This is a follow up from yesterday’s post and aims to dispel the myth of the term ‘printing money’ and the orthodox understanding of inflation. The end looks at what happened in Venezuela and Zimbabwe and identifies the cause of hyperinflation as minimal productive capacity and minimal capacity to purchase imported products. They are supply side constraints and you can’t purchase things you can’t make or have access to!
In part 1 The Mythology of Printing Money we covered how the term ‘printing money’ doesn’t apply to any spending operation in a fiat currency, looked at how all Federal Government spending was an appropriation bill and the operations of treasury and the central bank marking up an account. You may also wish to read the prequel in this series How loans create deposits and why we should have public banking…
All spending by the currency issuer can be considered new currency. This can be a difficult concept to wrap your ahead around at first. You need to break the myth that a government is like a household. It is not. It is an issuer of the currency and can be considered more like a scorekeeper.
When you are watching the football the umpire gives an instruction to mark the scores up when a try is scored. Theses ‘points’ don’t come from anywhere, they are keystroked into existence. The deduction of the points scored don’t give the umpire an ability to award more points.
The purposes of bond issuance (Government Debt) isn’t too ‘fund’ expenditure but is used as a tool for liquidity management. The RBA needs to ensure there is sufficient liquidity in the Exchange Settlement Accounts so Authorised Deposit Taking Institutes can pay each other at the end of each day. As banks create loans, they need to be able to pay each other. This is what they use their ESAs for. The image below shows how bond issuance (called Australian Government Securities) move reserves in the system from ESA to securities accounts.
- Governments spend by marking up the appropriate account
- Bonds are issued voluntarily to match deficit spending changing the portfolio mixture.
- The RBA uses its Domestic Market Operations to ensure there is liquidity in the system so ADIs can pay each other. (see image above)
- The RBA uses a corridor system to defend an interest rate.
The RBA from 20 March has embarked on Quantitative Easing (QE) – sometimes this is called ‘printing’ money. In the image above we can see when treasury issues AGS it takes reserves from ESAs and places them in AGS accounts. There is what is called a primary bond market. There is a list of approved ADIs that can participate in this first round of issuance to purchase AGS and they can then trade them in what is called the secondary bond market. It’s important to note that QE is the RBA specifying a yield on a AGS maturity. You purchase AGS for a specified amount if time. For example a three year maturity. As the demand for AGS increases it raises the price and lowers the yield.
QE undermines the target rate when it chooses a particular maturity, in this case three years and purchases as many AGS as necessary to meet its target, which is currently 0.25%, its purchases increase reserves in ESAs and the target rate falls until it hits zero. If you’ve understood the corridor system, the current floor rate of reserves is 0.1% so the QE program undermines the target cash rate. *
To date since the 20 March the RBA has bought $25,000,000,000 (that is billion) of AGS it holds on its book. Upon maturity of those AGS, the RBA deletes funds from the OPA. *
There is often a mistaken belief that banks loan out reserves. Previously during the GFC we had all sorts of predictions of inflation taking off, banks increasing their lending, predictions of additional Government spending causing inflation and none of that came to fruition. This is because orthodox economics prescribes to the loanable funds theory that states banks loan from a limited pool of savings and as governments increase their expenditure it raises rates and increases the price which leads to inflation. This is not what happens, Government spending adds to reserves, decreasing the interest rate and banks create deposits when they loan to credit worthy customers.
You can see Alan Kohler on ABC News come to that realisation. The intro to the segment starts with ‘Is it something we can afford [stimulus]? and where does all the money come from?’ and in his concluding remarks Kohler says ‘What Dr. Lowe won’t be keen to do is give politicians the idea there’s a magic pudding – of printed money. There sort of is, just don’t tell politicians’
There you have it, there are no printing presses in any of that.
- Treasury deficit spends adding to reserve levels
- AGS are issued (voluntarily) to match the deficit
- RBA uses its domestic market operations to ensure there is liquidity
- RBA is currently purchasing AGS at three year maturites to lower the yield. The debt is now owned by the Government.
It is simpler to simply deficit spend and ignore all the accounting practices that are there in issuing AGS. They serve as a mechanism to deliver unearned income to already wealthy investors. These are the very same people that object to increases in welfare payments and public expenditure in general.
Disappointedly, I heard this radio interview on Radio National fear mongering around debt and deficit with language like ‘we’ve gone from balanced budgets to a blowout in debt and deficits’ and ‘will see the budget deficits balloon…’ This is language the invokes an unnecessary fear and that government spending at some point needs to rein its spending in or we all suffer. This crisis shows we always need government spending.
The interview continues with a nonsense analogy that previous generations had to pay for WWII spending. No they didn’t. There was no scarcity of jobs after the war. Governments used their fiscal positions to maintain full employment and seldom did it rise above 2%. Menzies almost lost an election in the 60’s and was forced to raise the deficit and bring unemployment below 2 per cent.
At the end of the interview Fran Kelly and senior business correspondent Sheryle Bagwell discuss the Governments QE program and how the RBA is purchasing Government bonds. They very clearly make the distinction that they are purchasing bonds on the secondary market and not directly from the Government [treasury]
‘If The RBA brought them directly that would be known as helicopter money, it would basically be firing up the printing presses to fund government deficits…lazy governments could really get used to that’
- Governments don’t fund deficits they are a result of spending more than taxation.
- Dollar for dollar Government Deficits have to match the non-government surplus.
- Whether the RBA purchases bonds on the primary or secondary market, the end result is the same. The bonds sit on the RBA balance sheet and at maturity treasury instructs the RBA to pay itself the face value and interest.
- The reason the RBA purchases bonds on the secondary market is that it allows investors to purchase bonds on the primary market and then make a capital gain when that bond is then brought by the RBA.
Stop it with the nonsense printing money analogy! There are no printing presses, there are no helicopters, the government is continuing to spend in the same way it always has, it instructs the central bank to mark up the relevant bank account after an appropriation bill has passed.
Inflation is excess spending (from any source) in excess of the productive capacity of the economy and the economy’s ability to absorb the additional spending. Currency issuing governments have an no financial constraint (they never need to find an income) but they are restricted by what is available for sale.
Yesterday I was involved in this Twitter exchange with Professor of economics Richard Holden from the UNSW.
The orthodoxy usually talks about deficit spending but budget balancing over the cycle. Holden in his tweet states ‘We can borrow at almost zero interest’
The Government never borrows, it spends adding to reserve levels of ESAs and bond issuance shifts those reserves from that account to securities account. The difference between that and a term deposit is that you can buy and sell access to those securities accounts.
If Holden understood that he wouldn’t feel the need to then respond back with the typical fear mongering around inflation ‘tell that to Venezuela or Zimbabwe‘ invoking hyperinflation fear!
Japan, The USA, The European Central Bank and now Australia has been purchasing bonds off the secondary market (QE) and holding treasury bonds on their books, paying the interest to themselves and there has been no outbreak of inflation.
Amongst the orthodoxy they’ll make the case prescribing to the Quantity Theory of Money. ‘the quantity theory of money (QTM) states that the general price level of goods and services is directly proportional to the amount of money in circulation, or money supply.’
The federal reserve (USAs central bank) says
‘The money supply is the total amount of money—cash, coins, and balances in bank accounts—in circulation.‘
Looking at the data for Recent balance sheet trends and the Selected liabilities at the Federal Reserve they note
On the liabilities side of the Federal Reserve’s Balance sheer, the amount of currency outstanding has continued to rise gradually, but reserve balances (deposits of depository institutions) have increased dramatically relative to the prior financial crisis’
The orange line is the increase in deposits of financial institutions in the US equivalent of exchange settlement accounts. Clearly, there has been no great inflationary outbreak, at least never in my life time. Since the GFC the Federal Reserve has embarked on several QE programs the latest of which has seen their purchases of bonds increase from $US700bn to an unlimited number of bonds. This swaps an asset of a bank (the bond) into currency in its exchange account and the bond is held with the central bank.
So we can put increases in the money supply, ‘printing money’ and an inflation outbreak to rest. It’s not a thing.
There are other factors that contribute to inflation and even hyperinflation. The first step is understanding what economist call ‘cost-push’ inflation.
This differs to the demand side in that it is the price level of a good or services increases either via an imported price (something the national government can’t control) or domestically via a fall in production and productive capacity.
Fadhel Kaboub at the Global Institute for Sustainable Prosperity in the linked news article below says
MMT points to a different primary cause of inflation in developing countries: not domestic spending, but foreign debt and a resulting lack of “monetary sovereignty.”Why Government Spending Can’t Turn the U.S. Into Venezuela, In these Times, 7 January 2019; http://inthesetimes.com/article/21660/united-states-venezuela-modern-monetary-theory-trade-deficits-sovereignty
A country that is monetarily sovereign issues its own currency and floats it on an exchange rate.
There are some countries which use a currency they don’t issue, such as the eurozone countries and there are countries that fix their exchange rates to maintain a parity to another currency.
Countries that don’t issue their own currency, like the eurozone, are reliant on taxes and bond markets to fund public expenditure.
Countries that fix their exchange rate have to ensure foreign currency reserves to maintain the peg. Countries then need to obtain foreign currency either by purchasing it on foreign exchange markets (FOREX) using their own currency or through exporting goods and services.
Provided spending doesn’t outpace an economies productive capacity you won’t have a period of accelerating inflation.
Any country that issues its own currency can purchase what is for sale in the currency it issues. This includes idle labour. A country that issues its own currency always chooses the level of unemployment.
That doesn’t mean because a country at full employment is materially prosperous. You need to consider the skills of the labour force, the raw materials it can access and what it is able to produce.
For a country that relies on imported products, they are reliant on their exchange rate or exports to be able to obtain foreign currency and purchase the goods and services they are unable to produce domestically.
Exports are a loss of a good or service, it is something a nation exchanges for a foreign currency, it means unless you are able to produce an excess of that product you are depriving your citizens of the use and instead giving it to foreigners.
For developing countries, the problem begins with trade deficits and resulting debt owed in foreign currencies.
Those deficits are the product of fundamental economic shortcomings, themselves often a legacy of colonial rule. Postcolonial countries are typically unable to produce enough food and energy to meet domestic need, and they face structural industrial and technological deficiencies. Because of this, they must import food and energy, along with essential manufacturing inputs. For example, Venezuela lacks refining capacity, so—while it exports crude oil—it must import more expensive refined oil, contributing to trade deficits.
Importing more than they export causes these countries’ currencies to depreciate relative to major currencies. With a weaker currency, new imports (like food, fuel and medicine) become relatively more expensive. This imbalance is the real driver of inflation, and often of social and political unrest.
The International Monetary Fund (IMF) historically steps in at this point with emergency loans coupled with painful austerity measures. To get out of IMF conditions, even progressive policymakers typically prioritize acquiring foreign currency reserves in order to honor external debt payments. They promote tourism (tourists bring foreign currency) and design agricultural and manufacturing policies to support export industries. Meanwhile, industries that would build self-sufficiency (and thus fix the trade imbalance), like food crops for domestic consumption, receive little government support. All of this decreases self-sufficiency and reinforces the dependence on foreign goods that caused the debt in the first place.Why Government Spending Can’t Turn the U.S. Into Venezuela, In these Times, 7 January 2019; http://inthesetimes.com/article/21660/united-states-venezuela-modern-monetary-theory-trade-deficits-sovereignty
Venezuela had external debt denominated in US dollars and little productive capacity to satisfy the needs of its population. It has nothing to do with Government spending or ‘printing money’ but sanctions imposed upon it that reduce self-sufficiency. A more just world would cancel debt denominated in an external country, aid the country in building productive capacity to be self-sufficient and have the US purchase Venezuelan bolívar on FOREX markets to maintain the currency between a certain range so they can purchase imported products.
Professor Bill Mitchell has detailed post on hyperinflation in Zimbabwe where he identifies one of the major causes of the inflationary outbreak to a fall in the nations productive capacity. In Zimbabwe’s case their agricultural production, that also happened to be one of the nations largest employers.
The problems came after 2000 when Mugabe introduced land reforms to speed up the process of equality. It is a vexed issue really – the reaction to the stark inequality was understandable but not very sensible in terms of maintaining an economy that could continue to grow and produce at reasonably high levels of output and employment.http://bilbo.economicoutlook.net/blog/?p=3773
The revolutionary fighters that gained Zimbabwe’s freedom from the colonial masters were allowed to just take over productive, white-owned commercial farms which had hitherto fed the population and was the largest employer. So the land reforms were in my view not well implemented but correctly motivated.
The output of the nation was decimated and it saw soaring unemployment levels, to over 80%. How do you reduce the demand for food without forcing people to remain malnourished and even starve?
The central bank was using its foreign reserves to purchase food supply, limiting the capacity of other industries like manufacturing on FOREX markets to purchase foreign currency and ending up in the situation where they couldn’t operate their plants. Mitchell goes on
The situation then compounded as other other infrastructure was trashed and the constraints flowed through the supply-chain. For example, the National Railways of Zimbabwe (NRZ) has decayed to the point the capacity to transport its mining export output has fallen substantially. In 2007, there was a 57 percent decline in export mineral shipments (see Financial Gazette for various reports etc).
Manufacturing was also roped into the malaise. The Confederation of Zimbabwe Industries (CZI) publishes various statistics which report on manufacturing capacity and performance. Manufacturing output fell by 29 per cent in 2005, 18 per cent in 2006 and 28 per cent in 2007. In 2007, only 18.9 per cent of Zimbabwe’s industrial capacity was being used. This reflected a range of things including raw material shortages. But overall, the manufacturers blamed the central bank for stalling their access to foreign exchange which is needed to buy imported raw materials etc.
The Reserve Bank of Zimbabwe is using foreign reserves to import food. So you see the causality chain – trash your domestic food supply and then have to rely on imported food, which in turn, squeezes importers of raw materials who cannot get access to foreign exchange. So not only has the agricultural capacity been destroyed, what manufacturing capacity the economy had is being barely utilised.http://bilbo.economicoutlook.net/blog/?p=3773
A country like Australia has none of these issues. Fears of hyperinflation are unwarranted. Mitchell describes the situation in Zimbabwe as a result of a supply side collapse, a 45% fall in agricultural capacity, difficulty in obtaining imported materials forcing manufacturing to lay idle and compounding that with a Government interested in spending for political favours while your nations productive capacity has collapsed
“Further, the response of the government to buy political favours by increasing its net spending without adding to productive capacity was always going to generate inflation and then hyperinflation. “http://bilbo.economicoutlook.net/blog/?p=3773
- Money is a creature of the state. All Government spending by a monetary sovereign is an appropriation bill through the relevant legislature.
- Tax liabilities serve the purpose of creating a demand for an otherwise useless currency.
- Government debt is issued after the fact a currency issuer has spent. It moves currency from reserves into a securities account.
- Deficits are a result of spending (and aren’t funded) and have a corresponding surplus in the non-government sector. This is an accounting rule and simple 7th grade algebra.
- Printing money – referred to by the orthodoxy as the central bank purchasing bonds from the treasury (QE) is not inflationary. Increases in the money supply (Quantity Theory of Money) have not resulted in any outbreak of inflation despite governments embarking on these since the Global Financial Crisis.
- Government deficits pushing rates up (Loanable funds theory) and contributing to rising interest rates and therefore costs and inflation is not a thing. Governments have run deficits, larger ones since the GFC and inflation has not happened. That is because loans create deposits.
- Hyper-inflationary episodes in Zimbabwe and Venezuela are supply side collapses and those nations had little domestic productive capacity, had debt in foreign currencies, depreciating exchange rates (where they couldn’t purchase imports) and no ability to obtain foreign currency without adhering into bullshit IMF rules to loan them foreign currency under conditions that impose austerity by mandating selling public assets to private corporations and aiming for budget surpluses.
Hearing economists peddle misunderstandings on the way the monetary system functions, like the many I’ve documented over these lasts two posts, continues to reinforce a neoliberal paradigm that will undermine progressive aims.
We shouldn’t have to moderate demands based on a misunderstanding that we need to find the dollars.
Currency issuing governments can always purchase what is for sale in the currency they issue and deploy those resources for a public purpose.
We have seen this during the covid-19 crisis the Australian Government double the rate of the JobSeeker payment (despite 25 years from both parties claiming it was unaffordable), they have temporarily nationalised private hospitals with a $1.3bn takeover, they have made childcare free. It is never an issue of finding the money but whether we have the resources to create the public services we desire.
Old paradigms take time to shift and you can see the economic orthodoxy feeling threatened. Richard Holden, despite pushing progressive aims and goals, is stuck under an economic paradigm that has no empirical evidence.
He felt the need to respond to an amateur that questioned where do financial institutes obtain Australian dollars to purchase Australian Government Securities? and brought up arguments of hyperinflation by referencing Venezuela and Zimbabwe.
I think that is a sign that the orthodoxy knows it is losing power. It is a choice to make that paradigm shift, admit your understanding was wrong and use MMT as a lens to advocate for your values.
*Edit: The initial publication of this made an error and said upon maturity of AGS the RBA credited the OPA. It is in fact upon maturity, the RBA deletes funds from the OPA. These are a liability of the RBA. and their deletion matches the deletion of the bonds, which are assets.
It was also picked up that there was bad phrasing and it was clarified that QE drives rates to zero (or the current floor which is 0.1% in Australia) and this has also been edited. The initial publication mistakenly said the current target rate was zero. It is not, it is 0.25%
Many thanks to Steven Hail for picking up the errors.
© Jengis 2020