MMT: A few thoughts on austerity, currency wars and exchange rates
Given the push toward austerity, I want to make a few remarks about the intersection of full employment with trade and exchange rates. It all begins with the British austerity budget. In regards to that budget, recently presented by the coalition government in the UK, I would say you can’t reduce the budget deficit more (and increase private savings) without a sharp fall in the currency. It’s the tyranny of accounting 101. In the American context, US Treasury Secretary Geithner’s focus on China as the problem is wrong, but there is a perverse logic to his policy.
A sensibly constructed fiscal policy which incorporates a Job Guarantee program would be great. But It is not going to happen any time soon. So, failing that, there clearly is a big problem, which is why I am worried about China’s export wave which is now hitting our shores. We’re clearly entering into a period of fiscal retrenchment (likely to increase after the mid-term elections in the US) and we are beginning to experience this tsunami of imports from China, which will create huge additional deterioration in our trade account. Since we’re unlikely to come up with a sufficiently robust fiscal response to offset the job losses, that spells trouble. We’re about to experience massive deterioration in the trade account in the US, along with sequential fiscal retrenchment, so we’ve got the makings of a disaster.
Should we blame China for that? Of course not, but the consequences of China’s fixed exchange rate policy along with our inclination to depress domestic demand via fiscal retrenchment has the makings of an economic disaster. As much as I very much agree with the theoretical argument of MMT’ers that exports are a cost and imports are a benefit, that theory is predicated on a full employment economy. And until full employment is reached, imports are only a potential benefit as I tried to explain, albeit not totally successfully in my latest interview at BNN (see here).
We have been saying for years that because exports are cost and imports a benefit, the US should maximize net imports. We have got absolutely no traction with this. It is easier to sell the sharing of underwear. Why? The reason, I am convinced, is because it is a contingent statement, true only at full employment. So while we are absolutely correct and we know how to get to full employment, no one is going to get on board until we do get to full employment and then it will be obvious to everyone that maximizing net imports is a good strategy. But we are years away from that happening.
It is far harder to make the case that it is an import that is a "good" and an export is a "bad", in an economy that is far below its production possibility curve (i.e., far below full employment). Higher exports could generate sufficient domestic growth of consumption so that, as much as you might be exporting an increasing amount of your domestic output to increase the per capita consumption of foreigners, there is also an accompanying increase in domestic consumption because of the multiplier effects domestically. Please remember that our per capita output and our per capita consumption does not only rise because of imports but also because we have more people employed! After all, while the Chinese are exporting ever more, they are also slowly increasing their own per capita consumption, especially as more and more of the disguised unemployed in the Chinese countryside become employed in the export sector. It’s harder in the US than, say, in Canada, but there’s a certain sectoral balances logic about it.
My view is that the US should be tougher in negotiating with China on the exchange rate. But is the right policy response to scapegoat China? No. The right policy response is to work toward a full employment policy. We’re not going to do that, and China is going to be hit with the collateral damage via a trade war. So they are doing themselves no favour by maintaining the pegged rate regime, which they should abandon as soon as possible.
The irony, of course, is that (as Warren Mosler, amongst others has noted before), when China does begin to construct policies which allows its population to fully consume the fruits of its own economic output, then we’ll be paying a lot more for basic stuff. Remember how great it felt to be paying $5.00 per gallon for gas during the oil run-up in the summer of 2008? That’s going to be child’s play compared to what’s ahead. But we don’t take advantage of the gift that China is giving us and things will get worse because we don’t understand basic public reserve accounting.
When I explained this all to my friend Lee Quantaince of QB Partners, he quipped:
Maybe the MMT’ers would get more traction if they said something like this?:
“Look, we get the joke that fiat currency systems are an illusion and doomed ultimately to failure. In the meantime, let’s maximize imports and minimize exports of anything that costs us a penny to produce. This system’s gonna eventually blow. Let’s milk it to the max for the time being.”
Clearly, Lee is not a fan of fiat money. Here’s what I would say in response.
I wouldn’t put it quite like that, but at least Lee acknowledges there is some logic to the accounting identities.
Look there’s a certain incoherence to Geithner’s proposals. I think we all agree with that. I do not know what, if any, economic theory guides Geithner’s thinking but it sure looks awfully confused—and what he advocates for China is precisely the opposite of the policy adopted in the US.
For example, the Fed appears to be doing everything it can to trash the US dollar—low interest rates, high job losses and unemployment, tanking financial markets, and dismantling the rule of law and any pretense that ethical behavior is expected of US firms. In other words, while the US accuses China of currency manipulation designed to increase its net exports, the US is trying to force a run out of the dollar to appreciate the currencies of our trading partners so that the US can export its way out of its Great Recession. How bizarre!
So we have a Treasury Secretary who refuses to respond to faltering domestic demand in the US, except by aiding and abetting bankers’ fraud, lecturing the Chinese about their excessively low interest rates—that he purports to hurt their savers, who need higher interest income so that they can spend more. Say what? Chairman Bernanke is doing his best to get the whole spectrum of US interest rates to zero—meaning OUR savers get nothing. Why isn’t he lecturing Bernanke on the evils of “QE2” instead?
Meanwhile, the Chinese have raised their rates in the face of fears that their economy is overheating. Yet Geithner lectures them on the necessity of pumping up their already booming domestic demand so that they can buy more US output. At the same time, he wants trade deficit countries like the US to boost saving and cut spending. Hold it, China is booming and he wants it to raise demand, while the US is slumping and he wants it to reduce demand?
We don’t need help from China to conduct our fiscal policy. But we have this bizarre fixation on current accounts.
No one in her right mind would worry about, say, a current account deficit for Manhattan or the State of New York, exactly equal to its capital account surplus. The rest of the nation (and world) produces the consumption goods NY wants, and NY produces the financial assets the rest of the nation (and world) wants. (OK, OK, in reality those were toxic waste assets that nobody wants, but bear with the hypothetical example.) No one admonishes the rest of the nation for running a “beggar thy neighbor” current account surplus against NY, or NY for “profligate” consumption based on “borrowing” from the rest of the nation. Yet when we discuss trade across national borders we do just that. Why? I suspect it is because we are then going across currency exchanges, which is just too confusing for most analysts—in large part because they instinctively think in gold standard terms. That is, the confusion is a relic of the gold standard, when the exporting nation got all the gold and the importers had to impose austerity to impoverish their populations to stem the flow. But since we dropped gold, that criticism of net exporters is no longer applicable.