Government solvency is daily headline news, whether relating to the health care bill, or the problems in Greece. However, what remains obscure is that insolvency is never an issue with a nation that has a non convertible currency and a floating exchange rate policy. This includes the U.S., Japan, the UK and others, but does not include the euro zone nations that have put themselves into a position equivalent to that of the states in the U.S. and the provinces in Canada; they have no 'federal' institution to backstop them.
And all this is nothing new. Let me relay a story from the 1990's for a sense of "deja vu all over again" as Yogi would say. And forgive me if my approximations of yields don't prove to be entirely accurate. This is from distant memory.
It was the early 1990's when Italian government bonds denominated in lira yielded about 2% more than the cost of borrowing the lira from the banks. One could buy Italian securities at about 14%, and borrow the lira to pay for them at about 12% for the term of the securities. This was a free lunch of 2% apart from one thing - the perceived risk of default by the Italian government. Professor Rudi Dornbusch, an influential academic economist, was insisting Italy was on the verge of default because of their debt to GDP ratio exceeded 110% and the lira interest rate was higher than the Italian growth rate. This situation caught my attention as there was easy money to be made if one knew for sure the Italian government wouldn't default.
So I started brainstorming the issue with my partners. We knew no nation had ever defaulted in its own currency with a floating exchange rate policy, and defaults only came with gold standards, fixed exchange rates, external currency debt, and indexed domestic debt. But why? The answer given was 'because they can always print the money.' Fair enough, but no one ever did 'print the money,' so there must be a better reason.
A few days later when talking to our research analyst, Tom Shulke, it came to me. I said 'Tom if we buy securities from the Fed or Treasury, functionally there is no difference. We send the funds to the same place (the Fed) and we own the same thing, so functionally it has to all be the same. Yet presumably the Treasury sells securities to fund expenditures, while when the Fed sells securities it's a reserve drain to offset operating factors and manage the fed funds rate. Obviously in fact they are the same - it's all just a glorified reserve drain!
Not long after that Maurice Samuels, then a portfolio manager at Harvard Management, set up meetings in Rome with officials of the Italian government to discuss these issues. The pivotal meeting was with Professor Luigi Spaventa at the Italian Treasury. I opened with "Professor Spaventa, this is a rhetorical question, but why is Italy issuing Treasury securities? To get lira to spend or, rather, because if you don't issue securities, the lira interbank will fall to 0 when your target rate is 12%?" Professor Spaventa at first looked puzzled, not prepared for that kind of question, then took a minute to think about it, and replied, "No, the interbank rate would only fall to one half of one percent as we pay one half of one percent interest on reserves." Perfect answer for us - here was a Finance Minister who actually understood monetary operations and reserve accounting! A few seconds later he jumped up out of his seat proclaiming "Yes! And they (the IMF) are making us act pro cyclical! A 20-minute meeting went on for two hours as he called in his associates, and made cappuccino for us before we had to run to the next meeting. A week later an announcement came out of the Italian Ministry of Finance - "No extraordinary measures will be taken. All payments will be made on time."
We and our clients were later told we were the largest holders of Italian lira denominate bonds outside of Italy, and managed a pretty good few years out of that position. Italy did not default, nor was there any solvency risk. Insolvency is never an issue with non convertible currency and floating exchange rates.
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Excess in policy has no consequences.
It can never happen here.
It has worked up until now, so it will continue to work ad-infinitum.
The Markets will settle everything out in the end.
I'm not being over-confident, and we have complete control..
I know the future, it's right here in the past.
I'll be at my house in the Hamptons this weekend.
Don't worry, I put my money where my mouth is a long time ago and am very happy I did.
the point Mosler is making is extremely important and cannot be dismissed by references to some possible inflation or exchange rate depreciation at some hypothesized or imaginary point in some distant future.
Sovereign government does not really borrow. It issues "debt" to hit interest rate targets. It cannot go bankrupt in its own currency. Mkts cannot hold it hostage.
So let us understand that point. then we can worry about possible inflationary effects of spending.
E-Z nations are, in terms of monetary options, much more like US states than like the US government. The author says as much in his first paragraph, and then goes on to tell us why we shouldn't worry, at least not about US debt. I worry, and given his candidate status, even though I'm not a CT voter, I would be very interested to see his thoughts on the US's options and best responses to the conditions that threaten us all directly or indirectly.
I love you - you're more intelligent then this planet deserves and so very charming.....but I gotta tell ya, you're sounding a little fanatical.
As an economist and Democratic challenger for Dodd's seat, I trust he understands that, while this economic reality may be essentially tautological, politically, such issues as the debt ceilings, foreign holding levels, political deficit rhetoric, and the reality of a sometimes intransigent opposition party, still makes treasury debt dynamics something much more than a sponge for excess reserves.
That's something you can bank on. But I agree, we need to ABOLISH MONEY altogether and convert to a GLOBAL RESOURCED BASED ECONOMY.
If we don't, BILLIONS will die and some of those will probably be AMERICANS.
See, I can do it to!
The only constraint on such governments is real. if the government issues too much currency relative to real output capacity, then inflation will result and if not enough, then an output gap will open and there will be recession and rising unemployment. The accounting is simple. If national income does not equal real output capacity, then some goods and services will not be purchased, inventories will increase, and business will cut back. Thus, to maintain full capacity utilization, government must make up the shortfall in demand. Otherwise, there will be a recession and unemployment.
The government as currency provider has the prerogative and corresponding responsibility to provide the correct amount of currency to balance spending power (nominal aggregate demand) and goods for sale (real output capacity).
1) Currency is issued through government spending to balance supply and demand.
2) Taxes and debt are not used to offset government spending; taxes are used to manage inflation and debt is unnecessary?
The implication: Too much currency or not enough taxes would result in inflation.
If we stick with most people’s understanding:
1) Taxes are collected to offset government spending with the balance being offset by a combination of debt and the issuance of currency.
The implication: Not enough taxes would result in either debt or inflation.
Either way, government spending must be constrained; otherwise inflation will result. You and the author are telling us that we shouldn’t worry about deficits and debt, but even under your model, the result is inflation.
Am I missing something?
Here's the basic problem. Most people's thinking is based on a convertible fixed rate currency such as the gold standard. This all changed completely when Nixon shut the gold window on August 15, 1971, and the world shifted to nonconvertible flexible rate (fiat) currencies. The way that government finance actually works changed at this moment and people haven't caught up.
If you want to get this, read L. Randall Wray, Understanding Modern Money (1998). It's written b y an economics professor for non-economists, and it presents a clear exposition of how government finance actually works now, not the way folks erroneously think it works based on obsolete gold standard rules that no longer apply to the modern monetary system. All of the hand wringing is much ado about nothing.
Ask yourself this: did anyone worry about inflation in the press or did you hear a peep out of many economists about inflation when the USA invaded Iraq, Grenada, Panama, Vietnam, Korean, Afghanistan or at the funding of any of the many interventions or bombings?
Everybody talks about how increasing the minimum wage (salaries) will cause inflation, but no one has examined if the extreme growth in exec pay has contributed to inflation?
Or maybe they have?
Just questions to examine.