Stocks, flows, and the little matter of debt in dollars

I often tell students that Kalecki had a dictum to the effect that macroeconomics is the art of confusing stocks and flows. As usual, it is not clear he said it exactly that way, but the point is correct. One must never let exact textual evidence get in the way of a good aphorism. The standard textbook story suggests that the flow of saving finances the flow of investment. In fact, the flow of spending is financed by stocks, money, credit, debt, previously accumulated wealth, bank balance sheets, central bank liabilities, and so on. Savings is mostly the accounting record left behind after the spending took place.

The relevant question is not whether the economy has enough saving lying around, but whether the financial system can create the means of payment, and whether the real resources are there to make the additional spending useful rather than inflationary.

In a closed economy with spare capacity, the answer is often more straightforward than the guardians of sound finance would like to admit. As Keynes suggested in his 1940s letter to Sir Edward Bridges (excerpt shown above), domestic expenditure and overseas expenditure are not the same animal. In the domestic case, “within reason anything is possible financially,” provided the case for the expenditure is strong enough.

But open macroeconomics requires an amendment to Kalecki’s dictum. If macroeconomics is the art of confusing stocks and flows, then open macroeconomics is the art of confusing debt in domestic currency with debt in foreign currency. The confusion is everywhere. Somebody notices that part of the public debt is held by foreigners and immediately concludes that the nation is now dependent on foreigners, that future generations are forever burdened. But the key issue is not who holds the debt. The key issue is the currency in which the debt is denominated. Btw, see this old post on Chester C. Davis, then President of the St. Louis Fed, who in 1942 understood perfectly well, as did Keynes, that a domestically denominated public debt did not present the same problems as an external debt.

If the debt is in the domestic currency, the state can always make the payments in that currency. That does not mean there are never distributive consequences, inflationary pressures, or political constraints. It means that default is not forced by the lack of the unit of account in which the debt is payable. The United States does not run out of dollars in the way Argentina can run out of dollars. This is not American exceptionalism in the usual tedious sense. It is merely monetary sovereignty, helped enormously by the fact that the dollar is the hegemonic currency.

Foreign-currency debt is different. It must ultimately be serviced with foreign-currency revenues. In the long run that means export proceeds. Borrowing abroad can postpone the problem, but it cannot abolish it. Principal and interest are not repaid with patriotic speeches or with central bank press releases in the domestic currency. If a country owes dollars and earns pesos, reais, drachmas, or some other less divinely ordained currency, it must somehow get the dollars. Printing domestic currency to buy foreign currency may work when markets are tranquil and foreign exchange is available. But when the problem becomes serious, the exchange rate moves, reserves disappear, import capacity is squeezed, and the only solution becomes devaluation, which is both inflationary and contractionary. That often means default. Keynes knew about that.

This is exactly why Keynes insisted on the distinction between domestic and overseas expenditure. Domestic expenditure mobilizes domestic resources and is paid in domestic money. Overseas expenditure creates a claim on foreign resources and foreign exchange. Keynes’ concern was not the silly household analogy, that Britain should tighten its belt because father had maxed out the credit card or something. His point was that external payments could impose a real constraint because they required command over resources abroad. You can always spend your own money at home, subject to real capacity and inflation. You cannot always spend someone else’s currency abroad, unless you can get it. Keynes was this close of finding out about the external constraint.

In some circles this simple and reasonable notion is mocked or seen as politically biased in some sense (see the tweet above in Spanish; I'm a pseudo progressive and Peronist, an insult I guess,* because I don't get the relevance of fiscal deficits. After that tweet one is tempted to say that for some Very Serious Political Scientists, all debt is external debt as long as the word debt appears in the sentence. The currency denomination, apparently, is a technicality best left to accountants, heterodox economists, and other suspicious characters). This is particularly true in developing countries where foreign debt is a problem, like Argentina. Of course the external debt limits what can be done in the fiscal front. See my paper on that here, and my response to an MMT author from Mexico, who suggested that with flexible rates you should have no need for reserves (in dollars).

So the amended dictum should be that open macroeconomics is the art of confusing domestic-currency debt with foreign-currency debt. The first confusion leads to the idea that saving finances investment. The second leads to the idea that all public debts are external debts. Both errors are useful, of course. They provide employment for orthodox economists, central bank consultants, and Very Serious People. One should not underestimate the Keynesian employment effects of bad economics.

* The funny thing is that the family was very Gorila, as they refer to non or anti-Peronists. As per the first page of the NYTimes below (hard to read, but you can enlarge it), my father's uncle had put Perón in jail in 1945.

Note, however, that my father was not a dogmatic man. He did vote for the Kirchners (not Menem, the Peronist that neoliberals love).

The Argentina of Javier Milei

A seminar organized by the Association for Heterodox Economics with myself, Ramiro Álvarez and the Argentine Senator Carolina Moisés.

Argentina and the Philippines: Similar development struggles

By Jesus Felipe and Matías Vernengo

ALTHOUGH the economies of Argentina and the Philippines are very different, the two share structural problems that make both nations’ development a complex process. The election of Javier Milei as the new president elect of Argentina, gives us the opportunity to review the differences and parallels between the two economies.

Milei is a radical libertarian populist economist with authoritarian tendencies. His proposals range from the dangerous in economics (dollarization, closing the Central Bank, a drastic reduction of social spending) and social issues (curtail human rights and democratic advances, loosen gun ownership laws, and the elimination of all those institutions that would have any relationship with his two biggest obsessions: the State and the “political caste”) to the insane: institute a free market for human organs. His election has shocked many in Argentina, but the reasons for his rapid rise are not hard to find. The Philippines has also had its share of populist presidents with also questionable ideas and behavior.

Argentina’s economy stagnated over the last decade, with an average annual rate of GDP growth of about 0.2%, and with an accumulated inflation of approximately 450%, reaching 140% on an annualized basis in October. Poverty has also soared. The poverty incidence increased from about 25% a few years ago to about 40%, when measured by the national poverty line. However, Argentina, with a population of about 46 million, is not a poor country. By the World Bank’s definition, it is an upper middle-income country with a GDP per capita of almost $12,000, about three times that of the Philippines. Argentina’s poverty rate is 2.5% by the $3.65 per day World Bank measure. The equivalent rate for the Philippines is 17.8%.

Read the rest here.

Prebisch After ECLAC and UNCTAD

My talk at the Universidad Nacional de Colombia last Friday, in Spanish of course. Part of the argument is that Prebisch, contrary to what is often assumed, moved from an argument that emphasized the role of the external constraint in leading to underdevelopment during his United Nations years, to one that put the emphasis on the patterns of domestic consumption, and its negative impact on the surplus, following the literature on stagnation, in his last book on peripheral capitalism. I suggest that the change is problematic.

On the crisis in Venezuela

I wrote a few entries over the last few years that might be useful to understand what is going on in Venezuela. This one from 2016, tries to explain how the crisis is related to an old problem, the dependence on oil exports and the balance of payments constraint. Venezuela can't manage to get beyond the oil dependence in the boom, since a sort of Dutch Disease sets in. One can certainly blame the Chavista governments for not breaking with that dependence, but in all fairness conservative governments also were unable to do it. In the period of a fall in international oil prices a crisis normally occurs (this one is probably already worse than the Caracazo).

Here for context the data on exports (note that about 90 percent of exports are basically oil, and those go mostly to the US that has refineries that specialize in the Venezuelan oil).

The numbers are from the World Bank Development Indicators up to 2016, and then I use the IMF estimates of growth (actually decline) from the World Economic Outlook database. So this is a brutal collapse, something the US government is doing, even at the price of some costs to local refineries, in order to promote regime change in Venezuela. Whatever your views on Maduro and the Chávez period, note that the US is fine with Saudi Arabia. Trump and Dems before too. And remember that Obama tightened the embargo as one of his last measures. Double standards are incredible, and difficult to defend.

Mind you with the collapse of exports and the fiscal capacity of the state, the economy collapsed too, and so did imports. The embargo makes imports of almost everything impossible and heightens the humanitarian crisis, and the refugee problem. It is somewhat hypocritical, to say the least, to complain about the humanitarian crisis and not acknowledging the US role and the embargo in causing it.

Note also, that in the absence of dollars, not only imports collapse, but payments on foreign denominated debt too. Hence, the close possibility of a complete financial meltdown. Not only default will take place, but scarcity of almost anything imported (including food essentials) and the rapid depreciation of the currency would lead to hyperinflation. If you want to understand external crisis in general read this entry, and for hyperinflation go to this one.

On the complex issues of democracy in Venezuela read this entry from 2017, and this one from 2018. For those that think that the current coup, or any coup including a military one would reduce violence (the opposite is more likely to happen) read this.

Middle Income Trap or the Return of US Hegemony

Short essay in Spanish for the special (40 year anniversary of the journal Coyuntura y Desarrollo, published by the Fundación de Investigaciones para el Desarrollo, FIDE). It is essentially a critique of the concept of middle-income trap and the idea of how the demographic transitions (discussed here before) affect the process of development. It suggests that the deindustrialization of the Latin American periphery results as much from the decisions in the hegemonic country to open up China, as from the decisions of the local elites to adopt neoliberal policies to punish its labor class. It is also noted that the deindustrialization of the central countries (particularly the US) should be taken with a certain degree of skepticism (see this old post), since manufacturing output went up (even if manufacturing employment has gone down, at least since the entry of China in the WTO), and the US maintains a significant leadership in key industrial sectors (let alone the military; see also this more recent post).

More on the National Accounts: Gross versus Value Added Exports

Yes, still teaching that. So end up thinking and reading about the stuff. At any rate, an interesting paper by Robert Johnson (here; subscription required), suggests that with the rise of global supply chains gross exports overstate the amount of domestic value-added in exports. Note that now exports have a greater content of imports, so gross trade is not a good measure of value added. Johnson says that: "estimates suggest that value-added exports are equal to 70–75 percent of the value of gross exports."

Interestingly there is more value added in services than the data on gross exports indicates, as can be seen above. In other words, manufacturers exporters tend to buy a lot of local services, and that ends up being part of gross manufacturing export numbers, undervaluing the role of valued added service exports.

The lowest value added to gross exports ratios are in East Asian countries, in the data presented South Korea and Taiwan, which is not surprising. China and Mexico are higher than both South Korea and Taiwan, and I was surprised by that.

An interesting result of his analysis is that: "the ratio of exports to GDP will overstate how much GDP falls when exports decline." Of course, for the external constraint, it might still be the case that gross exports are the relevant ones, since they provide access to hard currency for developing countries.

Did Inflation Bring Down the Allende Government?

Allende's glasses

Roberto Frenkel, the well-known Argentine economist, gave an interesting radio interview (transcribed, in Spanish, here) in which, as always, there is a lot to learn. In that interview he tells a touching story about his experience during the Allende government. Apparently he was told by the Finance Minister Carlos Matus to make a presentation on inflation, and warned of the dire consequences of not pursuing contractionary demand policies. After that he says (I keep his Spanish version and translate below):

"Yo había explicado cómo la inflación se iba a acelerar, la situación iba a empeorar rápidamente... y entonces se me acerca Allende con quien yo había tenido la oportunidad de estar en pocas oportunidades, y me dice '¿Por qué no me lo dijeron antes?' Y es una cosa que me pesó en el corazón... al poco tiempo el hombre se suicidó en La Moneda. Y eso se lo conté a algunos que estuvieron con el gobierno de Kirchner hasta hace poco y ahora salen preocupados y tratan de abandonar el barco y no hundirse con él, y les conté esta anécdota y los insté a hablar y a hacer explícita su alarma y preocupación por la situación (...)."

"I explained that inflation was going to accelerate, and things would worsen precipitously... and then Allende, with whom I had opportunity to meet in a few occasions, approaches me and says: 'Why didn't anybody tell me?' And that sunk my heart ...not long after that he committed suicide in La Moneda [presidential palace]. I told that story to some people that were members of the Kirchner's government until recently and now leaving the boat to avoid sinking with it and encourgaed them to speak up..."

So now we know. Inflation actually brought down Allende, and Frenkel almost saved the government, but was too late to avoid the military coup. And his concerns with Argentine inflation are similar now, since we are on the verge of total collapse.

All jokes asides, the notion that inflation brought the government down is silly to say the least. As noted here, if anything the nationalization of copper, that did hurt transnational corporations and local elites was certainly more important [note also that by 1973 inflation was not a Chilean problem, but a global one associated to the oil shocks and wage resistance]. So resistance to reforms by powerful groups within the country were at center stage. The connections of Pinochet with US corporations and security and intelligence apparatus are also well documented. Even if Frenkel had told Allende in time about inflation ... Oh well.

There are other nuggets in this interview, in particular the insistence that demand has to be curtailed even when it is admitted that inflation is essentially inertial, but I'll leave those for other posts. It seems that more and more authors at the Centro de Estudios de Estado y Sociedad (CEDES) are converging to mainstream positions, like the economists at the Catholic University in Rio (PUC-RJ) and sociologists like Fernando Henrique Cardoso in Brazil did back in the 1990s.

Troika Kleptocracy

From the Guardian (see here):

"The imposition of a levy on savers in Cypriot banks marks a new turn in the European crisis. Savings of over €100,000 will be subject to a 10% tax, and those under €100,000 one of 6.7%, although it's reported these levels may change. The raid has been instructed by the "Troika" – the European commission, the IMF and the European Central Bank – as part of a characteristic "take it or leave it" ultimatum to the Cypriot government. The parliament in Nicosia is being pressed to ratify the deal with the threat that without it there will be no bailout funds and the ECB will withdraw all liquidity support to the stricken banks.

The Troika and its supporters have justified the levy by arguing that the state could not support the debt burden of a bank bailout. But this simply means the debt burden has been transferred from the banks, where it properly belongs, to households, who had no part in their lending decisions.

 ...
But it is foolish of the Troika to assume that its confiscation of Cypriot savings will have no international implications. Savers all across Europe will look on in horror, and are bound to wonder whether it could happen in their own countries. It is entirely possible they will respond by shifting their savings into state or postal savings banks at the very least, even if outright bank runs are avoided. If this happens on sufficient scale, it could further undermine the fragile banking system in a number of countries.

To prevent Troika raids, deposits need to be put into protective custody to preserve both savings and the domestic banking sector. For anti-austerity governments, these funds could then be used to support state-led investment and reverse the European depression."

Read the full piece here.

Energy sources in Latin America and Asia

The graphs below (World Bank data) show the sources of energy in a few selected countries in Latin America and Asia. The first thing to notice is that Asia burns way more coal than Latin America, which tends to depend more on hydroelectric and natural gas sources (the US is a natural gas and coal country, by the way).

One reason for the difference is that Latin America does not have a significant share of the global coal reserves. China and India have a reasonable share (the US has the largest reserves of coal, followed by Russia).

In terms of the environment hydro sources are considerably better for emissions (zero) than coal, but do have other impacts, associated with flooding, reduced streams and negative impact on fish migration patterns among the worse. Natural gas is also better than coal. So Latin America is slightly more environmentally friendly. Coal tends to be cheaper (although fracking may be changing that in the US), which gives a competitive edge to Asian countries.

Note that energy is essential for the functioning of the economy. Lenin said that: "Communism is Soviet power plus the electrification of the whole country." Paraphrasing, capitalism is power to the corporations and electrification of the whole world. Note that this implies that sometimes, at least, the constraint to the expansion of demand could come from a supply restriction. Interestingly enough, more often than not, it still manifests itself through an external constraint, since many developing countries are net importers of energy.