the MMT view of sovereign money—one that uses the principles we haveestablished in previous chapters to resolve the problem of unemployment in amanner that is consistent with both the liberal and the conservative views.That is the employer of last resort or job guarantee approach. I will concludethis series with my own view on whether MMT must include the ELR/JG proposal.

Warning:when we address views on whatgovernment ought to do, we have moved beyond description. My views of what government ought to do need not beaccepted by others, even those who fully understand MMT. I will be makingpolicy recommendations that are consistent with MMT. You do not have to likemine; you can come up with your own. I will devote a blog to an Austrianapproach to policy-making, and its goals will be different from my own.

Just Because Government Can Afford to Spend, Does Not MeanGovernment Ought to Spend. Understanding how government spends leads to the conclusion that affordability is not really theissue—government can always affordthe “keystrokes” necessary to make expenditures as desired. But that does notmean it should. We can list severallegitimate reasons for constraining government spending:
  • too much spending can causeinflation
  • too much spending couldpressure the exchange rate
  • too much spending by government might leave too few resources forprivate interests
  • government should not do everything—impactson incentives could be perverse
  • budgeting provides a lever to manage and evaluate government projects

Forexample, suppose government decides to newly hire 1000 rocket scientists for anexpedition to Pluto. Our first consideration is whether there are 1000 rocket scientists available forhire with the necessary skills. Even if government can afford its desired spending plan that does not mean it canaccomplish its mission if the resources are not available. In other words, thegovernment always faces a “real resource” constraint: do the resources exist,and are they for sale or hire? Related to this consideration: are the existinginfrastructure, technology, and knowledge up to the task of achieving programgoals. That, of course, is an important question. Let us presume that theseconditions are met.

The secondconsideration, then, concerns competition with alternative uses of theresources, what is called the “opportunity cost”. If those 1000 rocketscientists would otherwise be unemployed, then the opportunity cost of hiringthem for the Pluto mission is low or zero. (We might find, for example, that ifthey were not employed they would take care of their children at home so thenon-zero opportunity cost of employing them is the value of the foregonechildcare services. You get the picture—it is not likely that opportunity costsare zero, but for unemployed laborthey are probably low relative to benefits of employment in appropriate jobs.)

Moreimportantly, it is likely that many or most of them are already working, eitherin the private sector or on other government projects. Since sovereigngovernment does not face an affordability constraint, it can win a bidding waragainst the private sector if it chooses to do so. In that case, it will pushup the wages of rocket scientists so high that the private sector gives up andhires workers with other credentials. The impacts on the private sector couldbe complex—likely leading to higher wages, higher product costs, and even lessoutput in those sectors that use rocket scientists and other skilled workerswho can substitute to some degree for rocket scientists (perhaps for somepurposes, other types of engineers are almost as good, so firms bid up theirwages). At the very least, the Pluto mission could lead to“bottlenecks”—relative shortages of key resources—and some (perhaps limited)price hikes. In that case, public policy must consider the much greateropportunity cost of hiring rocket scientists away from other employment.

Inaddition, other wages and prices might be increased through spill-over effectsif a new government program is so big that it sets off a general bidding warfor labor and other resources. For example, during a major war like WWII,government not only conscripts workers into the military but it also redirectsresources to production for the war effort. Without rationing and wage andprice controls, it is relatively easy for this to lead to a general price andwage inflation. Note that it does not take a major war for this to happen. Ifgovernment spending pushes the economy to, and beyond, full employment it islikely that inflation will result even in the absence of a major war. At thesame time, high domestic employment and income can—under somecircumstances—lead to a trade deficit (as domestic demand for imports risesrelative to foreign demand for exports—discussed in the previous section). Thismight then pressure exchange rates (although the correlation between tradedeficits and exchange rate depreciation is far from certain).

Hence,while government can afford to spend more, it must weigh the consequences interms of withdrawing resources from other (perhaps more desirable) uses, aswell as possible impacts on prices and exchange rates.

There aremany other reasons to constrain government spending. For example, conservativesoften argue that spending on “welfare” affects incentives. A strong socialsafety net might send the signal that individuals do not really need to workbecause they can always live well enough on government hand-outs. Or,government bail-outs of business might encourage management to take excessiverisks on the belief that no matter what happens, government will cover thefirm’s losses.

Further, acorrupt government might spend on programs that help friends, but refuse to doanything to assist more deserving groups—what is often called “cronycapitalism”.  So, there could be complexand even unintended consequences of government programs.

All of thatmust be considered when undertaking government spending programs—and negativeconsequences raise legitimate concerns about the size of government spending,not due to the (im)possibility of insolvency but rather to undesired (andunknown) effects of government programs.

Finally,governments should, and do, use budgets, which are a form of self-imposedconstraint. Typically, the elected representatives will allocate a sum to bespent on a particular project. Program managers are then held accountable forfinishing the project within the budgeted amount. Over-running the budget canbe used as an indication of mismanagement. The budgeting process also helps toreduce the incentive for “mission creep”, expanding the project to enhance themanager’s power and prestige. In other words, budgeting by sovereign governmentprovides a useful mechanism for project control and evaluation.

We concludethis section by observing that absence of an “affordability” constraint doesnot imply that government ought tospend without constraint. As we discuss in the next blog, its spending ought tobe aimed toward achieving the “public purpose”. 

Response to Comments on Blog #35: Thirlwall’s Law

By L. Randall Wray

Sorry for being late. There were really only two issuesraised (ignoring the comment about MMR vs MMT—which I’m not going to addresshere).
The first concerned the orthodox belief that trade dependson comparative advantage: Italy specializes in wine because of its climate andsoil. In the case of agriculture in the old days, there isn’t too much doubtabout that—it was hard to grow grapes at the North Pole, so Santa tradeddelivery services for products made in southern climes. But once we move beyondagriculture, and after we’ve invented greenhouses and the like, there is muchless truth in this. In manufacturing, a factory can be set up anywhere in theworld, often in a few weeks, and it takes a couple more weeks to train theworkers. And out in the real world what we find is that much of the trade infinished goods is actually between “equals”: Italy sends Fiats to Germany andGermany sends VWs to Italy. Tastes or preferences, styles, desire to be different,brand loyalty, and all that matters much more.
The second is more important and concerns the belief thateconomic growth is balance-of-payments constrained, as described by TonyThirwall’s “Law”. As Neil “Ramanan” Wilson Jargued: “There have been some suggestions that Thirlwall’s law stops thegovernment expanding domestic policy and will cause ‘twin deficits’ problems(increased government and external deficits). But why would that apply togovernment and not private expansion? Thirlwall’s law appears to have a fairamount of empirical data behind it, but is that curve fitting? In other wordsdoes the Law appear true because nobody dare do the domestic expansion in thecorrect fashion necessary to test the underlying assumptions on which it is based.”
To simplify and summarize: A country like the US that has ahigh propensity to import will tend to run a trade deficit if we grow fasterthan our neighbors who have low propensities to import. We will then run out offoreign reserves quickly so will be constrained to the extent that ourneighbors won’t take our currency in exchange. Thus, our growth will beconstrained—it needs to be slower than that of our neighbors.
To be sure, Thirlwall would throw in lots of caveats thatare usually ignored by those who wave his “Law” about. Not all growth has thesame implications for the trade balance. Income distribution matters forimports—so it depends on who benefits from the growth. We could target ourgrowth to areas that make us more competitive internationally—increasingexports. If we do grow faster than our neighbors, their demand for our currency(to invest in the US, for example, to share in the bounteous growth) might growas fast as our current account surplus. If we float the currency, theconstraint is softened since a trade deficit might cause the exchange rate tofall and thereby increase exports and reduce imports. And we can change policyto encourage exports and restrict imports, or to encourage “capital” inflows(demand for our currency to buy assets). So for all these reasons, there is nosimple “Law”.
Neil also raises an important point usually overlooked bythose who advocate the “Law”: the evidence in favor of a constraint probablyhas more to do with policy overreaction than to any real constraint.Governments react to a current account deficit by tightening the fiscal andmonetary policy screws, trying to raise unemployment and slow growth. That is apolicy choice. Except for those nations that choose to peg their currencies (oradopt foreign currencies—as Greece did), it is almost always going to be a badpolicy. Indeed, pegging the exchange rate is a bad policy because it usuallyforces government to give up policy space. Unemployment is the normal price ofpegging—and it is pegging and the reaction to a current account deficit that thenmakes Thirlwall’s Law “bite”.
Let us say that a country does not impose the “Law” onitself, refusing to adopt austerity when a trade deficit appears. What happens?At a constant (but not pegged—this is a little mental experiment) exchangerate, for its current account to increase, there must be a demand for itscurrency so that its capital account surplus rises by the same amount. In otherwords, there are two sides to the coin, and as foreigners demand the currency,a capital account surplus is created, and as the domestic population demandsthe imports, a current account deficit is created. We cannot split the coin inhalf to blame one side or the other.
Let us say that the rest of the world (ROW) will not allowthat to happen—the ROW will accept the currency only if it depreciates. OK,then, the currency falls in value to find holders of the currency given acurrent account deficit. And as the currency falls, exports might rise a bit,and imports fall a bit. But let us say that this will not restore trade“balance” (recall from my earlier blog however that “balance” is a misleadingword—the balances always balance!). As the currency depreciates, the terms oftrade turn against the country. In other words, it gives up more currency toget the same basket of imports.
(Yet in real terms as a current account deficit is created,the country gives fewer exports to get imports! How ironic: the real terms oftrade move in the favor of a trade deficit nation. Exports are the cost,imports are the benefit.)
If you are an OZ that imports oil and finished manufactures,a depreciating A$ raises the A$ cost of much of what you buy. And as BillMitchell argues, the swings of the A$ are historically large and do lead to verylarge fluctuations of the domestic purchasing power. But so long as Australiakept its commitment to full employment, it tolerated these swings withoutimposing austerity. Policymakers preferred to use their domestic policy spaceto maintain growth with (nearly) full employment. So Oz consumers would remainemployed and would substitute out of expensive imports as best they could. Andthey’d probably have to reduce overall consumption when the Oz Dollar fell. Thosewho follow MMT and Functional Finance believe that is the best policy.
Should a nation like Oz adopt other policy in response to atrade deficit? Bill often uses the example of auto manufacture. Oz might havetried to keep out Japanese autos in order to promote Oz auto production. Billhas argued this makes little sense, and would cost Australian consumersdearly—both in terms of loss of choice but also in terms of a policy ofdevoting substantial real resources to produce autos at what might be a scalefar too small to achieve economies of scale. I have no dog in this hunt and noparticular opinion on the issue of Oz auto production. But Bill’s argumentmakes sense to me as a general statement. It is also related to the comparativeadvantage argument briefly discussed above. If you can import high quality andlow cost products from abroad, it may not make sense to use government policyto block the imports and to subsidies domestic production. Remember: importsare a benefit, exports a cost, in real terms. Of course that is only true ifyou have a commitment to full employment. So if auto jobs are lost governmentmust ensure alternative employment.
The immediate response always is: “but auto jobs are good;nonmanufacturing jobs are bad”. Only one who has never worked in a factorycould literally believe this. (Full disclosure: I worked in a soup factory andwhile I liked the pay, I hated the work.) What most mean is that factory jobspay well, many service sector jobs don’t.
The solution—of course!—is to make the service sector paymore. I am always amazed at the lengths to which people will go to offer“crazily improbable” (in Keynes’s words) solutions rather than looking to theobvious.
To be clear, I have nothing against using domestic policy ina strategic manner—to target areas for expansion. All economies area alwaysplanned. The questions are: by whom and for whom. But responding to a tradedeficit by imposing austerity simply imposes a “Thirlwall’s Law” growthconstraint unnecessarily.
There are many other issues related to imports, exports, andexchange rates—we’ll return to some of them in the remainder of the Primer.

A Dimon Repeatedly in the Rough who Demands Winter Rules (aka Preferred Lies)

By William K. Black
(Cross-posted from

Golf is one of the sports associated with the CEOs of big banks, so it is not surprising that Jamie Dimon is expert at seeking to invoke Winter Rules whenever JPMorganChase (NYSE: JPM) finds that its actions have placed it in an unfavorable lie.

Golfers know that they cannot unilaterally invoke Winter Rules – only the folks in charge of the course can put Winter Rules in effect. When Winter Rules are put in effect the golfer can improve his lies by placing his ball in a preferred lie.

A New York Times investigation by Edward Wyatt documented the depth of the rot at the SEC in a February 3, 2012 article entitled “S.E.C. is Avoiding Tough Sanctions for Large Banks.”

“JPMorganChase, for example, has settled six fraud cases in the last 13 years, including one with a $228 million settlement last summer, but it has obtained at least 22 waivers, in part by arguing that it has “a strong record of compliance with securities laws.””

SEC investigations have found that JPMorganChase is a serial violator of the securities laws. The bank gets caught, promises to clean up its act, gets fined, signs a typically useless consent decree that has no admissions, creates no precedent, and undercuts deterrence, and gets waived out of the few detriments there are to banks with records of serial SEC staff findings of violations.

JPMorganChase exemplifies this pattern of the SEC winking at serial fraud by the systemically dangerous institutions (SDIs). The SEC routinely allows the SDIs to operate under Winter Rules and the SDIs routinely and repeatedly employ preferred lies.

But the metaphor is inexact for three reasons. First, Winter Rules are not supposed to be routinely available. They are reserved for unusual circumstances where the course is unusually unplayable due to weather. Second, Winter Rules are available due to problems with the course not caused by the player. Third, when Winter Rules are invoked by the golf course the course posts that information publicly and Winter Rules are available to all players rather than to a subset, i.e., the wealthiest players.

Consider what the world would be like if we had a “three strikes law” for corporations. Assume that the corporations were only assessed a “strike” if the violations were attributable to the actions of a senior officer. Assume further that the SEC and the Department of Justice (DOJ) actually brought actions against the SDIs and required admissions of violations of the law in settlements and pleas. The SDIs would have been dissolved (the equivalent of being sent away for life) decades ago.

Consider the chutzpah of JPMorganChase claiming “a strong record of compliance with securities laws” after SEC staff investigations found six violations in 13 years. But that kind of arrogance and indifference to complying with the law is inevitable under an SEC regime that allows the SDIs to play by Winter Rules. “Improved lies” captures perfectly the perverse incentives that the SEC has created.

The CEOs of SDIs who know that they can commit fraud with effective impunity (the SEC fines are typically chump change from the SDIs’ standpoint) develop a belief in their divine right to transcend the law and conventional morality. Jamie Dimon captures the mindset that Nietzche celebrated for the Superman. Dimon extends the logic of transcendence to its ultimate, absurd, extreme. He is enraged that the CEOs running the SDIs have been criticized. It turns out that the SDIs’ CEOs are sensitive types. Nobody exemplifies this Rich White Whine motif better than Dimon.

“I’ve disagreed right from the beginning of this blanket blame of all banks,” Dimon said in an interview with Charlie Gasparino of the Fox Business Network Tuesday. “I don’t like that. I think that’s just a form of discrimination that should be stopped.”

The interview was taped shortly before Dimon left for the World Economic Forum summit in Davos, Switzerland, where Dimon said he will be speaking with other attendees about financial regulation. At last year’s Davos summit, Dimon made similar remarks pushing back against the vilification of the banking industry, calling it “a really unproductive and unfair way of treating people.”

No serious critic has a “blanket blame of all banks.” The blame is focused on SDIs, particularly SDIs like JPMorganChase that investigations find engaged in recurrent fraud, yet were treated to Winter Rules because they were SDIs. These SDIs are not only the bane of the world economy; they are the bane of honest banks.

Dimon has also reached the logical, albeit absurd, conclusion about the legitimacy of investigating JPMorganChase. He is tired of the investigations finding fraud, so he has decided, in the context of the settlement negotiations of the widespread foreclosure fraud by five large mortgage servicers including JPMorganChase, to offer a settlement in return for prohibiting the government from investigating his banks’ mortgage origination and foreclosure fraud.

When news reports claimed that the federal government was reducing its disgraceful offer of widespread impunity from investigation and prosecution, Dimon responded that it was likely that JPMorganChase would not enter into a settlement that did not have a broad prohibition on investigating JPMorganChase’s frauds.

“The new unit “has a pretty good chance of derailing it,” JPMorgan Chase CEO Jamie Dimon told CNBC on Thursday, referring to the settlement. JPMorgan is one of the five banks involved in those negotiations.”

Dimon is the face and mindset of crony capitalism. It is long past time for the SEC to end selective Winter Rules and Preferred Lies for the SDIs.

Bill Black is the author of The Best Way to Rob a Bank is to Own One and is an associate professor of economics and law at the University of Missouri-Kansas City. He spent years working on regulatory policy and fraud prevention as Executive Director of the Institute for Fraud Prevention, Litigation Director of the Federal Home Loan Bank Board and Deputy Director of the National Commission on Financial Institution Reform, Recovery and Enforcement, among other positions.

Bill writes a column for Benzinga every Monday. His other academic articles, congressional testimony, and musings about the financial crisis can be found at his Social Science Research Network author page and at the blog

Follow him on Twitter: @WilliamKBlack

Greece and the Rape by the Rentiers

Here’s the draft of the supposed agreement to “sort out” the Greek debt problem once and for all. According to Bloomberg, here are the essentials:

  • Greece’s 2012 GDP will shrink by as much as 5%.
  • Greece is expected to return to growth in 2013.
  • Greece will cut 15,000 state jobs in 2012.
  • Minimum wage will be cut by 20 percent.
  • There will be no increase to sales tax.
  • The government will cut medicine spending from 1.9% to 1.5% and merge all auxiliary pension funds.
  • It will also sell stakes in six companies—in particular, energy companies and refineries.

Of course, the current thrust of fiscal policy will almost certainly guarantee that there still will be a default, involuntary or otherwise, in spite of this agreement. If you don’t have a mechanism to allow growth, then how can the Greeks service their debt, even with the reduced debt burden?

Perhaps that’s the idea. Make the deal so miserable for the Greek people that the Spanish, Portuguese, Irish and Italians don’t even begin to think of trying to get a similar haircut on their debt.
Certainly, the deficit reduction won’t come. It can’t when you deflate a rapidly declining economy into the ground. Common sense suggests that a drop in private income flows while private debt loads are high is an invitation to debt defaults and widespread insolvencies.

Even with all of the concessions, the euro bosses have not officially signed off on the agreement:

* Finance ministers of the 17-nation euro zone arriving for talks in Brussels warned there would be no immediate green light for the rescue package and said Athens must prove itself first. 

* “It’s up to the Greek government to provide concrete actions through legislation and other actions to convince its European partners that a second program can be made to work,” EU Economic and Monetary Affairs Commissioner Olli Rehn said. 

* German Finance Minister Wolfgang Schaeuble, whose country is Europe’s biggest paymaster, told reporters: “You don’t need to wait around because there will be no decision (tonight).” 

* Greek Finance Minister Evangelos Venizelos flew to Brussels after all-night talks involving Prime Minister Lucas Papademos, leaders of the three coalition parties and chief EU and IMF inspectors left one sensitive issue – pension cuts – unresolved.

It is also worth pointing out that Greece’s pension payments on a per capita basis are amongst the lowest in Europe. Still, apparently, this plunder hasn’t gone far enough The Greek people must feel like Sabine Women right now.

Game, set and match to the Troika.
While we’re at it, let’s address this “Greeks as tax cheats” canard once and for all. Greece’s tax revenue from VAT collapsed by 18.7pc in January from a year earlier. As Ambrose Evans Pritchard noted:

“Nobody can seriously blame tax evasion for this. It has happened because 60,000 small firms and family businesses have gone bankrupt since the summer. 

The VAT rate for food and drink rose from 13pc to 23pc in September to comply with EU-IMF Troika demands. The revenue effect has been overwhelmed by the contraction of the economy.
Overall tax receipts fell 7pc year-on-year.”

We’re one step closer to ensuring that the birthplace of democracy becomes a form of national indentured servitude. That is of course, unless Greece regains some modicum of self-respect and tells the Troika to take a hike and leaves the euro zone.

The Elephant in the Room is Spain, Not Italy

By Marshall Auerback

Another day andthe markets remain fixated on whether Greece comes to a “voluntary” arrangementwith its creditors.  The key word is“voluntary” because the myth of “voluntary compliance has to be sustained sothat those deadly credit default swaps avoid being triggered. 
But let’s faceit:  Greece is a pimple.  If the rest of the euro zone could cut itlose with a minimum of systemic risk, Athens would have long gone the way ofTroy.  The real issue is whether thecredit default swaps trigger such a huge mess with the counterparties that itcreates renewed systemic stress which more than offsets the benefits to theholders of the CDSs. 
The moreinteresting question is:  suppose Greece finally does get a deal?  Irealize everybody says it is a “one-off”, but do you really think theIrish, Portuguese, or even the Spanish and Italians will go along with that,particularly if (as is likely) they continue to experience double digitunemployment and minimal growth?
Now you could argue thatPortugal and Ireland, like Greece, are but small components of the EuropeanUnion and could well be covered in one form or another via the existingbackstops established over the last several months, notably the EuropeanFinancial Stability Fund (EFSF) and the European Stability Mechanism(ESM). 
But you can’t say this aboutSpain, which remains the real elephant in the room – not Italy – even thoughSpain’s borrowing costs remain lower than Italy’s. This is perverse. 
Though Italy has a highsovereign debt, it has a low private debt (the product of years of high budgetdeficits, but that’s the story for another blog). Italy has a fiscal deficitthat is low relative to most economies today. It already has a primary surplus.The greater than expected past expansion of the ESCB and the current ongoingLTROs are likely to absorb panic and forced selling of Italian debt. TheItalian 10-year yield could fall back below 5% (having already fallen from the 7%plus levels, pertaining a mere 6 weeks ago).

In theory, this rally in bond yields should lead to a reassessment of thegravity of the Italian problem and therefore the European sovereign debt andbanking problem. That could be positive for equity markets and, indeed, hasbeen so since the start of the year. 

But does Spain truly deserve theborrowing advantage it now has in relation to Italy?  Its 10-year bonds are yielding some 60 basispoints lower. True, its sovereign debt to GDP ratio is low at about 75%, but partof its enormous private debt will almost certainly have to be “socialized.”  Moreover, Spain has virtually the highestnon-financial private debt-to-GDP ratio of all the major economies.  Its ratio is almost twice that of Italy’s. Itsfiscal deficit last year was probably higher than the official estimates, closeto 9% of GDP (the previous Socialist government routinely lied about itsfigures – in fact, no country, not even the US, has lied more extensively aboutthe condition of its banks.  Spain, relative to GDP, has the largestshadow real estate inventory in the world, with the possible exception ofChina, which probably doesn’t even have a reliable second or third set ofbooks).

Let’s be clear about onething:  this is not a tale of Mediterranean“profligacy”, as least as far as public spending was concerned.  Anybody looking at Spain through a sensiblefinancial balances framework in the mid-2000s would have observed that theprivate sector was being squeezed badly by the fiscal drag. The externalposition was in deficit (current account) which means the public and externalbalances were draining growth from the economy. Yet it still boomed up into theonset of the crisis. How did that happen?

The profligates were all in theprivate sector, although you could readily argue that the government’s“responsible” fiscal policy created the conditions for a private sector debtbinge.
  Prior to 2008, the Spanisheconomy was held out as the darling of Europe however the reality was quitedifferent. The country was running budget surpluses by 2005 and foreigninvestment was booming. Most of this investment went into construction whichwas stimulated by a massive real estate boom.

A few years ago, using data fromData from the Banco de España (central bank) Bill Mitchell graphed the nationalbudget deficit as a percentage of GDP for Spain and the EMU overall from 1989to 2008 (data for the EMU clearly didn’t start until 1995). As Mitchell
notes,one can observe the tightening of fiscal positions as the Growth and StabilityPact provisions were forced on the EMU nations:

EMU and Spain: Budget deficit % of GDP,1989 to 2008

Consistent with a tighteningfiscal position leading to surpluses in 2005, the only way that this boom couldcontinue was for the private sector to go increasingly into debt.That is exactly what happened and because the property boom was so large thedebt levels were also very high – average household debt tripled. And that, incontrast to Italy, is the core problem with which Spain is dealing today to asubstantially greater degree than Italy. So it’s wrong to lump the two together interchangeably as the marketshave been doing.  Paella and pasta don’tmix well together.

Okay, but that was the previousZapatero
Administration.  Now we supposedly have a new “responsible” conservativegovernment that promises to carry out the same policies even moreresolutely.  And look how successfulthey’ve been:  Spain’s joblessclaims shot up a further 4% in January from December to 4.59 million, a signthat the euro zone’s fourth-largest economy is still shedding jobs at a recordrate. All sectors posted more claims but the rise was sharpest for services at5.1%. In construction, weighed down by a four-year property slump, the numberof residents registered as job seekers rose 2.1%. Compared with the same perioda year ago, overall claims rose 8%.  GDPcontracted 0.3%.  

Okay,“give them time”, argue the defenders of the new government.  And, if the Rajoy Administration was trulyembarking on a new policy course, that would be a fair comment.  Unfortunately, this government has signed onto even tighter fiscal policy rules.
Somehowthey are expected to suck demand out of their economies through tax increasesand spending cuts, but when the slower growth that results in means the targetfor deficit reduction is not met, the Spanish, like their Greek, Irish,Portuguese and Italian counterparts, will be punished for it.

Eventhe Rajoy Administration implicitly appears to recognize this danger, as it isalready moving the goalposts in regard to its spending cuts targets as apercentage of GDP.  Unfortunately, theyblame this on external circumstances beyond their control. To the extent thatthey agree to submit themselves to rules which were routinely disobeyed by theGermans and French during the EMU’s inception, that is true, although theSpanish government refuses to acknowledge that their resolute tightening fiscalpolicy ex ante might well have something to do with the fact that Spain’seconomy continues to deflate into the ground ex post.  Remember,
thehistory of the Stability and Growth Pact has long demonstrated that thesenonsensical rules are already impossible to keep within during a significantdownturn. And now the new Spanish government wants to tighten them even furtherand invoke pro-cyclical fiscal reactions earlier.
This, at a time when the nationalunemployment rate is approaching 23%, and the youth unemployment rate (25 yearsor younger) is at 49%, according to the latest Eurostat data.

Sonearly 50 per cent of willing workers under the age of 25 in Spain are withoutwork and will remain like that for years to come. That will damage productivitygrowth for the next decade or more. It is an indication that the monetarysystem has failed and attempting to reinforce those failures with moreausterity will only make matters worse.  The new government’s proposed fiscal policy “reforms” areparticularly toxic policy mixture for Spain.

Of course, the ongoing threat ofa disorderly default in Greece also remains a potentially dangerous areaif it is not contained by the ECB’s actions.
 But it’s more interesting to see what happens as the magnitude ofSpain’s problems become more apparent.  Will the troika tell Spain that a Greek style70% haircut is not in the cards?  Willthey try to suggest that the government is rife with corruption, that thecountry is chock-a-block full of scoff-laws and tax evaders, and that theefficient Germans would do a much better job of collecting taxes?

Spain is still a relatively youngdemocracy.
  The transition began a mere37 years ago when Francisco Franco died in 1975, but there was an attemptedcoup by Antonio Tejero as recently as 1981. This is worth pondering whilst observing the implosion of Spain’seconomy. The decision for Europe’s bosses is this: they must ultimately confront theconsequences of their policy choices. They can destroy the eurozone by continuing with the same failed mix ofpolicies or by salvaging it by adding what has been missing from the outset: amechanism for shifting surpluses to the deficit regions in the form ofproductive investments(as opposed to handouts or loans). Turning stateslike Spain into sundrenched economic wastelands within the eurozone, andforcing the rest of the currency area into a debt-deflationary spiral, is amost efficient way of blowing up the whole system and possibly threatening thevery existence of Spanish liberal democracy itself.

MMP #35 Functional Finance: A Conclusion

By L. Randall Wray

Let’sfinish up the discussion of Lerner’s functional finance approach addressing twoissues: functional finance and developing nations and also the functionalfinance approach to trade deficits.

Functional Finance and Developing Nations. Most of the developing nations havea sovereign currency—which means they can “afford” to buy whatever is for salein the domestic currency, including unemployed labor. As Lerner would put it,unemployment is evidence that there is an unmet demand for domestic currencythat can be filled by additional government spending. At the same time, manydeveloping nations have fixed or managed exchange rates that reduce domesticpolicy space to some degree. They can increase policy space either throughpolicies that generate foreign currency reserves (including development thatincreases exports), or they can protect foreign currency reserves throughcapital controls.

Inaddition, they can favour policy that leads to employment and developmentwithout increasing imports (import substitution policies, for example). Theycan create jobs programs that are labor intensive (so that foreign made capitalequipment is not needed) or programs that provide the output that the newlyemployed workers need (so that they do not spend their new incomes on imports).

Governmentcan favour domestic producers over foreign producers. It can limit itspurchases of foreign goods and services to export earnings. It can try to avoidborrowing in foreign currency in order to limit its need to devote foreigncurrency earnings to interest payments.

Asdiscussed, ability to impose and collect taxes can be impaired in a developingnation. This will limit government’s ability to directly command domesticoutput. And even if it finds plenty of unemployed labor willing to work for itscurrency, those workers might find it difficult to purchase output with thatcurrency at stable prices. More diligent tax collection will help to increasedemand for the currency (since taxes are paid in the domestic currency). Inaddition, government needs to focus job creation in those areas that will leadto increased production of the kinds of goods and services the new workers willwant to purchase. That can relieve inflationary pressures resulting from risingemployment. 

For thelong run, avoiding foreign currency indebtedness and moving toward floatingexchange rates would be conducive to expansion of domestic policy space. Fullutilization of domestic resources (most importantly, labor) will allowdeveloping nations to maximize output while reducing inflation caused byinsufficient supply. Full employment of labor also provides many otherwell-known benefits that will not be detailed here.

A sovereigncurrency provides more policy space to government—it spends by crediting bankaccounts and thus is not subject to the budget constraint that applies to acurrency user. A floating exchange rate (or a managed rate with capitalcontrols) expands the policy space further—because the government does not needto accumulate sufficient reserves to maintain a peg. Well-planned use of thispolicy space will allow the government to move toward full employment withoutsetting off currency depreciation or domestic price inflation. To that end, theemployer of last resort or job guarantee model is particularly useful, a topicpursued in more detail elsewhere in the Primer.

Exports are a cost, Imports are a benefit. In real terms, exports are a costand imports are a benefit from the perspective of a nation as a whole. Theexplanation is simple. When resources including labor are used to produceoutput that is shipped to foreigners, the domestic population does not get toconsume that output, or use it for further production (in the case ofinvestment goods). The nation bears the cost of producing the output, but doesnot get the benefit. On the other hand, the importing nation gets the outputbut did not have to produce it. For this reason, in real terms net exports meannet costs; and net imports mean net benefits.

Now thereare several caveats. First, from the perspective of the producer of output, itdoes not matter who buys the produced goods or services—the firm is equallyhappy selling domestically or to foreign buyers. What the firm wants is to sellfor domestic currency in order to cover costs and reap profits. If the outputis sold domestically, the bank accounts of purchasers are debited, and theaccounts of the producing firm are credited. Everyone is happy. If the outputis sold to foreigners, the receipts will need to go through a currency exchangeso that the producer can receive domestic currency while the ultimatepurchasers are using their own currency. We will not concern ourselves with thedetails, but usually a domestic bank or the central bank will end up holdingreserves of the foreign currency (this will normally be a credit to a reserveaccount at the foreign central bank). The fact remains, however, that in termsof real resources, the “fruit of the labor” is enjoyed by foreigners when theoutput is exported, even though in financial terms the producing firm receivesa net credit to a bank account and the nation receives a net financial asset interms of foreign currency.

Second, netexports add to aggregate demand and increase measured GDP and national income.Jobs are created to produce goods and services for export. Hence, a nation thatwould otherwise operate below full employment can put resources to work in theexport sector. Wages and profits are generated, families receive incomes theywould not have received so that they are able to purchase consumption goods,and firms stay in business that otherwise might have gone bankrupt. This isprobably the main reason why governments encourage growth of exports. In themidst of the economic downturn, President Obama announced that his goal for theUS economy was to double its exports. This is a common strategy for nationsthat want to grow. However, note that for every export there must be an import;for every trade surplus there must be a trade deficit. Obviously it is notpossible for all countries to simultaneously grow in this manner—it isfundamentally a “beggar thy neighbour” strategy.

To theextent that resources are mobilized to produce for foreigners, the domesticpopulation does not receive any net real benefit. True, labor and otherresources that would have been left idle are now employed; workers who wouldnot have received a wage now get income; owners of firms who would not havesold output now receive profits. Yet, if the produced output is sent abroad,there is no extra output for domestic residents to purchase. What happens isthat existing output gets redistributed to these additional claimants—who nowhave wage and profit income. Thus, if we have only put unemployed resources towork in order to produce exports, there is no net benefit—the domesticpopulation is working “harder” but not consuming more in the aggregate becausethe “pie” available for the domestic population has not increased. Theredistribution process itself will probably require inflation as those who nowhave jobs compete for a piece of the pie, bidding up prices. To be sure, thiscould be a desirable social outcome—output gets redistributed from the “haves”to the “have-nots”, and putting unemployed people to work has numerous benefitsfor families and society as a whole (in terms of crime, family break-ups, andsocial cohesion).

But notethat this relied on the presumption that the nation had excess capacity tobegin with. If it had been operating at full capacity of labor, plant, andequipment, then it could only increase exports by reducing domesticconsumption, investment, or government use of resources. Labor and otherresources would be shifted from producing for domestic use toward satisfyingforeign demand for output. Clearly it would usually be preferable to achievefull employment by producing for domestic use rather than for export. Theadditional employment would provide both income as well as more output. Thedomestic “pie” would be larger, so that rather than redistributing from “haves”to “have-nots”, the newly employed would get pieces of the larger pie.

Anotherobvious caveat is that producing output for foreigners can be in a nation’seconomic and political interests. A nation might produce goods and servicesthat are sent abroad for humanitarian reasons—to aid in disaster relief, forexample. It might produce military supplies to aid allies. Foreign directinvestment could aid a developing country that might become a strategicpartner. And there is certainly no reason for a nation to balance its currentaccount on an annual basis—something that would be nearly impossible in ahighly globalized economy with international links in production processes.Hence we would not want to ignore various strategic reasons for exportingoutput and running trade surpluses.

We concludethat we should also take a “functional” approach to international trade: itmakes no more sense for a sovereign government that issues its own floatingcurrency to pursue a trade surplus than it does for that government to seek abudget surplus. Maximization of a current account surplus imposes net realcosts (given the caveats discussed above). Instead, it is best to pursue fullemployment at home, and let the current account and budget balances adjust.That is far better than the usual strategy—which is to pursue a trade surplusin order to get to full employment.

We now turnto a policy that will generate full employment at home. Next week: more on theemployer of last resort proposal.