Saturday, March 20, 2010

Marshall Auerback: Britain Not Part of Any Greek Tragedy

Marshall Auerback's latest at the Roosevelt Institute's New Deal 2.0.

They certainly know what “schadenfreude” means in Germany. But the attempt by the German paper, Der Spiegel, to link the UK to the travails of Greece, takes the concept to a malicious and irrational extreme:
The British pound is tottering. The economy finds itself in its worst crisis since 1931, and the country came within a hair’s breadth of a deep recession. Speculators are betting against an upturn. Instability in the banking sector has had a more severe impact on government finances in Great Britain than in other industrialized countries. London’s budget deficit will amount to £186 billion (€205 billion, or $280 billion) this year — fully 12.9 percent of gross domestic product.
Sounds pretty, grim, especially given that Britain’s budget deficit is even higher than that of the “corrupt” Greeks, whom the Germans also seem so intent on abusing in print and punishing for their alleged fiscal profligacy.

But the article itself is rife with intellectual dishonesty. You cannot mindlessly conflate EMU states — Germany included — which operate with no real fiscal authority as sovereign states in the full sense — with countries, such as the United Kingdom, which fortunately has a government with currency issuing monopolies operating under flexible exchange rates (even though the British haven’t quite figured it out). And, as strange as it may sound, public sector profligacy at this time is preferable to Germanic style prudence, because as the private sector’s spending and borrowing go into hibernation, government borrowing must expand significantly to compensate. Even the French Finance Minister, Christine Lagarde, seems to understand that fact (and is taking heat from her German “allies” as a result). Her sin? She had the temerity to suggest that Berlin should consider boosting domestic demand to help deficit countries regain competitiveness and sort out their public finances. Noting that “it takes two to tango”, Lagarde suggested that an expansionary fiscal policy had a role to play here, not simply “enforcing deficit principles”.

Of course, that’s harder to do in the euro zone, given the insane constraints put forward as a condition of euro entry. As a consequence of these rules, the EMU nations cannot even run their own region properly. They have established a system which has consistently drained aggregate demand and brought increasingly high levels of unemployment to bear on their respective populations. In the words of Bill Mitchell:
The rules that the EU made up and then imposed on the EMU via the Maastricht Treaty’s Stability and Growth Pact were not based on any coherent models of fiscal sustainability or variations that might be encountered in these aggregates during a swing in the business cycle. The rules are biased towards high unemployment and stagnant growth of the sort that has bedeviled Europe for years.
Having conspicuously failed to deliver prosperity to their own countrymen, the Germans now see fit to lecture the UK (after taking out the Greeks, of course) on the grounds of Britain’s “crass Keynesianism” (in the words of Axel Weber, the President of the German Bundesbank).

There is no question that the UK has some unique features which make it more than just another casualty of the global credit crunch. It foolishly leveraged its growth strategy to the growth in financial services and is now paying the price for that misconceived policy, as the industry inevitably contracts and restructures as a percentage of GDP. This structural headwind will no doubt force the UK authorities to adopt an even more aggressive fiscal posture than would normally be the case. This is politically problematic, given that the vast majority of the UK’s policy makers (and the chattering classes in the media) still cling to the prevailing deficit hysteria now taking hold all over the world. But the reality is that the UK has considerably greater fiscal latitude of action than any of the euro zone countries, including Germany.

Let’s go back to first principles: In a country with a currency that is not convertible upon demand into anything other than itself (no gold “backing”, no fixed exchange rate), the government can never run out of money to spend, nor does it need to acquire money from the private sector in order to spend. This does not mean the government doesn’t face the risk of inflation, currency depreciation, or capital flight as a result of shifting private sector portfolio preferences. But the budget constraint on the government, the monopoly supplier of currency, is different than what most have been taught from classical economics, which is largely predicated on the notion of a now non-existent gold standard. The UK Treasury cuts you a benefits check, your check account gets credited, and then some reserves get moved around on the Bank of England’s balance sheet and on bank balance sheets to enable the central bank (in this case, the Bank of England) to hit its interest rate target. If anything, some inflation would probably be a good thing right now, given the prevailing high levels of private sector debt and the deflationary risk that PRIVATE debt represents because of the natural constraints against income and assets which operate in the absence of the ability to tax and create currency.

Unlike Germany, or any other EMU nation, there is no notion of “national solvency” that applies here, so the idea that the UK should follow Greece down the road to national suicide reflects nothing more than the traditional German predisposition to sado-monetarism and deficit reduction fetishism. A commitment to close the deficit is also what doomed Japan throughout most of the 1990s and 2000s, when foolish premature attempts at “fiscal consolidation” actually increased budget deficits by deflating incipient economic activity. Why would you tighten fiscal policy when there is anemic private demand and unemployment is still high?

Remember Accounting 101. It is the reversal of trade deficits and the increase in fiscal deficits, which gets a country to an increase in net private saving, ASSUMING NO STUPID SELF IMPOSED CONSTRAINTS along the lines proposed by Germany under the Stability and Growth Pact (which should be re-christened the “Instability and Non-Growth Pact”). Ideally, we want the deficits to be achieved in a good way: not with automatic stabilizers driving the budget into deficit because unemployment is rising and tax revenue is falling as private demand falters, but one in which a government uses discretionary fiscal policy to ensure that demand is sufficient to support high levels of employment and private saving. That in turn will stabilize growth and improve the deficit picture. Once this is achieved, any notions of national insolvency (or more “Greek tragedies”) should go out the window.

The UK can do this, even if its policy makers fail to recognize this. But not in the eyes of Der Spiegel, which warns that “tough times are ahead for the United Kingdom, so tough, in fact, that none of the parties has dared to say out loud what many in their ranks already know. At a minimum, Britons can look forward to higher taxes and fees.” And much lower growth if that prescription is followed.

We suspect that many in Germany and the rest of Europe understand this. So what other motivations are at work here? Clearly, calling attention to the state of Britain’s public finances and drawing specious comparisons to Greece in effect invites speculative capital to take its collective eye off the euro zone and focus it on the UK. Given that the alleged “Greek solution” proposed recently by the European Commission does nothing to resolve the country’s underlying problems, it behooves the euro zone countries to draw attention elsewhere before their collective resolve to defend their currency union comes under attack again.

And heaven forbid that the UK was actually successful (admittedly unlikely today, given the paucity of British political leaders who truly understand how modern money actually works). If Her Majesty’s Government spending actually managed to conduct fiscal policy in a manner which supported higher levels of employment and a more equitable transfers of national income (via, for example, a government Job Guarantee program) then what would be the response in the euro zone? Wouldn’t this cause its citizens to query what sort of bogus economic “expertise” that has been fed to them from their technocratic elites over the past two decades? The same sort of neo-liberal pap fed to the US courtesy of groups such as the Concord Coalition.

No question that public spending should be carefully mobilized to ensure that it is consonant with national purpose (not corporate cronyism). But the idea perpetuated by Der Spiegel that the government is somehow constrained by some self imposed rules with no reference to the underlying economy is comedy worthy of a Brechtian farce. Unfortunately, this particular German joke is no laughing matter.


  1. "the deflationary risk that PRIVATE debt represents" - Private deebt presentsno deflaionary risk. if it is"wiped" out, the money is still with those who received payments from the debtor! This "fear of deflation" is just a ruse by central banks to keep inflating the money supply. Deflation does not keep people from spending – they always spend what's necessary. And money NOT "spent" is then saved which means it is credit to someone who invests it for capital goods etc. thus it is again being spent, only not for consumption. Money never lies completely idle to any extent whether there's inflation, deflation, stability or a solar eclipse. For deflation to seriously happen, not only the current extreme credit expansion by the central banks and states (through "quantitative easing", stimulus packages, monetising and then spending national debt etc.) but also the money that was released into the economy PRIOR to the collapse would have to be "mopped up" again. This is nowhere to be seen nor would it be technically possible (confiscation aside) so we will rather see inflation than deflation.

  2. Auerbeck’s “job guarantee” idea is positively Neanderthal.  Job Guarantee more or less equals “make work” which inevitably involves hoards of unskilled people being supervised by one permanent skilled person. This is a recipe for hopeless levels of output per head. Most European countries and a few U.S. states have advanced beyond the job gurantee idea and are implementing subsidised work with EXISTING employers, as an alternative to unemployment. The latter gives a better mix of unskilled labour, skilled labour, capital equipment, etc, thus productivity is higher.

  3. If you think the government can just print its own currency willy nilly to pay for its own profligacy, then you are insane. I would hope for you to suffer the consequencesof such a policy, if it would not also condemn millions of other to penury.

    The moment the people with serious money realise that the State has no intention of living even remotely close to its means is the moment they shift their capital out, resulting in a decimated currency, and poverty for the poor wage slaves left behind.

  4. Agree, the entire deflation-negative-spiral argument is idiotic when we have real examples of the opposite happening: The markets in semiconductors and IT that have grown *because of* deflating prices pushing price/performance up and yesterdays kit becoming worthless creating incentives for replacing it.

    <span>And money NOT "spent" is then saved which means it is credit to someone who invests it for capital goods etc</span>

    The banks does not need savings because the central banks will backstop anything they can just issue debt directly, no margin is required at all. This is supposedly more "efficient" or whatever. The negative real rates paid on savings should be a sign that banks does not want your money at all - it has negative value to them because they have to pay it back eventually unlike the funding they get from the central banks.

  5. Chris of StumptownMarch 24, 2010 at 1:11 PM

    Don't UK banks have substantial (ie valued @ multi trillion USD) foreign currency obligations?

    If there is a GBP crisis, the UK will either have to take drastic measures to save them, or let them sink.  Auerback is missing the danger by considering the position of the UK govt without considering the financial system.