Property busts preceded by large run-up in household debt tend to be more severe; Australian household debt to disposable income quadrupled in 30 years
Tweet Topic Started: 10 May 2012, 09:16 PM (4,527 Views)
Is inflation the only danger, or are there other possible problems?
IMO there are three risks with a fiat monetary system;
1. Ignorance: The political narrative in most of the Countries I mention is "we may become the next Greece". Politicians then self inflict unnecessary pain. (The UK is the best example). 2. Inflation: If / When the economy is running at full steam, and the Government attempts to buy additional real resources from the economy, the result is higher prices & ultimately inflation 3. Government Stability & acceptance: Some people would call this hyperinflation. Unlike how the name sounds, hyperinflation is NOT very high inflation. It represents the breakdown of the system of Government and therefore the loss of faith in the currency. The best example of this was in Iran at the end of 2011. Iran ran trade and budget surplusus, but the currency collapsed in 2011 as residents fears US attack and the overthrow of the Government
I have a question for you. You posted somewhere recently that before the GFC, Irelands balance sheet looked very respectible as a percentage of GDP. But shortly afterwards, they were heavily in debt. How did this happen exactly? What transactions took place to result in the increased debt. (I would be interested in the UK too, but I thought Ireland would be a simpler model)
Some people would call this hyperinflation. Unlike how the name sounds, hyperinflation is NOT very high inflation.
But it appears that way. In Zimbabwe, it took nearly 3 years of extremely high inflation before what we would call Hyperinflation. In that period, food output fell nearly 45%, manufacturing output 62% and unemployment rose to 80%. Printing ever larger denominations of currency was the response to deteriorating economic conditions, not the cause. And so it is true of every fiat currency issuer. Printing to pay debts is a response to deteriorating economic conditions, not a cause. Because in growth periods, tax receipts are on the rise, so the government can spend it's surplus.
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It represents the breakdown of the system of Government and therefore the loss of faith in the currency. The best example of this was in Iran at the end of 2011. Iran ran trade and budget surplusus, but the currency collapsed in 2011 as residents fears US attack and the overthrow of the Government
But that is not what happened in the Wiemar republic. The government had large debts from the war, punitive reparation payments and a stagnant economy. The currency didn't Hyperinflate because the people of Weimar germany lost faith in the government. On the contrary, they were rejoicing as their equities rose more than sevenfold from January 1919 to December 1921. Up to this point, inflation has been running at around 11-12%, in the first 5 months of 1922, general prices for goods doubled, by April the cost of living was increasing by 50% per month, and by June merchants are losing faith in the currency and starting to demand foreign currency. By the end of 1922, it was pretty much over.
The question is, when did the Hyperinflation in the Wiemar republic start? Was it in 1915, when inflation began to rise, or 1919, when the stock market bubble began, or was it really containable all the way up to April 1922, when the people began to lose faith in the currency?
I think the most telling story from the Wiemar experience though is this quote: "Hugo Stinnes himself, the richest and most powerful industrialist in Germany, whose empire of over one-sixth of the country's industry had been largely built on the advantageous foundation of an inflationary economy, paraded a social conscience shamelessly. He justified inflation as the means of guaranteeing full employment, not as something desirable but simply as the only course open to a benevolent government. It was, he maintained, the only way whereby the life of the people could be sustained." Wow, printing money as a surety to full employment by a benevolent government. Why does that sound familiar?
But it appears that way. In Zimbabwe, it took nearly 3 years of extremely high inflation before what we would call Hyperinflation. In that period, food output fell nearly 45%, manufacturing output 62% and unemployment rose to 80%. Printing ever larger denominations of currency was the response to deteriorating economic conditions, not the cause. And so it is true of every fiat currency issuer. Printing to pay debts is a response to deteriorating economic conditions, not a cause. Because in growth periods, tax receipts are on the rise, so the government can spend it's surplus.
But that is not what happened in the Wiemar republic. The government had large debts from the war, punitive reparation payments and a stagnant economy. The currency didn't Hyperinflate because the people of Weimar germany lost faith in the government. On the contrary, they were rejoicing as their equities rose more than sevenfold from January 1919 to December 1921. Up to this point, inflation has been running at around 11-12%, in the first 5 months of 1922, general prices for goods doubled, by April the cost of living was increasing by 50% per month, and by June merchants are losing faith in the currency and starting to demand foreign currency. By the end of 1922, it was pretty much over.
The question is, when did the Hyperinflation in the Wiemar republic start? Was it in 1915, when inflation began to rise, or 1919, when the stock market bubble began, or was it really containable all the way up to April 1922, when the people began to lose faith in the currency?
I think the most telling story from the Wiemar experience though is this quote: "Hugo Stinnes himself, the richest and most powerful industrialist in Germany, whose empire of over one-sixth of the country's industry had been largely built on the advantageous foundation of an inflationary economy, paraded a social conscience shamelessly. He justified inflation as the means of guaranteeing full employment, not as something desirable but simply as the only course open to a benevolent government. It was, he maintained, the only way whereby the life of the people could be sustained." Wow, printing money as a surety to full employment by a benevolent government. Why does that sound familiar?
This is a nice summary of the Weimar.
Essentially reflects a series of bad policies and collapse production (money supply > output), and collapse of Government.
The difference between inflation and Hyperinflation is under one, citizens still demand the currency, and under the other, they reject it outright.
If you look at any western banking and government system it never operates as MMT says it operates
But it could do so. But it does not.
MMT is kind of insane in the way it says it operates differently to the way it does operate.
If you begin a conversation with an MMTer about this they go all thru it with you and then say 'it is smoke and mirrors' and only accounting.
According to MMT the US debt is more or less irrelevant. The fact that trillions of IOUS are held by people who are wealthy who are expecting those IOU's to remain valueable is regarded as irrelevant because the US can print whenever it wants.
But MMT agrees that to control inflation you either spend less or tax more. So in the event the US begins to print money or monetize the debt there is the risk that bondholders will be devalued or taxed more (since they are wealthy people)
MMT however has a complex argument that full employment does not lead to inflation because somehow the government spends sensibly!
If you want an excercise in futility then study MMT.
It is socialism by another name
Socialism might be better but still is socialism of one kind or another.
Thanks for the explanation of how this works. Very informative!
Couple of questions/quibbles:
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Step 3. Banks are penalised by the RBA (-0.25%) if they hold excess cash / reserves. So if nothing else happens at this point, the Banks will try to lend their excess cash to each other to maximise their interest income (since their interest expense has increased by the fact their deposits have increased). Since the banks are all in the same position, interest rates would fall by 0.25%, and the RBA will have lost control of the cash rate.
Step 4. To prevent this from happening, the RBA and the AOFM issue short and long term Government Securities to "mop-up" the excess cash from the Banking system and allow the banks to earn income from their cash assets.
1. Is Step 4 what they call "sterilization"?
2. Obviously the banks are not going to just buy short-term securities, since they earn far less than the liabilities that they have acquired. In fact, even the 15-year bond yields less than deposit rates right now. So in fact the only way the banks can "earn income" from Australian sovereign debt is to use that debt to meet their Capital adequacy requirements as they lend more money to consumers and businesses.
Let's say for every $1M of bills/notes/bonds that they buy they lend $1M out on the market. This means that only half the money that got "printed" is "sterilized". Keep printing money and sooner or later you get one of:
a) A credit bubble and inflation; or b) A situation like Europe where the banks will not buy the govt debt at any price and just keep the cash sitting in central bank reserves losing money. (Witness what has happened with LTRO) c) A situation like the US (and to a lesser extent in Australia) where there is just not enough credit demand in the market for loans to use up the cash. (liquidity trap) d) A situation where so much of your debt is owned by foreign institutions that a large portion of your budget just goes to paying interest to enrich foreigners. (It's not so bad if it is people in your own country, since presumably they will spend money which will mean either local real production or foreign real production will get captured in the local economy.)
I think a lot of this stuff works best if you say it fast. Or at least, it is not as constraint-free as some would like us to believe.
The truth will set you free. But first, it will piss you off. --Gloria Steinem AREPS™
If you look at any western banking and government system it never operates as MMT says it operates
But it could do so. But it does not.
MMT does not say how things should operate. It simply describes the current monetary system. From this, people can make their own judgement on what is the best policy.
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If you begin a conversation with an MMTer about this they go all thru it with you and then say 'it is smoke and mirrors' and only accounting.
Accounting is a discipline based on fact. That is the real strength of MMT.
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According to MMT the US debt is more or less irrelevant. The fact that trillions of IOUS are held by people who are wealthy who are expecting those IOU's to remain valueable is regarded as irrelevant because the US can print whenever it wants.
US Bond issuance is irrelevant (subject to the requirements of monetary policy). The USA has been printing for 230 years. So far the system seems to work ok.
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But MMT agrees that to control inflation you either spend less or tax more. So in the event the US begins to print money or monetize the debt there is the risk that bondholders will be devalued or taxed more (since they are wealthy people)
Not quite. Tax is used to reduce demand from the private sector. This frees up resources (labour etc) so the government can purchase such resources to meet its social and economic needs (for example, raise an Army). The term "monetise the debt" is actually an irrelevant term since the end of Bretton Woods in 1971. Money printing now occurs every day via spending out of the Treasury. Bond holders have since done very well from this arrangement.
Quote:
MMT however has a complex argument that full employment does not lead to inflation because somehow the government spends sensibly!
If you are referring to the jobs guarantee, this is an idea which divides the MMT community somewhat. I think it's great. Others not so. If you are interested in this please read bill mitchell below. http://bilbo.economicoutlook.net/blog/?p=17528
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If you want an excercise in futility then study MMT.
It is socialism by another name
MMT is a study of the facts. It is not an ideology. Followers of MMT are either left wing socialists (Bill Mitchell), or right wing capitalist hedge funds (Warren Mosler). When you understand MMT you can still support big government. or small government. You could be for the Jobs guarantee (Mitchell) or against it (Roche). It is truly apolitical.
What is does offer is a deep understanding of monetary economics.
2. Obviously the banks are not going to just buy short-term securities, since they earn far less than the liabilities that they have acquired. In fact, even the 15-year bond yields less than deposit rates right now. So in fact the only way the banks can "earn income" from Australian sovereign debt is to use that debt to meet their Capital adequacy requirements as they lend more money to consumers and businesses.
Banks take a view on future interest rates. If they think the 10 year average cash rate will be less than the ten year bond, they will buy the bond. Of course Banks are not the only entities who can buy bonds. When a company or ordinary citizen buys a bond, it drains the excess reserves too. Foreigners (with local bank accounts) have been heavy buyers of Aussie bonds.
Capital adequacy has nothing to do with liquidity.
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Let's say for every $1M of bills/notes/bonds that they buy they lend $1M out on the market. This means that only half the money that got "printed" is "sterilized". Keep printing money and sooner or later you get one of:
That is not how banks lend. When banks approve a loan, a deposit is created simultaneously. They do not get it from the reserve bank. The process is performed by double entry bookkeeping. In short, Banks are not reserve constrained.
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a) A credit bubble and inflation; or b) A situation like Europe where the banks will not buy the govt debt at any price and just keep the cash sitting in central bank reserves losing money. (Witness what has happened with LTRO) c) A situation like the US (and to a lesser extent in Australia) where there is just not enough credit demand in the market for loans to use up the cash. (liquidity trap) d) A situation where so much of your debt is owned by foreign institutions that a large portion of your budget just goes to paying interest to enrich foreigners. (It's not so bad if it is people in your own country, since presumably they will spend money which will mean either local real production or foreign real production will get captured in the local economy.)
a) Credit bubble come from Banks writing excess loans. Banks can do this because they are not reserve constrained. For more on this please read steve keen's Roving Cavaliers of Credit. http://www.debtdeflation.com/blogs/2009/01/31/therovingcavaliersofcredit/ b) For A country like Australia, it does not matter whether the banks buy the bonds. The spending happens first. In Europe, bonds are issued first, and only then can spending occur. LTRO was always going to fail (and every MMTer knew it) c) The Cash (reserves) is never used up - but yes, when a country runs out of credit worthy customers, credit growth stops. d) This does not matter so long as the debt is in local currency. Foreigners can have as many bits of paper with pictures of Aboriginals they want - we can't run out of AUD.
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I think a lot of this stuff works best if you say it fast. Or at least, it is not as constraint-free as some would like us to believe.
MMT does not say how things should operate. It simply describes the current monetary system. From this, people can make their own judgement on what is the best policy.
Accounting is a discipline based on fact. That is the real strength of MMT.
US Bond issuance is irrelevant (subject to the requirements of monetary policy). The USA has been printing for 230 years. So far the system seems to work ok.
Not quite. Tax is used to reduce demand from the private sector. This frees up resources (labour etc) so the government can purchase such resources to meet its social and economic needs (for example, raise an Army). The term "monetise the debt" is actually an irrelevant term since the end of Bretton Woods in 1971. Money printing now occurs every day via spending out of the Treasury. Bond holders have since done very well from this arrangement.
If you are referring to the jobs guarantee, this is an idea which divides the MMT community somewhat. I think it's great. Others not so. If you are interested in this please read bill mitchell below. http://bilbo.economicoutlook.net/blog/?p=17528
MMT is a study of the facts. It is not an ideology. Followers of MMT are either left wing socialists (Bill Mitchell), or right wing capitalist hedge funds (Warren Mosler). When you understand MMT you can still support big government. or small government. You could be for the Jobs guarantee (Mitchell) or against it (Roche). It is truly apolitical.
What is does offer is a deep understanding of monetary economics.
In the US system, the accounts and legislation describe the system as everybody other than MMT believes the system works. MMTers consistantly say it works differently because the accounts are not relevant.
Note the comment the accounts are a charade and the belief that there will never be a crisis caused by bond vigilantes.
Go to Pragmatic capitalist and you will be told the accounts are just smoke and mirrors and people get exasperated if you do not agree.
Warren Mosler attempted to run for president on the basis the taxes were simply burnt and were unrelated to government spending. Given the accounts and the legislation it is just weird he would phrase it like that.
Bill Mitchell says that Austerity is insanity/criminal and is unnecessary and we could have full employment. Bill is not really an expert in MMT and has to refer to people like Scott Fullwiler on the finer details.
As far as I can see we will just have to wait and see if the Bond vigilantes do eventually turn up to find out who is right or wrong
For my sanity i have to be done talking about it. After months/years I just ended up where I began.
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