And in the news this week…

Education…education…education.

Last week the Public Accounts Committee published its findings on the sale of the student loan book.  The government was criticised for having sold yet another public asset for half its face value, but it explained that net government debt would fall as a result, enabling it to borrow more. The PAC, in its turn, said in its report that it had expected the Treasury to get the best possible deal on behalf of the taxpayer and achieve its aim of reducing the public sector net debt.  And then according to the Office for Budget Responsibility, in its Student Loans and Fiscal Illusions working paper published earlier this year, the sale was also a ‘perverse incentive’ to make it appear that the public finances had improved. It then went on to estimate that the government’s plans would, in addition, deprive the Treasury of billions in repayments over the lifetime of the loans thus making the country poorer in the long term.

The fiscal language of government and its institutions cited above is instructive, and demonstrates how government’s success or failure is being measured in household accounting terms rather than the effects of its spending policies on environmental, economic and social well-being of the nation.  A good deal for taxpayers, reducing public deficit and debt, depriving government of revenue, borrowing from the future and debt burden are all examples of recurrent tropes which are fed into the public arena daily by politicians, journalists and institutions. So, it is no surprise that people are led to believe that the state finances resemble their own household budgets and they judge a government by how much it reduces or increases the deficit or debt. The vocabulary of income, spending, borrowing and debt however does not apply to a government which issues its own currency and the term fiscal responsibility should be confined to measuring how such a government balances the economy by ensuring that money creation does not exceed the productive capacity of the nation.

And in more news on education

“Privatisation, marketisation, neo-liberalism and austerity are beams of the same sun.”

Steve Watson, Faculty of Education (Cambridge University).

While the government focuses on accounting gymnastics to balance its accounts, the dire state of higher education has been in the public spotlight this month as it was revealed that the universities watchdog was forced to give a struggling institution an injection of cash so that it could remain afloat. This followed news earlier this month that three universities were on the verge of bankruptcy and having to rely on bridging loans to keep going.  The financial uncertainty was said to be linked to falling numbers of 18 year olds applying to go to university, increased competition for students and more stringent immigration controls on foreign students who, in the absence of adequate government funding, bring much needed revenue to university coffers.  The University funding policy and funding report published in 2016 noted that given limited government funding and the fact that not all universities can borrow more over the long term, they will need to maintain and grow their student numbers, including those from outside the EU, to fund increased investment.  As governments fights over allowing foreign students to access higher education and adequate funding streams from government a train crash would seem inevitable.

How have we come to this pass? The process started in the 1990s with the first steps towards the marketisation of higher education.  New Labour followed the Tories lead and gave universities the right to charge tuition fees, thus changing the very basis upon which universities were funded. Private debt instead of government spending became a primary mechanism to finance higher education. As Steven Watson who lectures in the Faculty of Education at Cambridge University notes:

“The introduction of student loans, tuition fees and subsequent increases are all part of the commodification and privatisation of higher education. The Higher Education and Research Bill that was hurried through before the general election in 2017 further embeds the consumerization of higher education, with the creation of the Office for Students and providing opportunities to establish challenger institutions to increase competition in the sector.”

Universities have become businesses with a product to sell and students have become customers with choices. University management elites command huge salaries whilst lecturers increasingly face the prospect of insecure contracts and low pay. According to an analysis by UCU published in 2016 university teaching is now dominated by zero-hours contracts, temp agencies and other precarious work.  It also noted that the richest Russell Group institutions rely heavily on insecure academic workers.

Instead of higher education being about learning, exploration and creativity, it is increasingly becoming commodified; serving the interests of capital rather than the development of the individual for life and the benefit of society. Already, as Steve Watson notes, there is the potential for subjects that do not have a direct link to the world of work to disappear or be reconfigured for employability.  And while universities struggle for funding and try to cut costs, students face the prospect of a lifetime of education debt without even the certainty of finding a good, well paying job at the end of it.

The public is fed a daily diet of the benefits of choice, competition and private-sector efficiency and innovation, whether we are talking about education, the NHS, or the energy, rail and water sectors, when the reality is that it has more to do with accruing capital, than providing high quality public services. We are also fed the daily lie that the government has no other alternative as it has no money of its own and must seek to balance its accounts to prove its financial competence.

BUT the national economy is not one great big household, and a government which issues its own currency could, by making a political choice, spend on our public services tomorrow. Why would it not do so?  Education is an investment which is not just about economics. It gives people the skills they need for life, enables them to ask questions and seek solutions as well as confront the challenges of our times from social issues to environmental ones. Getting with monetary realities is a first step in challenging the neoliberal, market driven status quo.

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The post Education…education…education appeared first on The Gower Initiative for Modern Money Studies.

In my last post, I said that the fact that a government can buy anything that is for sale in its own currency is not sufficient to confer monetary sovereignty. A country which is dependent on essential imports, such as foodstuffs and oil, for which it must pay in dollars is not monetarily sovereign. Some people disputed this on the grounds that such a country could earn the dollars it needs through exports. So I thought I would write a post discussing how realistic this is in practice.

Strictly speaking, the only country in the world that can always pay for everything it needs in its own currency is the United States. However, most developed  countries that issue their own currencies have deep and liquid FX markets that enable them to exchange their currencies freely for other currencies; many also have swap lines with the Federal Reserve. Eurozone countries don't issue their own currencies, but the bloc as a whole issues the world's second reserve currency. It is not going to run out of the means to buy imports.

In practice, therefore, developed countries can generally use their own currencies to pay for imports. But this is not true of developing countries - and most countries in the world are developing countries. In my view, a definition of monetary sovereignty that does not work for most countries in the world is not much use.

A developing country with poor creditworthiness and a thinly-traded currency is unlikely to be able to pay for imports in its own currency. It must obtain what used to be known as "hard currency," usually dollars. A country that must obtain FX to buy essential imports is effectively using the currency of another country even if it issues its own currency with a floating exchange rate. The government may be able to buy everything that is for sale in its own currency, but it is not able to buy everything the country needs. It is dependent on external sources for hard currency.

There are essentially three ways of obtaining hard currency: earning it through exports, buying it on FX markets, or borrowing it. None of these fully protect the country from FX crisis. A negative terms-of-trade shock, such as happened to commodity exporters in 2014-15, can quickly wipe out net export earnings, turning a current account surplus to a deficit and forcing the country to borrow FX. Exchange rate collapse (which may be associated with a terms-of-trade shock) can make buying FX on international markets to pay for imports all but impossible. And borrowing in foreign currencies quickly becomes unsustainable if the exchange rate drops. Floating exchange rates do not confer monetary sovereignty, even for a developing country that issues its own currency, if the country is dependent on imports for essentials such as basic foodstuffs. This is true even if the country normally runs a current account surplus.

Those who say that developing countries can always pay for essential imports with money earned from exports are really saying that developing countries should never under any circumstances run current account deficits. Where imports are concerned, the country must "live within its means." It can spend only what it earns from exports, and no more. These governments really are like households.

Since the Asian crisis of 1997-8, many developing countries - particularly those with dominant extractive industries - have done exactly this. They have opted to run persistent current account surpluses, building up FX reserves to protect themselves from "sudden stops" and enable them to support their exchange rates. In theory, these countries earn all the FX they need to pay for imports. They do not need to borrow FX.

And yet many still have FX debt, particularly in the private sector. As I noted in my previous post, a developing country with high private sector FX debt is vulnerable to exchange rate collapse. Servicing debts in ever-more expensive foreign currencies is damaging for indebted corporations, and the rising cost in domestic currency of obtaining dollars seriously hinders trade and business development. This applies whether or not the country has sufficient FX reserves to support businesses that need dollars, and whether or not the government can obtain more FX by exchanging its own currency. The rising cost of dollars as the exchange rate falls is itself enough to push the economy into recession.

But if the current account is in surplus and there are ample FX reserves, why does the private sector, and sometimes the public sector too, have FX debt? There are two reasons.

The first is cash flow. Businesses may overall have an FX surplus, as indeed the country might. But cash doesn't always arrive when you want it to, and suppliers have to be paid. So corporations can be forced to borrow FX to pay essential bills in advance of the necessary FX funds arriving. In theory, a currency-issuing government should not have to borrow FX - it should simply be able to exchange its own currency. But if the currency is thinly traded, selling it can cause the exchange rate to fall precipitously, especially if the government is printing the currency it is selling. Because of the adverse effect of sharp exchange rate falls on domestic inflation and indebted private sector actors, many governments prefer to borrow FX to cover short-term shortfalls.

The second, and more significant, is investment. Consider a company that is buying plant to establish a new business in, say, Morocco. It is likely to have to pay for that plant in dollars. It could borrow dirhams and exchange them for dollars, but as this would most likely have to come from a local bank rather than from the cheaper international capital markets, it could pay very high interest on the loan. Furthermore, if it is planning to manufacture goods for export in dollars, borrowing in dirham would create a currency mismatch on its balance sheet which would expose it to exchange rate fluctuations. For these reasons, many companies prefer to issue dollar debt rather than borrow in local currencies. But this means that they have FX debt on their balance sheets even if the cost of their imports in dollars is lower than their export earnings in dollars.

The same is also true of the government. And this brings me to the core weakness in the argument that developing countries can always earn the FX they need through exports.

Consider a country which does not produce enough basic foodstuffs to feed its population. It may have poor quality land and water shortages; it may have seriously underdeveloped agricultural production; it may be overpopulated. Whatever the reason, in the short term it must buy the food it needs to feed its population. And because international foodstuffs are invoiced in dollars, it must pay for this in dollars. If its export sector is also undeveloped, it will lack sufficient FX to buy the food its population needs.

The obvious long-term solution is for the country to increase its agricultural production so that it can feed all its people. Alternatively, if developing agriculture is problematic, for example due to persistent flooding, the country needs to increase production for export so it can earn the FX to buy the imports to feed its people. Both of these approaches require investment, and investment requires dollars. Additionally, production takes time to develop - and in the meantime, people must be fed. So the country must in the short-term borrow FX to pay for imports, and it must also borrow FX to invest for the future. If it does neither, then its people will starve both in the short term and the longer term. FX debt is thus inevitable in a country that has an insufficiently developed supply side.

A few people suggested that a job guarantee would help to develop the supply side. This is true, but supply side improvement takes time, and in the meantime people must eat. The story of the Irish famine delivers a cautionary tale about relying on job guarantees to relieve hunger. Starving people aren't productive. They need to eat first, then work. Paying them a job guarantee wage when the country is not earning sufficient dollars to import the food they need to eat is pointless and cruel.

Keeping the current account in balance or surplus by restricting imports and favouring exports is extraordinarily difficult to achieve, especially for a country with weak institutions and widespread corruption. To understand why, we need to think through what forcibly keeping the current account in balance or surplus entails.

• Imports must be controlled so that the country can never find itself with an FX gap that must be funded. High import tariffs can help the country to restrict non-essential imports. But if FX earnings from exports fall, even essential imports may have to be cut, regardless of the impact on the population.
• Following from this, exchange rate movements cannot be allowed to wipe out terms of trade advantage. Many developing countries, particularly commodity exporters, fix or manage their exchange rates to prevent them rising.
• The country must make sure that FX earnings from exports do not leave the country except in payment for imports. This means strict capital controls, including complete prohibition of profits repatriation by foreign industries, and limiting or banning FX and bullion holdings by the private sector.
• FX borrowing by government must be outlawed completely, and FX borrowing by the private sector must be restricted so that it can only be used for investment. If corporations and households are allowed to borrow in foreign currency to fund consumption spending, the current account will go into deficit.

Keeping the current account in balance or surplus at all times means deliberately suppressing domestic demand, to prevent imports from rising. In a country which depends on imports for essential foodstuffs, this could mean the poorest being constantly at risk of starvation. Additionally, since all resources would be directed to export production and supply-side development, the better-off might struggle to save. And there would be unemployment, since in an FX-dependent economy, full employment is limited by the ability of the import-export sector to generate net earnings. Creating jobs that do not increase export production, and do not substitute domestic production for imports, simply causes inflation.

There needs to be fiscal restriction too. Developing countries with real resource shortfalls that force them to import essentials must develop strong supply sides in preference to boosting domestic demand. The last thing such a country needs is deficit spending in its own currency that boosts domestic demand beyond what its own supply side can satisfy, sucking in imports which must be paid for externally with dollars even if they are sold domestically for local currency. Hey presto, before you know it, you have rising FX debt and a falling market exchange rate, the essential ingredients for an FX crisis.

This has played out time and time again in places like Latin America. Own-currency fiscal stimulus creates a short-term economic boom driven by rising consumption spending, which sucks in imports, creating a FX gap which must be funded with FX borrowing. As FX borrowing rises, investors get nervous and start selling both the FX debt and the currency, causing interest rates to rise and the exchange rate to fall. Servicing the FX debt starts to become more expensive as the domestic currency exchange rate falls. Eventually, the country either runs out of FX reserves or is effectively shut out of FX markets by prohibitively high interest rates on FX debt. When this happens, either the country defaults or it ends up in an IMF programme.

But the social costs of keeping the current account in balance or surplus are high. Consequently, there is always a risk that a populist government, encouraged by reading economic theory that prioritizes deficit-funded social programmes over externally-funded supply-side development, will abandon these restrictions and embark on a fiscal stimulus programme that quickly draws in imports funded by high FX borrowing. Because of this, economic theories designed for rich developed countries are positively dangerous to FX-dependent developing countries.

And if you don't believe me, read Rudiger Dornbusch, and weep for the countries - and they are many - that repeat the same mistakes again and again.

Related reading:

A Latin American Tragedy
Never mind Greece, look at Venezuela
Argentina And The Lure Of Dollars - Forbes

(These remarks will be delivered today at the UBS European Conference in London.)

Q: These questions about deficits are usually cast as problems to be solved. You come from a different way of framing the issue, often referred to as MMT, which—at the risk of oversimplifying—says that we worry far too much about debt issuance. Can you help us understand where fears may be misplaced?

Wray: First let me say that I think the twin deficits argument is based on flawed logic.

It runs something like this: the government decides to spend too much, causing a budget deficit that competes with private borrowers, driving interest rates up. That appreciates the currency and causes a trade deficit.

The budget and trade deficits are unsustainable as both the private sector and the government sector rely on the supply of dollars lent by foreigners. At some point the Chinese and others will demand payment and/or sell out of dollars causing US rates to rise and the dollar to crash.

While that’s a simplified summary, I think it captures the main arguments.

Here’s the way I see it:

1. Overnight rates are set by the central bank; deficits raise them only if the central bank reacts to deficits by raising them.
2. Budget deficits result in net credits to bank reserves and hence put downward (not upward) pressure on overnight rates that is relieved by bond sales by the Fed and Treasury—or by paying interest on reserves. In other words, there’s no crowding out effect on rates. (Inaction lets rates fall.)
3. Budget deficits result from the nongovernment sector’s desire to net save government liabilities. So long as the nongovernment sector wants to net save government debt, the deficit is sustainable.
4. Current account deficits result from the rest of the world’s (ROW’s) desire to net save US dollar assets. So long as the ROW wants to accumulate dollars, the US trade deficit is sustainable. So there is a symmetry to the two deficits, but not the one usually supposed.
5. The US government does not borrow dollars from China. China’s net exports lead to accumulation of dollar reserves that are exchanged for higher earning Treasuries. If China did not run current account surpluses, she would not accumulate many Treasuries. All the dollars China has came from the US.
6. If the US did not run current account deficits, the Chinese and other foreigners would not accumulate many Treasuries. This shows that accumulation of Treasuries abroad has more to do with the trade deficit than with Uncle Sam’s borrowing. (Compare the US with Japan—where virtually all the Treasuries are held domestically.)
7. A sovereign government cannot run out of its own liabilities. All modern governments make and receive payments through their central banks. Government spending takes the form of a credit by the central bank to a private bank’s reserves, and a credit by the receiving bank to the account of the recipient. You cannot run out of balance sheet entries.
8. Affordability is not the question. The problem with too much government spending is that it diverts too many of the nation’s resources to the public sector—which causes inflation and leaves the private sector with too few resources.
9. So, no, I don’t worry about sovereign government debt if it is issued in domestic currency—although I do worry about inflation, and about excessive private sector debt as well as non-sovereign government debt.
10. To conclude: We’ve reversed the twin deficit logic and emphasized quantity adjustments. The twin deficits are the residuals that accommodate the desired net saving of the domestic private sector and the ROW, respectively.
11. Usually the domestic nongovernment sectors want to accumulate dollars so the only sector left to inject dollars is the US government. This means Uncle Sam runs a deficit because others want to accumulate dollars. The government also accommodates the portfolio desires of the nongovernment by swapping dollar reserves and bonds on demand.
12. Finally, if the ROW does not want dollars anymore, it can buy goods and services in the US. That will reduce the external deficit, stimulate domestic demand, and thereby reduce the fiscal deficit.

The old "should the government issue bonds" debate has come up again. I would point the reader to this article at Mike Norman Economics, as well as the Richard Murphy article it refers to. I would argue that there is limited room for debate. The Treasury of the central government certainly can stop issuing bonds, conditioned on there being changes to the legal/regulatory framework for the central bank. The more important question is whether such a policy is a good idea. My argument is that doing so would run into a variety of consequences, and other policy decisions would need to be rethought (mainly the structure of pension provision).

I have written about this before, and will therefore keep this article short. In particular, I discussed this in Section 6.7 of Understanding Government Finance. I just want to respond to this statement by Richard Murphy:

In the light of my blog on modern monetary theory today and the comment I made in it that the government must act as the borrower of last resort I think it appropriate to republish it. I do so knowing it contradicts modern monetary theory. Political judgement and the needs of financial markets suggests that doing so is appropriate for the reasons I note.

Whether or not the Treasury issues bonds is not a "contradiction" of Modern Monetary Theory (MMT). Certainly that is a policy proposal that has been put forth. However, I would argue that it is a secondary policy issue. (I certainly have a bias in this matter - I just published a book on inflation-linked bonds, which are almost entirely issued by central governments.) There would be ramifications of such a policy shift, and we would need to address those issues at the same time.
Is it Possible? Yes!It is not hard to find people who argue that suspending bond issuance is impossible because it would run afoul of some particular operating rule under current law. Which is a remarkably silly response. Abolishing bond issuance by the Treasury is a policy proposal. One amazing empirical regularity of policy proposals is that they invariably seem to propose changing policies.

(As a technical note, this discussion does not apply to all "government" bonds; sub-sovereigns would probably have to issue bonds.)

The easiest way to get there is for the Treasury to switch to running an unlimited overdraft at the central bank. Whether or not it pays interest on that overdraft is not material: all the interest income gets swept back to the Treasury anyway!

This does not mean that there will not be central government securities. Currently, there are entities that need default risk free assets, and only the central government can supply them. The ugly solution is to allow entities to bank directly with the central bank. However, this puts the central bank in direct competition with private banks for providing financial services to the non-bank sector. A simpler solution is to issue bills on a fixed price basis. That is, sell unlimited amounts of bills at a fixed yield. This is similar in concept to savings bonds, but they are securities that can be traded in the secondary market. The central bank could be the entity issuing the bills.

Some readers may have concerns about "money printing." These concerns are entirely ideological; we cannot differentiate the proposed system from the existing system within most mathematical models of the economy. The only difference is the intra-governmental accounting, which has no effect on the behaviour of entities outside the central government.
Policy ImpactThere would be a number of side effects of such a policy.

• Prudential financial regulations that refer to Treasury bonds would need to be revised. Since banks can hold settlement balances ("reserves") at the central bank, the banking system should largely be unaffected.
• Non-bank entities that require risk free assets will need some mechanism to directly hold government liabilities. It will be inefficient to force them to use bank intermediaries to get safe assets, since the patterns of banker behaviour are well documented.
• From a Minsky-ite perspective, the loss of Treasury bonds will be dangerous for private sector portfolios. The fact that Treasury bonds increase in price during a financial crisis is a key factor propping some entities' balance sheets, giving them the buying power to intervene and stabilise the markets in private sector liabilities.
• We live in environment where pension provision has been pushed onto individuals. Taking away the only easily understood source of safe assets will make personal pension planning even harder. (Pension and insurance funds need safe assets, and Treasury bonds are extremely useful for their portfolios, as noted in the previous point. However, one might hope that they would have the sophistication to find "safe" private assets, although 2008 showed the limits of such "sophistication.")
• As a technical addendum to the previous, almost 100% of the supply of inflation protection comes from central governments (Section 4.6 of Breakeven Inflation Analysis).
• Abolishing bond issuance would largely imply a loss of control of the risk-free interest rate, unless the central bank starts issuing long duration instruments. Although this is not a major concern of MMTers -- who mainly are argue that the effects of interest rates on the economy are mixed -- the reality is that a significant majority of economists (and market participants) believe that interest rate policy is crucial. Losing that policy lever would be a massive political fight, with extremely limited gains. The compromise I would push for is to dump interest rate control in the hands of the central bank, and let them take the political heat for their mistakes.

One might hope that the private sector can sort out the safe asset issue (I have serious doubts), but pension provision is an extremely important question. We have a very large cohort of people in retirement needing guaranteed cash flows. (It would have been a lot easier to muck around with pension policy in the 1960s-1970s, when the population was weighted towards youths.) Although I am not a fan of the policy trend to push pension provision into the hands of individuals, there is no obvious policy fix at present. I see serious political or implementation issues with almost any proposal at this point. Obviously, there can be improvements, but those improvements will likely be highly jurisdiction-dependent.
Concluding RemarksThere is no doubt that central governments can stop issuing Treasury-backed bonds; the question is how to deal with the side effects of the policy.

(c) Brian Romanchuk 2018