China has all our debt!

OH NO! But not really.

A lot of people are concerned with China owning so much of our country's debt. What if they make us pay it back all at once? Well they can't do that, and frankly, they don't want to. But there is reason to be concerned, or at least, to understand what it means that China owns so much of our debt.

First we must ask, how did they get that debt?

This is partially tied in with 'globalization' or cheaper labor costs in developing nations and relatively cheap transportation costs. China can manufacture goods more cheaply the United States can because China has been taking advantage of lower labor costs and labor standards to grow its economy, but it needs someone to sell it goods to. Domestic demand in China isn't enough to help it grow as much as it has, it needs a buyer abroad. That's where we come in. The U.S. has run a trade deficit (imports>exports) for a few decades now, and recently much of those exports have been coming from China.

When the U.S. gets goods from China, it sends its dollar to China. We get the goods we want, they get the dollars they want. Now they have excess dollars that they can either: A) convert to Renminbi (the Chinese currency), B) leave as US dollar cash, C) buy goods for sale in Dollars, or D) buy US bonds or other financial assets.

(A) causes appreciation of the Renminbi which China doesn't want, because it makes their goods more expensive relative to the rest of the world causing a decrease in their exports. They really want and need to be an exporting nation to grow fast enough to catch up to the US and Europe.

The Value of Money

A couple weeks ago I wrote a post addressing the question 'why does money matter?'. I hope I laid out a clear explanation of the role of money in our economy and how many mainstream economists misunderstand just what it is at its most fundamental level.

The basic insight is that money is credit or an IOU, and not a commodity nor a representation of a commodity (or commodities). So if money is credit, then what gives it value?

The metallists, those who believe money is like a commodity or a 'fiat' representation of commodities, believe money gets its value from that commodity or commodities. That is, they believe money gets its value from gold or in more modern times, from the bundles of goods a currency area produces.

I wondered about this question long ago, why is gold so valuable? I just didn't get why a mostly useless shiny metal would be so coveted by the Egyptians, Romans, or Europeans. Then I took a money and banking course in college that provided me with an explanation. Gold and other precious metals were used as money because they were easily molded into small, transportable coins. And because of its moldability, it could be divided into larger and smaller coins with varying values with markings to protect against counterfeiting. This mostly satisfied my curiosity. I though, 'oh, the people of Egypt (or wherever) were smart enough to figure out that this commodity, of all the commodities available to them, would serve best as money because of its inherent properties'.

Later in the course, however, I learned of an alternative approach to money that completely flips this view on its head. This is the Chartalist view that regards money as credit. To them, all money is an IOU or credit and anyone can then create money as long as someone is willing to accept it. Monies fall into a sort of hierarchy of acceptance with the most worthy creditors (or debtors) at the top and the worst at the bottom.

And it is here were we find the key to money's value. It isn't anything based on intrinsic worth of the commodity used to represent the IOU, it is rather the acceptability of the IOU. The most acceptable IOUs have more value!

Monopoly and Modern Money Theory

This is a brilliant post by J.D. Alt on how the economy is like the game of monopoly. It is kind of long, but really understands how the economy works, particularly from a MMT perspective.

Full Post: Playing Monopolis Monopoly

Highlights:

Why does it seem like there isn’t enough money to pay for the things we really need? The headlines are filled with stories about our nation’s “debt problem” and dire warnings about our impending “bankruptcy.” As an architect who fills his waking hours thinking up all kinds of wonderful things we could be building, I’m alarmed by the idea there isn’t enough money to pay for any of them. Before wasting more time dreaming, I had to find out: Is it really true? Are we really too poor to put America back to work making and building the things we need to maintain a prosperous nation?

Searching for an answer, I discovered a small (but growing) group of economists (see here, here, here, here, here, here) who represent an emerging school of thought known as “modern monetary theory” (MMT). These men and women are valiantly trying to make us all understand a paradigm shift that occurred some forty years ago, when the world abandoned the gold standard. Their key insight shocked me: A sovereign government is never revenue constrained when it is the Monopoly issuer of its own pure fiat currency; it has all the money that’s needed to put its citizens to work building anything—and providing any service—that is desired by the public (provided the real resources are available). Even more remarkable, sovereign “deficits” in the fiat currency are just the accounting record of the surpluses that have been injected into the private economy. Eliminating the sovereign currency deficit by imposing austerity will not make the economy healthier; it will, in effect, bankrupt the citizens!

If this seems to defy logic, stay with me for just a few minutes. I’m going to propose a simple exercise that will help you “see” this reality for yourself. The exercise is simply that everyone join me in a familiar game of Monopoly. By the end of the game, I hope to convince you that MMT is correct
and that we could be doing better, much better – for ourselves and future generations—if we just understood and took ad vantage of our modern monetary system.

Let’s begin.

Playing Monopolis Monopoly

We’ll play by the normal rules (I’ll suggest some added features as we go along) except this time we’ll pay special attention to certain things that are happening. For example, you’ll recall that before the game can begin, one player has to agree to be the “banker” (a tedious task, but someonehas to do it.) But now choosing this person has a special importance: it must be done democratically, with the players voting to determine who will manage the game’s money. We’ll do this little exercise because we want to pay special attention to the fact that the Monopoly “bank” is an entity created by the players themselves for their mutual benefit. In fact, we won’t refer to it as the “bank” anymore, but instead will call it our “currency issuing government” (CIG). In a real sense, we all “own” CIG together, and taking a minute to democratically choose who will manage it heightens our awareness of this key fact.

To reinforce this awareness, the next thing we’ll think about, as we set up the Monopoly board, organize the Deed Cards, shuffle the Chance Cards and choose our tokens, is that what we are really doing is setting up, and getting ready to operate, a miniature nation-state. Let’s even give it a name: Monopolis. We, the players, are the new citizens of Monopolis. We have just established, through democratic consensus, our currency issuing government, and we are now getting ready to operate our economy. That’s what the game is about.

Issuing the Currency

As we get ready to play, we immediately discover an odd dilemma: CIG has all the money! We, the players, are ready to go but we can’t start the game until we have some of CIG’s money. This is an awkward moment, which is dispensed with so quickly in regular Monopoly we hardly notice it. (The “banker” is instructed to make initial cash distributions in the amount of $1500 to each player). If we pay attention, we can see that this moment raises some interesting and crucial questions.

Approaching the 'Fiscal Cliff'

My comments in red:

Congress May Toss the Economy over the Fiscal Cliff

We are barreling towards the year end “fiscal cliff” Federal Reserve Board Chairman Ben Bernanke has warned about.

Unless lawmakers and the President can agree on a slew of confounding budget and tax issues before the end of the year, a double whammy of sharp tax increases and deep cuts in domestic and defense spending will jolt the struggling economy beginning in early January. That’s because two Bush era tax cuts and a raft of other tax relief measures are set to expire by the end of the year, and Congress must implement the first installment of $1.2 trillion of long-term deficit reduction that lawmakers and the White House agreed to last summer.

While an abrupt surge in tax revenues of about $500 billion, and a steep cut in government spending of about $110 billion early next year would certainly put a big dent in next year’s deficit, many budget experts fear it would also undercut the economic recovery in the short run. It would be extremely detrimental to the economy and would have no impact on solvency of the government budget.

Boehner said this week that Congress will be inviting a legislative “train wreck” if it leaves all these big- ticket fiscal issues to a lame duck session of Congress after the November presidential and congressional elections. He revealed plans to schedule a vote on the House floor before the fall election to extend the two Bush-era tax cuts that are very popular with his members. I'm not opposed to extending tax cuts, but I think extending the FICA tax cuts will be much more helpful to the economy and those who are in need then will extending cuts for those who are doing just fine.

Preferential Option for the Rich

Here is yet another great post from Catholic Moral Theology. Charles Camosy points out the apparently missing preferential option for the rich from Catholic Social Teaching which has in many places written about the preferential option for the poor. CST has, I think, danced around the 'preferential option for the rich' but certainly hasn't explicitly named any such principle as it has the preferential option for the poor. For example one can find this passage in Populorum Progressio:

We must repeat that the superfluous goods of wealthier nations ought to be placed at the disposal of poorer nations. The rule, by virtue of which in times past those nearest us were to be helped in time of need, applies today to all the needy throughout the world. And the prospering peoples will be the first to benefit from this. Continuing avarice on their part will arouse the judgment of God and the wrath of the poor, with consequences no one can foresee. If prosperous nations continue to be jealous of their own advantage alone, they will jeopardize their highest values, sacrificing the pursuit of excellence to the acquisition of possessions. We might well apply to them the parable of the rich man. His fields yielded an abundant harvest and he did not know where to store it: "But God said to him, 'Fool, this very night your soul will be demanded from you . . .' "

I agree with Charles, that there should indeed be an explicit preferential option for the rich, particularly in our wealthy society. We should at once emphasize not only the need to help those who suffer from materially poverty, but all forms of poverty, including the poverty in virtue and faith that materialism or consumerism causes as Pope John Paul II makes clear in Centesimus Annus:

Today more than ever, the Church is aware that her social message will gain credibility more immediately from the witness of actions than as a result of its internal logic and consistency. This awareness is also a source of her preferential option for the poor, which is never exclusive or discriminatory towards other groups. This option is not limited to material poverty, since it is well known that there are many other forms of poverty, especially in modern society—not only economic but cultural and spiritual poverty as well. The Church's love for the poor, which is essential for her and a part of her constant tradition, impels her to give attention to a world in which poverty is threatening to assume massive proportions in spite of technological and economic progress.

Pope Quotes 5-8-12

Sorry for the interruption in my series on Pope Quotes. There are still so many great quotes from the CST encyclicals to share, so let's get to it!

The socialist, capitalist debate is always a fierce one and so I always find the many quotes on this topic to be a good read. This debate is still largely and understandably emotionally charged and unfortunately the Church's stance is widely misunderstood. Many seem to know the Church condemned socialism, but less seem to know exactly why or that it is nearly as critical of capitalism/liberalism. Many take the Popes's quotes out of context, (which I understand I also run the risk of doing with this series and is why I recommend a full reading of the encyclicals!), or even use them to support a position they hold. Much of the debate has centered over the issue of private property versus state socialization of property.

Today I chose this excerpt from Laborem Exercens, which was written by Pope John Paul II in 1981, marking the 90th anniversary of Rerum Novarum. It is an encyclical that addresses the question of 'work' and the issue of private property. I'd like to draw your attention to a few things:

1) CST is critical of both capitalism and socialism;
2) Though defending the right to private property, CST makes clear that the right to common use, also known as the universal destination of goods, supersedes this right;
3) Possession of goods, particularly capital goods, is only okay if it serves labor and is never okay simply for possession's sake;
4) Socialization of means of production is not excluded completely, there is some legitimation for it;
5) State socialization of means of production (capital goods) does not guarantee true socialization of those goods, that is, the state may use them for purposes opposed to the good of society;
6) Rigid capitalism needs revision, particularly with profit-sharing or joint ownership forms of cooperation so that workers may share in the produce and not be pitted against the owners of the capital goods;
7) Work is not only a means for material goods, but is more importantly a means for personal development and fulfillment and private or personal initiative is a key component of this developmental side of work;

Here is the excerpt from Laborem Exercens with highlights in bold/purple:

The above principle [on private property], as it was then stated and as it is still taught by the Church, diverges radically from the programme of collectivism as proclaimed by Marxism and put into practice in various countries in the decades following the time of Leo XIII's Encyclical. At the same time it differs from the programme of capitalism practised by liberalism and by the political systems inspired by it.

Why Does Money Matter?

You may have noticed that I post a lot about money, particularly this "modern money" stuff and you may be wondering why I care so much about money. I have long been fascinated with money, particularly with what gives it its value. I remember way back in middle school wondering why green pieces of paper had value, or why gold was so valuable (a topic I wish to explore more in a follow up post). I never really got what I thought were adequate answers nor did I seek it further until my interest turned toward economics in college. Now after four years of undergrad and a couple years in grad school, I understand why money matters and I think you should too.

To be clear, I am not saying love of money (greed) is a good thing...it isn't, but rather understanding just what money is and how it affects our economy is crucial to achieving our economic, political, and social objectives.

So what is money? The most often told story is that money is a commodity that evolved out of a barter economy. For example, tradespeople in small villages started using seashells or gold or whatever to exchange for goods that each made so as to avoid the problem of barter economies. The butcher wants shoes, but the shoemaker doesn't want meat, so the butcher would have to trade meat to someone for something that the shoemaker wanted in order to obtain shoes. This problem is called the 'double coincidence of wants' and money is thought to have sprung up as a medium of exchange to eliminate this problem. All could exchange their goods for seashells or gold or whatever which could then be exchanged for any other commodity one wanted.

This story seemed plausible to me at first, it does seem logical, but as I learned more I quickly became unsatisfied with this explanation. This view hinges precariously on everyone accepting the commodity to be used as money. It also assumes barter economies existed and doesn't translate well to today's fiat money system because the commodity used as money is thought to be intrinsically valuable (gold) which also poses a problem for those who used seashells.

Another view believes that money is a social unit of account tracking credits and debts, just like an inch measures distance, or a gallon measures volume. One dollar is a unit of account, a measurement of credits/debts. Thus money is always a two-sided affair, it is an IOU, with a creditor and a debtor. Having money means that one has claims to another's goods/labor/cup of sugar/whatever that other gave in the IOU. From this view, one can see that anyone can create money, it is the matter of acceptance that is key. I can issue IOUs all I want, but in order for them to become 'money', someone must accept them. Which means they must accept that my word is good. If I don't my 'money' defaults.

Missing the Point on Poverty

Another great post by Meghan Clark from over at Catholic Moral Theology, which has become my favorite Catholic blog.

She has a very good understanding of the economy and of Catholic Social Teaching and I continually find myself in overall agreement with what she writes.

Full post here.

Highlights:

There has been a lot of discussion this week about the morality of the Ryan Budget. Since Paul Ryan’s statement on subsidiarity, the media and blogs have been full of posts either supporting or correcting Paul Ryan’s use of Catholic social teaching.

This week’s discussion heated up as the USCCB Committee on Domestic Justice and Human Development released 4 key statements/press releases pleading with Congress to “to draw a circle of protection around the programs that serve “the least among us.” when dealing with housing programs, SNAP/food stamps, agriculture and the Child Tax Credit.

There is a beautiful coherence and symmetry to the four statements – they all have one clear message – protect the poor and vulnerable. While they acknowledge (as do we all) that we live in difficult and complex economic times, we cannot in good conscience balance the budget or protect the economy through sacrificing the poor and vulnerable within our communities. In the Letter on Snap, Bishop Blaire reiterates the three key moral guidelines for evaluating the morality of a budget:

1. Every budget decision should be assessed by whether it protects or threatens human life and dignity.
2. A central moral measure of any budget proposal is how it affects “the least of these” (Matthew 25). The needs of those who are hungry and homeless, without work or in poverty should come first.
3. Government and other institutions have a shared responsibility to promote the common good of all, especially ordinary workers and families who struggle to live in dignity in difficult economic times.

Now the Bishop’s letters have gotten quite the response.

Sectoral Balances

Phew! After a tough April I am back in action! I hope to be blogging more regularly now, and I have a lot of ideas I am excited to share with all of you.

One area I will continue posting about is the still common misunderstandings surrounding government debt. At the heart of it is a misunderstanding of money. If we can understand money, then we can better understand government debt. I hope to make this more clear in the coming weeks, but for now I thought this video might prove to be helpful.

It was made by undergraduates at Lewis and Clark college in Portland, Oregon. The video explains sectoral balances using accounting identities and principles. It shows why the government cannot go bankrupt like a household or business can and subsequently that sound, responsible government finance means something different than sound, responsible household finance.

Enjoy!