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Government Financial Asset Addition = “Deficit”; Government Financial Asset Destruction = “Surplus”

12:50 pm in Uncategorized by letsgetitdone

The word “deficit,” when applied to the Government financial accounting of a monetarily sovereign nation, that is, one that issues a non-convertible fiat currency, with a floating exchange rate, and no debts in a currency it doesn’t issue, is a problem, because the label “deficit” when applied to such a Government doesn’t mean what most people think it means. As Michel Hoexter points out:

. . . The word “deficit” is a hold-over from conventional accounting and the era of the gold-standard when currencies were supposed to be fixed in their quantity by convertibility of the currency into a fixed quantity of precious metal. Deficit means primarily a “lack”, an “absence” and in conventional accounting it means being “in the red”, not having taken in enough income to cover expenditures. . . .

Euros on a monopoly board.

Maybe to fix the 'deficit' we must redefine our terms.

The term “deficit” in this sense can be properly applied to households, corporations, other private and inter-governmental organizations, and states and nations that aren’t monetarily sovereign such as the US States and the members of the Eurozone. In all these instances the governments involved can run out of money, and the more deficits they run, the more the risk that they will become insolvent increases. But when that term is applied to monetarily sovereign nations, then the “deficit” notion is profoundly misleading because neither the size of the “deficit,” nor its accumulation over time when it is accompanied by selling debt instruments, makes a bit of difference when it comes to solvency, because monetarily sovereign governments always have unlimited power to issue currency, if they decide to remove all self-imposed constraints on currency issuance and use that power.

There’s a corresponding problem with the term “surplus” as applied to monetarily sovereign Government accounting. Surpluses are supposed to represent the situation where tax revenues exceed spending and the gap between them is described as net “savings” increasing the financial assets of the Government running the surplus. A surplus over a particular time period is viewed as being “in the black” for that time period, as a good thing for the Government doing it, and as reducing the “debt” of that government giving it an increased financial capability to spend in the future.

The term “surplus” in this sense can be properly applied to households, corporations, other private and inter-governmental organizations, and states and nations that aren’t monetarily sovereign such as the US States and the members of the Eurozone. In all these instances the governments involved can accumulate surpluses as financial assets, and the more surpluses they run, the more the risk that they will become insolvent decreases. But when that term is applied to monetarily sovereign nations, then the “surplus” notion is also profoundly misleading because neither the size of the “surplus” during a time period, nor its accumulation over time, makes a bit of difference when it comes to solvency, or adding to the government’s capability to spend in its own currency either currently or in the future.

So, from the viewpoint of Modern Money Theory (MMT), both the terms “deficit” and “surplus,” and also the term “national debt” are misleading when applied to monetarily sovereign nations. Recognizing this, some of us have been kicking around the idea of using new terminology for talking about national financial accounting. In the recent post by Michael Hoexter I referred to earlier he proposes:

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The President Needs To Stop Demonstrating His Ignorance About National Income Accounting

9:45 am in Uncategorized by letsgetitdone

On Monday, Dean Baker decided that Robert Samuelson needed a lesson in National Income Accounting. Dean said:

”National income really is very basic stuff. It gets taught in every intro econ class. Anyone writing on economics should know it inside out. They should be able to do it blindfolded, with one hand tied behind their back, and standing upside down.
Unfortunately, it seems that most people reporting and writing on economics for major news outlets can’t do national income accounting at all. Let’s take Robert Samuelson at the Washington Post. I had a lesson on this topic for him last month, which I won’t repeat here.

But his column today really would benefit enormously from an understanding of national income accounting. He is asking why the economy has not recovered despite President Obama’s stimulus. His answer is that firms are not investing because of regulatory uncertainty created by President Obama’s health care plan and other measures and that consumers are worried after the collapse of the housing bubble and therefore not spending money.
See, if Robert Samuelson understood national income accounting, he would know that there really is no problem with either investment or consumption. Investment in equipment and software has pretty much risen back to its pre-recession level as a share of GDP. This is actually quite impressive, since there is a huge amount of excess capacity in most sectors of the economy.

Consumption is actually high, not low. The saving rate is hovering near 5.0 percent. This is well-below its post-war average of 8.0 percent, before the wealth created by the stock and housing bubbles sparked a consumption boom.

So, if neither investment nor consumption is the problem, then why isn’t the economy bouncing back? This is where national income accounting would be very useful to Mr. Samuelson. The problem is that the country has a large trade deficit. It is close to 4.0 percent of GDP now, and would likely be in the 5-6 percent range if we were back at full employment. (Higher GDP increases imports, which would increase the size of the deficit.) This creates a huge shortfall in demand.
This shortfall was filled during the housing bubble years by a consumption boom and boom in residential construction and some categories of non-residential construction. With the loss of housing bubble wealth, there is no reason to expect consumption to return to its bubble levels. Nor would this be desirable, since it would mean that families are not saving adequately for retirement even as the nation’s elite (e.g. the Washington Post, Peter Peterson, etc.) are planning to cut back their Social Security and Medicare.

The only way to get close to full employment in the short-term is through much higher levels of deficit spending. In the longer term we will have to lower the value of the dollar to get the trade deficit closer to balanced.

It really is that simple. The problem is not regulation, taxes, or uncertainty, the problem was that the stimulus was not big enough or long enough. As it is, we are sitting around watching our national leaders debate why the water that they heated to 160 degrees is not boiling. This is getting really painful.

It’s too bad Dean Baker can’t teach a little bit of National Income Accounting to President Obama, as well, since there is no one who is in need of such lessons more. In his long-awaited jobs speech, and ever since, Mr. “I understand the economy.” and his chorus of paid retainers have boasted that his proposed job legislation is fully paid for, as if this were a good thing, when all it does is demonstrate that all of them are ignorant of the most fundamental National Income Accounting relationships.

The role of Federal spending, can be better understood by looking at the Sectoral Financial Balance Model accounting identity I’ve referred to before. It is:

Private Sector Surplus – the Current Account Balance – the Government Deficit = Zero.

In a country like the US, with a fiat currency system, floating exchange rates, no debts in any other currency, and a negative current account balance, the identity tells us that the only way we can have a private sector surplus (private sector savings) is for the Government sector to run a deficit. That deficit must be great enough to balance the sum of the balance of payments deficit, and the total amount of private savings. So, in general, the more deficit spending by the Government, the more savings by the private sector, other things being equal. For private savings in the aggregate to increase over time in a situation like this, Government deficit spending also must continue and increase.

In addition to supporting and increasing private savings, Government deficit spending, when directed toward domestic needs like infrastructure, education, innovation, and other human needs, creates a structure of public goods that supports economic activity and growth, without at the same time reducing demand through taxation. The consequence of constraining Government deficit spending over a long period is declining shared “commons” capital that all of us can use to facilitate our economic activity.

In short, it is not good news that Mr. Obama’s jobs program “is all paid for.” And it is even worse news that he continues to believe that Government spending designed to solve problems needs to be “paid for.” It is even worse news because it tells us that he doesn’t understand the basics of National Income Accounting, and that means that he is unqualified to be the President of the United States because he will never be able to lead us out of this recession and create full employment. He should resign and give Joe Biden a chance, before he destroys the Democratic Party and and all it stands for.

(Cross-posted from Correntewire).

Stephanie Kelton and the Catfood Commission: “I Know Which Scenario Benefits Me; Do You?”

9:01 am in Uncategorized by letsgetitdone

In a beautifully simple post that should crystallize everything for you, Professor Stephanie Kelton of the University of Missouri at Kansas crystallizes the logic of the Sectoral Financial Balance Model for President, Obama, the Catfood Commission, the deficit hawks and doves and you and me. She says:

In a ‘closed economy’ (one without foreign trade), the government’s budget position is, by accounting logic — the negative of the private sector’s (firms and households combined) position. Thus, a public sector DEFICIT is equal to the private sector’s SURPLUS. To the penny.

So, in a closed economy, a Federal Government budget deficit adds to private sector financial assets, while a Government surplus represents a leakage and subtracts financial assets from the private sector. Or more briefly, Government deficits make private individuals richer; Government surpluses make private individuals poorer.

Of course, we don’t have a closed economy, we have an open one. We have to consider the foreign trade sector too. So:

. . . like a government SURPLUS, a trade DEFICIT reduces the private sector SURPLUS, which creates an even bigger need for a public sector deficit.

Or, in other words, a trade deficit makes the private sector poorer in financial assets, while a trade surplus adds to private sector financial assets. Combining all three sectors and the current condition of the United States, Stephanie concludes:

As long as we (Americans) continue to run trade deficits, there are only two options: (1) the government runs deficits (and they must be at least as large as the trade deficit), or (2) the rest of us do. I know which scenario benefits me. Do you?

I think that most of us, including the President and all the other hawks either don’t, or are deliberately trying to make people poorer, or there wouldn’t be any Catfood Commission. Think about it. The Catfooders want to reduce or eliminate the deficit and one day even get to a surplus. And they want to do that by implementing cuts that will take effect on a time schedule without regard to economic conditions at that time.

So, Government spending is to be cut beginning in 2012. But what if we’re not out of our sick economy then and still have high levels of unemployed? Then we’ll be taking away demand from the private sector and, assuming we still have a trade deficit, condemning the economy to either a downturn, or a private debt-financed expansion (credit bubbles again). And what if we’re still in a depressed state by 2015? Then we’ll be facing mandated spending cuts of $427 Billion or so (according to Jan Schakowsky’s new “progressive” deficit reduction plan), at a time when we will still need the additions to private sector financial assets that Government deficits provide.

Even worse, larger cuts over the years proposed by the Commission will provide a continuous drag on the economy and the well-being of our children and grandchildren without regard to current economic conditions in the out tears. The insanity of the Catfood Commission and the deficit hawks is that Government economic policy ought to be put into a framework of constraints by us now without regard to economic conditions that may obtain in the future. This is an engineer’s newtonian approach to the economy. The economy, however, is a complex adaptive system and both it and we have to adapt as we go along.

Our most important tool for adaptation is the capability of the Federal Government to add financial assets to the private sector when demand is slack and those assets are needed, and to subtract such assets by taxing when demand is overheated and we see inflation. These powers of the Federal Government should never be constrained or compromised on the basis of a long-term plan of any kind, because they are our most important tools for coping with unexpected and unwelcome change.

The President, the deficit hawks, and even the deficit doves, by focusing on a non-existent long-term debt/insolvency fantasy (see Stephanie Kelton on solvency too), rather than trying to produce full employment and price stability in the here and now, don’t know what’s good for them and us. We need them off our backs. They’re the problem; not the solution!

(Cross-posted at All Life Is Problem Solving and Fiscal Sustainability).

Jamie Galbraith’s “Foreword” To Modern Money: A Commentary

7:00 am in Uncategorized by letsgetitdone

Warren Mosler has an important forthcoming book called The Seven Deadly Innocent Frauds, which is, fortunately, available right now in a pre-publication version for reading and commenting from Warren’s site.

Jamie Galbraith, Warren’s friend and occasional co-author has recently written a Foreword to the book, which also can serve as a Foreword to the Modern Money (or Monetary) approach to economics. I think the foreword is important enough in itself that I decided to comment on it. That commentary is the subject of this blog post. I’ve arranged the post as a series of quotes and additional, hopefully, value-added, comments on what Jamie said.

Warren Mosler is a rare bird. A self-taught economist who is not a crank. A successful investor who is not a blowhard. A business person with a talent for teaching. A financier with a true commitment to the public good.

We have co-authored testimony and the occasional article, and I attest firmly that his contributions to those efforts exceeded mine.

Many economists value complexity for its own sake. A glance at any modern economics journal confirms this. A truly incomprehensible argument can bring a lot of prestige! The problem, though, is that when an argument appears incomprehensible, that often means the person making it doesn’t understand it either.

(I was just at a meeting of European central bankers and international monetary economists in Helsinki, Finland. After one paper, I asked a very distinguished economist from Sweden how many people he thought had followed the math. He said, "Zero.")

I really laughed at this. How many of us have had the experience of encountering someone who offered an incomprehensible argument, and then questioning that person, and finding that no matter how hard they tried, they really couldn’t explain what they meant. Leading to the conclusion that they really don’t understand their own view well enough to explain it to someone else. This observation is true all too often, and reminds me of one of the themes of John Kenneth Galbraith’s work, which always emphasized graceful expression and arguments that were very easy to understand and which avoided formal models based on the economic theory of markets, but instead focused on analysis of the relations between components of the economy governed by markets and other components that were not subject to them, but could manipulate them instead.

Warren’s gift is transparent lucidity. He thinks things through as simply as he can. (And he puts a lot of work into this – true simplicity is hard.) He favors the familiar metaphor, and the homely example. You can explain his reasoning to most children (at least, to mine), to any college student, and to any player in the financial markets. Only economists, with their powerful loyalty to fixed ideas, have trouble with it. Politicians, of course, often do understand, but rarely feel free to speak their own minds.

Simplicity is the distinguishing feature of Warren’s work. Other, MMT practitioners, Jamie himself, Randy Wray, Bill Mitchell, Marshall Auerback, Stephanie Kelton, and Pavlina Tcherneva all write very well and are cultivating the art of communicating ideas to people who aren’t economists. They’re remarkable in that way, and any one of them can exhibit extraordinary simplicity in anything they write. But for putting things simply on topic after topic in a book length presentation, Warren is unequaled in his success in doing that, and this whole book reflects that success. It’s a beautifully simple and painless introduction to a difficult subject.

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Hoover or FDR?

2:24 pm in Uncategorized by letsgetitdone

Sometime during the past 32 years many prominent Democrats forgot the lessons of the Great Depression, or never learned them, and, instead, absorbed the lessons of Hooverism, in part from Ronald Reagan who believed in the religion of free market capitalism, and also in the derivative idea that real economic growth always come from the private sector, but also, in part, I think, from Democratic opposition to Reagan’s deficit’s, which they opposed, not simply because they were incurred to give tax cuts to the rich, but also, on the old-time religious grounds that balanced budgets and surpluses should be the norm for a virtuous America.

Bill Clinton reinforced the old-time religion when his restrained public spending coupled with good economic fortune in the private sector, led to higher Federal revenues, and to surpluses in the last years of his Administration. Democrats since have taken these surpluses as points of pride, and proof that it is the Democratic Party that is fiscally responsible, and not the Republicans, who shortly after the accession of George W. Bush returned to deficit spending. In taking pride in Clinton’s “achievement,” Democrats have conveniently ignored that the very end of the Clinton Administration was marked by a recession following the collapse of the Internet bubble of 1999. They make no connection between the appearance of that recession, and the Administration’s insistence on managing for budget surpluses rather than for economic development and job growth. Read the rest of this entry →