Jesse — The Great Fallacy at the Heart of Modern Monetary Theory

But here is the matter of disputation, emphasis in caps theirs, in italics mine. "The sovereign government cannot become insolvent in its own currency; it can always make all payments as they come due in its own currency because it is the ISSUER of the currency, not simply the USER."

Do you see what is missing here, and more importantly, what is implied?

What is missing is the acknowledgement that the users of a currency, call them 'the market,' can and will and have quite often throughout history questioned the valuation of a currency, and often to the point of practical worthlessness, if certain actions are taken by the sovereign in creating their currency.
This speaks to a principle that I spelled out some time ago, that the practical limit on a sovereign government in printing money is the willingness of the market toaccept it at a certain value. And this applies to any sovereign, more readily perhaps if they are smaller and weaker, but always given time nonetheless.

If Russia, for example, were to merely start printing more rubles and set a target valuation for them, they could enforce this internally. And in fact, many sovereigns have done so throughout history. I remember visiting Moscow shortly after the fall of the Soviet Union, and marveling at the disconnect between the official stated valuations and the actions of the ordinary people in seeking alternatives like the US Dollar, gold, diamonds, and even Western style toilet paper, a more useful sort of paper than the ruble…

Jesse mistakes insolvency for currency depreciation. They are not the same. Conflating them is a common error. Insolvency can result in currency depreciaton as savers shun the currency, but insolvency is not the only cause of depreciation. Instability is also a chief cause. This might be political instability, inflation, or falling fx rate as foreigners  reduce saving desire in the currency. for whatever reason.

A currency sovereign is not constrained operationally by insolvency although a currency sovereign may chose voluntarily to default, as Russia did in 1998. But this is a political choice, just as would defaulting on the US public debt owing to the voluntary political imposition of a debt ceiling.

Currency depreciation can occur for many reasons, some that are potentially under the government's control or ability to influence, and some not, such as capital destruction in wartime that reduces the potential of the economy, or the changing condition of the world economy that has led to the depreciation of the currencies of countries lacking broad and deep economies that are significantlly dependent on oil exports.

Insolvency is defined as the inability to meet financial obligations as they come due. The government of a nation that is sovereign in its currency and does not borrow in a a currency that it does not control cannot become insolvency. Balance of payments issues may arise but they affect domestic firms and the government itself unless it is liable for the debts of domestic firms. Clearly, a country that issues it own currency and floats the exchange rate cannot become insolvent in this sense, although the fx rate can plunge or inflation can ensue from imprudent policy thereby debasing the currency to the degree that there is currency flight. This, however, is not insolvency.

MMT economists claim that insolvency is not an operational constraint on a currency sovereign but both the foreign exchange rate and domestic price level are operational constraints that governments must take into consideration. For example, petroleum exporters Russia and Venezuela are both adversely affected by steeply falling oil price to the degree that their fx rates are plunging and inflation rate rising, provoking currency flight as holders of the currency no longer wish to save in these currencies. This is entirely consistent with MMT analysis. MMT also observes that a falling fx rate is self-correcting to the degree that the balance of trade shift toward exports.

However, this would not greatly aid emerging countries without broad and deep economies that dependent on exporting a commodity whole value is falling. For example, Venezuela would likely be affected by a collapsing oil price than Russia, whose economy is much broader and deeper than Venezuela's. Indeed, as President Putin has observed, the fall in oil prices is a blessing in disguise since Russia has known for a decade at least that the economy is to tilted toward export of natural resources and needs to be broadened and deepened further by recapturing lost industrial potential and expanding its domestic consumer economy.

MMT also shows how a country can use currency sovereignty to address such issues. For example, Russia was pegging its currency to the USD, threatening a run on its foreign exchange reserves, so it correctly chose to drop the peg and float the ruble. This gives the central bank some leeway in curbing speculation by intervening on occasion to drive up the cost of speculation by squeezing the shorts. The ruble also gained strength at tax time when Russian exporters had to purchase rubles to pay Russian taxes that are only payable in rubles. The firms therefore sold foreign currency obtained through trade in order to meet their tax obligation. As MMT says, taxes drive a currency by creating demand for it.

Furthermore, as Warren Mosler has pointed out, governments control the own rate in setting the policy rate and controlling the yield curve if they choose by setting price and purchasing the quantity necessary to set those yields. Government also influence the price level through the prices they pay in markets, using their currency to transfer resources owned by nongovernment for the public purpose. And as the Great Depression and the aftermath of the recent crisis has shown, government has powerful tools that can be used to address emergencies through both the central bank and fiscal policy.

Then Jesse reveals his ideological concern.

Technically Russia could not become insolvent in rubles, because they could always print more of them to pay all their debts, make purchases, and salary payments. The great caveat in this is that Russia had to maintain a measure of control and enforcement to make that principle 'stick.'

And this is what probably makes MMT inadvertently statist, and dangerous. That is because this belief only works within a domain in which the state exercises complete control over valuation.

So is the "fatal flaw" in MMT that is is too "Keynesian" and not Austrian enough?  :)

I suppose that there are many other things in MMT that are correct, as it seems to be quite the usual thing in many ways, but there is an important exception in the assertion that the state has no limit to its power to set value, because that is exactly what is implied in the canard that a sovereign cannot default in its own currency. Technically it cannot because it can always print more than enough pay off debts and make more purchases. But it can create money in such a way as to break the confidence of the market, and call its valuation into question. And this is a de facto default.

De facto default in the typical Austrian rejoinder to what Austrians see as too much government control and currency profligacy. The error of this is pointed out above. MMT readily admits that there are operational constraints on a currency sovereign but insolvency and forced default are not among them. They are rather the availability of real resources and currency stability, which involves both the price level and fx rate.

Moreover, not all currency instability is the result of "debasement," as some seem to think. The West, President Obama and Prime Minister Cameron, for instance, have stated or strongly implied that the sanctions directed at Russia are design to destabilize the economy and as a consequence the political situation in Russia, with a few to regime change, just as in Cuba and Iran and now Venezuela also. This is intentional application of force majeure that is sufficient legal reason not to honor debts.

Jesse's Café Américain
The Great Fallacy at the Heart of Modern Monetary Theory

Jesse