Rebalancing into a black hole

[Gumby]

I found it to be kind of humorous that I realized the ramifications of foreign-denominated debt before Krugman did

http://pragcap.com/a-puzzle-solved

(...all thanks to MMT, of course.)

[stone]

There is the pernicious falicity that money is something that a nation has to aquire from outside rather than being a freely generated administrative tool for the nation to conduct itself so as to offer real goods and services to earn its way in the world.
The euro screw up is still getting touted by some of the UK media as being about Italian "profligracy". If you don't count debt interest, Italy has run a 2.5% surplus for the last few years.
What really strikes me about your link is the phrase "reduced to the status of third world nations borrowing in someone else's currency".
It seems doubly evil that in the 1980s and 1990s, the IMF persuaded third world nations to not have their own genuine soverign currencies but to instead borrow in USD or GDP or whatever. I think the penny dropped when Malaysia told them to get lost in 1997 and did very well as a consequence.

[moda0306]

You mean the Euro debt crisis isn't simply about generous welfare states being punished by the markets?

Sorry if the sarcasm was a little thick...

[Gumby]

It seems doubly evil that in the 1980s and 1990s, the IMF persuaded third world nations to not have their own genuine soverign currencies but to instead borrow in USD or GDP or whatever.

Agreed.

My understanding is that Germany dreamed up the Euro in order to prevent its neighbors from devaluing their currencies. The original logic was that if Italy, Ireland, Greece, etc were allowed to devalue their currencies, Germany was afraid they would have to follow their lead in order to stay competitive in the global marketplace. The German public is deathly afraid of devaluing their own currency because they still remember the hyperinflation of the Weimar Republic.

...Of course the irony is that if you look at the table on the first page of this discussion, we see that the Weimar Republic's hyperinflation was triggered by (regime change, and) its foreign-denominated debt!!

[sigh]

[moda0306]

Let's just call a spade a spade... Germany has hornswaggled Europe once again and instead of death camps we have effective debtors prisons that are simply entire economies in size.

I'm 80% kidding, and pardon my frankness if we're still in "too soon" territory with comparing the Euro to the Holocaust.  These countries all got themselves into this mess by forming a monetary union without a fiscal union, and anything Germany did they did with willing, if misinformed partners.  If anything, Germany should get credit for being good salesmen and financial engineers.

[Gumby]

But, it's very sad for countries like Greece. The people there have no future now — thanks to their politicians. Richard Engel — the NBC News correspondent who usually reports from the most dangerous locations on Earth — did a report from Greece this week about the people there. It's very, very sad:

http://on.msnbc.com/vRYlT8

[murphy_p_t]

It seems like the whole currency collapse dynamic is the result of a combination of political, economic and monetary mismanagement.  Without mismanagement on all three fronts, it seems like it's hard to kill a currency.

I wonder if a currency has ever collapsed of a country with the world's most powerful military.  No matter what else happens, a country with a powerful military can always rent out its military bandwidth to parties needing protection and who are willing to pay for the service.  This arrangement between the U.S. and certain middle eastern countries is probably part of the reason that the U.S. dollar has remained as strong as it has in recent decades.

I'm not a historian, but this sounds like the Roman Empire.

[murphy_p_t]

It seems like the whole currency collapse dynamic is the result of a combination of political, economic and monetary mismanagement.  Without mismanagement on all three fronts, it seems like it's hard to kill a currency.

I wonder if a currency has ever collapsed of a country with the world's most powerful military.  No matter what else happens, a country with a powerful military can always rent out its military bandwidth to parties needing protection and who are willing to pay for the service.  This arrangement between the U.S. and certain middle eastern countries is probably part of the reason that the U.S. dollar has remained as strong as it has in recent decades.

I really think this is why we have a ridiculously overfunded military. The nightmare scenario for our currency is that a country, or group of countries, would somehow agree to no longer accept dollars for things that we want from them. Having a strong military makes our dollars not only more appealing from a promise/liability perspective, but it also makes doing business with us a necessity in terms of preserving regional stability. If a country (or countries) refused to accept dollars, they would either feel the full force of our military, or be abandoned from its protection. Mind you, I don't like this approach. It just seems to be the reality of the dangerous world we live in. The US is basically an 'Crime Boss' for the planet — threatening that "accidents might happen" for those countries who don't offer their generous cooperation.

These are likely over-simplifications, but perhaps contributing factors?

Exhibit A: Iraq
I believe they sold oil in Euro...fatal decision

Exhibit B: Libya
"excessive" gold reserves...shows no interest in holding US$...fatal decision
 http://www.zerohedge.com/news/battle-li ... -tons-gold
http://www.bbc.co.uk/news/business-12824137

[MediumTex]

It seems like the whole currency collapse dynamic is the result of a combination of political, economic and monetary mismanagement.  Without mismanagement on all three fronts, it seems like it's hard to kill a currency.

I wonder if a currency has ever collapsed of a country with the world's most powerful military.  No matter what else happens, a country with a powerful military can always rent out its military bandwidth to parties needing protection and who are willing to pay for the service.  This arrangement between the U.S. and certain middle eastern countries is probably part of the reason that the U.S. dollar has remained as strong as it has in recent decades.

I'm not a historian, but this sounds like the Roman Empire.

I suppose it's similar, but I certainly wouldn't use the word "collapse" to describe the decline of the Roman Empire, which took place over a 400 year period.

As we sit here today in a country a little over 200 years old, a 400 year period of decline doesn't sound too bad at all.

[Lone Wolf]

You mean the Euro debt crisis isn't simply about generous welfare states being punished by the markets?

Let's just call a spade a spade... Germany has hornswaggled Europe once again and instead of death camps we have effective debtors prisons that are simply entire economies in size.

Come on.  I'm no fan (at all) of the entire Euro project, but this "death camps" talk is laying it on much too thick.

All the politicos that jumped into this Euro dream thought that they were getting something out of it.  It wasn't a bunch of stern-looking Teutons in lederhosen shouting "Achtung!!" and herding all these sobbing old Greek ladies into debtor's prison.

German politicians wanted competitive exports.  Greek politicians wanted all the benefits of German fiscal prudence while still maintaining a monstrous public sector and letting everybody retire at 55.

It was all a lie.  Telling the truth is going to be painful but it has to happen.  Greece should exit the Euro.

[moda0306]

LW,

I did say I was 80% kidding and that all parties were complicit.  I was more trying to be extreme and sarcastic, and was probably more 99% kidding.

I banter with guys sometimes and take things WAY over the line just to make them funny... I really didn't mean to offend anyone or mislead my true impressions of what's going on.

I will say though, that the "welfare states are the problem" banter is common and appears very incorrect.

[Lone Wolf]

I did say I was 80% kidding and that all parties were complicit.  I was more trying to be extreme and sarcastic, and was probably more 99% kidding.

You think I mind?  It gave me a rare opportunity to make a lederhosen joke while simultaneously trying to preen self-righteously.  Chances like that don't come along every day.  Carpe diem.

I will say though, that the "welfare states are the problem" banter is common and appears very incorrect.

Insofar as those welfare states lead to unsustainable debts, how are they not a great deal of the problem?  These are expensive things to maintain.

Would Greece have been able to maintain its current level of fiscal profligacy if it had its own currency?

[stone]

I thought that France actually pressurized Germany to form the Euro because France was nervous about German reunification. European integrationists wanted the Euro as an underhand way to force European integration.

[6 Iron]

You think I mind?  It gave me a rare opportunity to make a lederhosen joke while simultaneously trying to preen self-righteously.  Chances like that don't come along every day.  Carpe diem.

LW, this is the second time you have been the cause of my sending an adult beverage into my nasal cavity reading one of your posts...makes me feel like I am in the lunch room in grade school, but milk was easier to tolerate.

[Lone Wolf]

LW, this is the second time you have been the cause of my sending an adult beverage into my nasal cavity reading one of your posts...makes me feel like I am in the lunch room in grade school, but milk was easier to tolerate.

Cheers, glad to take you back to your youth!  (Get enough of those adult beverages in you and all of my posts get better.)

[stone]

Lone Wolf "Would Greece have been able to maintain its current level of fiscal profligacy if it had its own currency?"

I think in nominal terms the answer is a resounding yes.
http://www.nakedcapitalism.com/2011/10/ ... 80%99.html

"the Greek social safety nets might seem very generous by US standards but are truly modest compared to the rest of the Europe. On average, for 1998-2007 Greece spent only €3530.47 per capita on social protection benefits–slightly less than Spain’s spending and about €700 more than Portugal’s, which has one of the lowest levels in all of the Eurozone. By contrast, Germany and France spent more than double the Greek level, while the original Eurozone 12 level averaged €6251.78. Even Ireland, which has one of the most neoliberal economies in the euro area, spent more on social protection than the supposedly profligate Greeks"

If a Greek central bank existed and stood by as a buyer of last resort, then Greek bonds would have no credit risk and so would have low yields. With the current Greek bond yields of >100%, any profligracy or austerity is basically neither here nor there. Default is unavoidable either way.

To me the key point about the euro crisis is that the structure of the euro makes even small imbalances between countries become amplified in a self reinforcing vicious spiral. In the USA both Texas and Oklahoma have viable economies. If you were to link them in a euro style with no fiscal union, then over the coming decades one would become an economic basket case whilst the other would become a vilified oppressor. -Even if initially it was hard to predict which would become which.

[Lone Wolf]

"the Greek social safety nets might seem very generous by US standards but are truly modest compared to the rest of the Europe.

It's not a question of whether they get more goodies than Germany or Spain or whomever, but rather one of buying what they can afford given their level of national productivity.  Greece is a much poorer country than Germany and they generate far, far less tax revenue.  They simply aren't going to be able to afford the same level of spending, kick their feet up at age 55, and assume things will all work out.

I'm not sure what point the author of this piece is trying to make, but Greece chose to run this level of deficits for years, through good times and bad.  This was a very foolish choice and I hope that they'll make better choices in the future.

If a Greek central bank existed and stood by as a buyer of last resort, then Greek bonds would have no credit risk and so would have low yields. With the current Greek bond yields of >100%, any profligracy or austerity is basically neither here nor there. Default is unavoidable either way.

We certainly agree that it's time for them to cut the debt loose.  You can't afford 100% bond yields... unless your economy is growing at, say, 100%.  Then it's all good. 

I agree that yields should be much lower unless they let inflation rage out of control (in which case the sky's the limit, obviously!)  I'm not convinced that yields will necessarily be "low" unless they get their fiscal act together, though.  Brazil in 1990 certainly wasn't able to get low bond yields, printing press or no!

I hope for the best, though.  Certainly it's time that they reclaim their sovereignty.  If they can do this and manage to stop screwing themselves over fiscally then the future should be much brighter.

[stone]

Lone Wolf, did Brazil ever use QE? With taxes collected in the currency issued and even the threat of QE, I didn't realize the bond vigilantes had a hope?

[stone]

Lone Wolf, I don't think it is as simple as saying that the Greeks were living beyond their means and so by avoiding doing that could have easily avoided the crisis. All the eurozone nations as with other nations had government debt. The crazy thing is that the afordability of say Greek debt servicing depended on the value of the euro and that was set by what was going on across the whole eurozone. So Germany had an advantage when exporting BMWs as they could undercut Japanese cars because the euro was not fully responsive to the German economy. That export advantage for the Germans strengthened the euro and so made Greek debt servicing unafordable. Greece could in theory have swiveled on the spot and started exporting goods to outside the eurozone or something but in reality a perfectly sustainable economy got derailed by a daft monetary system IMO.

[murphy_p_t]

Why do so many people fail to understand this?

I've heard so many seemingly logical arguments for inflation, or even hyperinflation, in the US, from supposed experts.

How come none of them distinguish between foreign-denominated debt and debt owed in US dollars?  It seems very logical (now that you've pointed it out).

It has to do with the politics or agenda of the supposed experts. Many are influenced by their own agenda or political leanings. Many don't even realize it. It's a lot easier for a Congressman, pundit, or a political party member to argue that we can't afford to [insert monetary policy here] because it will result in [insert scary monetary phenomenon here]. Most of their supporters will believe it without challenging their argument. Repeated enough times and becomes a pseudo-truth.

Gumby / Adam,

Please help me understand...are you implying that there are no dangers/risks in the size of the federal debt? Do you not acknowledge risks of excessive debt/GDP ratios?

If that's the case, then why not go full throttle & have the federal gov't issue $1m (borrowed from the Federal Reserve) to each citizen so we can go on a shopping spree?

[stone]

murphy_p_t, I think the MMT argument is that it is important to consider debt and deficit each on their own. The example you gave, of a $1M hand out to each person, is a huge current deficit whilst the debt to GDP ratio is a historical acumulation of all prior deficits to date. MMTers would say that giving each person $1M would probably overwhelm existing supply. 80% of the population would probably take early retirement.  Mundane and low status jobs would get left undone and those are the most vital jobs. If supplies of food and fuel dried up, hyperinflation could kick in. By contrast a deficit such as we currently have but projected decades into the future so that debt/GDP was 1000% or whatever is a much more subtle question. That amounts to a huge stock of treasuries. Most people don't own treasuries. A huge stock of treasuries held in a bank or insurance firm isn't going to stop the average Joe from going to work in the morning. What it does do is to permit trade imbalances to perpetuate. I do think it has pernicious effects like that leading to offshoring of jobs and such like. That is very different from having a fast appocalyptic effect such as hyper-inflation. The "deficit hawk" argument for "austerity" seems to me to be panic mongering to herd people into handing over their prosperity to kleptocrats.

[Gumby]

Gumby / Adam,

Please help me understand...are you implying that there are no dangers/risks in the size of the federal debt? Do you not acknowledge risks of excessive debt/GDP ratios?

Nope. I'm definitely not implying that high debt levels have no risk. But, in our current system, money doesn't exist without debt — since all money (other than coins) is born from either public or private debt/liabilities. So, in our current system, public and private debt is necessary to actually have a money supply.

As far as Debt/GDP ratios go, Robert J. Shiller took those tired Reinhart and Rogoff arguments to task over the absurdity of magical debt thresholds. In reality, the ability to "service" debt is really dependent on how much control a country has over the currency it borrows in — not its debt/GDP ratio.

If that's the case, then why not go full throttle & have the federal gov't issue $1m (borrowed from the Federal Reserve) to each citizen so we can go on a shopping spree?

Because that would almost certainly cause inflation. The goal of MMT is to provide a framework so that the money supply matches the output of the nation, in a way that doesn't cause high inflation. MMT doesn't recommend printing money in a way that is foolish. The idea is to spend money wisely, in ways that grow the economy in a steady manner.

The best example of MMT I can give you is the following analogy (which I didn't write):

"MMT (Modern Monetary Theory) focuses on the way monetary systems such as ours operate and the implications from this knowledge.

Is MMT advocating a free lunch? Is it saying that we can simply spend our way to prosperity? No! It instead identifies the real as opposed to imaginary constraints on economic growth.

Think about our economy as of a car that needs to get from where we're now to its destination – Prosperity! MMT recognizes that the car has a gas pedal and a brake pedal and a steering wheel that if used right can get us to our destination. Think of the gas pedal as injection of money into the economy (also known as "spending"), the brake as removal of money from the economy (also known as "taxation") The driver is the government and it can steer the car in various directions. Other countries have their own economies, so, think of other cars sharing the roads with yours.

The "deficit-hawks" believe that big deficits are always bad. Deficit is the difference between spending and taxation. So, their position is similar to a belief that too much pressing on gas (without counterbalancing by braking) causes crashes. While it is true that if you go too fast you are more likely to crash, pressing on gas and going too fast are two separate things. For example, when the car is going uphill or stalling, you really need to step on the gas to get it moving. So, deficit hawks in their myopia ignore the road conditions. They concentrate on numbers that are meaningless without a context. Additionally, their fear of spending prevents the economy from realizing its potential. Either they'd have you press on the gas very gently (spend less) or brake too often (tax more), without realizing that they might be causing the car to move too slowly and by the time you'd get to the destination Prosperity – if you got there – the rest of the world was there long ago and left to even further destinations.

The deficit hawks don't know how the car really works. They don't even understand that the deficit should be automatically adjusted to road conditions. Imagine if somebody told you you should never press on gas continuously without braking for more than, say, 1 mile. You'd laugh and say: this depends on where you drive and a myriad of other things!

What MMT is saying, is that you should not be shy to press on the gas when needed, to press on the brakes when needed and to steer the wheel as needed. MMT allows you to take the full potential of the car, without imposing arbitrary constraints (such as "pressing on the gas is bad" or "pressing on the brakes is bad"). Is there a fool-proof way to get to the destination? No, there is always an risk and sometimes the driver will make a mistake and sometimes crashes can even occur because of other driver's actions. But have you ever seen a fool-proof system?"

Much like a US State or local government, Eurozone nations owe debt in a currency they can't print more of, so they can't take part in these MMT rules of a true fiat currency. In other words, States, local governments, and Eurozone nations have to be careful, because they can all run out of money.

A nation that is the sole producer of its currency, has a free-floating exchange rate, and does not owe money in a foreign currency cannot run out of money and can follow an MMT framework. And, more importantly, the bond market confirms this — yields are actually down on US and Japanese debt despite "downgrades".

I have to reiterate, if the US were to ever owe debt in a foreign currency, we'd be in big trouble. So, the stability of the government, military, and its currency is extremely important because other countries could always demand payment for their goods in a more stable currency if they wanted to. Much of our foreign policy (and military spending) is postured in a way that tries to prevent that from ever happening. For instance, providing worldwide regional stability and protection is important to ensure that dollars are gladly accepted everywhere.

It ain't pretty, but that's how it works.