Deficit Chicken Littles Miss Another Doomsday Deadline

Aug 17, 2010Marshall Auerback

marshall-auerback-100 China is dumping Treasuries and interest rates remain low.  Will the doomsayers see the error of their ways?

marshall-auerback-100 China is dumping Treasuries and interest rates remain low.  Will the doomsayers see the error of their ways?

In a post titled "China Cuts US Treasury Holdings By Record Amount," Mike Norman makes the excellent observation that while China is moving its money out of Treasuries, interest rates are hitting record lows.  In other words, the sky still isn't falling.  So, Mike wonders, "Where is the Debt/Doomsday crowd?"  He rightly concludes that “They’re nowhere to be found because they can’t explain this. This is a ‘gut punch’ to them. Their whole theory is out the window.  They just don’t understand or don’t want to understand, that interest rates are set by the Fed…PERIOD!!!”

Also of note: Nikkei QUICK News reports that the #309 10-year bond, the current benchmark, has traded to a yield of 0.920% Tuesday morning, down 2.5 basis points from yesterday's close. This is the lowest yield since August 13, 2003. U.S. Treasuries traded higher overnight and press articles suggest that China is finding the safety of JGBs attractive.

This, from a country with a debt-to-GDP ratio of 210%!

I know what the deficit hawks are now saying -- it is only a matter of time! Yes, and doom-merchants have been predicting the end of the world forever and the Y2K bugs were predicting it then and the gold bugs were predicting Weimar-style hyperinflation by the end of 2009 and… We can just let the “it is only a matter of time” brigade worry themselves sick and leave us in peace.

Marshall Auerback is a Senior Fellow at the Roosevelt Institute, and a market analyst and commentator.

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How I Learned to Quit Worrying and Love Corporate Globalization

Aug 12, 2010Joe Costello

money-globe-150Corporate globalization is in vogue for politicians, but it benefits no one.

money-globe-150Corporate globalization is in vogue for politicians, but it benefits no one.

General Ripper: It's incredibly obvious isn't it? A foreign substance is introduced into our precious bodily fluids, without the knowledge of the individual, certainly without any choice. That's the way your hardcore Commie works.

Captain Mandrake: Tell me Jack, when did you first develop this theory?

General Ripper: Well, I first became aware of it Mandrake, during the physical act of love. A profound sense of fatigue and feeling of emptiness followed. Luckily, I was able to interpret these feelings correctly...loss of essence.

-- Dr. Stangelove

One interesting thing that has happened over the last several decades is a shift in our elites' view of international conspiracies. If you are unfortunately old enough to remember our existential obsession with "international communism," you will remember for the most part it was party line for both parties to look with suspicion on things labeled "international" or "global." Yet a funny thing happened with the rise of corporate globalization: suddenly "international" not only lost suspicion, but was necessary. It's to the point now where a Democratic administration can cut auto workers' pay in half in the name of international competition, and the move is met not only by complete silence but approval from the workers so-called representatives, the UAW.

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The Washington Post has a story about a report released by the Congressional Oversight Panel on the bank bailouts, bringing to light one of the dirty little not-so-secrets -- a good chunk of the bailout money went to foreign firms:

The federal government's effort to stabilize the financial system in 2008 by flooding money into as many banks as possible resulted in a boon to many foreign firms and left the United States shouldering far more risk than governments that took a narrower approach, according to a new report by a panel overseeing the Treasury's $700 billion bailout fund.

They cite as a case study the bailout of insurance giant American International Group. While the Treasury committed up to $70 billion to AIG through its Troubled Assets Relief Program, the report states, much of that money ended up in the coffers of foreign trading partners in France, Germany and other countries. The cash that the United States poured into AIG alone equaled twice what France spent on its total capital injection program, and half what Germany spent.

AIG was a hole big enough to save the world -- call it "loss of essence". (See good piece on AIG by William Greider.) Corporate globalization's impact on the planet has pretty much been the same as nuclear bombs: it entirely rearranges the globe and is good for neither those "controlling" matters, nor those on the receiving end. It is beneficial only in the short-run for the bomb makers. At some point, we will realize this is simple madness.

Joe Costello was communications director for Jerry Brown’s 1992 presidential campaign and was a senior adviser for Howard Dean’s effort in 2004.

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Do Deficits Matter? Foreign Lending to the Treasury

Aug 3, 2010L. Randall Wray

money-globe-150How can we reconcile our lending to China with the interests of the United States?

money-globe-150How can we reconcile our lending to China with the interests of the United States?

Deficit hawks raise three objections to persistent federal government budget deficits: a) they pose a solvency risk that could force to government to default on its debt; b) they pose an inflation, or even a hyperinflation, risk; and c) they impose a burden on our grandkids, who will have to pay interest in perpetuity to the Chinese who are accumulating treasuries as well as power over the fate of the dollar.

I have argued that federal budget deficits and debts do not matter so far as national solvency goes (see here). The sovereign issuer of the currency cannot be forced into an involuntary default. I have also dealt with possible inflation effects of deficit spending (see here). To summarize that argument as briefly as possible, additional deficit spending beyond the point of full employment will almost certainly be inflationary, and inflation barriers can be reached even before full employment. However, I argued that the risk of hyperinflation for a country like the US is exceedingly low, and high inflation will be avoided by every stripe of policymaker the US is likely to appoint.

In this blog I will address the connection between trade deficits and foreign accumulation of treasuries, the interest burden supposedly imposed on our grandkids, and the possibility that foreign holders might decide to abandon the dollar.

Let us set out the framework. At the aggregate level, the government's deficit equals the nongovernment sector's surplus. We can break the nongovernment sector into a domestic component and a foreign component. As the US macrosectoral balance identity shows, the government sector deficit equals the sum of the domestic private sector surplus plus the current account deficit (which is the foreign sector's surplus). Let me stress that this is an identity, beyond dispute. Even those who are worried about the sustainability of continued budget deficits recognize the macro accounting identity (see here). We will put to the side discussion about the behaviors that got us to the current reality -- which is a large federal budget deficit that is equal to a (smallish) private sector surplus (spending less than income) plus a rather large current account deficit (mostly resulting from a US trade balance in which imports exceed exports).

There is a positive relation between budget deficits and the current account deficit that goes behind the identity. All else equal, the government budget deficit raises aggregate demand so that US imports exceed US exports (American consumers are able to buy more imports because the US fiscal stance generates household income used to buy foreign output that exceeds foreign purchases of US output.) There are other possible avenues that can generate a relation between the US government deficit and the current account deficit (some point to effects on interest rates and exchange rates), but they are at best of secondary importance. To sum up: a US government deficit can prop up demand for output, some of which is produced outside the US-so that US imports rise more than exports, especially when a budget deficit stimulates the American economy to grow faster than the economies of our trading partners.

When foreign nations run trade surpluses (and the US runs a trade deficit), they are able to accumulate dollar denominated assets. A foreign firm that receives dollars usually exchanges them for domestic currency at its central bank. For this reason, a large proportion of the dollar claims on the US end up at foreign central banks. Since international payments are made through banks, rather than by actually delivering federal reserve paper money, the dollars accumulated in foreign central banks are in the form of reserves held at the Fed-nothing but electronic entries on the Fed's balance sheet. These reserves do not earn interest. Since the central banks would prefer to earn interest, they convert them to US treasuries-which are really just another electronic entry on the Fed's balance sheet, albeit one that periodically gets credited with interest. This conversion from reserves to Treasuries is akin to shifting funds from your checking account to a certificate of deposit (CD) at your bank, with the interest paid through a simple keystroke that increases the size of your deposit. Likewise, treasuries are CDs that get credited interest through Fed keystrokes.

In sum, a US current account deficit will be reflected in foreign accumulation of US Treasuries, held mostly by foreign central banks. The figure below displays the top foreign holders of US treasuries. While most public discussion has focused on Chinese holdings, Japanese holdings are of a similar size.graph-l-randall

(Seen here)

While this is usually presented as foreign "lending" to "finance" the US budget deficit, one could just as well see the US current account deficit as the source of foreign current account surpluses that can be accumulated as treasuries. In a sense, it is the proclivity of the US to simultaneously run trade and government budget deficits that provides the wherewithal to "finance" foreign accumulation of treasuries. Obviously there must be a willingness on all sides for this to occur-we could say that it takes (at least) two to tango-and most public discussion ignores the fact that the Chinese desire to run a trade surplus with the US is linked to its desire to accumulate dollar assets. At the same time, the US budget deficit helps to generate domestic income that allows our private sector to consume-some of which fuels imports, providing the income foreigners use to accumulate dollar saving, even as it generates treasuries accumulated by foreigners.

In other words, the decisions cannot be independent. It makes no sense to talk of Chinese "lending" to the US without also taking account of Chinese desires to net export. Indeed all of the following are linked (possibly in complex ways): the willingness of Chinese to produce for export, the willingness of China to accumulate dollar-denominated assets, the shortfall of Chinese domestic demand that allows China to run a trade surplus, the willingness of Americans to buy foreign products, the (relatively) high level of US aggregate demand that results in a trade deficit, and the factors that result in a US government budget deficit. And of course it is even more complicated than this because we must bring in other nations as well as global demand taken as a whole.

While it is often claimed that the Chinese might suddenly decide they do not want US treasuries any longer, at least one, but more likely many, of these other relationships would also need to change.

For example it is feared that China might decide it would rather accumulate euros. However, there is no equivalent to the US treasury in Euroland. China could accumulate the euro-denominated debt of individual governments-say, Greece!-but these have different risk ratings and the sheer volume issued by any individual nation is likely too small to satisfy China's desire to accumulate foreign currency reserves. Further, Euroland taken as a whole (and this is especially true of its strongest member, Germany) attempts to constrain domestic demand to avoid trade deficits-meaning it is hard for the rest of the world to accumulate euro claims because Euroland does not generally run trade deficits. If the US is a primary market for China's excess output but euro assets are preferred over dollar assets, then exchange rate adjustment between the (relatively plentiful) dollar and (relatively scarce) euro could destroy China's market for its exports.

I am not arguing that the current situation will go on forever, although I do believe it will persist much longer than most commentators presume. But changes are complex and there are strong incentives against the sort of simple, abrupt, and dramatic shifts often posited as likely scenarios. I expect that the complexity as well as the linkages among balance sheets ensure that transitions will be moderate and slow-there will be no sudden dumping of US treasuries.

Before concluding, let us do a thought experiment to drive home a key point. The greatest fear that many have over foreign ownership of treasuries is the burden on our grandkids-who, it is believed, will have to pay interest to foreigners. Unlike domestically-held treasuries, this is said to be a transfer from some American taxpayer to a foreign bondholder (when bonds are held by Americans, the transfer is from an American taxpayer to an American bondholder, believed to be less problematic). So, it is argued, government debt really does burden future generations because a portion is held by foreigners. Now in reality, interest is paid by keystrokes-but our grandkids might decide to raise taxes on themselves to match interest paid to Chinese bondholders and thereby impose the burden feared by deficit hawks. So let us continue with our hypothetical case.

What if the US managed to eliminate its trade deficit so that it ran a perpetually balanced current account? In that case, the US budget deficit would exactly equal the US private sector surplus. Since foreigners would not be accumulating dollars in their trade with the US, they could not accumulate US treasuries (yes, they could trade foreign currencies for the dollar but this would cause the dollar to appreciate in a manner that would make balanced trade difficult to maintain). In that case, no matter how large the budget deficit, the US would not "need" to "borrow" from the Chinese to finance it.

This makes it clear that foreign "finance" of our budget deficit is contingent on our current account balance-foreigners need to export to us so that they can "lend" to our government. And if our current account is in balance then no matter how big our government budget deficit, we will not "need" foreign savings to "finance" it-because our domestic private sector surplus will be exactly equal to our government deficit. Indeed, one could quite reasonably say that it is the budget deficit that "finances" domestic private sector saving.

Yet, the deficit hawks believe the federal budget deficit would be more "sustainable" if foreigners did not accumulate treasuries that supposedly burden future generations of Americans.

OK, how could we eliminate the current account deficit that allows foreigners to accumulate treasuries? The IMF-approved method of balancing trade is to impose austerity. If the US were to grow much slower than all our trading partners, US imports would fall and exports would rise. In fact, our current "great recession" did reduce our trade deficit-although only moderately and probably temporarily. In order to eliminate the trade deficit and to ensure that we run balanced trade, we are going to need a much deeper, and permanent, recession. By reducing American living standards relative to those enjoyed by the rest of the world, we might be able to eliminate our current account deficit and thereby ensure that foreigners do not accumulate treasuries said to burden future generations of Americans.

Now, can the deficit hawks please explain why we should desire permanently lower living standards on their promise that this will somehow reduce the burden on our grandkids?

I think my grandkids would prefer a higher growth path both now and in the future, so that we can leave them with a stronger economy and higher living standards. If that means that thirty years from now the Fed will need to stroke a few keys to add interest to Chinese deposits, so be it. And if the Chinese some day decide to use dollars to buy imports, our grandkids will be better situated to produce the stuff the Chinese want to buy.

L. Randall Wray is Professor of Economics at the University of Missouri-Kansas City.

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Marshall Auerback Dissects State Budget Woes on BNN

Jul 30, 2010

Thought that deficit hysteria is only a problem on the Federal level? Think again. The Governator is in deep trouble, and so are "48 out of the 50 states", which are all facing fiscal crises, Marshall points out. Part of the problem is due to falling tax revenues and state politics that require balanced budgets, but the larger problem is a lack of chutzpah in Congress to pony up some Federal assistance to state budgets. Lacking that, however, California is taking matters into its own hands and issuing IOUs, which now hold some weight.

Thought that deficit hysteria is only a problem on the Federal level? Think again. The Governator is in deep trouble, and so are "48 out of the 50 states", which are all facing fiscal crises, Marshall points out. Part of the problem is due to falling tax revenues and state politics that require balanced budgets, but the larger problem is a lack of chutzpah in Congress to pony up some Federal assistance to state budgets. Lacking that, however, California is taking matters into its own hands and issuing IOUs, which now hold some weight. They can be used to pay state taxes -- exactly what gives currency value. That's the difference, for example, between the "normal piece of paper" Marshall holds up and the "piece of paper with a dead president on it." The dead president can be used to pay Federal taxes. After all, we're not on the gold standard anymore, Toto.

Meanwhile, although Marshall concedes that there is political dysfunction in California's government, now is not the time for Schwarzenegger to give the smack down. "When you have a fire going on, and a fire engine comes up to your house to put out the fire, you don't complain because of the design of the fire engine." Put out the fiscal fire. Then give the truck a new coat of red paint.

Check out the full interview here.

And check out some of Marshall's latest posts:

The Summer(s) of Our Discontent

The Trouble with Tim's Treasury

The Self-inflicted Insanity of American Unemployment

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Despite Foreign Debts, U.S. Has the Upper Hand

Jul 16, 2010Henry Liu

money-globe-150U.S. public debt as of July 8, 2010 was $ 13.192 trillion against a projected 2010 GDP of $14.743 trillion. As of April 2010, China held $900.2 billion of US Treasuries, surpassing Japan's holding of $795.5 billion.

money-globe-150U.S. public debt as of July 8, 2010 was $ 13.192 trillion against a projected 2010 GDP of $14.743 trillion. As of April 2010, China held $900.2 billion of US Treasuries, surpassing Japan's holding of $795.5 billion. As of 2007, outstanding GSE (Government Sponsored Enterprises like Fanny Mae; Freddy Mac) debt securities (non-mortgage and those backed by mortgages) summed up to $7.37 trillion.

Does this mean disaster for the US? Conventional wisdom is misleading, as the case of China illustrates.

Paulson's Worry

Former Treasury Secretary Hank Paulson revealed in his recently published memoir that in August 2008, while attending the Olympics in Beijing, he was informed by Chinese officials that "Russian officials had [earlier] made a top-level approach to the Chinese suggesting that together they might sell big chunks of their GSE holdings to force the U.S. to use its emergency authorities to prop up these companies." Paulson said while "the Chinese declined to cooperate", the report was nonetheless "deeply troubling," as "heavy selling could create a sudden loss of confidence in the GSEs and shake the capital markets."

In an Op-Ed article in the June 14, 2010 edition of Foreign Affairs by Benn Steil, Senior Fellow and Director of International Economics, and Paul Swartz, Analyst, Center for Geoeconomic Studies, the authors suggest that "with the U.S. needing to sell another $1.3 trillion in debt in 2009, the risk Paulson describes is certainly real."

They point out that over the past decade, foreign ownership of U.S. debt has increased dramatically. Foreign holdings of Treasurys have risen from 29% to 48% of the outstanding stock, while foreign holdings of U.S. government agency and GSE backed debt have increased from 6% to 16%. Virtually the entire increase in both has been accounted for by foreign governments, as opposed to private investors. And one government dominates: China. By the authors' estimates, China has accumulated an astounding $850 billion in Treasuries and $430 billion in agency debt over the decade -- almost half the total foreign government accumulation. (As of April 2010, China held $900.2 billion of U.S. Treasuries, ranking top surpassing Japan's holding of $795.5 billion.)

The authors report that to some, the fear that the Chinese might dump U.S. debt is misguided. "It would be very much against their own interest to do so," Federal Reserve chairman Ben Bernanke said back in 2006. Heavy selling would precipitate precisely the fall in the dollar's local and global purchasing power that the Chinese fear. So the Chinese would not cut off their noses to spite their faces. But the same faulty argument can be made about anyone caught in a Ponzi scheme, the authors warn. No one who finds himself in a Ponzi scheme wants to see it collapse, yet he will still sell because he knows he will be worse off if others sell first.

So, the authors ask, how serious is the risk of strategic, coordinated foreign selling, of the type that could destabilize financial markets? They answer that "Here is where Paulson drops the ball. He tells us only that China rejected the Russian scheme to coordinate the mass dumping of GSE debt. Yet large-scale near-simultaneous selling is precisely what happened. By our calculations, Russia sold $160 billion worth, virtually all of its holdings, over the course of 2008, while China sold nearly $70 billion worth between June 2008, when its holdings peaked, and the end of that year."

And while the fire sale went on, the yield spread between GSE debt and U.S/ Treasury debt soared. From 2003 to 2007 it averaged 34 basis points. When Russia started selling GSE debt in January 2008, it stood at 57 basis points. When China started selling in July, it hit 86 basis points. As GSE debt was widely used as collateral in the U.S. repo market, the rising spread forced U.S. financial institutions to pony up more and more securities to support their borrowing. The government put the GSEs into conservatorship in September. Yet Chinese and Russian dumping of GSE debt accelerated into the fourth quarter of 2008, as did spreads, which peaked in November at over 150 basis points.

This episode highlights the clear risks to the U.S., and indeed the wider world, of growing American dependence on foreign government lending, the authors conclude.

But this is the wrong conclusion. Why? Because the U.S. owes no foreign debt denominated in foreign currencies.

Dollar Hegemony

The authors did not ask why the U.S., while vulnerable, is not critically over a barrel by massive foreign holdings of U.S. sovereign debt. The reason is because U.S. sovereign debts are all denominated in dollars, a fiat currency that the Federal Reserve can issue at will. The U.S. has no foreign debt in the strict sense of the term. It has domestic debt denominated in its own fiat currency held in large quantities by foreign governments. The U.S. is never in danger of defaulting on its sovereign debt because it can print all the dollars necessary to pay off foreign holders of its debt. There is also no incentive for the foreign holders of U.S. sovereign debt to push for repayment, as that will only cause the U.S. to print more dollars to cause the dollar to fall further in exchange rates.

In this situation, the borrower enjoys market power over the lender. This advantage that the U.S. enjoys comes from dollar hegemony, a peculiar condition in global finance in which the dollar, a fiat currency that the U.S. can issue at will, is recognized worldwide as a reserve currency for international trade because of U.S. geopolitical power with which to force the trading of critical basic commodities to be denominated in dollars. Everyone accepts dollars because dollars can buy oil and every economy needs oil. Granted, one can buy oil also with euros and yen, but only because these currencies are freely convertible to dollars, and therefore they are really derivative currencies of the dollar.

But this is not quite a free ride. Although the US is getting low-price imports paid for with paper dollars that it will never have to buy back with gold, this type of trade comes with is a penalty of losing low-paying manufacturing jobs overseas, mainly to China. In recent months, as the Chinese government realizes that a low-wage economy is an underdeveloped economy, it has encouraged Chinese workers to demand higher wages through collective bargaining and strikes. Low-wage jobs then will move by transnational corporations to other underdeveloped low-wage economies such as Vietnam, Indonesia and some countries in Central and Latin American. But this type of trade globalization through cross-border wage arbitrage also pushes down wages in the US and other advanced economies, causing insufficient consumer income to absorb rising global production. This is the main cause of the current financial crises which have made more severe by financial deregulation. But the root cause is global overcapacity due to low wages of workers who cannot afford to buy what they produce. The world economy is plagued with overcapacity as a result. It is not enough to merely focus on job creation. Jobs must pay wages high enough to eliminate overcapacity. Instead of a G20 coordination on fiscal austerity, there needs to be a G20 commitment to raise wages globally.

Click here to read the full article.

Henry C.K. Liu is an independent commentator on culture, economics and politics.

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The G20 Plan for Prosperity: Rubber Bullets and Shredded Social Safety Net

Jul 14, 2010Paul Jay

protest-target Police brutality at the G-20 protests in Toronto targeted freedom of speech and assembly, putting the world's poor and working people on notice.

protest-target Police brutality at the G-20 protests in Toronto targeted freedom of speech and assembly, putting the world's poor and working people on notice.

The Toronto G-20 summit sent a message to poor and working people in Europe and North America. "You will pay for the global financial crisis through cuts to your social safety nets. There will be no taxing of those who actually caused the crisis and made fortunes in the various bubbles over the last decades."

Of course not in so many words -- what they said was they had committed to fiscal plans that will at least halve deficits by 2013 and stabilize or reduce government debt-to-GDP ratios by 2016. That means austerity plans, which was pretty much what was on the agenda before the countries got there.

This was bad enough. But there was another message, too, sent through the Canadian police: "If you don't like it, how about a rubber bullet?" It looks like G-20 countries will deal with opposition to their plans through martial law and police brutality.

I was there in Toronto, where police turned the downtown center into something resembling martial law. The invocation of an archaic piece of legislation called the "Public Works Protection Act" at the G20 site essentially suspended probable cause, giving police the rights of search and seizure to anyone, anywhere in the area. In other parts of the city peaceful demonstrators were charged with "conspiracy to commit mischief" and "disturbing the Queen's peace".

Canadians learned that there was no right to freedom of assembly and no freedom of speech as long as extraordinary measures could be rationalized.

And what were the circumstances? Well, in the midst of twenty thousand peaceful demonstrators were around one hundred people dressed in black (known as the Black Bloc tactic). At a certain point on Saturday afternoon, they broke away from the main protest march, and ran up and down Yonge Street breaking windows. Four police cars were trashed and burned. There is evidence a few of the cars were abandoned by police for hours before they were set upon. On one such car, protesters painted the words "bait".

There was nothing very secret about the Black Bloc's intentions or plans. There is evidence that the police had infiltrated the group, but in any case, they actually published most of their plans on a public web site. Yet in footage captured by a freelance journalist and dozens of cams posted on YouTube, police can be seen standing by for as long as an hour or more while the rampage occurred.

Was it a deliberate plan by the security forces (led by the RCMP), or a lack of resources as police claimed? When you try to answer that, keep in mind the Canadian government spent close to a billion dollars on security that included around 19,000 police on the streets.

In any case, television images of burning police cars became the rationale for almost a thousand arrests, mostly not of people wearing black, but of ordinary demonstrators. We know of times when people sat cross-legged holding up peace signs had rubber bullets fired at them. Journalists were manhandled, thrown to the ground, beaten with batons or punched in the face or gut, which happened to Jesse Rosenfeld (writing for the British paper The Guardian) and our own Jesse Freeston at The Real News.

The public has a right to know whether police are or are not abusing their powers. And the public can't know this without professional journalists with the courage to report from the centre of the storm. These journalists must be able to stand their ground if police try to move them, and the law must protect their right to do so. Without this, we are on our way to a police state.

Canadians are still processing the Toronto protest. What happened with the $1 billion the federal government is spending on security? Are the people of Ontario going to put up with the Public Works Protection Act, implemented quietly for the G-20? Will they accept the principle that the police can declare any protest or demonstration an illegal assembly? Will they demand full accountability from politicians and the police?

If the protest marked a turning point for the city, then it also marked a turning point for the world. If the Toronto G-20 is the shape of things to come, then people faced with drastic reductions in their living standards will be denied their freedom of speech and assembly at the snap of a police officer's or politician's fingers.

The firing of those rubber bullets should be a shot heard round the world.

You can watch a collection of G-20 video reports, including "Doves on finance reform, hawks on austerity" with Rob Johnson, at the Real News Network.

Paul Jay is the CEO and Senior Editor of The Real News Network. He is an award-winning filmmaker, founder of Hot Docs! International Film Festival and was for ten years the Executive Producer of the CBC Newsworld show counterSpin.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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G20’s “Violent Agreement” on Austerity Will Smash Global Economy

Jul 13, 2010Mario Seccareccia

hawk-150 Too many economists have forgotten the Keynesian lesson: The boom, not the slump, is the time for fiscal austerity.

hawk-150 Too many economists have forgotten the Keynesian lesson: The boom, not the slump, is the time for fiscal austerity.

In November 2008, when most of the world's financial markets had been rescued, after many governments in Western countries had spent billions in bailouts, the G20 countries met. They did not meet to discuss the need for deficit spending. That was already a fait accompli that had resulted from the effects of the initial subprime crisis in 2007-2008 and the huge bailout package to prevent the banking sector from falling into a financial abyss. Rather, they met to discuss a coordinated "fiscal stimulus" strategy in order to avert a severe collapse of real private sector aggregate spending, which, at the end of 2008, seemed unavoidable.

A quick look at Figure 1 shows the dramatic change in the fiscal stance of Western countries after 2007. Instead of pursuing policies of "sound finance" in which most governments try to climb out of fiscal deficits or target fiscal surpluses, as can be seen after 2001, all these countries plunged into significant budgetary deficits after 2007 (see shaded area in Figure 1).

Figure 1: General Government Financial Balances (Actual/Forecasted) as a Percentage of GDP, Total OECD, Euro Area, and G7 Countries, 1991-2010

seccareccia-figure-1

Source: OECD

At the G20 meeting in Toronto at the end of June 2010, we witnessed a complete reversal of the policy discourse. With a bit of pressure on the representatives of the developing world, the Western leaders of the G20 pact left agreeing on the goals that had been proposed by the host prime minister, Stephen Harper, and other deficit hawks, such as David Cameron and Angela Merkel. According to the G20 declaration, these government leaders had committed themselves to fiscal plans that would surgically cut their deficits by at least 50 percent by 2013 as well as stabilize and begin to reduce government debt-to-GDP ratios by 2016, all in the name of stabilizing the macroeconomy. Although there was some debate over the precise timetable of their "exit strategy," Barack Obama emphasized that on the issue of fiscal austerity "there is violent agreement between the parties."

It is hard to imagine how "violently" the world political elite can "agree" to deflate the world economy in light of the mostly peaceful protests against austerity in the streets of Toronto. However, when asked how the economy is supposed to be stabilized and brought back to a desirable high growth path, these world leaders referred to the positive effects on growth of a reduced burden of overhanging public debt. They pointed to the necessity for public debt stabilization and fiscal sustainability. And they highlighted the need to make way for the private sector in the growth strategy.

It is obvious that public sector debt ratios can stabilize and fall only if revenues start to exceed spending. But it is not at all obvious that high public debt ratios are inimical to growth and that the private sector will grow as a result of cuts in spending and/or increases in taxes. In fact, prima facie evidence from the week following the G20 summit offers some ominous signs that stand in sharp contrast to what the G20 leaders envisaged as the economic outcome of their proposed policies. The week following the G20 meeting, prices at the principal North American stock exchanges declined sharply and forecasts of growth were revised in countries such as China that rely on exports as their engine of growth. Despite some recently embellished forecasts from the IMF, there are real fears in world markets of a 1937-style "double-dip" recession, fears reinforced by the decisions taken in Toronto at the end of June. Market expectations of future prospects for growth have not been positively influenced by the formal statement of the G20 leaders. On the contrary, concerted policies of austerity in a world economy that is struggling just to stand still could merely push many economies over the edge of the precipice, since public sector retrenchment could only feed negatively on growth through standard Keynesian multiplier/accelerator effects. This is because a public sector budgetary deficit is not some financial black hole that removes much needed loanable funds that would otherwise be available for investment purposes for the private sector. Quite the opposite, deficit spending creates private sector savings through the income-generating process.

Indeed, what the G20 leaders and their economic advisers fail to understand is an elementary accounting fact: what is spending for one sector (say, the government sector) is necessarily a receipt or income for another sector (say, the private sector) and that what is a net spending (or a budgetary deficit) of one sector must inevitably be a positive net saving (or a financial surplus) of another sector.  Regardless of how they are financed, expenditures generate income, and private sector saving is merely the pecuniary accountancy of public sector deficits. This also means that any net budgetary surplus of the public sector merely destroys private sector net income or saving. In terms of Figure 1 above, one ought to just imagine this same chart but stood on its head, which would delineate the net saving position of the private sector for all those countries. For illustrative purposes, both the private and public sector balances are displayed in Figure 2, but only for the US and the countries of the Euro zone combined. Indeed, the only reason why these series are not literally a mirror of one another is because we have not taken into consideration the international current account balance, which could fluctuate somewhat over time and blur to some extent the otherwise symmetrical relation between the two domestic series.

Figure 2: Net Private and Consolidated Public Sector Balances for the Euro Area and the US as a Percentage of GDP, 1991-2010

seccareccia-firgure-2

Source: OECD

The fiscal hawks want to cut spending that encourages private sector  investment and productivity, but this means that people will earn lower wages and profits, they will be unable to save money, and still more of them will be out of work. How does growth happen in this scenario?

We need policies that sustain growth on a permanent basis, not abort it. As Keynes said, "the boom, not the slump, is the right time for austerity at the Treasury." This kind of policy framework, associated with Keynesian ideas, is known as "functional finance". It was quite successfully implemented during the early postwar years to achieve full employment before these policies succumbed to the monetarist onslaught. Since the 1970s, several generations of young economists have had little or no exposure to these Keynesian ideas and have been trained to think that there is no alternative to the neoclassical doctrine of "sound finance," which had been discredited during the 1930s.

There are, however, economists out there who do think otherwise. A good example is the recent letter signed by over 200 Italian economists who affirm that yes we can imagine positive alternatives to austerity and economic retrenchment. They reject the misguided neoclassical ideology that has gripped the European members of the G20. A similar letter was signed by a number of British economists earlier this spring. While the deficit hawks seemed to have won the battle in the Western countries, it is less clear to what extent the G20 leaders from Asia and Latin America are actually swallowing this ideological-driven rhetoric from the likes of Cameron, Harper and Merkel, whose policies that they advocate could drive the world economy into a vicious downward deflationary spiral.

Roosevelt Institute Braintruster Mario Seccareccia is editor of the International Journal of Political Economy.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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The Fighting Deficit Twins

Jul 1, 2010Henry Liu

deficit-150How a controlled fiscal deficit can be a useful government tool to fight reliance on foreign trade.

deficit-150How a controlled fiscal deficit can be a useful government tool to fight reliance on foreign trade.

In monetary economics, the trade deficit and the fiscal deficit are referred to as the "Twin Deficits," as if they were genetically related twins merely because they both contribute to increases in the public debt. Yet these two deficits are genetically opposite and can act like fighting twins to neutralize each other in their adverse economic effects.

A fiscal deficit is created by government spending in excess of revenue in the domestic economy. The external penalty of a persistent fiscal deficit is the devaluation of the exchange rate of the domestic currency in foreign trade.

A trade deficit is created by excess imports over exports in foreign trade. One of the curative measures for a persistent trade deficit has been conventionally identified in trade economics as a devaluation of the domestic currency against those of its trading partners, or in multilateral trade, against a reserve currency. Currency devaluation is expected to make exports less costly and more competitive in price. It is also expected to make imports more costly in local currency terms.

Therefore, there is logic in viewing a fiscal deficit as a solution to a trade deficit, through its function in devaluing the domestic currency.

Under the Bretton Woods regime of a fixed exchange rate pegged to a gold-backed dollar, it was considered normal that an economy that ran persistent trade deficits would see its foreign trade decline unless the currency was devalued officially, since at that time, foreign exchange markets were not allowed to operate beyond currency settlement at the central bank of the reserve currency -- the US Federal Reserve.

A deficit in foreign trade for an open economy is equivalent to a corporation running a loss in domestic market operation due to imbalance between cost of production and sales revenue derived from the market price of its products. The solution to operational losses in a corporation is to either lower the unit cost of its products without reducing quality, or to increase the unit price without affecting sale volume, or an optimum mixture of both.

Increasing the volume of trade would cut operational losses only if the greater sale volume reduces the unit cost of production, and provided that greater sale volume is not achieved through price discounts. If the unit cost in sales is fixed independent of production volume, increasing the trade volume will only exacerbate the losses.

This happened to General Motors at a time when its labor cost per car remained independent of volume of production to result in a negative unit profit margin. Under such circumstances, the more cars GM sold, the higher its losses. The solution then was to shut down production, even if that would lead to losing market share.

The monetary regime of an open economy allows the exchange rate of its currency to be determined by market forces. The central bank can still and does intervene in open market operations to keep the exchange rate of its currency at the level targeted by monetary policy. This is done by selling its own currency in the open market for foreign reserves to keep the currency from rising in exchange value, or buying its own currency with foreign reserves to keep it from falling in exchange value.

Depreciating a currency in an open economy without capital control and with full currency convertibility can be achieved by a central bank accumulating foreign reserves through selling its own currency. Or it can be achieved by government running a persistent fiscal deficit to signal market forces to push down the exchange rate of its currency. Thus a controlled persistent fiscal deficit is a form of soft intervention that can produce the same result as a hard intervention of conducting open market operations through selling or buying the currency to accumulate or drain foreign reserves.

Even for countries that have accumulated excessive foreign reserves from trade surpluses, such as China and Japan, the option of soft intervention with a persistent fiscal deficit serves as a way to absorb the excess accumulation of foreign reserves not usable in the domestic economy, through high domestic spending from a fiscal deficit.

For countries that have insufficient foreign reserves and trade deficits, such as the Baltic states in recent years, the option of soft intervention with a persistent fiscal deficit serves as a relatively less painful way to reduce the trade deficit by lowering the exchange value of its currency to stimulate more export.

However, if the trade deficit failed to be reduced or eliminated by currency depreciation alone, as frequently the case, the trade deficit then can only be reduced by lowering the trade volume, or in extreme cases, stopped completely. In such a case, a fiscal deficit can still act as a stimulus on the domestic economy to create needed domestic production to replace the reliance on imports and to develop import substitutions.

Of course, the fiscal deficit must be used constructively and not for wasteful indulgence. Furthermore, a perpetual fiscal deficit is unsustainable and will lead to hyperinflation independent of foreign trade. But a controlled fiscal deficit can be an effective measure to wean economies from excess dependence on foreign trade, both for those with trade deficits or those with trade surpluses.

Henry C.K. Liu is an independent commentator on culture, economics and politics.

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Ireland in Decline, or, What Austerity Looks Like

Jun 30, 2010Marshall Auerback

ireland-200Governments are increasingly getting bullied into adopting austerity measures, apparently thinking it will help their economies grow.

ireland-200Governments are increasingly getting bullied into adopting austerity measures, apparently thinking it will help their economies grow. A number of us who oppose this approach suspect that the austerity measures now being demanded (and implemented) will undermine growth, and when growth finally returns it will be tepid as a result of other factors unrelated to the austerity. In the meantime, there will be massive casualties among the poor and disadvantaged. Ireland is exhibit A.

In April 2009, the Irish government forecasted a decline in Gross Domestic Product (GDP) of 7.7 percent in 2009, and a contraction of 2.9 percent next year, before returning to growth of 2.7 percent in 2011. It had originally projected GDP to shrink by 6.75 percent. There is no sign of growth on the horizon.

"Fiscal adjustment" (as the weasels euphemistically call it now) does not generate growth. It comes WITH growth. The raison d'etre of fiscal policy is to support growth when private spending is undermining it, and to constrain growth when private spending is supporting it. With high unemployment, high public deficits are inevitable. The only choice is between an active deficit, incurred by putting people to work or otherwise serving national needs -- such as providing a decent retirement and health care to the aged -- and a passive deficit, incurred because tax revenues necessarily fail to cover public spending at high unemployment. Cutting public spending or raising taxes, now or in the future, by any amount, cannot reduce a deficit due to high unemployment. The only fiscal effect is to convert an active deficit into a passive one -- with disastrous economic and social effects. Ireland's experience, captured in a recent New York Times article, vividly demonstrates this point:

As Europe's major economies focus on belt-tightening, they are following the path of Ireland. But the once thriving nation is struggling, with no sign of a rapid turnaround in sight.

Nearly two years ago, an economic collapse forced Ireland to cut public spending and raise taxes, the type of austerity measures that financial markets are now pressing on most advanced industrial nations.

"When our public finance situation blew wide open, the dominant consideration was ensuring that there was international investor confidence in Ireland so we could continue to borrow," said Alan Barrett, chief economist at the Economic and Social Research Institute of Ireland. "A lot of the argument was, ‘Let's get this over with quickly.' "

Rather than being rewarded for its actions, though, Ireland is being penalized. Its downturn has certainly been sharper than if the government had spent more to keep people working. Lacking stimulus money, the Irish economy shrank 7.1 percent last year and remains in recession.

Read the full article here.

Roosevelt Institute Senior Fellow Marshall Auerback is a market analyst and commentator.

ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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Rob Johnson on fiscal austerity: 'If it wasn’t so tragic I would say it was humorous'

Jun 28, 2010

As the world waits for the decisions to roll out from the G20 summit, Rob Johnson discussed fiscal austerity with the Real News Network. "If it wasn't so tragic I would say it was humorous," he started out. But tragic it is. A lot of it all comes back to banks: why are deficit numbers so high? The financial crisis, caused by big banks. Who does fiscal austerity benefit, when it risks killing economic recovery? Those who hold treasury bonds at 0% interest -- big banks. "Finance is supposed to be a servant to commerce, [the] economy, [and] social goals. Well the servant's servant has become the master's master. And it's time to reinvert that," Rob says. Watch the full interview:

As the world waits for the decisions to roll out from the G20 summit, Rob Johnson discussed fiscal austerity with the Real News Network. "If it wasn't so tragic I would say it was humorous," he started out. But tragic it is. A lot of it all comes back to banks: why are deficit numbers so high? The financial crisis, caused by big banks. Who does fiscal austerity benefit, when it risks killing economic recovery? Those who hold treasury bonds at 0% interest -- big banks. "Finance is supposed to be a servant to commerce, [the] economy, [and] social goals. Well the servant's servant has become the master's master. And it's time to reinvert that," Rob says. Watch the full interview:


ND20 ALERT: Join us in NY for fresh ideas, July 16-18! Guild Hall, in collaboration with the Roosevelt Institute, will gather thought leaders in the arts, the economy, and the media in East Hampton for a can’t-miss symposium featuring George Soros, Van Jones, plus ND20 contributors Elizabeth Warren, Rob Johnson, Jeff Madrick, Editor Lynn Parramore, and more. RSVP today - seats are limited.

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