This article will be a bit of a mix of economic things. Prompted by a few comments on a “tips” page, it will look briefly at world debt, what is an SDR and what it means if China joins the IMF as an SDR nation; and then explore what a credit ‘unwind’ is, and what happens when they go badly in a ‘part 2’ article.
The Links In Question
Jay Martin has a link to a good article on the ‘rotation’ of the ‘debt crisis’ to the 3rd world:
Normally I would just quote a ‘tease’ section with some good bits in it and let you take the link to the whole thing. The Economist has decided to use aggressive pop-ups (plural) so the quote will be large enough to spare you the experience…
The world economy
The never-ending story
First America, then Europe. Now the debt crisis has reached emerging markets
Nov 14th 2015
IT IS close to ten years since America’s housing bubble burst. It is six since Greece’s insolvency sparked the euro crisis. Linking these episodes was a rapid build-up of debt, followed by a bust. A third instalment in the chronicles of debt is now unfolding. This time the setting is emerging markets. Investors have already dumped assets in the developing world, but the full agony of the slowdown still lies ahead.
Debt crises in poorer countries are nothing new. In some ways this one will be less dramatic than the defaults and broken currency pegs that marked crashes in the 1980s and 1990s. Today’s emerging markets, by and large, have more flexible exchange rates, bigger reserves and a smaller share of their debts in foreign currency. Nonetheless, the bust will hit growth harder than people now expect, weakening the world economy even as the Federal Reserve begins to raise interest rates.
Chronicle of a debt foretold
In all three volumes of this debt trilogy, the cycle began with capital flooding across borders, driving down interest rates and spurring credit growth. In America a glut of global savings, much of it from Asia, washed into subprime housing, with disastrous results. In the euro area, thrifty Germans helped to fund booms in Irish housing and Greek public spending.
As these rich-world bubbles turned to bust, sending interest rates to historic lows, the flow of capital changed direction. Money flowed from rich countries to poorer ones. That was at least the right way around. But this was yet another binge: too much borrowed too fast, and lots of the debt taken on by firms to finance imprudent projects or purchase overpriced assets. Overall, debt in emerging markets has risen from 150% of GDP in 2009 to 195%. Corporate debt has surged from less than 50% of GDP in 2008 to almost 75%. China’s debt-to-GDP ratio has risen by nearly 50 percentage points in the past four years.
IMHO there is a grievous error in this view of things. It lays blame on a ‘glut of savings’. There is NO ‘glut of savings’. Most people have zero in a ‘savings account’. There is a large glut of ‘easy money’ from central banks to “too big to fail money center banks” and under government policy from them into housing creating a housing boom. It doesn’t change the scenario much, but does hide the real responsibility.
Now this boom, too, is coming to an end. Slower Chinese growth and weak commodity prices have darkened prospects even as a stronger dollar and the approach of higher American interest rates dam the flood of cheap capital. Next comes the reckoning. Some debt cycles end in crisis and recession—witness both the subprime debacle and the euro zone’s agonies. Others result merely in slower growth, as borrowers stop spending and lenders scuttle for cover. The scale of the emerging-market credit boom ensures that its aftermath will hurt. In countries where private-sector indebtedness has risen by more than 20% of GDP, the pace of GDP growth slows by an average of almost three percentage points in the three years after the peak of borrowing (see article). But just how much pain lies ahead will also depend on local factors, from the scale of the exchange-rate adjustment that has already taken place to the size of countries’ reserves. Crudely, most emerging economies can be put into one of three groups.
The first group includes those for which the credit boom will be followed by a prolonged hangover, not a heart attack. The likes of South Korea and Singapore belong in this category; so, crucially for the world economy, does China. It still has formidable defences to protect it against an exodus of capital. It has an enormous current-account surplus. Its foreign-exchange reserves stood at $3.5 trillion in October, roughly three times as much as its external debt. Policymakers have the ability to bail out borrowers, and show little sign of being willing to tolerate defaults. Shovelling problems under the carpet does not get rid of them. Firms that ought to go bust stagger on; dud loans pile up on banks’ balance-sheets; excess capacity in sectors like steel leads to dumping elsewhere. All this saps growth, but it also puts off the threat of a severe crisis.
For that risk, look instead to countries in the second category—those that lack the same means to bail out imprudent borrowers or to protect themselves from capital flight. Of the larger economies in this category, three stand out. Brazil’s corporate-bond market has grown 12-fold since 2007. Its current-account deficit means that it relies on foreign capital; its political paralysis and fiscal inflexibility offer nothing to reassure investors. Malaysia’s banks have lots of foreign liabilities, and its households have the highest debt-to-income ratio of any big emerging market; its cushion of foreign-exchange reserves looks thin and its current-account surplus is forecast to shrink. Turkey combines a current-account deficit, high inflation and foreign-currency-denominated debts that have become more onerous as the lira has fallen.
The third group of countries consists of those emerging markets that will either escape serious trouble or have already gone through the worst. Of the big ones, India is in healthier shape than any other big emerging economy and Russia might just surpass expectations. The rouble has already gone through a bigger adjustment than any other major currency, and the economy shows tentative signs of responding. Argentina, a perennial flop but one with little private debt, could also shine if a reformist wins the presidency this month.
Such brighter spots aside, everything else points to another pallid year for the world economy. The IMF has forecast higher growth in emerging markets next year; the lesson of past debt cycles suggests another year of slowdown is more likely. And weakness in the developing world, which accounts for over half of the global economy (in purchasing-power-parity terms), matters far more than it once did. Lower growth in emerging markets hits the profits of multinationals and the cash flows of exporters. Low commodity prices help oil importers but ratchet up the pressure on indebted miners, drillers and traders, which between them owe around $3 trillion.
Europe’s open economy is most exposed to a cooling in emerging-market demand, which is why more monetary easing there looks likely. But America’s policy dilemma is more acute. The divergence in monetary policy between it and the rest of the world will put upward pressure on the dollar, hurting exports and earnings. And waves of capital may again seek out the American consumer as the borrower of choice. If so, the world’s debt crisis may end up right back where it started.
I also take exception with this assertion that it ‘started’ with the USA and the American Consumer. It started with central banks and an embrace of Modern Monetary Theory (that isn’t very modern IMHO) globally:
Modern Monetary Theory (MMT or Modern Money Theory), also known as neochartalism, is an economic theory that details the procedures and consequences of using government-issued tokens as the unit of money, i.e., fiat money. According to modern monetary theory, “governments with the power to issue their own currency are always solvent, and can afford to buy anything for sale in their domestic unit of account even though they may face inflationary and political constraints”. Adherents of the theory tend to see inflation as being caused primarily by resource constraints rather than monetary expansion.
MMT aims to describe and analyze modern economies in which the national currency is fiat money, established and created by the government. In many systems, banks can create money but these horizontal transactions do not increase net financial assets as assets are offset by liabilities. In addition to deficit spending, valuation effects e.g. growth in stock price can increase net financial assets. In MMT, money enters circulation through government spending. Taxation and its legal tender power to discharge debt establish the fiat money as currency, giving it value by creating demand for it in the form of a private tax obligation that must be met. In addition, fines, fees and licenses create demand for the currency. This can be a currency issued by the government, or a foreign currency for example the euro. An ongoing tax obligation, in concert with private confidence and acceptance of the currency, maintains its value. Because the government can issue its own currency at will, MMT maintains that the level of taxation relative to government spending (the government’s deficit spending or budget surplus) is in reality a policy tool that regulates inflation and unemployment, and not a means of funding the government’s activities per se.
The basic notion being that taxation creates value in a fiat money so you can spend as much of it as you want as long as you tax enough. Yeah, that crazy…
The next block of quotes are mostly so that when the Wiki gets re-written I’ve captured the history as it was when I read it. You can skip on down if not that interested… Those who advocate for a Gold Standard need to understand what they are up against.
Modern Monetary Theory synthesises ideas from the State Theory of Money of Georg Friedrich Knapp (also known as Chartalism) and Credit Theory of Money of Alfred Mitchell-Innes, the functional finance proposals of Abba Lerner, Hyman Minsky’s views on the banking system and Wynne Godley’s Sectoral balances approach.
Knapp, writing in 1905, argued that “money is a creature of law” rather than a commodity. At the time of writing the Gold Standard was in existence, and Knapp contrasted his state theory of money with the view of “metallism”, where the value of a unit of currency depended on the quantity of precious metal it contained or could be exchanged for. He argued the state could create pure paper money and make it exchangeable by recognising it as legal tender, with the criterion for the money of a state being “that which is accepted at the public pay offices”.
Yeah… 1905. That’s “modern” for you…
Next we get a ‘slight’ at the folks who actually had some clue, claiming they had some statements (unquoted…) supporting the notion:
The prevailing view of money was that it had evolved from systems of barter to become a medium of exchange because it represented a durable commodity which had some use value, but proponents of MMT such as Randall Wray and Mathew Forstater argue that more general statements appearing to support a chartalist view of tax-driven paper money appear in the earlier writings of many classical economists, including Adam Smith, Jean-Baptiste Say, J.S. Mill, Karl Marx and William Stanley Jevons.
Alfred Mitchell-Innes, writing in 1914, argued that money existed not as a medium of exchange but as a standard of deferred payment, with government money being debt the government could reclaim by taxation. […]
Knapp and “chartalism” were referenced by John Maynard Keynes in the opening pages of his 1930 Treatise on Money and appear to have influenced Keynesian ideas on the role of the state in the economy.
By 1947, when Abba Lerner wrote his article Money as a Creature of the State, economists had largely abandoned the idea that the value of money was closely linked to gold. Lerner argued that responsibility for avoiding inflation and depressions lay with the state because of its ability to create or tax away money.
So a reference to something becomes an endorsement of it?…
Here, too, you can see the rise of the Central Bank as creator of inflation and depressions, so must also be able to prevent them…
Further information: Sectoral balances
MMT labels any transactions between the government sector and the non-government sector as a vertical transaction. The government sector is considered to include the treasury and the central bank, whereas the non-government sector includes private individuals and firms (including the private banking system) and the external sector – that is, foreign buyers and sellers.
In any given time period, the government’s budget can be either in deficit or in surplus. A deficit occurs when the government spends more than it taxes; and a surplus occurs when a government taxes more than it spends. MMT states that as a matter of accounting, it follows that government budget deficits add net financial assets to the private sector. This is because a budget deficit means that a government has deposited more money into private bank accounts than it has removed in taxes. A budget surplus means the opposite: in total, the government has removed more money from private bank accounts via taxes than it has put back in via spending.
Therefore, budget deficits add net financial assets to the private sector; whereas budget surpluses remove financial assets from the private sector. This is widely represented in macroeconomic theory by the national income identity:
G − T = S − I − NX
where G is government spending, T is taxes, S is savings, I is investment and NX is net exports.
The conclusion that MMT draws from this is that it is only possible for the non government sector to accumulate a surplus if the government runs budget deficits. The non government sector can be further split into foreign users of the currency and domestic users.
MMT economists aim to run deficits as much as the private sector wants to save and for real resources to be fully used e.g. full employment. As most private sectors want to net save and globally, external balances must add up to zero, MMT economists usually advocate budget deficits.
Yup, spending all the money you can just increases “private surplus”… Wheee!!! Free Ride!!! Spend Spend Spend Baby!!!!
Now you know why Dimocrats and Republicrims alike are on the Government Spending Binge bandwagon. They believe this crap. Likely since it lets their Cronies accumulate that “private surplus”…
Interaction between government and the banking sector
Modern monetary theory provides a detailed descriptive account of the “operational realities” of interactions between the government and the central bank, and the commercial banking sector, with proponents like Scott Fullwiler arguing that understanding of reserve accounting is critical to understanding monetary policy options.
A sovereign government will typically have a cash operating account with the central bank of the country. From this account, the government can spend and also receive taxes and other inflows. Similarly, all of the commercial banks will also have an account with the central bank. This permits the banks to manage their reserves (that is, the amount of available short-term money that a particular bank holds).
So when the government spends, treasury will debit its cash operating account at the central bank, and deposit this money into private bank accounts (and hence into the commercial banking system). This money adds to the total reserves of the commercial bank sector. Taxation works exactly in reverse; private bank accounts are debited, and hence reserves in the commercial banking sector fall.
The notion being that money in the Central Bank is different from money in the Commercial Bank. Really. They think that. That is why The Fed does a load of the things it does with reserve requirements and discount rates and why The Government no longer just prints money. (And part, IMHO, of why Kennedy got done in as he was having the Treasury do just that. Those notes have red ink on them, but have largely been pulled from circulation. (An interesting, if somewhat narrow POV, article is here:
“The high office of the President has been used to foment a plot to
destroy the Americans freedom and before I leave office I must inform the
Citizen of his plight.” PRESIDENT JOHN F. KENNEDY(10 days before he was
On June 4, 1963, a virtually unknown Presidential decree, Executive Order
11110, was signed with the authority to basically strip the Federal Reserve
Bank of its power to loan money to the United States Federal Government at
interest. With the stroke of a pen, President Kennedy declared that the
privately owned Federal Reserve Bank would soon be out of business. The
Christian Common Law Institute has exhaustively researched this matter
through the Federal Register and Library of Congress and can now safely
conclude that this Executive Order has never been repealed, amended, or
superceded by any subsequent Executive Order. In simple terms, it is still
When President John Fitzgerald Kennedy – the author of Profiles in
Courage -signed this Order, it returned to the federal government,
specifically the Treasury Department, the Constitutional power to create and
issue currency -money – without going through the privately owned Federal
President Kennedy’s Executive Order 11110 [the full text is displayed
further below] gave the Treasury Department the explicit authority:
“to issue silver certificates against any silver bullion, silver, or
standard silver dollars in the Treasury.”
But MMT doesn’t like that idea, so we still have The Fed and the idea that the USA must only have authority to create money through it…
I’ll skip over the Wiki section on bonds and such. There is also a big section on international transactions that help to explain the whole SDR system. But we will skip down to here:
Foreign sector and commercial banks
Although a net-importing nation will transfer a portion of domestic currency into foreign ownership, the currency will usually remain within the importing nation. The foreign owner of the local currency can either (a) spend them purchasing local assets or (b) deposit them in the local banking system. In each scenario, the money ultimately ends up in the local banking system.
Foreign sector and government
Using the same application of vertical transactions MMT argues that the holder of the bond is irrelevant to the issuing government. As long as there is a demand for the issuer’s currency, whether the bond holder is foreign or not, governments can never be insolvent when the debt obligations are in their own currency; this is because the government is not constrained in creating its own currency (although the bond holder may affect the exchange rate by converting to local currency). Similarly, according to the FX theory outlined above, the currency paid out at maturity cannot leave the country of issuance either.
Just a sidebar on that last assertion. Yes, I left out the theory of it… but just realize what was said. Countries all over the World, including Liberia as one example, use the $US as local currency. Their assertion is that can not happen. So a bond maturing in the USA pays me $1000 and I can’t spend it in Liberia? Or even Mexico for that matter? Never heard of the drug trade I guess…
MMT does point out, however, that debt denominated in a foreign currency certainly is a fiscal risk to governments, since the indebted government cannot create foreign currency. In this case the only way the government can sustainably repay its foreign debt is to ensure that its currency is continually and highly demanded by foreigners over the period that it wishes to repay the debt – an exchange rate collapse would potentially multiply the debt many times over asymptotically, making it impossible to repay. In that case, the government can default, or attempt to shift to an export-led strategy or raise interest rates to attract foreign investment in the currency. Either one has a negative effect on the economy. Euro debt crises in the “PIIGS” countries that began in 2009 reflect this risk, since Greece, Ireland, Spain, Italy, etc. have all issued debts in a quasi-“foreign currency” – the Euro, which they cannot create.
MMT claims that the word “borrowing” is a misnomer when it comes to a sovereign government’s fiscal operations, because what the government is doing is accepting back its own IOUs, and nobody can borrow back their own debt instruments. Sovereign government goes into debt by issuing its own liabilities that are financial wealth to the private sector. “Private debt is debt, but government debt is financial wealth to the private sector.”
In this theory, sovereign government is not financially constrained in its ability to spend; it is argued that the government can afford to buy anything that is for sale in currency that it issues (there may be political constraints, like a debt ceiling law). The only constraint is that excessive spending by any sector of the economy (whether households, firms or public) has the potential to cause inflationary pressures. MMTers argue though that generally inflation is caused by supply-side pressures, rather than demand side.
Some MMT economists advocate a government-funded job guarantee scheme to eliminate involuntary unemployment. Proponents argue that this can be consistent with price stability as it targets unemployment directly rather than attempting to increase private sector job creation indirectly through a much larger economic stimulus, and maintains a “buffer stock” of labor that can readily switch to the private sector when jobs become available. A job guarantee program could also be considered a powerful automatic stabilizer to the economy, expanding when private sector activity cools down and shrinking in size when private sector activity heats up.
So there you have it. The Economic “justification” for things like ever more bloated government and never firing anyone. “hire them all it’s good for employment” comes straight out of MMT. Similarly the Universal Minimum Income since it is funded out of government spending is seen as free. After all, it isn’t consumption or spending, it is “creating private surplus”…
Enough Of The MMT Wiki
China on Saturday welcomed backing from IMF experts that the yuan should be included in its reserve currencies, saying the move would strengthen the world’s financial system.
Now the world’s second-largest economy, China asked last year for the yuan to be added to the elite basket of SDR currencies, but until recently it was considered too tightly controlled to qualify.
It now looks likely the yuan will be formally admitted to the IMF’s “special drawing rights” currency basket at the end of the month, which would mark a milestone in China’s efforts to become a global economic power.
IMF chief Christine Lagarde said the fund now deemed the yuan “meets the requirements to be a ‘freely usable’ currency” — a key hurdle to joining the yen, dollar, pound and euro as a leading unit in international trade.
The yuan hit headlines in August when China’s central bank devalued the currency and said it would use a more market-oriented system to calculate the point around which the currency can trade each day.
The move sent markets into a tailspin as investors took it as a sign of slowing growth in China, a key driver of the world economy, but the central bank on Saturday said such reforms had taken it closer to joining the SDR basket.
“China thinks that the inclusion of the RMB (yuan) into the SDR basket will strengthen the representativeness and the attraction of the SDR (and) that it will improve the existing international monetary system,” the People’s Bank of China (PBoC) added.
“It will have win-win benefits both for China and the world.”
Some Definitions and Descriptions
The International Monetary Fund is sort of a Central Bank for Central Banks. The purpose being to make that international portion of MMT easier to handle.
DEFINITION of ‘International Monetary Fund – IMF’
The International Monetary Fund (IMF) is an international organization created for the purpose of standardizing global financial relations and exchange rates. The IMF generally monitors the global economy, and its core goal is to economically strengthen its member countries. Specifically, the IMF was created with the intention of:
1. Promoting global monetary and exchange stability.
2. Facilitating the expansion and balanced growth of international trade.
3. Assisting in the establishment of a multilateral system of payments for current transactions.
Basically, member countries can deposit a variety of ‘assets’ and then draw other currencies out against them. Gold, $US, £, € are all just fine. Now if you want to buy, say, a few $Billion of oil from Saudi Arabia, you can’t just walk in with Bank Of Smith 100 Zingy Notes and get anywhere. YOUR Central Bank has to hustle up some Saudi Currency, or you have to get a Reserve Currency (traditionally the $US ‘lately’ in history). It goes to The IMF and asks for a few $Billion, please. To get it, they must deposit something of value. That means a reserve currency or gold. Then the $US go to Saudi, who put it in the bank, and collect some Saudi currency in exchange, or buy a nice chunk of downtown New York City… recycling those Petro Dollars.
$US trade must ‘clear’ though a US bank, so the US Government gets to see who is buying what… Some folks don’t like that.
Now all those ‘special’ currencies in the IMF are bundled up into Special Drawing Rights. That means you put in, say, $1 Trillion of your ‘reserve currency’, you can borrow or ‘draw’ out $1 Trillion worth of anything else. (It isn’t quite that simple, but that’s the idea of it. To facilitate balancing the books on currency imbalances by treating a basket of them as more or less fungible.)
There’s a very nice write up of Reserve Currencies here:
I won’t bother to quote it all as it is long and well written.
Benefits of Reserve Currency Status
Why all the hubbub surrounding reserve currency status? Being the country issuing a reserve currency reduces transaction costs, since both sides of the transaction involve the same currency and one is yours. Reserve currency issuing countries are not exposed to the same level of exchange rate risk, especially when it comes to commodities, which are often quoted and settled in dollars. Because other countries want to hold a currency in reserve and use it for transactions, the higher demand means lower borrowing costs through depressed bond yields (most reserves are of government bonds). Issuing countries are also able to borrow in their home currencies and are less worried about propping up their currencies to avoid default.
It also means that a Chinese buying oil can pay in Yuan and NOT have it ‘clear’ through a US bank with the US Government watching, but instead ‘clear’ though a Chinese bank. Similarly, the Saudi Bank can hold it as ‘reserves’ without telling the USA…
Now just change Saudi to Iranian…
As China joins the SDR Club
So what happens as China joins the SDR Club?
They can print international money and spend it for free.
They can have transactions in international markets that never show on US ‘radar’.
They can withdraw $US or £ or € or most any other currency against YUAN deposits at non Chinese banks, including the IMF.
Globally, lots of banks will start holding piles of Yuan as “reserves”. Paper China prints, but that does not get used to demand $US from China to redeem it.
It displaces some $US and € from that use and those DO get redeemed.
Unwinds, Currency Collapses, Defaults, Hyperinflation, Stagnation, and more
As this article is already a bit long, and editing it is slow at this size (the Pi starts to swap memory), I’m going to cover this part in a “Part 2”.
What happens when things go wrong?