Sunday, 28 February 2016

The Limits of understanding of MMT

I've got a good amount of time for LK's blog. It is my 'goto' blog for good sense on many a topic. But I have to say I'm somewhat disappointed at the latest missive on foreign trade. It still has the usual straw men in it. I really don't understand why PK people can't get their head around the dynamics of floating rate exchange systems and still stick to fixed exchange analysis based around apparent Kaldorian views.

Bill has already debunked the Kaldorian points in his post of a few weeks ago.

I'll take the points in LKs post one at a time.

Now MMT would work for the US, Western Europe, Australia, Japan, South Korea or Taiwan, but not for much of the Third World.

MMT works wherever it is used for the fairly obvious reason that it is a description of how a floating rate exchange system on a sovereign currency works. With the correct policy operations it is perfectly applicable to all nations.

But it is important to note that the fiscal space and the real space are separate entities. Each operates within its own sphere and the influence of the fiscal space on the real space is akin to an electrical induction circuit. Importantly there is no one-to-one relationship between the two.

As Bill's blog on world development shows, it is the real constraints on a nation that limit how prosperous it is. If you have a country with a small population and limited real resources then what it can create at full output may not be sufficient to adequately feed, house and clothe the population. No amount of financial wizardry can help sort that out and the country needs international gifts of real aid.

That is, MMT-style policies are best suited for advanced capitalist nations, not necessarily for Third World countries, because most of them face severe balance of payments constraints. Increasing aggregate demand would, for many Third World nations, simply cause a balance of payments crisis, as imports surged.

There isn't really such a thing as a balance of payments crisis in a floating rate exchange system.  For those excess imports to exist at all, the saving of the local currency must occur at the same time. Otherwise the financing of the deal would have failed and the transaction would never have happened.  And there would be no excess imports. The floating rate balances out the successes and failures automatically. That's its job.

Very simply imports cannot 'surge' unless the equivalent local currency savings by foreigners 'surges' at the same time. And if the savings don't surge then the exporter loses a sale and their economy shrinks as well - because there is nowhere else to export to in aggregate. Mars isn't open for business as yet.

Generally this entire misconception comes about by failing to analyse a transaction end to end,  and by failing to separate the transaction into a real and financial component. (Every transaction requires the real part and the financial part to be in place before they will complete). And in particular failing to model the transaction(s) coming in the opposite direction that allows the FX swap to happen in the first place.

Imagine a system where nobody in the world wants your tally sticks. You want a larger standing army which means freeing up some people from land work. So you impose a tax on the land and issue tally sticks to those who sign up to your army and those that make pointy sticks. Productivity is improved by division of labour and the army gets the spare manpower  and goods - which they then use to improve the water drainage and irrigation systems further boosting output.

Everybody is more fully employed by using the state's power to create money, but there is no 'surge' in imports because nobody wants your tally sticks outside your border. But inside the border there is a demand due to the taxation system.

Only when you have that 'reductio' clear in your mind can you get a grip on the dynamics within a floating system. Where you have drawn the border is an artificial device based on political boundaries. If you just have a dynamic border that encompasses everybody holding a denomination then it becomes much clearer to see what is actually happening.

But it boils down to this. The end buyer always gets to use the type of money they want and the end supplier always gets the type of money they want. Otherwise there will be no deal. It doesn't matter what the invoice is priced in. It doesn't matter what the currencies are. It doesn't matter where people are physically located in the world. The finance system has to make the finance channel tie up or it all stops and the deal chain collapses.

Statistics showing excess of imports or excess of exports are thus the result of successful end to end deals on both the real and financial sides. They can't be anything else in a floating rate system.

Moreover, a huge stream of imports from the developed world tend to cripple the development of a domestic manufacturing sector in developing world nations

That is simply bad policy. MMT makes the point that excess imports, if you can get them, increase the standard of living of the population. But primarily you have to maintain your domestic economy at maximum output. And that will require anti-dumping policies, equality policies and other policies along those lines to ensure that the development of your economy proceeds in a sensible manner. That would include sourcing imports from multiple competing nations to ensure diversity of supply.

As Bill's blog above also mentions: Selective import controls, if they can be effectively designed, can ensure that a nation with a limited export base can import goods and services that target the provision of benefits via imports to the poor in the first instance

There is no super powerful magic in a floating rate. It's one tool. You still have to do all the other stuff to develop an economy. But with a floating rate you will ensure that you have all your available resources fully occupied and the development should then proceed at a brisker pace. That is the key issue that always appear to get lost in these discussions.

Exports matter a lot even for some developed countries, because exports bring in foreign exchange if you can’t attract foreign exchange via the capital account

This is particularly confused in a floating rate setup. It doesn't matter which side of the fence the swaps get done on - the buy side or the sell side of the currency zone boundaries. They have to happen at the same time as the real transaction or there is no deal. The whole chain collapses.

You don't need to 'attract' anything. The process is handled via the FX system which is a swapping mechanism. Insufficient matches = no deal.

These processes all happen in parallel and in real time. Attempting to serialise the process in your mind leads to the wrong result.

Where is this idea that you don't export coming from? If you have an excess of coffee you will export it and import something more useful - like corn. Or you may export your fish and import beef - because basically you're not a fish kind of people.

I feel the missing part here is understanding the process from the other point of view. Again the focus on a particular economy rather than the world in toto leads to a skewed viewpoint. Let's look at it from the exporter's point of view.

When exporters export to excess (i.e. beyond what they buy back in imports) then they cease to be exporting in any generally understood sense. In reality they have started to import demand. And that is what a net import nation is selling - demand to a wider world that is short of demand due to export led policies. Since demand is in short supply, it is valuable in its own right.

Excess exporters simply take foreign currency, discount or swap it for their domestic currency in some way and then figuratively chuck the foreign currency in the back of a drawer - pretty much like most of us do after a foreign holiday. The whole process is in fact a way of injecting domestic currency into the excess exporters economy, but they have a foreign currency asset to make the books look better. It's that simple - and that stupid.

The feedback into the import economy is the same as any saving. A reduction in domestic flow that has to be accommodated or you get a paradox of thrift. That is rarely done due to neo-classical beliefs. So you can't use economies that are operating under neo-classical rules and have failed to support an argument against floating rate systems. That's like blaming the aircraft for crashing when the person piloting didn't know how the controls worked.

Finally, manufacturing matters – a lot.

Never understood the metal bashing argument. I work in software - which is a service business. I can license tens of thousands of copies all across the world with next to no distribution costs. That's a far more efficient way of exporting than anything real.

If you have to import your resources it doesn't really matter if you import the steel or the iron ore. You've still got a supply chain requirement. That's why I can't understand the argument for virgin steel works in the UK. We've had to import iron ore, and these days coal, for decades. In fact our steel plants can't even work on the remaining iron ore deposits in the UK because its the wrong type for the plants that have been built. So why bother importing the rock, when you can import the steel from multiple locations? UK steel works should be recycling plants.

(I understand the 'good jobs' argument, but that is similarly controversial for other reasons which are outside the scope of this post).

The secret is the same as any business resilience plan - diversity of supply. And definitely diversity across political groupings. Because the USA, Russia and China are never going to be on the same side in anything.

I certainly don't go for the comparative advantage nonsense however. You need a multi-culture.  If you can't get diversity of supply you need to create at home. There is always a trade off between resilience and efficiency to get a sustainable cohesive economy that has low-coupling with the rest of the world.

But I see little difference between manufacturing and services. It's an old fashion separation that really doesn't hold that well in a modern world.

It seems to me that effective demand is the real source of power.

If you think imports are only a benefit, look at the devastating de-industrialisation of large parts of the Western world
Again this 'only a benefit' is a strawman argument that nobody seriously looking at floating rate systems is proposing. Imports is an aggregate. What is in that aggregate? BMWs or food? What are the strategic issues of supply and creation outside your political borders vs. inside them. And similarly what are the 'beggar thy neighbour' impacts of changing the status quo? Do we really want our fellow humans in China back in paddy fields dying of starvation?

And note that this all came about because governments operated neoliberal policies that didn't understand net-importing causes a paradox of thrift effect that has to be compensated for by government action. Precisely my point above.

As Alex Douglas discussed recently, even the supposed Post Keynesians still don't seem to get the issue with savings desires.

The dynamics at the borders of currency zones is indeed complicated and there is much to learn about how to manage them more appropriately. But it would help if people stopped analysing aircraft flight as though they were driving a car. It gets a bit tiring having to point out all the time that yes you do have to pay attention to the Z axis as well.