Monday, November 19, 2012

Soft Money Economics

The title of this post is similar to the title of Warren Mosler’s book.

Mosler, Warren (2012-10-25). Soft Currency Economics II (Modern Monetary Theory) (Kindle Locations 1003-1015). . Kindle Edition.

The Kindle addition can be purchased from Amazon for $3 and read on your Kindle, if you have one, or on your computer or smartphone if you don’t.

Even though the book is short, it’s not light reading for non-economists, so the intent of this post is to give Mosler’s conclusions only, along with the conclusions I’ve drawn from the work. 

The amazing thing is, the content of this book is common knowledge among many analysts at the Fed, which has issued its own publications on the same topic. Alan Greenspan and Ben Bernanke have made comments to congressional committees along the same lines. But, many economists, politicians,  press, and pundits either are not aware of it’s content, can’t get their minds around it, or refuse to acknowledge it to further their own agendas.

Mosler is only one of many economists who understand what goes under the acronym, MMT, Modern Monetary Theory,  these days. Others include most of the economic faculty of the University of Missouri, Kansas City and others in Universities around the world. The people who have done the most to publicize the misunderstandings of our current system, in addition to Mosler, include Stephanie Kelton, L. Randall Wray, Michael Hudson, Marshall Auerback, and William Mitchell. These individuals consult with governments around the world on the subject and have blogs on the internet in addition to their academic contributions.

The following is the Conclusion from Mosler’s book:

“The supposed technical and financial limits imposed by the federal budget deficit and federal debt are a vestige of commodity money. Today's fiat currency system has no such restrictions. The concept of a financial limit to the level of untaxed federal spending (money creation/deficit spending) is erroneous. The former constraints imposed by the gold standard have been gone since 1971. This is not to say that deficit spending does not have economic consequences. It is to say that the full range of fiscal policy options should be considered and evaluated based on their economic impacts rather than imaginary financial restraints. Current macroeconomic policy can center on how to more fully utilize the nation's productive resources. True overcapacity is an easy problem to solve. We can afford to employ idle resources. Obsolete economic models have hindered our ability to properly address real issues. Our attention has been directed away from issues which have real economic effects to meaningless issues of accounting. Discussions of income, inflation, and unemployment have been overshadowed by the national debt and deficit. The range of possible policy actions has been needlessly restricted. Errant thinking about the federal deficit has left policy makers unwilling to discuss any measures which might risk an increase in the amount of federal borrowing. At the same time they are increasing savings incentives, which create further need for those unwanted deficits.”

The following are my conclusions drawn from the work.

1. Any government with its own currency cannot go broke. The government does not need to borrow from the private sector or impose taxes to pay its bills. It simply uses keystrokes on a computer to debit and credit the appropriate accounts. Any limitation on the national debt can only be imposed through law.

2. Individuals and states in the US do not have their own currency so they do not operate under the same rules as the federal government. Hence, their budgets are constrained, whereas the federal budget is not constrained in the same way. Comparison of what individuals and states must do to what the federal government must do are erroneous.

3. Ignoring international transactions, when the private sector runs a savings surplus, as it is now, the federal government must run a deficit. It’s an accounting identity and has been proven by scientific observation of the spending and saving patterns.

4. Banks don’t take deposits and make loans from them. They make loans and then add to their reserves at the Fed from other funds on hand after the fact. If they don’t have funds on hand to increase their reserves, they borrow the money from the Fed or from other banks.

5. The main limitation that the federal government has in running up deficits and debt is the threat of devaluing the currency. This only occurs when the demand for goods and services exceeds the capacity of the country to produce them, not a condition that exists now. This condition leads to rising prices and devaluation of the currency. So, when the economy is booming and this condition occurs the federal government must impose additional taxes or retire federal debt to reduce demand to where it can be satisfied by existing productive capacity.

6. The statements made here are conditioned by international trade.  International payments can change the balance between federal deficits and private sector surpluses. So, there are actually three sectors that must be considered. We have not gone into the ramifications of the third international sector here to make the essential points without getting overly complicated.

Other posts in this blog have identified resources for further investigation.

Saturday, October 13, 2012

How Debt Stifles Growth and Employment

When people are using their income to service debt they are not using it to buy the goods and services that sustain demand and grow the economy. If we continue on the path we're on the small elite that have the wealth to make the loans will receive most of the national income. Inequality will continue to increase, spending on goods and services that drive growth will diminish, and the economy will go into another depression. It's really not that hard to understand. We need to reduce taxes on earned income and increase tax rates on investment income to rebalance the economy and strengthen the middle class that creates the demand and generates growth.

A productive economy that furnishes goods and services and employs people requires credit to finance capital formation that is necessary to accommodate the increase in population and the advancement of technology.

But, there is another kind of credit that is parasitic on the productive economy, namely credit that is used to bid up of the price of assets through speculation.

Credit is always accompanied by debt. If credit for investment does not contribute to productivity increases and employment of a growing population, its accompanying debt becomes a drag on the economy. If earnings are used to pay interest on debt and retire principal they are not available to buy the goods and services an economy produces. Only if the economy benefits more from the investment than it loses from this drag on the economy, is the investment valuable to the economy.

If  laws are enacted that advantage capital formation beyond what is necessary for productive investment, investors turn to speculation to sustain their return on investment. So there must be a balancing of taxes on income earned from investment and income earned from production of goods and services.

In the past several decades lower taxes on investment income have led to capital accumulation beyond what is necessary to finance production growth and investors have turned to speculation, primarily in real estate and stocks. As more loans are made to finance asset purchases at a lower interest rates, prices of assets like real estate and stocks are bid up. The increasing price trend reinforces this type of  speculative investment.  Investors use increasing leverage to take advantage of the opportunity until a point is reached where risks are being taken which jeopardize the entire enterprise. Finally, it comes crashing down, as prices stagnate and borrowers find themselves unable to service the loans. This is the financial crisis we have just experienced.

Sunday, September 09, 2012

Exploding Economic and Political Myths

One reason our political economy is so unstable is that there are many economic and political fallacies that are widely accepted in political circles and the press and continue to be propagated because they are challenged by only a relative few recognized economists and public policy advocates. Among these fallacies are the following:

1) Governments should behave like households regarding their budgets.

2) Deficits are bad, surpluses are good.

3) Government borrowing crowds out private investment.

4) Inflation is inherently bad.

5) Money for government spending must come from the private sector.

6) Government is the problem, not the solution.

7) Governments with their own currency can become insolvent.

8) The value of a country’s currency is an indication of its economic health.

9) The national debt can reach levels that can’t be sustained

10) Government debt is a burden handed from one generation to the next.

11) Unemployment is necessary

12) Unemployment is mainly a result of structural considerations, not lack of demand.

There are more, but I’ve gone on too long already.

My intent is not to write a tome on all of these fantasies but to present a few sources that introduce the reader to the nature of the problem. The first entries in the list are the most fundamental, later entries more verbose, detailed and complicated. The subject is complex, but getting into it slowly will ease the journey.

Seven Deadly Innocent Frauds of Economic Policy

New Sense, Common Sense

Modern Money Mechanics

Fifteen Fallacies of Financial Fundamentalism

Understanding the Modern Monetary System

And, if you don’t like to read . .

Thursday, August 30, 2012

The Government’s Response in the Case of a Financial Crisis Requiring a Bank Bailout

A prior post explained how financial crises develop and the need for a government bailout of banks to prevent a complete collapse of the economy.

There are two ways governments could respond to a financial crisis. One way is to take over failing banks and restructure them. This involves creating new healthy entities that can continue to operate with only loans that can be serviced, and putting loans that can’t be serviced into new entities that will enter bankruptcy where investors and lienholders will suffer the losses. The other is to give the banks money to continue to weather the storm over a long period of time by investing the money in other areas and using the income to deleverage and write off bad loans as they occur.

Political reasons have dictated the second course in the case of the current financial crisis. The financial sector has tremendous political power through contributions to politicians and influence with the national press. Both political parties are subject to this lobbying pressure and succumbed to it.

The bailout funds from the government and through the Fed’s buying of troubled assets has been used by banks primarily to speculate in foreign currencies and invest in productive assets denominated in foreign currencies that pay higher interest rates. Funds that are not invested in this way are simply left in reserve accounts at the Fed where they earn interest.

The government has done little or nothing to reduce overall debt in the private sector by forcing banks to accept losses on bad loans. Again, for political reasons, it has not embarked on any significant government programs to create demand in the economy. Instead it has chosen to allow the financial sector to use government bailouts to generate the kinds of income described above to slowly, over decades of high unemployment, to allow the deleveraging process to slowly bring the economy back to health.

To compound the problem, government  has done little or nothing to curb the excesses that caused the problem over the last several decades, in terms of reregulation of  banks and investigating and prosecuting fraud that occurred in the financial sector. The financial sector continues in much the same mode it did before the crisis, threatening the reinflation of the asset bubbles that caused the current crisis.

So what can be done about this dilemma? Stay tuned to this blog.

A Simple Explanation of the Cause of the Financial Crisis in the United States

Over the last several decades the private sector has taken on more and more debt, primarily in the real estate sector. Why has this happened?

The main reason is that many consumers don’t view debt as a problem as long as the servicing of that debt is within their budget. Furthermore, they don’t consider only their earned income when they assess their ability to pay service on their debt. They also consider the appreciation of their assets, and the possibility of refinancing these assets as their value increases to pull out money to service the debt. So asset appreciation becomes another source of income.

So, you might ask, are consumers really this smart that they can analyze their financial situation and come to these conclusions? The answer is that they don’t have to be. The financial sector will show them exactly how to do it.

The financial sector gets rich by making loans. As they compete to make loans they find ways to make them ever more accessible to consumers at lower servicing rates with schemes such as adjustable rate loans, balloon payments, securitizing the loans to hide risk, and pointing out to consumers that the appreciation of their assets will allow them to refinance over and over again to pull more money out of the assets to pay for servicing. This is the classic Ponzi scheme, paying servicing out of the appreciation of the asset, instead of out of earned income from a job.

The only problem is, eventually asset prices are bid up to way beyond their replacement value and the whole house of cards comes tumbling down as it did in the financial crisis. This can happen very quickly, but the cause builds very slowly, over decades. As more and more income is used to service debt, it is not available to create demand for consumer products. This results in businesses cutting back on expansion plans, research and development, and eventually leads to layoffs. The layoffs, in turn, lead to reduced ability to service debt, and a vicious downward cycle ensues.

Eventually, the financial sector gets in trouble as consumers default on their loans, or realize that their assets are no longer appreciating and income from refinancing disappears. This downward cycle accelerates and interlocking bank loans put the whole financial system in jeopardy. At this point the financial sector looks to government to bail them out, which it must, or see the whole economy come crashing down.

To be continued in future posts.

Tuesday, July 03, 2012

The Long Range Problem

We have become one world. Communication, transportation, and commerce have weakened national borders and culture.

Meanwhile, world population continues to increase.

The choice to be made is whether private enterprise or governments will be allowed to dominate world affairs.

If private enterprise is allowed to dominate the world will end up like countries that now exist where an elite exploits resources and labor for their own benefit at the expense of the mass population. This will result in a few living a life of luxury while the mass population exists at a subsistance level or below.

If governments can be organized to represent the interests of the mass population, resources and the rewards of productivity can be broadly distributed to the mass population. This will necessarily result in a lower standard of living for the elite few to afford a slightly higher standard of living for all.

As world population continues to increase resource shortages will reduce the standard of living accordingly.

So, the dilemma is how to contain world population to maintain a comfortable standard of living and how to create governments that act in the interests of all instead of an elite few. It’s the problem humanity has had since it came to dominate the world. But, previously it operated on a national basis, with some nations doing better than others in achieving these goals. Now it’s a worldwide problem the must be confronted on a worldwide basis.

Thursday, March 22, 2012

All About Apps and Intel’s AppUp Initiative

Back when there was no internet, cell phones, or other portable devices there was only hardware and software, computer programs that ran on the hardware.

As more software became available it became divided into categories: operating systems, drivers, utilities, and applications. Applications were programs that were designed to do a specific task like word processing, spread sheets, graphics, etc.

With the arrival of the internet a specialized application called a browser was needed to access all the sites on the internet.

When smart phones and other mobile devices arrived, the size of applications became important, both due to the size of the hardware devices and the processing power that could be incorporated in them. The device size limited the screen size so less information could be displayed and limited the storage that could be made available. Also, the use of mobile devices took on a different complexion. These devices were more suitable to the use of information than the generation of information, having no full keyboards or other suitable entry devices.

Since the mobile processors and operating systems were different from desktop systems, software designed for desktops wasn’t easily portable to mobile systems, and browsers had to be adapted to the small screen, limiting their utility for mobile use. As a result, specialized compact applications became the software of choice for mobile systems. The name was soon abbreviated to apps and online app stores opened to distribute the apps to users. These app stores were the brainchild of the mobile operating system companies like Apple and Google, rather than the hardware manufacturers. In the desktop world applications were sold by the developers directly to the customers, some at quite high costs. Mobile apps, in contrast, were mostly given away free or at nominal costs, the difference being recouped from advertising, since the users were individuals, prime prospects for directed commercial advertising on mobile devices.

So, you might ask, why isn’t there an app store and apps for PCs and Macs. Well, there are. You probably just haven’t heard much about them because it’s a relatively new phenomena. Where you previously had to chase around to different internet sites to find the maker of an application, you can now go to places like The Best Free Applications and Intel AppUp to find what you want. The former allows most Windows apps to be downloaded from a single internet site, whereas the latter is an Intel program for Windows PCs similar to iTunes for Apple apps. In this case apps are downloaded and maintained with the AppUp program.

Earlier applications for desktop computers were expensive but few in number compared to the app market, which is low cost and high in number. So you will find only a few apps out of hundreds or thousands that are useful to you, making app stores a better way to market them.

Looking ahead, the wide variety of devices and operating systems is causing a rethinking of the app market. Some industry analysts are predicting a move towards device independent apps. The applications development industry is already moving in that direction with operating system suppliers providing development kits to app developers to make it easier for them to develop applications that will run on any kind of hardware.

Microsoft is taking a big step with Windows 8 to bridge the gap between mobile and stationery systems. The new operating system will have versions that run on both mobile and stationery systems and with touch, mouse, and keyboard user interfaces. So, you might want to experiment with Intel AppUP to see how apps work with your current PC. You will find some very useful apps from suppliers like Accuweather and nNews that will save you from chasing around to internet sites. But, there are a plethora of apps that are only of interest to a limited spectrum of users. Intel has done a good job of categorizing the apps to guide you to what you need. Intel also has a blog that covers new activity in the AppUp world.