Monthly Archives: December 2013

Description Of Cryptocurrencies Using SNA

In India – at least a while ago – they were many tickers trading on the stock exchanges with no income and in some cases with no office whatsoever!

Why would anyone incorporate such a thing? For two – illegal – reasons: first the IPO of the company gets the money in – which makes the owners rich – and the second way is to manipulate the price of the stock to fool more investors. The owners would trade among themselves and fool trend followers to buy the stock.

Cryptocurrencies are like that – with the difference being that they are equity liabilities of unincorporated and unregistered enterprises trading in unregulated markets. The deceit lies in marketing them as some sort of currency and inducing people to trade in them as if it were some currency.

If that is the case, what is the national accounts description (like the 2008 SNA) of such a thing? First, there is no incorporation so we have to treat them as quasi-corporations as national accountants do.

Sec 4.42 of the 2008 SNA has a description of quasi-corporations. That is for general economic activity but here I use the concept to describe cryptocurrencies. The difference here is that unlike the quasi-corporations, the cryptocurrency quasi-corp has no income!

The other reason for thinking of a quasi-corporation is that one usually sees money as a liability of an institution, so we need to think of cryptocurrencies as a liability of some economic unit.

So how does the balance sheet of this cryptocurrency quasi-corp look like at various stages?

Let us say that the cryptocurrency quasi-corporation raises $100mn at the “IPO”:


Liabilities and Net Worth

Bank Deposits = +$100mn

Equities Issued = +$100mn
Net Worth = $0

Note: Here the symbol $ is for the United States dollar and not for any cryptocurrency such as the bitcoin.

Now, the owners of the cryptocurrency quasi-corporation make a “withdrawal of equity”. That is, whatever money is received in ordinary currency is transferred to the owner’s personal account. After this, the balance sheet of the quasi-corporation looks like:


Liabilities and Net Worth

Bank Deposits = $0

Equities Issued = +$100mn
Net Worth = −$100mn

which has a counterpart that the owners’ net worth rises by $100mn (as a result of the transfer of payment received in dollars to the owners’ account).

Once the “cryptocurrency” starts trading in unregulated markets, the price of a unit rises or falls, so let’s say it rises 10 times the IPO price. At the time,


Liabilities and Net Worth

Bank Deposits = $0

Equities Issued = +$1bn
Net Worth = −$1bn

Of course, there is nothing wrong with the net worth of a corporation going negative – as may sometimes happen in times when there is a stock market boom, even for the corporate sector of a nation as a whole.

In this case however, this cryptocurrency quasi-corporation has no income whatsoever. In fact, it is using your services and hence making a loss which is covered by issuing more equities!

There is a concept of mining in cryptocurrency which is the most interesting part.

So suppose users “mine” cryptocurrency worth $100mn by providing services to the quasi-corporation, the balance sheet of the quasi-corporation will look like (assuming the price of the cryptocurrency hasn’t changed):


Liabilities and Net Worth

Bank Deposits = $0

Equities Issued = +$1.1bn
Net Worth = −$1.1bn

In the language of flows, the cryptocurrency quasi-corporation has:
an operating surplus of minus $100mn,
a balance of primary income of minus $100mn,
entrepreneurial income of minus $100mn,
disposable income of minus $100mn, and,
saving (undistributed profits) of minus $100mn.

This has a counterpart in the financial account as a net borrowing of $100mn by issuance of equities worth $100mn.

(For the above refer to the tables in Annex 2 – The Sequence of Accounts of the SNA).

The ultimate user of this intermediate consumption is another firm but the trick here is that its costs are reduced because of the issuance of cryptocurrencies for which it is not liable at all.

In the case where you own some cryptocurrency and pay for some pizza using it, it is a transaction between you and the pizza maker and shouldn’t affect the accounts of the quasi-corporation except the change in the name of ownership of the cryptocurrency – like a transaction using bank deposits. Here it is more like buying a pizza using Apple stocks with Apple Inc. acting as the settlement agent.

Of course, I repeat – currencies are not like equities but in this case, cryptocurrencies have been marketed as currencies whereas they are more like stock market equities but traded in unregulated markets.

The cryptocurrencies are thus a more sophisticated version of stocks of companies trading in markets with no income and no office.

Happy Holidays

Here’s wishing the readers of this blog a happy holiday break.

Happy Holidays


I can never repeat this often enough – always remember:

The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.

– Joan Robinson, 1955, “Marx, Marshall And Keynes”, Occasional Paper No. 9, Delhi School of Economics. Also in Collected Economic Papers, Volume Two, 1960.


Good Reference On Wage-Led Growth

An excellent discussion on wage-led economic growth is a paper by Marc Lavoie and Engelbert Stockhammer titled Wage-led Growth: Concept, Theories And Policies which appears in the recently released book Wage-Led Growth: An Equitable Strategy For Economic Recovery (Palgrave Macmillan book page)

Wage-Led GrowthFrom the article:

… The advocacy of a wage-led economic strategy has a long history. It has been articulated in reformist visions within the labour movement and was discussed under the heading of ‘underconsumption’ in 19th century economics. Famous underconsumptionists in the history of economic thought include Malthus, Sismondi and Hobson.1

Underconsumptionist ideas got a boost from their endorsement by Keynes, when he proposed his theory of effective demand, arguing that excessive saving rates, relative to deficient investment rates, were at the core of depressed economies. Underconsumption theories can also be related to the problems of the realization of profit, as discussed by Marx and subsequently by various Marxist authors such as Baran and Sweezy (1966), while other authors, closely related to Kalecki (1971), such as Steindl (1952) and Bhaduri (1986), have brought together the theory of effective demand and the problem of the realization of profit. On this basis, the benefits of a wage-led growth strategy has been resurrected and formalized by several Kaleckian or post-Keynesian authors, starting with Rowthorn (1981), Taylor (1983) and Dutt (1987). Taylor (1988) showed early on that when emerging countries had enough capacity to adjust, a wage-led growth strategy made sense. More recently, the policy-oriented concept of a wage-led growth strategy was prominently used by UNCTAD (2010, 2011).

A standard objection to the consideration of the underconsumption thesis or the consideration of problems related to the lack of effective demand is that long-run growth – the trend rate of growth, also called the potential growth or the natural rate of growth – is ultimately determined by supply-side factors, such as the growth rate of the labour force and the growth rate of labour productivity. While adepts of the so-called ‘endogenous growth theory’ will recognize that investment in human capital or research and development may end up modifying the potential growth rate, they usually set aside the idea that actual growth rates could have an influence on potential growth rates. Yet, since the advent of the global financial crisis, government agencies and central banks in many industrialized countries have lowered their forecasts of long-run real growth, thus demonstrating clearly that weak aggregate demand does have an impact on potential growth. As Dray and Thirlwall (2011, p. 466) recall, ‘it makes little economic sense to think of growth as supply constrained if, within limits, demand can create its own supply’. This explains why we shall focus on the income distribution determinants of aggregate demand, paying less attention to the supply-side factors…

1See Bleaney (1976) for a historical account of underconsumptionist theories.

Underconsumption And The Rate Of Saving

It is sometimes said that capitalists consume a lot and the theory of underconsumption fails.

For example, Federal Reserve paper (h/t WinterspeakDisentangling the Wealth Effect: A Cohort Analysis of Household Saving in the 1990s – although not suggesting a failure of underconsumption – says that in the ’90s, personal saving rate fell a lot due wealth effects from a rise in the market value of equities held by high-income earning households (although suggesting alternate interpretation as well) inducing them to consume more.

But some on internet discussion groups seem to have interpreted it as a failure of the underconsumption theory.

Before I say what I want to say, some preliminaries: In Keynesian theories, there are two things – propensity to consume and propensity to save. A lot of people erroneously think that these add to 1. I will go further and say that a theory which considers the interaction of stocks and flows with a notion of a propensity to save will end up with paradoxes. Rather saving – household saving in particular should be seen as a result of a model which traverses in historical time between one configuration of stocks and flows to another. With consumption depending on income and wealth, the notion of propensity to consume is more appropriate than the somewhat inferior “propensity” to save. Or one may say that the propensity to save is a derived concept.

What is the underconsumption theory? It can be conjectured in various ways. One is to say that the propensity to consume out of wages is higher than the propensity to consume out of interest income, dividends and capital gains. Another is to say that low income earners have a higher propensity to consume out of wages than high income earners. This is then given a policy angle and the underconsumptionists then claim (rightly in my opinion) that a better distribution of national income will lead to stronger effect on growth because low income earners will consume more and have multiplier effects on output – in contrast to “supply-side” policies.

Back to the Federal Reserve paper. Some seem to have interpreted it as saying that it is a blow to the theory of underconsumption citing low rate of saving for high income earners. There are several things wrong with this. The fact that high-income earners spent a lot in some periods doesn’t mean it is a better policy than aiming for a better distribution of income, especially when the former is more unpredictable because of the unpredictability of stock-markets, while the latter is more direct. Although this point is more important, the citing of low saving of high-income earners in some periods following high capital gains should be dismissed. Low saving was not the result of a low “propensity to save” – which is a derived concept but the result of higher consumption due to rise in wealth than due to a rise in “propensity to consume” by high-income earners.  

So if household consumption is given by

C = α1·YD +  α2·W-1

where C is consumption, YD is disposable income, and W is wealth. α1 and α2 are the propensities to consume out of income and wealth, respectively. The subscript -1 indicates it is the value for the previous period. The wealth term also includes capital gains at the end of previous period.

Saving is given by

S = YD – C

Now, as per national accounts, income doesn’t include capital gains, although taxes on capital gains may reduce YD but let’s ignore that. This doesn’t mean capital gains are irrelevant, because consumption behaviour depends on capital gains. So the rate of saving  S/YD is given by

S/YD = (1 – α1) – α2·W-1/YD

which may hit zero or even turn negative if there is a large rise in W-1 because of capital gains even if the parameters αand αhave not changed. So for example αmay be something like 0.5 and yet the rate of saving may be negative.

In other words, the data of the 90s doesn’t disprove the fact that low-income earners’ propensity to consume out of income is higher than high-income earners – it just shows that some high income earners’ saving may have gone negative because of higher consumption due to capital gains in some periods.

So what if there is a fair distribution of income? Since low-income earners have a higher propensity to consume, less inequality will lead to a higher output and national income than otherwise.

Strange Claims About KfW

Earlier, I had two posts on this but now these have been merged into one. 

Chartalists again!

This blog post The fiscal role of the KfW – Part 1 by Bill Mitchell of Australia makes the most exorbitant claims about an institution called KfW and the government of Germany.

Bill Mitchell claims:

It is a major reason why the public debt ratio in Germany is 80 per cent rather than close to 100 per cent. It is a major reason why the federal deficit has been reduced without scorching the German economy. It is a story about smoke-and-mirrors accounting, German-style.

This is a bizarre claim. For Mitchell’s claim on the deficit to be valid, KfW should be a net borrower each year of a big size. For the claim on the public debt, KfW’s net indebtedness should be large. If Mitchell means anything other than this when saying “fiscal role”, what is it?

Unfortunately for Mitchell, KfW is a net lender to the private sector and the rest of the world sector in the flow sense and a net creditor in the stock sense.

First, Germany’s 2012 GDP was €2.666tn (source: OECD.StatExtracts) and 1% of that is about  €26.66bn and 20% of GDP is €533bn.

Here’s the 2012 financial report of KfW.

Let’s get an order of magnitude of the numbers. The net lending of KfW would identically be its undistributed profits minus capital expenditure. KfW doesn’t distribute profits (page 10 of the report) and so its undistributed profits is equal to its profits. Page 66 of the financial report says 2012 profits is €2.38bn and capital expenditure is negligible (page 72).

Hence KfW is a net lender and not a net borrower!

In other words, Prof. Mitchell seems to present a story in which the German government is using KfW as a tool to have a higher budget deficit than what it shows in its own books but it is in fact the opposite. This is because the combined entity KfW + Government of Germany has a lower deficit than the deficit of the government of Germany.

Moving to the balance sheet, its size is about €511bn – also quoted by Mitchell. But the size is not the main thing here. It is whether KfW is a net debtor or not. The balance sheet (page 68) says that equity is about €20.69bn. Of course, the item equity doesn’t by itself say anything about net indebtedness – an economic unit can possibly have a large net worth (in this case with no stock market shares issued, the same as equity) and yet be a net debtor if it holds a large proportion of its assets in non-financial form. The balance sheet however suggests that this is not the case – property, plant and equipment and intangible assets are small compared to other numbers.

Hence KfW is a net creditor and nothing like an institution with net indebtedness of about €533bn (100% minus 80% of GDP, see the quote at the start of this post.)

This was for 2012 but for other years just mirror the analysis – different numbers but of order of magnitude like these and nothing like what Prof. Mitchell interprets them to be. Supposedly, according to him, KfW

It spends, I mean lends millions each year at very low rates … pumps millions of Euros in the domestic economy and the export sector.

I suppose it subsidies lending and the fiscal part is how these subsidies are calculated and not the amount of lending which Mitchell seems to present by saying “pumps millions of Euros”. These lending flows are not like a government expenditure flow.

And spending is not lending!

In other words, the subsidy provided indirectly by the government via KfW. This can perhaps be estimated by the profits of a domestic bank of similar size or by some similar sort of comparison – and estimating what profits would have been otherwise. After this one would compare it to various numbers in the government budget. This however in my opinion will be nothing like what Mitchell makes it out to be.

Further Bill Mitchell makes another claim:

There are three reasons to look closely at the KfW:

1. It played a role in the Deutsche Telekom (so-called) privatisation, which helped the German government slip out of an embarassing excessive deficit procedure in 2004. Sleight-of-hand is the best description for what happened.

Except that there was no sleight-of-hand.

In national accounts such as in the 2008 SNA, items such as privatization appear in the financial account and perhaps sometimes in the “other changes in assets accounts”. This ECB Convergence Report June 2013, page 68, box 6 says:

a reduction in financial assets (as a result of privatisations for instance) tends to reduce the borrowing requirement as it generates cash, while leaving the deficit unchanged.

In other words, the privatization of Deutsche Telekom has no effect on the deficit. It reduces the public sector borrowing requirement and the public debt, but the private sector net worth doesn’t change at the time of the transaction. So it is not as if the private sector holds more of financial assets as a result of the privatization. It may see holding gains but that is a different matter.

At any rate, what would have been the alternative to bring the gross public debt down to meet the debt-deficit-criteria? Attempt to deflate German domestic demand and consequently demand and output in the rest of the Euro Area?

Also, even if one counts the effect of privatization in the deficit, it would have Germany’s deficit from 4.3% to 4.2%. As a commentator in Billy Blog writes:

Take for instance the purchase in November 2003, which according to you was done as a result of the pressure from the EU in reducing the deficit. The KfW purchased about 200 Million stocks, wow, sounds impressive… except the actual value of those stocks was only about 2.5 Billion €. The german deficit in 2003 was 89 Billion € or 4.2% of the GDP, so without the KwF buy it would have been… 4.3% (if you round up generously). The KfW buys and sells had no practical relevance for Germany either going below or above the deficit rule of the Growth and Stability Pact – the sums involved were simply not big enough for that.

Thus, the entire story about the supposed fiscal role of the KfW is incorrect.

More Strange Claims On KfW (10 Dec 2013)

Phil Pilkington writes in defense of Bill Mitchell in response to my previous post Strange Claims About KfW [Updated].

Pilkington’s errors are simple accounting errors and misunderstanding of flow-of-funds. Pilkington seems to assume the same logic of Mitchell. According to him:

The trick is that this borrowing doesn’t appear on the government balance sheet so, given a level of aggregate net expenditure equal to,

[Government Deficit + KfW Lending],

the Federal deficit is lower than it would otherwise be if the government had to foot the bill for all this expenditure.

First, the government would not have to “foot the bill for this expenditure” if it were to lend directly to the private sector on its books because the lending would not be “expenditure” but a loan by the government and it would be making a profit on it. The loan would not add to the budget balance even if the government were to directly lend. The expenditure would be for the firm using the proceeds of the loan and it is not public expenditure. Pilkington seems to confuse income/expenditure flows with financial flows. Or in the language of the 1993/2008 SNA confuses current accounts with the financial account.

In fact the profits if the government were to lend directly would reduce the federal deficit by a bit, not increase as claimed by Pilkington.

Further Pilkington seems to assume that another counter-factual in this case is less borrowing by the private sector and hence lesser private expenditure. No! this counter factual is the private sector borrowing from other banks – i.e, private banks. Why would German firms find difficulty in borrowing if they happened to show their creditworthiness to KfW?

Also, as I highlighted in the previous post, a proxy for the subsidy would be the profit of the bank of a similar size minus the actual profit of KfW. It is nothing like Mitchell’s rabble-rouse.

Endogeneity Of Budget Deficits

In this New Economic Perspectives post Randy Wray and Eric Tymoigne confuse accounting identities with behaviour.

In a context, the bloggers claim:

… Only a government deficit induced by fiscal policy leads to net saving.

where “net saving” is saving net of investment.

This posits a one-way causality of the sectoral balances accounting identity S − I = G − T from the right to the left.

This is inaccurate because of the endogeneity of the budget deficit which Wray himself is aware of but nonetheless confuses. This is because private expenditure may lead to a change in output and tax flows which may change the sign of the private sector balance (S minus I)

Suppose the private sector is in deficit and the government budget in surplus and the household sector drastically reduces its propensity to consume. This will lead to a fall in output and income and hence reduce tax flows to the government even if fiscal policy hasn’t changed (government expenditure and tax rate decisions haven’t changed) and the private sector’s balance can turn into a surplus from a deficit position.

That’s what endogeneity of the budget balance is all about. [Some government expenditure may change because of social transfers but the magnitude of this may be much lower than other things involved such as the private sector balance or changes.]

Second, it ignores the external sector.

Moreover the authors make another claim:

Monetary policy can change the composition of net saving by buying financial assets in the domestic sector in exchange for government currency, but it cannot change the size of net saving, i.e. the net accumulation of financial assets.

Cannot change the size of private sector saving net of investment?

Suppose the private sector is in surplus and interest rates are high. The central bank reduces interest rates drastically to induce the private sector’s expenditure to rise. If there is a large rise in investment for example, the private sector can go into a position of a deficit. It is true that the private sector may want to target a small surplus but this isn’t the case always and the private sector can remain in a deficit for long – not necessarily due to fiscal policy.

In the opposite case/scenario, starting from a case of a private sector deficit, suppose the central bank drastically raises interest rates to the point of causing the economy to go into a recession. The private sector balance may rise as people save more and output will fall, leading to lower tax outflows to the government and hence changing the private sector balance.

Some humility is needed by a few people who incorrectly seem to think they know how the world works with confused language such as “taxes aren’t revenue”!