Barack Obama On The Trillion-Dollar Platinum Coin

Axios reports that Barack Obama gave his last interview to Pod Save America. He recalls his experience with the trillion dollar platinum coin – the idea invented by Carlos Mucha. When he was asked, “When were you most scared in the White House, what was your scariest moment” he said it was the debt ceiling crisis on 2013:

There were all kinds of wacky ideas about how potentially you could have this massive coin I mean… it was like some primitive — it was like out of the stone age or something. And I pictured rolling in some coin … It gets pretty technical, but there was this theory that I had the authority to just issue … through the mint… this massive trillion dollar coin… and that on that basis we could try to pay off our U.S. treasuries. … It was a very realistic possibility that we couldn’t get the votes for that and that we couldn’t get those debts rolled over … and at that point you were in uncharted territory.

The audio mp3 file is available here and the above discussion starts around 27m00s

Of course the President was misinformed because the coin needn’t be “massive”. But it’s nice to know that he seriously considered this possibility.

Xi Jingping And Free Trade As A Not-So-Subtle Form Of Mercantilism

Xi Jingping, the President of the People’s Republic of China spoke today at the World Economic Forum at Davos.

click the picture to see the video on YouTube. Transcript here

In his speech, he argues for globalization, although also points out the negatives. He says:

We must remain committed to developing global free trade and investment, promote trade and investment liberalization and facilitation through opening-up and say no to protectionism. Pursuing protectionism is like locking oneself in a dark room. While wind and rain may be kept outside, that dark room will also block light and air. No one will emerge as a winner in a trade war.

The timing of this speech is not surprising because it comes at a time when Donald Trump is going to become the President of the United States and is threatening to take action on China. Although economists and policy wonks have kept denying it, the Chinese government’s trade practices have been highly damaging to the United States’ economy. For China, “free trade” has been highly advantageous. By keeping its exchange rate at a highly devalued level, the government of China has made large gains for its economy at the expense of the rest of the world. But this “currency manipulation” is not the only unfair practice. Producers in China do what’s called predatory pricing in which prices of their products are kept low in the international markets to gain market share and harm competitors.

It’s an irony of our times that Donald Trump, a right-wing leader is insistent on taking action on China via protectionism, i.e., by setting large tariffs on Chinese exports to the US. It’s even more ironic that China is communist and is declaring free trade to be good.

China’s Mercantalism reminds us of a quote by Joan Robinson. In her 1977 essay What Are The Questions?, she says:

From a long-run point of view, export-led growth is the basis of success. A country that has a competitive advantage in industrial production can maintain a high level of home investment, without fear of being checked by a balance-of-payments crisis. Capital accumulation and technical improvements then progressively enhance its competitive advantage. Employment is high and real-wage rates rising so that “labor trouble” is kept at bay. Its financial position is strong. If it prefers an extra rise of home consumption to acquiring foreign assets, it can allow its exchange rate to appreciate and turn the terms of trade in its own favor. In all these respects, a country in a weak competitive position suffers the corresponding disadvantages.

When Ricardo set out the case against protection, he was supporting British economic interests. Free trade ruined Portuguese industry. Free trade for others is in the interests of the strongest competitor in world markets, and a sufficiently strong competitor has no need for protection at home. Free trade doctrine, in practice, is a more subtle form of Mercantilism. When Britain was the workshop of the world, universal free trade suited her interests. When (with the aid of protection) rival industries developed in Germany and the United States, she was still able to preserve free trade for her own exports in the Empire. The historical tradition of attachment to free trade doctrine is so strong in England that even now, in her weakness, the idea of protectionism is considered shocking.

[boldening: mine]

In her article she was talking about how free trade is a subtle form of mercantilism. What she was imagining was a nation typically not seen as mercantilist but pro-free-trade but that the latter is a subtle form of the former. In the present case, China is seen more as Mercantlist (although the establishment economists deny it) and it’s promoting free trade now. So these two ideologies have a lot in common. Jinping’s speech makes this obvious. Free trade is now a not-so-subtle form of mercantilism.

What Is “Crowding Out”?

J.W. Mason has a nice article What Does Crowding Out Even Mean? on his site The Slackwire. I agree with some aspects of it not all.

Let me offer a slightly different (but similar) perspective. First the definition. When an economist—typically a new consensus economist—uses the phrase “crowding out”, he/she means that if government expenditure rises, private expenditure falls without output rising.

That’s it: rising government expenditure will lead to a fall in private expenditure with no positive effect on output according to this. And since new consensus economists also talk of government expenditures as less efficient, it also means that they are saying that real output will fall – a proposition that follows.

But this is a highly unlikely scenario.

There are various mechanisms that are claimed by the new consensus economists which will lead to this. The most basic mechanism is based on the assumption of an exogenous stock of money which is incorrect. There are other mechanisms highlighted: such as the central bank raising interest rates following a rise in demand.

Now suppose there is a rise in government expenditure leading to a rise in output and it follows with a central bank rate increase. Private expenditure will be affected, although this effect is not as strong as economists claim. But I won’t call this crowding out. Private expenditure may fall but compared to the counterfactual of no rate increase. Private expenditure in the future is likely to be higher than in present. So it’s not crowding out. Also output has risen in this scenario.

Also new consensus economists’ description around such issue is that the central bank’s interest rate rises endogenously but in reality it is in control of the authorities and it’s not as if interest rates rise naturally as the new consensus economists make it look.

In reality, there is only one extreme case where I can see crowding out happening in my definition. Suppose the economy is running under full capacity and the government raises its expenditures without changing the tax rate. Imagine the government is interested in some construction and does this via an auction to constructors. Since by assumption, the economy is under full capacity, a constructor working for the government means its project for a private firm needs to be postponed. So a rise in government expenditure has led to a fall in private expenditure with no effect on output.

But the above scenario is rather extreme and is unlikely to happen in most economies.

But, interest rates hikes in the US economy to say 5% in one year because of the Federal Reserve raising the short term rates in response to rising demand and output, whether justified or not, is not really crowding out.

Paul Krugman Flip-Flops

In two recent posts, I had mentioned how economists are shifting their positions because of politics:

  1. Opposing Principles Of Political Economy Just Because Donald Trump Supports It,
  2. The Soon-To-Be Conventional Wisdom: “Fiscal Policy Is Not So Good”.

Thanks to Kevin Glass on Twitter, I came across two headlines highlighting this.

Headline 1, post-election (click for the link)

Headline 2, pre-election (click for the link)

I am sure an apologist would go, “Can you read beyond the headline?”. Well, yes and the two articles mean precisely what the headlines imply.

Krugman says,

This diagnosis — shared by most professional economists — didn’t come out of thin air; it was based on well-established macroeconomic principles. Furthermore, the predictions that came out of those principles held up very well. In the depressed economy that prevailed for years after the financial crisis, government borrowing didn’t drive up interest rates, money creation by the Fed didn’t cause inflation, and nations that tried to slash budget deficits experienced severe recessions.

What changes once we’re close to full employment? Basically, government borrowing once again competes with the private sector for a limited amount of money. This means that deficit spending no longer provides much if any economic boost, because it drives up interest rates and “crowds out” private investment.

There are several things wrong with this:

  1. Krugman is trying to argue that fiscal expansion makes sense only in limited scenarios
  2. We are not really close to full employment. There are enough people unemployed, and underemployed. Even if the US economy were close to full employment, a fiscal expansion will raise production and hence productivity via the Kaldor-Verdoorn mechanism. So it’s not like supply-side constraints are exogenously given.
  3. “limited amount of money” is Monetarism. Paul Krugman claims that he is no longer a follower of Milton Friedman but that’s not really the case.
  4. “Crowd out” is just like “patriotism is the last refuge of the scoundrel”. Krugman himself debunked it:

    There is, however, a somewhat related doctrine — call it the doctrine of immaculate crowding out — which has now, I’d argued, achieved true zombiehood. That is, it keeps coming back no matter how many times you kill it.

But Krugman is not the only one. Simon Wren-Lewis is echoing him and so is Ben Bernanke.

Bernanke says:

There is still a case for fiscal policy action today, but to increase output without unduly increasing inflation the focus should be on improving productivity and aggregate supply—for example, through improved public infrastructure that makes our economy more efficient or tax reforms that promote private capital investment.

ignoring the fact that rise in production can lead to a rise in productivity.

It’s sad that all this happened. Orthodoxy needs to be fought harder.

The Trouble With The Recent Consensus

In a speech The Specture Of Monetarism, at Liverpool John Moores University, the Governor of the Bank of England, Mark Carney talked about globalization and inequality.

The central theme of Carney’s speech and also the new/recent consensus of the economics profession is this:

III. The Way Forward

Given these developments, the challenge is how to manage and moderate the forces of innovation and integration which breed aggregate prosperity for the economy as a whole but which also foster isolation and detachment for substantial proportions of the population. In the balance of my remarks, I will focus on three priorities for doing so.

First, economists must clearly acknowledge the challenges we face, including the realities of uneven gains from trade and technology.

Second, we must grow our economy by rebalancing the mix of monetary policy, fiscal policy and structural reforms.

Third, we need to move towards more inclusive growth where everyone has a stake in globalisation.

[bold in original]

click the picture for the video and the text

While this acknowledges the trouble with globalization—under the current rules—it is still flawed. Carney continues to say:

Consider the disconnect between economists and workers. The former have not been sufficiently upfront about the distributional consequences of rapid changes in technology and globalisation. Amongst economists, a belief in free trade is totemic.xiv But, while trade makes countries better off, it does not raise all boats; in the clinical words of the economist, trade is not Pareto optimal.xv

(endnotes)

xiv E.g. Bhagwati, J. (2011), “Why free trade matters”, Project Syndicate, June 23.

xv In neoclassical models, free trade is Pareto Optimal in principle – in that the aggregate gains are sufficient to compensate those that lose out while preserving gains for the winners. This typically means some form of redistribution of the gains from trade is needed to achieve this outcome. This is the Kaldor-Hicks compensation principle. It is an open question, however, whether redistribution of this kind actually takes place in practice and, indeed, whether it is itself costless, as the Kaldor-Hicks principle assumes.

So Carney’s point is more about “Pareto optimality”, than on globalization under the current system.

The trouble with this view—as can be inferred from the quotes above—is that it’s based on the assumption of convergence of nations’ fortunes via globalization and free trade under the current system, instead of divergence and polarization. In other words, not only does globalization and free trade contribute to grievances for some economic actors, but also to nations and hence the world as a whole. Under a different set of rules, each nation would be better off and might avoid polarization.

As Nicholas Kaldor himself said (quoted above!) in 1980 in Foundations And Implications Of Free Trade Theory, written in 📚 Unemployment In Western Countries:

Owing to increasing returns in processing activities (in manufactures) success breeds further success and failure begets more failure. Another Swedish economist, Gunnar Myrdal called this’the principle of circular and cumulative causation’.

It is as a result of this that free trade in the field of manfactured goods led to the concentration of manufacturing production in certain areas – to a ‘polarization process’ which inhibits the growth of such activities in some areas and concentrates them on others.

You can preview Kaldor’s article on Google Books. It’s his finest.

Thomas Palley — The Federal Reserve Raising Interest Rates Is Unwelcome And Unnecessary

FOMC Projections

Thomas Palley writes:

Wednesday’s decision by the Federal Reserve to raise interest rates is unwelcome and unnecessary. As admitted in its statement, investment remains soft, growth is only moderate, and inflation expectations are little changed. Moreover, the economy confronts financial headwinds from the recent jump in long term interest rates and an even stronger dollar.

The Federal Reserve seems to be relying on old economic thinking that should have been discarded after the financial crisis. That poses a danger the economy will be slowed before full employment is reached, putting a stop to workers reclaiming their fair share.

If the Federal Reserve is worried about financial market exuberance, it should use its regulatory tools and not the blunderbuss of higher interest rates. Financial markets must not be allowed to stampede the Fed into raising rates.

Also see his article The Federal Reserve Must Rethink How it Tightens Monetary Policy, written in September.

Not only that, Janet Yellen said this in the press conference following the interest rate hike decision:

I would say at this point that fiscal policy is not obviously needed to provide stimulus to get back to full employment.

That’s unconscionable.

Some Legal Issues Around Demonetisation

Arjun Jayadev has a nice article, With Its Talk Of Extinguishing Unreturned Cash, Is The Government Defaulting On Its Obligations? for Scroll.in about what happens subsequent to the withdrawal of the legal tender character of bank notes in the denominations of ₹500 and ₹1,000 (or “demonetisation”).

The idea of the government was to cause a loss for holders of “black money” (see this Government of India white paper on definitions) and fight counterfeiting.

Picture from a September 2015 press release showing additional features of the old notes. The notes bear signature of Raghuram G. Rajan

There are two important separate issues here: one is the withdrawal of the legal tender character. The other is whether the RBI will exchange the notes. When the Indian PM announced the former, Indians were told that the old notes (which were about 86% of currency in existence by value) ceased to be a legal tender in four hours and that banks would exchange them for new bank notes or accept them as deposits till December end. Banks would then exchange them with the Reserve Bank. The Reserve Bank itself would exchange them directly after that till the end of March.

Soon people asked the question whether the Reserve Bank can set a last date for exchange directly at their offices (even though the notes are no longer legal tender). This is because the bank notes have a promise. The Reserve Bank’s own site says:

What is the meaning of “I promise to pay” clause?

As per Section 26 of Reserve Bank of India Act, 1934, the Bank is liable to pay the value of banknote. This is payable on demand by RBI, being the issuer. The Bank’s obligation to pay the value of banknote does not arise out of a contract but out of statutory provisions.

The promissory clause printed on the banknotes i.e., “I promise to pay the bearer the sum of Rupees …” is a statement which means that the banknote is a legal tender for the specified amount. The obligation on the part of the Bank is to exchange a banknote with bank notes of lower value or other coins which are legal tender under the Indian Coinage Act, 2011, of an equivalent amount.

So technically I could still have the old notes of denominations ₹500 and ₹1,000 and go to the Reserve Bank’s office and ask them to exchange it after December end (when banks will no longer accept them), even though the note have lost the legal tender character on November 8 itself. And the RBI seems to be allowing it till March end. The question is: what about later?

The above quote does use the phrase “legal tender”, but it’s not written in the notes. In fact, because of the promise, the Reserve Bank has to provide the bearer in legal tender (i.e., old notes of lower denomination and/or new notes).

Some have argued that because of this “demonetisation” never made sense as the notes should have continued to have the value. I don’t agree with that because that assumes certainty on these issues. If I collect the old notes from people, I have a risk that I might lose the money because I could be wrong.

Anyway, a report today from The Hindu quotes the Reserve Bank Governor:

“Actually, the withdrawal of legal tender characteristics status does not extinguish any of RBI’s balance sheet. Therefore, there is no implication on the balance sheet as of now. The question of a special dividend automatically does not arise as of now,” Mr. Patel had said.

The report is basically source based and informs us that the government is indeed going to make a law to get around the issue.

Euro Area NCBs’ TARGET2 Balance As Cumulative Accommodating Item In The Balance Of Payments

There’s a discussion on Nick Rowe’s blog about the interpretation of TARGET2 balances of the NCBs in the Euro Area’s Eurosystem. How do we interpret this? My answer is the headline.

TARGET2 balances arise because of cross-border payment flows within Euro Area countries. Instead of going through how these arise, I assume the reader knows them. I have covered it many times in my blog and many others have written it.

Let’s work here in the approximation that the Euro Area is the world and there’s no economic activity outside it. Since cross-border flows within the Euro Area banking system and the Eurosystem are transactions between resident economic units and non-resident units, these flows will give rise to entries in the balance of payments of each nation within the Euro Area.

In the new balance of payments terminology, such as as in the sixth edition of the Balance Of Payments And International Investment Position Manual, (BPM6), there’s an identity:

current account balance + capital account balance = net lending (financial account balance).

For terminologies see this table from the guide:

balance-of-payments-overview

This is an identity but suggestive of some behaviour. The question is what is the residual in this. The current account consists of things such as exports, imports, interest payments between resident and non-resident units and so on. The capital account consists of acquisitions and disposals of non-produced non-financial assets and capital transfers. The financial account consists of things such as direct investment flows, portfolio investment flows and so on. Other than that, there’s also “reserve assets” and “other investment”.

There is a nice 1991 article by the BIS Capital flows in the 1980s: a survey of major trends. The author quotes James Meade who makes this distinction between autonomous flows and accommodative flows:

[accommodative capital flows] take place only because the other items in the balance of payments are such as to leave a gap of this size to be filled … [while] autonomous payments … take place regardless of other items in the balance of payments.

Strictly, this distinction makes sense in fixed exchange rate regimes. In floating exchange rate system, the two—accommodative and autonomous—can’t be clearly be separated.

Anyway, coming back to the Euro Area, before the crisis started, the banking system was working fine. So there would be flows in both the current account and the financial account. The goods and services balance in the current account depends on domestic demand and output at home and abroad and relative competitiveness. There’s no reason for this to be zero. Economic units engaged in the financial markets would buy and sell securities and these affect the financial account of the balance of payments of the two nations involved in the transaction. There’s no reason for balance of things such direct investment, portfolio investment (and financial derivative flows) to balance or to equal the current account balance. Since flows typically are via TARGET2, this affects banks’ balances at their NCBs. So it’s possible toward the end of the day for banks in Spain 🇪🇸 as a whole to find themselves in need for reserves (or settlement balances) and banks in say Germany 🇩🇪 to be in a situation where they have excess funds. So banks in Spain will likely contact banks in Germany to borrow funds, either for one day or more. This is because they will get a cheaper interest rate. If they borrowed from their NCB, the interest rate is slightly higher.

These borrowings and lendings give rise to other investment in balance of payments of the two nations. So in Meade’s language, this is an accomodative flow. Not all other investment items are accommodative flows and similarly, not all accommodative items are other investment items.

But as the financial crisis began in 2007, the interbank system froze. Banks didn’t lend each other much. Hence the residual was balances between the NCBs. This would arise automatically. So these flows can be said to be accommodating. The counterpart of this is banks borrowing from their NCBs.

There’s a technicality: somewhere around mid-2000s, the system was changed so that the bilateral balances of NCBs were assigned to the ECB on a daily basis.

Since the TARGET2 balance of NCBs is a stock and not a flow, they can be hence thought of as the cumulative accommodative item. Since the crisis, a lot of things have happened. The European Central Bank has taken various steps, so that banks have sufficient liquidity. Banks have been given facilities to borrow huge amounts from their NCBs for collateral at cheap rates. Later the ECB also started its asset purchase program in which it bought government bonds, ABS and covered bonds. Some of these were already in existence when the interbank markets froze. So even as interbank markets opened, they didn’t feel the need to borrow funds from banks abroad.

The IMF’s guide BPM6 says in Appendix 3 that these intra-Eurosystem claims (the TARGET2 balances) are to be recorded in Other Investment:

Intra-CUNCBs and CUCB balances

A3.46 Transactions and positions corresponding to claims and liabilities among CUNCBs and the CUCB (including those arising from settlement and clearing arrangements) are to be recorded for the central bank under other investment, currency and deposits or loans (depending on the nature of the claim) in the balance of payments and IIP of member economies. If changes in these intra-CU claims and liabilities do not arise from transactions, relevant entries are to be made under the “other adjustment” column of the IIP. Remuneration of these claims and liabilities is to be recorded in the balance of payments of CU member economies as income on a gross basis under investment income, other investment.

where CUCB and CUNCB are abbreviations for currency union central bank and currency union national central bank, respectively.

There is some similarity with “reserve assets” in the financial account of the balance of payments and the international investment position when comparing all this to a fix exchange rate regime. In the latter, when autonomous flows aren’t sufficient, the central bank may sell gold or foreign reserves in the markets. It may also engage in borrowing funds in foreign currency. These are also accommodative flows. In the Euro Area case however, the inter-NCB claims (and the assignment to the ECB) happens automatically. Also “reserve assets” don’t go below zero, while TARGET2 balances can be negative in the sense that they are in liabilities of some NCBs instead of being in assets.

The conclusion of all this is that TARGET2 is a sort of a residual finance to a whole nation which arises automatically. Some have interpreted this to conclude that this is unlimited. This is however not the case. Since the counterpart to these are banks’ borrowing from their NCBs, this is limited to how much collateral banks can provide the Eurosystem, with or without the help of their government.

“In The Long Run”

But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again.

–  John Maynard Keynes, A Tract on Monetary Reform (1923), Ch. 3, p. 80.

As you might know, the Indian government cancelled the legal tender nature of majority of bank notes in circulation, earlier this month and asked Indians to deposit them at banks or exchange them for new. The aim according to the government was to curb counterfeiting and what’s called black money here. This is damaging as a large amount of transaction is in bank notes and the implementation has been a failure. People have been standing in queues for the whole day and some even reach banks at 2 am to get a good position in the queue. For many, standing in queues means that the day’s labour is lost. For others, there are delays in wage payments since their employers have problems getting hold of new bank notes. More than 50 people have died. Even 11 bank managers have died due to stress and work overload.

Despite this we keep hearing from the government and the ruling political party’s defenders that the benefits will be long term.

The previous Indian Prime Minister (who was the nation’s leader during mid 2004-mid 2014), Manmohan Singh gave a scathing speech in the Indian Parliament yesterday in which he quotes Keynes on the long run. Manmohan Singh was a student at Cambridge and his heroes are Nicholas Kaldor and Joan Robinson and presumably John Maynard Keynes as well. In this era where politicians are promoting neoliberal ideas, it’s good to see the master being quoted in a Parliament.

The seven-minute video is linked below.

manmohan-singh-quoting-keynes

click the picture to see the video on YouTube. 

This question about the long-term reminds me of super-hysteresis which was referred by Marc Lavoie recently in an article for INET. It’s closely related to the Kaldor-Verdoorn law in which demand affects supply.  The damage done to the demand side because of slowdown in production caused by the Indian government’s poor implementation of its decision to replace majority of bank notes by value affects the supply side as well. Almost nobody who talks about the long-term benefits talks about this issue.

Neochartalists Shifting Positions

In a three part series, Bill Mitchell, makes the case against free trade. While this is most welcome – success and failure of nations depends on success in international trade via the principle of circular and cumulative causation – it’s quite a drastic change from what Neochartalists have claimed before. From “exports are a cost and imports benefits”, they have shifted their position. Mitchell goes on to concede:

These so-called ‘free trade’ agreements are nothing more than a further destruction of the democratic freedoms that the advanced nations have enjoyed and cripple the respective states’ abilities to oversee independent policy structures that are designed to advance the well-being of the population.

[emphasis: mine]

Neochartalists have always denied – till recently – that free trade can put a constraint on fiscal policy. They interpreted such critiques as an argument against fiscal expansion, instead of realizing that it’s possible to both argue for fiscal expansion and realize that it is constrained by balance of payments. One potential solution is import controls. Mitchell concedes that it’s required sometimes. He says:

In those cases, import controls may be justified to limit the damage to the less developed nation, despite the material benefits to the more developed nation being obvious.

[boldening: mine]

In another blog post as I noticed here, Mitchell says this while making proposals on reforming the international institutional framework:

2. Macroeconomic stabilisation – support for national currencies in the face of problematic balance of payments.

This function recognises that all nations should maintain sovereign currencies and float them on international markets but at the same time recognising that capital flows may be problematic at certain times and that some nations require more or less permanent assistance due to their export capacities and domestic resource bases.

There have been many critiques of Neochartalism but very few touch on this or give attention. But since international trade is the most important determinant of the rise and fall of nations, and that Neochartalism claims to be some fundamental theory of human interactions, its extreme position and shifting away from it should be noticed and critiqued, although welcomed.

In short, Neochartalism which is some sort of moral superiority on fiscal policy has accepted that free trade can put constraints on it. The solution of course is beyond the scope of this post but this shift should acknowledged when Neochartalism is discussed.