On Thu, Apr 15, 2010 at 12:08 PM, wrote:
Hi Warren,

I must admit that your writing and thoughts have had a significant impact upon me. Interestingly—at least from where I sit—your Soft Currency Economics paper, which I have now read 5 or 6 times, has provided me with an odd peace of mind…not sure if that is a GOOD thing or not. 🙂

thanks!

KNOWING that—so long as trust and confidence in our fiat system remains—we are always able to mitigate, at least in some manner, the impact of global financial crises through the changing of numbers ‘upward’ in the accounts of men and of institutions, is somewhat akin, I’d imagine, to an alcoholic knowing that, no matter what, an endless supply of Johnny Walker Black always exists in his basement stash.

Actually, as long as we can enforce tax collections the currency will have value.

Problem is the currency can’t be eaten or drunk, so if the crops fail it won’t help much.
All we can insure is enough currency to pay people to work, not enough things to buy

OK, so maybe the analogy is a tad morose…but hence my funny feeling about my peace of mind.

So, my question of the week revolves around the U.S.’s apparent choice to monetize (again, if you will) the IMF coffers. I point to the following from Zerohedge:

“…As we reported a few days ago, the IMF massively expanded its last resort bailout facility (NAB) by half a trillion dollars, in which the US was given the lead role in bailing out every country that has recourse to IMF funding.

We buy SDR’s with dollars which the IMF then loans, so yes.

Yesterday, Ron Paul grilled Bernanke precisely on the nature of the expansion of the US role to the NAB: “The IMF has announced that they are going to open up the NAB which coincides with the crisis in Greece and Europe and how they are going to bailed out. The irony of this promise is that in the new arrangement Greece is going to put in $2.5 billion in. I think only a fiat monetary system worldwide can come up and have Greece help bail out Greece and be prepared to bail out even other countries.

Greece needs euros, so the IMF will sell SDR’s to the euro nations to fund Greece, not the US.

SDR’s are only bought with local currency.

But we are going from $10 to $105 billion… We are committing $105 billion to bailing out the various countries of the world, this does two thing I want to get your comments on one why does it coincide with Greece,

Coincidental.

what are they anticipating, why do they need $560 billion, do we have a lot more trouble, and when it comes to that time when we have to make this commitment, who pays for this, where does it come from?

Seems they anticipate more nations will be borrowing dollars from the IMF?

We buy them by crediting the IMF’s account at the Fed. If and when the IMF lends dollars we move those dollars from the IMF’s account to the account at the Fed for the borrowing nation.

Will this all come out of the printing press once again, as we are expected to bail out the world?

Short answer, yes. long answer above.

Are you in favor of this increase in the IMF funding and our additional commitment to $105 billion?”

No.

Bernanke, of course, washes his hands of any imminent dollar devaluation – it is all someone else’s responsibility to bail out life, the universe and everything else. Bernanke pushes on “I think in general having the IMF available to try to avoid crises is a good idea.”

2 problems. First the borrowers would probably be better off using local currency solutions rather than dollars, and second the IMF terms and conditions can and often do make things worse for the borrower.

Yet Paul pushes on “Where will this money come from? We are bankrupt too.” Indeed we are, but nobody cares – that is simply some other poor shumck’s problem…”

He’s flat out wrong about the US being bankrupt but that’s another story.

best,
warren

Warren, this strikes me as problematic. YES, we can add zeros to the end of accounts and thus ‘create’ more liquidity in the global economy. HOWEVER, at what point does the world choose not to believe that those numbers in those accounts have true value?

As long as we enforce dollar taxes the dollar will have value.

warren

32 Responses

  1. “Greece needs euros, so the IMF will sell SDR’s to the euro nations to fund Greece, not the US.”

    Greece can borrow SDRs from the IMF and sell them for whatever currency they want (that’s what gives SDRs value), no?

    So Greece can sell the borrowed SDRs for USD, JPY or GBP and then the Greeks can convert them to euros in the fx market. While risky (since their revenues are in euros), it would require no funding by the other EU nations.

  2. Dan said:

    Warren, this strikes me as problematic. YES, we can add zeros to the end of accounts and thus ‘create’ more liquidity in the global economy. HOWEVER, at what point does the world choose not to believe that those numbers in those accounts have true value?

    Warren said:

    As long as we enforce dollar taxes the dollar will have value.

    Dan’s…..errrr….MY follow-up question:

    So, is all of the clamor about a V.A.T. simply a way to (a) convince the world that we ARE enforcing a ‘dollar tax’, and (b) thus maintain the credibility of said dollar?? Wouldn’t a V.A.T. undercut your call for a payroll tax holiday?

  3. VAT is about a gov that thinks it’s run out of money and needs to get more from taxing, not realizing that taxes function to regulate agg demand and not to raise revenue per se.

    we need the right level of taxation for a give level of govt spending to keep the private sector humming along at full employment levels.

    1. Earlier you wrote: “…Actually, as long as we can enforce tax collections the currency will have value…”

      The world KNOWS—they MUST know—that our monetary policies are by the very definition of inflation…well, inflationary. As more dollars ‘exist’ so a proportionally larger number of dollars just be levied in taxes…if only to keep the world from coming to believe that the dollar is a hoax.

      As you point out, the government doesn’t raise revenues, per se, when it taxes ‘us’. You say such taxation serves to ‘regulate aggregate demand’. I would put it a tad differently. I would argue that taxation acts as a damper to inflation—and when I say inflation, I am not referring to COST inflation, but to inflation of the supply of so-called dollars that exist in the reserve accounts of the FED.

      Taxation as such not only moderates aggregate demand, but also creates global confidence in the fiat dollar regime.

      But here is where things get really shady. Tax policy needs to be incredibly fluid—much more so than it is—in order to account for the myriad variables that exist in the global, fiat-dollar denominated, marketplace. A rigid tax structure makes moderation of aggregate demand—or inflation—quite difficult at best.

      What are your thoughts about overhauling the tax code?

  4. written lots on altering taxation, starting with soft currency economics on this website.

    the unemployment line says taxes are too high now.

    why do we care about ‘foreign confidence?’ not that i want to do anything disruptive, but just asking

  5. RE: foreign confidence

    Because a good deal of our commercial success and financial success—and attendant economic growth—are based upon overseas operations. I understand that, from your view, concerning oneself with foreign confidence is a vestige of the pre-1971 gold-denominated non-irredeemable regime. That since August of 1971, our concerns with foreign ‘confidence’ in the dollar is an anachronism. But MY point is that if the major players AT HOME do not understand the realities of a floating-dollar world, than why would other nations? AND, if these other nations come to believe that our monetary policies—regardless of the realities—are destructive of THEIR economic health, I would expect them to find ways, over time, to restrict American growth in their marketplaces and bleed U.S. interests in their economies.

    1. restrict American growth in their marketplaces and bleed U.S. interests in their economies. What are you saying here? Today our trade partners are net savers of dollars. From a monetary/trade perspective the foreign sector can decide they no longer wish to accumulate our worthless electronic dollars. If so, then the only way not save those dollars is to spend them on US goods and services. That is the worse case. So the US would have to transition from net spenders to producers as imports and domestic production would become more expensive. Isn’t this what the mainstream wants? More jobs. Stop consuming.

      1. @ JCM,

        But since all of those “worthless electronic dollars” are simply funds that exist in reserve accounts at the FED, isn’t the point here that this entire conversation is rather moot? In fact, couldn’t the American consumer—as long as monetary and tax policies kept him fully employed and solvent—be the world’s consumptive engine for all time??? (Not saying I agree with this. Just posing a question.)

      2. The answer is yes so long as the foreign sector wishes to save in USD. Note -as Warren + others have often stated- the trade imbalance with China and others is their problem more than it is ours. Yes we need an industrial manufacturing base as a matter of national security and that is why for example de-funding NASA, seems like a horrible idea.

  6. Dear Warren,
    I think part of the cause of all this is our dismal trade deficit. China, which runs a trade surplus with us, prospers, while we stagnate and decline. Is there a relationship? I think so, and if so, any solution which does not address the cause is likely to be ameliorative, at best.

    The basic idea is that because of the increase in supply, the the price level in the importing country goes down, decreasing the revenue available to its industries. However, that country’s demand is ultimately equal to the revenue of its industries. That is the key relationship. The country’s demand declines with the decline of the revenue of its industries. Industries do not have enough revenue to sustain themselves. With continued imports, the price level continues to go down, as does revenue and demand, along the Aggregate Supply curve. With the continued erosion of revenue, industries are increasingly idled, and unemployment increases. The importing country is forced into a deflationary spiral.

    In the exporting country, on the other hand, the price level goes up, and including the revenue from its exports, so does the revenue of its industries, and ultimately the country’s demand. Its industries, with increased revenue, grow, as does the country’s demand, along the Aggregate Supply curve. With continued exports and continuing increases of revenue, industries continue to grow. So does demand, and employment.

    A more detailed argument at my website under ‘The Effects of Unbalanced Trade.’

    With balanced trade, the price level stays the same. While some indurtries may suffer, others benefit. Total revenue, and thus total demand, do not change.

    The $400 billion or so dollars taken out of the economy in the past year represents revenue lost to US industry. I figure that’s about 4 million jobs, or almost 3% to the unemployment rate.

  7. Charles,

    I tend to agree with Antal Fekete in his assessment of this issue (of trade imbalances). The problem with such imbalances is not necessarily a monetary one per se, but one of access to productive capital. As revenues fall in domestic industries, the ability to employ the necessary greater amount of productive capital (for the purchase and servicing of equipment, for salaries and benefits, etc.) to grow the business declines concomitantly. Thus we find that the majority of productive capital growth—and export capacity—happens in overseas marketplaces, while the U.S. is compelled to grow its economy through the consumption of such goods and through the development of a larger service-oriented industrial base.

    From my conversations with Warren, and from reading his online works, I assume that he (Warren) sees this dynamic as totally fine, as long as American purchasing power, and access to dollars, remains viable. I know that there are many out there—even one of Warrens’ Senatorial-hopeful foes, Peter Schiff—who view the outsourcing of production as catastrophic for our economy. I ALSO assume that Warren would argue that this position is anachronistic, and is yet another vestige of our understanding of how economies worked prior to 1971.

    MY VIEW, at this point, lies somewhere in the middle. The problem with the views of such men as Fekete and Schiff is that a return to a capital-intensive production-based economy would, by its very nature, result in very little if any economic growth. In fact, such a move would probably result in a contraction in overall GDP, as 71% of our current model is consumptive, and any transition away from such a model would naturally flatten the growth curve.

    HOWEVER, I also am leery (not Timothy) of a model for economic stability that relies almost entirely upon the ministrations of the Federal Reserve and the Treasury, as they seek to constantly and artificially manipulate and create the need for products and the ability (of the citizenry) to pay for such products by adding zeros to the end of strings of numbers in FED and other financial accounts.

    In the end, I am still of the opinion that our belief in the power of the FIAT dollar—and the belief that we can create an economy based upon our tweaking the numbers—will eventually falter. I understand that from a purely accounting-based and mathematical standpoint, the floating currency regime is virtually infallible. But lest we forget, ALL of the systems that control and maintain the workings of our monetary system are extremely fallible…they are human. And until we find a a way to employ an irredeemable currency regime that cannot be gamed and abused and defrauded by the greed of men, we are, in my opinion, setting ourselves up for a big fall.

    DW

    1. Dan

      I think Antal Fekete has it exactly right. While the FIAT dollar may work in isolation, or in a balanced trade regime, I’m not so confident in its ability to overcome the massive trade imbalance we experience. Eventually, things have to be repaid with things. We can’t just throw money at the Chinese, or expect the world to feed our appetites, without equal return. I don’t think the consumptive model is viable in the long run, a return to capital intensive production is desirable. I think a GDP that is 71% consumptive, is more than we can afford. (It was under 65% until 1990.) And I think basing a growth in GDP on a growth in consumption is the cart before the horse. In the long run, we have to produce as much as we consume. We have to invest, but I’m afraid the fiscal conservatives may initiate slash and burn before we get to it, and that would be the worst thing, contracting the economy when there’s still lots of dollars out there.

      Anyway, if the Chinese dump their dollars, won’t the government have to raise taxes to bring inflation under control? And does the government have the balls to do it enough?

      Perhaps I’m still under the delusion that a dollar is a promise by the American people to provide the equivalent in goods and services, and that a run on them will weaken our currency to such extent that… well, I’m not sure. It can’t be a pretty picture though.

      Hmm. Think this through. With balanced trade, it wouldn’t matter, because on the net we would be trading goods for goods. With unbalanced trade though, a contraction in imports, a spike in commodity prices. A seriously lowered standard of living….Add to this, we’ll have to recapitalize, and under adverse circumstances. And the Chinese would get the opposite.

      Meanwhile, our banks are furiously buying up commodities. Thoughtful of them.

      1. @ Charles:

        you wrote, “…Eventually, things have to be repaid with things. We can’t just throw money at the Chinese, or expect the world to feed our appetites, without equal return. I don’t think the consumptive model is viable in the long run, a return to capital intensive production is desirable. I think a GDP that is 71% consumptive, is more than we can afford. (It was under 65% until 1990.) And I think basing a growth in GDP on a growth in consumption is the cart before the horse…”

        I USED to totally agree with you in this sentiment Charles. But now I am questioning my own beliefs. The dilemma that we face…one of myriad dilemmas, caused by an increasingly complex and interwoven set of highly mutable variables…is that a return to ‘capital intensive production’ is, in our case, a growth killer. It is akin to purchasing a 1972 VW Bug in 2010, and expecting same said vehicle to perform at a level that exceeds its contemporary competition.

        I am fascinated by Warren’s argument (I think I have this right, Warren) that the U.S. could, in fact, maintain optimal employment and consumer purchasing power—and could continue to grow our economy—by creating the appropriate monetary and tax policies. That in fact consumption is a highly desirable standard for economic expansion, in that the bulk of American citizens would experience a growing standard of living and would continue to benefit from the industrial activities of nations such as China.

        Peter Schiff, as I’m sure you know, is fond of purporting that our model for economic growth puts the cart before the horse. That decades of out-sourcing of production has destroyed the capital base of our nation. I happen to AGREE with some of his assessment. I AGREE in the sense that the off-shoring (if you will) of production has placed the American working class in a rather precarious position, as organized labor is having an extraordinarily difficult time defending the eroding standard-of-living of the rank-and-file.

        HOWEVER…I also think that the debate over monetary and financial policies might be easier to tackle if we stepped away from the intensity of social and political discourse inherent in the process—if just for a moment—and examined the ideas of economists like Warren for their theoretical and functional probability of success.

        DW

      2. Dan

        I don’t know. Seems like cloud castles to me. Suppose instead we didn’t produce anything. Suppose we got all our goods from overseas. They’re going to work to support us in the style to which we have become accustomed. They’re going to give us what they produce. And we’re going to give them what? A fine example? A song and dance? Promises perpetually postponed? It seems to me eventually the guy across the table is going to say, “Wait a minute. Why am I.. working for you?” And we’re going to say, “But we give you all these pieces of paper.” And he’s going to say, “And..?”

        But maybe I have an anachronistic, or simplistic, view of economics…

        I think the woes of the working class are going to work their way up the social pyramid. Not something to look forward to.

        I agree the debate over financial policies is way too narrow. I agree with Warren that the government needs to operate at a deficit, (but needs to have the political will to tax when necessary,) and his three solutions: Tax holiday, money to states and universal employment. But I don’t think they’re solutions to the China problem. I suggest instead we first ask the Chinese to please spend our money.

  8. @ Tom @ Gold,

    In a word, Heck No! It could never happen, IMO of course. While there is some merit to the argument that a commoditized dollar would make much of the silliness in Washington D.C. vis-a-vis foreign misadventures subject to further scrutiny, there is no way to return to a ‘gold standard’ as such, because to do so would summarily eviscerate the type of growth and expansion to which we have become accustomed (addicted???).

    I view this issue in the same light as I do claims by our political leaders that ‘real’ financial reform is coming. Bah! Humbug!! REAL financial reform would mean capital requirements and leverage limits that would, by their very nature, hammer GDP.

    It’s FIAT currency for the long haul. My big fear remains: At what point does belief in the viability of the irredeemable dollar run up against a series of as-yet-unforeseen events that blows the dollar-foundation sky high and leaves us all wondering how the dollar went, in one brief century, from the ‘gold standard’ of currencies to just another group of worthless zeros and ones on a computer screen.

    DW

    1. Dan:

      Pls look at actual third world currency regime, like India. You will see mix of US$, rupees, and gold, all living together. Everyone becomes their own little fx trader. If people want to save less in US$, it will devolve into mixed currency regime like this one.

      People who think only options are between gold standard and hyperinflation should look at actual real world example of what people do in countries where Govt has limited sovereignity.

      US$ “confudence” is merely — to what degree that US Govt retain sovereignity and can impose taxes. Nothing more or less.

      Real financial reform is doable if administration was willing to recapitalize households with all the tools it has at its disposal (but does not know). Instead, they just want to give money to their masters, unions and bankers.

      1. @ Zanon,

        A very interesting example and point! Why, in your opinion, does our government “…just want to give money to their masters, unions and bankers…”.?

      2. Why, in your opinion, does our government “…just want to give money to their masters, unions and bankers…”.?

        Follow the money AKA campaign donations. The US has a rented government, no matter which party is in power.

  9. @ Tom RE: Campaign donations and Influence:

    While I agree with your assessment Tom regarding the ‘bought and sold’ nature of our political leaders, I don’t think that Zanon’s assertion can be so simply defended.

    Remember, this conversation began because we were discussing the issue of Financial Reform. Zanon made the point that, “…Real financial reform is doable if administration was willing to recapitalize households with all the tools it has at its disposal (but does not know)…”. So….if ‘they don’t know about it’, how can they so cynically be accused of simply going the other more nefarious direction in favor of graft or campaign monies, etc.? More succinctly, how can we accuse these officials of choosing one route over another when they fail to grasp the monetary reality (of recapitalizing households, and not falling prey to the money-multiplier, fractional-reserve modus operandi)?

    DW

    1. Dans:

      I am merely pointout what is happening. If republicans were in charge, then money would go to bankers and some non-union special interest.

      in either case though, bankers say “look you hurt us and we won’t have money to lend” which is acutlaly true. Raise capital requirements, and banks will lend less and less favorably.

      If Govt recapitalize household though, it does not matter.

      the problem really is that academy, who tell politicians on these matters, have no idea how economy works. biggest failure of MMT is its complete lack of progress in academy IMO. If economist from Harvard was saying on NYTimes what Warren is saying om some backwater blog, it would be different world

  10. agreed

    we’re paying the price of my father not wanting to spend the money to send me to a name school instead of UConn

    1. But, Warren, if that had been the case and you had gone to, say, Harvard and made a name, they you’d be too invested to say anything, even if you realized it was true.

      🙂

  11. @ Zanon and Warren and Tom…..oh my

    I get it. As Warren said in a response to a post on April 4th of this year, “…the [no overdraft constraint] is political, not operational…” I get the distinction that is being drawn between purely operational issues in a FIAT, non-convertible floating rate monetary system, and all of the political and social detritus that obscures our understanding of the numerical truths existent in the current economic paradigm. I get that we are using anachronistic language and thinking, as we apply our former ‘gold-standard’ mentality to issues that are not constrained by such limitations.

    But understand that for me at least, letting go of the old ‘tapes’ is both frightening and disempowering. It is so because it involves leaps of faith that appear on the surface to not only be counter-intuitive, but in fact to be fraudulent. Let me explain:

    I assume we’d all agree that the recent global financial crisis was caused, to a great extent, by avarice and by fraud. And the natural populous backlash is to vilify government complicity in such actions, as well as to ‘go after’ the financial giants who have apparently pillaged the coffers of society to satisfy their own unbounded greed.

    Because this fury is being directed at our political and financial leaders, it also makes sense that ‘we’ would view the ministrations of modern economists and financial gurus—the Greenspans and Bernankes of the world—with contempt. “Their post-Keynesian, neo-classical economic policies are to blame!!!” we clamor. And so, on some level, it is frightening and disempowering to purport belief in and support for an underlying system of finance that—for many and varied reasons of course—has brought us the worst financial crisis in 80 years.

    As we know, EVERYTHING in life is political. And in a nation of some 300+ million people: a nation in which 1/6 of the people live at or below the poverty level; in which organized labor, the folks who built the country from the ground up, is getting hammered both economically and politically; in which the gap between wealthy and poor is growing daily; in which government complicity in the quasi-criminal and outright criminal activities of Wall Street and its subsidiaries is making people really damned angry…in a nation like this, how do we promote economic policies that reflect the realities of a FIAT currency existence while simultaneously guaranteeing for the citizens that such a system CAN be properly governed and CAN be properly regulated, and that will NOT make them poorer—and the rich richer—at the same time?

    DW

    1. Dan, glad to hear that you got it.

      You ask, how do we promote economic policies that reflect the realities of a FIAT currency existence while simultaneously guaranteeing for the citizens that such a system CAN be properly governed and CAN be properly regulated, and that will NOT make them poorer—and the rich richer—at the same time?

      Well, that’s what we are talking about here and at billy blog, etc. The idea of MMT is catching on, and it is being discussed ever more widely.

      Of course, MMT is not the silver bullet of macro. It just removes the veil of ignorance that presently clouds the debate. Many issues remain to be debated, but at least we will be talking on the ground of reality rather than myth and be able propose policy solutions that are operationally sound instead of based on theory, the assumptions of which either involve specious reasoning or have been disproved by events.

      For example, Zanon and I both agree on MMT principles but we disagree on applying to policy solutions, since we come from different sides of the political spectrum. MMT shows up the operational reality of the current monetary system, but that knowledge can be applied differently based on different political and philosophical views, e.g., concerning political purpose and economic prosperity.

      People who dismiss MMT principles out of hand, for various reasons that foresee some dismal scenario, also have to look at the dismal scenarios that follow from ignoring operational reality. Once we agree that MMT describes how the monetary system functions in relation to the economy, then we can cooperate on developing solutions that are practical politically. In a democracy that involves taking good ideas from both sides and integrating them into policy proposals.

      Moreover, if fiscal policy going to replace monetary policy as the primary tool, adequate safeguards have to erected to ensure that the fiscal process is not hijacked by interests, as well as means and criteria for proper application in different situations in order to balance nominal aggregate demand with real output capacity while also increasing that capacity to meet the need of a growing population. And then there are the challenges of the emerging global economy. Plenty to discuss here.

      1. We are all Keynesians now after all. :o)

        Speaking of Nixon, I was just reading how in 1971 (same year he dropped the gold standard), he adopted the Kennedy White House idea of a “Full Employment Budget”, setting the federal budget outlays at the level they’d be in an economy no output gap and 4% unemployment.

        He explained that a full employment budget is one in which “spending does not exceed the revenues the economy could generate under the tax system at a time of full employment”. His call to arms was “prosperity without war and without runaway inflation”…
        http://news.google.com/newspapers?id=uNcfAAAAIBAJ&sjid=ItkEAAAAIBAJ&pg=746%2C1535720

  12. All this is nothing new. Frederick Soddy,Major Clifford Douglas, and Arthur Kitson were all writing about this just after the first world war. the following quote is from Kitsen talking about Douglas’s plan from his work “Economic Democracy”

    http://yamaguchy.netfirms.com/7897401/kitson/kitson_index.html

    THE REMEDY.

    To remedy these evils, some such plan as that suggested by Major Douglas will have to be started. The consuming public must have some control over prices as well as over the volume of purchase power that is created. These are the two objects to which special attention must be paid and a complete change from the present system established.

    Of course, the conclusion reached and the proposals suggested in these articles will doubtless cause consternation in the minds of some and amusement in others. They will be pooh-poohed by most of the orthodox philosophers, and all the fogeys will hold up their hands in horror. But on the ground of truth, I venture to say that, though they may be challenged, they cannot be permanently subverted. We have only to wait until the intelligent public have had time to digest them thoroughly, and the present system has reached the final goal towards which it is rapidly hastening.

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