The G20 Summit: Hijacked by Neo-liberalism
Thursday, 10/1/2009 - 4:57 pm by Marshall Auerback | 17 Comments
Roosevelt Institute Braintruster Marshall Auerback explains a few basics of deficits and saving– which global policy-makers ignore at our peril.
We’ve said it before and we’ll say it again. As a matter of national accounting, the domestic private sector cannot increase savings unless and until foreign or government sectors increase deficits. Call this the tyranny of double entry bookkeeping: the government’s deficit equals by identity the non-government’s surplus.
So, if the US private sector is to rebuild its balance sheet by spending less than its income, the government will have to spend more than its tax revenue. The only other possibility is that the rest of the world stops saving on a massive scale — letting the US run a current account surplus. But that is highly implausible and socially undesirable, since it means we export our economic output, rather than consume it domestically. And if the government deficit does not grow fast enough to meet the saving needs of the private domestic sector, national income will decline, which, given the size of the private sector’s debt problem, will generate a huge debt deflation.
This is the foundation of modern monetary theory. Would that the IMF and the G20 understood these basic facts. The anodyne communiqué from last weekend’s Pittsburgh summit makes clear that this is not the case. Western policy makers appear determined to consign us to years of additional economic misery because of the continued embrace of a flawed market fundamentalist economic paradigm.
So far, instead of trying to revive the productive economy, most of the G20’s resources have consisted of mouth-to-mouth resuscitation for a dying financial sector. This has not “worked” to the extent that last weekend’s communiqué advertised. The best analogy to describe the current state of our financial system is that we have placed scaffolding over a decaying building, but done little to repair the underlying structure. What happens when the economic scaffolding is removed via “exit strategies”, as the G20 participants have advocated?
For many generations, we didn’t face the unprecedented financial fragility we are experiencing today. But there are good reasons why we avoided this until recently. We have spent the past quarter century eviscerating what was fundamentally a robust structured originally devised during New Deal, a system which basically saved the US capitalist system and served the interests of its citizens very well until it was hijacked by a bunch of corporate predators under the guise of deregulation and neo-liberalism.
To read the communiqué from the Pittsburgh summit is to gain insight into an ideology which views government, not as a stabilizing influence protecting us from private sector rent seeking monopolists. Rather it’s an unwanted stepchild, brought out on display as a necessary evil, and destined to be shoved away as soon as we get back to a “normal” economic state of affairs, where the government minds its own business and lets the magic of the “free market” operate. Hence, the emphasis by the Pittsburgh summiteers on “sustained, strong and balanced growth“, the usual code words designed to encourage budget surpluses, more private sector savings and shift from public to private sources of demand.
There is little understanding that if households and firms try to net save (save more out of income flows than they tangibly invest) incomes collapse, and desired private net saving is thwarted. The private “excess saving” cannot exist without a budget deficit or a trade surplus. Many people make this mistake. At best, we can talk about planned private saving being in excess of planned private investment, but other than that, we are violating double entry book keeping principles.
And consider this: in 1998, 1999 and 2000 (increasing each year), the US government “virtuously” ran budget surpluses. And guess what happened? The private sector became more heavily indebted than before as the fiscal drag squeezed liquidity and destroyed aggregate demand and incomes. Along with our misconceived embrace of financial deregulation, the combined result was sharply rising unemployment and a major recession in 2001-02 with unemployment rising sharply and the automatic stabilizers pushing the budget back into deficit.
Unfortunately, that was the yellow flag for what was to follow, a warning signal blithely ignored by our economically illiterate policy makers. Instead, we perpetuated a massively leveraged financial system via Frankenstein financial products such as collateralized debt obligations, and credit default swaps. We squeezed private sector incomes via constrictive fiscal policy, thereby inducing the debt-fueled consumption that is now regularly decried by our officialdom and the commentariat.
The bottom line is that if we want habitual private sector savings, we need habitual government deficits.
And government deficits are not an aberration; they are the norm. Our first (and possibly greatest) Treasury Secretary, Alexander Hamilton, called the national debt a “national blessing”. Similarly, Paul Krugman and L Randall Wray have argued that it was World War II and the subsequent cold war that ended the depression, which created the foundations for a significant expansion of government debt, which in turn set the stage for the “Golden Age.” The government deficit reached 25 percent of GDP during the war, providing a massive amount of private sector saving in the form of safe financial assets that strengthened balance sheets. From 1960 onward, the baby boom drove rapid growth of state and local government spending, so that even though federal government spending remained relatively constant as a percent of GDP, total government spending grew rapidly until the 1970s. This pulled up aggregate demand and private sector incomes, and thus consumption.
This is unsurprising: The private sector cannot create “net nominal wealth” because every private financial asset is offset by a private financial liability. Over the long term, the maximum that a government can hope to collect in the form of taxes is equal to its purchases of goods of services. There is no hope of running long-term budget surpluses because the government cannot possibly collect more than the income it has created as it paid out dollars. When the government attempts this, as it did during the Clinton Administration, the public finds that its net financial assets would be less than its tax liability, requiring households to dip into its “reserves” of accumulated savings, which gradually become depleted. In the absence of other factors, demand slows and the government almost invariably falls back into deficit.
If an external creditor is added (such as China or Japan) it merely delays or extends the process, since for a time, countries running current account surpluses with the US can use their surplus dollars to accumulate additional US dollar financial claims. But in the absence of any increase in US government spending (which is the only source of NEW NET FINANCIAL ASSETS), the end result is still a massive accumulation of private sector debt, which is what got us into this mess in the first place. By contrast, assuming a non-convertible, freely floating fiat currency, a government can never be insolvent even if its tax revenue declines significantly. Its balance sheet can never become precarious in the same way that a household balance sheet can.
In the abstract, this always sounds controversial to those uncomfortable viewing the world within a financial balances construct. It also helps to explain the intellectual incoherence at the heart of the G20 communiqué and the Obama Administration’s economic policies, which has been dominated by Wall Street interests.
So it’s worthwhile considering some historic examples, which illustrate the point better. During WWII, the US government generated huge deficits and bond issues. The record expansion of government deficits not only facilitated the war effort, but created full employment. (As an aside, it is always interesting to pose the following question to “deficit terrorists “: if government budget deficits are so awful, and so egregious for the long term performance of an economy, then why run them at all during wartime, when presumably we need the economy to be functioning in an optimal manner?) After the war, the Fed was concerned with potential inflationary pressures and raised interest rates. President Truman, a hard money man par excellence, drastically cut defense spending from $90.9bn to $10.3bn and the US accumulated huge fiscal surpluses. Post war surpluses, combined with Fed tightening, contributed to a recession in 1949. Unfortunately, it took the “military Keynesianism” brought on by the Korean War to shift Truman away from his aversion to deficit spending, which was continued by Eisenhower, and sustained via his national highways building program. During that period, unemployment decreased. Similarly benign effects on unemployment were manifested in the wake of the Kennedy tax cuts and those of Reagan in the early 1980s.
Today, budget deficits are the highest as a percentage of GDP, but they are overstated to some degree, because they include the TARP measures to stabilize the financial system which brought the global economy to its knees in 2007/08. Classic Treasury expenditures deal with the purchase of real goods and services; Federal Reserve functions deal with the purchase and sale of financial assets. And yet, the focus of policy makers is quickly reverting to “exit strategies” and a reduction of budget deficits, where the Pittsburgh communiqué pledged to “prepare our exit strategies and, when the time is right, withdraw our extraordinary policy support in a co-operative and co-ordinated way, maintaining our commitment to fiscal responsibility.”
If only that were true. The only way one could politically justify a government running a sustained surplus would be to make the case that unemployment created a more functional way of ensuring high profits (via wage discipline) than full employment. Put in those terms, it’s not a particularly compelling message, but it has the virtue of being consistent with modern monetary theory.
Oddly enough, the G20 communiqué devotes considerable attention to the government’s “exit strategies”, which came in response to the destructive private sector financial practices which created this catastrophe. There has been less attention directed to the underlying causes themselves. Thus the IMF, in its latest “Global Financial Stability Report”, suggests that restarting securitization markets is “critical” to a wider economic recovery, and that current US and European proposals to force banks that originate loans to hold on to the first 5% of losses in all securitizations, were not sufficiently flexible and might backfire. In the words of Credit Lyonnais Asia strategist, Christopher Wood:
“[The IMF] is yet again doing the world a disservice by acting as a lobbying group for the securitised debt peddlers. It is clearly fundamentally correct that the agents of securitisation should be made to retain some ’skin in the game’ after the terrible damage they have inflicted. It is true that the collapse of securitisation represents a massive deflationary risk for the global economy. But that does not mean that the answer is to allow a new free-for-all in securitisation assuming, charitably, there is demand for the securitised product.” (”Greed and Fear”, 24 Sept. 2009, CLSA, Asia Pacific Markets)
The IMF, the G20, indeed virtually all policy makers — including the Obama Administration — will make themselves far more relevant when they emphasize that full employment and prosperity can only be achieved to the extent that governments are prepared to spend up to a level justified by non-government saving. That does not mean unconstrained government spending. But the spending ought to be set with regard to results desired and competencies to execute plans — not out of some pre-conceived notion of what is “affordable”. Our federal government can afford anything that is for sale in terms of its own currency. And if it spends too much after getting us to a state of full output, it can get inflationary. But let’s get to that state of affairs first before we start worrying about perpetuating the flawed model of the past. That got us transitory prosperity and wage gains. And it promises years of economic misery if we do not move beyond neo-liberal economic fairy tales.
Roosevelt Institute Braintruster Marshall Auerback is a market analyst and commentator.
This is such an important thing for the ordinary citizen to understand - and we’ve got to simplify the message as much as we can because the right-wingers (and the neo-liberals, as you point out) will exploit the seemingly ‘common sense’ idea that governments should be running deficits. You A=B formula is a helpful step in that direction.
Posted by Nellie | September 28th, 2009 at 12:44 pm
I meant to say ‘government should NOT be running deficits’ as the myth to counter. Jeez–even somebody paying attention can get it wrong!
Posted by Nellie | September 28th, 2009 at 12:50 pm
I knew what you meant! At least you’ve got the basic point. I was called a “capitalist non-believer” by another reader, and a “government propagandist” by a third (although I wondered which government they were talking about, as it certainly wasn’t the current one in Washington!). What most people (including most neo-classically trained economists) is that only the state can be the source of all new NET FINANCIAL ASSETS. Because of that, it is the ONLY entity that can increase spending to increase output when the private sector is flat on its back.
Of course, deficits matter. But not in the way that most people describe it in terms of something we can “afford”, as I suggested above.
Even trained economists find modern monetary theory difficult to grasp at first because they are so conditioned by their own gold standard training. The general public is even more baffled because they have been so conditioned by 30-second grabs on TV and radio and the experts they read in the newspapers who cannot see that 1 + 1 = 2, by all the rules of commutation that we learn in primary school.
How does the government which is the monopoly supplier of the fiat currency issue it? Well by spending. So yes, we can “spend” our way to prosperity, although technically speaking, the government is not “spending” per se, but electronically crediting and debiting bank accounts.
The exact statement that was made in the summary on Steve Keen’s blog is that “As a matter of national accounting, the federal government deficit (surplus) equals the non-government surplus (deficit). In aggregate, there can be no net savings of financial assets of the non-government sector without cumulative government deficit spending.”
I don’t see the words “private” included. Government deficits do equal private savings if the external sector is in exact balance always. Not likely.
By the same token, in a fiat currency regime, taxation initially functions to generate a demand for the otherwise worthless currency. The ability to force the non-government sector to get hold of the government’s currency allows the latter to conduct its socio-economic program (by spending). In addition, taxation is a way to destroy net financial assets held in the non-government sector if the government wants that sector to have less purchasing power. For example, to reduce inflationary pressures.
Someone might argue that he/she does not like fiat currencies, but that’s a separate issue (and, by the way, we had lots of depressions under a gold standard, so I don’t see that as being the panacea as so many of the Austrians theologically assert). We can debate the politics, but let’s get the current economics straight.
Posted by Marshall Auerback | September 28th, 2009 at 2:13 pm
How kind of you to respond. I think I may need Econ-for-Dummies because I’m not sure I fully ‘get it’ –though your posts certainly help. I think it’s all just difficult for the non-economist to grasp because we’re really talking about intangibles — eletcronic crediting/debiting, etc. Terribly abstract. This is the part I’m having trouble with - ‘In a fiat currency regime, taxation initially functions to generate a demand for the otherwise worthless currency.” Something escaping me on that…
Posted by Nellie | September 28th, 2009 at 4:02 pm
Taking a stab at it: Is that because a fiat currency has no initial value in and of itself, except where a government is literally demanding that that currency be how taxes are paid - thus ensuring the circulation and use of that currency? (i.e., enforcing the American greenback rather than assorted other private notes, the British pound, etc.)
Please correct me if I’m way off base.
Posted by James Call | September 28th, 2009 at 5:38 pm
Your point, of course, is that government deficits must be envisioned at all times as a positive element in the makeup and management of the economy and not simply as a kind of deus ex machina brought in at the critical moment to right a foundering ship, eh? The notion that the economy functions best when left to its own devices suffers, in your view, from an impoverished vision of what is now an established reality: That there exists an on-going partnership of government deficits and private wealth creation in which both must be seen as positive factors, that for better or for worse, private economic wellbeing is inextricably bound up with properly managed public indebtedness. I hope I’ve not insulted you with naive oversimplifications.
If I’ve understood you correctly, what is underscored by such insights is the crying need for a supervisory structure for the economy that is utterly isolated from and completely independent of the political reality, either that or a political reality that is utterly impervious to economic interests at all levels. Querry: Might not a democracy organized along occupational or industrial lines be better suited to bringing about these objectives than one given over to the “representative” form we have at the moment? Your sense? I mean reform of the present structures seems so remote, so unacheivable at the moment that any healthy management of the private wealth/public deficit symbiosis of which you speak seems entirely out of the question.
Posted by Andrei Vyshinsky | September 28th, 2009 at 8:51 pm
James, yes, you’ve got it. It seems counterintuitive, but in a fiat currency regime, money has no intrinsic value in the absence of state sanction. In the words of economist Abba Lerner:
“The modern state can make anything it chooses generally acceptable as money…It is true that a simple declaration that such and such is money will not do, even if backed by the most convincing constitutional evidence of the state’s absolute sovereignty. But if the state is willing to accept the proposed money in payment of taxes and other obligations to itself the trick is done.”
The modern state, then, imposes and enforces a tax liability on its citizens and chooses that which is necessary to pay taxes. We could make beaver pelts the currency, if the government decided to let its citizens use that as the method of extinguishing state liabilities (ie paying tax). The unit of account has no real value if not ultimately sanctioned by use from the State.
By extension, the state is never revenue constrained because it alone determines what is money. The tax is what gives the currency its value insofar as it functions to create the notional demand for federal expenditures of fiat money, not to raise revenue per se. Value has been given to the money by requiring it to be used to fulfill a tax obligation, but the money is already in existence, not “created” by the revenue.
Andrei, you make a good implied point, insofar as the government, as monopoly issuer of money, must also perceived to be acting in concert with public purpose. Without that, you have political dysfunction, and this is a danger for Obama, which I have discussed in previous blogs. But I guess that’s the risk of having a democracy, rather than an enlightened dictatorship.
Nellie,see my comments to James and hopefully that will clarify. But if you want a really good book on this stuff, which isn’t full of mathematical equations, L. Randall Wray’s book, “Understand Modern Money” is the best introduction to this stuff. Good luck with your journey!
Posted by Marshall Auerback | September 28th, 2009 at 9:09 pm
Hey Nellie, from what I’ve read on this subject (relatively recently, my *expertise* on the subject dates back a month or so from reading Randall Wray’s writings on the subject) the purpose of taxation is to drive a demand for the currency being taxed, by the simple fact that government force compels taxation. It works like this- people must pay their taxes, or face criminal sanctions of some sort. The government decides what type of currency it will accept as payment for taxes; that currency is U.S. dollars. That drives demand for people to accept payments for goods and services in U.S. dollars so they can pay their taxes with it, which leads into Wray’s argument for the state government of California to accept the IOU’s it’s paying right now as payment for state taxes…it would in effect create a new currency, and pump more money into the system by freeing up U.S. dollars for other purposes.
At least, I think that’s how it works.
Posted by Zach P | September 28th, 2009 at 9:22 pm
“I was called a “capitalist non-believer” by another reader, and a “government propagandist” by a third (although I wondered which government they were talking about, as it certainly wasn’t the current one in Washington!).”
Mr. Auerback, welcome to the world of conservative misinformation, fringe-style, where all government spending is socialist and enslaving future generations, and any hint of government involvement totally destroys “free-market capitalism”. Crap like this is repeated 24/7, for years, on every media outlet you can think of. It’s scary.
Posted by Zach P | September 28th, 2009 at 9:31 pm
Regarding the issue of currency and currency valuations, it is important to realize that, while the foreign exchange system is made mostly of “non-convertible, freely floating fiat currency,” the U.S’ largest creditor, China, does not operate on such a system. In reality, as Secretary Geithner pointed out in his confirmation hearings in January, China keeps its currency valued at an artificially low level. This enables the Chinese to maintain their current account surplus by maintaining a high flow of profitable exports, which they then use to finance our government’s debt. However, many domestic manufacturers are quick to point out that an artificially cheap Chinese Yuan prevents fair international competition and weakens their ability to succeed in the global marketplace. This, of course, means that there are less jobs available for American workers in such industries. So, this issue quickly becomes much more complex than many anticipate.
Posted by Lucas Puente | September 28th, 2009 at 9:46 pm
Lucas,
Not sure I agree that this is relevant, as far as the US goes. Again, it would have implications if we were still on a gold standard system. They are exporting their output when in fact they should be considering consuming it domestically (therefore less vulnerable to protectionist pressures). But it’s not a cost to us per se. The Chinese can refuse to roll over their $ assets which means getting dollar deposits and a lower return. Americans can always provide enough jobs so long as the government is committed to a full employment policy. Unfortunately, all of our government policy is predicated on silly notions of “affordability”. I realise they don’t teach you this stuff in most economics courses, because they are wedded to neo-classical textbook stuff, but it’s not the way the modern monetary system really works.
Posted by Marshall Auerback | September 28th, 2009 at 10:18 pm
Well, given ideological taboo of both tariffs and a pro-union policy, which is the stance of the two major political parties in the U.S., what would a full employment policy even look like?
Posted by James Call | September 29th, 2009 at 6:51 am
Excuse me, that probably should have read as “taboo against,” not “of”. Also, I was wondering if you could clarify the above statement: “Not sure I agree that this is relevant, as far as the US goes. Again, it would have implications if we were still on a gold standard system. … But it’s not a cost to us per se. The Chinese can refuse to roll over their $ assets which means getting dollar deposits and a lower return” I’m embarrassed to admit that I don’t understand how a gold standard or lack thereof has any bearing on Chinese US debt purchases and our credit, etc.
Posted by James Call | September 29th, 2009 at 6:55 am
Marshall,
Thanks for the explanation. I’ll ask my international finance professor to offer her perspective on this issue as a comparison.
Posted by Lucas Puente | September 29th, 2009 at 10:39 am
What would a full employment policy look like? How about starting with Minsky’s idea of Government as Employer of Last Resort? The U.S. Government can proceed directly to zero unemployment by offering a public service job to anyone who wants one as a supplement to the current budget. Furthermore, by fixing the wage paid under this ELR program at a level that does not disrupt existing labor markets, i.e., a wage level close to the existing minimum wage, substantive price stability can be expected.
The ELR program allows for the elimination of many existing government welfare payments for anyone not specifically targeted for exemption, as desired by the electorate. Minimum wage legislation would no longer be needed. Labor would welcome the safety net of a guaranteed job, and business would recognize the benefit of a pool of available labor it could draw from at some spread to the government wage paid to ELR employees. Additionally, the guaranteed public service job would be a counter- cyclical influence, automatically increasing government employment and spending as jobs were lost in the private sector, and decreasing government jobs and spending as the private sector expanded.
This ELR proposal at one level resembles workfare, which has been rejected by Congress, though some state welfare reform programs are not unlike workfare. However, unlike this ELR proposal, the state programs may be serving to create a new class of sub-minimum wage employees who are replacing regular public employees.
The ELR proposal also has characteristics similar to the current Federal unemployment compensation policy. There are, however, significant differences as unemployment is 1) compensation is payment for not working, 2) temporary, 3) does not cover everyone, and, 4) is less than the proposed ELR wage.
In addition to zero unemployment, I can show that this ELR policy establishes price stability not entirely unlike many proposed income policies have been designed to do. However, an ELR program would, nonetheless, face stiff opposition as it allows the federal budget deficit to float, with a high probability of permanent and growing deficits. For example, using rough estimates, if the government employed 8 million new public servants at, say, $12,500 per year, that would be a new expense of $100 billion. Subtract from this some portion of approximately $50 billion currently spent on unemployment compensation, $15 billion spent on AFDC, and over $20 billion spent on food stamps that may be reduced, and the net may be an additional $50 billion of annual deficit spending. Therefore, this study will first focus on why the fear of deficits per se is unwarranted.
Posted by Marshall Auerback | September 29th, 2009 at 12:08 pm
Very interesting. I’d like to know more about the ELR proposal. Of couse, “that would be socialism,” so, perhaps, never mind. Thanks again for the explanation, Mr. Auerback.
Posted by James Call | September 29th, 2009 at 1:18 pm
You make the claim that the only way money can be added to the money supply is for the government to spend it. You completely miss the point that the government can lend money as well, adding cash to the money supply without adding to the deficit.
Posted by Jason | October 29th, 2009 at 2:43 pm