Tag Archives: balance of payments

Trump Proposes A Ring Around The Collar

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In a recent interview with Larry Kudlow, Donald J. Trump has proposed a 10% tariff on all goods and services produced by nonresident economic units which he calls “a ring around the collar”.

Trump has a chance to be reelected the President of the United States and it’s noteworthy not just because of that but because there is hardly anyone proposing the same. I think that the US balance of payments and hence its financial position is in an unsustainable path and it has to take such measures.

It is important to realise that Trump was using protectionist measures in his Presidency, he faced ridicule from supposed experts. But soon when Joe Biden became the President, Biden not only continued Trump’s policy but also did more to try to improve the US’s net international investment position.

But instead of acknowledging this, the expert class obviously has its narrative. It’s partly to do with the fact that they don’t want to acknowledge that they were wrong and the rest with the fact that they want to return to the old world order of free trade once the US presumably improves its economic/financial position.

Paul Krugman has a Twitter thread and an article in The New York Times on this. It’s a tribe defense, plus a plan to keep this as it is after a small change, with the assumption that it will succeed.

The Euro Area Crisis As A Balance-Of-Payments Crisis

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In a recent blog post Revisiting The Euro Crisis, J. W. Mason argues that the current account imbalances in balance of payments isn’t a/the cause of the Euro Area crisis.

This is completely wrong!

Current account deficits have an effect on the government budget balance and a higher current account deficit would lead to a higher budget deficit than otherwise. This is not just a matter of accounting but true behaviourally. The large current account deficits ultimately caused a large public debt and investors in government debt became nervous and there was a crisis in the government bond markets of the Euro Area. Since lot of government debt is held by foreigners, as it is difficult for residents to hold all that debt (when there’s large net international indebtedness), the sale and the movement of funds abroad after the sale also resulted in a banking crisis, as banks went heavily overdraft at their NCBs and didn’t have sufficient collateral.

The crisis in banking and government bond markets caused more crisis in private debt markets and fiscal retrenchment, fall in GDP and that leading to more crisis!

As simple as that!

One of Mason’s arguments is that since lending by foreigners needn’t arise out of prior saving, the result liabilities owed to foreigners isn’t really debt. But how does it follow that one thing implies the other? If foreigners transfer a large amount of funds to accounts in their home countries, there would be a banking crisis as banks would find it difficult to post collateral to their NCB (National Central Bank). The government would have to rescue banks adding to public debt and making investors nervous.

Greek banks endogenously creating money doesn’t mean that a purchase of a German product by Greek residents doesn’t reduce Greek’s net asset position or increase its net indebtedness to Germany.

Mason says:

 Many people with a Keynesian background talk about endogenous money, but fail to apply it consistently

Perhaps he is the one failing?

Take a simpler example: loans make deposits. But it’s also true that deposits are funding banks. The fact that banks created funds doesn’t imply that the created deposit isn’t a liability or debt.

Mason also discusses how the TARGET2 system works with the ECB/NCBs. The NCBs have  unlimited and uncollateralised overdrafts with each other and unlike the arrangements prior the formation of the Euro Area, there isn’t an equivalent worry about central banks running out of reserves. But unlimited overdrafts for the NCBs does not imply unlimited overdrafts for the whole country! It’s just that the crisis is seen elsewhere, like in banking and the government bonds markets.

Mason also takes issue with phrases such as “capital flight”. But investors can sell assets and move funds to another country and that can put pressure on banks. How is the phrase not helpful in describing what is going on?

The problem with the Euro Area is that with exchange rates fixed irrevocably and with governments prevented from making overdrafts at their NCBs, governments cannot devalue their currency or take independent fiscal action than allowed by markets. Fixed or floating, the problem is there, and the Euro Area setup makes it worse. Doesn’t remove the problem altogether!

You can see from the data from Eurostat that Euro Area countries with the worst net international investment position were the ones seeing the worst crisis. The net international investment position is accumulated current account balance plus revaluations/holding gains/”capital gains”.

Of course, the solution of the crisis isn’t wage deflation (sometimes referred to as internal devaluation), but the formation of a central government. With the central government, there are fiscal transfers with some Euro Area countries receiving more from the government than what they send in taxes. This would improve the current account balance of those countries, keeping imbalances in check. A central government would both be able to take independent action and keep imbalances in check.

Marc Lavoie On The Euro Area And Neochartalism

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Marc Lavoie has a new paper MMT, Sovereign Currencies And The Eurozone. It’s based on a lecture he was asked to give in 2021 STOREP conference. In this he analyses what neochartalism (“MMT”) is and what is says about the Euro Area.

Marc Lavoie also discusses Sergio Cesaratto’s work. Sergio had an excellent book Heterodox Challenges In Economics: Theoretical Issues And The Crisis Of The Eurozone and I somehow missed Marc’s review of it earlier.

My view on these issues—with good grasp of the institutional details—is that countries face a balance-of-payments constraint and the way the Euro Area is set up makes the balance-of-payments constraint stronger. Euro Area countries can no longer devalue their currencies (or hope their currencies depreciate by market forces) and the government can’t make overdrafts on their central banks.

It’s true that the European Central Bank (ECB) can buy government bonds but that it can doesn’t mean it actually will do to the extent needed. Indeed, the ECB has also pushed for tightening of fiscal policy using its powers. Countries face a BOP problem because like in other institutional setups, they’re at the mercy of foreigners. In fact more it’s more than otherwise in case of the Euro Area. And international indebtedness ultimately falls on the shoulders of the governments and hence we saw crisis in the government bond markets.

Countries with a strong international investment position such as Germany do not face this problem.

Ultimately, the problem is that the Euro Area doesn’t have a central government which would be involved in large fiscal transfers and keeping imbalances between countries in check. But as Sergio Cesaratto argues, it was never meant to be that way as the founders of the Euro Area designed it in a way to take away powers from national governments.

I should add one question which arises: the question about the political role of the ECB, which is similar to the role of governments in other places such as the US. There seems to be an inconsistency in the position of people such as Sergio (and I) that we treat the ECB and the US government differently. We say that the US government should be involved in more fiscal stimulus but don’t exactly say that the problems of the Euro Area can be resolved by proposing that the ECB promises to purchase government bonds without limits.

The answer to that is: even outside the Euro Area, rich countries’ central banks can bail out poor countries facing balance-of-payments financing problems. Does that mean that countries outside the Euro Area don’t face a bop-constraint??

It’s a rhetorical question posed as an answer.

Ultimately the balance-of-payments problems in the Euro Area is more severe than otherwise.

Where does neochartalism (“MMT” or “M.M.T.”) fit in my description? The idea that Euro Area governments cannot make overdrafts at their national central banks (NCBs) is something stressed by neochartalists is right but many authors who didn’t call themselves MMTers stressed this such as Wynne Godley in 1992. The idea that current account deficits don’t matter isn’t useful as you still have to explain why Germany didn’t go into a crisis like Greece.

Roy Harrod On The Balance-Of-Payments Constraint

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I am always interested on how close economists come on a full model of how the world works. And so I found this passage from John McCombie in his article Harrod, Economic Growth And International Trade on Roy Harrod in the book Economic Dynamics, Trade And Growth: Essays On Harrodian Themes interesting:

Harrod, through the development of his open economy model, implicitly saw the fallacy of Keynes’s argument. On the basis of a model with no government sector, Harrod (1948, p. 103) noted that ‘the balance of trade depends upon whether the ratio of the volume of exports to the volume of home investment is greater or less than the ratio of the propensity to import (viz. imports represented as a fraction of income) to the propensity to save’. But there was no reason why, at full employment, these ratios should be equal and why the balance of payments should be in equilibrium. If there was initially a balance-of-payments disequilibrium, and it was impossible to finance perpetually the deficit, there would be a financial crisis and ‘investment would come tumbling down’. It is here that we perhaps have the first reference to the possibility of a balance-of-payments constraint, where conditions in the external markets dictate the level of domestic activity. Harrod also appreciated early on the deflationary bias which the balance-of-payments imposed on the international system, with the burden of adjustment falling on the deficit countries and where there was little to force a surplus country to expand its level of economic activity.

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References

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Harrod, R.F. (1948), Towards a Dynamic Economics, London: Macmillan.

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Nicholas Kaldor’s View That Exports Is The Only Exogenous Source Of Demand

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From a Twitter discussion on balance-of-payments, I was reminded of a section of John E. King’s 2009 biography of Nicholas, titled by the name.

From pages 193‒195 (+ endnote + references in Bibliography):

Kaldor’s willingness to take extreme positions was very well illustrated by his post-1966 emphasis on exports as the only exogenous source of effective demand, which I criticised in Chapter 4, Section 7. The closely related balance-of-payments-constrained growth models seem, at first glance, to be more relevant to a (long-departed) world of fixed exchange rates than to the world we live in, with floating currencies and huge payments deficits (and surpluses) that can apparently be sustained indefinitely. Kaldor would probably have responded to this with four counter arguments. First, he would have claimed that it was true only of rich countries with currencies that were sufficiently attractive for foreigners to hold to make continuing large deficits sustainable (for example the United States, the Euro bloc, Britain and Australia). The balance of payments constraint remained binding for small, poor countries with unattractive currencies (Bolivia, Zambia, Thailand). Such countries also continued to be dependent on the IMF and the World Bank, which dictated deflationary responses to their payments deficits, including (but not confined to) devaluation. In any case, Kaldor would have insisted, the external constraint continued to operate at the regional or sub-national level: poor, relatively backward regions cannot depreciate against richer, more productive regions within their own country (this was why he had advocated the Regional Employment Premium).

Second, Kaldor would have invoked his habitual ‘elasticity pessimism’ to deny that (at least for countries with initially serious problems of international competitiveness like the United Kingdom) currency depreciation would have the stimulating effect on exports, and the dampening effect on imports, that mainstream theory dictated. In this he would have been vindicated by evidence concerning the ‘Kaldor paradox’: countries that devalued in the 1950s, 1960s and 1970s tended to lose market share in world trade, while those countries whose currencies appreciated gained in market share (McCombie and Thirlwall 1994, pp. 289–99). Third, he might well have accepted Paul Davidson’s argument that a floating exchange rate regime introduced an unwelcome element of uncertainty into the world economy, discouraging investment and slowing growth across the board, so that a return to fixed exchange rates was both possible and desirable (Davidson 2006). 13

Fourth, and decisively, Kaldor would have argued that there were two channels through which the balance of payments constraint operated, not one. In addition to the policy channel (‘stop-go’, or demand deflation in response to payments deficits), there is an automatic process through which poor export performance leads to sluggish aggregate demand and thence to low business investment and slower output and productivity growth, in the absence of any policy response whatsoever. This fourth defence hinges on the controversial proposition that, for any individual country or region, exports are the only exogenous source of demand, with investment (and consumption) being entirely endogenously determined. This is a very strong assumption, but if it is accepted, the external constraint on growth becomes binding in all circumstances, and cannot be written off as historically or geographically specific, or confined to the Bretton Woods epoch (see also McCombie and Thirlwall 1994).

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Notes

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  1. Note, however, his stated belief that a return to Bretton Woods in the late 1970s would have made things worse (Kaldor 1978c, p. xxi). Not all Post Keynesians agree with Davidson on this important point, Wray (2006) for example arguing that flexible exchange rates are a necessary condition for national economic sovereignty.

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Bibliography

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Davidson, P. 2006. ‘Liberalization or regulating international capital flows?’, in L.-P. Rochon and S. Rossi (eds), Monetary and Exchange Rate Systems: A Global View of Financial Crises, Cheltenham: Elgar, pp. 167–90.
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McCombie, J. S. L. and Thirlwall, A. P. 1994. Economic Growth and the Balance-of-payments Constraint. Basingstoke: Macmillan.

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Wray, L. Randall. 2006. ‘To fix or float: theoretical and pragmatic considerations’, in L.-P. Rochon and S. Rossi (eds), Monetary and Exchange Rate Systems: A Global View of Financial Crises, Cheltenham: Elgar, pp. 210–31.

Now, I do believe in this (for the present rules of the game), as it otherwise stock-flow ratios rise without limits, fixed exchange rates or floating, something King seems to be fine with!

Also, King is extremising Kaldor’s views, which are extreme nontheless—not extreme in a negative way. What’s exogenous and endogenous also changes with the time-period we’re looking at. Something which is exogenous in the short-run can be consistently thought of as endogenous in the long-run.

Endogeneity Of Income Elasticities Of Trade

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Robert Blecker and Mark Setterfield have a new book, Heterodox Macroeconomics: Models Of Demand, Distribution And Growth.

In that there’s a chapter, Balance-Of-Payments Constrained Growth II: Critiques, Alternatives And Synthesis. It has an interesting section where income elasticities of trade are themselves thought to be endogenous.

There are of course many critiques of balance-of-payments constraint growth and Thirlwall’s law but the better ones are more about improvements than anything damaging for the theory. The ideas of Nicholas Kaldor stand.

As emphasised by the authors themselves (page 485), the endogeneity of income elasticities itself is consistent with the Kaldorian idea of circular and cumulative causation. 

Till now, circular and cumulative causation was thought via price effects:

Higher production → higher productivity → higher price competitiveness

But there’s no reason that success can’t increase non-price competitiveness itself, i.e., income elasticities.

The book discusses some of the studies.

It’s interesting to note that it was Paul Krugman who first proposed the idea that income elasticities aren’t fixed and that growth can lead to change in the elasticities. But he refused to accept the causality as implied by Thirlwall’s law. The right causality is both ways. Circular and cumulative causation!

Link

Anthony Thirlwall — Thoughts On Balance-Of-Payments-Constrained Growth After 40 Years

ROKE (Review Of Keynesian Economics) has a special issue, Thirlwall’s Law At 40, celebrating Thirlwall’s law which Anthony Thirlwall discovered in 1979.

Thirlwall himself has an article in the issue.

Interesting, from the conclusion:

Structural change almost certainly requires a country to design an industrial policy embracing a national innovation system to facilitate the flow of technological knowledge across all sectors of the economy. The market mechanism itself is unlikely to bring about the required structural changes needed. I am attracted to the concepts of growth diagnostics (Hausmann et al. 2008) and self-discovery (Hausmann and Rodrik 2003). Growth diagnostics involves locating the binding constraints on a country’s economic performance and to target these directly, giving the most favourable outcome from the resources available compared to the ‘spray gun’ approach to economic policy-making which may not hit hard enough the binding constraints on growth that really matter. In the case of the BoP, it would involve targeting exports with growth potential, and identifying imports where there is import substitution potential. Government expenditure on R&D to enhance export quality could reap high returns. Self-discovery involves seeking out new areas of comparative advantage and then implementing the most appropriate policies to foster them. Hausmann and Rodrik point out that there is much randomness in the process of a country discovering what it is best at producing, and a lack of protection reduces the incentive to invest in discovering what goods and services they are. Governments need to encourage entrepreneurship and invest in new activities, but the first best policy is not by the traditional means of tariffs and quotas, but public sector credit and guarantees which reward the innovator (and not the copy-cats), and can be withdrawn if firms do not perform well after a certain period of time.

Anthony Thirlwall, via Wikipedia

The Cambridge Political Economy Society Digital Archive

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I came across the Cambridge Political Economy Society digital archive today. It has scans of papers which aren’t available elsewhere.

There’s an interesting article, Causes Of Growth And Recession In World Trade, there, by Francis Cripps, in which he describes the Cambridge Keynesian idea of achieving balanced trade, because nations face a balance-of-payments constraint:

The main conclusion of the analysis presented below is that demand creation by means of fiscal and monetary action at the national level is very unlikely to be able to procure a recovery from world recession, because it does not offer a solution to the structural problem of imbalances in trade. On the other hand, demand creation at the international level, designed to boost countries’ import capacity in a manner analogous to a national budgetary stimulus of domestic spending, could in principle ensure a steady world reflation. But the political obstacles to an international programme of income creation are immense, partly because this would implicitly or explicitly involve massive transfers of income from surplus countries to deficit countries.

The alternative to a programme of income creation and redistribution would be an effective mechanism for the adjustment of trade shares, making it possible for individual countries to balance their payments at a high level of domestic activity. Exchange rate changes have hitherto been accorded this role, but experience during the past decade of large exchange rate adjustments has shown that they are quite inadequate for this purpose. The exchange rate mechanism therefore needs to be reinforced, or replaced, by some other system of trade discrimination. Import restrictions, already widely used by developing countries to regulate their trade balances, are at present more or less prohibited for Western industrial countries. Many of these could achieve a recovery of their own economies if they were allowed to introduce import controls. But such action on the part of industrialised countries would not help developing countries. Indeed to sustain growth of output and employment in every country, trade controls would have to be operated on a multilateral basis with positive discrimination in favour of the weakest. Given the desperate plight of some very poor countries, the case for positive discrimination in their favour is now becoming urgent.

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The analysis developed below treats world trade as a demand-determined system in which the level of demand is governed by balance-of-payments constraints facing individual countries and the way these interact. …

Link

Doug Henwood In Jacobin On Neochartalism

On Facebook, Doug Henwood says that he wanted the title The Phantasmic World Of Modern Monetary Theory, A Late Imperial Fever Dream for his piece critiquing Neochartalism but Jacobin editors changed it to Modern Monetary Theory Isn’t Helping.

Henwood has written an excellent critique of Neochartalism, a cut above most critiques. I liked the part about Beardsley Ruml who is quoted frequently by the Chartalists but it turns out that he is a right-wing nut, against taxes 😁

It’s important because as Henwood argues in this piece, Neochartalists do not seem to want high taxes. In my view they get deceived by their own rhetoric.

And the article contains an important discussion of Turkey, highlighting how Neochartalists avoid discussion of balance of payments problems:

When I asked Mosler what MMT had to offer Turkey, a country whose currency has been losing value for the last four years and had something of a financial crisis in the summer of 2018, he responded with a bit of avian whimsy: “Without our recipe for Turkey they’re a dead duck.”

However this recommendation to read his article shouldn’t be taken as an endorsement of all of Henwood’s views. Fiscal policy supremely matters. Just not the Neochartalist way. Henwood seems to not understand the importance. The cover of the issue is silly, as Bernie Sanders himself does soft imperialism.