Friday, 2 December 2016

Varoufakis's Santa Claus turned Minotaur

Marxist's are bewitched by the notion of 'surplus value'- i.e. wealth created by workers which can be confiscated from them. They believe Capitalism is doomed because surpluses confiscated from the workers won't get 'recycled'. They will be hoarded. So the wheels of the economy will fall off. There will be a 'Crisis'- one of 'under-consumption' featuring mass unemployment. Finally the State will step in and nationalize everything and create a Utopia. Then the State itself will wither away because workers will be smart enough to keep their surplus value for themselves. Neither Capital nor the State can appropriate it.

Under fixed currency exchange rates, a different sort of 'surplus' can create a problem. This is a trade surplus which means a country exporting more goods and services than it imports. If this country lends its currency to the deficit country the exchange rate can remain as it is. The problem is that the borrowing country has to pay interest and thus its deficit will increase.
There is an easy solution- let exchange rates float and find their own level. There is still the problem that some countries may want to keep running surpluses and can do this by lending or investing in deficit countries. This could be considered an unfair trading practice. The surplus country goes on building up its industries while the borrowing country gets lazy. The problem is compounded by borrowing countries running a budget deficit- i.e. the Government spending more than it gets in tax revenue- using the resources provided by the surplus country. Long term this is not sustainable.

Varoufakis's big idea is that there is a problem with what he calls the Global Surplus Recycling Mechanism. America is running a deficit which means countries, like China and Germany can run a surplus.

Varoufakis writes-
Before 1971, US global hegemony was predicated upon America’s current-account surplus with the rest of the capitalist world, which the US helped to stabilize by recycling part of its surplus to Europe and Japan.

This is nonsense. The US was militarily and economically stronger than the combined might of its allies. It could have chosen to run a current account deficit- the world was hungry for dollars- financed by 'seignorage'- i.e. the US could print money without inflationary consequences because foreigners would use that money to buy things off each other. Capital flight from a poor and starving Europe would have provided the off setting capital account surplus so that the US didn't lose gold reserves.

Instead, the US chose to administer a fixed exchange regime associated with Marshall Plan aid to help put its allies back on their feet. This was good for US exporters. It was bad for US consumers who had to pay more for imports. It was also bad for U.S investors who weren't allowed to own gold. Instead, the US govt. was prepared to sell gold for dollars at a fixed price to foreign Govts even if the open market price for gold was higher. De Gaulle took advantage of this putting the 'Bretton Woods' system in jeopardy.

However, the economist Triffin had already told Congress that, under fixed exchange rates, a country whose currency is used for international trade by third parties is going to have to either allow its country to appreciate or else suspend gold convertibility- otherwise it will end up exporting its reserves at an artificially low price. From the French point of view, the US  'seigniorage'- arising from its currency financing international trade- was an 'exorbitant privilege'. However, this was only an unmixed blessing for the Americans if they ended gold convertibility- which increased inflationary risk. Thus the US citizen, not allowed to own gold, had to watch as the French Govt. made an instant profit on gold it bought from the US at the artificial price.

Under fixed exchange rates, a country can run a deficit on the Balance of Payments as a whole. But, ultimately, it has to either export gold or other reserves or else devalue. The American deficit, in the Sixties, part of which is attributable to the inflationary financing of the Vietnam war, was unsustainable. American attempts to control 'the export of dollar's backfired'. It started exporting banks as well. It had become clear that Americans were becoming more and more impatient with bureaucratic restraints on their investment choices. It was also clear that fixed exchange rates didn't work. Sterling had to devalue- the Empire was gone and there was no way to bring it back. Meanwhile, the Gulf countries- which had an 'absorption problem'- i.e. they couldn't spend their money fast enough- running genuine structural surpluses wanted to invest them through freer markets so as to get better value for money.  Bretton Woods had to end, Nixon had to stop gold convertibility, inflation was the new enemy.

Varoufakis, however, has a different view- he thinks the US had a balance of trade surplus till 1971- actually, as the chart shows, it didn't, it broke even- which it magnanimously used to help Europe and Japan.

This is nonsense. The truth is that it had a Balance of Payments deficit- it was printing dollars not backed by gold which is why it had to go off gold and let its currency depreciate- i.e. suffer inflation. This was destabilizing for the world.

However, in Varoufakis's fact free fantasy world- 'This underpinned economic stability and sharply declining inequality everywhere.

So Varoufakis thinks that the US, prior to 1971, was a Santa Claus which stabilized the world and helped the poor so that inequality declined. What actually happened was that the post war world had inherited high tax rates and massive State capacity to reallocate resources. Fixed exchange rates were part of a global order whereby States kept power to themselves. However technology was changing in a manner bureaucrats didn't understand. Rent seeking was rampant. Inflation was a stop gap to postpone social conflict. Ultimately, the alternatives was were either stagnation or an increased role for markets. First, however, the genie of inflation had to be put back in the bottle. Nixon tried a Prices and Incomes policy. It didn't work. Nobody believed a democratic Government would put thousands of Trade Unionsts in jail just for demanding higher wages. The other problem was 'fiscal drag'. Working people had been pushed into higher tax brackets. This meant that Welfare payments could increase more than proportionately because the bureaucrats and politicians running things didn't want to hand money back to the tax payer. This meant there was a supply side shock in addition to the oil shock.

The good news was that floating exchange rates and competitive markets freed politicians from the recurring headache of the external balance. Trade could take off and become much freer. China, fortunately, entered the Global Economic system at a time when this lesson had been learned. Soon, their exports completely eradicated the inflationary bias which had bedeviled post War industrial democracy. Instead, there was the problem of asset bubbles. We have a situation where some countries- like China or India- can grow rapidly but which are financially and institutionally underdeveloped and thus opaque to the global investor. Knightian Uncertainty too has increased for technological reasons. There is clearly a lot of incentive incompatibility in Financial Services. Taken together, what all this means is that a lot of voters have an inarticulate sense that National Governments need to rebuild the sort of executive capacity they had in the post war years.

Varoufakis, in his own garbled manner, is channeling some such notion about a good post war Uncle Sam who brought presents to little children in Europe and Japan but which suddenly started suffering deficits and thus became a horrible monster.
 But, as America slipped into a deficit position, that global system could no longer function, giving rise to what I have called the Global Minotaur phase.

According to ancient myth, King Minos of Crete owed his hegemony to the Minotaur, a tragic beast imprisoned under Minos’s palace. The Minotaur’s intense loneliness was comparable only to the fear it inspired far and wide, because its voracious appetite could be satisfied – thereby guaranteeing Minos’s reign – only by human flesh. So a ship loaded with youngsters regularly sailed to Crete from faraway Athens to deliver its human tribute to the beast. The gruesome ritual was essential for preserving Pax Cretana and the King’s hegemony.

After 1971, US hegemony grew by an analogous process. The Minotaur was none other than the US trade deficit, which devoured increasing quantities of the world’s net exports. America’s burgeoning deficit was financed by billions of dollars of daily net inflows into Wall Street from the foreign (and often US) owners of these distant factories – a form of modern tribute to the Global Minotaur.

The more the deficit grew, the greater its appetite for Europe’s and Asia’s capital. What made the Minotaur truly global was its function: it helped recycle financial capital (profits, savings, and surplus money). It kept gleaming German factories busy. It gobbled up everything produced in Japan and, later, in China. But at the same time, Wall Street learned how to turbocharge these capital inflows through exotic financial instruments. The floodgates of financialization burst open and the world was flooded with debt.

In the autumn of 2008, the Minotaur was mortally wounded after running into the wall of private debt that was a by-product of its appetite. While the Fed and the Treasury refloated US markets (at the expense of weaker Americans left behind since the 1970s), nothing would be the same: Wall Street’s capacity to continue “closing” the global recycling loop vanished. The US banking sector could no longer harness America’s twin trade and budget deficits for the purposes of financing enough domestic demand to sustain the rest of the world’s net exports. From that moment on, the world economy would find it impossible to regain its poise.

2008 was an asset bubble which had a wealth effect which in turn affected aggregate demand. It wasn't about trade imbalances except in so far as quasi fixed exchange rates prevailed in some parts of the globe.

What made it so important was that it put an end to a type of optimism which dismissed Knightian Uncertainty and thus suggested that riskless positive return assets exist. They don't.
However, this story has nothing to with 'recycling surpluses' and everything to do with monetary policy.  China, a Communist country, wanted to build up foreign exchange reserves so as to increase faith in its own currency for its own citizens. The expected appreciation in the domestic currency puts a check on capital flight. Once they reversed this policy, put up interest rates and overvalued their currency, capital flight increased with a vengeance.

 It is true that China, like France's De Gaulle, espoused a stupid mercantilist view point. They talked of the Triffin dilemma after the crash because they were worried about two different thing- firstly that their dollar holdings would lose value and secondly that International Trade might grind to a halt because of a liquidity crisis.
In fact, this sort of mercantilism was stupid and the Chinese have dropped that sort of talk. They see that they have a long way to go to getting reserve status for their currency and that even when it happens that 'exorbitant privilege' can be a poisoned chalice.

Following the Minotaur’s mortal wounding, America has not only the Fed and the Treasury to thank for helping to avoid a new Great Depression. The US was also saved by the Dragon: the Chinese government cranked up domestic investment to unprecedented levels to pick up the slack created by the contraction in spending in the US and Europe. For many years, China allowed credit creation by its formal and shadow banks to run amok, even permitting them to benefit from the Fed’s easy-money largesse by taking out dollar-denominated loans. Put succinctly, the Dragon stepped in to rebalance the West when the Minotaur no longer could.

So Varoufakis thinks Uncle Sam was a Santa Claus prior to '71 which recycled its surpluses by buying toys for poor kiddies in Europe and Japan. Then the US turned into a horrible minotaur running deficits. In 2008 the World finally got wise to this evil monster. Luckily there was a nice Dragon which stepped in and 'rebalanced the West'.
The question is why was the dragon so nice?

China’s leaders knew what they were doing. They were creating a bubble of unsustainable investment to give Europe and the US a chance to get their act together. Alas, both failed to do so: America because of the standoff between President Barack Obama and the Republican-controlled Congress, and Europe for reasons too painful to recount. And when the perfect storm hit in 2015, with US interest rates climbing while commodity prices fell, China had to crank up credit creation once more.

The truth is that China has a fixed exchange rate and this imposes costs. It isn't concerned with rebalancing anything globally but with developing its own productive power.
China understands that the US borrows in its own currency from abroad and thus can always shrink its obligations by a dollar depreciation which imposes a 'demurrage' charge on foreigners using dollars for their trade with each other. This speeds the velocity of circulation and ensures liquidity.
However, it also creates a distributional asymmetry whereby the export sector which can borrow in dollars to secure assets or extinguish liabilities in the official currency gains at the expense of the rest of the country in a manner damaging to the State's resolve to deliver balanced growth.
One way to curtail the resulting mis-allocation of resources is to let the currency rise on the back of interest rates to shake out the secondary banking system.

Today, China’s credit boom is underpinned by collateral almost as bad as that on which Bear Stearns, Lehman Brothers, and the rest were relying in 2007. Moreover, because the Chinese renminbi is grossly overvalued, corporations are borrowing dollars to repay their legacy dollar-denominated debt early, putting downward pressure on the exchange rate.

In other words, the market is taking care of the problem. Since Chinese private debt is held mainly by Chinese people there is no 'contagion risk' for the rest of the world. No doubt, a Chinese shake-out will have a wealth effect which reduces their imports but there are other things happening in China which, if they succeed in improving resource allocation, will put Chinese aggregate demand on a better trajectory long run.

Trump’s plan for helping those left behind since the 1970s, to the extent that one is discernible, seems to turn on two axes: a domestic stimulus and bilateral deal-making under the threat of tariffs and quotas. But if he plays hardball with China, pushing the Chinese to revalue the renminbi and employing threats of tariffs and the like, he may well end up pricking the bubble of China’s private debt – unleashing a deluge of nasty consequences that would overwhelm any domestic stimulus he introduces.

US exports to China have already taken a big hit but not had much effect. Going forward, their agricultural sector may be endangered but the Federal Govt can easily take up the slack with set aside schemes which serve other functions as well.

In that case, Trump’s infrastructure spending would morph into more corporate welfare, implying a negligible multiplier effect. That, in turn, would set the stage for future austerity, as panic over further US interest rate rises and federal budget blow-ups put the squeeze on the government’s 
If Trump’s medium-term economic strategy is to have any chance of success, he must grasp that it is not US public debt, but Chinese private debt, that needs to be restructured. Otherwise, US Treasury yields could go through the roof, severely weakening US debt sustainability.

If, as seems likely, Trump goes in for Corporate Welfare with more or less full employment while dismantling Obamacare, all that happens is that the efficiency wage in some sectors- including the Rust belt- goes up as does Baumol cost disease in services- i.e. income distribution worsens within the working class in a manner that favors White Blue Collar workers. Corporations are sharing a rent with their workers for a specific political purpose- viz. so Trump can make good his promise to a strategically significant minority.

Trump has no interest in and no say in how Chinese debt is structured. He does have an interest in allowing a depreciation of the dollar which shrinks its liabilities and recurring interest charge on the invisible account. This is because 'exorbitant privilege' has ensured that a lot of US debt - 5 trillion of Treasury Bills for example- is held by foreigners. US devaluation has a deflationary wealth effect on them, but there is a perverse income effect whereby some foreigners have to work harder to rebuild the real value of dollar reserves. Thus global economic activity as a whole does not go off a cliff.

Likewise, Trump must realize that he cannot make America great again by emulating Ronald Reagan’s unfunded stimulus. That trick worked when the Minotaur was chained and fed; it won’t work when the Dragon has run out of fire. Instead, if Trump truly wants to rebalance the US economy so that growth benefits the abandoned people to whom he has promised so much, he should emulate Franklin D. Roosevelt and pursue a Keynesian makeover of Bretton Woods.

All nonsense. China was in no position to fund Reagan's deficit. It was very poor back in the Eighties. In fact as the table shows the US current account went back in balance towards the end of the Reagan era. This was a good thing all round.

FDR's new Deal failed. Bretton Woods also failed. A Keynesian makeover of Bretton Woods makes as much sense as a Gramscian revival of the League of Nations in which everybody sits around worrying about how Capitalist 'hegemony' is going to inevitably turn Merkel into Hitler.
Thanks in part to Varoufakis, the ECB is going to implode as Target 2 unravels and the Euro is seen as 'funny money'. The same thing would have happened to Keynes's 'bancor'.

Countries genuinely exist and the management of national currencies is constrained by prudence because very heavy punishments exist for countries which monkey around with their monetary system. The Eurozone could discipline Greece and other peripherals. It probably can't discipline its core. The ECB under Q.E is probably the designated 'bad bank' which permits a German-Dutch exit in the event that France and Italy elect lunatics.

What of Varoufakis's Minatour which eats children? Under what conditions will he declare that has turned back into Santa Claus bringing pressies for little kiddies in Europe and Japan?

The answer is, if Trump succeeds in restoring a U.S Current Account Surplus which he uses to prop up deficit finance based demagogues abroad while US corporations prowl about buying up all the productive assets.

I've said it before and I'll say it again- Varoufakis is a Trumpista. There's a good reason Trump loves the poorly educated. The case of Varoufakis proves that cognitively piss poor, historically illiterate, educators serve his cause just as well.                                                                                                                                                                       

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