Tuesday, May 8, 2018

Bill Mitchell — Trade and external finance mysteries

I have received many E-mails and direct twitter messages overnight and today following the ‘debate’ on Real Progressives yesterday, where trade issues and related financial transactions were discussed. I saw that section of the debate (after the fact) and concluded that only one of the guests knew what happened when nations exported and imported. But it appears that readers of this blog who listened to the debate were confused by what they heard. So, today, by request, I aim to clarify a few of these issues.
They are in fact fairly simple to understand once you trace through the transactions carefully, so it is a surprise that basic errors were expressed in the ‘debate’. So here is the way Modern Monetary Theory (MMT) helps you understand trade transactions.
There appears to be a lot of confusion about the external economy in a fiat monetary system. Many economists do not fully understand how to interpret the balance of payments in a fiat monetary system.
So it is no surprise that the general public struggles in this domain...
If you don't read billyblog regularly, this is one you probably should. Also see Neil Wilson's comments.

Bill Mitchell – billy blog
Trade and external finance mysteries
Bill Mitchell | Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at University of Newcastle, NSW, Australia

27 comments:

Matt Franko said...

“ concluded that only one of the guests knew what happened when nations exported and imported.”

Who were these people and who was the one that didn’t know?

Konrad said...

FROM THE ARTICLE: “The reality is that a nation facing a lack of ability to purchase imports, for whatever reason, has to either increase its exports or reduce its imports.”

Not necessarily. The USA has the world’s largest trade deficit by far, yet this is no problem for the US government, since the US government creates its spending money (dollars) out of thin air, and those dollars are accepted worldwide.

If the USA had a trade deficit, and if U.S. dollars were not accepted worldwide, then the USA would have severe economic difficulties, which would become even worse if the US government could not create its spending money out of thin air. The USA would be like France and Greece, which are caught in a spiral of ever-worsening debt and austerity, since those nations have trade deficits, and those governments cannot create their spending money out of thin air.

Reader Neil Wilson writes, “In a floating rate system central banks don’t need foreign currency reserves.”

Wilson means that a bank does not necessarily need foreign currency to engage in forex trading.

Other than that, however a central bank does indeed need foreign currency if the nation’s domestic currency is not accepted outside the nation’s borders.

Andrew Anderson said...

I disagree that trade deficits are good since they can hollow out a country's productive capability.

Nor are they fair to those who depend on wages to survive, unlike rich asset owners who don't.

Moreover, trade deficits are encouraged by positive yields on the inherently risk-free debt of a monetary sovereign. But risk-free assets should return at most 0% to avoid welfare proportional to account balance.

Joe said...

I was disappointed to see Steve Keen like that. Normally he's excellent, but some of his ideas seemed strange to me, since I think Warren was technically correct on everything. Unfortunately, Warren's internet connection was shit and a skype conversation wasn't exactly the best format. I would love to see these two discuss the same stuff but in the same room, with a whiteboard drawing T-accounts and Keen's Minsky program running so they could clearly demonstrate why they think the way they do.

Keen does bring an interesting point about persistent trade deficits. Warren is correct in the narrow sense that it's better to receive than give, but Keen's point was it is possible that trade deficits have real costs by undermining the nation's domestic productive capacity (why invest if you can just get shit for free from the trade deficit?). But his point about foreign claim resulting in foreign ownership of domestic assets and the resulting flow of profit back to the foreign owner is just one possible scenario among many... again Warren's correct, it's the incompetence of policy makers is what really causes the problems, not the trade deficit per se.

I have no idea what Keen was talking about with the trade deficit resulting in money creation. Was he referring to something like what China does: Chinese exporter receives US dollars and the Chinese central bank creates equivalent yuan to give to the exporter? (I think that's how Warren said the Chinese do it, but again, that's just one possible scenario)

Tom Hickey said...

Was he referring to something like what China does: Chinese exporter receives US dollars and the Chinese central bank creates equivalent yuan to give to the exporter? (I think that's how Warren said the Chinese do it, but again, that's just one possible scenario)

At one time this was the case, but I heard that China was relaxing this.

Chinese exporting firms were not permitted to hold foreign currency accounts in a foreign country. In the US, the $ were held by the PBOC and yuan issued to the firms in bank accounts in China. This increased M1 in China. The PBOC held the $ in US tsys at the Fed to earn the interest.

IIRC, China loosened this requirement so that at least some firms could hold funds externally in the local currency, but I don't recall the details.

Matt Franko said...

“I would love to see these two discuss the same stuff but in the same room, with a whiteboard drawing T-accounts“

LOL that does not seem to be the way the academe works now does it...

That’s the way that FIRMS work... but not the academe...

Matt Franko said...

“it's better to receive than give”

Not to the producers in society...

Matt Franko said...

So the two people were Warren and Keen and Keen didn’t know what was going on?

Oh this is rich.... this is awesome right here...

So now how can you guys keep blaming this on your big “neoliberal conspiracy!” when as shown here Keen doesn’t even understand the accounting????

This is checkmate I have you guys in for like the umpteenth time!!!! Helloooo!!!!!

Tom Hickey said...

Steve Keen and Scott Fullwiler did get together in front of a blackboard one time. Keen changed his mind on some things, IIRC.

Andrew Anderson said...

It's hardly news that a major lack in most economists' education is accounting. Otherwise, they would understand that banks create purchasing power when they make a loan.

But I'd bet it's easier for someone who knows differential equations to learn accounting than vice versa.

Tom Hickey said...

The problem is that the time it takes to learn mathematical economics doesn't leave a lot of room for anything else.

Basic accounting may be simple, but when different institutional arrangements are added, it becomes highly complicated. And institutional arrangements constantly change, so it is necessary to keep up.

The question is really how to allocate time.

Matt Franko said...

If Keen doesn’t get how is Larry Kudlow (Art degree in History, Princeton) going to get it????

I know I know.... “neoliberal conspiracy!!!!”...

Andrew Anderson said...

The question is really how to allocate time. Tom Hickey

And it takes a strong stomach too when one realizes how crooked banking is.

djrichard said...

I tried to post this over at Bill Mitchell's site, but it got flagged as spam, so posting this here instead. Breaking it in two to make the 4096 character limit.

As deep throat said, "follow the money". So China buys our currency by sending us goods and services. And they only repatriate some of that into goods and services from the US. What's happening to the rest of our currency?

- Some of it is from US corporations operating in China, buying the US dollar in order to repatriate their profits (profits they made in China in yuan): https://www.bloomberg.com/view/articles/2018-04-17/u-s-trade-deficit-does-not-reflect-subsidiaries-in-china "Overall, China subsidiaries of U.S. companies sold $223 billion of stuff in 2015, reckons Deutsche Bank AG." That $223B is revenue rather than profit. But still, a chunk of that would be profit which would be repatriated back to the US.

- Another "buyer" of the US dollar in exchange for yuan would be banks and institutions doing dollar-based financing in China. Here's BIS numbers on debt in China: http://stats.bis.org/statx/srs/table/C3?c=CN&p=20174&m= Suggests $820B debt denominated in USD (contrast to $10.1T debt denominated in yuan). I don't think a lot of that debt gets converted to yuan, so the debt in and of itself doesn't have an impact on demand for dollars in exchange for yuan. But the interest to be paid on that debt needs to come from somewhere. Some of it could be by competing for dollars injected into this dollar-based economy over there from new debt issuance denominated in dollars (which is increasing from year to year). And the rest of it would be simply by buying dollars using yuan.

- But my guess is that the above doesn't account for the majority of demand for US dollar in exchange for yuan. I'm guessing a majority of the surplus US dollars in China are used for acquisition of assets in the US. The PBoC was previously doing the heavy lifting in this regard, in their case printing yuan to acquire dollars (to keep the peg) and then using those dollars to buy treasuries. But the PBoC is mostly out of that business, able to pass the baton over to "market forces" which seem to be doing a good job of keeping the peg where the PBoC wants it. If we look at Japan, they've purchased $3T more in assets in the US than the US has bought in Japan over the last 15 years. See http://data.imf.org/?sk=d87ea63d-f2db-4dc3-a2b5-295ef18a671f vs http://data.imf.org/?sk=a386138e-ffa6-4830-b8e6-9d0344d99e19 The IMF numbers give some visibility on who the players are. But the IMF numbers don't show China doing the same. Indeed the IMF numbers don't even show the PBoC's current stock of US treasuries. So something is off there.

djrichard said...

On that last point, assuming there are market players in China that are buying assets in the US, the question is why? If the mind-set was that the holding of US assets is just temporary, a place to park surplus wealth, is the implication that this would be unwound in the future, so they would repatriate their wealth back to their native countries in their native currency? If so, their currency pegs would "invert" so to speak. In which case, their countries would likely have to run trade deficits to make up the difference.

But given the US dollar is the petrocurrency, they could easily repatriate wealth in the US dollar for future transactions in oil without impacting their pegs to the US dollar at all. In which case, it's a store of value which doubles as a hedge against a future where dollar liquidity in particular for liquidity of oil needs to be hedged. Which makes sense if you're a government operator. But if you're a private enterprise, is this this the best use of your surplus? No, but who's to say that the dollar liquidity has to be used for future transactions in oil. It could be used for any type of transaction under the sun, as long as both parties are willing to settle in dollars. Or cut to the chase, as long as both parties are willing to settle in US bonds. Kind of like parties used to do with gold.

So my speculative guess is that US bonds are acting as the new gold. Before Nixon took the world off the gold-interexchange standard, gold was the gold (so to speak): trade imbalances were settled in gold. So what serves as the alternative nowadays? I suggest it's US bonds. And gov bonds in other countries that run perpetual trade deficits as well (e.g. gilts in England). But primarily US bonds - with the US dollar as the petro currency, it requires the US to run a trade deficit to equip other nations with the currency they need to purchase oil. And all that US currency needs to be repatriated and parked into something. US bonds are the perfect receptacle.

Related to this theme is thinking that this could be displaced by a cryptocurrency, e.g. see http://www.coppolacomment.com/2018/04/the-bitcoin-standard-critical-review.html . The thinking being that a cryptocurrency could be the new digital/virtual gold for accumulating trade surpluses. I'm not convinced that that hangs together. Maybe it does if oil transactions are done in that same cryptocurrency? Dots need to be connected on that.

Matt Franko said...

“But still, a chunk of that would be profit which would be repatriated back to the US.”

No it doesn’t how do you think Ireland has over $300b of US treasury bonds?

What do you think the Trump tax reform bill was all about????

Ryan Harris said...

You have to get the economists to specify who the "we" is when they talk about "real benefits" and "nominal benefits" and to whom those accrue. MMT is kind of chunky in it's analysis of the "non-government" sector and even the more granular "external" sector.

Who winds up with the nominal costs and benefits? Who gets jobs and factories and who loses jobs and factories, or is all labor fungible? Walmart job, JG Job, Economist and factory worker interchangeable and no opportunity cost between them? I'm sure Bill would be just as happy to have the nominal benefit and real opportunity of working at Woolworths as he gets from being an economist? Or do we just let exporters government's or market invisible hands decide which professions the winner takes all?

The mathematically indisputable quickly crumbles when you take away the fragile framing. Refuse to cooperate with their "real" and "nominal" framing and relentlessly force the economists to specify who their pronouns refer to, are they talking about averages, aggregates or what? If so, force them to talk about deviations and distributions.

The economists mean well, they're just challenged when it comes to thinking outside their models that they've regurgitated and puked out onto society over the years.

djrichard said...

“But still, a chunk of that would be profit which would be repatriated back to the US.”

"No it doesn’t how do you think Ireland has over $300b of US treasury bonds?"

It's not like we saw a sudden spike in demand for the US dollar because of repatriation tax law changing recently. The exchange of euros by (let's say Apple in Ireland) for US dollars has been steadily happening in the background all along, regardless of the tax law. In fact, I would suggest that Apple and the other US corporations in Ireland were "fitting" their demand for US dollars, smoothing it out over time, to help the peg of the euro to the dollar to stay stable. And once they had dollars in hand, Apple of Ireland used immediately flipped that to buy US bonds and parked it in some account which was chinese walled from their US operation. Hence the $300b or so that US-based corporations in Ireland parked in US treasury bonds. When the tax law changed, presto chango, the chinese wall was lifted and the bonds moved from one account to another. And taxes paid.

GLH said...

"First, there was a denial that exports are a cost and imports are a benefit. That should be undeniable.

For an economy as a whole, imports represent a real benefit while exports are a real cost.

Exports mean that we have to give something real to foreigners that we could use ourselves – that is obviously an opportunity cost.

Imports represent foreigners giving us something real that they could use themselves but which we benefit from having. The opportunity cost is all theirs!"

I am not an economist but I disagree completely. If this statement were true then every country that imported would be rich and every country that exported would be poor. It is only true if you are considering raw materials. If you consider food and manufacture then it is completely wrong. In those cases an importer is exporting jobs, skills, and capital whereas an exporter is exporting excess production. Short term imports of agriculture and manufacture may be a benefit but long term,, I don't see it.

Matt Franko said...

“And taxes paid.“

They have not been paid there is no record in the Treasury Statements... and the TIC data still has the balances in Ireland:

http://ticdata.treasury.gov/Publish/mfh.txt

Iirc the tax law gives them 7 years to pay the taxes but the new liabilities ($250b) have been accrued at the firms as of Jan 1...

“the peg of the euro to the dollar”

The EUR/USD is not fixed FX it is floating FX... ?????

Matt Franko said...

“there are market players in China that are buying assets in the US, the question is why?”

Because they are hackers by nature and seek to steal the IP of the acquired firms...

Eg They were having trouble increasing the pork processing rates at their national pork firms and couldn’t figure it out so they bought Smithfield Foods and as I understand it, now Smithfield is transferring their technologies into new Smithfield processing plants in mainland China ... so China gets the boost in real domestic output now....

It accelerates China’s domestic technological development ....

djrichard said...

"Because they are hackers by nature and seek to steal the IP of the acquired firms..."

I think corporate assets accounts for only a small part of their asset purchases in the US.

I think they're doing what Japan is doing, buying bonds and stocks in the US. Over the last 15 years, Japan has purchased $13T of stocks and bonds in the US, while the US has only purchases $10T in stocks and bonds in Japan, making a net $3T position of Japan in the US.

Andrew Anderson said...
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Andrew Anderson said...

[my apologies for the multiple attempts to post this; I neglected to use the "Preview feature"]

Yves Smith, in effect, calls equal protection under the law wrt to money "balmy" but offers this lame remedy instead, ignoring that while the government-privileged usury cartel CREATES new purchasing power, the rest of us can only lend EXISTING purchasing power. Therefore, in aggregate, the more so-called creditworthy, typically white, have and continue to loot the less so-called creditworthy, typically non-white via price inflation and/or stolen investment opportunity.

The article below focuses on a different issue, namely, how black Canadians are excluded from banking services, and it also points out how the usual pet remedy, credit unions, aren’t much help. It discusses how various forms of mutual help financial organizations have been serving the needs of minority and disadvantaged groups. Americans might consider giving some of these approaches a road test. from Can Canada’s Mutual Help Financial Organizations for Disenfranchised Blacks Serve as a Model for the Un and Underbanked in the US?

Calgacus said...

GLH: "First, there was a denial that exports are a cost and imports are a benefit. That should be undeniable.

One has to understood how this is meant. It is obviously, tautologically, true by definition, if one is trying to not speak in a weird way. There would be no need to say it except that people generalize and specialize statements successively but don't follow or perform the logic correctly. Because they are afraid to look stupid by going over every stupid little baby step - but they end up talking nonsense. MMT and Functional Finance is all about "not talking nonsense."

If this statement were true then every country that imported would be rich and every country that exported would be poor.

This is true if the importing country pays nothing for the imports and exporting countries get nothing for the imports- usually called "stealing". That is the function of money/credit/debt when one is not just grabbing - to have something to "export" - the money/credit/debt, when one is importing. etc. In the real world imports are (almost) always matched by a financial "export" - so "imbalance, what imbalance?"

In those cases an importer is exporting jobs, skills, and capital whereas an exporter is exporting excess production. Short term imports of agriculture and manufacture may be a benefit but long term, I don't see it.
Sure, but the "exporting jobs & skills" is a different thing from the "importing excess production". It is not logical to blame the first on the second. Or call the "not exporting jobs & skills" - evil "government intervention". Of course much depends on (a) the aggregate net effect of trade deficits & their deflationary effects and (b) the importance of the particular jobs and skills and capacity. Functional finance and the job guarantee handle (a).

On (b) some things, video games say, well who cares? Others, like agriculture, the ability to feed yourself - I am very conservative on. I'm rather more insouciant about exchange rates and capital controls and whatever on the foreign front than Bill Mitchell - but he is imho too insouciant about national food self-sufficiency, which for all the development and increasing wealth of many countries, even many on the bottom, has been declining in too many places.