Posted by: Dirk | May 9, 2016

Failing in the 21st century: US vs euro zone

Paul Krugman writes about Donald Trump’s economic plans today in the NYT:

Last week the presumptive Republican presidential nominee — hard to believe, but there it is — finally revealed his plan to make America great again. Basically, it involves running the country like a failing casino: he could, he asserted, “make a deal” with creditors that would reduce the debt burden if his outlandish promises of economic growth don’t work out.

The reaction from everyone who knows anything about finance or economics was a mix of amazed horror and horrified amazement. One does not casually suggest throwing away America’s carefully cultivated reputation as the world’s most scrupulous debtor — a reputation that dates all the way back to Alexander Hamilton.

The Trump solution would, among other things, deprive the world economy of its most crucial safe asset, U.S. debt, at a time when safe assets are already in short supply.

This is actually not so surprising. Decade after decade passed in which economists and politicians lied and lied and lied about government debt, the banking system and finance in general. Hocus pocus like the efficient market hypothesis, New Keynesian macroeconomic models and such passed for serious scientific theories, even though they did not feature money. The euro zone has started with a completely insane setup, basically declaring that there is no European safe asset in the financial market. Governments are now liable to go bankrupt if markets judge them to be bankrupt – Mario Draghi already helped to stop this doom loop, to the disgust of most German economists/politicians. Given that government bonds are fundamental for anchoring interest rates, which is somewhat complicated to explain, there is no sense in wishing for governments to go bankrupt. Do you want to become like the euro zone after the recent disasters?

Now Trump comes forwards with his great plan. That reducing government debt the Trump way reduces private sector wealth one-to-one he does not say. Probably he doesn’t understand it. For me, this is the symptom of intellectual decay of the past 3+ decades. What brought this decay in common sense and culture about would be an interesting question. Nevertheless, one consequence seems to be clear: economics needs more common sense and less mathematical distraction from some of the core facts of our monetary system. Sciences are supposed to enlighten.


Responses

  1. […] I have to say that yesterday’s article was based on misleading information that the NYT seems to have published, with Paul Krugman picking […]

  2. That may be true, but there is more to that than that. Better to understand that there is no real problem with the national debt. The government can borrow from banks forever, and banks can buy securities because they can ‘print’ the money and do so whenever they make loans. The Treasury can roll over securities sold to banks by simply creating new securities and swapping them for the mature securities held by the banks. Banks will go along because this is a free ride to getting free dollars in interest on the securities. But if the banks insist on getting their dollars back from the govt, they can put them up for auction and the Fed can buy them with dollars it creates out of thin air. This will entail a process whereby the central bank dollars get exchanged for ordinary bank dollars original used by banks to make the loan. Exchange takes place with the help of correspondent banks who keep both ordinary bank-created dollars and central bank dollars on hand for these exchanges. But when the bank-dollars finally come back in exchange for the securities, that cancels the bank’s loan to the government and the dollars returned to the bank are extinguished taken off the books along with the cancelled loan. That’s why, BTW, Quantitative Easing does not cause inflation, because the dollars banks get back for loans never go into circulation because they are extinguished. (Probably stored in vault cash accounts). Inflation came at the start, if it did at all, when the Treasury took the dollars from sale of the securities, and distributed them to whomever Congress intended them to pay for government services and grants. If there was already inflation, these dollars only contributed more dollars to inflation. But if there was recession or depression (deflation) then the dollars would help get the economy going again.
    One other point: not all securities are sold to get money for deficit spending. A preponderance of the securities sold, are sold to investors, who expect their money back at some point with interest. Their money is not spent but kept in time deposit accounts (actually the securities themselves) and returned to them with interest by the Fed at maturity, if the investors don’t want to roll over their investment to get further interest. Govt gets new money for interest by selling more new securities just like it does for deficit spending. Or the Fed can just create the interest money out of thin air when it returns the face value on securities to their owners.
    Most of these points are not generally known to the public, and that includes Trump whose comments on buying and selling securities in the private sector are irrelevant to buying and selling government securities to banks for deficit spending and to investors.
    There is no real national debt problem!


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