Monday, October 08, 2012

More On Inflation

One of those "I got into it in a forum, and might as well repost the whole thing" articles. The original topic was on the correlation of payroll tax levels and unemployment levels - statistically there doesn't seem to be a very strong one. Edited slightly for clarity. I'll update the post if there's any further interesting discussion.


Fwiw, any government that is that worried about unemployment should just employ people.
And pay them out of what? (Other than a few energy exporters like Russia or Venezuela, the state depends on tax revenues from private commerce. Short-term countercyclical surges like the New Deal are one thing, but government hiring is not a viable long-term solution.)

Money. Something that any government (well, any not dumb enough to sign maastricht) doesn't even have a theoretical limit of.
 The Finance Minister of Zimbabwe called, he said to tell you "Bitch please".

Zimbabwe didn't run out of its own currency. It never faced a problem of 'not having enough money'. Its problem is hyperinflation. Different problem entirely.

If you think deficit spending leads one inexorably on to the path of Zimbabwe-style hyperinflation, well I'd like to introduce you to Japan. Still fighting deflation after 20 years of massive deficit spending leading to a national debt at 200% of GDP. They could (and probably should) deficit spend even more.
The fact that Japan has a 200% GDP debt rate is exactly because they don't treat their money supply as inexhaustible. Otherwise their debt rate would be zero. They wouldn't borrow money, they'd print it.

Anyway, Japan's got an economic problem because it's a high-wage country with an insular culture and an aging population right next to a gigantic source of cheap labor; the majority of its population can't produce anything that would be competitive on the world market, so it's turned to internal consumption. It can run up 200% GDP debt because of the unique circumstance that its real estate is far too expensive for young people to afford, and the money that would be parked in equity in any other developed country is diverted either to discretionary spending (bouncing around the economy and cyclically taxed as VAT) or to savings accounts, which the domestic banks use to buy government bonds.

From the Weimar Republic to Zimbabwe to early-90s Russia or more-recent Belarus - every time a state has actually treated its currency supply as inexhaustible, it's only led to hyperinflation.

(Other participant:) So you're agreeing with the part where he says "spending is inflationary", right? Any comments on deflation?
 Printing money and releasing it into the economy is inflationary, yes. The reason why QE hasn't caused as much inflation in the US, or the EU for that matter, as it ought to have, is because all that liquidity is actually parked in bank reserves - not bouncing around the economy.

Not all spending is necessarily highly inflationary though - an excellent example is US foreign aid to Israel, which is required to be spent on purchasing military hardware from US manufacturers. Effectively it is a form of government welfare spending - pumping money into the economy - but because it keeps people at work, the rate at which that money is released into the economy is hard-limited. This, incidentally, is part of why the EU is so happy to pump money into its periphery: most of it is earmarked spending, and is effectively the creation of a market for the core's vital manufacturing sectors. (We just got a huge pile of EU money to overhaul our commuter rail network, but the trains we buy can only be Spanish or Austrian.) This kind of spending, which is associated with real production and export of goods, and a gainfully employed population, is not immediately inflationary beyond the natural inflation caused by income growth - the problem is when the foreign aid comes from borrowed money. You can keep it up for a while and not have dangerous levels of inflation, but only until people stop lending to you.

As for deflation... Do not conflate falling real incomes with deflation. Deflation by definition is a numeric decrease in consumer prices, and that's a very rare thing indeed - although it did happen in Estonia for one year in the middle of the crisis, when the sharp drop in incomes and, inevitably, spending, actually did force retailers to decrease prices on primary consumables - through market pressure alone, not government regulation. But that was a fluke.
(First participant:) You do realize that I was saying only that a country could create limitless amounts of money, not that it actually should create near limitless amounts of money.

You were saying that they could somehow "run out", and required the private sector to produce it. The private sector doesn't produce it and even Zimbabwe didn't run out. It created hyperinflation. Fine. Not a problem that's on our horizon, so rather irrelevant.
It's not a problem on your horizon because you're not dumping massive amounts of printed cash into the economy. Your central bank is playing a shell game with creditor confidence, creating the illusion if liquidity by printing money but keeping it warehoused. If all that cash that private banks borrowed from the BoE at near-zero interest actually gets lent out as small business or consumer loans, you'll see a huge inflation spike immediately.

So: it's not a problem on your horizon exactly because your government is not doing it.
 (Other participant:) It's not going to cause inflation if rich people pocket it and get richer, in other words.
Yes, if they actually pocket it, as in, keep it in a big vault and not spend it. But in this case they're not even pocketing it. The government is letting them hold on to it for a little while, so they can show their business partners that they have a suitcase full of cash and can be trusted to pay for the truck full of frozen fish within 30 days, not immediately on delivery.

There's the problem of the rich people giving themselves massive paychecks out of that money, of course, but that's a different issue.

8 comments:

Temesta said...

"Anyway, Japan's got an economic problem because it's a high-wage country with an insular culture and an aging population right next to a gigantic source of cheap labor; the majority of its population can't produce anything that would be competitive on the world market, so it's turned to internal consumption."

Japan has had a current account surplus every year since 1981, so a lack of competitiveness is certainly not it's problem.

http://www.imf.org/external/pubs/ft/weo/2012/02/weodata/weorept.aspx?pr.x=70&pr.y=18&sy=1980&ey=2012&scsm=1&ssd=1&sort=country&ds=.&br=1&c=158&s=BCA_NGDPD&grp=0&a=

Andrei Tuch said...

Not enough of one to cover their government spending. They've also been running consistent deficits, and if you've got a budget deficit of 5% of GDP, then a current account surplus of 2% of GDP certainly helps, but doesn't resolve the problem.

But thanks for the link, it looks like a useful data source.

Temesta said...

That was not my point. The current account surplus shows that the Japanese economy is internationally competitive, while you said that it isn't competitive on the world market, but it is.

And Japan didn't turn to internal consumption, internal consumption is the problem. Growth of internal consumption stalled in the aftermath of the bursting of the huge stock market and commercial real estate (which fell 87%! from it's peak) bubble in the beginning of the nineties. This made many healthy Japanese companies technically insolvent (because suddenly their debts were worth more than their assets). In these circumstances companies stop taking up new debt for investment and instead focus upon repaying debt, they want to run surplusses (in ideal circumstances the government budget is in balance, households are in surplus, and businesses use these savings for investment). So there were excess savings in the system because the private sector was unwilling the use them. Someone's surplus is someone's deficit and the Japanese private sector wanted to run surpluses to repay debt, the Japanese economy as a whole was already in surplus versus the outside world (current account), so this left the government to run the corresponding deficit. Government spending, and exports, is what kept the Japanese economy from falling into a huge recession.
After 2004 the Japanese economy started to recover through an increase in private investment and sustained export growth, which resulted in decreasing budget deficits (only 2% of GDP in 2007), but then came the financial crisis and a huge earthquake.

http://www.imf.org/external/pubs/ft/weo/2012/02/weodata/weorept.aspx?pr.x=21&pr.y=3&sy=1994&ey=2011&scsm=1&ssd=1&sort=country&ds=.&br=1&c=158&s=GGXCNL_NGDP%2CGGSB_NPGDP&grp=0&a=

http://www.amazon.com/The-Holy-Grail-Macroeconomics-Recession/dp/0470823879

http://www.paecon.net/PAEReview/issue58/Koo58.pdf

Andrei Tuch said...

You'll notice I said it's right next to a gigantic source of cheap labor. It built up its first-world status as the efficient undercutter exporting to foreign markets, and now, because it's aging and expensive and right next to some really huge undercutters - efficient (South Korea) and simply really really cheap (China), it can't continue on the path it was on decades ago, growing significantly because it was sucking up value from export markets.

The idea that if individuals and businesses run surpluses, the government *has* to run a deficit, is stupid. The government has access to cheap internal credit, yes, but it doesn't *have* to use that credit. As you said yourself: ideally companies invest out of savings. If the deposits were not vacuumed up by government bonds, the cheap credit could have fueled further investment. (OK, it would also have been very difficult culturally for companies to wipe away debt through bankruptcy and start fresh.)

Temesta said...

I don't understand your reasoning. I would say that having such a fast growing neighbour is a great opportunity for more exports. And the numbers prove that I am right. Japan's fast growing neighbours have become it's most important export markets. Look at this data from the CIA world factbook:

China 19.7%, US 15.5%, South Korea 8%, Hong Kong 5.2%, Thailand 4.6% (2011)

And look at these numbers from the IMF:

http://www.imf.org/external/pubs/ft/weo/2012/02/weodata/weorept.aspx?pr.x=46&pr.y=7&sy=1990&ey=2017&scsm=1&ssd=1&sort=country&ds=.&br=1&c=158&s=TX_RPCH&grp=0&a=

And you claim that Japan has a problem with exports?
Such statements you have to back up with data.

The idea of the surplus and the deficit is not stupid, it is logical. The counterpart of a surplus is a deficit. If I borrow money there must be someone who has a surplus. If the private sector wants a surplus, either the government goes into deficit, or the outside world (If a country exports more than it imports, the outside world versus this country is importing more than exporting.) does. The sum of all sector financial balances must be zero. This is basic accounting. Of course, the government doesn't have to run a deficit, but if it doesn't and the outside world doesn't (or doesn't increase), the private sector will not be able to run a surplus and production will decline.

My point is that many Japanese companies didn't want to borrow, even with capital being so cheap, because they were in negative equity, so technically insolvent. These were companies with a healthy cashflow, making profits, there was no point for them to apply for bankruptcy, since they were perfectly capable of paying of their debts on schedule. Suppose in an economy there's an aggregate income of 1000 euro, of which 10% will be saved, and the rest spent. Someone will borrow the savings and spend them, and aggregate income will remain 1000 euro. But if no one is willing to borrow this 100 euro, aggregate income will shrink to 900 euro. 90 euro will be saved, and not used, and aggregate income will shrink to 810 euro and so one, untill it is not possible to save anymore and a state of equilibrium will be reached.

You should really read the paper I refered to in my previous comment, it backs all this up with data.

See also this (registering is free):

http://blogs.ft.com/martin-wolf-exchange/2012/07/25/getting-out-of-debt-by-adding-debt/#axzz29E1GDRhJ

Andrei Tuch said...

Again, yeah, you're not understanding what I'm saying. Japan was a heavily exporting country, like Korea was after it and China is today. It can't design its entire economy around exports any more, because it's too expensive to produce things there.

Deficit is not the counterpart of a surplus. A surplus can be channeled savings, the value stored until it can be used for investment without incurring debt. Yes, on a personal level, surplus is stored in a bank which will want to lend out that surplus to a borrower in order to make a profit, but the existence of a surplus does not necessitate that someone else run a deficit.

Conversely, a deficit does not necessitate the use of someone else's surplus. The mechanics of the financial crisis come down to derivative securities - people making bets and writing IOUs, incurring debts of money that they'd never borrowed from anyone, simply creating the idea of value that was not backed up by anything physical.

Andrei Tuch said...

"The sum of all sector financial balances must be zero. This is basic accounting."

You're misunderstanding basic accounting. If this were true, there would only ever be a fixed amount of money and/or value in the world, and there really would be a tremendous deflationary spiral. Populations grow, nominal efficiency grows with technological progress, and GDP grows. The amount of value in the world does keep increasing, it's not a zero sum game.

Temesta said...

Financial sectoral balances must not be zero? Then world renowned economists like Richard Koo, Martin Wolf or Simon Wren-Lewis are idiots. Obviously you failed to read the links I provided you with. It doesn't mean that growth is impossible, it just refers to financial balances in a certain time period. The current account is one them, maybe you understand it then. If in a certain year a country's current account surplus is 6%, it means that the rest of the world versus this country runs a current account deficit of minus 6%. Basic economics, basic accounting. The same is true for the relationship between the private sector of a certain country, it's public sector, and the outside world. If one of them is in surplus, at least one of the other two is running a deficit. Let's assume an economic system with two sectors A and B. In period T1 A's income is 10 but it has a surplus of 2, this means it spent only 8. But if it spends only 8, how can it's income in this period be 10? This could only happen if B spent 12, so 2 over it's income. B run's a deficit of 2, corresponding with A's surplus of 2. Or in other words: A produces 10 but it absorbs only 8, B produces 10 but it absorbs 12. This doesn't mean that an economy cannot grow, growth continues as long as A and B increase production and can sell this production, for example in T2 A has an income (and production) of 11 but spends only 9, B buys the remaining 2, providing A with it's desired surplus of 2.

About Japan. You keep repeating without evidence that 'Japan *was* a heavily exporting country, like Korea was after it and China is today. It can't design its entire economy around exports any more, because it's too expensive to produce things there.'

Again I request from you: back this up with hard data. By the way: the exportsector has never been the most important part of the Japanase economy. The earliest data I can find go back to the beginning of the eighties and exports as a share of GDP have since then fluctuated between 10 and 18 % of GDP.

http://data.worldbank.org/indicator/NE.EXP.GNFS.ZS

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