Some governments really are like households


In my last post, I said that the fact that a government can buy anything that is for sale in its own currency is not sufficient to confer monetary sovereignty. A country which is dependent on essential imports, such as foodstuffs and oil, for which it must pay in dollars is not monetarily sovereign. Some people disputed this on the grounds that such a country could earn the dollars it needs through exports. So I thought I would write a post discussing how realistic this is in practice.

Strictly speaking, the only country in the world that can always pay for everything it needs in its own currency is the United States. However, most developed  countries that issue their own currencies have deep and liquid FX markets that enable them to exchange their currencies freely for other currencies; many also have swap lines with the Federal Reserve. Eurozone countries don't issue their own currencies, but the bloc as a whole issues the world's second reserve currency. It is not going to run out of the means to buy imports.

In practice, therefore, developed countries can generally use their own currencies to pay for imports. But this is not true of developing countries - and most countries in the world are developing countries. In my view, a definition of monetary sovereignty that does not work for most countries in the world is not much use.

A developing country with poor creditworthiness and a thinly-traded currency is unlikely to be able to pay for imports in its own currency. It must obtain what used to be known as "hard currency," usually dollars. A country that must obtain FX to buy essential imports is effectively using the currency of another country even if it issues its own currency with a floating exchange rate. The government may be able to buy everything that is for sale in its own currency, but it is not able to buy everything the country needs. It is dependent on external sources for hard currency.

There are essentially three ways of obtaining hard currency: earning it through exports, buying it on FX markets, or borrowing it. None of these fully protect the country from FX crisis. A negative terms-of-trade shock, such as happened to commodity exporters in 2014-15, can quickly wipe out net export earnings, turning a current account surplus to a deficit and forcing the country to borrow FX. Exchange rate collapse (which may be associated with a terms-of-trade shock) can make buying FX on international markets to pay for imports all but impossible. And borrowing in foreign currencies quickly becomes unsustainable if the exchange rate drops. Floating exchange rates do not confer monetary sovereignty, even for a developing country that issues its own currency, if the country is dependent on imports for essentials such as basic foodstuffs. This is true even if the country normally runs a current account surplus.

Those who say that developing countries can always pay for essential imports with money earned from exports are really saying that developing countries should never under any circumstances run current account deficits. Where imports are concerned, the country must "live within its means." It can spend only what it earns from exports, and no more. These governments really are like households.

Since the Asian crisis of 1997-8, many developing countries - particularly those with dominant extractive industries - have done exactly this. They have opted to run persistent current account surpluses, building up FX reserves to protect themselves from "sudden stops" and enable them to support their exchange rates. In theory, these countries earn all the FX they need to pay for imports. They do not need to borrow FX.

And yet many still have FX debt, particularly in the private sector. As I noted in my previous post, a developing country with high private sector FX debt is vulnerable to exchange rate collapse. Servicing debts in ever-more expensive foreign currencies is damaging for indebted corporations, and the rising cost in domestic currency of obtaining dollars seriously hinders trade and business development. This applies whether or not the country has sufficient FX reserves to support businesses that need dollars, and whether or not the government can obtain more FX by exchanging its own currency. The rising cost of dollars as the exchange rate falls is itself enough to push the economy into recession.

But if the current account is in surplus and there are ample FX reserves, why does the private sector, and sometimes the public sector too, have FX debt? There are two reasons.

The first is cash flow. Businesses may overall have an FX surplus, as indeed the country might. But cash doesn't always arrive when you want it to, and suppliers have to be paid. So corporations can be forced to borrow FX to pay essential bills in advance of the necessary FX funds arriving. In theory, a currency-issuing government should not have to borrow FX - it should simply be able to exchange its own currency. But if the currency is thinly traded, selling it can cause the exchange rate to fall precipitously, especially if the government is printing the currency it is selling. Because of the adverse effect of sharp exchange rate falls on domestic inflation and indebted private sector actors, many governments prefer to borrow FX to cover short-term shortfalls.

The second, and more significant, is investment. Consider a company that is buying plant to establish a new business in, say, Morocco. It is likely to have to pay for that plant in dollars. It could borrow dirhams and exchange them for dollars, but as this would most likely have to come from a local bank rather than from the cheaper international capital markets, it could pay very high interest on the loan. Furthermore, if it is planning to manufacture goods for export in dollars, borrowing in dirham would create a currency mismatch on its balance sheet which would expose it to exchange rate fluctuations. For these reasons, many companies prefer to issue dollar debt rather than borrow in local currencies. But this means that they have FX debt on their balance sheets even if the cost of their imports in dollars is lower than their export earnings in dollars.

The same is also true of the government. And this brings me to the core weakness in the argument that developing countries can always earn the FX they need through exports.

Consider a country which does not produce enough basic foodstuffs to feed its population. It may have poor quality land and water shortages; it may have seriously underdeveloped agricultural production; it may be overpopulated. Whatever the reason, in the short term it must buy the food it needs to feed its population. And because international foodstuffs are invoiced in dollars, it must pay for this in dollars. If its export sector is also undeveloped, it will lack sufficient FX to buy the food its population needs.

The obvious long-term solution is for the country to increase its agricultural production so that it can feed all its people. Alternatively, if developing agriculture is problematic, for example due to persistent flooding, the country needs to increase production for export so it can earn the FX to buy the imports to feed its people. Both of these approaches require investment, and investment requires dollars. Additionally, production takes time to develop - and in the meantime, people must be fed. So the country must in the short-term borrow FX to pay for imports, and it must also borrow FX to invest for the future. If it does neither, then its people will starve both in the short term and the longer term. FX debt is thus inevitable in a country that has an insufficiently developed supply side.

A few people suggested that a job guarantee would help to develop the supply side. This is true, but supply side improvement takes time, and in the meantime people must eat. The story of the Irish famine delivers a cautionary tale about relying on job guarantees to relieve hunger. Starving people aren't productive. They need to eat first, then work. Paying them a job guarantee wage when the country is not earning sufficient dollars to import the food they need to eat is pointless and cruel.

Keeping the current account in balance or surplus by restricting imports and favouring exports is extraordinarily difficult to achieve, especially for a country with weak institutions and widespread corruption. To understand why, we need to think through what forcibly keeping the current account in balance or surplus entails.
  • Imports must be controlled so that the country can never find itself with an FX gap that must be funded. High import tariffs can help the country to restrict non-essential imports. But if FX earnings from exports fall, even essential imports may have to be cut, regardless of the impact on the population.
  • Following from this, exchange rate movements cannot be allowed to wipe out terms of trade advantage. Many developing countries, particularly commodity exporters, fix or manage their exchange rates to prevent them rising.
  • The country must make sure that FX earnings from exports do not leave the country except in payment for imports. This means strict capital controls, including complete prohibition of profits repatriation by foreign industries, and limiting or banning FX and bullion holdings by the private sector.
  • FX borrowing by government must be outlawed completely, and FX borrowing by the private sector must be restricted so that it can only be used for investment. If corporations and households are allowed to borrow in foreign currency to fund consumption spending, the current account will go into deficit.
Keeping the current account in balance or surplus at all times means deliberately suppressing domestic demand, to prevent imports from rising. In a country which depends on imports for essential foodstuffs, this could mean the poorest being constantly at risk of starvation. Additionally, since all resources would be directed to export production and supply-side development, the better-off might struggle to save. And there would be unemployment, since in an FX-dependent economy, full employment is limited by the ability of the import-export sector to generate net earnings. Creating jobs that do not increase export production, and do not substitute domestic production for imports, simply causes inflation.

There needs to be fiscal restriction too. Developing countries with real resource shortfalls that force them to import essentials must develop strong supply sides in preference to boosting domestic demand. The last thing such a country needs is deficit spending in its own currency that boosts domestic demand beyond what its own supply side can satisfy, sucking in imports which must be paid for externally with dollars even if they are sold domestically for local currency. Hey presto, before you know it, you have rising FX debt and a falling market exchange rate, the essential ingredients for an FX crisis.

This has played out time and time again in places like Latin America. Own-currency fiscal stimulus creates a short-term economic boom driven by rising consumption spending, which sucks in imports, creating a FX gap which must be funded with FX borrowing. As FX borrowing rises, investors get nervous and start selling both the FX debt and the currency, causing interest rates to rise and the exchange rate to fall. Servicing the FX debt starts to become more expensive as the domestic currency exchange rate falls. Eventually, the country either runs out of FX reserves or is effectively shut out of FX markets by prohibitively high interest rates on FX debt. When this happens, either the country defaults or it ends up in an IMF programme.

But the social costs of keeping the current account in balance or surplus are high. Consequently, there is always a risk that a populist government, encouraged by reading economic theory that prioritizes deficit-funded social programmes over externally-funded supply-side development, will abandon these restrictions and embark on a fiscal stimulus programme that quickly draws in imports funded by high FX borrowing. Because of this, economic theories designed for rich developed countries are positively dangerous to FX-dependent developing countries.

And if you don't believe me, read Rudiger Dornbusch, and weep for the countries - and they are many - that repeat the same mistakes again and again.


Related reading:

A Latin American Tragedy
Never mind Greece, look at Venezuela
Argentina And The Lure Of Dollars - Forbes

Comments

  1. The Irish economic crisis of 2008 was essentially about consumption fuelled by private sector debt fuelled by foreign money. This caused inflation and a large current account deficit.

    The Peronist Fianna Fail used revenues from the property market to finance various social programs and tax cuts.

    It seems like a more sophisticated version of a developing country's crisis as the author describes.

    Ireland is already subject to the kind of politic dynamics you normal see in Latin America of course. The only EU member state to have left wing guerillas such as the IRA is one notable example.

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    1. I don't think Ireland's economic crisis was remotely like what I am describing in this post.

      Ireland is nothing like Latin America. Describing the IRA as "left wing guerrillas" is an extraordinary revision of Irish history and politics. Their goal is a reunited Ireland, not a socialist paradise.

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  2. Although I think a discussion of FX effects is really important and obviously what this post is about I think it muddies the water to invoke the household analogy. For me the fault with the household analogy is the entities (Gov, Hh) are on fundamentally different scales. This gives rise to emergent effects at the macro level (this being the crux of problems with micro-founded macroeconomics).

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    1. I agree with this to some extent. However, in aggregate household behaviour has macro effects at the national level. And looked at from a global perspective, the woes of (say) Burundi don't have any macro impact.

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  3. You make some good points. To sum up, it's all very tricky.

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  4. Even when looking at foreign exchange constraints, countries are NOT AT ALL like households. As you say yourself, there are capital controls and possible tariffs which will ensure that the purchasing power of the local currency against dollars can be influenced. No household can influence a market with capital controls or tariffs.
    The local central bank is the only supplier of local currency, and as a monopoly provider can of course set the price. No household can do that.
    Sure, ultimately a government cannot buy everything it wants abroad - but nobody has ever claimed that.
    And what does that mean "to invest you need dollars"? There is plenty of investment which can be done without any dollar whatsoever. Education, health services, house- and roadbuilding, development of agriculture, pensions, all financed through local currency should be possible and desirable. Especially if you have lots of human resources which would otherwise be unemployed or underemployed. All this can be done through deficit spending.
    Even when looking at foreign exchange constraints, countries are NOT AT ALL like households. As you say yourself, there are capital controls and possible tariffs which will ensure that the purchasing power of the local currency against dollars can be influenced. No household can influence a market with capital controls or tariffs.
    The local central bank is the only supplier of local currency, and as a monopoly provider can of course set the price. No household can do that.
    Sure, ultimately a government cannot buy everything it wants abroad - but nobody has ever claimed that.
    And what does that mean "to invest you need dollars"? There is plenty of investment which can be done without any dollar whatsoever. Education, health services, house- and roadbuilding, development of agriculture, pensions, all financed through local currency should be possible and desirable. Especially if you have lots of human resources which would otherwise be unemployed or underemployed. All this can be done through deficit spending.
    Clearly, countries which cannot even feed their population have to get help. But beyond that there is absolutely no reason to have to rely on fx spending. Let's say you have a country with plenty of potential food but no exports, and no energy resources. That country might not have any cars or machinery, but a healthy and well educated population. In reality, even the poorest countries seem to have exports worth about 10% of their GDP. Plenty get remittances from family members who sent money back to their home country from jobs they have found abroad. And clearly foreign governments get development aid from western countries. This is often in the form of grants, not loans.

    "But the social costs of keeping the current account in balance or surplus are high." I Successful economies which provide increasing standards of living for their population have done so by doing just that. Keeping the current account at least in balance or in surplus. So I am very surprised you say that. There seems to be a social cost of running a current account deficit (apart, perhaps, from the US due to its reserve currency status).

    And which economic theories promote deficit spending for social programs which draws in imports funded by high fx borrowing? I do not think anybody promotes this.

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    1. This post is specifically about developing countries that are dependent on imports for essentials such as basic foodstuffs. As your comment is about everything except these countries, it is a straw man.

      MANY developing countries are dependent on imports for essential foodstuffs. For example, the Arab Spring was partly caused by rising international food prices causing distress among local populations in import-dependent Middle Eastern countries. Oil exporters are particularly likely to be dependent on imports for basic foodstuffs, because extractive industries drive out other production, including agriculture - this is known as Dutch disease. You hand-wave away the problems of these countries in a single sentence. They deserve better.

      You are factually wrong about what can be achieved in local currency. Health care, for example, needs pharmaceuticals and other supplies, which cannot be paid for in local currency - indeed healthcare is often one of the first sectors to suffer when a country runs short of FX. Education needs books and other resources which may only be available internationally. House and roadbuilding may also need imported raw materials and tools. Being unable to obtain FX is economically disastrous for developing countries. That has been shown again and again.

      I will write another post about capital controls and exchange rates. Suffice it to say for now that protectionist measures cannot prevent FX crisis. They may make it less likely, but at a price.


      I'm frankly amazed that you think helping the poor to remain poor is an adequate strategy.

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    2. "Oil exporters are particularly likely to be dependent on imports for basic foodstuffs, because extractive industries drive out other production, including agriculture - this is known as Dutch disease. "


      (This Dutch disease should really be re-named. That is what the Dutch Statistical office says: "The Netherlands is the second largest exporter of agricultural goods after the United States. "

      https://www.cbs.nl/en-gb/news/2017/03/agricultural-exports-up-by-over-4-percent)


      But even in countries where food production becomes uncompetitive because of rising currency (it now cheaper to import than produce at home) the country has leavers to support food production. That is why you still have loads of agriculture in Switzerland, although it would be far cheaper to import everything. So basically the Swiss provide some job guarantee programme to their uncompetitive farmers, which keeps cheap imports out.

      Health care, education, construction was paid for in local currency in the whole of the Eastern Bloc countries (without any $ investment). Health care in Cuba seems to be better than in the US by some measures. No US$ needed here. In fact in Cuba health became better when they had a dearth of foreign exchange.


      https://www.theatlantic.com/health/archive/2013/04/how-cubans-health-improved-when-their-economy-collapsed/275080/

      Sure, their might be medicines which cannot be obtained unless FX is available, that does not mean a country should not do anything to improve its citizens health (or education or housing) up these constraints.


      And I clearly pointed out that running a balanced current account (or surplus) seems to help the poor countries becoming rich more than running current account deficits. So that seems to be how poor countries get richer. The government deficit in its own currency seems to be irrelevant.

      IF you have an example of a country which produced sustainable development by running a current account deficit financed by FX borrowing I would be interested to know. I can see various reasons why this strategy will not be successful, but I am happy to be proven wrong.

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    3. Why are you discussing developed countries like Switzerland? They are not remotely relevant to the subject of this post.

      The Atlantic piece does not discuss Cuba's healthcare system. It is about what happened to private sector consumption when the USSR folded. As I have been clear in this post that developing countries should not encourage private sector consumption booms, your piece rather supports my argument, though from a health perspective rather than a financial one.

      FWIW Cuba's healthcare system was heavily supported by the USSR, as were Eastern bloc healthcare systems. It is now suffering badly from underinvestment due to US trade sanctions, so clearly Cuba does need external funding for healthcare. Cuba is now looking to China to provide the investment it needs to upgrade its healthcare system. http://theconversation.com/is-the-cuban-healthcare-system-really-as-great-as-people-claim-69526

      I have never said that developing countries should do nothing to improve healthcare or education. This is yet another straw man.

      And so is your question about sustainable development. The whole point of my post, and the previous one, is that sustainable development CANNOT be financed with a current account deficit. It can with a current account surplus. But the government deficit is NOT irrelevant, for the reasons that I gave.

      I really don't understand how you managed to miss the point so comprehensively.

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    4. "I have never said that developing countries should do nothing to improve healthcare or education. This is yet another straw man. "

      True. You said, however, that "And there would be unemployment, since in an FX-dependent economy, full employment is limited by the ability of the import-export sector to generate net earnings. Creating jobs that do not increase export production, and do not substitute domestic production for imports, simply causes inflation. "

      Now I just argued that jobs in health care, education, construction would increase employment, even in a country which has to import food. Using resources of the country, more health, education and houses/roads does obviously increase the wealth and well-being of the country. And does not cause inflation.

      What point am I missing?

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    5. 1) Employment is limited by the availability of real resources
      2) In an FX-dependent country, the real resources available to the country are below what the country needs
      3) therefore employment must also be below what the country needs

      Health, education and houses/roads are all dependent on external resources, as I explained previously. Therefore employment in these sectors is dependent on the availability of FX to obtain the real resources needed by these sectors. Jobs in those sectors are unproductive if real resources cannot be obtained. The deficit spending required to sustain such unproductive jobs would be inflationary. Again, this has been shown repeatedly throughout history. Supply-side development is essential, and if a country is short of real resources, export development is also essential. This is not to say that Improving healthcare, education and construction are not important - they are all investment in human capital - but they are not possible until there is reliable, sustainable access to real resources.

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    6. "Jobs in those sectors are unproductive if real resources cannot be obtained."

      Maybe you can point me to a concrete example in the world where government provision of new health care, education, housing and road infrastructure led to a loss of overall wealth and well-being, and, because of their perceived "unproductivity" to an increase of inflation. How much would the inflation have been?

      And should there indeed have been inflation because of these new jobs (which I really doubt), perhaps you could let me know whether it is more important to have health, education, housing and roads; or whether it is more important to fight inflation?


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    7. There can't be new healthcare, education or housing without real resources. If the real resources aren't there to enable people to do the jobs you want government to create, the jobs are unproductive, by definition. No amount of deficit spending by a government in its own currency will make those jobs productive if the real resources they need are only obtainable with FX that the government does not have. Paying people to do jobs that can't be done because the real resources don't exist is inflationary. So the priority must be to obtain real resources.

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    8. @Matt

      "Maybe you can point me to a concrete example in the world where government provision of new health care, education, housing and road infrastructure led to a loss of overall wealth and well-being, and, because of their perceived "unproductivity" to an increase of inflation."

      This is such an obvious straw man. Frances's point was about situations where increased govt spending of its own currency does not correlate with increased productivity, not about how govt provision of overall wealth and well being (ie health care, education and all the other good stuff you mention) leads to net 'loss of overall wealth and well being'. Two different things.

      'Health care, education, construction was paid for in local currency in the whole of the Eastern Bloc countries (without any $ investment).'

      That's actually not quite right. You may want to consider communist Romania as a 'real world example'. Romania had chronic trade deficits and had very reluctantly (for obvious reasons) accrued dollar denominated debts from both private banks and the IMF. The dollars were used precisely for purposes that the Romanian currency was not capable of achieving, that is acquiring basic commodities and technology in order to develop modern industrial and civil infrastructure. What you call 'health care' in an Eastern Block country like Romania, was basically an inhumane system that couldn't deliver the most rudimentary health services. Pharmacies were almost empty. Hospitals were properly staffed but they were still severely under-equipped. They would lack basic medical equipment, basic medication, they were not heated, they would go through frequent power outages, the few ambulances available were poorly maintained and had to severely ration their gasoline etc, etc. It was all a nightmare and to think that all this could have been improved if only the government had the wits to use its own 'sovereign currency' to buy a little more of that healthcare and education seems a bit simplistic and naive.

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  5. Thanks for your very sensible and informed insights, Frances.

    Would I be wrong in thinking that if your analysis is correct, then the case for a MMT/hard-Brexit utopia (such as fervently advocated on a certain blog) would be severely weakened?

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    1. I think so, yes. It's founded on what I regard as a fundamental fallacy, which is the notion that "sovereignty" is naturally absolute. I think that in reality, national sovereignty is negotiated with the rest of the world and conditional on their agreement. Attempts to increase sovereignty by cutting ties with other nations (or taking them over) are detrimental to both national and global well-being.

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  6. "The deficit spending required to sustain such unproductive jobs would be inflationary. Again, this has been shown repeatedly throughout history."

    I am still looking for a list of countries showing me that education, health, road and housebuilding financed from government deficit spending will lead to the above.

    Or examples where the above investment is unproductive.

    As far as Romania is concerned, I think it was bad government led by a useless communist dictator in charge, It cannot have been FX constraints, as Romania was running a current account surplus at the time. So it could have diverted resources to its hospitals.

    https://en.actualitix.com/country/rou/romania-balance-of-payments.php



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    1. Matt, as I have repeatedly said that the problem is lack of real resources not government deficit spending per se, your comment is yet another straw man. If there are insufficient real resources available, government is unable to improve education, health and house/roadbuilding through deficit spending, however many people it pays to work in those fields.

      I explained in the post how a country can have FX constraints, especially with respect to investment, despite running a current account surplus.

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    2. @Matt

      'As far as Romania is concerned, I think it was bad government led by a useless communist dictator in charge'

      Certainly. But it is interesting to examine in what respect the government was indeed 'bad'. In MMT terms, Romania had a nationalised banking system, a 'sovereign' currency, capital controls, a job guarantee program, and a legal system that made it very easy for the government to mobilise real resources from one sector to another at its full discretion, with minimal delays and costs. So what went wrong?

      'It cannot have been FX constraints, as Romania was running a current account surplus at the time.'

      The data you refer to is from the 80'. Trade deficit originates in the 60's, in the meantime Ceausescu regime disaligns itself with the USSR and by the early 70s, Romania is faced with the same dilemmas pointed out by Frances in her post. The austerity program of the 80s was caused rather by FX constraints in an attempt to balance the current account and eliminate the possibility of default, rather than by domestic monetary constraints.

      'So it could have diverted resources to its hospitals.'

      This again begs the question. More precisely, what resources are you referring and how would they get them?

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  7. Frances: " If there are insufficient real resources available, government is unable to improve education, health and house/roadbuilding through deficit spending, however many people it pays to work in those fields. "


    Ultimately it comes down to extreme examples: Should a government build roads "by hand" using thousands of labourers if it does not have the FX to build roads using imported road building machinery with dozens of labourers? I think you would have to look at a real world example and see whether it would make sense and its impact on inflation.


    Wallflower: "In MMT terms, Romania had a nationalised banking system, a 'sovereign' currency, capital controls, a job guarantee program, and a legal system that made it very easy for the government to mobilise real resources from one sector to another at its full discretion, with minimal delays and costs. So what went wrong?"


    Why did it go wrong for Romania, but goes well for China? Both used outside capital to bring in know-how and modern industrial techniques. But China brings in capital through joint ventures, not government borrowing in FX as Romania did.

    China concentrated initially on export producing industries producing consumer goods mainly for export, starting in four special economic zones on the coast. So China's economy was immediately exposed to world markets, and it immediately concentrated on production where it was competitive in world markets. As determined by foreign joint venture investments.

    Romania thought industrialisation through buying heavy industry know-how and plants from the West was the way forward in the 1970s. It then struggled to pay these loans back, being hit badly by the 70s oil crisis and subsequent higher interest rates on its FX borrowing. So a large dose of bad luck. Romania then followed the IMF prescription of austerity, plus it then attempted to repay these expensive loans, prioritizing exports to do so. That obviously hit production of consumer goods for its own market.


    But crucially, in Romania everything was centrally planned, which frequently gets it badly wrong, in China there is a thriving private sector, which much better allocation of resources and man-power.


    Wallflower: " More precisely, what resources are you referring and how would they get them?"

    IF there was no heating in hospitals and a lack of pharmaceuticals in Romanian hospitals or no petrol for ambulances, that is clearly central planning faults. Or a deliberate attempt to prioritise heavy industry production, exports and IMF loan servicing and repayment (that seems to be the reason for the current account surplus during that time) over pharmaceutical production and ensuring that hospitals are heated.




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    1. I provided a link in the post to a cautionary tale about using a job guarantee scheme to build roads in the absence of both tools and basic foodstuffs. I suggest you read it. I also suggest you learn some history. When there are no tools, people can be - and are - worked to death building roads and houses.

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    2. LOL, I do not think I said anything about building roads which nobody needs without ensuring the workers' food supply, without any basic tools like shovels. Although clearly that example of Ireland during the potato famine is a cautionary tale of what happens when you try it.

      Let us take a more up-to-date example. Any African country will probably benefit from additional roads. The government has made an economic assessment which confirms that. The country has enough home made resources (building material/shovels) to build the roads, they have man-power (loads of people unemployed). They have enough food and a secure home food supply. But not enough foreign exchange to buy a fancy western road building machine for $ which would allow you to build the same road with a lot less manpower. What should the country do?

      That is what traditional economic advisor would say: Do not build it without the machinery, you would have to run a massive government deficit to do it, which will be inflationary. Building by hand is not very productive. Government deficits are bad.


      The African minister in charge of road building is also not very interested. He does not want to employ thousands of people for road-building. His main aim is to have an easy life, hoping someone in the future lets the country borrow some foreign exchange, some dollars, so that he can get a $ bribe from the western road-building machinery manufacturer when he buys it. Then his cousin can run the new road-building company, employing only dozen of people. Much easier.

      So the real resource constraints of road building are bad economic advice and a corrupt minister.

      That is a real resource constraint on development, in my view, good economic advice and capable, incorrupt governments.

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  8. @Matt

    'IF there was no heating in hospitals and a lack of pharmaceuticals in Romanian hospitals or no petrol for ambulances, that is clearly central planning faults.'

    But in making this argument about central planning and misallocation, you still are arguing within the household framework. That is, you're still acknowledging real resources/FX constraints. We are not disagreeing about the virtues of proper allocation, we are disagreeing about whether deficit spending of domestic currency can summon real resources when these resources are not available for purchase in that currency, and the consequences of that. So far, your only counter example seems to be that the govt can buy exploitation of human capital (to restlessly build roads with their bare hands and such).

    'But crucially, in Romania everything was centrally planned, which frequently gets it badly wrong, in China there is a thriving private sector, which much better allocation of resources and man-power.'

    I definitely agree with all that but I don't think it helps your argument. This boils down to good household vs bad household where real resources are presumed to be available. The point at issue was that there can't be new healthcare, education or housing without real resources and that deficit spending alone cannot fix that.

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    1. "So far, your only counter example seems to be that the govt can buy exploitation of human capital (to restlessly build roads with their bare hands and such)."

      I was actually arguing for well paid government jobs, (if you want to call that exploitation of human capital - fine) because a very common feature of developing countries are an enormous resource of unemployed people.


      "….and that deficit spending alone cannot fix that."


      Romania ran out of drugs. Romania ran out of FX. Romania ran out of workers as well.

      Romania, in common with other Eastern European communist countries at the time, did not have any unemployment. So the economy literally runs out of capacity. It does not allocate FX to buy drugs, nor does it re-allocate its resources from heavy industry to drug manufacturing. So, yes, deficit spending in its own currency is not useful when at full employment.

      Which is not the case in developing countries. Which usually needs to solve an unemployment/underemployment problem.


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    2. Why do I think you are hinting at a UK Sterling crisis given its gross dependence on euro food imports.

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    3. OK. Let's think about a UK "gross dependence on euro food imports". How can British citizens come up with euros to buy this food?

      Over the long run, the British government can not print or borrow currency to supply this need. A guaranteed minimum income will not work either. Instead, somehow, Britain must achieve a balance of real-product-trade that reliably delivers food to Britain.

      I can see that any reliable system can be disrupted. This seems to be happening in the U.S.A. as we speak. Agricultural products sold offshore are (hopefully) balanced with non-agricultural imports. Obviously, such imports can be expected to compete with local production, potentially causing Dutch disease. In the U.S. case, steel caught the disease and now the hope is that tariffs will provide a cure.

      It seems to me that agricultural trade is good and extra steel imports is also good. When it all turns bad seems to be a political judgement made on the macro level.



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    4. There is no "balance" in a capitalist system .
      Equilibrium might be achieved in a truly feudal system but the UK has the very worst system , that is feudal controls operating a capitalist economy.
      Certainly since the 19th century a vicious dynamic has built up - that is plantations figuring their economy & society for export , a movement of people back to the UK as that is where the food flows and subsequent overpopulation in the UK relative to its domestic agricultural capacity.
      If the core / periphery balance breaks down because of mercantile export of wealth in the plantation and overpopulation / price pressures in the core .......

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  9. The sisyphean nature of the system was illustrated today in Ireland as the local economic advisory council called for more migrants to build houses...
    All of the population rise and I mean all of it since the early 1990s birth nadir is a result of migration pressure .
    Today Ireland has stagnant to falling net income per capita but exploding prices or GDP.
    A typical British hell on earth is being created again.

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  10. «To sum up, it's all very tricky. »

    Actually it is not very tricky at all and the post says something obvious in a convoluted way.

    As H Minsky pithily summarized anybody can issue money, the problem is getting it accepted.

    * To have it accepted by domestic suppliers is easy: just put a gun to their head, figuratively or physically, and then a government can "buy" anything it wants from them by issuing any amount of its "money".

    * To have it accepted by foreign suppliers it is not at all easy: as a rule they want payment in advance via letters of credit in "hard currency". Short of issuing letters of marque to corsairs a government can do very little to put a gun to their head, and all MMT treatises in the world cannot change that.

    Therefore for imports a government must either issue or buy "hard currency", and only "hard currency" can buy "hard currency" sustainably, and a freely issued soft currency instead has a constantly sliding exchange rate (e.g. the pound since WW1).
    What our blogger has done is simply list the conditions under which money becomes "hard currency". That applies to both developed and developing countries in exactly the same way.

    «Some people disputed this on the grounds that such a country could earn the dollars it needs through exports. So I thought I would write a post discussing how realistic this is in practice.»

    It is entirely realistic, but it means that instead of printing money to buy stuff, a government has to sell stuff to buy stuff, which is not MMT.

    «However, most developed countries that issue their own currencies have deep and liquid FX markets that enable them to exchange their currencies freely for other currencies;»

    That is a ridiculous argument, because what matters is not whether the money issued by the government can be exchanged freely, but whether it can be exchanged at a constant rate. A government that issues freely its own money to buy "hard currency" will suffer a constantly falling exchange rate.

    «many also have swap lines with the Federal Reserve.»

    Those swap lines are not unconditional: if a government tries to issue a lot of local currency to pay for imports and convert them to "hard currency" via the swap lines, the Fed will close them. Their purpose is not to allow foreign governments to buy imports they cannot buy with their own money by indirectly freely issuing dollars, the Fed really really would object to that.

    «Eurozone countries don't issue their own currencies, but the bloc as a whole issues the world's second reserve currency. It is not going to run out of the means to buy imports.»

    That's laughable because it exchanges cause and effect: the euro is a reserve currency not because of some decree of the Almighty, but because it is a "hard currency", and it is a hard currency because the eurozone pays for imports with exports, that is as a whole it has a balance of payments, and as a whole does not do MMT.

    All of this does not mean that MMT is worthless, but that it is far more limited than "can buy anything that is for sale in its own currency" with the all important qualification "as long as there are unused resources": suppose for example that the government buys unemployed domestic labour with their own currency, that works to the extent that the workers don't consume imports.

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    Replies
    1. @Blissex2


      "As H Minsky pithily summarized anybody can issue money, the problem is getting it accepted."

      What Minsky summarised ('Stabilizing an Unstable Economy' 1986) was a point about the nature of money, not a point about how different currencies have different strength (domestically or otherwise). Of course they differ in strength. Water is wet and wind blows. Nobody is debating here whether some currencies are really 'money'.

      "To have it accepted by domestic suppliers is easy: just put a gun to their head, figuratively or physically"

      Physically, those are lots of guns put to lots of heads 24/7 all year round.

      "and then a government can "buy" anything it wants from them by issuing any amount of its "money"

      Perhaps suppliers won't be willing to sell in that currency if they have no use for it? And if we're still talking guns put to suppliers' heads 'physically or figuratively', are we really talking about sales transactions or rather about expropriation/requisition? If that is the case, the problem of currency acceptance would be redundant, wouldn't it?

      "Short of issuing letters of marque to corsairs a government can do very little to put a gun to their head"

      Same here. Corsairs acting upon letters of marque were neither interested in purchasing things nor in getting the Crown's currency accepted.

      "That's laughable because it exchanges cause and effect: the euro is a reserve currency not because of some decree of the Almighty, but because it is a "hard currency", and it is a hard currency because the eurozone pays for imports with exports, that is as a whole it has a balance of payments, and as a whole does not do MMT."

      "the post says something obvious in a convoluted way"

      But you're not exactly Ockham Razor's Captain Obvious either.

      "Those swap lines are not unconditional: if a government tries to issue a lot of local currency to pay for imports and convert them to "hard currency" via the swap lines, the Fed will close them."

      In MMT parlance the Fed is part of govt. What 'govt' are you talking about and how would it try to 'issue a lot of local currency'? Why would they try to convert US dollars? Doesn't make any sense.

      "All of this does not mean that MMT is worthless, but that it is far more limited than "can buy anything that is for sale in its own currency" with the all important qualification "as long as there are unused resources"

      The topic is 'some governments are really like households'. Agree or disagree? Why?

      Delete

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