Problems with 'Sovereignty' in the Periphery Nations

Some fresh MMT education material starts today. I’ve been posting to the Blog recently more regularly, since starting the DougBot Project , and as part of that research effort the opportunity to pose some questions to the founder of MMT (in the modern 20th century form, as opposed to the Sumerian form) arose.

To prepare for a chat with Sir Warren Mosler (you guys have Knighthoods yet in the USA?… well, c’mon, keep up you laggards). I first wanted to dip into a topic dear to my heart, which is how MMT applies to poorer nations, so-called “on the periphery” of international relations. Could it be MMT does less to help these nations than advertised? Or is the New Keynesian or bastardized Keynesian orthodoxy equally as deluded about the insights of MMT for weaker nations as they are about decent small nations like New Zealand?

The paper this discussion is based upon is by Vergnhanini and De Conti (2017), Modern Money Theory: a criticism from the periphery .

If you want to skip the preliminary defences of MMT, which reply to standard criticism, and go staright to the trade issues, then click here to the Trade Issues section.

They Still Aren’t Stating MMT Correctly

Before they get around to their supposed critique of “MMT”, Vergnhanini & De Conti give a pretty good summary of MMT ideas, however, they fail at the last hurdle, and it is not a trivial failure. The trouble being it is central to their (false) arguments “against MMT”.

The weak chink they point to is Randall Wray’s admission that sometimes international markets might force a nation to purchase goods for sale in a foreign currency. This would be only when the weaker nation needs critical imports that it cannot source domestically or purchase in their own currency.

However, to argue on common ground we have to accept the MMT Base Case, otherwise the authors are being disingenuous. The base case is:

1. The (supposedly “weaker”) nation is running a fiat currency on a floating exchange rate, no peg, no fixed rate policy.
2. They are maintaining ZIRP — so any central bank bond issue is zero interest, for purposes of running the payments layer only, interbank clearing. (Or not, the MMT base case is really that currency issuers never need to offer bonds for sale, private banks can be permitted to operate term deposits for customers).
3. The nation runs a Job Guarantee, which supports a base wage floor, permanent full employment for anyone wishing to work for the tax credits.
4. Non-convertible currency.

We, they, you, cannot criticize “MMT” if we are not considering all of: ZIRP, a fiat float, tax-driven, and the Job Guarantee.

What this means is that the “weakness” pointed to by Wray is false for the MMT Base Case. It occurs in the present day real world because the nations in the global south are not running job guarantee policy, they are instead forcing the poor, the unemployed, to pay the price for getting the imports in the foreign currency.

With this all stated, we can see the first mischaracterization by Vergnhanini & De Conti of “MMT”, they write,

“The [sic.] MMT recognizes that if the country is forced to [sic.] international indebtedness because it is obliged to issue debt in a foreign currency or because it needs goods or services that are not available in exchange for the domestic currency, then it would be subjected to constraints of international markets (Wray, 2014a)."

This “recognition” is an opinion and analysis of an MMT economist (Randy Wray) about a putative global south nation that is not running an MMT Base Case system. However, they probably still have an MMT system. The lack of following the Base Case matters. Why? It is because under a full MMT Base Case no nation is obliged to issue foreign debt. Private citizens and corporations might want to, might do so, but the government does not. They can pay all debts in their own currency and have no need to borrow a foreign currency.

If “international markets” are obliging the government of the weak nation to issue foreign debt this is not an MMT Base Case, it would be called neocolonialism or economic warfare.

The MMT Base Case has to be adjusted, as Wray does so, in the event of such international warfare.

If the international markets, specifically the FOREX desks, refuse to exchange the global south nation’s currency for euro or USD, guess who is at fault? Who sparked this economic war?

It is not MMT or the global south nation at fault, it is the foreign empires.
Provided the global south nation are driving domestic demand for their currency via taxation, their currency is always worth real value, specifically whatever that nation’s people can produce for a unit tax credit worth of their labour and industry.

The FOREX rate for that weak nation is thus never zero. It is zero only if imperial nations force it to be zero by economic and political warfare. No nation should accept this, and we have something called the United Nations to at least mildly act against such imperialism.

It is something else too if that weaker nation is utterly corrupt and has no functioning legal system. In that case it’s currency is of highly indeterminate value, but it is still never zero, so can still be exchanged. Which means they can still pay for imports.

They might not get many imports, but that’s the real price they pay for corruption and lack of rule of law, or rule of fair law.

If one sets up a so-called “periphery nation” that is corrupt as hell to start with, then that’s not a fair criticism of MMT. It is a criticism of that nation’s politics. MMT still applies if their government want it to apply. They can have as much prosperity as their domestic production allows.

What that means is optimising their real terms of trade.

The only condition when the weaker nation cannot optimize it’s terms of trade (sacrifice some desired domestic output to get critical imports) is when they are suffering from out-right economic warfare, like Iran or Cuba.

Incidentally, what nation has the lowest exchange rate against the USD? It is Iran. But they have a fair enough justice system. They are a good example of how political decision in Washington exerts trade effects upon exchange rates. Yet their people are not suffering terribly badly. Their average wage still buys a lot of stuff. That is the thing about a fiat currency. When apples cost say 20,000 tax credits per kilogram, but your wage is 50,000,000 tax credits a month, you might be grumpy, but you are probably not starving.

The MMT Base Case is Where to Start

All such issues of superimperialism accounted for and acknowledged, what is the best policy for the weaker nation to pursue?

In all cases, without exception, it is the MMT Base Case.

The fact the MMT Base Case analysis fails to apply for a weak, corrupt, periphery nation held under oppression of imperialism, is not an argument against MMT, and nor is it an argument something other than MMT should be their monetary system. In all cases they are better off employing MMT operations to run full domestic employment. They gain nothing in real terms by unemploying their workers.

If their workers are being exploited to produce military munitions for foreigners, then MMT is not the problem, the political economic warfare is the problem.

Now I wrote this little section before reading part-3 of Vergnhanini and De Conti’s paper. I did this because I expected, or hoped, to be surprised that they would refute this assertion that regardless of the nation’s standing on the international stage, they are still better off adopting MMT Base Case policy. I was prepared to be awed by any counter-argument to this assertion.

The “General” Criticisms

Let’s first see if the general criticisms raised by Vergnhanini & De Conti are of any merit (and if not, why are they repeating them?).

1. Origin of Money — The criticism is that MMT places too much emphasis on tax-driven demand. The critics say MMT ignores the secondary functions of: means of payment, store of value, and “unit of account”. The third of these is a stupid critique, since the tax-driven chartal currency is the unit of account, so Vergnhanini and De Conti are off to a poor start, not giving MMT its due. The first two functions are fully recognized by MMT. Why does a currency attain a store of value functional and means of payment function? It’s because there is demand. What drives that demand is the point in question. MMT does not deny methods other than taxes can drive demand, see Wray’s latest readable book “Making Money Work for Us” and the earlier “Modern Money Primer” and “Modern Money Theory 101: A reply to critics” .
2. Consolidated Government Framework — MMT analysis often consolidates Central Bank and Treasury, even while acknowledging they have different functions and mandates. Marc Lavoie this time, and Palley (again) are called upon as the critics. This is again a completely stupid critique. Firstly, MMT recognizes the separation of functions (monetary and fiscal policy). But consolidating governments is the correct framework for the most basic sectoral balances. For when Treasury makes payments to the central bank, it is the left pocket of government paying the right pocket. Lavoie is the fictionalizer here. If Treasury defaults on payments due to the CB it’d be entirely pointless, and those liabilities have zero real economic consequence other than exerting some false psychology effects (policy insanity). It is the false psychology of policy makers that is at fault here, not MMT. Lavoie is better to start teaching the reality, which is that for many purposes it’s a good idea to consolidate government in an analysis. If you think Parliament has to constrain spending because it “owes” the “independent” Central Bank scorepoints, you are the problem, not MMT.
3. Inflation and Interest Rates Explanation — MMT is “lacking a rigorous explanation” says Palley. This is truly Orwellian. Total bollocks. Only MMT has an explanation of the general price level, which implies also rate of change, i.e., inflation. The general framework can be found in Mosler and Forstater, “A general framework for the analysis of currencies and commodities” . For the interest rate the framework is found in another Mosler and Forstater paper, “The Natural Rate of Interest is Zero” . The “L shaped” inflation (Phillips) curve described by MMT is not seen in the real world not because MMT is a flawed framework, but because no government runs a Job Guarantee labour buffer. If they did, by definition the Phillips curve would flatten, it would not even be visibly L-shaped. It would be ‘—’ shaped. But we will not know this empirically until some government runs a Job Guarantee policy. However, the theory is solid, and Bill Mitchell, here: “Full Employment Abandoned: shifting sands and policy failures” has plenty of modelling to show the basic idea of flattening the Phillips curve.
4. ZIRP Effects — Tom Palley again, asserts ZIRP would lead to asset price inflation. This is wrong, or would need to be supported by lax bank credit collateral requirements and/or government fiscal injections supporting asset prices. Both effects could occur, and do occur. But MMT is not at fault here. How does a monetary authority prevent asset price inflations caused by ZIRP? Firstly, ZIRP does not cause anything, since the natural rate is zero. It therefore must be the regulatory policy governing bank lending and collateral that supports rising asset prices. Moreover, in the MMT Base Case a rise in interest rates will inject currency into the economy whenever the government Treasury issue to GDP ratio is above about 50%, which is pretty typical, in this case higher interest rates are more free money but only to people who already have money. If this likely to push up asset prices? Over time youbetcha. Short run it may drive savings into bonds rather than other assets, but once the interest payments flow the asset prices will pick up. The opposite to how fools like Palley see things.
        MMT suggests the role of government should be to better regulate banks, not use interest rates. Palley cannot ever deny this is true, unless it is tried and does not work. But of course regulating banks would work, if enforced, if not corrupted. So is the “critique” of MMT that in the real world governments are corrupt? That’d be highly disingenuous, since it is not a critique of MMT, it’d be a critique of certain governments. This is, to their credit, acknowledged by Vergnhanini and De Conti, so this one of Palley’s is recognized as not a valid critique of MMT.
5. Floating Exchange Rate — This critique is the more apropo for Vergnhanini & De Conti’s paper. Tom Palley again is resuscitated from the vampire crypt to attack MMT, he claims floating exchange rates are insufficient to “insulate” a small open economy from pass-through effects of inflation. This attack misses the mark by a country mile, because the purpose of MMT informed policy for a small open economy is not price stability, it is full employment. Price stability can be abandoned indefinitely. Few critics of MMT understand this, and many MMT advocates also fail to appreciate the purpose of price stability. Price stability is a political goal, not an economic goal. The economic goal is a gradual improvement in the real wage, and that can occur with any inflation level that is tolerated by political psychology. The limits here are entirely political, not monetary, not real resources. Since you will not see this in most standard MMT literature, I will reference the analysis of the Weimar hyperinflation by Armstrong and Mosler . It should suffice.

It you take issue with any of these defences of MMT or the references let me know after donating here so I can justify the time responding to your argument.

Fixed Exchange Rate Brainworms

The exchange rate criticism is a common one coming from post-Keynesians, who are slightly dysfunctional parents to the MMT off-spring prodigy. Paul Davidson is a prominent PK economist who advocates for Kenyes’ Bancor program of fixed exchange rates.

What the PK’ers have is a mental disease, which is a fundamental misunderstanding of the state currency purpose, which is to float supply in order to stabilize price. I’ll try to give a basic synopsis of the problem with fixed exchange rate policy, for which concrete examples can be found all over the world, the Hong Kong currency board problems (due to fixed exchange rate control and US$\$$ fiscal tightening), and the Russian ruble late 1990’s deterioration (due to fixed exchange rates and loss of tax enforcement power), are two illustrative examples, but I will only give the abstract case.

Warren Mosler goes through the gory details for Russia and Hong Kong here if you’re interested.

We start off with any normal state currency. A fixed exchange rate is desired, as is full employment. It is not too violent a loss of abstraction to consider this abstract country, say Peekayland, pegs to the US dollar (USD), thus offer convertibility at their central bank from their currency the PKD to USD.

Holder of marginal PKD (no use for them) have only three options,

1. Hold PKD in a deposit account.
2. Buy PKD Treasuries, we’ll call these PKGB.
3. Swap PKD for USD at their central bank.

Options 2 and 3 are competing. But could be initially “in equilibrium” (there is indifference between 2 and 3).

But then something happens, it could be one critical import their economy needs (this’d usually be energy or grain) runs short and their import price goes up, or maybe the USD rate is hiked, or Peekayland suffers some on-going chronic labour disruptions or other supply shock. Note (for later) this disturbance need not be too big.

This creates enormous pressure for the holder of marginal PKD to go for option 3, since why would they not? The option is available and they know the intrinsic value of the PKD, which is backed by the industrial output of Peekayland’s labour, is threatened. The run ‘out of’ the PKD ‘into’ USD places downward pressure on the Peekayland exchange rate. But wait! They’re operating a fixed rate policy. The response of the Peekayland central bank, the PCB, must be to raise the interest rate on PKD bonds, to attract back some PKD, so they do not run out of USD reserves.

Note the PCB and their Parliament + Treasury can create PKD by fiat (Parliament authorize, Treasury keeps books and advises, PCB makes payments), so solvency is not a problem. But they are worried about price inflation too, so need to restrict supply of PKD appropriately, through taxation or spending adjustments.

The issuance of more PKGB (Peekay Government Bonds) at the higher rate adds to their government deficit, all other things equal. If this scenario is sustained for a while this becomes a huge net injection of PKD into the Peekayland economy, creating inflationary pressures (all demand for zero supply). Typically some inflation will materialize, leading the PCB to hike rates further to draw in some of the excess purchasing power into PKGB (hypothetically you understand, because we’re assuming they’re post-Keynesians or neo-Keynesians, so do not understand their monetary system).

This can snow-ball, as the interest payments on the PKGB inject more PDK into the top-end of the economy it can push up asset prices, but also “trickle-down” to even more consumer spending, but then also more demand for USD, which the PCB cannot create legally, so the reserves get drained, leading to an even higher PKGB rate, and so more deficit injection, and so on.

This is all hypothetical, but realist. Events might not turn out this way, supposing there is a sudden huge upsurge in demand for the goods Peekayland produces — then they can gain foreign revenue and prevent the (mistaken) imperative for PCB interest rate hikes. Or they might wake up one day and realize they don’t have to be neo-Keynesians. But for illustration we’ll continue with the realistic case.

How does this all get stabilized? Maybe the USD interest rate drops exogenously, or the USA fiscal policy becomes expansionary, more Americans buying imports generally and supply the foreign sector (hence Peekayland) with USD. This is chancy, it’s not going to happen by magic wands and wishes. If such exogenous exchange rate adjustments fail to materialise (and typically they’ll not materialize) Peekayland faces a never-ending upwards pressure on the PKGB interest rate, or the option to run out of USD and default on their swap obligations.

In the latter case they’ve decided (or been forced) to go off the fixed exchange rate, they will devalue, or move to a floating exchange rate.

If not, they could choose the highly regressive option of restricting PKD, impose austerity. Either by raising taxes drastically (if they were Russian they’d be unable to enforce, so this’d not work) or they could cut government spending drastically — closing public utilities and maybe cutting pension payments (which ought to have been guaranteed!) and whatnot.)

Their other source of exchange rate stabilization would be to export more to the USA, or to other nations who have currencies convertible to USD or tradeable for USD. But you again cannot wave magic wands to suddenly boost exports without contracting the domestic real economy. Exports are a real cost. So this is also austerity by any other name. They could seek to employ cheap immigrant labour for a time trying to “weather the storm” (the immigrants are never the problem, they’re your solution, especially in these fixed exchange rate situations). The exporters could also make their goods more attractive by cutting the wages they pay to reduce their prices. Again, austerity. This always results in higher involuntary unemployment.

There is no non austere solution, I hope you can see.

The fixed exchange rate has directly undermined their real standard of living in Peekayland. For sure, the supply shock or small disturbance started this ball rolling, but they cannot insulate themselves from all possible shocks. It’ll happen sooner or later. We just had major flooding and earthquakes at the same time in New Zealand. But luckily we’ve got a floating exchange rate. Our imports will thus get relatively dearer, but our economy will be fine. You have to pay in real terms for natural disasters, no magic since we’ve actually not got Gandalf here ensconced at Hobbiton smoking pipe-weed, sorry to say.

The tragedy of countries like Peekayland, run by neoclassically trained but maybe bastard Keynesians, is they will often in the real world choose this second scenario, even if they’re not Russia and could raise taxes. The least powerful political constituency, the poor, the low waged, take all the bullets, in uncivilized societies.

You might say, “Well, why didn’t they just devalue the PKD manually themselves?” The answer is firstly, “Devalue to what?” There’s no magic formula for obtaining PKD$\leftrightarrow$USD market stability, they’d risk deflation and hence economic contraction. Secondly, the central bankers who are neoclassical or bastard Keynesian, tend to think the markets will correct, they tend to always make the exchange rate devaluation too late, so the damage gets done. We know this because they’re the type suggesting fixed exchange rates in the first place. You’d hope less damage occurs than if no correction was taken, but needless unemployment of Peekaylanders results all the same — a decline in the standard of living.

On an exchange rate float there is no such dynamic. Full employment can always be maintained in perpetuity. The price paid for the supply shock is a lower exchange rate, which redistributes imports domestically (who gets to play golf, who has to show up at the factory). The loss in standard of living is then minimal, because domestically such a government desiring to protect its people can always (if they so desire) make the necessary fiscal adjustments to make sure everyone has about the same amount of “golf time”.

Fair Trade Issues

Here we are at the critical point where the critique of Vergnhanini & De Conti coalesces with a similar critique of MMT by friend Steve Keen. The MMT case is that imports are a real benefit, and exports are a real cost. The issue is that some post-Keynesians see this as “too simplistic.” However, they ignore the macroeconomics point of MMT, which is based on realism about the Base Case for Analysis (no imperial despots, floating exchange rates, fiat currency driven by tax liabilities). Under the Base Case it is a truism that imports are real benefits and exports are real costs.

I’ve grown used to these sorts of disingenuous or ignorant attacks on MMT. A beginning MMTer can find them perplexing, but after some maturity you realise it’s the orthodox economists who are simplistic. Their level of comprehension of MMT is extremely flawed and too simplistic. A case of Moles calling the Owl blind: “You can’t see it because I can’t see it, so if you see it you must be going mad.”

For these purposes — for trade relations — the MMT Base Case applies pretty well to New Zealand, Australia, Canada, Japan, maybe the UK, any country trade-friendly with both the USA and China. (Although the Japanese have not yet figured out their exports are too high a cost, given their aging population dependency ratio problem.)

Steve Keen, for his ill part, oftens leaves off the qualifier “real” in “exports are a real cost”, and so false frames the debate into monetary terms. Certainly, allowing foreigners to accumulate your currency means they can buy your goods. But MMT would counter that this is no risk unless governments make it a risk. Goods you produce domestically do not have to be for sale to foreigners.

Keen also raises the “de-industrialization” fear-mongering. But why would being a net importer mean you have to de-industrialize? It means no such thing. Anything that can be produced at more expense domestically can be sourced domestically, if that is desired for strategic reasons. So this is not a fair critique of MMT, because such strategic resource policies are entirely up to governments to choose. In fact it’s a backhanded endorsement of MMT if you think about it (a government always has the capacity to fund higher wage cost domestic production). They may choose right or wrong for their people, regardless of what MMT teaches them. Better to regard MMT, I say.

The purpose is to optimize your real terms of trade, not your current account balances, which for governments are mere accounting records. Any nation may optimize their real terms of trade. That does not mean all can be net importers, which is an impossible state, there must be at least one net exporter, by capital account balances. That country is still seeking to get as many quality imports it can get for the minimal amount they can export. Or, at least, that’s what they ought to be doing in trade negotiations. There’s no telling for what ignorance will accomplish.

If you drop the qualifier “real” then you’ll misunderstand. The money becomes unimportant in the case when we’re analysing real terms of trade (since there is assumed no imperialism).

((Do the neoclassicals even account for imperialists? The point is all realist economists should be factoring in imperialists, but this does not change the fact MMT is your best Base Case. You do not resist imperialism by borrowing from the IMF and unemploying your workforce. As a government, why not at least employ everyone looking for work to fight the imperialists. It’s economic war, so no one has to die, and certainly not because they’re unemployed.))

You may, like Steve Keen or Michael Hudson, still get it wrong if you are thinking in currency terms and fixed exchange rates instead of real terms and floating exchange rates. The trade risk is never nominal inflation. The risk is running out of real resources, that is to say, the risk should be thought of in terms of real inflation (eroding of the purchasing power of the annual wage).

Under MMT, there are still two major factors that can erode the real wage:

1. Rentiers — rent extraction to the top One Percent, which is tantamount to stolen wages from the working class, although MMT generally is taken to subsume Keynes, so you’d be euthanizing your rentiers, would you not? So not much of a risk factor for an MMT informed government wishing to protect all their people.
2. Imperialists — a large nation simply refuses to trade with you. MMT is not going to help here, but nor is any other school of economic thought, since it is a political problem. So you might as well adhere to MMT policy and at least maximise domestic non-bullsh*t output.

Unemployment directly reduces output too, eroding the real wage, but that’s not going to happen in the MMT Base Case, so it is not a risk factor.

You might include other risks like plagues, droughts, asteroid strikes, war, general stupidity and educational dumbing down and whatnot. All of which can erode the real wage potentially. If you can foresee these, then definitely include them in policy planning to mitigate the foreseeable erosion of real wages. To implement those policies MMT is only going to be able to help, not hinder, and will help you far better than any other school of economic thought. (“You” meaning a commoner, not necessarily you if you’re in the rentier upper class.)

Under an international imperialist despot (like the USA) of course this simple story can get twisted. But this is hardly a fault or flaw in MMT. If you do not like imperialism then failing to adopt an MMT system and policies will not help you, it’ll make things worse. Remember, any pass-through effects of inflation can be tolerated indefinitely for a monopoly currency issuer, without altering domestic full employment. It might lower bullsh*t job employment, but that’s a good thing.

On a floating exchange rate, with a non-convertible currency, domestic full employment is a simple policy choice, not a foreign-set exogenous variable. This is so for any nation, whether they are import dependent or poor or not.

The problem is getting other nations who have things to sell to accept your currency. If they will not accept your currency then you need to swap on the FOREX market, which if done on a mass scale risks currency depreciation and pass-through inflation. However, that inflation can go on forever. There is no limit, provided the domestic currency is fiat and on a float.

In severe cases the FOREX market will not even accept your currency, in which case you have bigger problems than monetary economics. Almost all nations today can operate a FOREX desk, and should always find takers for their currency if they are imposing and enforcing domestic tax liabilities payable only in their unit of account. (The ‘unit of account’ being equivalent to the tax credit, which was misunderstood by Palley in the note above — the state unit of account need not be the tax credit, but almost invariably is!)

Basket case nations like Ecuador (converting to USD) and Argentina (using a dual currency) and Venezuela (oligarchs looting billions and converting bolivar to USD) are not cases proving MMT is false, because they’re not employing an MMT Base Case system. On the other hand, MMT very well describes their predicaments, so they “prove MMT” by counterfactual, showing you what happens when you do not understand MMT.

The better way to understand all this is to understand the purpose of exporting real goods: the exports pay for the imports. They are a price you pay for keeping pass-through inflation under control while receiving a few nice imports.

Keeping inflation under control for a non-convertible fiat currency is not a financial problem, it’s a psychological problem. People do not like to see prices go up even when their real wage is appreciating! Go figure. Not a fault of MMT, but a psychological problem an MMT system has to psychologically socially overcome if they are under foreign imperialist or import embargo pressures.

I mean, you’d better figure out how to combat the false psychology, or you’ll end up being a dictator like Castro, or simply collapse into something much worse — neoliberal slaves to the IMF and Washington Consensus. MMT is only going to help fix the false psychology, not hinder.

The way to remove the damaging neoliberal psychological effect of inflation is to raise domestic production over time. You cannot do this any better than with full domestic employment, so you will need MMT in both theory and practice.

It is possible benign rich nations could gift you imports. Or they might lend at zero interest rate. That’d obviate the need for an exchange rate float, but who is ever going to rely on such a commonwealth? Nice if you can get it.

What about trade embargoes, like those imposed upon Cuba?

Even here, Cuba is best advised to run an MMT system. There is no benefit to doing otherwise. Why unemploy your workers just because some other nation is not trading with you? It’d be like punishing your dog for stepping in your neighbours doodoo while he was warding off an intruder.