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Tuesday, May 22, 2012
Ramanan disputes Warren Mosler on capital flight
Ramanan presents a short argument, if you are interested in this.
Ramanan seems to think that as soon as the currency depreciates, the central bank has to intervene in fx markets and use up its foreign reserves.
All this stuff about banks immediately collapsing as the result of a large currency depreciation - is there any evidence of this ever actually happening?
Krugman mentions (in a post below) a sharp depreciation of the franc - did this result in bank collapses and economic chaos?
"You refer to this a lot Paul, but I'm not sure exactly what you mean."
From Wikipedia…
"In thermodynamics, a closed system can exchange energy (as heat or work), but not matter, with its surroundings. In contrast, an isolated system cannot exchange any of heat, work, or matter with the surroundings, while an open system can exchange all of heat, work and matter.
For a simple system, with only one type of particle (atom or molecule), a closed system amounts to a constant number of particles.
However, for systems which are undergoing a chemical reaction, there may be all sorts of molecules being generated and destroyed by the reaction process. In this case, the fact that the system is closed is expressed by stating that the total number of each elemental atom is conserved, no matter what kind of molecule it may be a part of."
How is this relevant to economics?
Consider a monetary system of dollars and dollar-denominated financial assets as the definition of the closed system, where ever they may be in the world.
Without some injection or leakage external to the system, the quantity of dollars and dollar-denominated assets CANNOT change. It is mathematically impossible.
Any claim that violates this principle cannot be true.
If a NET increase in profits is reported through the sum of all balance sheets in the system, an equal amount of dollars HAS to have been either net-spent into the system by the government or has to be returned to the system through a trade surplus.
Credit cannot provide those dollars because credit nets to zero on balance sheets.
If the goal is positive economic growth that can be measured in nominal dollars, that growth cannot occur without an injection from outside the system.
"If a NET increase in profits is reported through the sum of all balance sheets in the system, an equal amount of dollars HAS to have been either net-spent into the system by the government or has to be returned to the system through a trade surplus."
Not sure how you mean net here but couldnt an increase in the price of something (like a stock or a house) lead to an increase in reported profits. A rising stock market might cause the asset side of your balance sheet to look larger and could be reported as increased profit could it not? This doesnt mean you have actually been paid that price yet but a stock that has tripled in price can be accounted for as an increased profit can it not.
I know that in 2008 everyone in my department thought they had lost a lot of money in their 401K accts when the market tanked. Their "profits" had fallen. I imagine a lot of banks and investment firms suffered the same fate. I sold before the crash and actually had the dollars and realized my profit. Many people (monetarists it seems) think a stock worth a 1000$ and a 1000$ bill are virtually the same thing on a balance sheet.
"Credit cannot provide those dollars because credit nets to zero on balance sheets."
I agree with this
"If the goal is positive economic growth that can be measured in nominal dollars, that growth cannot occur without an injection from outside the system."
Seems that all Warren is saying is that the whole banking system is completely interconnected and while dollars may change the names associated with them and even change the numeraire attached to them (when converted to say Euros) they dont actually go anywhere or flee. This doesnt mean that a mass conversion of dollars to Euros will be inconsequential, far from it, but there is a limit to how far it will go.
"a stock that has tripled in price can be accounted for as an increased profit can it not."
I do not believe so. Only if you sell it, it is then treated as a capital gain (income).
Also, the banking system has to provide settlement balances for you to sell the shares to someone. That person has to have possessed the USD balances prior to buying your shares which had to have come from the govt in the first place.
One way I sometimes look at it: Bill Gates may have $10B in shares of MSFT but he cannot ever convert those shares into USD NFAs unless those USD NFAs are already in the non-govt sector in the possession of non-govt entities.
Until the stock is monetized by a sales transaction the increase is on paper only and has no effect on the quantity of NFA's in the system. That gain will not affect the holders net cash balance (dollar assets less dollar liabilities).
Once the sale takes place cash increases on the seller's balance sheet and decreases on the buyers balance sheet (unless it's a trade transaction, in which case the gain isn't monetized).
So far, the quantity of NFA's (talking about cash here) still hasn't changed. It is only a transfer.
There can only be a net increase in NFA's on balance sheets if the government net spends into the economy, otherwise every gain must be offset by another agent's decrease in it's cash balance.
Net gains in NFA's (cash) in the aggregate can only be monetized by money creation (not credit).
The nice thing about the closed system principle, once you are aware of it and the infallibility of it, there is no need to go down rabbit holes trying follow arguments through a maze that purports to prove that something can be created out of nothing if we just make it complicated enough.
Greg,
"Not sure how you mean net here…"
At any given moment there is some quantity x dollars in the system (non-government) and some quantity y liabilities, and x+y > 0 (dollars plus dollar liabilities is greater than zero). There is net cash in the system (NFA's are cash or cash equivalents).
The net is that amount greater than zero. It can't be changed from within the system. Increasing credit will add ∆x + ∆y to the system. ∆x = -∆y, so the net change is zero.
Private entities are forbidden from creating dollars (it's called counterfeiting).
If the sum of cash positions on all balance sheets in the system is higher than the previous budget year that is a net increase.
All I was saying is it's possible for both government and domestic private sector to reduce their debt levels (and as we know many people want them to) if the country exports more relative to its imports. It's wrong to say the private sector can only reduce its debt if the government increases its deficit.
Personally I don't see the point of saying that the governemnt doesn't have a debt. Ok, it can always produce the dollars needed to pay it off, but it's still a 'debt' (money owed to certain people, to be paid by certain dates).
"Rightwingers think this can be done by introducing supply side changes, slashing wages and regulation."
Actually, their argument is that this will increase real assets not financial assets. The financial system is a closed system, which is why the identities work, but real assets can be increased by investment of bank money, which cannot increase financial assets, since it nets to zero.
This is the essence of the neoliberal argument: deregulate and reduce wages and real assets (growth) will ensue through private investment, part of which is debt-based through the financial sector.
It's not a stupid argument. The problem with it is that leads to all the problems resulting from laissez-faire capitalism historically, which they either deny or ignore.
Free market capitalism makes for a good story, but the social, political and economic premises on which it rests are flawed, so that the outcome is concealed or misrepresented.
When the inevitable happens, then the response is either that is was the result of exogenous shock that could not be anticipated and prevented, or else that free market capitalism was not actually allowed to work, e.g., the failure resulted from govt intervening in some way.
Neoliberalism claims to be based on economics as a science, but the theory cannot be tested because failure of hypotheses can always be accounted for by some explanation that the theory permits.
In other words, it's BS and the "science" is just propaganda for an ideology that distributes income and wealth to the top by extracting it from the bottom largely by means of economic rent, especially private debt.
"It's wrong to say the private sector can only reduce its debt if the government increases its deficit…"
Not really.
A reversal in a current account balance - for us running a surplus is contingent upon balances that were accumulated by the foreign entity through prior deficits.
It's a timing issue. The government created the deficit in prior years which only now (under surplus) is coming back to monetize gains in the domestic non-government.
In the case where there is no prior balance the government must still create the dollars and exchange them for the foreign currency before the foreign entity can buy our products.
This is still raw money creation. To say this isn't a deficit from our point of view is a distinction without a difference. It is no different than if the government spent the money directly into the economy, except the government holds foreign currency instead of US Treasuries.
At any rate, I'm mainly trying to point out the implications of closed-system arithmetic and how powerful such a simple concept is.
Although credit can facilitate growth in real or paper wealth, that wealth can't be realized in nominal terms unless the government follows through and prints the money. A few agents can cash in and get their gains, which ends up coming from another agent - it's a transfer.
If enough agents tried to cash in at the same time the system would freeze up. Kind of like your home electrical panel would do if you tried to load all or even most of the circuits at once.
Actually, a home electrical distribution system is a very good model for our monetary system in math terms.
When all of the baby boomers begin to cash in their retirement funds we may witness such an event if the government hasn't created enough dollars to cover the payments.
We will then hear the cries of "We're broke. We can't afford to make these payments".
paul: "Although credit can facilitate growth in real or paper wealth, that wealth can't be realized in nominal terms unless the government follows through and prints the money. A few agents can cash in and get their gains, which ends up coming from another agent - it's a transfer. If enough agents tried to cash in at the same time the system would freeze up. Kind of like your home electrical panel would do if you tried to load all or even most of the circuits at once."
Right, only wealth that is realized through asset sales (cashing out) is financial. Most really wealth people are wealthy in terms of claims on real assets, like equity share.
But is the equity capitalization realistic when figured on the based of marginal price of shares. What would be the marginal price of a share if owners decided to just cash out and dropped their shares into the market?
"But is the equity capitalization realistic when figured on the based of marginal price of shares. What would be the marginal price of a share if owners decided to just cash out and dropped their shares into the market?"
Tom, my brain doesn't parse this very well so I'm not sure what you are asking.
If I understand at all, it seems like the value of shares for the agents that are slow cashing out would get caught as the value of their shares would evaporate.
"A reversal in a current account balance - for us running a surplus is contingent upon balances that were accumulated by the foreign entity through prior deficits."
Right, changes in the capital-current account do not create NFA but only shift them around within a period. That is, fluctuations in the flow from external to domestic and vice versa change the composition of the stock of NFA, but the amount of the stock remains the same unless govt adds to it through injection (deficit spending) or decreases it through withdrawal (taxation).
The way I defined the closed system in the beginning of my example was…
…"Consider a monetary system of dollars and dollar-denominated financial assets as the definition of the closed system, where ever they may be in the world"
This eliminates the current account argument for this case. The current account doesn't exist.
paul, " If I understand at all, it seems like the value of shares for the agents that are slow cashing out would get caught as the value of their shares would evaporate. Kind of like the GFC."
Right, so what does it really mean to say that the market cap of X company is Y. Is that actually realizable on cash out?
Right, let a person with ERISA account convert that to some sort of govt guaranteed public pension.
Perhaps just as a transition to a much more robust permanent public retirement pension scheme.
As the next generation will not have near the ERISA assets that this generation has (they will be in China's possession as current retirees never had China and India to deal with like those working now do).
"Rightwingers think this can be done by introducing supply side changes, slashing wages and regulation."
Tom: "Actually, their argument is that this will increase real assets not financial assets"
Yes, but if supply-side reforms (etc) lead to a reduced CAD then it also means that the distribution of debt is changed - the foreign private and government sectors hold the debt instead of the domestic private/govt sectors.
"It's wrong to say the private sector can only reduce its debt if the government increases its deficit…"
Paul: "Not really.
A reversal in a current account balance - for us running a surplus is contingent upon balances that were accumulated by the foreign entity through prior deficits."
Not entirely.
The foreign sectors can accumulate debt based on increased domestic private sector leverage.
- debt and leverage are not the same thing.
Sure, the domestic govt has to produce enough base money to maintain interest rates at its target level.
"The current account doesn't exist"
Not sure what you mean by that. the current account is:
"the sum of the balance of trade (net earnings on exports minus payments for imports), factor income (earnings on foreign investments minus payments made to foreign investors) and cash transfers."
"…it's still a 'debt' (money owed to certain people, to be paid by certain dates)."
It's interest owed, not principal. The holders of the Treasuries still have their cash, except they are paid interest not to spend it. It is a savings account. Practically speaking holders of large amounts of wealth have no options if they want safety for their cash while maintaining liquidity.
That's why the more deficit spending we do the more in demand Treasuries become and the yield goes down.
They can still spend it, for example when one company like Apple buys another company. Treasuries are cash-equivalents.
They just can't spend it at McDonalds without cashing out in the secondary market first.
Rather than call it debt I prefer to look at it as an operation that makes dollars more valuable.
The government creates Treasuries out of thin air just like dollars.
"A reversal in a current account balance - for us running a surplus is contingent upon balances that were accumulated by the foreign entity through prior deficits."
Not really -
Say a foreign company wants to purchase US products. It exchanges its country's currency for dollars - So a US bank buys the currency in exchange for creating a USD-denominated deposit. If the bank needs additional reserves to meet its reserve requirements, it can get these on the interbank market or direct from the Fed.
The govt/Fed has to provide enough reserves to keep the Fed Funds rate at its target rate. That's it.
So some deficit spending is needed to create an adequate level of base money, but it's not as if every dollar bought by a foreign company has to have been "spent into existence" beforehand by the government.
A foreign company can exchange its currency for dollars.
"the more deficit spending we do the more in demand Treasuries become and the yield goes down"
No, the yield goes down if the Fed pushes it down (by buying loads of bonds), or if the financial sector stops using its reserves for other things (expanding credit, etc).
"Say a foreign company wants to purchase US products. It exchanges its country's currency for dollars - So a US bank buys the currency in exchange for creating a USD-denominated deposit. If the bank needs additional reserves to meet its reserve requirements, it can get these on the interbank market or direct from the Fed."
Your not even reading my respones. I already said that at May 23, 2012 11:29 AM.
""The current account doesn't exist."
Yes, it does. OK, so the dollars are (mainly) held within the US banking system. Big deal. The CAD still exists."
Again, you aren't reading my responses. The CAD doesn't exist in the system I defined to begin with because it is within the system. I defined the system as NFA's no matter where they are held. Under that definition there is no CAD. The non-government is the closed system. I can define the boundaries of a closed system where I choose. I could define it around my house if I chose, if that was convenient for my purposes.
Further, none of these distinctions you bring up are important with regard to closed system arithmetic, which was the point of my original comment.
Net dollar assets in a closed system can't increase unless they are injected into the system from an external source. You don't appear to be convinced of that.
"That's not correct - they have a bond, not cash. In order to get cash they have to sell their bond. Again, what is gained by pretending otherwise?"
I'm not pretending anything. I see it differently than you. Treasuries are cash equivalents. "money good" so to speak. They are as close to cash (liquidity) as you can get without actually holding cash, which no one wants to do with large quantities of cash anyway. Plus they pay interest and are safer than any other option, including cash.
Apple is constantly being singled out for its huge cash hoard ($100 Billion to date). About 70% of that cash hoard is in Treasuries and marketable securities. I didn't frame that argument.
Further, a dollar bill is debt, as is all money. The question is where do you draw the line as to when that debt is a burden?
From my perspective it's a burden if I have to pay interest AND principal. If I can create the interest out of thin air I don't see much of a burden. YMMV. We will have to agree to disagree.
Anyway, I don't want to get overly distracted by these semantic arguments that have no bearing on the mathematical model within which the economy works (sectoral balances). My part in the discussion started as a response to Anonymous's question regarding the meaning of "closed system" at May 22, 2012 4:52 PM.
On the credit theory of money, all money is debt. See Randy Wray's Money (Levy 2010). There is onerous debt, when revenue is required for payment of interest and principal, unless assets are sold or more debt acquired. Non-onerous debt is not revenue dependent. The debt of a currency sovereign are non-onerous, while the debts of currency user are onerous.
As Wray says in the article cited above, all debt can be defaulted on. However, a currency sovereign is never forced to default operationally, but it can be do so voluntarily if it chooses not to use available options for whatever reason.
"In the case where there is no prior balance the government must still create the dollars and exchange them for the foreign currency before the foreign entity can buy our products."
No, it doesn't have to do that. That was what I was trying to say.
The govt has to create enough reserves to keep the interest rate at its target level. Banks can purchase foreign currency in exchange for creating a deposit.
"The CAD doesn't exist in the system I defined to begin with because it is within the system"
Certain assets within the system belong to foreigners, some belong to nationals. The point is that there are assets owned by foreigners. That's what 'CAD' generally refers to. It makes no sense to say that "it doesn't exist".
@y When a bank creates credit money, however it is done, there is an asset and corresponding liability that nets to zero. Foreigners can borrow dollars from a US bank but that doesn't increase NFA since net is zero. If exchanges USD for foreign currency they mark down their cash account and mark up their open position in that currency. If their open position moves against them, they may take a loss on it. Same if a loan defaults.
"The point is that there are assets owned by foreigners. That's what 'CAD' generally refers to. It makes no sense to say that "it doesn't exist". "
You are missing the entire point of the discussion - a discussion of a closed system - the non-government.
I'm not saying that literally CAD doesn't exist. I'm saying that as I have defined the system boundaries, mathematically CAD has no relevance.
The closed system as defined includes net dollar and dollar-denominated financial assets created by the government. It doesn't matter who holds them. It has been reduced to a simple math problem.
The discussion is about the quantity in existence and what it would take to increase or decrease them.
There is no entity within the system as defined that can increase or decrease NFA's.
The quantity is fixed, finite and unchangeable without net government spending negative or positive (deficit or surplus).
If that does not make sense to you I suggest you try to learn more about closed systems. Although the concepts may be abstract, they are quite simple and very powerful.
I appreciate you making the effort to address my comments.
Excerpt: "In the social sciences an open system is a process that exchanges material, energy, people, capital and information with its environment......... David Harvey uses this to argue that when systems such as capitalism enter a phase of crisis, it could happen through one of a number of elements, such as gender roles, the relation to nature/the environment, or crises in accumulation.[5] Looking at the crisis in accumulation, Harvey argues that phenomena such as foreign direct investment, privatization of state-owned resources, and accumulation by dispossession act as necessary outlets when capital has overaccumulated too much in private hands and cannot circulate effectively in the marketplace."
??????? 'Capital' can 'circulate'?
Looks like some look at all of this as some sort of OPEN System...
When funds flow into a country from outside through investment, real or financial, asset prices are driven up and this can leads to goods prices increasing, too. I.e., capital inflow is stimulative and can become inflationary. When the country raises interest rates to quell inflation, that attracts more foreign funds, the increased demand pushing up the value of the currency, adversely affecting exports. All this can have a destabilizing effect, which eventually drive capital away to a safer parking place.
When capital is withdrawn from a country by foreigners selling assets, real or financial, asset prices fall and this is disinflationary.
Smaller emerging economies are susceptible to buffeting as a result and may resort to capital controls or at least threaten it, as Brazil did recently.
Free capital flow is a cornerstone of neoliberalism along with "free" (unregulated) markets and free trade. It's the price that emerging nations have to pay to get in the game.
I should add that "capital flight" is usually used to mean the flight to safety, but it can also mean capital leaving a country in search of better return, capital "naturally" seeking maximum risk-weighed return.
Andy Grove has been complaining about capital flight from the US to the emerging world where investment opportunity is perceived as better. and rather than increasing investment in the US, other countries just seek to increase exports to the US.
Grove claims that this is seriously damaging the US productive economy, and the US needs to address it.
The way I understand Warren is, that to him the process of capital flight that you describe is completely analogous to domestic movements in asset prices. The closed system argument. People either invest or disinvest - the private buffer stock being government provided public equity, aka money/bonds. It is the unlimited provision of public liquidity through functional finance and the subsequent stabilisation of interest rates that counteracts and thus supposedly disincentivises erratic movements in and out of assets in the first place. The other contention is that functional finance with ELR will serve to maximise the real capital value within a currency area over the medium to long term by maintaining full employment.
Where I see Ramanan's point, and this touches with Matt's comment from above about Marx's M-C-M' as well as your's, is that the capital owners are a: not in it for the long run and b: don't give a flying f**k about fundamentals or their own role in nurturing them, as long as they can extract a reasonable rent and feel secure that there's an exit. In cross border trade, because country b may be doing something completely different from country a, this causes great fluctuations that are disruptive. Hence the de facto need for buffer stocks and the call for, dare I say it, concerted action.
It's a question of who is slave to whom (in the real world, that is). And in this sense I think more extreme or simplified readings of MMT tend to be somewhat naïve in their belief in the powers of the currency issuing entity to disincentivise and counteract flows of capital. Clinging to the idea of a stable, closed system is futile if the notional value of the underlying real economy fluctuates around it. Attempts to euthenise the rentier capitalists will just drive them somewhere else. That's a dilemma inherent to capitalism that no amount of functional finance will resolve.
Having said that, my personal reading of MMT, is that it is acutally an attempt to frame an economy from a distinctly real, as opposed to financial, perspective. All things financial are subsidiary to the primary goal of full employment. If, for a small, open economy, this may necessitates capital controls or the like, so be it. It's just a more optimistic way of looking at the world than through circuitist lenses. And we certainly need optimism right now.
The way I understand Warren is, that to him the process of capital flight that you describe is completely analogous to domestic movements in asset prices. The closed system argument. People either invest or disinvest - the private buffer stock being government provided public equity, aka money/bonds. It is the unlimited provision of public liquidity through functional finance and the subsequent stabilisation of interest rates that counteracts and thus supposedly disincentivises erratic movements in and out of assets in the first place. The other contention is that functional finance with ELR will serve to maximise the real capital value within a currency area over the medium to long term by maintaining full employment.
Where I see Ramanan's point, and this touches with Matt's comment from above about Marx's M-C-M' as well as your's, is that the capital owners are a: not in it for the long run and b: don't give a flying f**k about fundamentals or their own role in nurturing them, as long as they can extract a reasonable rent and feel secure that there's an exit. In cross border trade, because country b may be doing something completely different from country a, this causes great fluctuations that are disruptive. Hence the de facto need for buffer stocks and the call for, dare I say it, concerted action.
It's a question of who is slave to whom (in the real world, that is). And in this sense I think more extreme or simplified readings of MMT tend to be somewhat naïve in their belief in the powers of the currency issuing entity to disincentivise and counteract flows of capital. Clinging to the idea of a stable, closed system is futile if the notional value of the underlying real economy fluctuates around it. Attempts to euthenise the rentier capitalists will just drive them somewhere else. That's a dilemma inherent to capitalism that no amount of functional finance will resolve.
Having said that, my personal reading of MMT, is that it is acutally an attempt to frame an economy from a distinctly real, as opposed to financial, perspective. All things financial are subsidiary to the primary goal of full employment. If, for a small, open economy, this may necessitates capital controls or the like, so be it. It's just a more optimistic way of looking at the world than through circuitist lenses. And we certainly need optimism right now.
For myself, I can see how a corp could move their equipment to another country and set up manufacturing operations over there and pay people in the new country in local currency to operate the relocated equipment. Then export from that country even back into the country that was their former home if they still wanted the former country's currency.
This I can understand.
But I would think that equipment would be on the corps balance sheet as 'Assets' not 'Capital'.
So I would perhaps call that 'Asset Flight'. Assets that were probably already depreciated to zero btw.
Tom above says: "When funds flow into a country from outside through investment" I cannot fathom how that can happen???? How can I take my USDs to the UK and "invest them"; do not they use a different currency system in the UK?
This would violate the system boundary of what is a closed system. In this case the closed system is the "USD System" if you will.
This talk of 'Capital Flight' makes no sense to me (I believe mine is a 'mathematical brain' vice 'semantic brain') ... I view it as some sort of sophistry as I recoil at the thought of a boundary violation of a closed system as being possible (can't happen in my world).
PS, I dont think Harvey knows what "money" is.... Harvey is out of paradigm imo.
If he doesnt know what "money" is then he doesnt know what "capital" is either because he uses the word "money" (which he doesnt know what it is) TWICE in his definition of "capital"... and he has been teaching a book titled "Capital" for 40 years! And he doesnt even know what it is!
"Looks like some look at all of this as some sort of OPEN System... "
It depends on the way we define the system boundary.
MMT defines the system as "closed" wrt the quantity of NFA's - the closed system is the sectoral balances relationship.
If no amount of economic activity can change the quantity of NFA's within the system then it follows that nominal growth is impossible without expansion of the persistent money supply.
Note that it is possible for the economy to grow due to credit. The gotcha is that when credit exceeds the ability of the agents income to service, the economy will contract and growth will go negative, so the net is near zero.
Obviously all of the stuff created during the expansion doesn't disappear but agents are saddled with nominal losses that can't be gotten rid of without a reset.
"PS, I dont think Harvey knows what "money" is.... Harvey is out of paradigm imo."
I'm not sure he's out of paradigm so much as he is caught up in semantic argumentation which, inevitably it appears, generates a lot of confusion, which math avoids (assuming an understanding of math).
I think moving back and forth between the semantic and the math introduces misunderstandings that probably can't be avoided because communication is a caricature of reality.
Why do laws and legislation have so many unintended consequences?
This from Marx: "Since every commodity disappears when it becomes money it is impossible to tell from the money itself how it got into the hands of its possessor, or what article has been changed into it"
???????
Reads like a Harry Potter book to me.
I think I would flunk Harvey's course for sure if I didn't end up getting thrown out!
But I would think that equipment would be on the corps balance sheet as 'Assets' not 'Capital'.
As far as I know, Marx uses the term 'capital' in the sense of physical assets used as intermediaries in production. I.e. machines, land and the like.
I only managed 2 of Harvey's lectures, let alone any of Marx himself - I just haven't got the time - but as I understand it, Marx's main concern, and to me the crux of the matter, lies in the theory of value. He doesn't even touch money which is probably why he can still be considered relevant today. Had he done so, he would have probably relied heavily on his peers - to his own disadvantage in this case.
Anyway, forget companies moving equipment abroad for a moment and ask yourself by which mechanism(s) and through how many value translations the domestic factory, its machines and/or its workers translate, first into corporate financial claims and then into claims on government. All value estimates are notional, all three are constantly in flow and subsequently the VALUE of each (conveniently denominated in local fiat terms) will be subject to relative changes. I.e. they float. Already, without even looking abroad, and forgetting the complexities of stocks and flows for a minute, you have 3 separate systems that interact with each other. And it's what happens between them that determines the stability and attractiveness of an economy as a whole. The absolute amount of bank, central bank or government credit is secondary to any such considerations although an elastic supply of the latter 2 may help contain swings in overall domestic, i.e. nominal financial wealth to some degree. I don't think it can somehow preserve the wealth of a nation or currency area though, which must always be seen in comparison to others. Wealth is always relative.
Consider the example of a general sell-off of corporate papers. While corporate wealth sinks, other wealth must rise, either with more money or through deflation. So far, so good. Now, a large number of holders of government fiat suddenly want to invest in Brazil by exchanging their $ for Reais and buying Brazilian corporates. This drives down the VALUE of all outstanding $ denominated financial assets relative to assets denominated in Reais, rtiggering further movements in that direction. No equipment needs to leave the country - i.e. the underlying fundamentals need not change for there to be large swings in value. For nations that rely on imports for large parts of their economy, such as developing nations or small, open economies, this represents a problems that may be worth addressing by managing the currency and / or having capital controls.
By what mechanism does the value of 1 piece of Apple stock fluctuate vis à vis the US$, assuming # of stock and # of $ are constant. The way I interpret your answer, this can't happen and yet it obviously does.
But I think I see what you mean. The $ remain in the system. My point was, they are now worth less. A Dollar is a Dollar, but it isn't a Real. Nor is it worth anything without reference to what it can buy, or at least to what you think it can or will at some point buy. Happiness, e.g. :-).
The world is squishy. Squishy is where the juice is. And any theory of the world that doesn't do squishy, doesn't describe the world.
Dollars aren't "worth" anything. They aren't a store of value.
Well, in philosophical terms I agree, but we do expect it to act in such a manner and price stability is in most every CB mandate. Even MMT puts it slap bang in the middle - full employment & price stability.
I'm just making the point that value is based largely on leverage.
The "squishy" world is mostly untethered from the nominal one.
Individuals can work within this "squishiness" and attempt to extract their share. All they are doing is moving piles of dollars from one place in the economy to another.
In the aggregate this can't work.
What happens if all the dollars end up in one pile?
There is a transfer function between nominal and real of some sort but it is non-linear and at least for now, unknown.
Observation of nominal flows and constraints based on simple math will steer us away from policies that can't work by arithmetic.
No one is claiming otherwise. Ignoring it or misunderstanding it can do a lot of damage. Unforced errors.
"By what mechanism does the value of 1 piece of Apple stock fluctuate vis à vis the US$, assuming # of stock and # of $ are constant. The way I interpret your answer, this can't happen and yet it obviously does."
There is no direct relationship between the number of dollars in the system and the value of some real asset.
As I said value is "squishy" and the transfer function, if there is one, is unknown.
Why would the value of an asset not fluctuate, even as the number of nominal NFA's remains fixed?
And before you label me a montarist, I might add that endogenous money, as embraced by circuit theorists, PKers and MMTers, solves the problem of currency system internal value fluctuations quite elegantly. It doesn't address the external sector, though. Some PKers seem to prefer managing exchange rates, even reintroducing a gold standard, MMTers just say f***k it, let it float and the rest will follow. I personally don't think there's a 'one size fits all' answer, nor is it probably quite that simple a dichotomy. But staying focussed on fundementals instead of engaging in 11-dimensional fx chess certainly seems like a good strategy.
Have I gone down the monetarist rabbit hole? I hope not. I'm all for clean cut analysis, but it just seems at some point one needs to REconnect spheres of thought in order to deepen one's analysis. Or where do you see my fundamental error? I'm no physicist or methematician...
The classical meaning of "capital" is the means of production, i.e., what we now call "capital goods" in the from of real assets on a balance sheet. Real investment is in capital goods, while financial investment in the saving of funds that can be used subsequently for investment in capital goods, or have already been so invested, i.e., equity shares. These are not accounting terms so the colloquial meanings are slippery and imprecise.
The major difference between mainstream economists and Keynesians of all strips but New Keynesians is that the Keynesian position is that modern capitalism is financial in nature and failure to take this into account vitiates any economic theory, e.g., those theories that subscribe to money neutrality.
Modern capitalism is based on free flow of capital internationally. They results in a number of problems including what is called "capital flight," which generally means that funds flow into an economy, usually a "hot" emerging one, as money managers seek to take advantage of greater return. Sine the trade is one-sided, there is significant exposure to that capital leaving suddenly either when returns seem more promising elsewhere or problems develop in the economy.
Matt asks how it is possible. Well if interest rates rise to give risk-weighted advantage, somewhere, then "financial capital" will flow into that country. USD, euro, yen, etc, are converted into, say, Brazilian real or Thai bhat and saved as govt or corp bonds, for instance, which funds are then used domestically for expansion. If the wind shifts, then the funds are converted in the other direction, often suddenly if there are lot of people involved. Moreover, a lot of this involves carry trade, and the conditions can shift from the other side of the trade, too, reducing the profitability and resulting it an exit.
These have been regular occurrences over the recent decades, and many countries consider "global hot money" a problem for their stability.
Matt: "This part of it: "exchanging their $ for Reals" seems impossible to me... this simply cannot be done, it cannot happen."
I don't understand. "Foreign exchange" means exchanging one currency for another, which is necessary for all cross border transactions involving different currencies.
If I as an American want to buy equities in the EZ or China, I first have to exchange the equivalent amount of USD for euro or yuan at the going rate at the time unless I have a euro or yuan account with sufficient funds.
"No dollars were destroyed or created through the exchange operation. Everything is the same except the dollars are rendered useless to Americans."
The point is that use of $ for investment did not happen but rather use in real or yuan or whatever. Of course, the $ are still in the currency zone, but they may be saved rather than used for investment, which is what is happening in the US at present. E.g., US corps are investing abroad and saving at home.
Mammoth: "Do you have any links to MMT literature on capital flight?"
Warren: "there are probably brief discussions somewhere in the mandatory readings and elsewhere on this website. there isn’t much to talk about because there is no such thing with non convertible currency/floating fx. and with fixed fx it’s easy- people ‘cash in’ the convertible currency for the gov’s reserves."
I think I see what Warren is saying...
Let me chew on this a while for both you and Oliver here... I think we are on to something here...
The essence of market capitalism is price wrt value. Price is the nominal representation of real value. Actual value is priced through the discovery process that free markets provide. This is the essence of "the invisible hand."
New Classical economists presume that price is identical with value, which is a basis of money neutrality. Money is only veil over barter that contributes nothing but convenience in exchange by storing value for subsequent use in exchange. (This is why the fetish over price stability.)
Thus, in this view, market price is the best guess at approximating real value across time under conditions of rational agents pursuing max u in an environment of perfect knowledge and perfect competition.
Keynesians hold that this view is based on assumptions that are too simplistic to fit reality. Markets are not perfectly competitive, knowledge is not perfect, and agents are often driven by "animal spirits," e.g., fear and greed.
Therefore, price and value can become dissociated in the imperfect discovery process of market pricing. Moreover, many markets are heavily influenced by monopoly conditions, as well as cheating.
Traders recognize that price fluctuates around a mean, which is indicative of the actual value, and this is only discovered in hindsight. The challenge is making the best guess in approximating not actual value but market movements in which the movement itself influences the market, what Soros calls reflexivity. Traders are largely attempting to anticipate other traders by discovering patterns of behavior. But discovery of these patterns changes the patterns.
This is what technical analysis is mostly about, for example. Technical analysis attempts to predict future price action based on past price action in terms of fluctuations around actual value, hourly, daily, short term, intermediate term, and long term. Presently, the best mathematical minds available are employed in this endeavor, which means diverting mathematicians, physicists, and other scientists and engineers from productive enterprise into financial pursuits that are essentially extractive.
Yes under a convertible system there can be real capital flight as gold and silver shift across borders.
Under convertibility, there is no advantage in a trade deficit in real terms, because another real asset is automatically exchanged. They actually moved gold bars around in the vault deep under the FRBNY building prior to Nixon's shutting the gold window.
So in that sense there is no (real) capital flight under a floating rate system.
But that doesn't mean that fx issues can't arise either. They do.
Warren's point is that they can be dealt with intelligently if one understands the system instead of letting them blow things up periodically, which is just stupid. That's not possible under a convertible system. I.e., there's less policy space.
"Warren's point is that they can be dealt with intelligently if one understands the system instead of letting them blow things up periodically, which is just stupid."
Not a great deal different than the private debt issue, which could also blow things up if we were stupid. Oh, wait…
Right, Warren's point is two-fold. First, we aren't using the policy space that the existing monetary system affords and secondly, key institutional arrangements are skewed and need to be fixed. The former is usually associated with MMT and the later with institutionalism and Minsky. But as Scott Fullwiler points out, the MMT professional literature shows that Minsky and institutionalism are a key aspect of MMT, too.
And to your last point. I agree, accommodate and regulate are two sides of the same coin. There's a qualitative side to the quantitative argument. The conventional position is that one must regulate by not being to accommodative - which to me is a purely quantitative view of the world and a dangerous one too.
There has to be a balance between accommodation and regulation, or easy accommodation will result in moral hazard. Conversely, over-regulation will lead to underperformance.
Ram has never been a big fan of the "currency shredding" story either....
ReplyDelete;) Resp,
Ramanan seems to think that as soon as the currency depreciates, the central bank has to intervene in fx markets and use up its foreign reserves.
ReplyDeleteAll this stuff about banks immediately collapsing as the result of a large currency depreciation - is there any evidence of this ever actually happening?
Krugman mentions (in a post below) a sharp depreciation of the franc - did this result in bank collapses and economic chaos?
Someone should ask Ramanan to explain the 2nd Law of Thermodynamics in his own words.
ReplyDeleteHis response if any would be interesting. We might find out once and for all if he groks the significance of a "closed system".
I can't ask him - we aren't on speaking terms.
For me his arguments seem to all come out of left field, with no particular point or conclusion other than someone is wrong (just not him).
The discussion looks interesting, but it's over my head.
ReplyDeletewhat paul said...
ReplyDelete"closed system"
ReplyDeleteYou refer to this a lot Paul, but I'm not sure exactly what you mean.
Maybe you should get back on "speaking" terms with Ramanan.
This comment has been removed by the author.
ReplyDeleteThis comment has been removed by the author.
ReplyDelete"Capital" doesn't "fly".
ReplyDeleteresp,
Anon
ReplyDelete"closed system"
"You refer to this a lot Paul, but I'm not sure exactly what you mean."
From Wikipedia…
"In thermodynamics, a closed system can exchange energy (as heat or work), but not matter, with its surroundings. In contrast, an isolated system cannot exchange any of heat, work, or matter with the surroundings, while an open system can exchange all of heat, work and matter.
For a simple system, with only one type of particle (atom or molecule), a closed system amounts to a constant number of particles.
However, for systems which are undergoing a chemical reaction, there may be all sorts of molecules being generated and destroyed by the reaction process. In this case, the fact that the system is closed is expressed by stating that the total number of each elemental atom is conserved, no matter what kind of molecule it may be a part of."
How is this relevant to economics?
Consider a monetary system of dollars and dollar-denominated financial assets as the definition of the closed system, where ever they may be in the world.
Without some injection or leakage external to the system, the quantity of dollars and dollar-denominated assets CANNOT change. It is mathematically impossible.
Any claim that violates this principle cannot be true.
If a NET increase in profits is reported through the sum of all balance sheets in the system, an equal amount of dollars HAS to have been either net-spent into the system by the government or has to be returned to the system through a trade surplus.
Credit cannot provide those dollars because credit nets to zero on balance sheets.
If the goal is positive economic growth that can be measured in nominal dollars, that growth cannot occur without an injection from outside the system.
He didn't listen to what I said carefully enough.
ReplyDelete"If a NET increase in profits is reported through the sum of all balance sheets in the system, an equal amount of dollars HAS to have been either net-spent into the system by the government or has to be returned to the system through a trade surplus."
ReplyDeleteNot sure how you mean net here but couldnt an increase in the price of something (like a stock or a house) lead to an increase in reported profits. A rising stock market might cause the asset side of your balance sheet to look larger and could be reported as increased profit could it not? This doesnt mean you have actually been paid that price yet but a stock that has tripled in price can be accounted for as an increased profit can it not.
I know that in 2008 everyone in my department thought they had lost a lot of money in their 401K accts when the market tanked. Their "profits" had fallen. I imagine a lot of banks and investment firms suffered the same fate. I sold before the crash and actually had the dollars and realized my profit. Many people (monetarists it seems) think a stock worth a 1000$ and a 1000$ bill are virtually the same thing on a balance sheet.
"Credit cannot provide those dollars because credit nets to zero on balance sheets."
I agree with this
"If the goal is positive economic growth that can be measured in nominal dollars, that growth cannot occur without an injection from outside the system."
I agree with this too
Seems that all Warren is saying is that the whole banking system is completely interconnected and while dollars may change the names associated with them and even change the numeraire attached to them (when converted to say Euros) they dont actually go anywhere or flee. This doesnt mean that a mass conversion of dollars to Euros will be inconsequential, far from it, but there is a limit to how far it will go.
ReplyDeleteGreg,
ReplyDelete"a stock that has tripled in price can be accounted for as an increased profit can it not."
I do not believe so. Only if you sell it, it is then treated as a capital gain (income).
Also, the banking system has to provide settlement balances for you to sell the shares to someone. That person has to have possessed the USD balances prior to buying your shares which had to have come from the govt in the first place.
One way I sometimes look at it: Bill Gates may have $10B in shares of MSFT but he cannot ever convert those shares into USD NFAs unless those USD NFAs are already in the non-govt sector in the possession of non-govt entities.
Resp,
Right Matt,
ReplyDeleteUntil the stock is monetized by a sales transaction the increase is on paper only and has no effect on the quantity of NFA's in the system. That gain will not affect the holders net cash balance (dollar assets less dollar liabilities).
Once the sale takes place cash increases on the seller's balance sheet and decreases on the buyers balance sheet (unless it's a trade transaction, in which case the gain isn't monetized).
So far, the quantity of NFA's (talking about cash here) still hasn't changed. It is only a transfer.
There can only be a net increase in NFA's on balance sheets if the government net spends into the economy, otherwise every gain must be offset by another agent's decrease in it's cash balance.
Net gains in NFA's (cash) in the aggregate can only be monetized by money creation (not credit).
The nice thing about the closed system principle, once you are aware of it and the infallibility of it, there is no need to go down rabbit holes trying follow arguments through a maze that purports to prove that something can be created out of nothing if we just make it complicated enough.
Greg,
"Not sure how you mean net here…"
At any given moment there is some quantity x dollars in the system (non-government) and some quantity y liabilities, and x+y > 0 (dollars plus dollar liabilities is greater than zero). There is net cash in the system (NFA's are cash or cash equivalents).
The net is that amount greater than zero. It can't be changed from within the system. Increasing credit will add ∆x + ∆y to the system. ∆x = -∆y, so the net change is zero.
Private entities are forbidden from creating dollars (it's called counterfeiting).
If the sum of cash positions on all balance sheets in the system is higher than the previous budget year that is a net increase.
A related conclusion from today's Bill Mitchell blog-post:
ReplyDelete"The next time you hear someone tell you that the private and government sectors have to reduce their debt to resolve this crisis ask them to…
outline, in detail, the tyranny of the arithmetic.
My bet is that very few will know where to start.
Even debt-obsessed economists get this wrong.
The inescapable rule is that if one sector is running a surplus then at least one other sector has to be running a deficit.
In times of private de-leveraging, it is fairly obvious which sector has to be supporting that process with commensurate deficits."
These are closed-system arguments Bill is making.
They aren't opinions.
"The next time you hear someone tell you that the private and government sectors have to reduce their debt to resolve this crisis ask them to…
ReplyDeleteoutline, in detail, the tyranny of the arithmetic."
Both govt and private sectors can reduce their debt simultaneously if the country reduces its current account deficit.
Rightwingers think this can be done by introducing supply side changes, slashing wages and regulation.
"Both govt and private sectors can reduce their debt simultaneously if the country reduces its current account deficit."
ReplyDeleteThe government doesn't have any "debt", in the sense that it has to re-pay it so why would the government want to reduce it's debt?
The government is unconstrained in it's ability to pay it's "debt". To make any payment it simply marks up bank accounts.
Transfers from the Current Account only have meaning wrt the non-government.
A clarification…
ReplyDeleteWhen I said in an earlier comment…
"If a NET increase in profits is reported…"
by this I mean a net increase in the CASH position on balance sheets, including cash and cash equivalents.
All I was saying is it's possible for both government and domestic private sector to reduce their debt levels (and as we know many people want them to) if the country exports more relative to its imports. It's wrong to say the private sector can only reduce its debt if the government increases its deficit.
ReplyDeletePersonally I don't see the point of saying that the governemnt doesn't have a debt. Ok, it can always produce the dollars needed to pay it off, but it's still a 'debt' (money owed to certain people, to be paid by certain dates).
"Rightwingers think this can be done by introducing supply side changes, slashing wages and regulation."
ReplyDeleteActually, their argument is that this will increase real assets not financial assets. The financial system is a closed system, which is why the identities work, but real assets can be increased by investment of bank money, which cannot increase financial assets, since it nets to zero.
This is the essence of the neoliberal argument: deregulate and reduce wages and real assets (growth) will ensue through private investment, part of which is debt-based through the financial sector.
It's not a stupid argument. The problem with it is that leads to all the problems resulting from laissez-faire capitalism historically, which they either deny or ignore.
Free market capitalism makes for a good story, but the social, political and economic premises on which it rests are flawed, so that the outcome is concealed or misrepresented.
When the inevitable happens, then the response is either that is was the result of exogenous shock that could not be anticipated and prevented, or else that free market capitalism was not actually allowed to work, e.g., the failure resulted from govt intervening in some way.
Neoliberalism claims to be based on economics as a science, but the theory cannot be tested because failure of hypotheses can always be accounted for by some explanation that the theory permits.
In other words, it's BS and the "science" is just propaganda for an ideology that distributes income and wealth to the top by extracting it from the bottom largely by means of economic rent, especially private debt.
"It's wrong to say the private sector can only reduce its debt if the government increases its deficit…"
ReplyDeleteNot really.
A reversal in a current account balance - for us running a surplus is contingent upon balances that were accumulated by the foreign entity through prior deficits.
It's a timing issue. The government created the deficit in prior years which only now (under surplus) is coming back to monetize gains in the domestic non-government.
In the case where there is no prior balance the government must still create the dollars and exchange them for the foreign currency before the foreign entity can buy our products.
This is still raw money creation. To say this isn't a deficit from our point of view is a distinction without a difference. It is no different than if the government spent the money directly into the economy, except the government holds foreign currency instead of US Treasuries.
At any rate, I'm mainly trying to point out the implications of closed-system arithmetic and how powerful such a simple concept is.
Tom,
ReplyDeleteAlthough credit can facilitate growth in real or paper wealth, that wealth can't be realized in nominal terms unless the government follows through and prints the money. A few agents can cash in and get their gains, which ends up coming from another agent - it's a transfer.
If enough agents tried to cash in at the same time the system would freeze up. Kind of like your home electrical panel would do if you tried to load all or even most of the circuits at once.
Actually, a home electrical distribution system is a very good model for our monetary system in math terms.
When all of the baby boomers begin to cash in their retirement funds we may witness such an event if the government hasn't created enough dollars to cover the payments.
We will then hear the cries of "We're broke. We can't afford to make these payments".
The banks win again.
paul: "Although credit can facilitate growth in real or paper wealth, that wealth can't be realized in nominal terms unless the government follows through and prints the money. A few agents can cash in and get their gains, which ends up coming from another agent - it's a transfer. If enough agents tried to cash in at the same time the system would freeze up. Kind of like your home electrical panel would do if you tried to load all or even most of the circuits at once."
ReplyDeleteRight, only wealth that is realized through asset sales (cashing out) is financial. Most really wealth people are wealthy in terms of claims on real assets, like equity share.
But is the equity capitalization realistic when figured on the based of marginal price of shares. What would be the marginal price of a share if owners decided to just cash out and dropped their shares into the market?
"But is the equity capitalization realistic when figured on the based of marginal price of shares. What would be the marginal price of a share if owners decided to just cash out and dropped their shares into the market?"
ReplyDeleteTom, my brain doesn't parse this very well so I'm not sure what you are asking.
If I understand at all, it seems like the value of shares for the agents that are slow cashing out would get caught as the value of their shares would evaporate.
Kind of like the GFC.
"A reversal in a current account balance - for us running a surplus is contingent upon balances that were accumulated by the foreign entity through prior deficits."
ReplyDeleteRight, changes in the capital-current account do not create NFA but only shift them around within a period. That is, fluctuations in the flow from external to domestic and vice versa change the composition of the stock of NFA, but the amount of the stock remains the same unless govt adds to it through injection (deficit spending) or decreases it through withdrawal (taxation).
A further clarification of my reply to y earlier…
ReplyDeleteThe way I defined the closed system in the beginning of my example was…
…"Consider a monetary system of dollars and dollar-denominated financial assets as the definition of the closed system, where ever they may be in the world"
This eliminates the current account argument for this case. The current account doesn't exist.
paul, " If I understand at all, it seems like the value of shares for the agents that are slow cashing out would get caught as the value of their shares would evaporate. Kind of like the GFC."
ReplyDeleteRight, so what does it really mean to say that the market cap of X company is Y. Is that actually realizable on cash out?
Right, so what does "real" mean when folks are talking about real wealth,
ReplyDeleteespecially with respect to equities.
This is why I think our retirement funds are a scam.
Any kind of run on the funds destroys their value. Another foreseeable event. Another reason why we need government.
A functional one that is.
"Right, so what does it really mean to say that the market cap of X company is Y. Is that actually realizable on cash out?"
ReplyDeleteI say No. Any large-scale cashing-out would be a bank run event.
The system isn't really designed for shocks in my view.
And, like insurance companies, banks and funds don't really plan on paying out.
maybe they ought to let retired long term savers buy a guaranteed long term annuity from the govt. Subject to some limits...
ReplyDeleteMatt,
ReplyDeleteHopefully you mean transfer from an existing fund/401k to a government plan.
I plan on investing in Treasuries when the time is right. Now?
At least my principal will be protected. Lost over 40% when the GFC hit, now back up to only a 20% loss.
Paul,
ReplyDeleteRight, let a person with ERISA account convert that to some sort of govt guaranteed public pension.
Perhaps just as a transition to a much more robust permanent public retirement pension scheme.
As the next generation will not have near the ERISA assets that this generation has (they will be in China's possession as current retirees never had China and India to deal with like those working now do).
Resp,
I forgot to mention another thing:
ReplyDeletethe govt and domestic private sector can simultaneously reduce their debt if:
a) the CAD is reduced
b) the part of the domestic sector which has savings reduces its "savings desires", i.e. invests/spends more.
*domestic private sector
ReplyDeletey,
ReplyDeleteYou may have missed it but I posted a few replies to your earlier comment above.
"Rightwingers think this can be done by introducing supply side changes, slashing wages and regulation."
ReplyDeleteTom: "Actually, their argument is that this will increase real assets not financial assets"
Yes, but if supply-side reforms (etc) lead to a reduced CAD then it also means that the distribution of debt is changed - the foreign private and government sectors hold the debt instead of the domestic private/govt sectors.
"It's wrong to say the private sector can only reduce its debt if the government increases its deficit…"
Paul: "Not really.
A reversal in a current account balance - for us running a surplus is contingent upon balances that were accumulated by the foreign entity through prior deficits."
Not entirely.
The foreign sectors can accumulate debt based on increased domestic private sector leverage.
- debt and leverage are not the same thing.
Sure, the domestic govt has to produce enough base money to maintain interest rates at its target level.
"The current account doesn't exist"
Not sure what you mean by that. the current account is:
"the sum of the balance of trade (net earnings on exports minus payments for imports), factor income (earnings on foreign investments minus payments made to foreign investors) and cash transfers."
(wiki)
"…it's still a 'debt' (money owed to certain people, to be paid by certain dates)."
ReplyDeleteIt's interest owed, not principal. The holders of the Treasuries still have their cash, except they are paid interest not to spend it. It is a savings account. Practically speaking holders of large amounts of wealth have no options if they want safety for their cash while maintaining liquidity.
That's why the more deficit spending we do the more in demand Treasuries become and the yield goes down.
They can still spend it, for example when one company like Apple buys another company. Treasuries are cash-equivalents.
They just can't spend it at McDonalds without cashing out in the secondary market first.
Rather than call it debt I prefer to look at it as an operation that makes dollars more valuable.
The government creates Treasuries out of thin air just like dollars.
The difference between a savings account and a government bond is that the latter has a specific maturity date and interest payment structure.
ReplyDeleteI don't see what there is to gain by arguing that that government "debt" is not really a debt.
"The holders of the Treasuries still have their cash"
ReplyDeleteThat's not correct - they have a bond, not cash. In order to get cash they have to sell their bond. Again, what is gained by pretending otherwise?
* I don't know why I wrote "that" twice in a row. Odd.
ReplyDelete"A reversal in a current account balance - for us running a surplus is contingent upon balances that were accumulated by the foreign entity through prior deficits."
ReplyDeleteNot really -
Say a foreign company wants to purchase US products. It exchanges its country's currency for dollars - So a US bank buys the currency in exchange for creating a USD-denominated deposit. If the bank needs additional reserves to meet its reserve requirements, it can get these on the interbank market or direct from the Fed.
The govt/Fed has to provide enough reserves to keep the Fed Funds rate at its target rate. That's it.
So some deficit spending is needed to create an adequate level of base money, but it's not as if every dollar bought by a foreign company has to have been "spent into existence" beforehand by the government.
A foreign company can exchange its currency for dollars.
ignore the last sentence. It's these little boxes - difficult to see what you've typed sometimes.
ReplyDelete"The current account doesn't exist."
ReplyDeleteYes, it does. OK, so the dollars are (mainly) held within the US banking system. Big deal. The CAD still exists.
"the more deficit spending we do the more in demand Treasuries become and the yield goes down"
ReplyDeleteNo, the yield goes down if the Fed pushes it down (by buying loads of bonds), or if the financial sector stops using its reserves for other things (expanding credit, etc).
y,
ReplyDelete"Say a foreign company wants to purchase US products. It exchanges its country's currency for dollars - So a US bank buys the currency in exchange for creating a USD-denominated deposit. If the bank needs additional reserves to meet its reserve requirements, it can get these on the interbank market or direct from the Fed."
Your not even reading my respones. I already said that at May 23, 2012 11:29 AM.
""The current account doesn't exist."
Yes, it does. OK, so the dollars are (mainly) held within the US banking system. Big deal. The CAD still exists."
Again, you aren't reading my responses. The CAD doesn't exist in the system I defined to begin with because it is within the system. I defined the system as NFA's no matter where they are held. Under that definition there is no CAD. The non-government is the closed system. I can define the boundaries of a closed system where I choose. I could define it around my house if I chose, if that was convenient for my purposes.
Further, none of these distinctions you bring up are important with regard to closed system arithmetic, which was the point of my original comment.
Net dollar assets in a closed system can't increase unless they are injected into the system from an external source. You don't appear to be convinced of that.
"That's not correct - they have a bond, not cash. In order to get cash they have to sell their bond. Again, what is gained by pretending otherwise?"
I'm not pretending anything. I see it differently than you. Treasuries are cash equivalents. "money good" so to speak. They are as close to cash (liquidity) as you can get without actually holding cash, which no one wants to do with large quantities of cash anyway. Plus they pay interest and are safer than any other option, including cash.
Apple is constantly being singled out for its huge cash hoard ($100 Billion to date). About 70% of that cash hoard is in Treasuries and marketable securities. I didn't frame that argument.
Further, a dollar bill is debt, as is all money. The question is where do you draw the line as to when that debt is a burden?
From my perspective it's a burden if I have to pay interest AND principal. If I can create the interest out of thin air I don't see much of a burden. YMMV. We will have to agree to disagree.
Anyway, I don't want to get overly distracted by these semantic arguments that have no bearing on the mathematical model within which the economy works (sectoral balances). My part in the discussion started as a response to Anonymous's question regarding the meaning of "closed system" at May 22, 2012 4:52 PM.
On the credit theory of money, all money is debt. See Randy Wray's Money (Levy 2010). There is onerous debt, when revenue is required for payment of interest and principal, unless assets are sold or more debt acquired. Non-onerous debt is not revenue dependent. The debt of a currency sovereign are non-onerous, while the debts of currency user are onerous.
ReplyDeleteAs Wray says in the article cited above, all debt can be defaulted on. However, a currency sovereign is never forced to default operationally, but it can be do so voluntarily if it chooses not to use available options for whatever reason.
"In the case where there is no prior balance the government must still create the dollars and exchange them for the foreign currency before the foreign entity can buy our products."
ReplyDeleteNo, it doesn't have to do that. That was what I was trying to say.
The govt has to create enough reserves to keep the interest rate at its target level. Banks can purchase foreign currency in exchange for creating a deposit.
"The CAD doesn't exist in the system I defined to begin with because it is within the system"
ReplyDeleteCertain assets within the system belong to foreigners, some belong to nationals. The point is that there are assets owned by foreigners. That's what 'CAD' generally refers to. It makes no sense to say that "it doesn't exist".
*
ReplyDeleteThe foreign entity can also take out a loan from a domestic bank.
@y
ReplyDeleteWhen a bank creates credit money, however it is done, there is an asset and corresponding liability that nets to zero. Foreigners can borrow dollars from a US bank but that doesn't increase NFA since net is zero. If exchanges USD for foreign currency they mark down their cash account and mark up their open position in that currency. If their open position moves against them, they may take a loss on it. Same if a loan defaults.
@y
ReplyDelete"The point is that there are assets owned by foreigners. That's what 'CAD' generally refers to. It makes no sense to say that "it doesn't exist". "
You are missing the entire point of the discussion - a discussion of a closed system - the non-government.
I'm not saying that literally CAD doesn't exist. I'm saying that as I have defined the system boundaries, mathematically CAD has no relevance.
The closed system as defined includes net dollar and dollar-denominated financial assets created by the government. It doesn't matter who holds them. It has been reduced to a simple math problem.
The discussion is about the quantity in existence and what it would take to increase or decrease them.
There is no entity within the system as defined that can increase or decrease NFA's.
The quantity is fixed, finite and unchangeable without net government spending negative or positive (deficit or surplus).
If that does not make sense to you I suggest you try to learn more about closed systems. Although the concepts may be abstract, they are quite simple and very powerful.
I appreciate you making the effort to address my comments.
http://en.wikipedia.org/wiki/Closed_system
ReplyDeletepoking around and I found this:
ReplyDeletehttp://en.wikipedia.org/wiki/Open_system_(system_theory)
"Open System"
Excerpt: "In the social sciences an open system is a process that exchanges material, energy, people, capital and information with its environment......... David Harvey uses this to argue that when systems such as capitalism enter a phase of crisis, it could happen through one of a number of elements, such as gender roles, the relation to nature/the environment, or crises in accumulation.[5] Looking at the crisis in accumulation, Harvey argues that phenomena such as foreign direct investment, privatization of state-owned resources, and accumulation by dispossession act as necessary outlets when capital has overaccumulated too much in private hands and cannot circulate effectively in the marketplace."
??????? 'Capital' can 'circulate'?
Looks like some look at all of this as some sort of OPEN System...
Previous post on Harvey:
ReplyDeletehttp://mikenormaneconomics.blogspot.com/2011/12/enigma-of-capital-and-money.html
Harvey: "Capital is not a thing but a process in which money is perpetually sent in search of more money."
"Capital Flight" then: A process in which money is sent in search of more money rapidly flows out of a country.... Whaaaaaaaat??????
When funds flow into a country from outside through investment, real or financial, asset prices are driven up and this can leads to goods prices increasing, too. I.e., capital inflow is stimulative and can become inflationary. When the country raises interest rates to quell inflation, that attracts more foreign funds, the increased demand pushing up the value of the currency, adversely affecting exports. All this can have a destabilizing effect, which eventually drive capital away to a safer parking place.
ReplyDeleteWhen capital is withdrawn from a country by foreigners selling assets, real or financial, asset prices fall and this is disinflationary.
Smaller emerging economies are susceptible to buffeting as a result and may resort to capital controls or at least threaten it, as Brazil did recently.
Free capital flow is a cornerstone of neoliberalism along with "free" (unregulated) markets and free trade. It's the price that emerging nations have to pay to get in the game.
I should add that "capital flight" is usually used to mean the flight to safety, but it can also mean capital leaving a country in search of better return, capital "naturally" seeking maximum risk-weighed return.
ReplyDeleteAndy Grove has been complaining about capital flight from the US to the emerging world where investment opportunity is perceived as better. and rather than increasing investment in the US, other countries just seek to increase exports to the US.
Grove claims that this is seriously damaging the US productive economy, and the US needs to address it.
@ Matt
ReplyDeleteHarvey: "Capital is not a thing but a process in which money is perpetually sent in search of more money."
That's Marx's M - C - M' in words to which Kenyes then added C - M - C'.
@ Tom @ 10:40 & 10:49
ReplyDeleteThe way I understand Warren is, that to him the process of capital flight that you describe is completely analogous to domestic movements in asset prices. The closed system argument. People either invest or disinvest - the private buffer stock being government provided public equity, aka money/bonds. It is the unlimited provision of public liquidity through functional finance and the subsequent stabilisation of interest rates that counteracts and thus supposedly disincentivises erratic movements in and out of assets in the first place. The other contention is that functional finance with ELR will serve to maximise the real capital value within a currency area over the medium to long term by maintaining full employment.
Where I see Ramanan's point, and this touches with Matt's comment from above about Marx's M-C-M' as well as your's, is that the capital owners are a: not in it for the long run and b: don't give a flying f**k about fundamentals or their own role in nurturing them, as long as they can extract a reasonable rent and feel secure that there's an exit. In cross border trade, because country b may be doing something completely different from country a, this causes great fluctuations that are disruptive. Hence the de facto need for buffer stocks and the call for, dare I say it, concerted action.
It's a question of who is slave to whom (in the real world, that is). And in this sense I think more extreme or simplified readings of MMT tend to be somewhat naïve in their belief in the powers of the currency issuing entity to disincentivise and counteract flows of capital. Clinging to the idea of a stable, closed system is futile if the notional value of the underlying real economy fluctuates around it. Attempts to euthenise the rentier capitalists will just drive them somewhere else. That's a dilemma inherent to capitalism that no amount of functional finance will resolve.
Having said that, my personal reading of MMT, is that it is acutally an attempt to frame an economy from a distinctly real, as opposed to financial, perspective. All things financial are subsidiary to the primary goal of full employment. If, for a small, open economy, this may necessitates capital controls or the like, so be it. It's just a more optimistic way of looking at the world than through circuitist lenses. And we certainly need optimism right now.
@ Tom @ 10:40 & 10:49
ReplyDeleteThe way I understand Warren is, that to him the process of capital flight that you describe is completely analogous to domestic movements in asset prices. The closed system argument. People either invest or disinvest - the private buffer stock being government provided public equity, aka money/bonds. It is the unlimited provision of public liquidity through functional finance and the subsequent stabilisation of interest rates that counteracts and thus supposedly disincentivises erratic movements in and out of assets in the first place. The other contention is that functional finance with ELR will serve to maximise the real capital value within a currency area over the medium to long term by maintaining full employment.
Where I see Ramanan's point, and this touches with Matt's comment from above about Marx's M-C-M' as well as your's, is that the capital owners are a: not in it for the long run and b: don't give a flying f**k about fundamentals or their own role in nurturing them, as long as they can extract a reasonable rent and feel secure that there's an exit. In cross border trade, because country b may be doing something completely different from country a, this causes great fluctuations that are disruptive. Hence the de facto need for buffer stocks and the call for, dare I say it, concerted action.
It's a question of who is slave to whom (in the real world, that is). And in this sense I think more extreme or simplified readings of MMT tend to be somewhat naïve in their belief in the powers of the currency issuing entity to disincentivise and counteract flows of capital. Clinging to the idea of a stable, closed system is futile if the notional value of the underlying real economy fluctuates around it. Attempts to euthenise the rentier capitalists will just drive them somewhere else. That's a dilemma inherent to capitalism that no amount of functional finance will resolve.
Having said that, my personal reading of MMT, is that it is acutally an attempt to frame an economy from a distinctly real, as opposed to financial, perspective. All things financial are subsidiary to the primary goal of full employment. If, for a small, open economy, this may necessitates capital controls or the like, so be it. It's just a more optimistic way of looking at the world than through circuitist lenses. And we certainly need optimism right now.
Oliver thanks...
ReplyDeleteFor myself, I can see how a corp could move their equipment to another country and set up manufacturing operations over there and pay people in the new country in local currency to operate the relocated equipment. Then export from that country even back into the country that was their former home if they still wanted the former country's currency.
This I can understand.
But I would think that equipment would be on the corps balance sheet as 'Assets' not 'Capital'.
So I would perhaps call that 'Asset Flight'. Assets that were probably already depreciated to zero btw.
Tom above says: "When funds flow into a country from outside through investment" I cannot fathom how that can happen???? How can I take my USDs to the UK and "invest them"; do not they use a different currency system in the UK?
This would violate the system boundary of what is a closed system. In this case the closed system is the "USD System" if you will.
This talk of 'Capital Flight' makes no sense to me (I believe mine is a 'mathematical brain' vice 'semantic brain') ... I view it as some sort of sophistry as I recoil at the thought of a boundary violation of a closed system as being possible (can't happen in my world).
Resp,
Oliver,
ReplyDeletePS, I dont think Harvey knows what "money" is.... Harvey is out of paradigm imo.
If he doesnt know what "money" is then he doesnt know what "capital" is either because he uses the word "money" (which he doesnt know what it is) TWICE in his definition of "capital"... and he has been teaching a book titled "Capital" for 40 years! And he doesnt even know what it is!
resp,
"Looks like some look at all of this as some sort of OPEN System... "
ReplyDeleteIt depends on the way we define the system boundary.
MMT defines the system as "closed" wrt the quantity of NFA's - the closed system is the sectoral balances relationship.
If no amount of economic activity can change the quantity of NFA's within the system then it follows that nominal growth is impossible without expansion of the persistent money supply.
Note that it is possible for the economy to grow due to credit. The gotcha is that when credit exceeds the ability of the agents income to service, the economy will contract and growth will go negative, so the net is near zero.
Obviously all of the stuff created during the expansion doesn't disappear but agents are saddled with nominal losses that can't be gotten rid of without a reset.
@Matt
ReplyDelete"PS, I dont think Harvey knows what "money" is.... Harvey is out of paradigm imo."
I'm not sure he's out of paradigm so much as he is caught up in semantic argumentation which, inevitably it appears, generates a lot of confusion, which math avoids (assuming an understanding of math).
I think moving back and forth between the semantic and the math introduces misunderstandings that probably can't be avoided because communication is a caricature of reality.
Why do laws and legislation have so many unintended consequences?
So look what pops up today over at Naked Capitalism:
ReplyDeletehttp://www.nakedcapitalism.com/2012/05/anonymous-the-fable-of-moral-arithmetic.html
Interesting.
Paul,
ReplyDeletehttp://en.wikipedia.org/wiki/Capital,_Volume_I
This from Marx: "Since every commodity disappears when it becomes money it is impossible to tell from the money itself how it got into the hands of its possessor, or what article has been changed into it"
???????
Reads like a Harry Potter book to me.
I think I would flunk Harvey's course for sure if I didn't end up getting thrown out!
I guess it takes all types of people....
resp,
Paul,
ReplyDeleteThanks yes that is good over at NC...
Sounds like it was Dan that wrote that (maybe) ;)
Resp,
Matt,
ReplyDeleteIt's the same guy that wrote this the other day:
http://mikenormaneconomics.blogspot.com/2012/05/j-d-alt-semantic-problem-with-mmt.html
@ Matt
ReplyDeleteBut I would think that equipment would be on the corps balance sheet as 'Assets' not 'Capital'.
As far as I know, Marx uses the term 'capital' in the sense of physical assets used as intermediaries in production. I.e. machines, land and the like.
I only managed 2 of Harvey's lectures, let alone any of Marx himself - I just haven't got the time - but as I understand it, Marx's main concern, and to me the crux of the matter, lies in the theory of value. He doesn't even touch money which is probably why he can still be considered relevant today. Had he done so, he would have probably relied heavily on his peers - to his own disadvantage in this case.
Anyway, forget companies moving equipment abroad for a moment and ask yourself by which mechanism(s) and through how many value translations the domestic factory, its machines and/or its workers translate, first into corporate financial claims and then into claims on government. All value estimates are notional, all three are constantly in flow and subsequently the VALUE of each (conveniently denominated in local fiat terms) will be subject to relative changes. I.e. they float. Already, without even looking abroad, and forgetting the complexities of stocks and flows for a minute, you have 3 separate systems that interact with each other. And it's what happens between them that determines the stability and attractiveness of an economy as a whole. The absolute amount of bank, central bank or government credit is secondary to any such considerations although an elastic supply of the latter 2 may help contain swings in overall domestic, i.e. nominal financial wealth to some degree. I don't think it can somehow preserve the wealth of a nation or currency area though, which must always be seen in comparison to others. Wealth is always relative.
Consider the example of a general sell-off of corporate papers. While corporate wealth sinks, other wealth must rise, either with more money or through deflation. So far, so good. Now, a large number of holders of government fiat suddenly want to invest in Brazil by exchanging their $ for Reais and buying Brazilian corporates. This drives down the VALUE of all outstanding $ denominated financial assets relative to assets denominated in Reais, rtiggering further movements in that direction. No equipment needs to leave the country - i.e. the underlying fundamentals need not change for there to be large swings in value. For nations that rely on imports for large parts of their economy, such as developing nations or small, open economies, this represents a problems that may be worth addressing by managing the currency and / or having capital controls.
Oliver thanks,
ReplyDelete"Now, a large number of holders of government fiat suddenly want to invest in Brazil by exchanging their $ for Reals"
This part of it: "exchanging their $ for Reals" seems impossible to me... this simply cannot be done, it cannot happen.
This is describing some type of confluence of two completely separate closed systems, which is impossible.
I'm not arguing with you Oliver, trying to just reveal how my mind (and the mind of many others imo) works...
Resp,
@Matt
ReplyDelete"This part of it: "exchanging their $ for Reals" seems impossible to me... this simply cannot be done, it cannot happen."
In my view all this exchange does is re-distribute dollars in the closed economy to a place where they don't do
the domestic economy any good.
Kind of like savings. Good for the saver, bad for everyone else.
No dollars were destroyed or created through the exchange operation.
Everything is the same except the dollars are rendered useless to Americans.
They may have well been destroyed from our perspective.
By what mechanism does the value of 1 piece of Apple stock fluctuate vis à vis the US$, assuming # of stock and # of $ are constant. The way I interpret your answer, this can't happen and yet it obviously does.
ReplyDeleteBut I think I see what you mean. The $ remain in the system. My point was, they are now worth less. A Dollar is a Dollar, but it isn't a Real. Nor is it worth anything without reference to what it can buy, or at least to what you think it can or will at some point buy. Happiness, e.g. :-).
@Oliver
ReplyDeleteValue is "squishy".
There is no one-to-one relationship between the value of Apple stock and nominal dollars.
That's why value and "real" is so misleading in discussion of economies.
Value and gains can't be realized unless followed through to some extent by money printing.
I say "some extent" because agents don't all "cash out" at the same time.
The system is heavily leveraged.
"…My point was, they are now worth less…"
ReplyDeleteDollars aren't "worth" anything. They aren't a store of value.
Dollars are a measure of value, value is relative, and everything needs an anchor for comparison purposes.
Lets say the dollars exchange for less.
Dollars are worth whatever they will buy at any given moment.
If I get lucky and buy a Tiffany lamp at a garage sale for $50.00 that is really worth $10,000, how much is a dollar worth?
Value is "squishy".
ReplyDeleteThe world is squishy. Squishy is where the juice is. And any theory of the world that doesn't do squishy, doesn't describe the world.
Dollars aren't "worth" anything. They aren't a store of value.
Well, in philosophical terms I agree, but we do expect it to act in such a manner and price stability is in most every CB mandate. Even MMT puts it slap bang in the middle - full employment & price stability.
Oliver
ReplyDeleteI'm just making the point that value is based largely on leverage.
The "squishy" world is mostly untethered from the nominal one.
Individuals can work within this "squishiness" and attempt to extract their share. All they are doing is moving piles of dollars from one place in the economy to another.
In the aggregate this can't work.
What happens if all the dollars end up in one pile?
There is a transfer function between nominal and real of some sort but it is non-linear and at least for now, unknown.
Observation of nominal flows and constraints based on simple math will steer us away from policies that can't work by arithmetic.
Then we can focus on the ones that can.
Yes, it can help, but isn't the whole story.
ReplyDeleteOliver,
ReplyDelete"Yes, it can help, but isn't the whole story."
No one is claiming otherwise. Ignoring it or misunderstanding it can do a lot of damage. Unforced errors.
"By what mechanism does the value of 1 piece of Apple stock fluctuate vis à vis the US$, assuming # of stock and # of $ are constant. The way I interpret your answer, this can't happen and yet it obviously does."
There is no direct relationship between the number of dollars in the system and the value of some real asset.
As I said value is "squishy" and the transfer function, if there is one, is unknown.
Why would the value of an asset not fluctuate, even as the number of nominal NFA's remains fixed?
Oliver is having trouble disconnecting NFAs from real assets...
ReplyDeleteThis is not a criticism Oliver...
Resp,
And before you label me a montarist, I might add that endogenous money, as embraced by circuit theorists, PKers and MMTers, solves the problem of currency system internal value fluctuations quite elegantly. It doesn't address the external sector, though. Some PKers seem to prefer managing exchange rates, even reintroducing a gold standard, MMTers just say f***k it, let it float and the rest will follow. I personally don't think there's a 'one size fits all' answer, nor is it probably quite that simple a dichotomy. But staying focussed on fundementals instead of engaging in 11-dimensional fx chess certainly seems like a good strategy.
ReplyDelete@ Matt
ReplyDeleteHave I gone down the monetarist rabbit hole? I hope not. I'm all for clean cut analysis, but it just seems at some point one needs to REconnect spheres of thought in order to deepen one's analysis. Or where do you see my fundamental error? I'm no physicist or methematician...
The classical meaning of "capital" is the means of production, i.e., what we now call "capital goods" in the from of real assets on a balance sheet. Real investment is in capital goods, while financial investment in the saving of funds that can be used subsequently for investment in capital goods, or have already been so invested, i.e., equity shares. These are not accounting terms so the colloquial meanings are slippery and imprecise.
ReplyDeleteThe major difference between mainstream economists and Keynesians of all strips but New Keynesians is that the Keynesian position is that modern capitalism is financial in nature and failure to take this into account vitiates any economic theory, e.g., those theories that subscribe to money neutrality.
Modern capitalism is based on free flow of capital internationally. They results in a number of problems including what is called "capital flight," which generally means that funds flow into an economy, usually a "hot" emerging one, as money managers seek to take advantage of greater return. Sine the trade is one-sided, there is significant exposure to that capital leaving suddenly either when returns seem more promising elsewhere or problems develop in the economy.
Matt asks how it is possible. Well if interest rates rise to give risk-weighted advantage, somewhere, then "financial capital" will flow into that country. USD, euro, yen, etc, are converted into, say, Brazilian real or Thai bhat and saved as govt or corp bonds, for instance, which funds are then used domestically for expansion. If the wind shifts, then the funds are converted in the other direction, often suddenly if there are lot of people involved. Moreover, a lot of this involves carry trade, and the conditions can shift from the other side of the trade, too, reducing the profitability and resulting it an exit.
These have been regular occurrences over the recent decades, and many countries consider "global hot money" a problem for their stability.
Oliver,
ReplyDeleteDiscussing these things rather than waving them off is healthy.
We all can learn from the exchange.
I learn because you ask questions I haven't asked myself and it forces me to think.
I don't always force myself to think, being naturally lazy.
Matt: "This part of it: "exchanging their $ for Reals" seems impossible to me... this simply cannot be done, it cannot happen."
ReplyDeleteI don't understand. "Foreign exchange" means exchanging one currency for another, which is necessary for all cross border transactions involving different currencies.
If I as an American want to buy equities in the EZ or China, I first have to exchange the equivalent amount of USD for euro or yuan at the going rate at the time unless I have a euro or yuan account with sufficient funds.
"No dollars were destroyed or created through the exchange operation. Everything is the same except the dollars are rendered useless to Americans."
ReplyDeleteThe point is that use of $ for investment did not happen but rather use in real or yuan or whatever. Of course, the $ are still in the currency zone, but they may be saved rather than used for investment, which is what is happening in the US at present. E.g., US corps are investing abroad and saving at home.
Tom,
ReplyDeleteThis is from over at Warren's recently:
Mammoth: "Do you have any links to MMT literature on capital flight?"
Warren: "there are probably brief discussions somewhere in the mandatory readings and elsewhere on this website.
there isn’t much to talk about because there is no such thing with non convertible currency/floating fx.
and with fixed fx it’s easy- people ‘cash in’ the convertible currency for the gov’s reserves."
I think I see what Warren is saying...
Let me chew on this a while for both you and Oliver here... I think we are on to something here...
Resp,
The essence of market capitalism is price wrt value. Price is the nominal representation of real value. Actual value is priced through the discovery process that free markets provide. This is the essence of "the invisible hand."
ReplyDeleteNew Classical economists presume that price is identical with value, which is a basis of money neutrality. Money is only veil over barter that contributes nothing but convenience in exchange by storing value for subsequent use in exchange. (This is why the fetish over price stability.)
Thus, in this view, market price is the best guess at approximating real value across time under conditions of rational agents pursuing max u in an environment of perfect knowledge and perfect competition.
Keynesians hold that this view is based on assumptions that are too simplistic to fit reality. Markets are not perfectly competitive, knowledge is not perfect, and agents are often driven by "animal spirits," e.g., fear and greed.
Therefore, price and value can become dissociated in the imperfect discovery process of market pricing. Moreover, many markets are heavily influenced by monopoly conditions, as well as cheating.
Traders recognize that price fluctuates around a mean, which is indicative of the actual value, and this is only discovered in hindsight. The challenge is making the best guess in approximating not actual value but market movements in which the movement itself influences the market, what Soros calls reflexivity. Traders are largely attempting to anticipate other traders by discovering patterns of behavior. But discovery of these patterns changes the patterns.
This is what technical analysis is mostly about, for example. Technical analysis attempts to predict future price action based on past price action in terms of fluctuations around actual value, hourly, daily, short term, intermediate term, and long term. Presently, the best mathematical minds available are employed in this endeavor, which means diverting mathematicians, physicists, and other scientists and engineers from productive enterprise into financial pursuits that are essentially extractive.
@ Matt
ReplyDeleteYes under a convertible system there can be real capital flight as gold and silver shift across borders.
Under convertibility, there is no advantage in a trade deficit in real terms, because another real asset is automatically exchanged. They actually moved gold bars around in the vault deep under the FRBNY building prior to Nixon's shutting the gold window.
So in that sense there is no (real) capital flight under a floating rate system.
But that doesn't mean that fx issues can't arise either. They do.
Warren's point is that they can be dealt with intelligently if one understands the system instead of letting them blow things up periodically, which is just stupid. That's not possible under a convertible system. I.e., there's less policy space.
@Tom
ReplyDelete"Warren's point is that they can be dealt with intelligently if one understands the system instead of letting them blow things up periodically, which is just stupid."
Not a great deal different than the private debt issue, which could also blow things up if we were stupid. Oh, wait…
@ paul,
ReplyDeleteRight, Warren's point is two-fold. First, we aren't using the policy space that the existing monetary system affords and secondly, key institutional arrangements are skewed and need to be fixed. The former is usually associated with MMT and the later with institutionalism and Minsky. But as Scott Fullwiler points out, the MMT professional literature shows that Minsky and institutionalism are a key aspect of MMT, too.
@ Tom
ReplyDeleteThanks for your elucidation. Very clear.
And to your last point. I agree, accommodate and regulate are two sides of the same coin. There's a qualitative side to the quantitative argument. The conventional position is that one must regulate by not being to accommodative - which to me is a purely quantitative view of the world and a dangerous one too.
There has to be a balance between accommodation and regulation, or easy accommodation will result in moral hazard. Conversely, over-regulation will lead to underperformance.
ReplyDelete