One will always find government debt in foreign currency for a nation having external issues. After the Bretton Wood system broke down and nations freely floating their currencies, they realized it is actually difficult to just float and let the fx markets find the clearing price. Hence there is official intervention in the currency markets, issuance of debt in foreign currency, holding of foreign reserves etc. Most people look at official intervention as the central bank preventing the price from falling too much but it’s more than that. It clears markets and prevents a prophecy to build up. For example if the currency falls, it may lead to expectations building leading to further outflows. So I saw STF in the mikenormaneconomics thread saying that the government didn’t behave in an MMT prescribed way and such – but it is impossible for the Treasury of most nations to behave that way. It’s “operational reality”.Ramanan in a comment at Modern Monetary Realism
According to MMT, there are two constraints on a currency sovereign, inflation rate and fx rate. There continues to be disagreement over the conception of the fx rate, in that the MMT position is generally understood to be that in a non-convertible flexible rate monetary system, floating rates are self-correcting so that markets will always clear for a currency the issuer of which does not take on foreign debt or fix its fx rate. While some qualifications are added, opponents do not believe they are sufficient and a more detailed analysis is necessary.
Ramanan and others dispute the MMT stance, holding that it needs to be carefully qualified with respect to the general case and specific instances, with the US being a special case that cannot be extended to many other countries, and that even the US cannot presume to enjoy its "special privilege" forever without capital flight and therefore exogenous pressure to raise interest rates to attract capital and curtail demand in order to decrease imports.
I hope I summarized both positions correctly. Please correct me if I did not.
131 comments:
Tom
You're using the extreme interpretation of mmt here that isaid yesterday was a misrepresentation. I provided quotes from Wray in addition. So, no, this does not have at least the mmtposition correct here. It doesn't surprise me that one day after I wrote that our critiques continue as if I didn't but the point of writing it was so that folks like you would correct them when you saw them doing what they always do.
Our critics not critiques
Scott, where did you post that comment?
Hi Scott.
I am trying to clarify this debate now that a putatively incorrect notion of the MMT position has proliferated. Am not really interested in why it proliferated here. It did and now it need to be dealt with.
One reasonI would say it has proliferated is that Warren's aphoristic style has given rise to the notion that a freely floating fx rate is sufficient for clearing.
What I think is needed is a precise and concise statement of the MMT position for reference and citation. I am attempting to provoke that to get clarity, along with the criticism, in order to resolve them.
I know you believe that you have already done that. But, whatever the reason, the debate continues and I would like to see it resolved with clear statements that make the differences evident, so that others can come to their own conclusions with everyone feeling that their actual positions are understood. I don't think we are there yet, so I am pursuing it.
Could you restate the MMT position regarding the fx constraint in as few words as possible. I think that maybe Warren's words are too few for clear understanding by non-experts, and non-experts aren't going to understand a professional paper either.
Think a talking point for non-economists presenting MMT and answering question on blogs and with acquaintances. Economists can argue this in papers.
Actually, what is really needed is a concise and precise account of the double constraint, inflation and fx wrt to availability of real resources, which as I understand MMT is the actual constraint underlying the operational (financial or nominal) constraints.
I think that this would be a very useful resource to post to the MMT wiki and the Wikipedia article also for easy reference of non-economists talking and blogging about MMT, as well as people interested in learning about MMT.
Perhaps you would be kind enough to rewrite what I wrote in the post about the MMT position, correcting it, and I will substitute that in the post, or else put up another post.
Thanks for participating in this discussion. You are an MMT expert. I'm just trying to draw you out in a way helpful to non-economists and also economists not familiar with the MMT corpus.
y,
This thread
http://mikenormaneconomics.blogspot.com/2012/05/ramanan-monetary-economics-of-sovereign_09.html
@y
see here and here for Scott's comments.
STF,
So MMT is not even applicable to most countries in the world, then. I think that's one of Ramanan's points. There are only a handful of nations that even fit the MMT world.
Tom
The MMP article that Scott referred to might be useful
mmpblog26sovereigncurrency
Thanks Tom
Peter,
imo running a Mercantilist or neo-Mercantilist system (under monetary economies) is in itself a policy choice made by the authorities of civil govt.
The policy of "Mercantilism under Monetary" allows the creation of imbalances in the financial systems in the first place.
Resp,
Let me be more specific about MMT and fx rate.
According to Randy, the MMT approach to operational constraints involves looking at the inflation-unemployment rates and the fx rate. I think that almost everyone who understands the basics of MMT knows that to deal with inflation and employment, use functional finance to adjust the fiscal balance.
But it's unclear to many what "looking at the fx rate" is supposed to show, and what to do about it from an MMT perspective.
Thanks.
this topic is also being debated at moslereconomics.com, on the 'contact' page.
"non-economists" that would be me asking the questions :)
cross checking randy and ramanan there doesnt seem to be any difference and ive certainly learnt a lot as i was missing a piece.
@Tom
"But it's unclear to many what "looking at the fx rate" is supposed to show, and what to do about it from an MMT perspective."
I second that.
Some countries are not in a position where they shouldn't support FX through a peg. Not everyone has strong domestic demand. So it can be advantageous to peg the currency. MMT says this relinquishes sovereignty, but the only other option is a weak economy.
" the only other option is a weak economy."
How so? Not enough exports?
Matt,
I guess there is another option. The MMT option, which is to print money like crazy. But as history has proven in many of these countries that just causes high inflation and does not necessarily fix the structural problem which is really just a weak production base.
If a current account deficit and/or demand leakage were able to be papered over by printing money then most of Latin America would be the most prosperous economies in the world. Instead, they're the poster children for hyperinflation.
The main problem I have is this notion that 'countries import in a foreign currency'.
They don't really. They import stuff and there is an opposite funding chain setup to allow that real transaction to happen. It doesn't really matter what the currency is.
If the funding chain can't be set up then the transaction cannot happen.
What is important is how many of those transactions are not matched with an equivalent export going in the opposite direction (via a clearing house as necessary) and who then holds the debt that allows the transaction to continue (and over what time period).
ISTM that it's the build up of that debt exposure and the risk profile of that debt that causes all the fun.
"The MMT option, which is to print money like crazy."
Peter, if you're going to comment on MMT do us all the courtesy of reading the policy recommendations first.
Peter,
If exports fell, I believe MMT would say that fiscal could then easily be used to sustain domestic demand and output.
imo A lot of the problem comes from how that banks look like they "broker" the forex imbalances that result from imbalanced trade.
Eventually it reaches what many believe is "unsustainable" levels as the exchange rates adjust and the banks "blow up" as they cannot "eat" the forex losses against their capital bases so they bribe the Central Banks to do an intervention to bail them out of it otherwise they would go bust.
But they could be let to go bust... and it would not be MMTs fault.
Resp,
The lack of national demand, you have to substitute with external demand via exports.
Not everybody in the world has 30k USD per capita of income. And to develop their own national demand you can't do just by printing money, you need to build up real capital, that is economic activity.
The problem is the lack of demand for national currency in the exterior, I think this critique has some legs and in not minor. But I don't agree with the mercantilist solution, is a race to the bottom and eventually to war as the past has demonstrated.
If you have employment problems (strong export nations) you need to build up national demand and 'fix' income distribution for developed nations, about fucking time of starting to share all that unleashed productivity with the proletariat lol.
But what if developing nation currencies continue to be little demanded? This is a very complex issue: juridical security of the nation, political stability, social structure, resources, etc. If you invest in dollars at least you know that returns in dollars will have certain value and you can exchange these dollars in the future in developed nations, same with other currencies (euro, GBP, yen, etc.), but using national currency, maybe not so much (I don't think I would hold even Chinese currency and assets right now for a very long time because the political system has always a possibility of blowing up).
Apart of the unilateral mercantilist policy there are only 2 other options and both require international coordination and agreement, so we are screwed. One the old bankor idea of Keynes or some derivative idea of it, the other to force investors to use national currencies and move to a total floating regime, to do this you need to force people to finance theirself in national banking markets, limti the power of international banking and capital flows in different denominated currencies around the world (no more t-bills for chinese).
All this looks like impossible, so the solution will be the same as always...
As Tom said, even with the chimerical relation both countries don't really believe in it and continue to invest a lot in military spending to prepare for the worse.
Neil,
I like your comments because I enjoy putting you in your place. So here goes:
Mosler: "a larger trade deficit means we can have taxes that much lower still."
Translation: "Print over the demand leakage".
As I said. Carry on.
No extremizing of position whatsoever. By Randy Wray's own "dissenting" opinion, he does not consider an external imbalance as an imbalance. Everything balances is his opinion.
http://www.levyinstitute.org/pubs/wp_704.pdf
Obviously, if the external deficit is not an imbalance, by the logic a nation should be able to run any deficit on the current account with no problems whatsoever later!
While Randy is right that the process can go on as long as foreigners do not mind in another paper quoted here, it is precisely when foreigners start minding that it hurts.
And if someone thinks that this is extremizing then clearly some high deficit on the current account is an imbalance but using Randy's own logic, it's not.
Neil Wilson says "They don't really."
http://www.abs.gov.au/ausstats/abs@.nsf/featurearticlesbytitle/2E5DC0CD8723CD0FCA2573AA001446E9?OpenDocument
says the opposite for the case of Australia.
and that
" It doesn't really matter what the currency is."
precisely the reason why there is a strong external constraint. Since it does not matter too much, it is equivalent to the case of purchasing all imports in foreign currency and it is rather easy to see that importing in foreign currency is limited by how much of foreign currency can be raised.
And looked at from a domestic currency perspective, it should be noted how much foreigners are willing to hold financial securities denominated in the domestic currency even if the imports are invoiced in the domestic currency. Since they are generally less willing, they shift funds abroad leaving banks with a net open position unless the central bank intervenes in the currency markets.
(For the case of the US remember - both imports are invoiced in USD AND foreigners wish to hold USD assets).
Ryan Harris talks of persuading foreign companies to sell products. Unfortunately he gets it wrong. There is a general tendency of nations to avoid the balance of payments constraint and hence they don't want foreigners but the ideology of "free trade" has led advanced nations force free trade on them. Even when they are welcome, they can sell the product in the domestic currency and repatriate funds abroad (as in back to their home).
Ram,
You're not being extreme at all. In 7DIF Mosler says:
"the higher the trade deficit
the better."
@Ramanan
"it is precisely when foreigners start minding that it hurts. "
On a point of reality though in my experience it tends to be the importing country that minds in the end, ive never come across a case of a country refusing to sell its always the importing country throwing up controls to stop imports before we get to that stage.
"On a point of reality though in my experience it tends to be the importing country that minds in the end, ive never come across a case of a country refusing to sell its always the importing country throwing up controls to stop imports before we get to that stage."
Andycfc,
Which kind of controls are you talking? Because there can be troubles arising due to the external sector and this makes fiscal expansion difficult to work, nations want more control on foreign trade - be it imports or capital controls.
The sellers won't mind because it works for free trade and is driven by the free trade lobby across the globe.
If I am a multinational, I am incentivized to sell elsewhere because I make more profits. So I push nations into removing taxes etc on imports via G20, WTO etc.
Nations are simply taking protection when they oppose. Why do you think it ends up in protectionism in the worst case?
Tom,
I posted a comment here before the last one and has disappeared. Can you check your spam filter?
Issuing foreign denominated debt to maintain a balance of payments or to adjust for cyclical capital flows is always wasteful when there are other policy options like capital controls, trade policy, fiscal policy, banking regulations.
The only purpose of issuing foreign denominated debt by a developing nation should be to obtain some good they can't otherwise obtain with domestic currency. My argument is that they can always (almost) obtain the goods without foreign debt because companies will find a way to make the sale happen.
The foreign debt problems faced by developing nations are often misrepresented and without proper detail. Take Argentina for example. They are most often presented as a monetary basket case. They allowed their citizens to buy their own domestic real estate in US dollars instead of pesos... insanity when the population was paid in Pesos.
When the government limited access to US dollars, people started buying real estate in pesos.
More debt denominated in Pesos makes their domestic market for financial assets flourish. More importantly they can control their own interest rates, inflation and their own banks etc. But it does take capital controls and restrictions to force the use of the domestic currency and discourage the use of the foreign. When most credit was issued in dollars, there was no way for their central bank to control monetary policy. Inflation soared, fiscal policy and interest rates were ineffective. And then the cyclical capital cycle turned... and chaos happened. Again and Again. And people lost faith in their currency and wanted to use more US Dollars. South America has some of the most fascinating experiments in money because they have done the craziest things. It also has had some spectacular success lately.
@Ramanan
Yes all of those points exactly were my thoughts see it all the time, little trade "barriers" here and there.
What i meant was your comment "it is precisely when foreigners start minding that it hurts. " It seems its the country importing that minds way before the sellers if you see what I mean.
Andycfc,
Okay probably I see what you mean here but it said hurts but Opposing free trade doesn't hurt!
Peter,
Yes I know. I can easily find many extreme positions.
In a comment posted which blogspot doesn't like, I linked to a Randy Wray piece in which he says the external deficit is not an imbalance.
One can hence conclude that there is no external constraint at all for countries with "sovereign currencies" because if there is a limit to continuous current account deficits such as 5%, then viewing what's usually imbalance as not imbalance is contrary to the claim.
"The only purpose of issuing foreign denominated debt by a developing nation should be to obtain some good they can't otherwise obtain with domestic currency. My argument is that they can always (almost) obtain the goods without foreign debt because companies will find a way to make the sale happen."
The purpose is not just to obtain foreign goods. It is to have sufficient foreign reserves so that the central bank can intervene frequently if there is a sudden outflow.
@Ramanan
Yep no argument there, more complex it is keeps me in a job ;)
You will like this, a certain famous software manufacturer come to me with 20 promo t shirts and wanted them sent to Bangalore and as they were freebies for a promotion were paying everything. I said look you are going to get hit here for some high charges they said ok has to be done, anyway got to India and customs threw up a nice one and sent them off for testing, 850 GBP the bill come back for the testing, made them bloody expensive t shirts lol!
Ramanan
I don't get it. You are obviously very bright so I don't get why you have such a beef with the main MMT guys.
OK they just as obstinate and intelligent as you and everyone wants to make their mark but they all accommodate each other in trying to move the debate on.
Why do you associate yourself more with the MMR guys whose main agenda, to an outsider, appears to be picking a fight with MMT to promote their own cleverness.
Is it personal?
Ryan,
You're just referring to exorbitant privilege or a truly statist regime. Let me explain.
A lot of countries do not have stable domestic currencies. It can be advantageous to use a foreign currency for many reasons. This is just one of the realities of developing economies. So accumulating debt in that currency often makes more sense than accumulating debt in the domestic currency. The government can't control this without imposing strict regulations that are often seen only in communist countries. I doubt MMT proposes that.
So it's not as easy as MMT often says. The situations aren't as black and white in 3rd world nations as they are in the USA for instance.
And if it becomes a debt crisis for the private sector it becomes a debt crisis for the government as well inevitably unless they do nothing, which government's aren't in the business of doing (nothing, that is).
The bottom line is, MMT doesn't apply to more than a handful of countries. It's just not as simple as "issue your own currency".
I can't speak for Ramanan or MMR, but my impression is that they both just want to get things right. Personally, I find their arguments far more appealing because they are based on fact and not on policy.
Ramanan and MMR agree on the foreign sector approach because it is right. They also agreed on the accounting stuff recently debated because it is right. MMT doesn't care about being right so much as they care about pushing their policy agenda forward even if it means obscuring reality a little bit.
Anonymous
@May 11, 2012 5:21 PM
Complicated. I don't think the two MMR/T should fight. I do comment there because my comments are more appreciated and there is less hostility. I used to comment on mmt blogs before but was met with huge hostility after some initial friendliness. Hence I don't even read comments there now.
Except for Tom who has been friendly all along - whatever our disagreements. So I comment here mostly when something related to me is referred to. Or comment minorly on other issues.
Fair enough. That makes sense.
Ummm. We need this guy on board.
AndyCFC,
:-)
Then again.........
Anonymous,
Great. Also "less hostility" in the previous comment mean zero hostility by hosts. I was referring to commentators there not hosts.
"Ramanan and others dispute the MMT stance, holding that it needs to be carefully qualified with respect to the general case and specific instances, with the US being a special case that cannot be extended to many other countries, and that even the US cannot presume to enjoy its "special privilege" forever without capital flight and therefore exogenous pressure to raise interest rates to attract capital and curtail demand in order to decrease imports"
First, what is its special privilege? Seems to me that its privilege isthat its economy can pretty much produce anything in the world. How long will it take for that condition to change? Wayyy longer than any of us will be alive I suspect, if ever. We dont NEED to import anything, we choose to.
Second what is capital flight and why would it happen? People will stop investing in the US when it no longer has anything worth buying. Do you see that happening anytime in our lifetimes or our childrens lifetimes? In spite of our dismal education statistics people from all over the world come here to get degrees and pay good money. Our good products have zero problem selling overseas. Seems to me that one problem is our finance sector which treats our currency as a commodity and packages our debt like its a real asset or something.
Exogenous pressure on interest rates can be ignored in my view as long as we continue to produce quality products that we ourselves are willing to consume.
"I don't think the two MMR/T should fight. I do comment there because my comments are more appreciated and there is less hostility. I used to comment on mmt blogs before but was met with huge hostility after some initial friendliness. Hence I don't even read comments there now"
Ah believe me these rows even at there worst are nothing by internet standards, sitting in a pub having a drink they would never get to this stage.(not picking on you Ramanan btw, could have used anonymoses question but you were closer! no other reason)
I have a geeky hobby where splits,denounciations, accusations etc are pretty much every day occurances, bannings happen all the time, accusations of favouritism have 500 replies, one argument that comes to mind has been going on 5 years and has literally thousands of threads,posts and opinions...... the hobby is making scale model aircraft (you know the ones you did as a kids)
"Fair enough. That makes sense.
Ummm. We need this guy on board."
I agree!
:o)
"…The bottom line is, MMT doesn't apply to more than a handful of countries. It's just not as simple as "issue your own currency"…"
MMT applies to a country that issues it's own free-floating fiat currency and has little or no debt in a foreign currency. This criteria applies to several countries including but not limited to the U.S., UK, Japan, Australia, Canada and China.
Obviously many countries can't for various reasons issue their own currency or chooses to peg their currency against that of another country.
This is not nor has it ever been a secret so why must you belabor the point?
MMT applies to most developed countries if they choose to adopt the paradigm.
If countries choose not to adopt it they will still have to live with the constraints that define MMT whether they like it or not since those constraints are dictated by the laws of arithmetic and systems and are thus irrefutable.
"I can't speak for Ramanan or MMR, but my impression is that they both just want to get things right. Personally, I find their arguments far more appealing because they are based on fact and not on policy.
Ramanan and MMR agree on the foreign sector approach because it is right. They also agreed on the accounting stuff recently debated because it is right. MMT doesn't care about being right so much as they care about pushing their policy agenda forward even if it means obscuring reality a little bit."
…what a pile of arrogant hubris.
"I don't think the two MMR/T should fight."
I agree. I think they are allies more than anyone else in the field of economics. They have disagreements, but they agree on a lot more than they disagree about. I thought Roche made a good comment the other day (can't find it) where he said MMR would help make MMT more acceptable. I think he's right. Hopefully both sides cool it a bit so we can all get back to fighting the actual bad guys.
Hey Paul,
Your comments don't add any value to anything. You and NeilW and a few other MMTers just detract from every conversation by talking down to everyone and getting emotional. Do your MMT friends a favor and stop commenting. Being associated with people like you is bad for everyone involved. On that note, I am done here. Too many egos and petty comments (as is always the case in an MMT conversation).
Greg,
"We dont NEED to import anything, we choose to."
Unfortunately we do not live in that world. Protectionism is a taboo. Of course it's bad too but the other extreme is free trade. So one needs a balance.
"Second what is capital flight and why would it happen?"
Capital flight typically happens when a nation's solvency is under question or if there is some crisis somewhere leading to a "flight to quality" - i.e. shifting funds back home - to the US dollar etc.
"Exogenous pressure on interest rates can be ignored in my view as long as we continue to produce quality products that we ourselves are willing to consume."
I do not know which context you are referring to, unfortunately nations become indebted to foreigners and double entry bookkeeping gives a lot of trouble.
The thing is...
MMR is nothing without MMT
The only way you can.promote yourselves is by slagging off MMT.
Not a great position.
"Unfortunately we do not live in that world. Protectionism is a taboo. Of course it's bad too but the other extreme is free trade. So one needs a balance"
I dont advocate protectionism but the truth is the US doesnt NEED to import anything. They choose to. How is that not true? What do we need form others to function? Maybe oil but I think we COULD even produce all that we need..... right now. Choosing to is a great thing as well. We need to interact and take advantage of what the rest of the world offers but when "forces" align and make us choose between keeping our own citizens underemployed and having the luxuries of elsewhere, our choice should be for our citizens and ignore the "forces".
There is more than one way to correct a trade imbalance. Exporting more is one way importing less is another. I think we need a little of both.
You dont really think the US solvency should be in question do you?
Regarding exogenous pressure on interest rates Im simply arguing that in the US it can largely be ignored. Its not true for every country thats for sure but for the US, I think they can thumb their nose at it and set the rates they want. Interest rates are a policy option not a market driven number here.
To accumulate foreign reserves at their CB a country must sell foreign denominated bonds? Think about that. Singapore. China. Brazil. Russia. Canada. Mexico. Korea. Czech Republic. A hundred different ways to skin that cat. Enough said. I recognize that for fledgling nations with few resources, nothing can be taken for granted.
A sudden large outflow is usually due to shadow banking in a foreign currency.. that can be regulated without scaring off anyone. See countries listed above!
Alot of these observed problems for developing nations are caused by NOT using their own domestic currency.
In reality, Merchant banks with branches that have access to both central banks can smooth out many of the perceived balance of payment problems using the same old dog and pony tricks so long as the politicians don't do anything stupid.
Capital flows can be dealt with through regulation like they are the world over, depending on need.
I think the big problem with MMT isn't with the current account issues. It is rather that all modern democratic countries set fiscal policy with large slow legislatures that could never adopt fiscal and tax policies quickly enough for the changing needs of the private sector. That is a real problem for MMT to work that makes it wholly unrealistic. The mechanism needs to fast and automatic and respond to the right economic measurements. None of which have been defined. When we tried to describe a system to do that, like the JG in the US or a pension system in Europe, it scares the hell out everyone.
On the MMR/MMT not being applicable, neither apply to any country! Every country deviates from the idealized models because every country has different laws. All descriptive systems make assumptions. It shouldn't matter with what name you label your idea: it is either accurate or it isn't for illustrating how the monetary system works. MMT people don't care that MMR thinks it is different. If the ideas help illustrate things from a different angle, great. It isn't a competition, there isn't one winner, there isn't one right description. Knowledge will build and there will be give and take.
Ramanan, I checked the spam filter and found a number of previous comments going back over a month and fished them out, so they will appear on the various poses now. Sorry about being so late. But I did not see one of yours from today. No idea where it went.
It was there for a while - I started to go to the link he referred to and got a 503 Service Not Available Error.
After I reloaded his comment was gone.
"Maybe oil but I think we COULD even produce all that we need"
Wh do you think finds the oil and gets it out of the ground? Just a few companies. Who makes the equipment and and innovates. Only a few companies.
The US and Canada can produce a huge amount of oil, but at tremendous cost in terms of negative externalities. Natural gas and coal, too. That's a problem rather than a solution.
@ paul
Must a a quirk in blogspot. I don't know where else to look to fish it out.
I think that problem is probably with links. Maybe best to break the html so that blogspot doesn't recognize them as links. Those wishing to follow a link can then fix it before using it.
Don't know what else to say. Any other ideas?
Peter,
"exorbitant privilege or a truly statist regime...A lot of countries do not have stable domestic currencies."
Which countries are you thinking about and what monetary/fiscal/tax/financial/regulatory policies do you think are causing their currency to be unstable? Would MMT or MMR help them understand why their currencies aren't stable? That is the goal after all, isn't it?
"MMR is nothing without MMT"
No economics is anything without something to build on. MMT is nothing without Knapp and Godley and Minsky.
The earlier thread: http://mikenormaneconomics.blogspot.com/2012/05/ramanan-monetary-economics-of-sovereign_09.html is continuing and there are important questions that Ramanan hasn't answered.
Letsgetitdone,
Done.
"Think about that. Singapore. China. Brazil. Russia. Canada. Mexico. Korea. Czech Republic. A hundred different ways to skin that cat. Enough said."
New version of the song which goes
"Brazil, Morocco, London to Ibiza, Straight to LA, New York, Vegas to Africa" ?
Greg,
"I dont advocate protectionism but the truth is the US doesnt NEED to import anything. They choose to."
Now that sounds like playing with words. What do you mean choose to. Does the US government choose how much the US imports? It could restrict imports by brute force. Deflate demand to the point of inducing a recession. Imports will automatically reduce because of lower income.
"There is more than one way to correct a trade imbalance. Exporting more is one way importing less is another. I think we need a little of both."
Yes nations try to export more such as sometimes - by providing subsidy to exporters for example (as India was planning to do). But exports are limited by how successful a nation is in selling products abroad.
"Interest rates are a policy option not a market driven number here."
Yes they are exogenous but does not mean that the monetary policy reaction function is completely independent of balance of payments.
Only for a few industrial nations is this the case that it is independent.
What happens today is a matter of policy choices nations made in coordination yesterday. e.g., the treaties, etc. that establish free markets, free trade and free capital flow, as well as a floating rate monetary system, although some pegs are permitted. So we have to describe what actually happens within these parameters establishing what can happen. What can happen operationally is not necessarily what happens since circumstances are different and countries therefore act differently.
It may be true theoretically that fx markets clear with floating rates, or it might not. That is a question of the how the model operates. But how nations actually behave is an empirical matter that can be checked.
We know that currency crises have happened. Some are attributable to countries borrowing in foreign currencies, pegs, etc. the violate the definition of currency sovereignty.
The question is whether countries that meet the definition of currency sovereign can become involved in a currency crisis theoretically and if so how. Then the question is the degree to which this has happend — all with a view toward figuring the probability a currency crisis, given certain conditions.
I am far from being clear on this.
Obviously, if international policy changed or if a country changed its stance wrt international policy that would alter the game. But let's stick with the present system and assume for simplicity that all countries stick with it too.
Ramanan's argument that the "FX market won't clear" is strange. By definition, a free floating currency will always clear; all that can happen is the price is not at a level you don't like.
Most currency crises revolve around at attempting to keep a currency pegged at too high an external value. As long as policy makers don't make that mistake, the currency adjusts long before the foreign sector decides to "stop financing a current account deficit". (How can we model the portfolio decisions of the entire world as being the result of a single actor's motivations?) In practice, portfolio flows result in a gradual deterioration in the value of a free floating currency, which then sets up stabilization mechanism as asset and trade flows change.
@ Anonymous
The problem is that the "markets always clear" assumption is a New Classical one that Keynesians dispute. It's part of the "invisible hand" superstition that New Classicalism justifies with REH and DSGE, which are rejected by Keynesians other than "bastard" Keynesians.
For those interested, the Mosler Contact page discussion starts here: http://moslereconomics.com/contact/#comment-183483
"The only purpose of issuing foreign denominated debt by a developing nation should be to obtain some good they can't otherwise obtain with domestic currency. My argument is that they can always (almost) obtain the goods without foreign debt because companies will find a way to make the sale happen."
The purpose is not just to obtain foreign goods. It is to have sufficient foreign reserves so that the central bank can intervene frequently if there is a sudden outflow.
So what?
"Since they are generally less willing, they shift funds abroad leaving banks with a net open position unless the central bank intervenes in the currency markets. "
And that is the key point. The assumption there is that the central bank must intervene.
It need not. It can put the bank into administration and let bankruptcy clear the foreign debts in the usual fashion.
'net open positions' is just a fancy term for 'we screwed up in our gambling'.
The key here is to realise that the central bank is there to protect and control the domestic currency payment system so that domestic currency transactions can continue as uninterrupted as possible.
The whole problem with Greece, the private banks and most of the world's messes seems to boil down to mistaking a liquidity crisis for a solvency crisis.
Although a central bank can help smooth liquidity in anything else, it has to do that on the basis that it is a currency user - and therefore it is little better at it than any other entity in the system.
We would all be better of if the central bank moved to put entities into bankruptcy rather more often than it does at present.
And the reason they don't is because 'independence' of the central bank put the central bank firmly under the control of the class of people running the other financial institutions.
So for me the way to deal with outliers like this is to treat them the same as ponzi build up in the private sector.
You have to be able to let the banks go bust, write off their external debts and then reset them with in injection of domestic funds.
But like the Irishman giving direction the best way to deal with outliers is not to get there in the first place. Prudent regulation of banks under your control so that they don't build up ponzi debt is key to that - as is a diverse poly-cultural domestic economy.
"The problem is that the "markets always clear" assumption is a New Classical one that Keynesians dispute"
Markets do clear, but they don't necessarily clear rationally. They may clear by people simply walking away and saying 'no deal'.
If you scrip is horse manure and nobody else wants to hold it, then you are back to bartering. You can only import what you export.
If you want to go beyon that then any debt instrument taken on must be by a domestic entity that can be placed into bankruptcy. There must be no unlimited guarantee, no debtors prison, or you get the Greek situation. That is why we invented bankruptcy and limited liability in the first place.
All of this talking past each other is down to a lack of clarity over the limited liability and bankruptcy rules for certain entities.
The highly coupled assets that cause system crises - like the payment systems - need to be maintained outside of entities that can go bust - or the process needs to be able to quickly retrieve them.
We need to decide which bit of the banking system is a public good - like the road or rail network - and likely nationalise it (or quasi-nationalise it).
This all boils down to standard Minsky stuff - how to avoid the build up of ponzi debt and eliminate it if it happens.
"That is a real problem for MMT to work that makes it wholly unrealistic. The mechanism needs to fast and automatic and respond to the right economic measurements. None of which have been defined. When we tried to describe a system to do that, like the JG in the US or a pension system in Europe, it scares the hell out everyone."
I don't understand that at all. Discretionary spending systems will not work.
The JG is just an enhancement to a system that we know works - the automatic stabilisers.
Unless you advocate exterminating excess population then those automatic stabilisers are the only option.
And they need to be powerful enough to act as your buffering mechanism - to handle the wild and rapid variations in the economy and dampen them down.
If those are given enough power, then you can have a system where the politicians are required to 'fund' their spending decisions with taxes.
It's like in business where you take away the worry of a profit from your project managers by using a standard cost chart with it all built in. Then all the project manager has to do is make sure they don't spend more than their budget. As long as it balances on that standard cost chart the business makes money. You don't then need PMs that understand profit.
Well designed auto stabilisers allow us to use politicians that don't understand monetary systems in the same way.
Senexx,
What do you mean so what? Strange.
Regarding mosler, he talks of an alternative world rather than a world which we live. At least for now he is aware of this. All his earlier descriptions would assume that imports are in the domestic currency of the nation
Anyways he makes another assumption which is incorrect that foreigners as a whole cannot shift funds away from the domestic currency leaving the banks or the central bank in a position to attract funds from abroad.
Tom,
Right.
"I think the big problem with MMT isn't with the current account issues. It is rather that all modern democratic countries set fiscal policy with large slow legislatures that could never adopt fiscal and tax policies quickly enough for the changing needs of the private sector. That is a real problem for MMT to work that makes it wholly unrealistic. The mechanism needs to fast and automatic and respond to the right economic measurements. None of which have been defined. When we tried to describe a system to do that, like the JG in the US or a pension system in Europe, it scares the hell out everyone."
Well put.
the problem with MMT is political. For example is totally unrealistic that you can use taxes to control inflation. It won't work, it will only work in one way (cutting, specially wealthy people) but not in the other (rising).
The world does not work that way so it's illusory to pretend you can control inflation through taxes (plus taxes have a temporary inflationary effect in the short term anyway).
I'm on MMR/Ramanan side on this forex/current account issue as well, the world simply does not work the way MMT ideally describes (sorry guys, you know I'm with you on most issues but it doesn't).
Now, solutions... we are talking politics, national politics (difficult) and international politics (impossible). So following Occam razor, I think the 'easiest' thing is what will happen. The path of last resistance is to kick the can, then when you can't kick the can anymore things collapse.
In case of developing nations kicking the can is using currency pegs, in case of developed nations is to not try to enforce serious regulation and capital controls because 'free market'. When things collapse then we see hyperinflation, currency & banking crisis etc. in developing nations. What happens in the bigger cases like the relation between China and USA, I don't know, but following Occam razor, I wouldn't expect coordinated and complex solutions and political effort...
Neil: Absolutely. Absolutely. Absolutely. Ramanan is the one making an oh-it-goes-without-saying hidden assumption "that the central bank must intervene." Not the MMTers.
Whether or not this happens in reality, whether there are some laws or treaties that say this MUST happen are empirical or legal questions, not economic ones. He appears to be using his old IMF treaty argument in the background.
According to what almost everyone in the world considers economies to be for, it is criminally insane, whether it is real or legal or illegal. It's just another of the infinite ways to provide welfare to the rich. And probably, when it has happened, it is a novel lunacy that pretends to be of great age, like the "independent central bank".
'net open positions' is just a fancy term for 'we screwed up in our gambling'. Yup. And the gamblers say their gambling debts MUST be made good by the state, the lesser people - whose welfare is all they have at heart, of course. Nice work if you can get it.
Leverage: For example is totally unrealistic that you can use taxes to control inflation. It won't work, it will only work in one way (cutting, specially wealthy people) but not in the other (rising). Really? Everbyody used to (half) understand MMT back when it was called functional finance or Keynesian economics.
Even the US Congress, which on economists' advice raised taxes against inflation in 1968 or thereabouts. Lester Thurow's old books have details. Maybe too slow, etc but it happened.
When we tried to describe a system to do that, like the JG in the US or a pension system in Europe, it scares the hell out everyone." For what value of "everyone"? Pensioners? The unemployed, the underemployed, the poor, people who work for a living and see their lives becoming worse than their parents'? Are there any "everyones" out there except for financial & other parasites?
Question to Ramanan: Suppose a state has a constitution that states that any politician proposing that any government organ borrowing in foreign currency- will be summarily shot, with his head displayed on a pike. Any bank, any firm, any individual who tries to borrow in foreign currency will be deported, jailed, stripped of all assets &/or shot. Not much foreign denominated borrowing then. No net open positions.
But anybody who has actual foreign currency, say in the form of printed bills can save them or do whatever they want with them, buy whatever they want at the foreigners' stores. Is there any foreign constraint on functional finance then? From your statements on Japan, I believe you would say "No".
calg,
"Suppose a state has a constitution that states that any politician proposing that any government organ borrowing in foreign currency- will be summarily shot, with his head displayed on a pike. Any bank, any firm, any individual who tries to borrow in foreign currency will be deported, jailed, stripped of all assets &/or shot."
Now we're talkin'!
If we could get that passed (along with some other key tweaks domestically), then I would immediately convert to MMR as then all I would want to do is "describe the system as it currently works".
And this is good from Neil:
"'net open positions' is just a fancy term for 'we screwed up in our gambling'."
That puts it in a nutshell, very good Neil...
Resp,
Neil,
What do you think the potential is for putting an information system together to track all trade via the boxes that goods travel in?
There are only 17M boxes total in the world:
http://en.wikipedia.org/wiki/Conex_box
As a point of reference in just the US the FAA's ATC systems currently track 64M take-offs and landings per year passenger flights:
http://answers.yahoo.com/question/index?qid=20061207081929AAgwh5P
What is the potential of putting a system together today to settle trade in real terms? ie require mercantilists to identify real offsets to all imports/exports? ie "this box" is going out and is offset with "that box" that is coming in... a certain million times per year.
Resp,
Tom Hickey said
"The problem is that the "markets always clear" assumption is a New Classical one that Keynesians dispute...."
I did not state that "all" markets clear, I said that a free floating FX market always clears. For every transaction in FX, there's a buyer and and seller, and if the model is stock-flow consistent, it's always in balance. (In a peg, there can be an imbalance at the posted price.) All that can happen, as I stated, is that the level is not one that you want it to be. But that's the definition of a float - you don't care about the level!
Re banks: Current account deficits in non-dysfunctional OECD floating rate countries (in particular non-Euro) are not financed by bank "open positions" in FX. If they were, we'd have had a lot of dead banks a long time ago (take a look at charts of FX levels post-Bretton Woods). With the dismantlement of capital controls the gross cross-border flows in financial assets amongst OECD nations is massive, and they swamp the net flows. Current account deficits are financed by a combination of foreign direct investment and position-taking in domestic financial assets, most especially government bonds and bank deposits.
A small EM country without functioning capital markets may have a hard time implementing a free float as advocated by MMT, but if you lack those capital markets, it appears that the "M" which stands for "Modern" in MMT does not apply to the country. So problems are to be expected,
"Suppose a state has a constitution that states that any politician proposing that any government organ borrowing in foreign currency- will be summarily shot, with his head displayed on a pike. Any bank, any firm, any individual who tries to borrow in foreign currency will be deported, jailed, stripped of all assets &/or shot. Not much foreign denominated borrowing then."
Why so much violent thoughts?
Milton Friedman said central banks should control the money supply. Hell the idea of freely floating without any intervention came from him.
It's true floating exchange rates have an advantage generally you can reach totally different conclusions.
Ramanan
I think Im largely agreeing with one of your critiques of MMT, that it can sometimes sound oversimplistic and can be downright difficult if not impossible to apply in every currency area in the world. I happen to think the Moslers, Wrays and Mitchells understand this but your point is taken by me.
My main point is that at present in todays world MMT does fully apply to the US. Imports are a net benefit for our country. If someone else will make something we like cheaper than we make it, lets buy it! There is no need to "correct" the CAD. We have a unique situation and should use it. We dont need to start making stuff for the rest of the world.
However we, as one of a select few, CAN make everything we like and need. So if things change and we are better off not importing so be it. No the US govt doesnt dictate how much we import but if it were to run a Mosler like tax/spend policy, US citizens would have their own say about what they want to buy and THEY may choose to buy more American made goods. Part of the reason we "need" cheap Chinese imports is too many of our own citizens have been impoverished by our stupid govt policies and can only afford Wal Mart trash.
Energy issues will soon make shipping products thousands of miles less cost effective
Neil, I totally agree with your point that banks borrowing in foreign currency should be allowed to fail, and that the banking system should be thoroughly reformed and closely regulated.
However, the problem is MMTers argue that countries like the US 'can't go bankrupt' (as they issue their own money), so there's no fundamental problem with increasing the govt budget and current account deficits. Popular concerns about the deficits are dismissed by MMTers as misguided and plain wrong.
In contrast, Ramanan has identified a situation in which countries like the US COULD potentially become bankrupt (as the result the current financial system 'design' and the fact that the CB would in all likelihood choose to intervene - or be forced to given the current size and systemic importance of international banks).
So the MMT claim that countries like the US 'can't go bankrupt', it turns out, is actually contingent upon these countries adopting certain fundamental changes to their financial systems and CB policies. That is, it's a claim which isn't actually true for the world in which we really live, only for a hypothetical world which follows MMT policy prescriptions.
So next time Norman laughs at someone for worrying about the debt or the current account, perhaps he should qualify his comments by saying "neither is a problem so long as the financial system is completely reformed and the Fed completely changes its policies in future".
"Imports are a net benefit for our country. If someone else will make something we like cheaper than we make it, lets buy it! There is no need to "correct" the CAD. "
A current account deficit is a leakage in demand (before we start worrying about its financing). So imports are benefits or whatever only at full employment.
With the current policy, imports are not net benefits as the leakage leads to a weak demand and hence more unemployment than the case of say zero current account balance.
No "net benefits".
"With the current policy, imports are not net benefits as the leakage leads to a weak demand and hence more unemployment than the case of say zero current account balance.
No "net benefits"."
MMT argues against current economic policy and shows why It is wrong. Now you use the same wrong economic policy that MMT argues against and you show that when using this economic policy, MMT argument is wrong. This is circular argument.
Using this argument, you can even say that currency wars are justified. Why? Because we don't understand how monetary system operates.
"a free floating FX market always clears. For every transaction in FX, there's a buyer and and seller, and if the model is stock-flow consistent, it's always in balance."
That the New Classical view that Ramanan is disputing. Markets fail when all the trade shifts to one side and either government steps in or the IMF to take up the other side, of the market freezes up. This happens in credit markets and fx markets, and generally cb's and international institutions step in to take up the slack. Otherwise, there is chaos when there is systemic risk as there usually is in a complex global financial system. And it is not like these are isolated occurrences in either credit markets or fx markets. They occur repeatedly, and so far no one has devised a way of avoiding them entirely in spite of the extensive and expensive damage they often involve.
"MMT argues against current economic policy and shows why It is wrong. Now you use the same wrong economic policy that MMT argues against and you show that when using this economic policy, MMT argument is wrong."
Well, as long as there is no full employment, imports are not net/benefits. Even Marshall Auerback agreed a couple of years back.
The MMT claim that WM often reiterates is that imports are a benefit in real terms of trade. While that is true at the time, the saving of the trading counterparty is a claim against real assets, other financial assets or goods in the future, either by the saver or whomever the saver wishes to exchange the claim with. It's not like the advantage is free. It's temporary in the sense that saving is postponed consumption or investment.
Moreover, it does create demand leakage, which is an economic expense unless offset, and offsetting demand leakage is not free either in that it reduces policy space for other options. That is to say, there is opportunity cost involved.
If I'm understanding correctly, Ramanan seems to say we're constrained poor policy that negates the benefits of imports in the present by failing to offset the leakage and compounds the mistake in a possible future by maintaining the level of excess imports with foreign currency borrowing should the circumstance of being able to buy them with domestic currency end.
Given what our policymakers have demonstrated in practice, that's not an unreasonable set of assumptions. It seems like it falls well within the policy space described by MMT, it just happens to be the "our policy makers are terrible and will remain terrible in the future" area of that space.
MMT offers policy alternatives to avoid those constraints but MMT can't endow us with politicians wise enough to apply such policies.
I've now replied to Ramanan's replies to me here:
http://mikenormaneconomics.blogspot.com/2012/05/ramanan-monetary-economics-of-sovereign_09.html
@May 12, 2012 12:23 PM
There are 6 replies beginning with the one at @May 12, 2012 12:23 PM
First, I agree with the previous comments made by Neil Wilson and Calgacus on all essential points. Anonymous here are some comments on your comment above:
"However, the problem is MMTers argue that countries like the US 'can't go bankrupt' (as they issue their own money), so there's no fundamental problem with increasing the govt budget and current account deficits. Popular concerns about the deficits are dismissed by MMTers as misguided and plain wrong."
That's a bit distorted, MMTers are saying that they can't go bankrupt if they acknowledge their debts and don't refuse to issue money to pay them when they fall due. MMTers never say that Governments won't be stupid and default on their obligations when they don't have to.
"In contrast, Ramanan has identified a situation in which countries like the US COULD potentially become bankrupt (as the result the current financial system 'design' and the fact that the CB would in all likelihood choose to intervene - or be forced to given the current size and systemic importance of international banks)."
In the US the CB cannot be "forced to intervene" to save exposed banks. They can choose to intervene. Again there are no MMT guarantees against corruption, perfidy, or stupidity.
However, even if the CB did intervene to save banks from their bad gambles, I don't see why this would force the US to declare bankruptcy, and I don't think that Ramanan has shown that it would FORCE bankruptcy, in violation of the 14th Amendment.
Finally,
"So the MMT claim that countries like the US 'can't go bankrupt', it turns out, is actually contingent upon these countries adopting certain fundamental changes to their financial systems and CB policies. That is, it's a claim which isn't actually true for the world in which we really live, only for a hypothetical world which follows MMT policy prescriptions."
No, not true for the US and many other Governments. There are no legal barriers in the US to the Government paying all its obligations, however large, when those fall due. I think the same is also true of Canada, New Zealand, Australia, the US, the UK Japan, Norway, and Sweden at least.
"First, I agree with the previous comments made by Neil Wilson and Calgacus on all essential points."
Ditto.
The issues have to be parsed into theoretical (general) and policy, strategy and tactics (specific). That's from Scott.
Neil's system approach to articulating this seems to me to have carried the day so far regarding this parsing. Calgacus is in the same vein. The systems approach kicks butt.
Maybe that is just the way my mind works, but that's my view on it anyway.
Tom
Seconded.
The purpose is not just to obtain foreign goods. It is to have sufficient foreign reserves so that the central bank can intervene frequently if there is a sudden outflow.
So what?
So what if that is the point?
The CAB is like the FX float, it floats too. If a country wishes to intervene by buying or selling local or foreign currency to support domestic policy, so what?
Intervention is an option, there is no pure position here, purity only exists in theory not operations.
Even if there is a boycott on a particular currency there are options to get around it for that country.
Given the position you've argued Ramanan - so what? There's ways out of it.
Seems like cb's are coordinating lately to prevent crises, e.g., the Fed stepping up with $ swaps.
This is what should be happening instead of international organizations like the IMF stepping up with lending and imposing austerity that holds back the growth of the country instead of just providing liquidity.
A reason that Asia is saving fx right now is in reaction to the previous financial crisis where they got hit with sudden capital outflow. That could have been buffered to avoid the crisis instead of letting them hang out to dry.
Similar in the EZ, where the problem is internal rather then external, but arising from trade, with Germany the surplus country.
These crises are "artificial" in the sense of being created by finance rather than issues with the real economy, i.e., available resources. Then they spill over into the real economy and result in real damage to lives and property, and constrain potential.
Surely a systems approach to flow could easily relieve this and resolve the issue of recurrent crises. Looks like an information and engineering issue that could be dealt with by better design.
Tom Hickey said:
"That['s] the New Classical view that Ramanan is disputing. Markets fail when all the trade shifts to one side and either government steps in or the IMF to take up the other side, of the market freezes up...."
Ramanan is the one taking up a New classical view - that governments need to worry about the "FX Market clearing".
Can you name any examples of a free-floating OECD currency failing to clear in the post-Bretton Woods era? I can't (except that it is tough to do any trades on New Year's eve). When the IMF has come in, it's usually after a peg of some sort has blown up.
And there's a reason for this. As is often deplored, the trading in the FX markets is at least an order of magnitude larger than the underlying net trade flows. Some of this represents idiotic hyper-active trading by FX desks, but the rest is the result of extremely large gross international capital flows. There is a huge variety of actors who undertake cross-border asset positions, and the net flows are just a residual of these gross flows.
These flows move currencies around with a spectacular volatility relative to economic fundamentals. That said, the net impact on domestic economies is remarkably small. For example, the Canadian dollar went from U$0.80 -> U$.60 -> U$1.05 (levels are from memory, don't have a chart handy) over the past 20 years, and the effects are barely noticeable in the domestic economic aggregates. And Canada is an open economy with massive cross-border flows to the U.S.
Thus in order for a currency to "freeze", you would have to get unanimity amongst market participants for the value of all asset classes in a domestic economy (plus exports or imports would have to stop dead). In practice, you don't see that sort of unanimity. And you are unlikely to see it, if the economy has at least some industries which are internationally competitive.
Senexx,
"The CAB is like the FX float, it floats too"
Strange to say CAB floats. Ever heard CAB is fixed?
"So what?
So what if that is the point? "
What is your point?
"Even if there is a boycott on a particular currency there are options to get around it for that country."
yes right - borrow from the IMF.
"Given the position you've argued Ramanan - so what? There's ways out of it."
Wishful thinking.
"Can you name any examples of a free-floating OECD currency failing to clear in the post-Bretton Woods era?"
Well yeah. Australia in the recent crisis when the RBA had to intervene heavily by borrowing from the Federal Reserve via swap lines.
"Some of this represents idiotic hyper-active trading by FX desks, but the rest is the result of extremely large gross international capital flows"
Well, hardly the best way to say this. The trading during the day and the high volume is due to banks trying to close their net open positions.
See my old post here
http://www.concertedaction.com/2012/02/06/fx-turnover/
"And you are unlikely to see it, if the economy has at least some industries which are internationally competitive."
Yes precisely implies the success of a nation depends on how competitive its producers are relative to other nations. And those who are unsuccessful, are unable to come out of it and worse have free trade imposed on them. there's nothing floating their currencies can do for them because they simply cannot float. There is decent literature worrying about why nations cannot fully float their currencies. Doesn't help proposing to float.
Ramanan sais:
"'Can you name any examples of a free-floating OECD currency failing to clear in the post-Bretton Woods era?'
Well yeah. Australia in the recent crisis when the RBA had to intervene heavily by borrowing from the Federal Reserve via swap lines."
I think I understand your problem - you are confusing FX swaps with currency positions.
An AUD currency swap is where I trade you some AUD for the same market value of USD, we pay eachother floating interest on the notional, and we then reverse the currency exchange at the end of the swap, at the original exchange rate.
In other words, this can be thought of as two offsetting loans between the two currencies. The net currency position cancels out across the life of the swap, which is why people can trade forward FX swaps without even looking at the level of the exchange rate.
This is a funding instrument, and the FX swap market was stressed as foreign banks were no longer able to get USD funding. (They originally funded using USD wholesale funding markets, were cut off by USD investors. They then turned to the backup method of getting USD funding via converting local currency funding to USD via currency swaps, which put the FX swap markets under stress. Finally, the central banks borrowed USD from the Fed, and they then lent the USD to their local banks. It was done this way as banks are mainly regulated by their "home regulator", and so the Fed is not in a great position to be able to decide whether to lend USD directly to the foreign banks. Also, the information would become public if the Fed lent directly to the foreign commercial bank; this way, the lending is conveniently opaque.)
Note that the banks (or anyone else) could buy USD or AUD outright any time they wanted to, but this did not help them with their funding mismatch problem, because banks do not run net currency positions of any size.
Yes, funding markets can break down, like any other credit market. But the ability to buy or sell the currency was unhindered (assuming we have not decapitated the banking system, which would cause grief in all domestic markets, not just FX).
Anonymous,
I know about fx swaps. So no need to lecture me on this.
The RBA intervene by borrowing from the Federal Reserve via fx swaps so that banks are in a better position as for their funding needs.
The issue is that simply because the funding markets break down, the central bank had to intervene.
It's true there's a price always but that is hardly called clearing because some banks simply aren't able to fund themselves.
The mmters simply wave hands saying there is a price and things are fine.
In developing countries this is a regular problem. There may be a capital outflow and hence as a result banks facing funding and rollover risks in foreign currency. To prevent that the central bank necessarily has to intervene. Even if they are able to fund, they may develop a large net open position which the central bank doesn't want.
"Note that the banks (or anyone else) could buy USD or AUD outright any time they wanted to, but this did not help them with their funding mismatch problem, because banks do not run net currency positions of any size. "
Precisely why the central bank has to intervene. And being limited by its reserves, it has to ask the Treasury to incur liabilities in foreign currency.
Back to Australia, the trouble is that because the nation runs a huge current balance of payments deficits, banks need funding from abroad. And this can break down easily.
The Australian dollar has a safe haven status so this didn't last long but it doesn't mean Australia can continue to run current account deficits forever.
It is misleading to say that fx markets clear.
Anonymous,
To be sure I am highlighting how nations have indebtedness of the official sector in foreign currency.
In the balance of payments language, one can state this by saying that the foreign currency official debt is an accommodating item.
For the mmters and Milton Friedman, it is simply the price which "accommodates" (my usage).
To be more sure ... in this thread and in general discussions we are discussing clearing with the constraint of low net open position of banks and no official intervention.
Somewhere along the thread, it simply became clearing without the need to mention the above constraints.
After reading through the arguments and counter-arguments made in this thread over the past few days a pattern has emerged that makes pretty clear what the root problem is in a mathematical sense.
The arguments criticizing claims (some supposed) by MMT economists…
…"The MMT option, which is to print money like crazy [fabrication]" ??? - Peter
"Mosler: "a larger trade deficit means we can have taxes that much lower still. [opinion]"" - Peter
In 7DIF Mosler says: "the higher the trade deficit the better. [opinion]" - Peter
"The only purpose of issuing foreign denominated debt by a developing nation should be to obtain some good they can't otherwise obtain with domestic currency. My argument is that they can always (almost) obtain the goods without foreign debt because companies will find a way to make the sale happen. [opinion]" - Mosler quoted by someone
"Regarding mosler, he talks of an alternative world rather than a world which we live…[opinion]" - Ramanan
By Randy Wray's own "dissenting" opinion, he does not consider an external imbalance as an imbalance. Everything balances is his opinion [opinion]. - Ramanan
I linked to a Randy Wray piece in which he says the external deficit is not an imbalance [opinion]. - Ramanan
and so on and so on…
None of these claims or quotes are fundamental to the MMT framework, which, after all is based on the mathematics of closed systems. That math will constrain the outcomes no matter what choices are made. The relationship is law.
They are CONCLUSIONS based on analysis of the flows garnered through the sectoral balances realtionship, a simple closed-system view of the flow of dollars in the domestic and/or non-government economies. Conclusions are educated opinions - they may be right but they could be wrong. That's how we learn.
The arguments many are making against MMT are not really targeting MMT though.
Those making the counter-arguments are doing a good job, but that is beside the point. There are an infinite number of what-if? rabbit holes one can go down chasing such "we can't do this or that (or anything) because something might break" arguments.
Making matters worse those making the anti-MMT claims aren't even directing their claims at the underlying principles, leading me to believe they don't really understand what MMT means and therefore don't understand the underlying relationships.
The bottom line at the root can be defined by one over-arching characteristic, that of wealth accumulation and by extension capitalism. Deficit spending is a response to wealth accumulation mainly. The CAB is a manifestation of wealth accumulation - foreigners are accumulating wealth in another nations currency.
This is the "problem" that must be solved. Related to this is the distribution problem.
Choices that agents in the economy make are simply that - choices. Some will be successful in the game and some will not. This is not an indictment of MMT, in fact it makes a stronger case for it.
MMT removes the fog from our view of the math system that is the economy so we can make better choices and avoid bad outcomes that are caused by lack of understanding.
It seems like some are trying to make the argument that MMT is not a "formula" that one applies without nuance to every economic or financial problem. It isn't supposed to be. It is a guide to what CAN'T work because of math constraints so we don't waste time chasing bad policy down the rabbit hole.
The naysayers are generally arguing for the status quo - "Regarding mosler, he talks of an alternative world rather than a world which we live". They are part of the problem, not the solution. We do live in an MMT world though, they just can't see it.
That's okay. Your ignorance. You are assuming MMT is the only game in town.
The sectoral balances approach came from Wynne Godley.
Ramanan wrote:
"In developing countries this is a regular problem. There may be a capital outflow and hence as a result banks facing funding and rollover risks in foreign currency. To prevent that the central bank necessarily has to intervene. Even if they are able to fund, they may develop a large net open position which the central bank doesn't want."
Sigh. I realize I skipped over a detail, which is not obvious to people who have spent time dealing with these issues (but was implicitly embedded in my comment). As I stated, the developed countries banks, like Australian and European, had access to LOCAL currency funding. They needed USD funding to fund positions in USD-denominated assets (I neglected to mention that these were USD assets.) It makes no sense to swap AUD funding for USD funding to fund AUD-denominated assets!
This has nothing to do with trade flows. Germany has a current account surplus, and their banks were doing the exact same things as banks in countries with current account deficits (i.e., funding USD assets in short-term USD money markets). Instead, this just demonstrates herding behavior amongst banks ("Hey, USD subprime securitizations have great carry with no credit risk!"), which regulators have to prevent (or at least be willing to throw their banks under the bus).
No bank in its right mind funds floating currency assets in a foreign currency. If you do this just 10% of your balance sheet, a mere 30% adverse move in the currency, which is easily achieved over the life span of most loans, you lose 3% of your equity. This is enough to effectively decapitalize most banks.
Sure, EM banks used to do this all the time (until 1998, at least). And why did they do this? They had either explicit pegs or heavily managed "floats". And they got annihilated in 1998. I don't think anybody does this anymore, outside of the euro zone, and the non-EUR eastern European periphery (and natural selection appears to be dealing with that exception). And since nobody does this anymore, I don't think you can argue that this is something that EM markets MUST do. Anyway, if your nation has no internationally competitive industries, it seems ridiculous to expect that you can open up your economy to the external sector in the first place without having some complications.
And with regards to Australia, I think they did buy AUD outright in 2008 (probably at the same time they used currency swaps; I can't remember whether they actually drew on those swaps). Why? They were selling AUD on the way up (prior to 2008). to lean against the carry monkeys. I.e., they had USD reserves built up. They then unloaded those USD reserves to smooth the "disorderly" FX markets. Other developed countries used to do this, but everybody else realized that this was just a huge waste of time and resources (you gotta pay the people on the central bank FX desk) and gave up. In any event, the amounts were trivial relative to the size of gross flows in AUD.
"That's okay. Your ignorance. You are assuming MMT is the only game in town."
Are you responding to me?
…"your ignorance"
If you are - go f**k yourself. If you aren't disregard the insult along with the rest of my comment as not applicable.
"…You are assuming MMT is the only game in town…"
MMT is based on the LAW, as in natural law. The fact that you don't get that is not an example of my ignorance.
"Anyway, if your nation has no internationally competitive industries,..."
Anonymous,
Precisely the problem with the world today which has pushed free trade today and imposing a few things on foreign products cries foul at WTO.
Would you then at least agree that for these nations, free float is not an option?
Well the amount (in the case of Australia) was not small either according to GAO. And some amount of intervention is good most of the times from a self-fulfilling prophecy from being build.
"As I stated, the developed countries banks, like Australian and European, ... USD funding to fund AUD-denominated assets!"
This is an old debate in literature about banks' position versus non-banks' position in an international context.
I do not know what you mean here. You are simply looking at banking and seem to ignore the general balance of payments. If foreigners prefer to not hold AUD denominated assets this will lead to Australian banks taking more debt in foreign currency and need to induce foreigners to hold AUD denominated bank liabilities.
How can foreigners get hold of the AUD denominated assets in the first place? By selling products to Australians - which adds to Australia's trade deficit.
"This has nothing to do with trade flows. Germany has a current account surplus,..."
Of course it has to do. (plus let's talk of debtor nations as opposed to Germany which is a huge creditor). The fact that daily trading is huge compared to trade in goods and services doesn't mean the latter can be ignored easily.
A nation running a current account deficit will need to attract foreigners to hold its debt. If it doesn't manage, banks can develop huge net open positions - in which case they have to attract funding in domestic currency. (Certainly not via fx swaps because fx swaps do not close net open positions! ... in case you doubt my assumption).
This can simply be seen by writing t-tables and a proper understanding of balance of payments accounting.
"No bank in its right mind funds floating currency assets in a foreign currency. If you do this just 10% of your balance sheet, a mere 30% adverse move in the currency, which is easily achieved over the life span of most loans, you lose 3% of your equity. This is enough to effectively decapitalize most banks."
Well yeah but where did I say the opposite?
In your comments, you are simply doing a banks without looking at other flows.
Let's say there is a lot of ouflow of funds from Australia. This would obviously require Australian banks get into some action. So they may want to compensate this by attracting local currency funds from abroad because funding from domestic sources isn't sufficient. The RBA and the rating agencies obviously know this. To the extent Australia doesn't manage foreigners to hold AUD-denominated assets, banks will be pushed into more trouble.
My general points are - like you- that competitiveness in international trade is a big factor in a nation's success and this gives it the ability to float its currency. The amount of debtor nations with a floating currency is few and by no means they are no constrained by their indebtedness to the rest of the world.
Part 2:
Anonymous:
Part 2:
Here's a general line of thought. The chaos is added due to huge trading in foreign exchange - which makes seeing the order in the chaos a bit difficult to see:
A debtor nation (defined by its NIIP and not public debt) runs a trade deficit. This results in the rest of the world accumulating funds in the domestic or foreign currency. Let's start with foreigners getting paid in domestic currency. If the foreigners do not wish to place these funds in the domestic currency (domestic relative to the importer), the foreigner exchanges these funds at a bank - which results in changing the bank's balance sheet. The bank is reacting to this. There are also other inflows and outflows but we know that CAB + KAB = 0. Hence the CAB is important to all this and the portfolio preference of foreigners has important implications for the banks' balance sheet as well.
When autonomous flows in KAB (including both banks and non-banks) are not sufficient, it requires state intervention. A constraint in this problem is that banks wish to have a low net open position.
Part 1:
"Anyway, if your nation has no internationally competitive industries, it seems ridiculous to expect that you can open up your economy to the external sector in the first place without having some complications."
Anonymous,
Precisely the problem with the world today which has pushed free trade today and imposing a few things on foreign products cries foul at WTO.
Would you then at least agree that for these nations, free float is not an option?
Well the amount (in the case of Australia) was not small either according to GAO. And some amount of intervention is good most of the times from a self-fulfilling prophecy from being build.
"As I stated, the developed countries banks, like Australian and European, had access to LOCAL currency funding. They needed USD funding to fund positions in USD-denominated assets (I neglected to mention that these were USD assets.) It makes no sense to swap AUD funding for USD funding to fund AUD-denominated assets!"
This is an old debate in literature about banks' position versus non-banks' position in an international context.
I do not know what you mean here. You are simply looking at banking and seem to ignore the general balance of payments. If foreigners prefer to not hold AUD denominated assets this will lead to Australian banks taking more debt in foreign currency and need to induce foreigners to hold AUD denominated bank liabilities.
How can foreigners get hold of the AUD denominated assets in the first place? By selling products to Australians - which adds to Australia's trade deficit.
"This has nothing to do with trade flows. Germany has a current account surplus,..."
Of course it has to do. (plus let's talk of debtor nations as opposed to Germany which is a huge creditor). The fact that daily trading is huge compared to trade in goods and services doesn't mean the latter can be ignored easily.
A nation running a current account deficit will need to attract foreigners to hold its debt. If it doesn't manage, banks can develop huge net open positions - in which case they have to attract funding in domestic currency. (Certainly not via fx swaps because fx swaps do not close net open positions! ... in case you doubt my assumption).
This can simply be seen by writing t-tables and a proper understanding of balance of payments accounting.
"No bank in its right mind funds floating currency assets in a foreign currency. If you do this just 10% of your balance sheet, a mere 30% adverse move in the currency, which is easily achieved over the life span of most loans, you lose 3% of your equity. This is enough to effectively decapitalize most banks."
Well yeah but where did I say the opposite?
In your comments, you are simply doing a banks without looking at other flows.
Let's say there is a lot of ouflow of funds from Australia. This would obviously require Australian banks get into some action. So they may want to compensate this by attracting local currency funds from abroad because funding from domestic sources isn't sufficient. The RBA and the rating agencies obviously know this. To the extent Australia doesn't manage foreigners to hold AUD-denominated assets, banks will be pushed into more trouble.
My general points are - like you- that competitiveness in international trade is a big factor in a nation's success and this gives it the ability to float its currency. The amount of debtor nations with a floating currency is few and by no means they are no constrained by their indebtedness to the rest of the world.
Part 1:
"Anyway, if your nation has no internationally competitive industries, it seems ridiculous to expect that you can open up your economy to the external sector in the first place without having some complications."
Anonymous,
Precisely the problem with the world today which has pushed free trade today and imposing a few things on foreign products cries foul at WTO.
Would you then at least agree that for these nations, free float is not an option?
Well the amount (in the case of Australia) was not small either according to GAO. And some amount of intervention is good most of the times from a self-fulfilling prophecy from being build.
"As I stated, the developed countries banks, like Australian and European, had access to LOCAL currency funding. They needed USD funding to fund positions in USD-denominated assets (I neglected to mention that these were USD assets.) It makes no sense to swap AUD funding for USD funding to fund AUD-denominated assets!"
This is an old debate in literature about banks' position versus non-banks' position in an international context.
I do not know what you mean here. You are simply looking at banking and seem to ignore the general balance of payments. If foreigners prefer to not hold AUD denominated assets this will lead to Australian banks taking more debt in foreign currency and need to induce foreigners to hold AUD denominated bank liabilities.
How can foreigners get hold of the AUD denominated assets in the first place? By selling products to Australians - which adds to Australia's trade deficit.
"This has nothing to do with trade flows. Germany has a current account surplus,..."
Of course it has to do. (plus let's talk of debtor nations as opposed to Germany which is a huge creditor). The fact that daily trading is huge compared to trade in goods and services doesn't mean the latter can be ignored easily.
A nation running a current account deficit will need to attract foreigners to hold its debt. If it doesn't manage, banks can develop huge net open positions - in which case they have to attract funding in domestic currency. (Certainly not via fx swaps because fx swaps do not close net open positions! ... in case you doubt my assumption).
This can simply be seen by writing t-tables and a proper understanding of balance of payments accounting.
"No bank in its right mind funds floating currency assets in a foreign currency. If you do this just 10% of your balance sheet, a mere 30% adverse move in the currency, which is easily achieved over the life span of most loans, you lose 3% of your equity. This is enough to effectively decapitalize most banks."
Well yeah but where did I say the opposite?
In your comments, you are simply doing a banks without looking at other flows.
Let's say there is a lot of ouflow of funds from Australia. This would obviously require Australian banks get into some action. So they may want to compensate this by attracting local currency funds from abroad because funding from domestic sources isn't sufficient. The RBA and the rating agencies obviously know this. To the extent Australia doesn't manage foreigners to hold AUD-denominated assets, banks will be pushed into more trouble.
My general points are - like you- that competitiveness in international trade is a big factor in a nation's success and this gives it the ability to float its currency. The amount of debtor nations with a floating currency is few and by no means they are no constrained by their indebtedness to the rest of the world.
Tom,
Sorry again ... Part 1 is missing. Can you please check.
I have saved it this time but I guess the more I repost, the more it thinks I am spam :(
Read this at another blog - think it is appropriate:
"…the composer Sibelius who once said, "I pay no attention to critics—after all, no one ever built a monument to a critic." So the rule around here is, "If you want to criticize something—make sure you also offer at least ONE proposed solution for the problem you present."
http://real-economics.blogspot.com/2012/05/on-blogging-trolls-and-weak-heart.html
Ramanan:
Your argument seems to be based on the premise that the central bank (or treasury) MUST intervene in fx markets under the conditions you describe. But nowhere do you actually explain why this must be the case.
"When autonomous flows in KAB (including both banks and non-banks) are not sufficient, it requires state intervention."
Please explain why this "requires" state intervention.
"A constraint in this problem is that banks wish to have a low net open position."
They may well do. But again, WHY should the government be overly concerned with accommodating the banks' desire to have a low net open position?
This is from the discussion over at Warren's site:
Mario: “why can’t the government not bail out the banks, let the bad banks fail, AND guarantee people’s deposits?”
Warren Mosler: "It can, does, should in the US. ‘Failing’ means shareholders losing all their funds and new shareholders taking over, as pretty much happened to many US banks over the last few years, including the very largest. It’s about turning over the equity holders, not bull dozing the buildings."
------
Have you read Mosler's proposals for banking reform? They include the following:
"Increase FDIC insurance to include deposits up to $10 million for private sector agents.
Unlimited FDIC insurance for Fed advances to US banks."
If banks end up with large net open positions in foreign currency, then that should be their problem (and also the problem of foreign creditor banks, let's not forget).
----
The government can, if it wants to, insure deposits denominated in the domestic currency - but there is no real reason why they should have to insure banks' dealings in foreign currencies.
The supposed "public-private" partnership between banks and government should only extend as far as the "border".
What banks get up to in foreign currency markets should be at their own risk.
y,
A good reference is
"Money And Finance On The Periphery Of The International Dollar Standard"
INTERNATIONAL JOURNAL OF FINANCE AND ECONOMICS Int. J. Fin. Econ. 7: 87–96 (2002) by RONALD I. MCKINNON
Check discussions around page 93.
If you do not have access you can comment on my blog and I will email it to you.
The author is neoclassical but really right the point we are discussing.
If a nation picks up a large net indebtedness position to foreigners, then it requires foreigners to fund them as a matter of accounting. In the US it is easy. Not for other nations. This is because currencies are not so easily acceptable to foreigners - generally investors have a home preference. This is especially true in times of crises. When they shift funds, this changes the banks' balance sheet in an undesired way. To close its net open position, banks will try to attract funding in domestic currency.
Let's think of a thought experiment. Lets start with an economy which is closed and opens up. Foreigners come and sell cars and exchange currency with banks. The payment system rules is such that when the bank is in the other side of the trade, it is acting as a dealer. The exchange leaves the bank with an open position in foreign currency. To close it, it has to do an opposite transaction. It can contact another dealer but the other dealer may have the same issue. This leads to a depreciation of the currency leading to an inflow from the financial sector and hence no need for official intervention. However a depreciation may sometimes not bring in flows from abroad because there are expectations that there can be further depreciation. It may even lead to more outflow of funds.
These are speculative flows - hence nations try to attract FDIs etc - because these sources are more stable etc. It gives the nation more room in the external world. But even this is limited because foreigners need to convinced.
Really not sure about Warren Mosler's proposals. He can let banks fail in their international setting but that effectively is losing credibility in front of the whole world. Good or bad, the State is forced to support banks to maintain financial stability. Of course it should regulate more but there is no regulation which can circumvent the problem of foreign funding. Easier to say let banks fail.
The international community puts a lot of pressure on nations to float their currencies. Some like China simply say no. Others who are less powerful don't manage to do it well. It's not easy to float.
Don't get me wrong. Floating definitely helps. But the external constraint is still there. The fixed vs floating debate completely misses this point.
Seems to me that the (neoliberal) Washington Consensus needs to be revisited. It was based on mercantilism of the North with the Sough providing resources and borrowing to the extent that resources didn't cover imports. Conditions have changed and trade needs to be better balanced on one hand and cb's need to coordinate more to provide the needed liquidity to accomodate so-called free markets, free trade and ree capital flow. Or neoliberalism has to be questioned as the model.
Ramanan,
I would have thought that the kind of crisis situation you are describing could be equally damaging for both domestic debtor banks and foreign creditor banks.
If you are right and govt intervention is 'required', is there any reason why the intervention shouldn't come from both sides simultaneously, without either side having to issue foreign currency denominated debt?
The foreign CB can provide funds to stabilise the situation (and thereby protect its own creditor banks from debtor's defaults) in return for the domestic currency.
Isn't this what the Fed swap lines were all about?
y,
Why should intervention come from both sides?
Think of two nations. Both open up trade. Nation A imports and the proceeds of exports of Nation B are repatriated to Nation B. This by itself leaves the banks in nation A indebted in foreign currency. However Nation B's bank do not have an open position in the currency of A.
More generally crisis can affect both debtors and creditors but hurts debtors much more - Keynes realized this long back.
The Fed swap lines are slightly different. Yes it was to help foreign banks. The Fed did swaps with other central banks and the central banks lent banks foreign currency so that they are able to meet their funding needs - arising out of outflow of funds from their nations and also due to lenders refusing to rollover existing liabilities of foreign banks.
The Fed's swap lines also helped US banks because LIBOR calculation uses foreign banks' opinions about their funding and a lot of financial securities, mortgages are linked to LIBOR.
In the swap lines, the Fed gets currencies of foreign nations but the Fed just parked these funds at the central bank and didn't do anything as far as I know.
But it is slightly tangential to the issue.
The only reason I brought it up in the first place is to show official intervention is required even for advanced nations.
Normal official interventions are borrowing from the IMF or foreign governments (no swap) for example - in extreme cases. Typical example is a sale of foreign currency by the central bank, but since foreign currency is limited, it has ask the Treasury to borrow in foreign currency.
When the central bank is selling foreign currency, it not only relieves pressure on currency depreciation but also modifies expectations of the fx markets.
"He can let banks fail in their international setting but that effectively is losing credibility in front of the whole world. Good or bad, the State is forced to support banks to maintain financial stability."
This doesn't follow.
In response to Ramanan's replies
"Back to Australia, the trouble is that because the nation runs a huge current balance of payments deficits, banks need funding from abroad. And this can break down easily."
In order to understand what's happening in Australia, I believe you need to look carefully at the behavior of multinational corporations. Reinvestment of profits is a significant source of external funding, as far as I remember.
Another major source of funding is done via vehicles such as the following: a Japanese housewife buys a AUD-denominated bond from a european supranational. The supranational has no need for AUD, so it swaps AUD into EUR. That open swap leg will ultimately allow some Australian entity to borrow in AUD. Good luck with the T-accounts on that transaction chain (I gave up when I tried it).
I don't have time to cover all your points, and it may be that our points of actual disagreement may not be too large. But I'll summarize my thoughts:
(1) For the developed countries, you are minimizing the impact of the 300% (of GDP) gorilla in the room - the capital markets. Public equities, private companies (M&A targets), commercial real estate, liquid bank instruments and the fixed income markets typically have a market value of around 300% of GDP. This provides an immense capacity to absorb international flows. The FX spot market bends, but does not break.
Since investors can change hedge ratios on assets, there is an immense capacity to absorb currency hedge flows.
You cannot treat the "foreign sector" as a single actor; there are a variety of investors for all these asset classes, and the pricing in the capital markets absorbs pressures from "imbalances".
(2) Funding markets, like FX swaps, can break down. Regulators need to regulate their banks' overseas operations. That is not just a suggestion, it is the basic principle of international bank regulation. So it's not new information to say that regulators need to watch banking system exposure overseas. This has nothing to do with net trade or current account flows. If they blow it, yes, they end up with a mess that requires "intervention" (but not in the FX markets).
(3) Well-run banks do not take (non-trivial) currency risk on their balance sheet. Full stop. Assets are always funded in the currency they are denominated in.
If they borrow from a foreign entity, they will swap out the currency risk. This makes the borrowing effectively local currency.
(4) The U.S. is not the only country that pays for imports in local currency. The feed through from currency moves to non-energy CPI in most developed countries is roughly 0. This is only possible if the supply chain, including in the source country, eat FX the risk for consumers.
(5) I don't follow developing countries. Almost all the significant ones float (after 1998). The only "pegs" you see are places like China (or OPEC countries), where the currencies are kept CHEAP to "fair value". (They also keep in place capital controls.)
Pegging your currency at a cheap level is a well-known development strategy, and can be sustained. Most MMT authors are well aware of this strategy; they may not recommend it, but it is compatible with the theory. (A central bank has an unlimited capacity to cheapen its currency.)
Sure, there are "basket case" economies you can't apply MMT principles to. It's sad, but what did you expect with a name like "Modern Monetary Theory?". The "Modern" does not denote that the theory is new, rather the "Modern" is the type of money it covers. It presupposes a functioning banking system and government.
"(3) Well-run banks do not take (non-trivial) currency risk on their balance sheet. Full stop. Assets are always funded in the currency they are denominated in."
Yeah right. You don't have to keep repeating it. Point me to a comment of mine where I said the opposite.
"Another major source of funding is done via vehicles such as the following: a Japanese housewife buys a AUD-denominated bond from a european supranational. The supranational has no need for AUD, so it swaps AUD into EUR. That open swap leg will ultimately allow some Australian entity to borrow in AUD. Good luck with the T-accounts on that transaction chain (I gave up when I tried it)."
Fun, but let's talk past each other. That says nothing about why Australia relies on it and such and how sectoral inter-debtedness and why it arises in the first place.
The flow of funds way of looking at it is using "Balance of Payments and International Investment Position, Australia"
y,
"This doesn't follow."
That was not a logical argument as in B follows from A kinds.
The logical part was there before the statement you quoted and the reference I gave you. You may not want to read the reference and even if you read, may not be convinced by it. In that case we can continue the discussion without referring to anyone.
What I was arguing was that there are sources of funding from abroad for financing the current account such as FDI. Sometimes even these are not sufficient and this is where the government debt in foreign currency comes in.
Ramanan,
That was anonymous, not me
y,
Oops!
Ramanan,
I quoted you over at Mosler's site, and got this response from ESM:
“Now Toyota will repatriate funds back to Japan – which leaves a Thai bank indebted in Yen because the Thai bank is acting as a dealer in foreign exchange markets.”
Ok, so Thai customer pays for car with baht. Toyota gets Thai baht deposit at Thai bank. Toyota wants to exchange that for yen. Why is the Thai bank involved in the fx transaction unless it wants to be? Toyota can sell baht, buy yen from anybody in the world. Maybe the Thai bank makes the tightest market, I don’t know. But that’s a separate issue from importing and exporting. As long as the fx market is free, the rate will be in equilibrium at all times between buyers and sellers of the baht/yen cross. And it doesn’t matter who the buyers and sellers are. Sellers of baht could be (indirectly) a Thai trying to buy a Toyota RAV. Or perhaps a Japanese investor pulling out of Thailand. Or perhaps it’s George Soros. Who cares?
If the sellers of baht are more aggressive than the buyers, then the baht will depreciate. No big deal. And when it goes down, you’ll find (usually) that the sellers of baht become less aggressive and the buyers more aggressive until a new equilibrium is reached. Every so often a panic happens, and the baht might overshoot on the downside. Not so good for Thais who want to buy Toyotas I guess, but it will only be a temporary situation. And in any case, the likelihood of a panic depreciation is much greater if the government has intervened to prevent (actually postpone) the necessary adjustment."
http://moslereconomics.com/contact/
So the MMT counter-arguments basically appear to be:
1.The problem you describe isn't as bad as you think or doesn't even exist in most cases.
2.Central Banks can use foreign reserves or currency swaps to intervene in fx markets (and also capital controls), but there is no real reason why the Treasury should have to start borrowing in foreign currency.
3.Proper regulation of banks can avoid them taking on too much risk and minimise the possible risks you describe.
3.If, despite all the regulation and structural reforms advocated by MMTers banks still get screwed in fx markets, then they and their creditors/debtors have to pay the price. Domestic deposits denominated in domestic currency can be guaranteed by the government. Banks have to be allowed to fail under certain conditions.
- I'd also add that govt borrowing in a foreign currency need not necessarily be as bad or as ruinous as you imply in your blog. Mexico chose to ask the IMF for a credit line, and this may have helped to stabilise the situation there. But the 'loan' from the IMF came without strings attached and apparently poses no repayment problems for Mexico. Their economy has improved since then and there appears to be no 'forced debt restructuring' on the horizon for them. The credit line was a temporary arrangement in extreme circumstances (global financial crisis). Mexico did not suddenly become irreversibly dependent on foreign borrowing as a result of it. They continue to deal in Pesos as before.
The same goes for all those countries that took part in the Fed's currency swap lines.
ESM had this to say on that subject:
"I suppose the Mexican authorities felt it was worth getting below market interest loans in dollars in exchange for mouthing sweet nothings in the ears of IMF officials. All other things being equal, such loans subsidize the terms of trade for Mexican residents.
Actually, one thing I do remember is that the Mexican government was very aggressive (and savvy) about buying back their own dollar- and euro-denominated debt. So perhaps they liked the idea of having a free credit line to do a little debt arbitrage when and if the $hit hit the fan."
y,
Thanks for at least giving some thought on what I was saying.
But ESM's comment doesn't say much. The fx market reaches equilibrium in his points. However with a deficit in the current account implying that the stocks of debt rising relative to gdp, there is hardly any "equilibrium".
"But that’s a separate issue from importing and exporting."
Unfortunately it's not. Just like the the discussion above, there is a general tendency to see this as if it doesn't matter at all. Most of trading in fx markets is dealers reacting to trade flows and hence we see such high turnovers. But the initial trade flow is nonetheless important.
"As long as the fx market is free, the rate will be in equilibrium at all times between buyers and sellers of the baht/yen cross."
Obviously same old Neoclassical equilibrium theory.
"And in any case, the likelihood of a panic depreciation is much greater if the government has intervened to prevent (actually postpone) the necessary adjustment."
Again the typical economist like stand - although he may not be an economist. All government actions make thing worse - create false expectations and all that. Same old Monetarist-like.
Now to your points which are much more thoughtful and less dismissive ....
While there is no debt restructuring in the horizon, the attitude "there can be no default" can create misleading implications. The reason is that fiscal policy and trade imbalances are tightly connected. They are connected via an accounting identity and hence likely to be connected via behavioural relationships and it is the case. A fiscal expansion brings in spillovers in trade imbalances via higher imports because of higher domestic demand created. Everything is interconnected. It's misleading to say that the only constraint is the production capacity (and tolerance for inflation).
Also when a government asks the IMF for help, it comes and writes their budgets. There is a definite reason for this. Curbing domestic demand improves the external situation but the huge flip side is that it comes with more unemployment!
You say that regulations can help which of course is true - but the underlying point of mine is that no regulation can prevent the more deeper problem. It's easy to say let banks fail but it doesn't solve the underlying problem at all - the trade deficit.
Also, about foreign reserves: they are limited. So on the one hand you agree that foreign reserves are useful but on the other hand you say there is no need to borrow. Unfortunately when the central bank starts losing foreign reserves - it has to get more of it and the route is more borrowing in foreign currency. Both sales of foreign reserves and borrowing are accommodative items in the balance of payments.
You cannot beat double entry book-keeping. If a nation is a debtor nation (as per its NIIP) and which arises due to current account imbalances - mainly - it has limited choices. Fiscal policy cannot solve this problem by itself.
If things were as easy as ESM says, central banks wouldn't have foreign reserves at all.
y,
Thanks for at least giving some thought on what I was saying.
But ESM's comment doesn't say much. The fx market reaches equilibrium in his points. However with a deficit in the current account implying that the stocks of debt rising relative to gdp, there is hardly any "equilibrium".
"But that’s a separate issue from importing and exporting."
Unfortunately it's not. Just like the the discussion above, there is a general tendency to see this as if it doesn't matter at all. Most of trading in fx markets is dealers reacting to trade flows and hence we see such high turnovers. But the initial trade flow is nonetheless important.
"As long as the fx market is free, the rate will be in equilibrium at all times between buyers and sellers of the baht/yen cross."
Obviously same old Neoclassical equilibrium theory.
"And in any case, the likelihood of a panic depreciation is much greater if the government has intervened to prevent (actually postpone) the necessary adjustment."
Again the typical economist like stand - although he may not be an economist. All government actions make thing worse - create false expectations and all that. Same old Monetarist-like.
Now to your points which are much more thoughtful and less dismissive ....
While there is no debt restructuring in the horizon, the attitude "there can be no default" can create misleading implications. The reason is that fiscal policy and trade imbalances are tightly connected. They are connected via an accounting identity and hence likely to be connected via behavioural relationships and it is the case. A fiscal expansion brings in spillovers in trade imbalances via higher imports because of higher domestic demand created. Everything is interconnected. It's misleading to say that the only constraint is the production capacity (and tolerance for inflation).
Also when a government asks the IMF for help, it comes and writes their budgets. There is a definite reason for this. Curbing domestic demand improves the external situation but the huge flip side is that it comes with more unemployment!
You say that regulations can help which of course is true - but the underlying point of mine is that no regulation can prevent the more deeper problem. It's easy to say let banks fail but it doesn't solve the underlying problem at all - the trade deficit.
Also, about foreign reserves: they are limited. So on the one hand you agree that foreign reserves are useful but on the other hand you say there is no need to borrow. Unfortunately when the central bank starts losing foreign reserves - it has to get more of it and the route is more borrowing in foreign currency. Both sales of foreign reserves and borrowing are accommodative items in the balance of payments.
You cannot beat double entry book-keeping. If a nation is a debtor nation (as per its NIIP) and which arises due to current account imbalances - mainly - it has limited choices. Fiscal policy cannot solve this problem by itself.
If things were as easy as ESM says, central banks wouldn't have foreign reserves at all.
Plus whatever arbitrage he is talking of, the fact remains Mexico went through a crisis in the external sector.
Damn blogspot doesn't let me comment.
I just fished i tout of spam. I don't know why the filter doesn't learn that you are an approved commenter.
Maybe try another browser? Stats show that Firefox is most used and then Chrome.
Tom,
Thanks.
Strange actually but I think Blogspot in general has an issue with this. I will try Firefox from the next time.
Yes, I have run into issues commenting on other Blogspot sites using Chrome, which is strange since Google owns both. Sometimes I was able to resolve the issue using another browser and sometimes not.
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