MMT: Yes Virginia, There is a Difference Between Greece and the US

Marshall Auerback here with a post which I originally published at New Deal 2.0. This post on deficits in fiat currency regimes is the second in a series of posts on Modern Monetary Theory.

Many market analysts, commentators and economists claim to be having a hard time finding a metric in which the US is in better financial shape than Greece. Ken Rogoff, for example, recently warned that a Greek default would usher in a series of sovereign defaults, and suggested recently on NPR that the crisis also had implications for the US. The historian Niall Ferguson made a similar claim a few months ago in the Financial Times. The cries of the deficit hawks grow louder: Repent all ye fiscal profligates, before the “day of reckoning” comes.

Let’s dial down the Biblical hysteria a wee bit while there’s still time for rational debate. The market’s recent response to the intensifying pressures in the euro zone suggests that investors are beginning to differentiate between countries that are sovereign issuers of currency, such as the US or Japan, and non-sovereign issuers, such as Greece or any other nations in the euro zone. The US dollar is rising in value, notwithstanding the federal deficit, while debt distress in the so-called “PIIGS” countries, especially Greece, are intensifying, thereby driving down the euro to fresh 12 month lows against the dollar.

The relative performance of various currencies against the US dollar is highly instructive in this regard. Over the past 3 months, the Australian, New Zealand and Canadian dollars have all registered gains of some 4% against the greenback. The worst performer? Not surprisingly, the euro, down 6.3% over that period. Whether consciously or not, the markets are demonstrating that they understand the distinctions between users of currencies (who face an external funding constraint), and those nations that face no constraint in their deficit spending activities because they are creators of currency.

That the US has the reserve currency is an irrelevant consideration here. The key distinction remains user vs. creator. The euro zone nations are part of the former; Canada, Australia, the UK, Japan and the US are representatives of the latter.

Using “PIIGS” countries as analogues to the US or the UK, as Rogoff, Ferguson and countless other commentators do, is wrong. Their faulty analysis comes as a result of the deficit critics’ failure to distinguish between the monetary arrangements of sovereign and non-sovereign nations. Any sovereign government (none within the EMU enjoy that status any longer) can deal with a collapse in revenue and an increase in outlays from a financial perspective without invoking the sort of deadlocks that are now crippling the EMU zone. That is why, for example, the Japanese yen is not in freefall against the dollar, despite having a public debt to GDP ratio in excess of 200%, almost 2.5 times that of the US. In fact, over the past few days the yen has actually appreciated against the dollar. Now why would that be, if the lesson we were supposed to learn was the evils of “unsustainable” government deficit spending?

Fiscal sustainability has no relevance in a system where there are no operational constraints on the ability of a government to spend. US Social Security checks will not bounce. Nor will the Canadian or Japanese equivalents. Similarly, their bonds will always be able to pay out interest.

Note that this doesn’t mean that there are no real resource constraints on government spending. Let’s be clear: anyone who advances the use of fiscal policy as an effective counter-stabilization tool is always careful to point out that these interventions can come at a cost. That cost could well be inflation if, as a result of the fiscal expansion, we reach full employment, resource constraints begin to appear, but the government continues to spend. But if the economy recovers, tax revenues will increase and safety net spending will fall. In the US, that means we will likely be back to “normal,” with deficits around 2-4% depending on the state of the economy, which is where we’ve been for the past 30 years aside from 1998-2001.

Why won’t these deficits be inflationary? As Professor Scott Fullwiler noted in a recent email correspondence with me, once the recovery is underway and the economy gets to a significantly higher capacity utilization where price pressures could emerge, the deficit will be declining substantially. It will also be at least a partially offset by a fall in discretionary spending on social welfare. It’s axiomatic that the faster the economy grows, the smaller the deficit becomes, unless the government continues to spend recklessly–which we certainly do not advocate.

And by the time we get to a point where we might have inflation, the deficit is back to 2-3%, which again is where we’ve been for the past 30 years, while average inflation has been about 2%. Note: inflation does not equal default. You and I could well buy credit default swaps on any country in the world, but we are unable to collect if any of the relevant countries register a positive rate of inflation — even a double digit rate of inflation — because inflation is not tantamount to default. Nor do the ratings agencies recognize default in this manner. Default is defined as a failure to perform a task or fulfill an obligation, especially failure to meet a financial obligation. Inflation is not incorporated into the definition when it comes to questions of national insolvency.

By contrast, the talk of Greek default is prevalent across the markets, and that is a reasonable concern in the context of the euro zone. The default option is considered a foregone conclusion, even allowing for the massive 110 billion euro bailout, which was designed to inspire “shock and awe” among investors but instead has simply engendered shock. If Greece costs 110 billion euros to bail out, how much next time for Spain, Italy, or even France?

If the markets have concerns about national solvency, they won’t extend credit. And that is the problem facing all of the euro zone countries. Greece, Portugal, Italy, France, and Germany are all users of the euro-not issuers. In that respect, they are more like any American state or municipality, all of which are users of the US federal government’s dollar.

And deficits per se will not create the conditions for default in the US. If the US continues to run net export deficits (all the more likely given the ongoing fall in the value of the euro), and the private domestic sector is to net save, the US government has to net spend–that is, run deficits. That is a basic accounting identity, nothing more, nothing less. If the US government tries under these circumstances to run surpluses, it will first of all force the private domestic sector into deficits (and increasing debt) and ultimately fail because the latter will eventually seek to increase their saving ratio again.

And the same logic applies for Greece. The call is for the IMF/EU package to reduce its budget deficit as a percentage of GDP from the current 13.6% to 8.1% in 2011. How will they achieve that? Trying to engineer a reduction in the deficit via austerity programs (or freezes or whatever else one might like to call them) at a time when private spending is still insufficient to maintain adequate real GDP growth is a recipe for disaster. It will increase the deficit.

Consider Ireland as Exhibit A in this regard. Ireland began cutting back deficit spending in 2008, when its banking crisis began to spread and its budget deficit as a percentage of GDP was 7.3%. The economy promptly contracted by 10% and, surprise, surprise, the deficit exploded to 14.3% of GDP. We would wager heavy odds that a similar fate lies in store for Greece, given the EU’s inability to understand or recognize basic financial balances and the interrelationships among the various sectors of the economy. Neither a government, nor the IMF, can predict with any certainty what the outcome will be–ultimately private saving desires will drive the outcome, as Bill Mitchell has noted repeatedly.

Why do we have huge budget deficits across the globe? It’s not because our officials have all suddenly become Soviet-style apparatchiks. It is largely because the slower global economy has led to lower revenues (less income=less taxes paid, since most tax revenue is based on income, and lower tax brackets) and higher spending on the social safety net. Gutting this social safety net because we extrapolate the wrong lessons from the euro zone’s particular (and self-imposed) predicament constitutes the height of economic ignorance. It also reflects a transparently political agenda, which the US would be ill advised to embrace. The rescue packages, the IMF intervention and all the talk about orderly defaults cannot overcome the EMU’s fundamental design flaw. Let neo-liberalism die with the euro.

  1. Michael Jung says

    Exhibit B is Japan – 1997/98?
    IMF urged Japan to cut spending, withdraw stimulus and increase taxes. Subsequently the economy tanked again = shortfall in tax higher than expected, deficit increased.

    Exhibit C is Germany – 2010/11!
    Current predictions for tax shortfall exceed predictions;
    1,2bn Euros less for 2010
    2011 11,7bn Euros less,
    2012 12,8bn less
    2013 13,7bn less,1518,693377,00.html
    I have yet to look up details and explanations. Either (1) a tax increase is implemented for the higher income brackets or (2) subsidies and smart welfare cuts have to be implemented, because (3) new expanded borrowing has to be ruled out as it is the most costly exercise and most lethargic plan.

  2. Kevin says

    Are you just a moron or an intellectually dishonest, government shill?

    1. Marshall Auerback says

      All of the above! Thanks for your kidn words!

  3. jdmckay says

    Fiscal sustainability has no relevance in a system where there are no operational constraints on the ability of a government to spend.

    “no” relevance? Can’t agree w/that at all… dangerous conclusion IMO.

    The key distinction remains user vs. creator.

    See above. The “key distinction” only makes Greece’s foibles immediate. If we (US) don’t get our house in order, our day will arrive soon enough.

    There’s a gazillion ways to deceive monetary policy. Multiple participants in this “modern monetary policy” foolishness are not good vs. bad (as you present), rather co-conspirators in deception.

    1. Marshall Auerback says

      Please note the word “operational”. I did say there was a resource/inflation constraint. Read the article more carefully.

      1. jdmckay says

        I did read it carefully, as I’ve read your articles for sometime echoing these same themes. Your “operational” modifier is an addendum.

        You build your entire premise w/USD gains for (however long) and go to lengths to construct that particular theme.

        I’m not trying to pick a fight. I just think you are very wrong. Nothing personal.

        1. Marshall Auerback says

          I’m trying (evidently with little success) to make a distinction between
          issuers of currency and those who are simply users of currency.
          “Operational” is not simply an addendum. There is nothing which can stop the US
          government from creating more dollars; likewise the Japanese government and
          yen. These are created at the stroke of a keyboard. That’s the key point.
          Note that this doesn’t mean that there are no real resource constraints on
          government spending; this should be the real concern, not financial
          constraints. If government spending pushes the economy beyond full capacity,
          inflation will result. Inflation can result even before full employment if there
          are bottlenecks or if firms have monopoly pricing power. Government spending
          can also increase current account deficits, especially if the marginal
          propensity to import is high. This could affect exchange rates. The
          alternative would be to use fiscal austerity to try to keep the economy sufficiently
          depressed that pressures on prices or exchange rates are eliminated. While
          we believe that this would be a mistake—the losses due to operating below
          full employment are almost certainly much higher than economic losses due to
          inflation or currency depreciation—it is an entirely separate matter from
          financial constraints or insolvency.

          I don’t take your comments personally, and I don’t think you are trying to
          pick a fight. In fact, if you have followed the thread of this debate,
          you’ll see that there were comments which were far more personally abusive.
          It’s a free country, and we’re entitled to have disagreements, but I don’t
          think the onus is on me to “prove” anything. If you tell me that there is
          a shortage of computer keyboards which prevents the creation of currency
          somehow, that’s a different matter, but otherwise I think the distinction
          I’ve made is valid. More to the point, the markets appear to be recognizing
          that the euro zone does have a unique set of problems which are not found in
          Japan or the US.

          Have you ever seen the US government bounce a Social Security cheque?

          In a message dated 5/6/2010 14:54:42 Mountain Daylight Time,

          jdmckay wrote, in response to Marshall Auerback:

          I did read it carefully, as I’ve read your articles for sometime echoing
          these same themes. Your “operational” modifier is an addendum.

          You build your entire premise w/USD gains for (however long) and go to
          lengths to construct that particular theme.

          I’m not trying to pick a fight. I just think you are very wrong. Nothing

          Link to comment:

          Options: Respond in the body to post a reply comment.

          To turn off notifications, go to:

  4. vergosity says

    Marshall I believe you’re missing a critical point. You believe we’re sheltered because we control our own currency but this works only so far as our credit worthiness will take us. We are not in the same situation as Japan. They’re not in great shape, their debt load is shockingly high, but it is almost exclusively internal, whereas our debt is mostly external and financed with very short maturity requiring constant refinancing.

    I like to put things in simple terms so even I can understand….Japan and U.S. both wanted to buy that shiny Harley. Japan borrowed money from his wife for the bike….we went to Guido down the street. After blowing our paycheck at Vegas Japan has to go crawling back to his wife. Chances are he’ll be sleeping on the couch for a while, he may even get to keep the bike. I don’t think Guido will be quite as understanding with restructuring this debt.

    We’re in worse shape. We then went down the street to borrow from Tony to pay Guido. As many middle class families have found out the hard way. Revolving credit works great as long as you have a good credit rating. Lucky for us we set the credit ratings! That means we get to keep this game running for a long time…..but eventually Guido and Tony are going to catch on. And I suspect some of the shine has come off our “rating” agencies after the little financial kerfluffle we had.

    imho we’re worse off than Greece because our privileged status as the reserve currency gives us that much more rope with which to hang ourselves.

    1. Marshall Auerback says

      I disagree. You are basing your view on a “loanable funds” theory, which
      was discredited by Keynes more than 70 years ago. There’s not a finite
      pool of funds which can move around “demanding” higher rates.The key
      distinction is between an issuer of the currency and a user of a currency, not
      whether the debt is held externally or domestically.
      To debunk this myth, you need to know two things. First, all foreign
      governments have checking accounts at the Federal Reserve Bank called “reserve
      accounts.” Second, US Treasury securities are nothing more than savings
      accounts at the same Federal Reserve Bank.
      How does China gets its dollars? It sells things to us. And when China
      gets paid, those dollars go into China’s checking account at the Federal
      Reserve Bank.
      And when China buys US Treasury securities what happens? We call it “
      borrowing from China” and “going into debt to China,” but all that happens
      is The Fed transfers China’s dollars in its checking account at the Fed to
      its savings account at the Fed. There are 13 trillion dollars worth of
      “savings accounts” held at the Fed, which we call the “national debt”.
      And how do we pay off that debt? Simple. When China’s Treasury
      securities mature and need to be paid off — just like any savings account — we
      just transfer their dollars (plus interest) from China’s savings account at
      the Fed to their checking account at the Fed. Debt paid! The dollars are
      nothing more than data entry on the Fed’s computer. They have no other
      existence. And it makes no operational difference- the actual process of moving
      money from one account at the Fed to another- when we spend whether China’s
      dollars are in their checking account or savings account.
      All we owe China is a bank statement that shows them where their dollars
      are. Sadly, they know this. But they also know that we think we are
      dependent on them, and take advantage of our error.
      And, as I said earlier, the reserve currency issue is a red herring here.

      In a message dated 5/6/2010 20:19:23 Mountain Daylight Time,

Comments are closed.

This website uses cookies to improve your experience. We'll assume you're ok with this, but you can opt-out if you wish. Accept Read More