Small banks, already penalized with a higher cost of funds than the large banks (link) have more recently been forced to contract due to ‘wholesale funding’ restrictions being imposed by the regulators.

Bank regulators distinguish between what they call ‘retail’ and ‘wholesale’ funding, and have set limits of small banks for ‘wholesale’ funding. This policy is meant to reduce the liquidity risk of a bank not being able to roll over its funding should depositors decide to take their dollars to another bank. The theory is that ‘retail’ deposits are ‘sticky’ and less likely to move to another bank, while ‘wholesale’ deposits are more likely to move. And the ‘better’ the ‘account relationship’ the more likely the funds are to stay with the bank. Oddly, when I inquired if the maturity of the deposit is a consideration the regulators responded ‘no.’ So that means a 10 year CD obtained through a broker is considered a wholesale deposit, which must be limited, while money market deposits from local depositors that can leave the next day are the core retail deposits required by the regulators for ‘stability.’

But apart from this obvious regulatory failure to recognize what’s more stable and what’s less stable for individual banks, there is also a highly problematic macro issue. In the banking system as a whole, loans create deposits, meaning that for each loan made by a bank (bank assets) there exists a bank deposit of the same amount originally created at the time of the loan as that bank’s liability. In short, for the banking system as a whole, loans equal deposits.

The problem is that money center banks attract more of these total deposits than the small banks in the normal course of business. That leaves the small banks short of deposits by an equal amount. This is easily resolved by the small banks needing funding borrowing the excess funds held by the large banks. And if the large banks decide to keep their excess funds at the Federal Reserve Bank the small banks can simply borrow from the Fed to cover their shortage. In any case the total funding of the banking system remains equal to the total loans outstanding, with the Fed acting as a ‘broker’ to facilitate system wide liquidity. However, when regulators restrict this ‘wholesale funding’ between banks, and also deem borrowings from the Fed ‘wholesale funding,’ they put powerful forces in place that force the small banks to either pay higher rates to attract deposits from the large banks, which is often impossible as large corporate customers can’t deal with small banks, or force the small banks to cut back on lending to reduce their dependence on wholesale funding.

The net result is a misguided regulatory policy that is both increasing the cost of funds to small banks and forcing small banks to cut back on lending.

The remedy is quite simple, have the Fed offer funding (fed funds) to all member banks at it’s target interest rate, which is the rate the Fed desires to in fact be the cost of funds for its banking system as a matter of public policy. In any case, bank borrowing and lending is rightly constrained by capital and other regulatory requirements, and not available funding, which is always attainable at a price. Using the liability side of banking for market discipline, as is currently the practice for small banks, is always evidence of a lack of understanding of banking fundamentals and counter to further public purpose.

Please distribute this to your favorite regulator, Congressman, and Fed official, thanks!

128 Responses

  1. Any regulatory framework will take into account the retail/wholesale deposit mix and – separately – the cash flow maturity structure. The cash flow maturity structure is typically measured at the consolidated level, not necessarily at the sub-level of the retail versus wholesale. In other words, the benefit of a 10 year fixed deposit will be recorded for cash flow matching purposes the same – whether its retail or wholesale in origin. Separate from that, the “stability” of the deposit base will be judged based on the retail wholesale mix. This latter criterion is subject to considerable subjective interpretation.

    1. Anon,

      Not related to your comment. What do you think of the last two paras in ?

      “By eliminating the 0.25% interest that the Fed pays banks to leave money on deposit with the central bank, the Fed could push the fed funds rate all of the way to zero.

      That, however, could disrupt the money market industry by eliminating revenues on funds the industry manages, which gives some Fed officials pause.”

      1. That concern has been around a long, long time – from people thinking longer term – way before rates actually came as close to the zero bound as they are now. It’s an example of funny operational things that can happen as rates go to zero.

        I don’t know how much of a concern it is, but managers can’t earn much of a gross operating margin on money market funds if rates are at zero, so I suppose there’s good reason to be cautious.

        The dumb thing is, we’re only talking about $ 2.5 billion a year in interest on reserves. Yet Scott Sumner thinks paying that 25 basis points is going to cause a global depression. I’d be more interested in Sumner coming up with a coherent thesis about the possibility of negative rates in general, which he doesn’t seem capable of doing. He continues to gnaw away at 25 basis points on reserves, completely disembodied from any other consideration of related market rates.

      2. I am not so sure that Scott is entirely wrong. I think many people here have drunk the Kool-Aid in a good way. But this has blinded them to the fact that the world does not even know about MMT nor does it act in ways that are cogent in relation to MMT.

        In the world we actually live in, this 25bps is a big deal. If it wasn’t, there wouldn’t be trillions sitting at the fed. This money would be somewhere else.

        Now, I want to be clear – I think that it isn’t a big deal. But I suspect if the fed changed this rate from 25 to -25bps there would be a rush of money out of the fed.

        Now, you have to remember, the fed is terrified of inflation from this money. They really believe with all of their decades of experience and fancy degrees that they have slain a dragon but at the cost of having an even bigger dragon chained in the Dungeon.

        At the Center of the Universe, we know there is no reason for their fear. But like my 6 year old afraid of the dark, there is little you can actually do to drive the fears away. We don’t live in a world where MMT is accepted.

        Now, we don’t live in a world where Scott Sumners views are accepted either – but his views are only a stones throw away from the world we live in. They make sense within a framework that isnt’ all that different than the framework we do live in.

        So, his views are both more likely to be accepted and more likely to be effective if they were implemented. I come back to the “Animal Spirits” quote from Keynes all the time, but any trader – Warren is a master at this – knows that being right in theory and being right in practice are two different things.

        Notice that Warren has a theory about the economy right now – but he is waiting for very specific proof about when and how this theory is going to be mainifested.

        My point is that Scott’s ideas aren’t totally cracked because the world we actually live in is likely to be improved by their adoption, and they would improve upon the status quo economic paradigm.

        Just to be clear – I’ve fully drank the Kool-Aid myself. I am a 100% MMT guy. I just don’t let perfection get in the way of good.

      3. In approaching Summer relative to MMT, I think it is useful to point out Thomas Kuhn’s description in The Structure of Scientific Revolutions of how a paradigm that is breaking down calls forth a new one with more explanatory power. In the course of doing normal science under the rules of the old paradigm, anomalies crop up and are addressed ad hoc and explained away as special cases. But this is not really satisfactory. A theory should be able to explain occurrences and therefore predict events without leading to anomalies. Anomalies (surprises) are indications that the theory has broken down.

        Summer’s solution is an ad hoc response to an anomaly arising in the old paradigm, which can neither explain how the crisis arose nor how to fix it. One of the reasons for this monetarily is that the theory is based on gold standard thinking that is no longer applicable to this regime.

        MMT presents a new paradigm based on an operation description of the currency monetary regime and a stock-flow consistent macro models. This has not yet been recognized because outsiders are looking at MMT from within the old paradigm and it seem to violate the norms established by that paradigm. MMT claims that those norms are ill-designed to explain current events, and so they do not lead to accurate predictions or correct diagnosis.

      4. If IOR were zero, treasury bill rates would go to zero, and the treasury curve would shift down out to two years. That would happen virtually instantaneously, and would be the end of it as far as banks taking any different action. They’d sit on their hands from there. The IOR would be arbitraged out of the treasury yield curve immediately. Bills and short treasuries are the only rational alternative to reserves for banks INDIVIDUALLY, and any price advantage/ opportunities would be gone for individual banks within 5 minutes.

      5. Yes, the present minuscule rate is still a subsidy. Any interest paid with excess reserves sufficient to drive the rate to zero is unnecessary when the threat is deflation rather than inflation and it is just a gift to banks. I suppose that the Fed justifies this on the basis that recapitalizing banks is a matter of public purpose now, just as taking their dreck onto its balance sheet. This is liberalism?

      6. Ramanan, so what public purpose does “the money market industry” serve?

        As Henry Paulson points out in his new book, its crazy that anyone should expect to get a risk-free investment that pays more than comparable short-term Treasuries (and of course, the Fed ended up bailing the money market industry guys too). But there are bigger fish to fry in terms of rent seeking, so its not worth making a federal case about. The 0.25% IOR is pretty minimal, though curiously, its supposed to peg the “overnight rate”, but its actually higher than the 3 month Treasury note (0.15%). Tsy could borrow at the 3 month rate to fund IOR payments and make a profit (all of a billion dollars), instead banks borrow at 0.25% to lend back to Tsy by buying 10 yr bonds at 3.15%. As Jon Stewart put it in his story about this, Uncle Sam is the worst loan shark in the world. :o)

      7. Well they may not have a public purpose but it is difficult to redesign the financial architecture to eliminate players who don’t contribute to public purpose.

        One can argue that money market mutual funds have helped CFOs find a cheaper route to funding and hence they are good.

        On the other hand, questions of regulation are different. Just like one can’t shout “Fire” inside a theatre, there should be regulations where the financial system does not create a damage.

      8. Ramanan, you’re right of course, and of all the players getting their beak wet in the current system, the money market funds are one of the most benign. It just annoys me when the Fed forgets its “maximum employment” mandate does, in fact, extend past that portion the American workforce that works in finance.

        Matt, clearly the banks aren’t making a fortune buying low from the government and selling high, again to the government. However, our system of government… any government really… is based on trust. We expect our public officials to be competent and honest, especially in the handling of public money.

        After the TARP bailout, big banks are about as popular as drug cartels. For the government (that is, Tsy, the WH, Congress– the Fed seems to think it’s its own country) to allow them to arbitrage a risk-free $7.5 billion out of Tsy’s pocket is a small thing in proportion to GDP, but in this environment its poison for public confidence in the government. Here’s the Jon Stewart video I was referring to.

        Hopefully GS agreeing with Krugman (sterilizing Paul, if you will) will push congressional Republicans to move away from the austerity position. Come on people, demand a tax cut– that can’t be hard!. :o)

      9. To calibrate a bit,

        Feds latest z.1 shows comm bank sector holdings of treasuries and Govt backed MBS up about $250B from the end of 2008 to end q1 2010.

        So even if they are doing what these folks are saying and so called “borrowing at 0.25%” and they net 3% (its probably less) that would mean about $7.5B gross profit max to the entire industry from taking up this type of business after the GFC. Theyre not going to dig themselves out of their hole any time soon at that rate. Anon probably knows more about historic banking sector earnings here but I dont think this is very much $ across the entire industry. They need to make alot more money than this.

        One hope Im getting this week is from the GS Econ report billyblog commented on. Maybe GS is starting to see that sooner or later, in order for their financial industry to really make money again, households need more income to be able to start borrowing against homes and autos. Perhaps GS is starting to realize this and soon the other banks also. At some point the powerful bank lobby may start to push for policies that primarily promote high employment levels as healthy/high levels of employment is the environment in which they can really make some money, not this paltry $7.5B industry annual from “buying treasuries” BS. They will soon start to feel that they are leaving money on the table if their lackeys in govt dont crank up the employment, and will start to assert their major influence. Right result for wrong reasons I know but Id take it at this point.

      10. Just noticed that Z1 L209 doesn’t seem at all consistent with F209, for commercial banks.

        I wonder what’s going on there?

      11. Anon,

        Whats the inconsistency ? Probably the F.s are multiplied by 4 i.e., annualized ?

      12. Beowulf Says: It just annoys me when the Fed forgets its “maximum employment” mandate does, in fact, extend past that portion the American workforce that works in finance.

        And Matt Franko says: At some point the powerful bank lobby may start to push for policies that primarily promote high employment levels as healthy/high levels of employment is the environment in which they can really make some money.

        Guys, I am terribly confused, you both seem to be backwards thinking like Robert Reich and my response in the fed minutes thread. Why is maximum employment a GOOD THING and a national mandate? Shouldn’t our goal in FACT be a MANDATE of maximum UNEMPLOYMENT, maximum IMPORTS, and MINIMUM exports. Please don’t get 2 ideas in your head that contradict each other, that makes you look silly, there is NO WAY you can truly BELIEVE that the BEST WAY to increase american standards of living is for me to get up from this computer and chat on this blog with you and go to WORK with a JOB in the strawberry field is there?

      13. Strawb,
        When WM sez ‘exports are cost/imports a benefit’ I interpret as another case of him being intellectually provocative. He is trying to get readers to turn their thinking around on this issue from the mainstream view that somehow we are all in some kind of nationalistic contest to see whose is bigger (exports that is!). He is reminding us that when an Asian country sends us drywall (hopefully not radioactive) and we punch in numbers on a computer system on their behalf in exchange, we can view that (on a national level) as a relative benefit if you think about it, as it is more hardwork to manufacture and transport drywall than data entry.

        But, dont try to extend this concept to a rediculous extreme that somehow he thinks nobody in the US has to work, we can just import. Remember, the trade deficit is only running at 3% GDP (where do you think the other 97% of the work comes from?). Most here support a full Job Guaranty program for all willing to work that would currently make at least 9.7% of the workforce alot happier.

      14. If we could all go to 100% ‘leisure time’ and somehow be able to import all of our material needs, school teachers, fire fighters, etc. it wouldn’t be a bad outcome!
        However, you can’t import all local services, they have to be done by residents, etc. so at least that much work has to be done domestically.

        My proposals include dropping all import restrictions and making sure that for a given size govt taxes are low enough so that we can buy everything we want that’s produced domestically at full employment plus whatever the foreign sector wants to sell us.

        This will go a long way to maximizing real terms of trade.

        (And, goes without saying, growth can be directed in non energy consuming, environmentally friendly endeavors.)

      15. Dropped this at Bill’s blog:

        Lets imagine a country running persistent current account deficits. The foreign reserves do not earn enough to compensate for the leakages through the current account. Faced with dwindling losses of foreign reserves both in the central bank and the Treasury’s balance sheets, the government needs to do something. There is an oil purchase to be made by a state-run corporation and the government needs to finance its purchases. The international money markets which holds a lot of bills and bonds are figuring out what to do with the upcoming debt maturity. The State is facing issues with the bid/cover ratios and rising yields. …

        The State funds the citizens who fund the government. The State doesn’t fund the international money markets or the currency markets. The State has to fund its purchases by hook or crook and agree to the currency markets’ demands. The currency market is under no compulsion. The State can ask the Treasury to ask the central bank to allow an overdraft or monetize the debt. If debt monetization is a non-sequiter, I don’t mind changing the wording to say that the State issues less securities than the deficit. Doesn’t help. The currency markets which is invested in the near-maturity debt makes a capital flight when its bank account is credited.

        The currency market is the Creditor. The State is the Debtor. The State is the Debtor.

      16. Rmanan, that of control that the nonconvertible floating rate system uses in place of a numeraire underlying a convertible fixed rate monetary regime. There are not only domestic boundaries (inflation) but also external boundaries.

        However, “free trade” is essentially a neoliberal construction based on the notion of the invisible hand. As we have seen, this is not always the most intelligent way to manage an emerging global economy, where “adjustments” involve disasters for countries and populations.

        Not that I am recommending returning to a convertible fixed rate regime. That, too, has its problems, e.g., chronic deflation. But just as PK’s point out that good policy can prevent domestic problems and quickly repair those that arise, so too, the global economy can be managed intelligently also with the knowledge at hand.

        There are enough real resources for a prosperous global economy for all, but neoliberalism does not appear to be the way to a prosperous global society. While a command economy does not seem to be solution either, a managed economy offers promise. But the devil is in the details. That is what is presently being worked out, and so far the project is not going all that well. The people at the bottom are being crushed, while those at the top regale in luxury. It’s neither efficient nor effective.

        We can do better. The question is how?

      17. Unfortunately, the State cannot always pay in its IOUs, fixed or floating. It is a bit surprising for me that MMTers pay so much attention to currency acceptability but readily accept acceptability of currency in international markets. Also MMT believes currencies adjust smoothly, which the Master (Keynes) himself violently opposed.

        All nations have foreign reserves, fixed or floating. There are different degrees of floats ranging from currency boards to fixed to managed floats.

        If a nation wants to import stuff and nobody is willing to buy its IOUs, MMT has no answer to that question. Such events are not outlier events. Currency crisis are common. Some imports such as oil as absolutely essential.

        Neoliberalism has nothing to do with all this.

        I had been seduced by the “who is funding whom” argument and fortunately or unfortunately my views have changed. I given myself a challenge to make MMTers accept the fact that the world needs to run in a very different way than they propose. I will take great pains to get this point across. I do not think that there is anyone, who “got it right” about the external sector and now sees the pitfalls of “getting it right”. For example Post Keynesians will simply argue that current account deficits are not sustainable – fixed or floating.

        I shall persevere !

      18. Ramanan,

        I don’t see how MMT can address/resolve your question unless you assume the exporter is willing to accept the currency of the importer. That’s the US situation. That’s why the US may as well have zero FX reserves, which is close to the case now. But who else is in that favored position?

      19. Anon,

        Yes, thats the situation with the US. And you are right – some arguments are difficult to resolve. MMT interprets the identity G – T + X – M = S – I in a different way. It writes it as

        G – T = Domestic sector net saving + Rest of the world saving

        and since deficits are somehow related to saving desires, it interprets it as the domestic sector saving desire plus rest of the world saving desire. It then argues that trade deficits are the result of the saving desire of the rest of the world.

        Its brutally wrong!

        The deficits and debts have something to do with the “propensity to save” and higher the propensity to save, higher is the debt/deficit. However Keynes somehow got rid of the confusion and introduced the “propensity to consume” :

        “Clearness of mind on this matter is best reached, perhaps, by thinking in terms of decisions to consume (or to refrain from consuming) rather than of decisions to save. A decision to consume or not to consume truly lies within the power of the individual: so does a decision to invest or not to invest. The amounts of aggregate income and of aggregate saving are the results of the free choice of individuals whether or not to consume and whether or not to invest: but they are neither or them capable or assuming an independent value resulting from a separate set of decisions taken irrespective or the decisions concerning consumption and investment. In accordance with this principle, the conception or the propensity to consume will, in what follows, take the place of the propensity or disposition to save.”

        (I haven’t read Keynes, saw someone else quoting this)

        The household sector decides to consume some from their income and it has a propensity to import. The rest of the world financial balance is the result of the decisions of the households to choose foreign products over domestic products. And the rest of the world’s financial balance is an ex-post number rather than some “saving desire” which MMT says. Also the accounting identity says nothing about the currency. A country may lose some foreign currency in order to import oil. There are complicated things happening when the external world is involved. By invoking “saving desire of the rest of the world” MMT misses out all the dynamics happening to acceptance of IOUs.

      20. Plus add more complications with currency manipulation and hence prices of goods and the weakening of the manufacturing sector due to this.

      21. Ramanan: “Neoliberalism has nothing to do with all this.”

        I disagree. I would distinguish Neoliberalism as an economic school from neoliberalism as an economic view associated with late stage capitalism. Virtually everyone that has been living in a developed country, or has been educated in one, holds this view to one degree or another. Keynes was trying to save liberal system that he saw was broken, instead of letting it be replaced by some form of socialism, different schools of which were active at the time.

        The presumption of liberalism is that markets (capitalism) if left free will most efficiently and effectively allocate scarce resource through price adjustment. This (microeconomic) view of markets has been transposed into the (macroeconomic) view of states and into a (global) view of human society. This involves fallacies of composition that manifest in the RW (real world) as imbalances.

        Assuming that free trade and free capital flows will be adjusted through floating rates alone is similar to thinking that the sectoral balances of nations will adjust through adjustment of market prices, including the price of labor. It is a failed idea because it is based on false assumptions.

        In order to address this discrepancy, neoliberalism (view, not school) has conceded that some management is required. For example, central banking is needed to control the price of money to influence interest rates (yield curve). Similarly, international institutions like the IMF, World Bank, and BIS have been put in place to manage the discrepancies that arise owing to free trade and free capital flows under a nonconvertible floating rate currency using the US dollar as the reserve currency. Neither central bank independence nor the international institutions are working very well at producing efficiency and effectiveness either nationally or globally. There are chronic imbalances and frequent disruptions.

        This is the system that the powers that be are intent on using to design the emerging global economy in this age of globalization. It is resulting in huge problems in many areas, in the undeveloped world, the developing world, and the developed world. This system needs to be rethought and revised.

        Liberalism and socialism have their advantages and disadvantages. The challenge facing the world today is crafting a “new world order” that serves humanity well. All knowledge and experience should be drawn on, and lessons learned the hard way not forgotten.

      22. Ramanan,

        Not sure I have quite that problem with it. MPS is the complement of MPS. The one is “not the other”. Keynes probably used MPC for expositional convenience/flexibility in aggregating at the macro level, I suspect. MPS is derived from MPC because S means “not C” – but a determined MPS requires a unique prior MPC- so use of the two is really interchangeable from a causal perspective.

        If China floated the yuan as a market currency and it’s exporters started demanding Yuan payments, it might still run a current account surplus. US importers would require Yuan balances generated either by running down Yuan assets or creating Yuan liabilities. Given a Chinese surplus, somebody in China with surplus yuan balances might end up exchanging them for dollars to buy US treasuries for example. But they’ve got to want the dollars to do that, and the FX rate would be determined by the market for dollar/Yuan rather than by PBOC as it is now. That was my point, I guess. Therefore, it’s still possible in that FX regime for China to desire to “net save” via a current account surplus and for the US to run a current account deficit with the rest of the world, including China. (The desire to net save is equivalent to the same desire not to consumer). It’s just that the FX dynamics would be entirely different, which would affect pricing of FX and knock on effects of that pricing on various CA balances involved, etc.

        In short, in that sort of regime, China could still desire to net save in the US fiat currency, independently from the US exporting dollars directly to China the way it does now. But there’d probably be funding risk for the US where there really isn’t any now. Now, the ROW is effectively stuck with the dollars the US exports.

      23. Tom,

        Precisely some of my points. MMT assumes that the currencies adjust by themselves. Though its not explicitly stated, there is an implicit assumption. However, the currency market is the ultimate Keynesian beauty contest.

        “… professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likely to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and some higher degrees. Even apart from the instability due to speculation, there is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, … Most … of our decisions to do something positive, … can only be taken as a result of animal spirits—of a spontaneous urge to action rather than inaction—and not to the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities. Enterprise only pretends to itself to be mainly actuated by the statements in its own prospectus, however candid and sincere. Only a little more than an expedition to the South Pole is based on an exact calculation of benefits to come.”

      24. Ramanan,

        For convenience of reference, feel free to paste the entire GT into the space below.


      25. Anon,

        Lets forget the dollar hegemony for a moment. A country such as India running a current account deficit doesn’t mean that foreigners want to save in the Indian rupee. They have to be conned to purchase Govt of India IOU directly or indirectly or India loses some foreign reserves. The Indian trade deficit says that India is not that competitive or that the Indian demand for foreign products is high. The trade deficit has to be “financed”

        In my opinion, the MMT discussion on who is funding whom is not the best route to take. Its good to use it to confront someone but then in a more formal setting its good to go back to good accounting and say that deficits are financed. Then we start building an argument such as “the US Treasury can finance its deficits on its terms” etc. Similarly, because the US is the reserve currency of the world, one can say that till now the US is having no problem financing its current account deficits. The advantage is that this description has the advantage of describing poor nations as well and one says that the poor nation one is talking of has to finance its deficits by hook or crook by inducing the foreigners to purchase its IOUs. This formal description can then be extrapolated to the case where there is a problem with capital flight and rapid currency falls.

        The advantage this has is that it doesn’t stop at the point where one says “no dollars leave the country” and it captures exchange rate complications and interest income to foreigners.

      26. Anon,

        Partially fulfilling your request

        “The problem of maintaining equilibrium in the balance of payments between countries has never been solved since methods of barter gave way to the use of money and bills of exchange. During most of the period in which the modern world has been evolved … the failure to solve this
        problem has been a major cause of impoverishment and social discontent and even of wars and revolutions.”

      27. “Our desire to hold money as a store of wealth is a barometer of our distrust of our own calculations and conventions concerning the future. … The possession of money lulls our disquietude.”

      28. “It is characteristic of a freely convertible international standard that it throws the main burden of adjustment on the country which is in the debtor position on the international balance of payments. … that is, on the country which is (in this context) by hypothesis the weaker and above all the smaller in comparison with the other side of the scales which (for this purpose) is the rest of the world. … The contribution in terms of the resulting social strains which the debtor country has to make to the restoration of equilibrium by changing its prices and wages is altogether out of proportion to the contribution asked of its creditors … the process of adjustment is compulsory for the debtor and voluntary for the creditor. If the creditor does not choose to make, or allow, his share of
        the adjustment, he suffers no inconvenience. For whilst a country’s reserve cannot fall below zero, there is no ceiling which sets an upper limit. The same is true if international loans are to be the means of adjustment. The debtor must borrow; the creditor is under no such compulsion.”

        My strategy is to attack the MMT tagline “imports are benefits” and to show that it doesn’t work for non-reserve nations. Then move to the advance nations.

      29. Anon @July 16th, 2010 at 1:06 pm,

        So you are saying that if payments are demanded in Yuan, its still possible for China to run a current account surplus right ?

      30. Anon,

        The reason that propensity to consume is more useful is that in stock-flow consistent models, there is a propensity to consume out of both income and wealth and hence there are two parameters.

        Imagine a closed economy growing at a very slow growth rate. For simplicity zero growth. There is no “saving desire”. All income is consumed in the “steady state”. The reason “all income is consumed” is that households consume both from income and wealth and the consumption out of wealth equals the saving out of income.

        Of course, the real world is never in any steady state or anything close to it and prices change but there in stock-flow consistent models, its advantageous to use the MPC instead of MPS. Of course SFC models don’t talk of equilibrium only but the process between two steady states or two long-run solutions in growth models.

      31. The US is different since the dollar is the world’s reserve currency, so economically we can continue to run a trade deficit indefinitely (and perhaps, have to).
        the country issuing the global reserve currency must be willing to run large trade deficits in order to supply the world with enough of its currency to fulfill world demand for foreign exchange reserves.

        I don’t now what would happen, per Triffin dilemma, if the US moved to balanced trade– could we supply demand for foreign exchange reserves with a jumbo size fiscal deficit instead? You know me, I’d set up Warren Buffett’s import certificates market to control the trade deficit and Bill Vickrey’s gross markups markets to control inflation… setting up an incomes policy in the middle of a deflationary trough, THAT’s staying ahead of inflationary expectations.

        Of course, these markets could be used in the opposite direction than they were intended- Tsy could attack deflation in a Vickrey market by requiring corporations ( ex SBA definition small business, say) to raise value-added prices at least 3% or buy warrants from another party who agrees to raise their value-added prices MORE than 3%. Likewise, President Mosler could confound the world with export certificates. Before your exports can leave the US of A, you must subsidize importers by purchasing on the a market the equivalent dollar value of export certificates issued to importers. :o)

      32. “They have to be conned to purchase Govt of India IOU directly or indirectly or India loses some foreign reserves.”

        Right – I’m assuming the case of a cumulative current account deficit – i.e. the case where the net international investment position is a net liability, regardless of the strength of the reserve position. The reserve position simply factors into the gross asset position. The case where there isn’t a cumulative deficit is moot.

        “in a more formal setting its good to go back to good accounting and say that deficits are financed”

        Not really. The mere existence of a deficit in flow terms or a net international investment liability in stock terms means ROW wants to net save in the deficit country. To suggest otherwise is a contradiction of accounting. This desire to net save can only be stopped at the source, which is the acceptance of payments made by the importer to the exporter. The exporter simply has to stop accepting those payments in order to stop the process otherwise. It is the acceptance of the payment that creates the deficit. So the payment finances the deficit – whether the payment is made in dollars, Yuan, or whatever currency or gold. I suppose in my example, the US could start issuing Yuan liabilities if China would accept them. If China accepts Yuan liabilities of some sort, then the deficit finances itself at that point, the same way it does now in dollars.

        The “imports are a benefit” is something I struggle with also.

        “So you are saying that if payments are demanded in Yuan, its still possible for China to run a current account surplus right?”

        Yes, as noted above.

        “The reason that propensity to consume is more useful is that in stock-flow consistent models, there is a propensity to consume out of both income and wealth and hence there are two parameters.”

        I understand what you’re saying, and it’s an interesting idea, but the definition of MPS is income based.

      33. The US cannot run a current account deficit forever. It increases the financial fragility of the whole nation. I will save the argument for a later post.

        MMT doesn’t like the import certificates because imports are benefits in MMT. The reduction in demand in MMT can be compensated by relaxing the fiscal stance.

        Firstly for non-reserve currencies, the game: increase fiscal stance to fight balance of payments doesn’t work because it leads to a rapid fall in the value of the home currency in the exchange rate markets. An increase in fiscal stance leads to another round of plummetting of the currency. The State can’t win this race and has to bow down to the international money markets because every country has to purchase foreign goods.

        Its the prospects for the reserve currency which is difficult to argue and I will prepare some arguments on it. But I hope you get the idea.

      34. Anon,

        The saving of the rest of the rest of the world is like a bonus.

        A weak analogy. A private economy with banks, producers and households. The production sector is a deficit spending unit. Because S = I and I is volitional – decided by the animal spirits of the producers, S is just equal to I. It doesn’t depend on the desire of households.

        If you have the time – this is explained well by Moore

        Similarly, the trade deficit is due to the volitional decisions of citizens of a country. The saving of the rest of the world is decided by these actions.

        MMT on the other hand invokes the invisible hand and says that the exchange rate adjusts to make the desire of the rest of the world desire equal to the trade deficit or some such thing. Its the same error made by neoclassical who say that interest rates adjust to make saving = investment.

      35. It’s not the same error, though some of the words are the same.

        MMT ‘explains’ how a nation gets the benefit of being able to run a trade deficit- it fulfills the rest of world’s desire to accumulate its financial assets.

        Furthermore, it says a floating exchange rate reflects real time indifference levels, for whatever reasons.

        What’s wrong with that?

      36. And you see how critical I am of MMT. There is a purpose and I will point it out if someone holds a gun on my head.

      37. Ramanan: “MMT on the other hand invokes the invisible hand and says that the exchange rate adjusts to make the desire of the rest of the world desire equal to the trade deficit or some such thing. Its the same error made by neoclassical who say that interest rates adjust to make saving = investment.”

        All contemporary economists that hope to be taken seriously are liberal. This is “the box” in which all thinking takes place. The problem is <a href=""the liberal paradox introduced by Amartya Sen.

        The liberal paradox is a logical paradox advanced by Amartya Sen, building on the work of Kenneth Arrow and his impossibility theorem, which showed that within a system of menu-independent social choice, it is impossible to have both a commitment to “Minimal Liberty”, which was defined as the ability to order tuples of choices, and Pareto optimality.

        Since this theorem was advanced in 1970, it has attracted a wide body of commentary from philosophers such as James M. Buchanan and Robert Nozick.
        The most contentious aspect is, on one hand, to contradict the libertarian notion that the market mechanism is sufficient to produce a Pareto-optimal society—and on the other hand, argue that degrees of choice and freedom, rather than welfare economics, should be the defining trait of that market mechanism. As a result it attracts commentary from both the left and the right of the political spectrum.

        What is the way out of the box?

        Virtually all modern economies are managed economies that pay lip service to liberalism. However, the trend is toward centralized of control under non-political “independent” technocrats that are allied with “special interests” or are intellectually captured by a worldview that sees technocracy based on wealth and power as the most efficient and effective system to organize the era of globalism. I see little evidence of the efficiency and effectiveness other than in advancing the interests of a minority.

        This trend bodes no good. We should be thinking out of the box instead, before millions more people die unnecessarily or continue to live in horrible conditions with little or no hope. Once state money is introduced, all sort of consequences follow that government have the responsibility to deal with.

        One thing seems pretty certain to me. We cannot never have stability while dollar hegemony remains in place. It is not good for the US and it is not good for the rest of the world. Imports may be a benefit for a while, but a long term trade deficit means that a country is exporting jobs and productive capital. Is that a good trade for trinkets?

        The US is running up against the limits of this as the middle class shrinks and their anger rises. If the US succumbs to deflation, this unrest will only ramp up. A demagogue could easily be swept to power in 2012 if debt- deflation materializes and leads to a depression. Randy Wray’s satire, The Great Depression and Revolution of 2017 may not be so far-fetched.

      38. “What’s wrong with that?”

        What’s wrong, broadly speaking, is that the well-off are isolated from market “adjustments” even though they may be “inconvenienced” by them, but the rest of the world suffers the consequences “for real.” People die due to the imbalances and disruptions that market “adjustments” entail.

        The argument offered is that liberalism is the most efficient and effective economic system developed and also the superior political system for generating maximum utility consistent with individual liberty. Maybe.

        But millions of people are impoverished or perish globally. Is it true that we have come to the end of the line in economic and political and social innovation, and that this is it?

        I believe that we can do better with economic theory and political policy based on different goals and different incentives. Government and economies exist for society, not vice versa.

      39. MMT ‘explains’ how a nation gets the benefit of being able to run a trade deficit- it fulfills the rest of world’s desire to accumulate its financial assets…. What’s wrong with that?

        You’re right of course. As long as we’re the world’s reserve currency, we’ll always be able to run a trade deficit and as long as we’re willing to run a trade deficit, we’ll always be the world’s reserve currency. Good times.

        The objections to this arrangement are, I think, on fairness and not efficiency grounds. Its great for the US economy in aggregate, but the gains are disproportionately captured by the wealthy. On the other hand the clear losers are our working class citizens who lose their manufacturing jobs (which average 20% more than median wages) and often never recover economically.

        Personally, I think moving trade deficit down towards balance is a reasonable sacrifice of efficiency in exchange for fairness. Another way, would be to reallocate the economic gains of our trade deficits in the direction of working and middle classes by programs such as Ed Phelp’s wage subsidies.
        To update Phelps’s 1993 numbers and ratio, the current minimum wage is $7.25 an hour, so a $5.44 an hour wage subsidy (added to paycheck) but would taper down as one goes up the income scale.

        A third way, I suppose, is take up Martin Wolf’s war against land rents (see July 9 FT column) and tie the “living wage” of each metro area to their respective costs of housing.

      40. Asking the exchange rate to make adjustments is like chasing a mirage.

        Trade deficit being equal to some rest of the world saving desire by the exchange rate adjustments is very neoclassical.

        The exchange rate is set in a beauty contest.

        The imports are household volitional decisions. Exports are dependent on the external world demand and the competitiveness of the country versus the rest.

        Also the line “imports are benefits” is not true. For a given fiscal policy, imports take away employment. Of course one can argue that fiscal policy can be relaxed to bring back the employment to the levels lost due to the deficit etc. Fiscal policy has to be relaxed because the endogenous expansion in fiscal deficit is not sufficient to bring back the employment to the levels lost due to trade deficits. However, right now governments do not do that. In the behavioural desciption of the world we see now, imports are no benefits.

        The story about expansion of fiscal deficits to do the job is an implausible story, whatever sovereignity powers governments have. I do not share the fears of neoclassicals in the proposed scenario. However, I doesn’t automatically mean that I assume that it is a sustainable process. If I were the head of my nation, such a solution will lead to a collapse of my country due to the external sector. The invisible hand will not help me because there isn’t one.

        Of course there are some solid ways to deal such as concerted action etc. The world has to decide again on how to trade with one another

      41. I have just now read this entire thread, and I have to say that I’m kind of surprised because some of the true believers (indeed proponents) of MMT don’t accept some of the logical consequences of MMT.

        With a floating fx rate and free market pricing of goods and services, the trade deficit/surplus of a particular country is a non-issue with respect to sustainability. If the excess demand from that country’s residents is not sustainable, then the price of goods and services will rise until it is. If the excess savings desire in that currency from the rest of the world (ROW) is not sustainable, then the price of goods and services ROW offers will rise until it is. These price changes can happen in the cost of goods and services one by one, or more efficiently through the fx rate, but either way, they
        will happen.

        I don’t see why a country needs to have its currency be considered a reserve currency to run a trade deficit and make this work. In fact, you don’t even need a particularly credible currency. The consequence for having a non-credible currency (in the sense that the government can’t be trusted to keep inflation and deflation at reasonable levels) is a low standard of living for its residents, not an inability to run a trade deficit (even indefinitely).

        Of course, imports represent both a benefit AND an aggregate demand leakage. The demand leakage must be addressed by fiscal policy — otherwise that country will have deflation and excess unemployment.

        What kills me about the people who worry about the “unsustainable” trade deficit is that the worst case scenario is that it won’t be sustained, which means of course that the country’s residents will be fully employed, working like dogs, and making money hand over fist (presumably exactly what the worriers would consider a rosy scenario).

        Now, there is no doubt that dislocations occur in the domestic economy due to global free trade. Certain jobs disappear or become less lucrative, just as other jobs are created or become more lucrative. But this type of creative destruction happens even without global free trade.

        The loss of high-paying manufacturing jobs is particularly acute for two reasons (1) these jobs have been a focus of developing countries’ mercantilist policies; and (2) these jobs were artificial to the extent that they were sustained at above market compensation levels by domestic union extortion.

        In any case, the only reason the politicians focus on these jobs is because the people doing them were overcompensated for their level of productivity and therefore not able to find similarly lucrative jobs (well, that, and the fact that the unions still have a lot of political power).

        But there is nothing special about manufacturing jobs viz a viz service jobs. Actually, I think it’s a good thing that we’re moving towards a more service oriented economy.

      42. ESM,

        What are you trying to say ? Some African nation can continue running current account deficits ?

        Its even more dangerous, if markets allow it. A sudden capital flight can ruin the fate of the nation. Doesn’t matter if you ban the speculators, if that is possible – someone has to make the currency markets.

      43. Also this digital divide between fixed and floating must be properly brought forward. If an argument is given, one is told that it applied to fixed regimes.

        There are all kinds of regimes – fixed, floating, managed float etc. Does that mean that for managed floats, the country half borrows and half does-not borrow ?

      44. “Efficiency is doing things right and effectiveness is doing the right thing.” (attributed to Peter F. Drucker; I have not yet located a citation of source)

        It all depends in the meaning of the word “right.”

        I don’t see how one can conscientiously assign a meaning to “right” that involves millions of people being impoverished and even perishing in the name of economic efficiency. That is making society subservient to an economic theory, and it recalls the times and places in which religion was the arbiter in society.

        Moreover, imbalances don’t always correct quickly and smoothly, and the new equilibrium may be far away from the previous one. This can lead to political disruptions, social unrest, regime change, and even a change in the system. Pretending this will always and everywhere be a smooth and automatic process under liberal principles (assumptions) is just myopic.

        If you want to say that this is inevitable, that is more realistic. My response is whether you think that humanity has reached the pinnacle of social, political, and economic evolution in liberalism, and what the justification for this claim is. I suspect that humanity as a way to go, and leaders need to be thinking out of the box of liberalism as optimal. After all, we already have politically “independent” (unelected and unaccountable) central banking setting the price of money. What is liberal about that? What is efficient and effective about it?

        I believe that MMT is a vast improvement of the present system, and it should be adopted in order to refit the system to operational reality after decades of being run on the basis of myth. But I also think that the present system is lacking. In the first place, it is not actually liberal. Secondly, the goals and incentives are wrong. Thirdly, this is the age of globalization, and the world needs to take this into consideration in political and economic theory, and policy-making as well.

      45. “What are you trying to say ? Some African nation can continue running current account deficits ? ”

        Yes, that is exactly what I’m saying. I don’t see any reason why it can’t. If the productivity growth of the nation is not sufficient then presumably the currency will depreciate eventually, at which point, the current account balance may go into surplus, but there is no reason I can think of why a current account deficit cannot be sustained for decades or longer.

        I don’t think there is anything special about the United States in this regard, except that perhaps because of its military strength and strong commitment to property rights, the dollar is more valuable than it otherwise would be.

        By the way, the sudden panic and collapse caused by capital flight from an emerging market country almost always happens because of prior intervention of the government in the fx market. I can’t think of a single example where the currency wasn’t managed in some way, except maybe South Korea in 1997, and I suspect the government was heavily involved in that case too.

      46. ESM,

        No offence, it is precisely arguments such as these that I am trying to argue against. That exchange rates will adjust to end up making the current account go into surplus. There is a huge difference in the assumption that the exchange rates move smoothly and the assumption that they do not. Non-oil producing African nations and in fact many underdeveloped nations face huge currency pressures. Nobody wants to save in their currencies if they are running current account deficits. The foreign investors have to be persuaded to buy their IOUs. Its not the desire of the foreign nations to save in their currencies that causes the current account deficits. The causality is backward.

        “So long as countries trade with the rest of the world, they must avoid all expansionary domestic policy that threatens external imbalance. Countries that engage in international trade must attempt to maintain expected future conversion rates of their currency at their current values. If the exchange rate is expected to fall, CBs must pay a risk premium to attract funds to compensate foreign portfolio holders for expected capital losses. Since currencies represent a store of wealth in asset portfolios, countries are doubly concerned about the current size of their foreign exchange reserves and the future value of their exchange rate. When a country’s current foreign exchange outflows consistently exceed its foreign exchange receipts, it has limited choices. It must either pay out foreign currencies from its reserves, borrow foreign currencies to cover its negative balance, let the exchange rate depreciate, or devalue its currency.”

        – Basil Moore, Shaking The Invisible Hand.

        No MMT solution works in such cases.

      47. Exactly. The countries of the Third World end up being the servants of the rich countries since they have to devote most of their resources to export and cannot build their domestic economies. In shocks and even “adjustments,” they are the ones that bear the brunt. This is not efficiency; it is exploitation.

      48. Ramanan,

        Just by way of clarification/review, exactly what MMT premise are you questioning on this issue of current account deficits and exchange rates? What is it that MMT says specifically about this area that you reject?

      49. Anon,

        Good question. Helps me state a few things.

        Virtually most things. I think the MMT discussion is parallel to the “government does not borrow” as in the case of a closed economy and when the open economy is included, the country doesn’t borrow and the government just satisfies the rest of the world desire to save and that the exchange rate moves to allow residents to enjoy imports and for the rest of the world to save in the currency.

        The MMT proposal is for all nations to float their exchange rates and not worry about trade deficits because exchange rates will move to either end in surplus or remain in deficit if the foreigners want to save in the currency in the latter case.

        Now, since the external sector is important for all nations and I believe that fiscal policy is biased to keep demand low in developing nations, I am not so satisfied with this. Its less to do with understanding the monetary system than to do with other factors.

        All proposals and questions such as sustainability of both public debt and current account deficits is what I challenge. True, the State can remove overdraft limits and the deficits just move numbers up and down and that the government can have great control of the yield curve if it needs to do so. So by itself, fiscal unsustainability is not an issue. And since public debt is just a number, the governments can expand fiscally and provide full employment and it doesn’t lead to inflation because inflation is mainly caused by wages and wages can be disciplined.

        However, several things can be said. True Krugman is wrong – there will be less price pressure domestically. (however, note Zimbabwe was caused by both supply side issues AND government continuously increasing wages). Net imports or current account deficits provide foreigners income in perpetuity. The loss of employment due to the fall in demand by continuous current account deficits can be compensated by the fiscal expansion without increasing prices. However, this worsens the foreign trade performance. The State can’t run out of its own money, but it would have caused an addiction to imports and a weakening of the local manufacturing sector. Since economies move in complex ways, the foreign exchange may either not react or overreact causing a lot of headaches. If it overreacts, then it worsens the current account deficits because while prices of foreign goods move, the quantity adjustment takes time causing another round of overreaction by the foreign exchange markets. It causes a currency crisis.

        MMT says (implicitly) that the exchange rate will take care of it – will adjust automatically. There are several assumptions. Its like saying my credit risk is in the price and there will be a buyer – its just a question of the price. However, I may not find any buyers to sell my bonds! Similarly there have been many currency crisis and the number is 100+.

        When this happens, foreigners bailing the nation out make several demands. One of the things is to do a fiscal contraction. Fiscal contraction seems silly because nations can’t run out their moneys but its a “good” demand. Its to make sure that nations go back to the case where they are net exporting. However MMT will say its “confused” because fiscal contraction is a non-issue because solvency is never an issue for the government! And I can foresee arguments such as these!

        At the same time, currency falls do lead to price rises. MMT will say that its a one-time price rise. However, if workers demand to be compensated for the price rise, then you have an imported inflation.

        Also if a country’s public debt/gdp is rising in an “unsustainable” way, the currency loses value in the exchange rate markets. Movement of public debt in this territory also leads to increased current account deficits.

        Persistent current account deficits are not sustainable! History is a proof. Fiscal policy is limited by the external sector. These are the things I want to say.

      50. Of course, that note shouldn’t have ended in pessimism. Fiscal policy should be the backbone of any growth and growth cannot happen without active fiscal policy.

        My way of going is to have a concerted effort and make plans about new ways of doing international trade and have some sort of Anti-Maastricht rules. But all countries should do it together so that the powers of the currency markets are limited. PKEish.

        Other PKEish work is due to Paul Davidson who has written at length on the foreign exchange markets. He has proposals for an international clearinghouse which may sound like a backward step, but I like his points here,%20regionalism,%20and%20economic%20activity&pg=PA245#v=onepage&q&f=false (Fixed vs. Flexible Exchange Rates, Economic Growth and International Stability)

      51. Strawberry Picker: “Guys, I am terribly confused, you both seem to be backwards thinking like Robert Reich and my response in the fed minutes thread. Why is maximum employment a GOOD THING and a national mandate? Shouldn’t our goal in FACT be a MANDATE of maximum UNEMPLOYMENT, maximum IMPORTS, and MINIMUM exports. Please don’t get 2 ideas in your head that contradict each other, that makes you look silly, there is NO WAY you can truly BELIEVE that the BEST WAY to increase american standards of living is for me to get up from this computer and chat on this blog with you and go to WORK with a JOB in the strawberry field is there?”

        We will not get such a leisure society unless we reduce socio-economic inequality.

        IMO, the best way to do that now is to promote employment. Prolonged involuntary unemployment ends up making the poor poorer.

        Let’s also reduce the work week and lower the retirement age, but that comes later. 🙂

  2. “The remedy is quite simple, have the Fed offer funding (fed funds) to all member banks at it’s target interest rate, which is the rate the Fed desires to in fact be the cost of funds for its banking system as a matter of public policy.”

    How about they crush big and small banks equally? 🙂

    Allow citizens to deposit funds at the Fed and then borrow 10x amount deposited at fed funds rate to enable purchases of government securities.

    1. Since govt sector = private sector + current balance, if private savings were marked up 10 times and used to buy Treasuries, the expanded govt deficit would boost private savings, oh, 10 times, and if those new savings were marked up another 10 times to buy Treasuries… well you see the problem.

      Another thought is where do state governments deposit their money? One interesting thing about the Bank of North Dakota is that all state (and municipal) tax receipts are deposited in the BND. And since candidates like Farid Khavari* aren’t going to take over state governments anytime soon (nor should they, politicians would use a state bank as a political slush fund), I’m curious how the other 49 states deposit govt receipts. Do they spread it out among small local banks or do large banks use their lobbying muscle to get all the deposits?

    1. Endogenous money creation nets to zero. Only exogenous money creation (currency issuance) increases nongovernment net financial assets. With a $-4-$ debt offset requirement, nongovernment net financial assets get saved as Tsy’s. So government “borrowing” is actually nongovernment saving.

    2. Jill K, look at the entire sentence…

      “In short, for the banking system as a whole, loans equal deposits.”

      If I borrow $1000 to pay off a $1000 loan (for example, I have a new Wells Fargo credit card and I transfer over the balance from my old BOA credit card), its a wash. In terms of the banking system as a whole, I still owe $1000.

  3. “well you see the problem.”

    Uh, what exactly is the problem?

    A citizen buying a tsy sec does not create a new tsy sec. Tsy secs would still have to be created through government deficit spending.

    Giving citizens access to Fed fund loans to purchase tsy secs just puts them on equal footing with large banks.

    1. The economy is probably running 20% to 30%, below its output capacity (reflected in the U3 unemployment rate of nearly 10%), so yes the government should be spending more. However if the government spends more than the economy has goods and services available for purchase, any money created will simply be inflated away.

      Since govt deficits create private sector surplus, you’re talking about increasing the money supply by 1000% (in just the first cycle),…unless the govt imposed credit controls and assessed loan risk. it could do that, but it would be reinventing the wheel, the banking system already does that. Granted, banks need to be reformed (and failed banks shouldn’t be bailed out) but they do serve a public purpose.

      1. ” you’re talking about increasing the money supply by 1000% (in just the first cycle),…unless the govt imposed credit controls and assessed loan risk. it could do that”

        No. Just allowing citizens to purchase any currently available tsy secs on the same terms as big banks.

        “unless the govt imposed credit controls and assessed loan risk. it could do that, but it would be reinventing the wheel”

        There is no credit risk as the tsy sec is the collateral for the loan if the bank or citizen defaults.

        This is one public purpose we could do without.

  4. In a simple world, loans = deposits for the banking system as a whole. However, for countries with a big financial sector such as the US, there are complications.

    Other than deposit effects due to the government sector, securitization creates a lot of complications. The liabilities to banks in non-banks’ balance sheets don’t add up to banks’ balance sheets. The difference is big ($9T+ ?). In the simplest case when banks securitize and sell the ABSs/MBSs, the following happens in the whole process.

    1. Loans create deposits
    2. Banks pool the loans and sell it to SPEs created by them
    3. The SPE creates ABSs and the banks buy these securities
    4. Banks sell the securities to “investors” and the banking system’s deposits go down.

    1. yes, the liabilities are switched to non bank liabilities and the assets are not held by the bank either.

      so it’s a loan and a deposit out side of the banking system, just like with corporate bonds, commercial paper, etc. are non bank liabilities funding non bank assets

      1. Its a bit different from corporate paper because the loans are moved off the balance sheet. In the consolidated balance sheet of banks and their SPEs, loans appear again and instead of deposits you have ABSs as liabilities.

    2. I saw loan officers who were illegal aliens make loans to other illegal aliens for houses and cars. The loan officer got a bonus, the borrower got an asset, and some sucker down the line got that bad loan in an basically unregulated financial wild west. IE some town in norway buying US MBS that eventually bankrupted thier local norwegion pension fund. The loan officer and borrower are now down in some south american margaritaville laughing at the US banking system.

      Warren I know you have a small bank in florida. How much .25% money have you been able to borrow to invest at 3%?

      1. as a matter of public policy the Fed sets the cost of funds for the banking system at levels deemed in line with public purpose.
        in today’s environment, with it’s shortage of aggregate demand, banks are seeing very few credit worthy borrowers resulting in very low loan demand.
        Our assets have been falling for over a year now, for example.

  5. I wish you people wouldn’t use so many acronyms (sigh). What are SPE’s? There are over 100 possible meanings on the web acronym dictionaries.

  6. Thank you, Tom. Very kind of you. Perhaps you could make a little acronym glossary for us uneducated ones 🙂

    1. P.S.

      on the one hand, he’s criticizing the “net foreign investment” language used to describe what is essentially an NFA position, which I agree with

      on the other hand, he’s saying imports of capital equipment shouldn’t be classified as a current account transaction, which I wouldn’t agree with

    2. P.P.S.

      This whole issue of S = I etc. as summarized by Moore is (just) another indication that most of the economics profession still hasn’t grasped Keyne’s fundamental message of logic about the fallacy of composition?

    3. The reason imports of capital equipment SHOULD be classified as a current account transaction is that at a global level, its the production of new investment goods that constitutes GDP capital investment and the income and saving that corresponds to it – not the sale and purchase of new investment goods. That logic holds within borders and across borders.

  7. Anon,

    I linked it for S = I for a closed economy. Will have to look at the other things he has to say. The reason I linked it to S = I is that I see a connection of the discussion around S = I (for a closed economy) and the MMT discussion around trade deficits and external sector saving desire.

    According to Moore, in neoclassical economics interest rates adjust to make S = I. The logic seems related to MMT, where exchange rates adjust to make trade deficits equal to foreign sector saving desire.

  8. I tried to read this thread and understand the arguments of Ramanan but I am failing.

    Ramanan, you used to a proponent of MMT who seems to have converted. So you generally used to subscribe to the idea that government has a clear role in economy but now you start to think it is only a part of the economy. Government has as much to say in the external sector of its economy as it has in the domestic. Why do you believe that it is perfectly fine to regulate domestic part but leave external part to free market? Regardless of reserve status imports in any currency are benefits and exports are costs. This might or might not have detrimental effects for the future well-being (and its stability) of population. However there are tools at the disposal of any government to reduce its dependence on imports and/or increase stability of its exports. At the end of the day (or taken to the limit) a “reserve” currency status does not make any economic sense and all trade balances around the world should be zero which by definition solves your problem.

    1. Of course I think that the government has a great role in the economy. Didn’t change that view a bit. Its the international trade and everything related with that, which I am trying to discuss.

      1. I think that there are two separate issues involved, market failure and Pareto inefficiency While liberalism avoids both theoretically, the assumptions required for this are not realistic. Practically, speaking, liberalism leads first to Pareto inefficiency, and then to either market failure or political failure, or both.

        Therefore, some management is required, and this management must take in account all factors, which in a global economy is “everything.” Under the current system “management” is biased toward the managers’ interests.

        This is not taken into sufficient consideration under liberal principles that presume automatic adjustments involving dynamic equilibrium.

  9. and btw, Ramanan, I see wage increases in Zimbabwe as consequences of price increases. Government, naturally, wanted preserve basic public services (start with police) and increased their salaries in line with increasing prices. So it is still a bit question what drove what in Zimbabwe.

    1. Yep its a feedback effect. Prices rose and the government kept increasing wage levels. That increased prices etc.

      Prices of manufactured goods is cost-dependent and higher wages means increased prices. Prices of other things are somewhat demand dependent.

  10. Ramanan,

    “The MMT proposal is for all nations to float their exchange rates and not worry about trade deficits because exchange rates will move to either end in surplus or remain in deficit if the foreigners want to save in the currency in the latter case.”

    I’m not sure that’s an explicit proposal but it’s been an evident theme in the case of the Euro.

    But more importantly, this has no bearing on the MMT approach to the US bilateral deficit with China. The “innocent fraud” about that deficit has nothing to do with floating, because China fixes (effectively) the yuan against the dollar. Yet the innocent fraud regarding CA deficit “funding” is most easily seen in the case of China buying treasuries. The US doesn’t depend on China buying its treasuries to “fund” the CA deficit. I guess this is the best example of why I’m a bit confused about where you’re coming from on MMT and CA deficits. The US doesn’t need to sell treasuries or do any “funding” when it’s exporting the dollars that China is redeploying.

    Question: how special is the US case to the issue of the innocent fraud of “funding” a current account deficit? Does the innocent fraud idea depend entirely on the fact that the dollar is a reserve currency?

    1. Anon,

      The example of the United States’ symbiosis with China is a special one and one cannot use that as an example to describe relations between two countries. The Chinese buying Treasuries without any hassles is a special case than a general case. Countries do finance their current account deficits by issuing IOUs to international investors. The issuance creates a income stream in perpetuity to foreigners and foreigners’ share of the national income may keep increasing to the point leading to a collapse in the currency. It is unsustainable.

      “Governments are not revenue constrained” can be used to explain anything. It can be used to explain that private sector debt is sustainable. The argument (my own, not an MMTer) is as follows. Loans make deposits – an increase in lending may initially increase aggregate demand but once interest payments start growing, aggregate demand will fall. No problem! Government is not revenue constrained and can relax its fiscal policy and hence private sector debt is sustainable.

      Now, no MMTer will argue like that but you see dangers of taking the “not revenue constrained” argument too far.

      Its not a good thing for any nation to run a current account deficit persistently. Because it is a deficit, it has to be financed. The terms are dependent on the foreigners demands. Foreigners need to be compensated for taking risks, especially exchange rate risks. And exchange rates can move in any direction. They cannot increase the fiscal policy without deteriorating the accounts with the rest of the world and causing huge currency volatilities. This causes rest of the world to demand a higher premium.

      The Rest of the world is the creditor and the United States is a debtor. The net foreign claims is around 40% of GDP. In fact it is not even a reliable number and could be higher.

      Enter MMT and claims that since the government is not revenue constrained, the US government can run current account deficits forever.

      Current account deficits lead to a rising public debt especially since employment has to be kept low. A public debt hurtling to high levels leads to rapid currency falls and a further deterioration of the current account. With the crisis having spread to all nations, the US is saved for now. But increasing points on the computer is anything but overconfidence about your currency.

      There are other issues as well. Manufacturing has deteriorated in the US because of currency manipulation. But wait, government is not revenue constrained and imports are benefits.

      1. So precisely why is US/China a special case in conflict with the general case? I assume that means you have less concern in the US/China case. What is it about US/China that “works” but that doesn’t work in the general case?

      2. The currency markets and their views about the future. They won’t tolerate persistent current account deficits. They may allow it for a while depending on their “moods” but not forever.

      3. Chinamerica is a special case because of the peg and dollar hegemony. Henry C. K. Liu has been writing extensively about this arrangement for several years. So has Michael Pettis. So far, it has apparently worked for the interests of both countries (the elites that make policy that is). However, now problems have arisen in both countries that are affecting that relationship. Michael Pettis and Andy Xie have been on this for some time now.

        Chinese workers are agitating for a bigger share of the pie even as inflation is rising in China due to the RE bubble that has been forming as a result of loose credit. Workers in the US are complaining that they are being replaced by Chinese workers as manufacturing flees the country and wage pressure mounts.

        This is politically unsustainable for both China and the US, and the crisis is threatening the special relationship between them, with unemployment too high in the US and wages too low in China. US workers enjoy the benefits of cheap imports but hate the cost of exporting jobs. Chinese workers lot the work they get from exporting but they hate not have the things that Americans have.

        No one I read thinks that China’s relaxing their peg a bit is anything but a fig leaf to avoid the inevitable protectionism coming their way as the US political situation heats up heading into ’10 and ’12 with unemployment stuck at historically high levels.

      4. I’m sorry Ramanan. I just think your argument is fatally flawed.

        Consider a small, developing country with a floating rate, non-convertible fiat currency. Its currency is valuable because it imposes a tax on its residents and (presumably) its residents are capable of producing goods and services with non-zero value. If the currency has value to its residents, it will have value to non-residents as well (for the same reason that residents with no tax liability still desire to have currency). If the currency has value, then it will trade at some positive value with respect to the dollar, the Euro, and any other currency. There is no need for foreign reserves or gold — the currency is backed by the taxing power of the state, which depends upon the credibility of the tax regime and the productivity of its residents.

        Now, the currency will trade in the market at some value which, if the currency is not managed or manipulated in some fashion, represents an equilibrium level between buyers and sellers. Foreigners come and offer their goods and services for sale at some price. It doesn’t matter if that price is denominated in dollars or in the local currency. Presumably, if the seller wants dollars, he can either accept payment in local currency and sell that into dollars, or demand payment in dollars in which case the buyer will have to sell local currency and buy dollars first (from some other foreigner) before making the purchase. Either way, everything should clear just fine, and the ROW owns more local currency. If there is too much selling pressure on the local currency (perhaps because every resident all of a sudden decides to buy an Ipad and, at the same time, Apple has no desire to hold the local currency), then the local currency will fall in value, and the price of imports will rise for local residents, and their desire for imports will decrease. Simultaneously, the price of domestically produced goods and services will fall in dollar terms, and the ROW’s desire for exports will increase.

        At every point in time, the fx rate will represent an indifference point, as Warren has stated. If trade deficits persist at a current fx rate, then it MUST mean that the ROW is willing (for whatever reason) to continue to accumulate the local currency at that current fx rate. When the ROW decides (in the aggregate) that it is not willing, then there will be selling pressure on the local currency and a new equilibrium established at a lower fx rate. At that new point, it is very likely that the trade deficit will be lower (although not a certainty!), but there could still be a deficit because the ROW is once again willing to accumulate local currency at the new lower fx rate (it’s a better deal after all).

        Now, you and Tom seem to have a problem with all of this — that the accumulation of local currency by foreigners somehow gives foreigners control over the country and the local residents. I suppose it gives foreigners the ability to trash the currency by selling in the fx market all at once, or perhaps to cause severe inflation by trying to buy all of the domestically produced goods and services all at once, but I don’t see why that would happen. And in any case, if you look at the cumulative benefit, the country would have essentially bought a whole lot of goods and services from the ROW at low prices and then paid the ROW back in goods and services at high prices. Sounds like a good deal to me.

        Note that there is no reason at all for the country to maintain fx reserves or to borrow, and in fact, it is better and more transparent that it doesn’t. If the government wants to do something silly and buy a $10B aircraft carrier from the US, it must print a whole lot of local currency to do so, and that will cause the value of the currency to plummet and inflation to rise. The effect of such wasteful spending will be immediate and obvious. It would actually be easier for the government to hide the deleterious effect of such spending by borrowing in dollars. That’s why the the safest course is for a country not to borrow and not to interfere in the fx market.

      5. Esm, I can’t speak for Ramanan, but I agree with the theory. My contention is that liberalism — the theory of the invisible hand in whatever form that guarantees automatic adjustments that are Pareto optimal — are, well, theoretical. They don’t turn out that way in practice for a number of reasons that have been examined.

        Most obviously, modern economies and the international economy are managed. They are not the perfect markets that liberalism assumes. My contention is that they are manage for the managerial class primarily, with the assumption of trickle down. It is further assumed that this is the best we can do. I dispute that. The Gini coefficients are much too skewed, indicating that there is a lot of wealth capture going on in this system.

        Obviously, I am not the only one that thinks this. Latin America is wising up to the US and countries are deciding not to eat the rotten food anymore. China is playing along until it is strong enough to confront the West, but it is not lying down either. It is calling for a monetary realignment, with more say for the G20. Russia and India, too, want a seat at the table instead of crumbs that fall to the floor.

        Even Europe is getting fed up with the US. Goldman is persona non grata there now.

        So, no, I am not against the theory if the assumptions were met. But they are not met, and they cannot be met as advertised, because they are unrealistic. I don’t see dynamic equilibrium. I see disruptions that look pretty chaotic to me. The problem is that the people controlling the process are, well, self-interested, and their interests conflict with Pareto optimality. At the extreme, there is already talk on the right in both the US and China that if their respective countries don’t get their way, then there will be war.

        Liberalism is a dead paradigm operationally. All modern economies are managed now. Liberalism — free markets, free trade, and free capital flows as the basis of political freedom under market capitalism — is just used as a slogan to further the interest of the managerial class that professes to embrace it and then lines up at the government trough, which it can easily do since it has effectively captured the state.

        I fully subscribe to MMT as far as it goes. It just doesn’t go far enough as a new paradigm. To stop short is just to make an ad hoc adjustment to the old paradigm to deal with some anomalies.

        My contention is that under the pressure of globalization, conditions have changed so much that a new paradigm is needed. What that would look like I don’t claim to know exactly, but I don’t like what I see developing with central bank political independence and international institutions that are unelected and unaccountable replacing popular sovereignty. There are a lot of other things happening that I don’t like, too, but that is beyond the scope of this post.

      6. ESM,

        The argument that “At every point in time, the fx rate will represent an indifference point, as Warren has stated.” is nothing but subscribing to the laissez-faire ideas.

        “I suppose it gives foreigners the ability to trash the currency by selling in the fx market all at once, or perhaps to cause severe inflation by trying to buy all of the domestically produced goods and services all at once, but I don’t see why that would happen.”

        Hmm well, they may not buy domestic goods, but dumping the currency has happened many times. There have been 100+ currency crisis.

        “Sounds like a good deal to me.”

        Yep its like saying high personal debt is good. Net imports create unemployment – all MMTers know.

        “That’s why the the safest course is for a country not to borrow and not to interfere in the fx market.”

        Thats in theory. All countries have reserves. Japan too I think.

        Btw, the MMT favourite example is Japan. However it is a net-exporting country.

        In your example on Apple, you assumed that the currency moves smoothly. Real world – they don’t. Thats a big difference. There is no equilibrium.

        The point is that MMT assumes that a nation’s IOUs can be sold to foreigners and its just a matter of price.

      7. regulation is for further public purpose and to establish the ‘box’ that market forces operate within. Hence regulation of monopolies, environmental standards, strategic industries, corporate law, contract enforcement, etc.

        there could be times where it makes sense for govt. to intervene in fx markets for further public purpose, I just can’t offhand recall when that would have made sense for the US.

      8. Tom/Ramanan:

        Here’s the problem I have with your argument. You say that you don’t believe that MMT will work in practice, and then cite the sordid history of currency crises as evidence. But the fact is that with the possible exception of the English-speaking countries (US, UK, Canada, Australia), I don’t think any country has subscribed to an MMT paradigm.

        The model for everybody since WWII — enforced by the IMF — is one based on a fixed exchange rate system with an independent central bank. Countries are encouraged to manage their currencies in order to keep inflation low and exchange rate volatility low. Perhaps those are worthy goals, but intervention in the fx markets to achieve them is artificial and in the end destabilizing. Better to adjust fiscal policy frequently based on inflation measures (which will include the price of imports).

        By the way, pretty much every country besides the English-speaking ones runs a mercantilist policy, Japan included, which is also out of paradigm.

        “Thats in theory. All countries have reserves. Japan too I think.”

        That’s because the goal of the Japanese government is to run trade surpluses no matter what. It necessarily follows that Japan will accumulate reserves. It doesn’t actually need them per se.

      9. But ESM, your view presumes that countries would start to do things differently (liberally) and stop managing for their own interest. I am saying that this is just as unrealistic as claiming that deregulation will lead to perfect markets. It just does not happen.

        As you say, many countries are pursuing mercantilist policies. The US, the most powerful nation in history, cannot get the Chinese to change even though they have been trying since Alan Greeenspan started jawboning about “the global savings glut.”

        What would make it happen?

      10. Tom, I am also saying that it doesn’t really matter what other countries do — it only matters what your own country does. If your own country embraces MMT, then things will be good, even if other countries run mercantilist policies. The US jawboning of China reminds me a little of Bugs Bunny begging not to be thrown in the briar patch, except in reality, Bugs Bunny (i.e. the US administration) really does have an irrational fear of the briar patch.

        You could come up with some specific things to be afraid of I suppose. I wouldn’t want China using its dollar hoard to buy up large swaths of our defense industry, for instance. But that can be controlled through government regulation. I don’t necessarily agree with the result, but when China tried to buy Unocal, it quickly discovered that not all dollars are created equal.

      11. ESM, I don’t think that the problem is particularly with the West. The West has controlled the game for a long time, and it is still in the driver’s seat, even though China is a manipulator on a grand scale. However, it’s manipulation is disadvantaging its own working class through internal financial repression, as Pettis point out. The US is benefiting from resources that the Chinese people are foregoing so that their elite can prosper disproportionately, just as in the West. The Chinese leaders figured that out.

        The real problem is exploitation of the resources of the Third World, which the developed nations have been extracting and continue to. In addition, the manipulation and exploitation goes beyond trade to imposition of domestic requirements that disadvantage the populations of these countries.

        I am also particularly concerned about the trend toward centralized policy-making by unelected and unaccountable bureaucrats that serve the interests of the elite, not only intra-nationally but also internationally. To put it bluntly, this is a take-over.

        This is being done under the rubrics of liberalism, the notion that free markets, free trade and free capital flows lead to in the direction of Pareto efficiency more directly than anything else.

        What I am opposing is the whole package rather than some isolated parts of it. It is an ideology that views wealth as the proof of success (efficiency and effectiveness) and argues on this basis that the people that are in charge have been established in that position by the mysterious working of the invisible hand, which gives them dibs on their position. I think that this is a bogus argument.

        For example, liberalism starts with the presumption that “freedom” results in greater efficiency and effectiveness than anything else owing to the invisible hand, and that this leads to maximum utility, which is equated with approaching Pareto efficiency as closely as possible. This is the liberal fallacy, because it presumes freedom where it does not exist, and the state of the world is the proof. As the Native Americans learned, “the white man speaks with forked tongue.”

        MMT begins domestically with a goal of full employment together with price stability and works toward it. I agree with this approach.

        I think that a similar approach needs to be implemented globally, and that international institutions need to be working in that direction. The idea that currency market adjust to maintain dynamic equilibrium doesn’t cut it for me in accomplishing this. MMT needs to come up with a global vision, too, if it is going to be a comprehensive theory in the age of globalization.

        If full employment with price stability is the goal domestically, what is the corresponding goal globally, and what economic/financial policy will achieve that goal? How would that be implemented and policed? I don’t see these questions being asked yet, let alone answered.

        The current goal of limitless growth is unsustainable, and the institutions that are emerging are anti-capitalist and anti-democratic, even though they are being erected in the name of liberalism. Deep contradictions are emerging that can only lead to untoward consequences, and the lives of billions of people will be adversely affected by unwise choices. Even the developed countries will not escape it, although they will be more isolated from the disastrous effects, at least for a while. In the end, however, climate change is going to hit everyone as this century unfolds.

    2. Forget the US-China T-shirt and T-bills example for now and start thinking of a developing nation which has to make some imports and assume neither the central bank nor the Treasury has any foreign exchange in its balance sheet.

      1. Ramanan,
        With Iceland when their banks were getting away with their scheme, seems the ROW was willing to ‘fund’ their CA deficits, now that it has blown up, you can see that they Iceland have had to turn that around to CA surpluses again. The ROW will not currently ‘fund’ their CA deficit. They had to go to the IMF right away and now have perhaps fully transititoned to a CA surplus to get the foreign currency they need for critical items. I wouldnt think they could solve this by spending ISK kroner (but the value of their currency has fallen which makes the exports easier to do).

        Link here.

        Is this perhaps a small example of your point here?


      2. I have to look carefully, but maybe an example. Nice website. MMT may say fixed exchange or so and it takes time to understand an economy. If its currency floated reasonably freely, it could be a perfect example.

        The IMF usually demands many things such as austerity and as far as doing the job of a creditor is concerned, they do it well. It doesn’t help blaming the IMF. Defeats the point of arguing about current account deficits by blaming the IMF. I know they act with no emotions but good to analyze a situation without emotion as well.

        It is characteristic of a freely convertible international standard that it throws the main burden of adjustment on the country which is in the debtor position on the international balance of payments. … that is, on the country which is (in this context) by hypothesis the weaker and above all the smaller in comparison with the other side of the scales which (for this purpose) is the rest of the world. … The contribution in terms of the resulting social strains which the debtor country has to make to the restoration of equilibrium by changing its prices and wages is altogether out of proportion to the contribution asked of its creditors … the process of adjustment is compulsory for the debtor and voluntary for the creditor. If the creditor does not choose to make, or allow, his share of
        the adjustment, he suffers no inconvenience. For whilst a country’s reserve cannot fall below zero, there is no ceiling which sets an upper limit. The same is true if international loans are to be the means of adjustment. The debtor must borrow; the creditor is under no such compulsion.
        – JMK

        You know, I have become this suspecter of facts around debt monetization. Clearness of the mind is reached if we think of the government borrowing first and then spending. Current account deficits lead to increasing interest rates. Wynne Godley comes close to saying these things.

        If a country is floating, since current account deficits lead to increased fiscal deficits, and national income doesn’t grow at the same rate, there can be some issues on government financing. Some debt has to be picked up by foreigners. If they don’t there is monetization. Monetization is not impossible, free or floating. If there is a crisis, the central bank has to give up its targeting rates. If foreigners do not pick up the debt and the central bank monetizes the debt, it can lead to a capital flight and rapid falls in the currency. In the case of the US, China automatically picks up the debt. Of course increase of reserves do not make banks lend more, so those dangers are not there. However, the problem is with the currency. Even if foreigners pick up the debt at high yields, there can be a fall in currency. There are many fourth and fifth order thinking that the currency market is doing.

        While the currency is plummeting, the balance of payments gets worse because quantities do not adjust with price. Another round of plunging of the currency!

      3. Clearness of the mind is reached if we think of the government borrowing first and then spending

        Oh boy. Perhaps it’d be faster if you just identify what parts of MMT you still think are valid, or what steps an individual country could take to improve its position.

      4. Beo,

        How did you forget the thread with 600+ comments ?

        My comment about “clearness of the mind is reached …” was to highlight the “non-non-sequiter” of debt monetization. The reason I highlighted it was that there is nothing universal about the Chinese-T-bill symbiosis. You have to pay high interest rates to foreigners. Else there will be capital flight causing a fast depreciation of the currency.

        I do not disagree with expansion of fiscal policy if you got the impression for some reason.

        My comments are to highlight the fact that there are hundreds of things to be done. I have stressed a lot about concerted action which I am sure went unnoticed.

        Most importantly, for the case of the US, instead of saying keep importing like there is no tomorrow, have policies to reverse the imbalances. I like this article

        More importantly I am trying to point out the detailed way in which the external sector is a headache.

        Reminds me someone asked someone earlier “whats your proposal”. One doesn’t need to have a proposal 🙂

  11. Ramanan, why don’t you limit fx-market to productive uses, i.e. one party to transaction should be non-financial? Does it solve your problems with fx-rates?

    1. Could be a good idea.

      My purpose in commenting here is to go into the anatomy of a currency crisis, things that lead to it and things that may happen after that.

      The reason I have been critical is not to criticize for the sake of it but get to the set of transactions and capital flows involving government bond auctions, banks and central banks, foreign investors arising out of international payments and settlements. The discussion around it will help us understand whats going on. The discussion obviously should involve exchange rate movements as well.

      China readily buying Treasuries is an exceptional case. For example, in the Chinese case, the PBoC gets hold of the dollars from banks who get it from exporters. PBoC then purchases Treasuries. In case of other currencies, the foreign central bank may not be involved in the game at all.

      1. In all other currencies (floating as well) central bank is running some fx-buffer to dampen volatility in the fx-market. Consider it as a simple liquidity issue with everybody having some liquid assets for unexpected outflows. Central banks are no different though their goal is.

        Clearly, as Soros and Bank of England showed, any developed world central bank can fall victim in case of fixed exchange rate if the world goes against it. But in a floating setup with central bank smothening volatility real economy effects should be manageable. In this context the focus of IMF on CB reserves versus days of imports is a very sensible thing to do. But ultimately it is the fx-rate which will give up so the question is then of ex-ante policies versus ex-post policies. Both options are possible but hope is a wrong macro-economic driver 🙂

      2. R,

        MMT does not deny exchange rate adjustment. What point are you disagreeing with?

      3. Well the whole philosophy actually.

        “A CAD signifies the willingness of the citizens to “finance” the local currency saving desires of the foreign sector. MMT thus turns the mainstream logic (foreigners finance our CAD) on its head in recognition of the true nature of exports and imports

        Subsequently, a CAD will persist (expand and contract) as long as the foreign sector desires to accumulate local currency-denominated assets. When they lose that desire, the CAD gets squeezed down to zero. This might be painful to a nation that has grown accustomed to enjoying the excess of imports over exports. It might also happen relatively quickly. But at least we should understand why it is happening.”

        Its a case of assigning a behavioral model to a static identity.

        If the basic assumption itself is debatable, and I can’t convince the other side about it 🙂 The empirical fact is that persistent current account deficits lead to currency crisis but one gets an example about China, T-shirts and T-bills and other examples are said to be about fixed fx regimes or gold standard.

        Imagine there are three countries – the US, Korea and China. India desires to save more in USD than China. Does that mean that Korea’s exports to the US will automatically be higher than China ? Or that US residents pick Korean goods over Chinese because Korea desires to save more in USDs than China ?

      4. Sorry that should be

        Imagine there are three countries – the US, Korea and China. KOREA desires to save more in USD than China. Does that mean that Korea’s exports to the US will automatically be higher than China ? Or that US residents pick Korean goods over Chinese because Korea desires to save more in USDs than China ?

      5. No, it means Korea is less apt to import US goods than China, relative to the dollars it receives from its exports. That import propensity is something that is under Korea’s control. The desire to save is reflected directly in the sluggishness of its import propensity.

      6. It also means that Korean companies may lower the dollar prices of goods and services offered in the US in order to capture a larger market share. Certainly, if the Korean central bank is offering to pay a premium for dollars in exchange for Won to Korean exporters, then these companies will lower their prices and increase their volume of sales in the US.

      7. Anon,

        So you are bringing in the propensity to import which is a bit of a demand side thing. Imports are defined

        M = μY, where M is imports, μ is the propensity to import and Y is the national income.

        Now if we have three countries we have to give subscripts to the μs. Y depends on fiscal policy, propensity to consume amongst other things.

        These quantities are inter-related but however, the trade deficit is due to these quantities and other things such as prices, exchange rates and so on. A simplest stock-flow consistent model runs into 100s of equations.

        The trade deficit however is the difference between exports and imports. For a given country the export depends on the external world’s imports and hence the demand in the external world. The trade deficit is nothing but the accounting record of these decisions.

        A country can increase its fiscal policy and demand but it in no way is due to the external world’s “desire” to save in the currency.

        If Korea increases its fiscal policy and becomes a net importer is it due to the “saving desire” of the citizens of the US ? The extra Korean currency that the US has is due to the decisions made by Koreans. How come US finds itself with Korean currency without me having assumed any change in the desire of the US to accumulate it ?

    2. “one party to transaction should be non-financial?”

      Something like this needs to be instituted be in commodities and derivatives too.

  12. “If Korea increases its fiscal policy and becomes a net importer is it due to the “saving desire” of the citizens of the US ?”

    Given such Korean fiscal stimulus, Koreans have a desire to dissave (spend) at the margin. If that reverses the current account direction, then yes the US now saves bilaterally by definition. If the US didn’t actually desire to save in this situation, it would have stampeded into Korean exports and bid up prices, thereby sucking demand out of Korea.

    1. Agreed. Or US residents would have sold Won on the fx market for something else, in which case the buyers of the Won presumably wanted to hold Won (probably because the price was depressed by the US selling pressure and thought it was a good deal).

      Or … US exporters would have raised the prices of goods and services offered in Won, thus reducing US exports to Korea and bringing trade back into balance.

      No matter how much you confuse the issue with that “math” stuff, you can’t get around the fact that a country will not run a current account deficit unless foreigners are willing to increase their holdings of that country’s currency. And in a free market, they are doing so willingly, without having to be tricked or bribed.

  13. note that since the euro opened it has traded in a range between maybe .85 and 1.60 vs the dollar.

    is that a ‘currency crisis?’

    what is a ‘currency crisis’ with floating fx?

    any examples?

    particularly with the smaller countries?

    Any examples of a drop in imports or increase in exports being considered a negative and a ‘crisis’ by the politicians?

    (I can see the headline now- ‘US takes emergency action to curb exports’ when that happens the battle has truly been won.)

    Odd that our politicians are afraid of China dumping dollars, driving the dollar down, and at the same time pushing for a stronger yuan?

    is much of the discussion in fact over the definition of the word ‘crisis’?

    good stuff, guys!

    1. Exactly! The worst possible scenario is apparently the scenario that all the politicians want — that we consume less than we produce.

    2. Fixed or floating misses the point.

      Most nations target foreign reserves.

      Paul Krugman has a book currency and crisis.

      Euro Zone is quite a different game altogether – there was a massive fear about the fall of the Euro. Hence.

      Most governments are worried about current account deficits turning negative and massively strive for export driven policies.

      There is a massive difference between a slow currency change and a fast move.

      Most nations go slow when the currency depreciates fearing further fall. Nothing that “. . . not revenue constrained” can do. And well a fiscal expansion leads to further depreciation.

      Billy Blog:

      Clearly, when an economy that experiences a depletion of foreign exchange reserves has to take some hard decisions in relation to its external sector, especially if it is reliant on imported fuel and food products. In these situations, a burgeoning CAD will threaten the dwindling international currency reserves.

      In some cases, given the particular composition of exports and imports, currency depreciation is unlikely to resolve the CAD without additional measures.

      The depreciation, in turn, raises the relative costs of imports, and imparts an inflationary bias to the economy. Moreover, depreciation leads to expectations of further depreciation and fuels the run out of the currency. There may be no interest rate that is high enough to counter expectations of losses due to depreciation and possible default.

      In the short run there is probably no alternative but to urgently restore reserves of foreign currency either through renegotiation of foreign debt obligations, international donor assistance or default.

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