Author Archives: V. Ramanan

Some Legal Issues Around Demonetisation

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Arjun Jayadev has a nice article, With Its Talk Of Extinguishing Unreturned Cash, Is The Government Defaulting On Its Obligations? for Scroll.in about what happens subsequent to the withdrawal of the legal tender character of bank notes in the denominations of ₹500 and ₹1,000 (or “demonetisation”).

The idea of the government was to cause a loss for holders of “black money” (see this Government of India white paper on definitions) and fight counterfeiting.

Picture from a September 2015 press release showing additional features of the old notes. The notes bear signature of Raghuram G. Rajan

There are two important separate issues here: one is the withdrawal of the legal tender character. The other is whether the RBI will exchange the notes. When the Indian PM announced the former, Indians were told that the old notes (which were about 86% of currency in existence by value) ceased to be a legal tender in four hours and that banks would exchange them for new bank notes or accept them as deposits till December end. Banks would then exchange them with the Reserve Bank. The Reserve Bank itself would exchange them directly after that till the end of March.

Soon people asked the question whether the Reserve Bank can set a last date for exchange directly at their offices (even though the notes are no longer legal tender). This is because the bank notes have a promise. The Reserve Bank’s own site says:

What is the meaning of “I promise to pay” clause?

As per Section 26 of Reserve Bank of India Act, 1934, the Bank is liable to pay the value of banknote. This is payable on demand by RBI, being the issuer. The Bank’s obligation to pay the value of banknote does not arise out of a contract but out of statutory provisions.

The promissory clause printed on the banknotes i.e., “I promise to pay the bearer the sum of Rupees …” is a statement which means that the banknote is a legal tender for the specified amount. The obligation on the part of the Bank is to exchange a banknote with bank notes of lower value or other coins which are legal tender under the Indian Coinage Act, 2011, of an equivalent amount.

So technically I could still have the old notes of denominations ₹500 and ₹1,000 and go to the Reserve Bank’s office and ask them to exchange it after December end (when banks will no longer accept them), even though the note have lost the legal tender character on November 8 itself. And the RBI seems to be allowing it till March end. The question is: what about later?

The above quote does use the phrase “legal tender”, but it’s not written in the notes. In fact, because of the promise, the Reserve Bank has to provide the bearer in legal tender (i.e., old notes of lower denomination and/or new notes).

Some have argued that because of this “demonetisation” never made sense as the notes should have continued to have the value. I don’t agree with that because that assumes certainty on these issues. If I collect the old notes from people, I have a risk that I might lose the money because I could be wrong.

Anyway, a report today from The Hindu quotes the Reserve Bank Governor:

“Actually, the withdrawal of legal tender characteristics status does not extinguish any of RBI’s balance sheet. Therefore, there is no implication on the balance sheet as of now. The question of a special dividend automatically does not arise as of now,” Mr. Patel had said.

The report is basically source based and informs us that the government is indeed going to make a law to get around the issue.

Euro Area NCBs’ TARGET2 Balance As Cumulative Accommodating Item In The Balance Of Payments

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There’s a discussion on Nick Rowe’s blog about the interpretation of TARGET2 balances of the NCBs in the Euro Area’s Eurosystem. How do we interpret this? My answer is the headline.

TARGET2 balances arise because of cross-border payment flows within Euro Area countries. Instead of going through how these arise, I assume the reader knows them. I have covered it many times in my blog and many others have written it.

Let’s work here in the approximation that the Euro Area is the world and there’s no economic activity outside it. Since cross-border flows within the Euro Area banking system and the Eurosystem are transactions between resident economic units and non-resident units, these flows will give rise to entries in the balance of payments of each nation within the Euro Area.

In the new balance of payments terminology, such as as in the sixth edition of the Balance Of Payments And International Investment Position Manual, (BPM6), there’s an identity:

current account balance + capital account balance = net lending (financial account balance).

For terminologies see this table from the guide:

balance-of-payments-overview

This is an identity but suggestive of some behaviour. The question is what is the residual in this. The current account consists of things such as exports, imports, interest payments between resident and non-resident units and so on. The capital account consists of acquisitions and disposals of non-produced non-financial assets and capital transfers. The financial account consists of things such as direct investment flows, portfolio investment flows and so on. Other than that, there’s also “reserve assets” and “other investment”.

There is a nice 1991 article by the BIS Capital flows in the 1980s: a survey of major trends. The author quotes James Meade who makes this distinction between autonomous flows and accommodative flows:

[accommodative capital flows] take place only because the other items in the balance of payments are such as to leave a gap of this size to be filled … [while] autonomous payments … take place regardless of other items in the balance of payments.

Strictly, this distinction makes sense in fixed exchange rate regimes. In floating exchange rate system, the two—accommodative and autonomous—can’t be clearly be separated.

Anyway, coming back to the Euro Area, before the crisis started, the banking system was working fine. So there would be flows in both the current account and the financial account. The goods and services balance in the current account depends on domestic demand and output at home and abroad and relative competitiveness. There’s no reason for this to be zero. Economic units engaged in the financial markets would buy and sell securities and these affect the financial account of the balance of payments of the two nations involved in the transaction. There’s no reason for balance of things such direct investment, portfolio investment (and financial derivative flows) to balance or to equal the current account balance. Since flows typically are via TARGET2, this affects banks’ balances at their NCBs. So it’s possible toward the end of the day for banks in Spain 🇪🇸 as a whole to find themselves in need for reserves (or settlement balances) and banks in say Germany 🇩🇪 to be in a situation where they have excess funds. So banks in Spain will likely contact banks in Germany to borrow funds, either for one day or more. This is because they will get a cheaper interest rate. If they borrowed from their NCB, the interest rate is slightly higher.

These borrowings and lendings give rise to other investment in balance of payments of the two nations. So in Meade’s language, this is an accomodative flow. Not all other investment items are accommodative flows and similarly, not all accommodative items are other investment items.

But as the financial crisis began in 2007, the interbank system froze. Banks didn’t lend each other much. Hence the residual was balances between the NCBs. This would arise automatically. So these flows can be said to be accommodating. The counterpart of this is banks borrowing from their NCBs.

There’s a technicality: somewhere around mid-2000s, the system was changed so that the bilateral balances of NCBs were assigned to the ECB on a daily basis.

Since the TARGET2 balance of NCBs is a stock and not a flow, they can be hence thought of as the cumulative accommodative item. Since the crisis, a lot of things have happened. The European Central Bank has taken various steps, so that banks have sufficient liquidity. Banks have been given facilities to borrow huge amounts from their NCBs for collateral at cheap rates. Later the ECB also started its asset purchase program in which it bought government bonds, ABS and covered bonds. Some of these were already in existence when the interbank markets froze. So even as interbank markets opened, they didn’t feel the need to borrow funds from banks abroad.

The IMF’s guide BPM6 says in Appendix 3 that these intra-Eurosystem claims (the TARGET2 balances) are to be recorded in Other Investment:

Intra-CUNCBs and CUCB balances

A3.46 Transactions and positions corresponding to claims and liabilities among CUNCBs and the CUCB (including those arising from settlement and clearing arrangements) are to be recorded for the central bank under other investment, currency and deposits or loans (depending on the nature of the claim) in the balance of payments and IIP of member economies. If changes in these intra-CU claims and liabilities do not arise from transactions, relevant entries are to be made under the “other adjustment” column of the IIP. Remuneration of these claims and liabilities is to be recorded in the balance of payments of CU member economies as income on a gross basis under investment income, other investment.

where CUCB and CUNCB are abbreviations for currency union central bank and currency union national central bank, respectively.

There is some similarity with “reserve assets” in the financial account of the balance of payments and the international investment position when comparing all this to a fix exchange rate regime. In the latter, when autonomous flows aren’t sufficient, the central bank may sell gold or foreign reserves in the markets. It may also engage in borrowing funds in foreign currency. These are also accommodative flows. In the Euro Area case however, the inter-NCB claims (and the assignment to the ECB) happens automatically. Also “reserve assets” don’t go below zero, while TARGET2 balances can be negative in the sense that they are in liabilities of some NCBs instead of being in assets.

The conclusion of all this is that TARGET2 is a sort of a residual finance to a whole nation which arises automatically. Some have interpreted this to conclude that this is unlimited. This is however not the case. Since the counterpart to these are banks’ borrowing from their NCBs, this is limited to how much collateral banks can provide the Eurosystem, with or without the help of their government.

“In The Long Run”

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But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again.

–  John Maynard Keynes, A Tract on Monetary Reform (1923), Ch. 3, p. 80.

As you might know, the Indian government cancelled the legal tender nature of majority of bank notes in circulation, earlier this month and asked Indians to deposit them at banks or exchange them for new. The aim according to the government was to curb counterfeiting and what’s called black money here. This is damaging as a large amount of transaction is in bank notes and the implementation has been a failure. People have been standing in queues for the whole day and some even reach banks at 2 am to get a good position in the queue. For many, standing in queues means that the day’s labour is lost. For others, there are delays in wage payments since their employers have problems getting hold of new bank notes. More than 50 people have died. Even 11 bank managers have died due to stress and work overload.

Despite this we keep hearing from the government and the ruling political party’s defenders that the benefits will be long term.

The previous Indian Prime Minister (who was the nation’s leader during mid 2004-mid 2014), Manmohan Singh gave a scathing speech in the Indian Parliament yesterday in which he quotes Keynes on the long run. Manmohan Singh was a student at Cambridge and his heroes are Nicholas Kaldor and Joan Robinson and presumably John Maynard Keynes as well. In this era where politicians are promoting neoliberal ideas, it’s good to see the master being quoted in a Parliament.

The seven-minute video is linked below.

manmohan-singh-quoting-keynes

click the picture to see the video on YouTube. 

This question about the long-term reminds me of super-hysteresis which was referred by Marc Lavoie recently in an article for INET. It’s closely related to the Kaldor-Verdoorn law in which demand affects supply.  The damage done to the demand side because of slowdown in production caused by the Indian government’s poor implementation of its decision to replace majority of bank notes by value affects the supply side as well. Almost nobody who talks about the long-term benefits talks about this issue.

Neochartalists Shifting Positions

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In a three part series, Bill Mitchell, makes the case against free trade. While this is most welcome – success and failure of nations depends on success in international trade via the principle of circular and cumulative causation – it’s quite a drastic change from what Neochartalists have claimed before. From “exports are a cost and imports benefits”, they have shifted their position. Mitchell goes on to concede:

These so-called ‘free trade’ agreements are nothing more than a further destruction of the democratic freedoms that the advanced nations have enjoyed and cripple the respective states’ abilities to oversee independent policy structures that are designed to advance the well-being of the population.

[emphasis: mine]

Neochartalists have always denied – till recently – that free trade can put a constraint on fiscal policy. They interpreted such critiques as an argument against fiscal expansion, instead of realizing that it’s possible to both argue for fiscal expansion and realize that it is constrained by balance of payments. One potential solution is import controls. Mitchell concedes that it’s required sometimes. He says:

In those cases, import controls may be justified to limit the damage to the less developed nation, despite the material benefits to the more developed nation being obvious.

[boldening: mine]

In another blog post as I noticed here, Mitchell says this while making proposals on reforming the international institutional framework:

…

2. Macroeconomic stabilisation – support for national currencies in the face of problematic balance of payments.

This function recognises that all nations should maintain sovereign currencies and float them on international markets but at the same time recognising that capital flows may be problematic at certain times and that some nations require more or less permanent assistance due to their export capacities and domestic resource bases.

There have been many critiques of Neochartalism but very few touch on this or give attention. But since international trade is the most important determinant of the rise and fall of nations, and that Neochartalism claims to be some fundamental theory of human interactions, its extreme position and shifting away from it should be noticed and critiqued, although welcomed.

In short, Neochartalism which is some sort of moral superiority on fiscal policy has accepted that free trade can put constraints on it. The solution of course is beyond the scope of this post but this shift should acknowledged when Neochartalism is discussed.

Opposing Principles Of Political Economy Just Because Donald Trump Supports It

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The blurb of a recent article, The Ruthlessly Effective Rebranding Of Europe’s New Far Right by Sasha Polakow-Suransky for The Guardian, says:

Across the continent, rightwing populist parties have seized control of the political conversation. How have they done it? By stealing the language, causes and voters of the traditional left

A better way to put it is that the left has genuinely lost interest in addressing people’s grievances, and is promoting policies of neoliberals. The far right has found a clever winning strategy.

Donald Trump will soon be the President of the United States 🇺🇸 and economists and financial analysts have discussed Trump’s liking of fiscal policy. There seems to be a tendency of economists who are leaning toward the Democratic Party in the US to not support this. To me it just looks like a defense of the party than a defense of the correct principles of political economy.

To be fair to them, Donald Trump indeed has a character and ideology leaning to the dark side. But it still doesn’t mean why the US government shouldn’t engage on a fiscal expansion plan. Because this is a principle which belongs to the traditional left. Else they should stop pretending to be ideologically leaning to the left in the “political spectrum”.

Brad Setser has a post on his blog Follow The Money in which he seems to be not excited about a possible fiscal expansion by the US government. Now, Donald Trump is an erratic person and we’ll never know what he’s going to do until he does it but let’s just assume that he does it.

Setser’s point is that surplus nations have more room for fiscal expansion than deficit nations and I agree with that. But Trump’s policy is also to declare China 🇨🇳 a “currency manipulator”, in his own words. In another post, Setser opposes this and favours status quo on this issue from the US viewpoint.

Currently, although the US has a large negative international investment position (minus 44% of Q2 GDP), it’s not that the US economy is under immediate threat from a collapse of the dollar. The US economy can expand by raising tariffs and also asking other governments to do fiscal expansion. Even if others don’t initially, they might when they start to see the positives.

But none of these points will be made by economists. Trump’s fiscal stimulus may not even be large and its effect on the US international investment position may not be that bad. The US anyway has the option to appeal to the Article 12 of the GATT (General Agreement on Tariffs and Trade).

I think Bernie Sanders said it the best about the Democrats in a speech at Berklee, a few days back (at 38m, 58s in the video):

In other words, one of the struggles that you’re going to be seeing in the Democratic Party is whether we go beyond identity politics. I think it’s a step forward in America if you have an African American head or CEO of some major corporation. But you know what, if that guy is going to be shipping jobs out of his country and exploiting his workers, doesn’t mean a whole hell of a lot if he’s black or white or Latino.

The Democrats have clinged on to social issues because Trump’s views are horrible on this. While Trump should be passionately opposed on such issues, it’s an attempt by the Democrats to impose neoliberalism on the population. Sanders, although a Democrat, understands this.

Sanders’ opinion on this, his statement after the US election results were out, is the right one and should be followed:

Donald Trump tapped into the anger of a declining middle class that is sick and tired of establishment economics, establishment politics and the establishment media.  People are tired of working longer hours for lower wages, of seeing decent paying jobs go to China and other low-wage countries, of billionaires not paying any federal income taxes and of not being able to afford a college education for their kids – all while the very rich become much richer.

To the degree that Mr. Trump is serious about pursuing policies that improve the lives of working families in this country, I and other progressives are prepared to work with him. To the degree that he pursues racist, sexist, xenophobic and anti-environment policies, we will vigorously oppose him.

Some Musings On The Phrase “Legal Tender”

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On 8th November 2016, at around 8pm, Narendra Modi, the Prime Minister of India, in a shock announcement, declared that 86% of currency notes in circulation—notes denominated ₹500 and ₹1,000—are no longer legal tender from midnight. Instead new notes with denominations ₹500 and ₹2,000 will be issued. Holders of old notes can deposit them at their banks or exchange them from any bank.rupees-one-thousand

A thousand rupee note, which is no longer a legal tender. Source: RBI

This has led to the “wisdom” that using the old notes is illegal or something. This was partly because of Modi’s own words:

To break the grip of corruption and black money, we have decided that the five hundred rupee and thousand rupee currency notes presently in use will no longer be legal tender from midnight tonight, that is 8th November 2016. This means that these notes will not be acceptable for transactions from midnight onwards.

What is a legal tender? Usually currency notes (and coins) are considered legal tender. It is something which can be used to:

  • extinguish existing debt,
  • settle fines decided by the courts,
  • pay taxes.

Credit card and cheque payments or electronic funds transfer are not usually considered legal tender. One can of course settle existing debts such as to a credit card company using funds in your bank account (i.e., not using legal tender) but this is perhaps because of the agreement you may have signed with your credit card company or in good faith: the creditor can insist you pay in legal tender but may not have a chance in courts if you settle your debt using funds in your bank account. Same with corporate bonds or loans from banks and government’s debt.

It’s also possible to pay in foreign currency to settle your debt as long as the creditor accepts.

It’s also important to make a distinction whether it is (pre)existing debt or not. So for example, payment for a T-shirt may not fall in the above list, as the funds you owe the shopkeeper comes into existence only after you express an interest to own the T-shirt. Hence the shopkeeper may reject your payment method. I believe, some shops in Sweden do not accept currency notes. But a Swedish creditor such as a credit card company or a bank must accept the currency notes for a repayment of a debt or a loan if the debtor insists.

And of course, people buy T-shirts with credit cards. So we come to the important point. As long a seller of goods or services in India accepts the old ₹500 or ₹1,000 notes, it’s not illegal at all for the same reason that buying something with a credit card is not illegal. The seller might accept it in the knowledge that he has time till Dec 30 to get the notes exchanged at bank.

But there are more complications. The message of the Indian government has been that anyone who deposits large amounts of cash notes can be investigated. So this affects the acceptance of old notes. Anyway, this point is separate from the confusion people have that it is illegal to use old notes. No, it is as legal to use old notes to transact like like it’s not illegal to buy a T-shirt with your credit card.

But in reality very few economic units are accepting old notes. I believe it’s party because of fear of being with too many currency notes and also because of the incorrect notion that it’s illegal to do so.

Update: After I wrote the first draft, I found this from the Swedish central bank Riksbank’s website:

Other questions about banknotes and coins

Can shops refuse to accept cash?

The main rule is that cash is legal tender and therefore shall be accepted as payment. This rule can, however, be waived by shops, restaurants, etc. In principle, therefore, a shop can refuse cash entirely, refuse to accept coins or certain denominations (e.g. 1000-krona banknotes) or even refuse to accept banknotes and coins that are soon due to go out of circulation, etc. From a consumer perspective, it is better for me to get this information in good time (for example in the form of a sign on the shop door) so that I can choose if I want to shop there or go somewhere else.

The question of whether a shop may refuse older banknotes and coins but accept new ones has, as far as we know, not been tested in court and it is therefore not possible to answer it with any degree of certainty. The Riksbank’s position is that shops that accept cash should accept both older and new banknotes and coins as long as they are legal tender. Shops should not refuse to accept the older banknotes and coins until after 30 June 2017, as this is when they will cease to be a valid means of payment.

Link

Jayati Ghosh: The Political Economy Of Demonetising High Value Notes

Who better to write about the recent demonetisation than Jayati Ghosh? In yesterday’s The Hindu, she writes:

The demonetisation of bank notes per se is not the problem. Indeed, it has occurred periodically in India and many other countries, both to reduce concerns about counterfeiting and to spread the use of cash-based illegal transactions. To the extent that it reduces these, it should certainly be welcomed. However, when this has been done in India in the past or in other countries, it has typically been done gradually, allowing adequate time for people to replace the old notes with new ones to prevent too much disruption of economic activity. This overnight shock, by contrast, is hugely destabilising, with likely medium-term material damage to a very large part of the population. It affects very little of the stock of ill-gotten wealth and does nothing about its generation, but it has severe impact upon ordinary people, whose lives have already been hugely disrupted.

Although, the best you can read on this issue, I’d differ saying that announcement should have been a shock. But that’s a minor quibble, since the government assumption on which this is based – that people have a stock of cash notes in their water tanks itself is wrong.

[The title of this page is the link]

The Soon-To-Be Conventional Wisdom: “Fiscal Policy Is Not So Good”

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Donald Trump is the President-elect of the United States. It hardly needs to be mentioned how bad his campaign was. Glenn Greenwald rightly called him an abusive, misogynistic, bigoted, scary, lawless authoritarian.

However on the economic scale, Trump’s plans seem to be to the left of Hillary Clinton. Trump wants to pump the prime, meaning do a fiscal expansion and also put tariffs.

Trump is yet to take his office, but the narrative change about fiscal policy has already started. The important thing to remember is that this is done by economists who might otherwise not object to it – at least the fiscal stimulus.

In other words, just to oppose Trump, economists are on the path to build a conventional wisdom that fiscal policy is neutral or impotent or even destructive if it’s expansionary (as in higher expenditure and/or cuts in tax rates).

Example: Lawrence Summers’ article A Badly Designed US stimulus Will Only Hurt The Working Class for Financial Times. While obviously unable to deny the importance of fiscal expansion (because it works), Summers says:

I am optimistic regarding the efficacy of fiscal expansion. But any responsible economist has to recognise that, past a point, it can lead to some combination of excessive foreign borrowing, inflation and even financial crisis. As Dornbusch showed, in emerging markets this can happen quite quickly. In the US the process would take longer.

Moreover, he also goes on to argue that China is not gaining unfair advantage by keeping its exchange rate at a highly devalued level. Notice the change in tone in Summers’ language. From writing about how the constraints are far, Summers is now saying that fiscal policy is not that good. Surely he’s using a language to hedge himself —as any economist should do—but he’s clearly not saying that, “Fiscal expansion will be good for the US economy. Trump should rather design taxes to be progressive” but instead, giving innuendos that fiscal policy is not that good.

Even a non-progressive system of taxation or even tax cuts for the wealthy can be expansionary. It raises inequality but the size of the pie is still rising. To me it’s still better than a neutral fiscal stance. But Summers’ language is such that it is worse.

Obviously no economist will jump overnight to shifting his/her position to saying, “fiscal policy is impotent or worse expansion destructive”, after the elections, from a position, “fiscal policy should be expansionary” before the elections. So conventional wisdom will be created slowly over the next few months – slowly manufacturing constent, borrowing the phrase from Noam Chomsky.

Is my reading of Summers wrong? Time will tell! But why didn’t Summers ever complain about the non-progressive system of taxation earlier?

Remonetisation

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On 8th November 2016, at around 8pm, the Prime Minister of India, in a shock announcement, declared that 86% of currency notes in circulation—notes denominated ₹500 and ₹1,000—are no longer legal tender from midnight. Instead new notes with denominations ₹500 and ₹2,000 will be issued. The press is calling this “demonetisation”, although “remonetisation” seems to be a better word.

rbi-2000-rupee-note

Picture source: RBI on Twitter. Click picture for higher resolution

These notes are worth about $7.37 and $14.75 (at today’s exchange rate USDINR = 67.811). Although this is not much for people resident in the advanced world, it is quite a lot for Indians, especially the poor.

Holders of these currency notes are given time till 30th December to either

  1. exchange these currency notes with banks who will provide the holders with old currency notes denominated ₹100, ₹50, ₹50 or ₹10, or
  2. deposit them in their bank accounts.

The reasons provided were that there is a lot of counterfeiting happening from across the border and there is a lot of “black money” with Indians. Now there is a lot of political rhetoric around “black money” but Indians have this imagery that everyone doing immoral or illegal things with their finances has hidden a lot of currency notes in the water tanks of their homes. Before the Prime Minister’s Bhartiya Janata Party, won the elections, he promised to bring in “black money” worth $40 trillion (no typo!) from abroad and promised that every poor Indian will easily get around $30,000. But having failed in this, he feels pressured to do something about it.

Now, as Pronab Sen points out in Mint, that is hardly the case. The one doing shady things with their financial statements may hold wealth in various forms such as real estate, gold, foreign exchange, foreign accounts, via Panama etc. Moreover, people have been standing in queues in banks and ATMs for the whole day, just to exchange their notes. This is because the Indian government and the central bank didn’t make the new notes immediately available. Since there is a liquidity shortage, and that since a lot of people live in daily wages, there have been delays in payments of wages. People have postponed their expenditures to subsistence levels because it’s not clear how long the shortage will last.

How does the Indian government hope to gain from this operation? Currently, currency notes equivalent of around $222 bn of old notes are no longer legal tender. India’s annual GDP was $1.51 tn in 2015 for comparison with the US (where the currency in circulation is $1.48 tn and annual GDP was $18.44 tn, annualized in Q2 2016 and India’s population is 1.25 bn while US population is 319 mn). When notes are returned and new currency is issued, the Reserve Bank’s liabilities changes because some people won’t return their currency notes in the fear that their finances will be investigated. How much it is is anybody’s guess. But let’s say currency notes equivalent of $210 bn is returned. The RBI will see this as income from this operation and will pay an additional dividend of $12 bn to the government. The government can raise its expenditure because of higher tax revenues.

But since all this was poorly implemented and 11 people have died so for this political propaganda of the government. It’s not like in the Western world here in India. There is a parallel “informal economy” in India and a large population is extremely poor. It is difficult to calculate the loss of output.

I want to distract here to Monetarism and the relevance of this to monetary theory especially the causality from money to prices and output. It’s usually argued by Post-Keynesians that the causality is from price and output to money but as central bank asset purchases (“QE”) have highlighted, there is causality in the reverse direction also via rise in prices of financial assets causing a wealth effect.

Right now in India, there’s a drop of liquidity and from the story above, I hoped to convince you that there is a causality from money to output. People’s wealth hasn’t dropped but liquidity has. So Monetarism can have some truth to it, in selected cases. In standard Post-Keynesian theory, it is assumed that all demand for “money” is accomodated. But right now, this isn’t the case, leading to the reverse-reverse causality.

rbi-500-rupee-note

Picture source: RBI on Twitter. Click picture for higher resolution

Let’s Say, “China”

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Trade has always been a subject close to non-orthodox economics. Post-Keynesians emphasize the principle of circular and cumulative causation, which in the words of Nicholas Kaldor means, “success creates further success and failure begets more failure”. The importance of trade for the prospects of the US economy was emphasized the most by Wynne Godley in his series of papers for the Levy Institute from the mid-90s to late 2000s. In his paper Seven Unsustainable Processes, Godley said,

The logic of this analysis is that, over the coming five to ten years, it will be necessary not only to bring about a substantial relaxation in the fiscal stance but also to ensure, by one means or another, that there is a structural improvement in the United States’s balance of payments. It is not legitimate to assume that the external deficit will at some stage automatically correct itself; too many countries in the past have found themselves trapped by exploding overseas indebtedness that had eventually to be corrected by force majeure for this to be tenable.

There are, in principle, four ways in which the net export demand can be increased: (1) by depreciating the currency, (2) by deflating the economy to the point at which imports are reduced to the level of exports, (3) by getting other countries to expand their economies by fiscal or other means, and (4) by adopting “Article 12 control” of imports, so called after Article 12 of the GATT (General Agreement on Tariffs and Trade), which was creatively adjusted when the World Trade Organization came into existence specifically to allow nondiscriminatory import controls to protect a country’s foreign exchange reserves. This list of remedies for the external deficit does not include protection as commonly understood, namely, the selective use of tariffs or other discriminatory measures to assist particular industries and firms that are suffering from relative decline. This kind of protectionism is not included because, apart from other fundamental objections, it would not do the trick. Of the four alternatives, we rule out the second–progressive deflation and resulting high unemployment–on moral grounds. Serious difficulties attend the adoption of any of the remaining three remedies, but none of them can be ruled out categorically.

In his 2008 paper, Prospects For The United States And The Rest Of The World: A Crisis That Conventional Remedies Cannot Resolve, he said:

At the moment, the recovery plans under consideration by the United States and many other countries seem to be concentrated on the possibility of using expansionary fiscal and monetary policies.

But, however well coordinated, this approach will not be sufficient.

What must come to pass, perhaps obviously, is a worldwide recovery of output, combined with sustainable balances in international trade. Since this series of reports began in 1999, we have emphasized that, in the United States, sustained growth with full employment would eventually require both fiscal expansion and a rapid acceleration in net export demand. Part of the needed fiscal stimulus has already occurred, and much more (it seems) is immediately in prospect. But the U.S. balance of payments languishes, and a substantial and spontaneous recovery is now highly unlikely in view of the developing severe downturn in world trade and output. Nine years ago, it seemed possible that a dollar devaluation of 25 percent would do the trick. But a significantly larger adjustment is needed now. By our reckoning (which is put forward with great diffidence), if the United States were to attempt to restore full employment by fiscal and monetary means alone, the balance of payments deficit would rise over the next, say, three to four years, to 6 percent of GDP or more—that is, to a level that could not possibly be sustained for a long period, let alone indefinitely. Yet, for trade to begin expanding sufficiently would require exports to grow faster than we are at present expecting, implying that in three to four years the level of exports would be 25 percent higher than it would have been with no adjustments.

It is inconceivable that such a large rebalancing could occur without a drastic change in the institutions responsible for running the world economy—a change that would involve placing far less than total reliance on market forces.

So there was a voice for the Post-Keynesian community talking about US trade.

Dean Baker has an article saying the TPP gave us Trump and I agree. Although Donald Trump is a disaster socially, he is less dogmatic about trade and has promised to put tariffs on China (and has even promised fiscal expansion!). Since the Democrats (except Bernie Sanders) didn’t say anything about it and guarded orthodoxies, I believe this was decisive for Trump’s victory.

For the sake of quotes, here’s from The New York Times, July 31, 2016:

Mr. Trump himself said in a telephone interview last week that he believed more borrowing and spending would help lift economic growth, a departure from traditional Republican economics.

“It’s called priming the pump,” Mr. Trump said. “Sometimes you have to do that a little bit to get things going. We have no choice — otherwise, we are going to die on the vine.”

He added: “The economy would be crushed under Hillary. But no matter who it is, the debt is going up.”

Here’s a fun video of Donald Trump saying China in loop

donald-trump-says-china

click the picture to see the video on YouTube.

Since today morning the BBC has been saying how immoral Trump’s policies are: that fiscal expansion invariably burdens future generations and that thinking of the Chinese government using unfair trade policies is orthodoxy.

That’s not all, Paul Krugman even claimed that equity prices aren’t going to ever rise to pre-Trump level, a position which he flipped within hours after financial markets recovered.

So it’s not difficult to conclude that purely for the sake of defending one’s favourite party or ideology, people are going to make the case against fiscal policy and for free trade. We might hear a lot of pre-Keynesian orthodoxies from smart people more and more. I won’t even be surprised if Paul Krugman becomes a fiscal hawk again.

This has already been the case in discussions around wars. George Bush started the Iraq war and faced a lot of opposition from the so-called progressives. But then Barack Obama is the record holder for the most number of days as being in office as the President of the United States while the nation was at war but hardly gets any opposition from those who opposed him. I have also noticed that the same people who opposed Bush are now war apologizers.

So economic orthodoxy lies ahead. What will be sad is that it will come from people to the left of Republicans in the political spectrum.