Yes, larger deficits are needed to support aggregate demand at desired levels.
However, the problem is the national govts are currently like US states and as such are revenue constrained.
So relaxing the deficit limits without some kind of ECB funding guarantees can cause markets to abstain from funding the nat govts.
Said another way, without the ECB the euro members are currently deep into ‘ponzi’.
Brussels to relax 3pc fiscal targets as revolt spreads
By Ambrose Evans-Pritchard
The European Commission is preparing a major shift in economic strategy, fearing that excessive fiscal tightening will inflict unnecessary damage on a string of eurozone countries.
But the National governments can force the hand of the ECB can’t they?
TARGET2 is an overdraft system, so the national governments just need to force the local banks to buy their debt, and then the ECB has to supply the liquidity to back that transaction via the national central bank. Essentially the national central bank goes into the red at the ECB.
Marc Lavoie detailed the process on pp24 of his ‘Friendly Critique’ (http://www.boeckler.de/pdf/v_2011_10_27_lavoie.pdf). Is he incorrect?
So is the problem really that the Eurozone states have the capacity to force the ECB’s hand but refuse to do so because the leaders don’t want to be thrown out of the Brussel’s gentlemen’s club?
@Neil Wilson,
If this policy shift gains traction and EU member states embrace larger deficits, does it not imply a weaker EUR going forward?
@Ed Rombach,
There is no accepted theory of exchange rates, so I’m not sure where you get that from.
Increased spending in an area increase the private returns on the productive assets in that area. Potentially weaker financial returns are offset by stronger returns on other assets. Layer expectations on that lot and who knows.
It could go either way. About the best you can say is that it will fluctuate – much as the stock market does.
@Neil Wilson,
Neil – Correct me if I’m wrong, but my understanding of MMT thinking is that all else being equal, an increase in deficit spending increases net financial assets and too much deficit spending can be inflationary. This suggests to me scope for the currency in which the deficit spending is taking place to weaken. Am I missing something?
” This suggests to me scope for the currency in which the deficit spending is taking place to weaken. Am I missing something?”
Yes. The spending increase the value of other assets as well.
If you sell more bread you make more profit. A system committed to offset the savings of the non-government sector and target full employment necessarily leads to more valuable corporations. There are more transactions cranking through the system.
And it won’t just be domestic entities wanting that increased income.
As the government asset investors leave, the private sector asset investors turn up – layered with expectations upon expectations of both of those.
Nobody knows what the balance will be. It’s just as likely that an increase in deficit spending will cause the value of the currency to increase – particularly if the government publicly commits itself to a policy of maintaining maximum domestic output.
@Ed Rombach, Higher deficits mean higher supply of the currency which has indeed downward impact. These higher deficits however will be supportive for growth. Many cross flows. When I read in the newspapers how many people already left the euro or went short then growth perspective may make some of them return.
@walter,
OK thanx Walter. Your explanation makes sense to me. In any event, I wasn’t trying to make an ideological point…..just trying to figure out how to position in the EUR.
@walter,
Does it
“Higher deficits mean higher supply of the currency”
Spending releases money (bank deposits) but this is often drained by Govt bond issue (it isn’t when commercial banks buy bonds but other wise does)
yes, but too early to trade on that!
😉
@Neil Wilson, Pretty much. Various nat’l electorates & nat’l govs can push the ECB in different directions with differing leverage.
Result is the the dynamic equilibrium seen so far. Anything’s possible, but the adaptive process seems alarmingly slow.
@Neil Wilson,
The ECB could take the bonds of an insolvent country off the list of eligible assets and the scheme goes poof.
@Jacob Goense,
TARGET2 is an overdraft system for the central banks. There is no collateral used.
The national central bank does the collateral bit to the private banks.
And the national central bank is ultimately under the control of the national government.
@Neil Wilson,
The NCBs are are part of the ESCB framework. According to its charter they conduct credit operations with credit institutions and other market participants, with lending being based on adequate collateral.. There is a single list of what is adequate collateral.
An NCB can’t start providing liquidity without adequate collateral without leaving the ESCB. If it intends to leave it will have to settle its TARGET2 balance.
@Neil Wilson,
“An NCB can’t start providing liquidity without adequate collateral without leaving the ESCB. If it intends to leave it will have to settle its TARGET2 balance.”
But it has adequate collateral downstream – the government bonds of the nation that it is in – provided by the private banks who bought them from the government. So the liquidity request is valid for so long as the collateral is adequate for the NCB.
It’s the NCB to the ECB leg that’s the key. And that doesn’t appear to be collateralised. It’s appears to be just an overdraft system without limit and with no time period to clear out.
@Neil Wilson,
The list of what is and what isn’t adequate collateral to provide a bank with liquidity is maintained centrally. When the ECB decides to toss eg. Greek bonds from the list, banks can’t obtain liquidity by posting these bonds as collateral at their NCB anymore. I think this adequately provides the ECB with an instrument to prevent being forced to fund national governments by proxy when a government holds its banks hostage.
The TARGET2 balances of ESCB member NCBs vis-a-vis the ECB are indeed unlimited and without collateral requirements. The sum of these special TARGET2 accounts is still zero, so the ECB never created a single cent through this channel.
“When the ECB decides to toss eg. Greek bonds from the list, banks can’t obtain liquidity by posting these bonds as collateral at their NCB anymore.”
Doesn’t that in itself present the ECB with a political problem?
Because that would cause a run on the Euro – since *no* NCB could then accept those bonds. And if the Euro collapses the ECB is out of business and everybody there loses their job.
It’s the same as reserves again. There is a constraint on reserves if a central bank wants to enforce it. But the consequence is that the payment system collapsed instantly.
So is the ability of the ECB to eject a national bond a constraint or a death sentence for the currency?
So I don’t think they can make this constraint stick without signing their own resignation slips.
@Jacob Goense,
Well, they suspended the Greek bonds from eligibility without losing their jobs or crashing the payment system. They are willing to draw a line in the sand.
@Jacob Goense,
No they didn’t.
“Until then, the ECB said it would be up to national central banks to decide whether to accept the bonds as collateral for their own emergency lending facilities.”
They suspended Greek bonds for collateral for direct ECB lending facilities. Not for the payment backhaul.
@Neil Wilson, If I am not mistaken the following happened when Fortis bank went under.
Belgium wanted to nationalize it. The ECB stopped it because Belgium’s Central Bank would reach a too large overdraft and could not give enough guarantees. Belgium then knocked on the door of The Netherlands to ask for the necessary guarantees. Fortis had a lot of activities in Holland so a rescue would benefit Holland. Holland then answered that in that case we better buy the Dutch part of Fortis ourselves. This split up of Fortis happened in the end.
Obviously there are clearly limits to these overdrafts of national central banks at the ecb.
@walter,
Might be worth finding out under what rules the ECB stopped that transaction (because that’s the key and I can’t find one).
It may simply be that the Belgium government didn’t turn round and quote chapter and verse at them.
In other words is it a treaty rule, or a weak Belgium government not wanting to upset the Germans.
@Neil Wilson, I think there is and was no clear treaty rule.
The case of Fortis played in summer 2008 and the breakup was negotiated in Sep/ Oct 2008.
To a certain extent it could be argued that Fortis had the disadvantage of being one of the first to get into trouble. The massive liquidity facilities from the ecb as we see nowadays were not yet in place at that moment.
yes, though can a national govt legally force banks to buy their debt?
and the ecb supplies liquidity only on a collateralized basis, and doesn’t have to accept the govt’s debt as collateral?
@WARREN MOSLER,
ECB doesn’t appear to supply on a collateralised basis to the national central banks – only directly to private entities.
ECB appears to run a decentralised payment system with a simple overdraft mechanism between the various NCBs. No collateral required. Again a design flaw likely based on the neo-liberal myth that national central banks are ‘independent’, ie de facto creatures of the ECB rather than the member state.
So all a national government has to do is assert the true situation – even within the Euro straitjacket – and force the national central bank to act for the nation.
“yes, though can a national govt legally force banks to buy their debt?”
Nationalise a bank. The Irish effectively have two they could use. Commercial banks, regardless of ownership, can purchase government debt. It’s the NCB that is prohibited by the Euro rules.
I’m just reporting the scheme that Marc Lavoie suggests in his Oct 2010 paper (pp24) and trying to find a hole in it.
So it would require a national government desperate enough to try the scheme, and not in awe of the Brussels gravy train (which is how they keep national politicians in line – promise of better things). Then it would become a battle of wills between the ECB and the national government.
Would the ECB say stop? If they did then the Euro payments system would likely collapse along with the Euro and they’d all be out of work.
The difference with the US is that the individual member states still own their central bank. Which isn’t the case in the US Federal Reserve system.
The ECB is a joint venture of the member state national central banks, with the dividend and control returned to the NCBs. The NCBs beneficial owner is the individual state, and mostly the legal owner as well.
It would be quite useful to work out what the legal and beneficial ownership is for each member state (if anybody fancies a challenge).
So the European member states are not quite like US states. The European member states still have their own central bank – even if it is severely hogtied.
It would be better if the member state just dumped the Euro, but short of that I was wondering if this idea allowed them to do similar things within the current Eurozone framework, ie bend the rules rather than break them.
Is Lavoie right? I don’t know – but I’d like to find out.
@Neil Wilson,
I often thought about this very solution, and I discussed it on this blog a few years ago with one of the regular posters (although I can’t remember with whom). My conclusion at the time was that it would still not be an unlimited source of funding because the commercial banks still have capital constraints. Also, haircuts will be applied to the posted collateral, which means the market is still in charge of setting the rates on these national government securities.
yes, and the banks themselves have capital constraints, and raising new capital is highly problematic currently
@Neil Wilson,
” My conclusion at the time was that it would still not be an unlimited source of funding because the commercial banks still have capital constraints. Also, haircuts will be applied to the posted collateral, which means the market is still in charge of setting the rates on these national government securities.”
Capital constraints are price based – bear in mind that with a nationalised bank the government can issue securities and then use the money to increase the capital of the bank buying the securities.
nationalized banks don’t need capital. however they do need the ability to fund themselves which in the UK is not an issue but in the euro zone is THE issue
@Neil Wilson,
“The difference with the US is that the individual member states still own their central bank.”
Just to be certain, you mean “The difference with the US is that the individual [euro nations] still own their central bank.” ?
@Neil Wilson,
“Capital constraints are price based – bear in mind that with a nationalised bank the government can issue securities and then use the money to increase the capital of the bank buying the securities.”
Ok, so what happens to the bank’s balance sheets? Cash on the bank’s balance sheet stays the same, government securities increases on the asset side and equity increases on the liability side. This can only be done up to a point because of the haircuts applied to these securities for funding at the ECB. And the government hasn’t really solved its funding problems because it is still constrained in spending.
@Neil Wilson,
“ECB appears to run a decentralised payment system with a simple overdraft mechanism between the various NCBs. No collateral required.”
And I’ve heard that unlike the system for, e.g., the regional Federal Reserve banks, there’s no term (maturity date) on Target2 funding?
The possibility of an ideologically induced design flaw is tantalizing on so many levels…
there doesn’t need to be.
it all functions like a single central bank.
it’s like if one member bank borrows (collateralized) from the Dallas Fed and another has a deposit at the NY Fed.
@Neil Wilson,
Yep, there appears to be no maturity for the overdrafts between the NCB.
So theoretically all you have to do is shift the government imbalances to the NCB imbalances at the ECB and we should be good to go.
Just need a mechanism to do that.
This change is not positive unless the ecb agrees to monetize the debt and from all i have read, the eurozone technocrats will not allow that. The technocrat plan is to eliminate democracy hence no facility will be granted to not allow government to finance itself. This change, as is, only grants an increase in the debt ceiling, before penalties will commence for exceeding treaty debt limits. How very kind.
“Said another way, without the ECB the euro members are currently deep into ‘ponzi’.”
Does it define ‘ponzi’ that the value of the amount of used currency is zero?
The practical total amount of issued currency in the area is bank credit and currency users debt. Net economic value of the currency: zero as if credits and debts were totally canceled there should remain no currency tokens. Present value of currency contingent on its realization in the future.
It is impossible to give a positive value to a currency if not a state issuer. This must be a drama for the people at the ECB. The ECB is the eternal widower eternally waiting for the widow that never arrives to marriage. The possible central bank of an impossible European federal state. The conceivers of such concept forgot that a state must have a head and the head must speak to the citizenry and to speak the head must use a language. Which one?
So, in gaining the bet to make states users of the bank single currency, and ultimately control macroeconomic decisions, the people at the ECB got the following reward: they rocked the economy. I guess that at the world community of central bankers, the ECB managers are considered the most naive and incompetent.
Now there comes the difficult question: what would I do if were in the situation of people at the ECB?
I would decide based on the assumption that the Eurosystem does not need to be a single currency system. There is no reason for a bank not to work with and issue several currencies in a multi-currency system.
Therefore I would proceed to having the EZ states issue their own sovereign currencies as national euro denominations in existing unoccupied currency codes: Euro-this, Euro-that, …
At each euro national creation an Euro reference of constant value would be issued to regulate following inter nations payment of debts. This is the proper rule to use to get out of the current mess. Inter-national debts and credits are to be restructured and paid. The reference creation rule makes optimal for all nations to decouple of the single currency at the same date. Therefore there would be only one reference of value to be maintained, the actual Euro whose value would be frozen at D (decouple) Day.
Such a move would have the immediate effect of making all states solvent and of converting trillions of state debt in trillions of private savings completely protected from the side of the issuer’s solvency. Furthermore, the values of the Euronationals must tend to be constrained in a proportion of 1 to 2 as this approaches the proportion of minimum to maximum productivities. Therefore, protection in the form of expectable maximal devaluation should arise.
Of course the plan assumes that the lenders may be convinced to be repaid in real goods rather than in paper assets. For real debts to be paid, the flow of trade between the surplus and deficit countries must invert. Citizens in the surplus countries must wake for the possibility of importing more than exporting feeling being repaid… This being the case…
Coordinated national policies for economic growth could be launched all over EZ facilitated by the ECB. Coordination will target real convergence of national productivities. This has the benefit of limiting the spread of values of the national currencies, zero net inter-national transactions value, optimize absolute value of transactions.
A multi-national, multi-currency Eurosystem would make the ECB the natural European inter-national settlements bank and economic coordinator.
Would such a policy maximize my possibilities of a brilliant path in the future as a person at the ECB?
I would consider survival of the ECB as granted in the foreseeable future. A multi-national currency system if enacted will last as long as money will last in Europe…
Actually I would bet that the income of people at the ECB could have very good prospects of growing. A wealthier Europe will pay easier the services of her bank of European settlements and office of economic coordination…
@PG,
“Therefore there would be only one reference of value to be maintained, the actual Euro whose value would be frozen at D (decouple) Day.”
Frozen relative to what benchmark? Pretty big and interesting idea. Reminds me of the precursor to the EUR….the European Currency Unit, (ECU).
@Ed Rombach,
No doubt a challenging task for numerical methods. Several options may be considered, in particular because there is no other option…
The single currency Eurosystem can be seen as a bundle of currencies with exchange rate fixed to 1:1 among them.
At D Day the Euro value is set to 1. Euronationals are issued. Suppose there are only 2 Euronationals. The changes in exchange rate among the 2 currencies can be recorded relative to the reference. Suppose that the exchange rate of the Euronationals goes 2 to 1. Then relative to the 1 reference the first has gone 0.707 and the second has gone 1.414.
By arbitrage a set of currencies have their exchange rates consistent. Therefore the principle can be applied to the case of adding more Euronationals and other currencies.
@PG,
“The single currency Eurosystem can be seen as a bundle of currencies with exchange rate fixed to 1:1 among them.”
We’ve already learned that fixed vs floating Fx impossibly constrains electorates that must be increasingly agile in order to adapt.
A fixed Fx rate simply won’t work.
ponzi is when you must continually borrow to make your payments, vs paying from future income, etc.
ponzi will be not only for Euro (in the future I will forecast that Bce will print money like Fed&Boe/Boj.. Ltro it’s only a first step).. but also for $ and Gp and Jpy..
Bric are building a New World Currency.. backed on Gold&Oil..
with Gold is the best do the same thing (buy) of Asian Central Banks ?
have the Iran Nuclear sanctions to block Swift (i.e. BIC) also another target : stop the New World Currency ?
http://www.forbes.com/sites/gordonchang/2012/04/22/the-best-reason-in-the-world-to-buy-gold/
I DON’T KNOW … AND YOU ?
it’s not ponzi for those who are issuers of their own currency as they are not revenue constrained when it comes to making payment.
that’s why an ecb guarantee takes the euro members out of ponzi
see ‘the 7 deadly innocent frauds’ on this website thanks
@WARREN MOSLER,
thanks Mosler.. I read about your meeting wiht Italian Minister Spaventa (Spaventa in italian have also meaning of “frightening” 🙂
Public Debt=Private Saving => Italian Private Saving are Triple of Public Debt.. now government is tempting to make a balance with Cuts&Tax causing strong recession and also suicide of little entrepreneurs and unemployeds..
with flexible currency plus no gold standard it’s impossible “Formal” State Default.. but it’s quite sure that this cause Currency Devaluation (Imported Inflation) that on the Long Run make the necessary reorganization of the real economy.. and this happen also with an OutputGap..
I think that Print (MMT) is better that Chain Default (Mises)..
I think that Draghi and Bernanke & Other Westwrn Central Banker are doing well to dilute the inevitable sorrows for the next years..
I read the report of Boj about last QE of Aprile, and they say: we do QE but it’s not enough.. we know that government have to cut public deficit or in the future (even if the great part of bond are held by “domestic” savers.. and Boj) we risk to do the same of Europe !!!
I believe the in 2014 could be a change between Us and Eu => Us cuts and no more QE.. in Eu stabilization of cuts and more QE (or Ltro or EuroBond)
Thanks
Piero
and full employment is better than mass unemployment
😉
Warren,
Are they really like US States? I mean, can US States run deficits the way ez member states do?
@walter,
Per memory, Aussie & Canadian provinces can or used to be allowed to run a deficit. A state-level bond is essentially running a deficit?
@roger erickson,
Canadian provinces are indeed able to run deficits. In fact the credit rating of the province of Ontario was lowered a notch by Moody’s just yesterday!
FYI, the Bank of Canada is authorised to buy provincial government securities. It is also authorised to lend up to 25% of a province’s yearly revenue, although this must be paid back within less than a year.
@walter,
Just a little bit different. The states issue municipal bonds. If the state stays within federal debt limits these are tax exempt for federal tax. The states are not running up GDP sized debts though.
the short answer is yes, they are like states, but no, markets won’t let states borrow that much.
the only way the euro govts have deficits as high as they do is because they created them back when they had their own currencies.
then they just waltzed into the euro with their far too high for states deficits and here we are
note the low deficit for Lux. they never had their own currency so are more state like.
@WARREN MOSLER, I agree with all that.
But where does the supply of the currency come from in the ez?
In the US this is from spending by the federal govt, tsy, not from the individual states.
In the US we say the tsy first needs to spend and then can borrow back the supplied currency.
In the EZ there is no fed govt, tsy.
If we say that member states are currency users and need revenues (income or loans) prior to spending then who is doing the deficit spending in the ez? Who is doing the supply of the currency?
Doesn’t this mean that in the EZ the supply of the currency comes from the deficit spending of the 17 member states and in that sense these ez member states are not like US states at all?
Doesn’t this mean that the problem of the ez member states is that they are not the monopolist supplier and therefor run the risk that for interest the currency users run to one of the other suppliers (e.g. because of lower perceived counterparty risk)?
states are currency users but they also have taxing authority, and therefore are part of the ‘value’ process, though in the case of the US subordinate to the Federal govt in critical ways.
So, for example, states could pay their workers double that of the Federal govt. at the ‘expense’ of their taxpayers and alter the private sector’s cost structure/labor force/etc. accordingly.
@walter,
From commercial banks. Which is where all our money comes from.
The only difference is the treasury in euro countries can not issue central bank reserves to back spending. The Euro countries must like me and you etc get the money from the market or banks first. At the markets or banks interest rates.
So the markets and banks have all the money power not the euro Govts.
banks get actual cash in exchange for clearing balances they hold at their local ECB agent
there is no ‘power’ involved
in fact, i hear it’s relatively easy to start your own euro bank in Malta.
@walter,
Doesn’t this mean that in the EZ the supply of the currency comes from the deficit spending of the 17 member states ?
In part maybe.
Our money (as opposed to central bank reserves) is a financial asset created by millions of commercial bank journal entries.
The commercial bank
DEBITS Debt (bank loan)
CREDIT Cheque account (MONEY)
For monetary sovereign Govts the banks
DEBITS Bank reserves (not a bank loan)
CREDIT Cheque account (MONEY)
whenever the Govt pays someone
@walter,
The bond system is the expansion mechanism and the ‘acceptable collateral’ list at the NCB the way in which sufficient liquid reserves are released from that bond system to clear the payments system daily (which generally doesn’t need that big a stock in aggregate – compared to the flow of transactions going through the system).
Anybody that can create ‘acceptable central bank collateral’ denominated in the central bank liability can essentially create those central bank liabilities and has a strange indirect sort of seigniorage available to them.
I think that viewpoint applies to any of the currency systems, not just the Euro. Not sure of the dynamic of it though compared to direct central bank lending and spending of a sovereign government.
The private market system was supposed to control the amount of these ‘acceptable collateral’ things that can exist.
It didn’t.
@walter,
@RJ
Commercial banks do not add net financial assets to the economy. Loans create deposits. It all adds to zero.
@WARREN MOSLER, So to clarify, are you saying that when the euro states converted to the euro, they took outstanding government bonds issued in their respective national fiat currencies and converted them, at the specified rate, into bonds denominated in euros? This is something I’ve wondered about.
Madness, very short term thinking. Deficits might help a tiny bit in the short term but that is all. Disaster in the long run, just pushing the problems down the road and making them far worse.
you need to read ‘the 7 deadly innocent frauds’ on this website?
@JBH,
Can you accurately define your definition of the term “deficit”?
Deficit in fiat?
Deficit in some pegged value system?
Deficit in some measure of national capability?
… the semantics do get very sloppy