Marshall Auerback: Inflation and Hyper-inflation

April 28th, 2010 by selise


“Inflation and Hyper-inflation”

Marshall Auerback, International Consulting Economist, blogger at New Deal 2.0 and New Economic Perspectives

Session 4 — 1st Fiscal Sustainability Teach-In and Counter-Conference
George Washington University, Washington DC, April 28, 2010



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TRANSCRIPT (Thanks to the Volunteer Transcription Team):


Marshall Auerback: Okay, hopefully I’m not going to have any video problems here, or technical problems, so I’m doing the bit that you’ve all been waiting to ask, because we get it all the time: Will the US turn into a modern day Weimar Germany or Zimbabwe? First of all I want to acknowledge that there’s been some excellent work done on this by one of my colleagues Rob Parenteau. We’ve written a lot of stuff together and I know he’d want to be here today, but he wrote a piece on Weimar and he writes ‘The Richebächer Letter’ ( He wrote a very good piece on Weimar which first started to make a very good historical comparison. So I’m indebted to him, and as far as Zimbabwe goes Bill Mitchell has done, well Bill always does very very good work, but he did a particularly good piece on Zimbabwe, ‘Zimbabwe for Hyperventilators,’ so like Minsky who said he was standing on the shoulders of giants when he talked about Keynes, I say the same thing about Rob and Bill and Randy and all the other people on this panel so I’m the hack by comparison. [00:01:19]

So will the US turn into a modern day Weimar Germany? So let’s start, I know some of this is stuff we’ve gone through it before but I’m going to start with a few operational points that been already made, to show that we’re not the only ones making it. I’ve got quotes here from an economist called Abba Lerner, he is often known as the father of functional finance. He was a Keynesian, I think it’s fair to say that he’s one of the progenitors or forbearers of modern monetary theory. [00:01:48]

Marshall Auerback - Slide 2

Marshall Auerback - Slide 2

So his comment, and it is as Warren gave you an illustration of it before, he said, “The modern state can make anything it chooses generally acceptable as money… It is true that a simple declaration,” as Warren showed you, “that such and such money will not do, even if backed by the most convincing constitutional evidence of the state’s absolute sovereignty. But if the state is willing to accept the proposed money in payment of taxes and other obligations to itself, the trick is done.” [00:02:27]

Marshall Auerback - Slide 3

Marshall Auerback - Slide 3

The other point, we talked about the purpose of taxes, we said they serve to regulate aggregate demand, not to raise money so that government can afford to spend. And again, the other idea that I think was a very important insight by Lerner is that he said that, “The central ideas of government fiscal policy is spending and its taxing, its borrowing, its repayments of loans, its issuance of new money,” etc. etc. “should be undertaken with an eye only to the results of these actions on the economy and not to any established traditional doctrines of what is sound or unsound.” So we look at the impact of policy, the effects of policy. That’s ultimately what we’re looking at. We’re not particularly interested in some vague notion of a debt to GDP ratio which is considered unsustainable or the general concept of fiscal unsustainability. [00:03:19]

The constraint as we’ve said is inflation. It’s not fiscal largesse or fiscal profligacy per se. And I often do this with Lynn Paramour and I would say, “What sort of visual cues do you have?” I often do this at a conference. Here’s two pieces of paper. This is one with a picture of a dead president on it, and this is one is just a piece of paper, this one they tell you is worth a dollar and this one is probably worth about three cents. Now I tell people that if I told you tomorrow that this piece of paper could be used as something with which you could pay your taxes I suspect it would be worth a lot more to you than the three cents whatever it is that you use to pay your taxes. [00:04:02]

When we talk about this being backed by the full faith and credit of the US government what we’re really saying is the US government guarantees that you can use these pictures of dead presidents, which aren’t backed by anything, there’s no gold nugget, it’s not rimmed by platinum or any precious metal. You can use this basically to pay your taxes and that’s what confers the value. [00:04:26]

Marshall Auerback - Slide 4

Marshall Auerback - Slide 4

Okay, let’s go into the history lesson. So when we look at Weimar… let’s take a step back. When we talk about these operational realities that I’ve mentioned earlier invariably, I mean I can tell you 9 times out of 10, ah, you look at the Huffington Post blog yesterday you could, we get comments saying, Well you’re just going to get hyper inflate, your going to turn this country into a modern day Weimar Germany. So I’ve heard this so many times, and so did Rob, that we decided to actually look at the history. Clearly, Weimar Germany came into existence after WWI, a very damaging war, hugely more damaging in many respects than WWII. The country’s productive capacity was absolutely shattered, and more importantly virtually the entire world was really pissed off with Germany and as a result the war reparations claims that they imposed on the country were extremely punitive. [00:05:23]

And many people at the time, such as Keynes, for example, realized that this imposed a tremendously harsh economic consequences on Germany and that the imposition itself was going to be impossible to be repaid. As I say here in 1919 it was reported that the German budget deficit was equal to half GDP. Half GDP. And what are we talking about in the US today? We’re talking about 8% of GDP I think it may have peaked at 10% and that’s including TARP, so let’s get a sense of perspective here. [00:05:55]

Marshall Auerback - Slide 5

Marshall Auerback - Slide 5

By 1921 in Germany, war reparation payments equaled one third of got spending. One third. So I think that is an important consideration to look at and I think more importantly is that the payments were demanded in a foreign currency. They weren’t being demanded in Deutsche Marks. They were being demanded in, the governments demanded huge gold reparations. [00:06:25]

Now by contrast as I said in the US you’ve got a fiscal deficit this year, I think it’s projected at, I think the latest out of the CBO is about eight and a half per cent of GDP, assuming that GDP is what everyone thinks it will be. [00:06:37]

So the scale of the fiscal responses, although large, are nothing like they were in Weimar Germany. So there is a big difference right there. Weimar Germany then didn’t have the gold so they had to aggressively sell their own currency, buy the foreign currency in the form of the financial markets. You keep doing that over, and over again, it drives down the value of your own currency, which causes the prices of goods to go over higher, and that starts the inflationary process. As I said earlier the US does not do this. The US gets to use debt in its own free floating non-convertible currency. You can’t exchange the dollar into anything, much as some people would like that. So there’s no external constraint along the same lines as Weimar Germany. [00:07:21]

Marshall Auerback - Slide 6

Marshall Auerback - Slide 6

Now I’ve also made this point here about German trade union membership. I am not, let me repeat, I am not making the point that unionization is a bad thing, that unionization causes inflation, and that we shouldn’t have unionization, in fact I think if we had more unions in this country, and stronger unions it would actually be better. My point really here is that you had a very, very significantly larger union membership in Weimar Germany than you do in the US, and they had considerably more political power than in the US. You had a social democratic government which was by and large it was very ideologically sympathetic to unions, but more importantly, and this is the point that Bill Mitchell made earlier, unions were able to negotiate cost of living adjustments in their wage packages after the mark fell in 1929. so this creates this automatic feedback mechanism for price inflation to wage hikes and it keeps going on and on and on. [00:08:15]

If you build these cost of living adjustments into the wage contracts, of course you can feed the inflation almost automatically. We don’t have that in the US. Absent such mechanisms in the US, or any country for that matter, nominal wage and salary growth can’t keep up with consumer prices, so ultimately the impact if you don’t do that is deflationary. If the price of oil and food and everything else starts going up in the US and your wage packages are not indexed to that in any particular way, your purchasing powers ultimately are going to go down, so you have to defer consumption expenditure in other areas to meet the cost to buy these essentials. As I say, that’s potentially deflationary, not hyperinflationary. [00:08:56]

Now the US as I say here does display some social democratic rhetoric, but as Warren has already pointed out, this administration, despite being an ostensibly progressive Democratic administration, has presided over one of the most regressive wealth transfers in history. It’s amazing to me that it’s happened, and it’s been allowed to happen. But that’s the reality and it could have been worse if we’d allowed some of these abominable programs like PPIP to go ahead, which fortunately we didn’t do. [00:09:27]

Marshall Auerback - Slide 7

Marshall Auerback - Slide 7

So what finally broke down Weimar Germany, the straw that broke the camels back was by May 1921, the so-called London Ultimatum. The Germans were asked to make an annual installment in payments of 2 billion in gold or foreign currency, in addition to a claim on just over a quarter of the value of German exports. [00:09:50]

So an extremely punitive measure, it was a condition virtually impossible to fulfill. The Germans attempted to fulfill it. They accumulated foreign exchange by paying with treasury bills and commercial debts denominated in marks, but the mark simply went into freefall. So they finally said, “You know, we can’t pay up anymore.” You are seeing a small parallel to, with that today in Greece, its not to the same degree but obviously its… the positions are reversed, it’s the Germans imposing conditions on the Greeks, saying “You know you have to pay X” even though the Greeks don’t have the money, so they’re trying to get blood out of a stone. But we don’t clearly have hyperinflation in Greece, but it is an interesting parallel. [00:10:33]

So the response to that was that the French and Belgium troops occupied the Ruhr to secure reparation payments. The problem was that the Ruhr was one of the industrial powerhouse regions of Germany, and they employed about a quarter of their workforce in that area, and they exported a huge amount from that area. Effectively you take away their… the largest chunk of their manufacturing capacity is eliminated to begin with, then you occupy a chunk of the country which has a huge portion of what’s left of manufacturing capacity, and then you say, “Now pay us the money.” And you can see why a central bank printing money in that situation, or creating currency in that situation, is not going to be able to do so, won’t be able to call forth goods and services. And you do create the conditions for inflation, and then hyperinflation. So again, it’s a very different situation from what we have today in the US. [00:11:32]

Marshall Auerback - Slide 8

Marshall Auerback - Slide 8

Now the modern day example everyone likes to go with: Zimbabwe. Zimbabwe as you well know had a civil war, even before Mugabe took over. It was a long-lasting civil war, that lasted through the sixties and seventies, low intensity guerilla warfare, but ultimately became much more serious to the point where ultimately there was an accord brokered by the British government. In 1980 President Mugabe became the new leader of the country in a coalition government. But by that point, a large chunk again of the country’s productive capacity had been destroyed, even before the onset of the land reform. [00:12:15]

Marshall Auerback - Slide 9

Marshall Auerback - Slide 9

Now this just gives you an illustration. There was some recovery, Zimbabwe, as you can see, did all right after Mugabe first came in. You had reasonably high growth, 11% in 1980, and it was positive throughout most of the decade of the 1980’s until a severe drought in the early 1990s which created great damage. But again there was a recovery from that. So even though we had some problem with productive capacity the economy was growing. So what was it that ultimately caused the problems in Zimbabwe? Well you have the legacy of colonialism. I used to have a girlfriend in Zimbabwe many moons back when I was at university and I remember visiting the country in 1982 and I thought, “God life is hell for these white farmers.” because they lived in these absolutely gorgeous palatial mansions, they had loads of staff working for them, there wasn’t apartheid as such but you had a very very cushy lifestyle. And 250,000 whites basically controlled over 70% of the most productive agriculture in the country, a nation of six million people, so that’s clearly a socially unsustainable situation. [00:13:29]

Marshall Auerback - Slide 10

Marshall Auerback - Slide 10

There were many attempts by the government to coax the white farmers into giving up a little then in order to make for a more equitable situation later and there was no give. As an aside, I think we talk a lot about income inequality in this country and to me, if its not something that’s addressed in a decent amount of time, you do get a huge socially unsustainable situation which will beget an even more extreme political response later. So I think it is in that regard the situation of what’s happened in Zimbabwe in terms of the misguided reforms that were subsequently introduced, it’s a legacy of the fact that we didn’t deal with the problem of inequality much earlier in that country. [00:14:22]

Marshall Auerback - Slide 11

Marshall Auerback - Slide 11

So what happens, Mugabe begins his land reform program. It’s a misguided land reform program. He seizes land from the whites, gives it to, mostly he gives it to his cronies in the ZANU party. Unfortunately many of them don’t have farming expertise and, not surprisingly, agricultural production in the country absolutely collapses; it collapses by almost 50%. The country then finds it is in a situation if in order to avoid mass starvation it has to use valuable foreign exchange reserves in order to import imported food. That creates an additional problem. You don’t have foreign exchange to pay for raw materials, so manufacturing capacity absolutely collapses and the end result is that you have about 80% unemployment. But here’s the statistics. I got this again from Bill Mitchell, output fell by 29%… manufacturing output fell by 29% in 2005, 18% in 2006, 28% in 2007. It’s worse than what you had in Latvia over the last few years, again, though self-inflicted. [00:15:34]

So you have no foreign currency to buy raw materials, the Bank of Zimbabwe uses foreign reserves to import food, and as Bill has pointed at on his blog, the land reform destroys domestic food production, foreign exchange is used to buy food to prevent starvation because, I guess, even as cruel as that government was, Mr. Mugabe didn’t think that it would be a good idea to allow mass starvation in order to bring supply and demand back together again. So you have no funds left to import raw materials, manufacturing output collapses, you have 80% unemployment. [00:16:09]

Marshall Auerback - Slide 12

Marshall Auerback - Slide 12

The government in the meantime uses, well, Mr. and Mrs. Mugabe use the foreign exchange reserves for their personal shopping expeditions to London and in general the government uses the foreign exchange reserves, what’s left of them, to increase net spending without adding to productive capacity. So it’s effective use is as a personal piggy bank. The same thing happened for example in the Philippines when the Marcos family was in power. You just basically steal what’s left in the piggy bank and use it for your own good. [00:16:39]

It’s a totally dysfunctional situation you have there. Obviously, again you could argue that this country does suffer from some political dysfunction, but I think we would agree that, at least not yet, it’s not quite as bad as Zimbabwe. And again the analogy is the wrong one. [00:17:12]

There are other examples of this. The loss of taxing authority during the civil war by the Confederacy is another example of a situation where a government’s inability to impose a tax ultimately did create hyperinflationary conditions. [00:17:25]

So political dysfunction and the inability to tax is an extremely important means of safeguarding the value of a currency. But in general as I said, despite what you might hear from the propagandists on the right, left, center, almost from everyone, there is no valid basis of comparison between the US and Weimar Germany or Zimbabwe. [00:17:45]

Marshall Auerback - Slide 13

Marshall Auerback - Slide 13

Any bad government can wreck an economy if it wants to, that’s quite evident. A sensible government using fiscal, the path of fiscal capacity provided by a fiat monetary currency system can always generate full employment and yet sustain price stability. Now I know we’re going to be talking about this later, but one of the things I’d like to talk about briefly is productive capacity. [00:18:12]

We talk about calling forth productive capacity and, as a few people have mentioned earlier, the most effective means of calling forth productive capacity is by ensuring that you have a productive labor force. And one of the means by which you insure that you have a productive labor force is by establishing a government job guarantee program, which I think will be discussed at greater length later. The point is that if you have a government that has shovel-ready labor, ready to be piled back into the private sector when private sector demand arises, not only is this good social policy but it actually means that you do create non-inflationary conditions because it means you are effectively retaining productive capacity, which can be used. [00:19:03]

Marshall Auerback - Slide 14

Marshall Auerback - Slide 14

If you have long-term unemployed, the social pathologies build up and you actually… these types of workers lose their productivity. So in fact even though you might have significant output gaps via unemployment, if you have long term unemployment it does create, it can potentially create difficulties if you don’t have these people in a position where they can actually call something back, bring something back into the economy as a whole. So I think that’s an important conclusion to draw as well. [00:19:31]

The other point I would make, which also comes up a lot in these discussions, Warren and I have had these discussions with people and they talk about Greece, Portugal and they talk about the US spending money and they say, “You know, eventually you’re going to default on your debt.” And we’ve both probed them on this question. We say, “What do you mean by default? Do you mean that the US is somehow going to, Social Security checks are going to start bouncing, or that we’re not going to make a payment to a bond holder?” [00:20:01]

They go, “No, no what we mean by that is that the currency is going to fall so much that you’re going to get huge amounts of inflation and therefore that is tantamount to insolvency.” We’ve had this debate, with let’s see, with Caroline Baum at Bloomberg, we’ve had this Martin Wolf at the Financial Times, and Charles Goodheart has even said the same thing. He’s a former member of the monetary policy committee the Bank of England. The only point I’ve made to these people is that if you buy a credit default swap in a country like the US or Germany, or any country in fact, you don’t get paid out if they run a rate of inflation. It’d be nice, I mean I’d love to, I’d buy credit-default swaps in every single country that I could find, actually, because anytime they run an inflation, any rate of inflation I can get paid. But clearly that’s not the way that we define default. So again, misleading terminology, misleading hints, are all examples. You can always call people on that and I think we should do so much more aggressively in the future. [00:20:57]

So that’s my presentation. Thank you very much. [00:21:00]




[begin Q&A for SESSION 4] [00:21:49]


Warren Mosler: Maurice [Samuels] and I went to Rome in 1993, after coming up with the idea that governments don’t default because, in their own currency, because all they’re doing is spending first and then collecting later. The securities function for interest rate maintenance and not to fund the debt. And a paper came out of that called Soft Currency Economics, and afterwards I ran into Randy and Bill and Pavlina and then they all started looking up the history of these ideas. And so it’s interesting we came up with ideas first and then found the history afterwards. Which is not necessarily normally the way things work. We then discovered Lerner, we discovered Knapp, we discovered Innes.

Now we’ve discovered somebody last week, Ruml, is that his name? From 1946 the Federal Reserve president of New York, who said the same thing we’ve been saying about quantitative easing. You notice things, we see how they work, then we go back in history and find reasonably prominent people who’ve said the same thing. Secretary of the Treasury Memminger, from the Confederacy, said the same thing about how currency worked and explained that’s how he was going to set it up. So what happens is I think historians who don’t know how the currency works don’t find these things because they’re not looking for them. You have to have enough knowledge of what, when you’re looking at something, about circumstances to be able to recognize them as any kind of value.

What’s that thing that was found back, the ball with the holes in it from some four thousand years ago, which they’ve all said was a means of accounting. It was a clay ball with holes in it where pebbles would fit in. And I’m saying no, those were used for money because you would, what you do is you have the clay ball and the stone would fit in when you took it out and spent it that would be the thing you’d accept for taxes. You knew it was the same stone when it fit into that clay ball. Now that’s a monetary mechanism. All the record books show that this thing was an accounting mechanism to keep track of things with these stones you stuck in. I think history is going to more and more find the things we’re talking about. [00:23:59]

Bill Mitchell: I think the point about Marshall’s talk is very clear and really easy to understand in terms of the public debate now and the simple way of saying it. Not to say that Marshall wasn’t exquisite in his oratory [laughter] but the simple way of saying it, if you take an economy, you trash about 60 or 70% of its productive capacity then any spending will start to generate inflation. And if you wanted to avoid hyperinflation in Zimbabwe then you would have had to have had mass deaths of the population from starvation. Private investment would have had to come to virtually a sudden halt, because you’ve just lost all that supply side. So, whenever anyone raises at your dinner parties about Zimbabwe. It had nothing to do with demand. It was a supply issue. They trashed their supply.

And the last I know, in the US you’re doing a pretty good job of trashing your supply at the moment, running down the capacity of your work force and your industrial structure, but you haven’t done it yet and the companies are still out there, there are still workers that will work for them if there’s enough demand for the products and all you need to do is get the production, your supply side working again. In Zimbabwe they lost it. It was non existent. About 60-70% was lost. That’s why they had hyperinflation. [00:25:50]

L. Randall Wray: I’ll add something on the Confederacy because it helps to drive home points we’ve made in every one of these sessions. So yeah, the Secretary of the Treasury was trying to tell the government, look we need the taxes to support the currency, because taxes drive the currency. But the government was saying, well hold it, we’re already putting such a huge burden on our population because they’ve got to fight the war and we’re taking all the resources away from them for the war effort and we don’t want to burden them also with the taxes. Okay, but see, our point is you’ve got to have the taxes in order to match the resources that you’re withdrawing. Okay, it’s in real terms. You’ve got to reduce the demand with the tax system and you also have to have a reason why people will accept the currency. And so people would not accept the currency and that is why they had to just continually print out more and more and more. [00:26:44]

Pavlina Tcherneva: On the point of hyperinflation, I think the key components here are a supply shock, a tax collection fall out, but also I think you have to have a ratchet that you could have something that fuels additional expenditure. And in most cases that you observe around the world that have hyperinflation, what was the initial inflationary shock was fueled by some sort of indexation, whether it was of wages or prices. And I think that falling off of the tax base will do that too, but you could fuel it artificially as opposed to what we were saying earlier that you have to let inflation dissipate by one mechanism or another through the economy. [00:27:43]

Edward Harrison: Okay, Edward Harrison here again and I have two questions that are unrelated. The first question I have has to do with indexation of retirement benefits. That is Social Security and things of that nature. If, you had mentioned that we don’t have a very strong labor movement in the United States but there is an increasing number of retirees, and Social Security is it effectively indexed to the inflation rate? So how does that play into the situation? [00:28:24]

Warren Mosler: Just quickly, if it causes a shortage of real resources because the seniors are getting all the food or getting all the housing, and there’s not enough left for anyone else it’s a real problem that has to be addressed. It’s not there yet, but that’s certainly a possibility. That we could over-provision a sector of the population and have to make adjustments. [00:28:44]

L. Randall Wray: I agree, it could be inflationary in the future. Indexing wages passes through a lot more quickly because wages are a cost. And so as wages go up, prices have to go up. Okay, but with Social Security, yeah, it’s once we get to full employment and a high level of aggregate demand. Which could be the case twenty years from now when we have, well most of the people in this room are going to be retired and on Social Security. [00:29:20]

Edward Harrison: The second unrelated question I had had to do with what happens with the hyperinflation scenarios. Now, in terms of a country that issues its debt — it has a sovereign currency — we were talking about the outcomes as being inflation or currency depreciation. Now a lot of people talk about a third outcome, which is interest rates increasing, and my question on this is to the degree that the central bank really could go into the market and buy up any sort of securities that it wanted to, obviously that is… that would control interest rates. However, aren’t interest rates a question in regards to currency depreciation – imported inflation via currency depreciation? [00:30:12]

So, just to sort of just make it more plain what I’m saying is, if the currency goes down, the price of oil and other imported goods goes up, that creates inflation and as a result of that inflation, and also the currency depreciation, you would normally expect interest rates to rise. [00:30:31]

Warren Mosler: Interest rates are set politically by the Federal Reserve. So unless they… that’s part of the reaction function, they’re not going to go up. So you have the Bank of Japan set rates at zero for twenty years. [00:30:41]

Edward Harrison: Then, you know, they set the short-term rate but the long term rate is effectively the imputed Federal Reserve funds rate going forward. [00:30:51]

Warren Mosler: Right, right. But let me suggest they also can set the long rate if they want to. [00:30:55]

Edward Harrison: That’s what I just said in terms of going in and doing so, but that’s an ideological, a political decision. [00:31:03]

Warren Mosler: They say Fed funds are going to stay at zero for ten years and then a ten-year will be at zero.[00:31:07]

Edward Harrison: Right. So I personally, I find that that sort of intervention not something I would support, and I guarantee you that lots of other people wouldn’t support that either. So I think that that’s a political problem. The concept of the Federal Reserve going out the yield curve and then setting rates. [00:31:26]

Warren Mosler: Okay, and the Treasury does the opposite when it issues long. It’s setting rates higher than otherwise, so either way the government is setting long-term rates now — either by default or by active policy, or lack of it. [00:31:39]

The other thing is, and I’m going to venture off into theory here, we’ve been in operational fact, but I see a lot of reason to believe that those zero rates are actually deflationary, not inflationary. Because again, Japan has a very strong currency after all these years and so you look for the channels where zero rates would be deflationary rather than inflationary. One is on the supply side because the cost of inventory is very low, so you don’t get the kind of bottlenecks, and it keeps the cost of production and new investment down by having a zero rate policy, so you have positive supply side effects. On the demand side it takes… all the nations are net savers, and the larger the budget deficit, the larger the net savers, so lower rates reduce income directly. And the other thing that tends to happen is bank net interest margins tend to grow as rates go down, which transfers income from savers with some reasonably high marginal propensity to consume to banks that have zero propensity to consume and reduces interest income. So through the interest income channels there seems to be – I have a lot of reason to think that zero interest rates are actually deflationary. [00:32:47]

If you look at currencies that have zero interest rates, such as the UMKC buckaroos, and my cards that I tell you you have to have to get out the door, paying interest on buckaroos is not going to increase the value from fifteen dollars to twenty dollars. We know where the value comes from. It comes from the monopolists setting price. And the currency is a public monopoly, and at the end of the day the value of the currency is what you have to do to get it from the monopolist, from the government. So in other words the price level is necessarily a function of the prices paid by the government when it spends, at the point of spending, and spending policies have a whole lot more to do with the price level than anything else. [00:33:26]

There are two ways for monopolists to spend, one is at market prices and the other is on a price constrained basis. An example of that would be if you have the electric monopoly for the city of Washington. You could say, okay, it’s ten cents a kilowatt and let supply adjust, or you could say we’re going to sell two billion kilowatts at the market, and let the market determine price. A monopolist always sets price and lets quantity adjust. With a currency monopoly we do the opposite. We set the budget and let the price adjust, well of course it’s going to be chaotic like it is, but we have the ability to set price and let quantity adjust. In other words just be on the bid side of the market and not pay the offered side. And that’s where Bill’s JG and Randy’s ELR comes in, where in a market economy you only need to set one price, in this case it’s the price of unskilled labor, and we can get into that later, I think it’s [inaudible] [00:34:17] [audio cuts out??] [00:34:22]

Bill Mitchell: Well if I keep talking I’ll stay awake, so [laughter]. There’s just a couple of points I’d make and Ed, your first premise is disputable. It’s the premise that’s always wheeled out, but it’s not necessarily inevitable.

First of all, a depreciation in the currency is not inflation. It’s a once-off price adjustment, inasmuch as import prices are weighted in your CPI or whatever your measure of inflation is, it’s just a once-off. For that to become inflationary there has to be some secondary effects where the participants in the real income distribution don’t agree to share the real income loss.

Warren Mosler: [inaudible] [00:35:16]

Bill Mitchell: Yeah. So depreciation isn’t inflation; that’s a myth. That’s a myth that’s commonly put out there.

Edward Harrison: If your currency goes down, doesn’t that almost naturally mean…

Bill Mitchell: It doesn’t naturally do anything.

Edward Harrison: All the resources, that is, the price of oil, as an example, the price of natural gas… [00:35:39]

Bill Mitchell: Yeah, there’s a real income loss to the economy.

Warren Mosler: That’s a one-time shift. [00:35:44]

Bill Mitchell: It’s a one-time real income loss.

Warren Mosler: It has to be continuous, that’s the definition of inflation.

Bill Mitchell: That’s the first point, but the second point is that…

Edward Harrison: So, you’re talking about the difference between permanent or an accelerating inflation versus a one-time… You would have inflation as measured by price levels at a specific adjustment. [00:36:08]

Bill Mitchell: No, a once-off adjustment in the price level is not inflation. That’s the myth. Inflation is a continuous increase in the price level. So you can have adjustments in Australia in July 2000, we brought in a ten percent GST, a value-added tax and all it did for about…[crosstalk] [00:36:29]

Edward Harrison: You can argue definitions but the reality is…

Bill Mitchell: No, I’m arguing the reality. All that happened in Australia when we put in a ten percent — hold on — all that happened was for two quarters the measured CPI jumped up and then it just — that was it.

Edward Harrison: That’s exactly what I’m saying. [00:36:47]

Bill Mitchell: Once off adjustment.

Edward Harrison: A lot of people would call that inflation. So it’s a definitional issue. [crosstalk]

Bill Mitchell: That’s the point I’m making: it’s one of the myths out there.

Warren Mosler: Right. People call it that but that’s… [00:36:57]

Bill Mitchell: That’s one of the myths out there that should be addressed. The second point is that there’s no intrinsic or inevitable relationship between a deficit position of government and the exchange rate. All the empirical work shows that there’s no systematic relationship between the fiscal balance and the exchange rate. And it’s quite plausible that you could have a strengthening exchange rate with very large deficits as a percentage of GDP if those deficits were creating conditions that allowed the capital account to improve. And if you really want to think about a country with — and I think Warren mentioned it — with a very strong currency and huge public debt, the highest in the world, and ongoing relatively large deficits think about Japan. They haven’t had any systematic meltdown in their currency; they’ve had deflation all of those years. [00:37:55]

Edward Harrison: Well they did go to 150 to the US dollar at one particular juncture in time. And they wanted to do that in fact, so given the fact they’re at 94 to the US dollar and they were at 150 you could say that that’s a fifty percent reduction in the real income of the people who live in that country relative to everyone else and as a result you would expect therefore people would be upset by that. [00:38:23]

Warren Mosler: You’re right, but don’t forget it was an active policy of intervention to push it up to 150 and then when they stopped intervening it got strong again. It didn’t get weak on its own. They had to push it up. [00:38:34]

L. Randall Wray: Can I try a different way of responding? Let’s put it in the framework of how does the central bank tend to react to inflation and currency depreciation? I think that you’re correct that they do tend to raise the interest rate, because they accept two — what we’re calling — myths. One is that if you raise interest rates that fights inflation, and that they should fight inflation that could result from currency depreciation and rising price of the commodities that you import for example, because raising interest rates is going to increase government spending on interest. And so you might actually stimulate the economy thinking you’re going to slow it down to fight inflation. And then the second belief is that raising interest rates helps your currency to appreciate and what Bill is telling you — there are no variables out there that economists have ever been able to find that are correlated with the currencies. There is no model that works. So there actually is no evidence that raising your interest rate appreciates your currency and as Bill was saying there’s no evidence that budget deficits are correlated with currency depreciation. Just plot the US budget deficit against our currency and there just isn’t any correlation. Sometimes currency appreciates with a budget deficit, sometimes it appreciates with a budget surplus. There just isn’t a correlation for this. But yes, I agree with you, central banks think this way and so these are to try to dispel. [00:40:13]

Bill Mitchell: Yeah I mean the example in Australia we were running massive record surpluses and our exchange rate went down to 49 cents US. And these characters here used to call us the half-price country. [laughter] And now I’m here to advise you that you are now very cheap to come here [laughter] and you’re getting cheaper by the day and we’re running huge deficits. [00:40:35]

Warren Mosler: We may not be visiting you in December. [laughter]

Dennis Kelleher, Rebel Capitalist: I have a hypothetical question – I don’t know if I should have disclosed that, but – let’s assume that a government has been enlightened and started practicing modern monetary operations and understanding it, and the link between wage growth and productivity was restored. What impact or potential impact would that have on inflation? [00:41:19]

Warren Mosler: Which link is that?

Dennis Kelleher: Pardon?

Warren Mosler: Which link specifically?

Dennis Kelleher: For years we had a linkage between wage growth and productivity. When productivity increased wage growth – wage – grew with that. Sometime in early, late seventies or eighties that was completely severed. So now we have productivity skyrocketing, wage growth stagnating. So… [00:41:46]

Bill Mitchell: It’s the same the world over. And the empirical studies have never been able to come up with a systematic relationship between wage share movements, which is what you’re really talking about, because the wage share is just the ratio of the real wage to labor productivity, and that clearly in all countries has diverged in — depending where you start — but in the eighties and nineties clearly, and there’s never never been… prior to that, you had a very close correspondence with that. I mean that was in a way the capitalists, if you like the terminology, they were smart enough to realize that you had to have someone to buy the stuff, and in the eighties and nineties they worked out a different way and that was to load the workers up with debt, and get a double whammy: steal the productivity in the first place and then load them up with debt so they could still realize the production. But we didn’t have major inflation breakouts in the fifties, in the sixties, in the seventies when there was an extremely close correspondence in all of our countries between real wage growth and productivity growth. The wage share in Australia used to be 62%, now it’s 51%. And that’s been a systematic erosion of workers’ entitlements. And prior — when it was 62% for years — I mean Nicholas Kaldor used to call it one of the stylized facts — the constancy of the wage share. And it’s only in this neoliberal era that that is no longer a stylized fact. We saw no inflation during those periods. Inflation occurs — sorry Warren — inflation occurs if expenditure nominal demand growth outstrips the real capacity of the economy to respond to that. [00:43:33]

Warren Mosler: Or the price shock.

Bill Mitchell: What’s that? Or a supplier price shock that’s not isolated from the distributional system. And it’s quite possible that if workers are enjoying… You know in Australia we’ve had a system of national arbitration, national wage determination like a Scandinavian system, and it’s always considered that real wage… productivity growth provides the real space for nominal wage adjustments. And as long as the real wages don’t grow faster than productivity growth, you’re unlikely to get nominal demand outstripping real capacity. And the only way you could actually get ongoing aggregate demand growth that will engage your real capacity without indebting your household sector is to make sure real wages do grow in line with productivity growth. [00:44:34]

Warren Mosler: Do you know the game theory story? The other thing is, it’s a basic mainstream game model — the first year, week, of game theory tells you that the labor market, whatever that is anyway, isn’t a fair game, because people have to work to eat, and business only hires if they feel they can make an acceptable rate of profit. So the idea is, as the unemployment goes down, then people who are left unemployed, their bargaining power goes up and they’re able to negotiate higher wages, and therefore as we get to lower… you know, there are productivity differences also, but the fact is, if you’re the last guy waiting for a job, and everybody else has one, and you’re offered a job and you don’t take it, you’re still going to starve. So you don’t have any more bargaining power because the unemployment pool is lower. And we saw unemployment fall below four percent in the late nineties even with the core inflation coming down, so that whole idea that there’s this NAIRU, etc – I don’t see the support for it either in the data or in mainstream theory itself, where once you take a look at rudimentary game theory, there’s no reason to expect real wages to do anything except stagnate, unless there’s some kind of support, either through some kind of Australian type of thing, or some kind of support to at least make it more of a fair game. [00:46:02]

Bryce Covert: Hi, I’m Bryce Covert, I’m with New Deal 2.0, and my apologies if this has already been touched upon, I’m not an economist so I’m not following everything, but it seems like the danger that you do admit to spending is inflation, you know you had that warning, and you’re talking about it a little bit now. I understand the differences between the hyperinflation of Zimbabwe and Weimar Germany but in the US, how much of a risk do we have of that and are there things that should be done or can be done to prevent inflation that we’re not doing? Are we going to run that risk or do you think we’re pretty safe? [00:46:45]

Warren Mosler: Let me just say I think we’re very safe. But the risks of inflation are political, they’re not economic. If we’re wrong and inflation goes up to four or five percent, when we thought it was going to go to one or two, we don’t lose any wealth as a nation, we might lose at the ballot box. We don’t lose anything in terms of employment and output, and in fact most studies show it’s actually more likely to improve things. And we don’t get hurt in terms of investment or anything else like that. Again, studies show that it helps those things. But you do lose at the ballot box. So we do come up with policies that will cater to what voters want and how voters feel good about living their lives. [00:47:24]

Marshall Auerback: I’ll make an additional point. Jamie Galbraith makes this point very well, I’ve seen him make it a number of times, and he talks about the asymmetry of risk. And he simply says that, look, if you don’t spend enough, there’s a major danger of a relapse and that’s coming at a time when we already have, officially, nine and a half percent unemployment, unofficially by any honest measure it’s close to twenty percent. You have very high debt levels in the US, you still have an ongoing housing crisis. So that’s the… you have a possibility of a significant relapse, 1937 style, if you don’t spend enough. Now, if you spend too much, what’s the risk? Well you’ll get fuller employment, you’ll get a lot more capacity being used, and you might eventually get inflation. Okay, you get the inflation, you can solve that through a tax. It’s a very easy problem to solve. Or you simply stop spending, or, equally likely, the automatic stabilizers start taking care of themselves; the economy begins to grow again, more revenues come into the government, social welfare expenditures come down. So that in itself will start to create a fiscal drag on the economy so it seems to me that risks are so stunningly asymmetric in regard to not spending, and that can be done either through direct government spending or by massively cutting taxes, that if I was a trader making a bet right now, inflation-deflation bet, I think it’s still heavily weighted towards the deflation side for all the reasons I’ve outlined. [00:48:57]

L. Randall Wray: Yeah, see, we really need to get into what we mean by inflation, and we need to distinguish between different things that might cause prices to increase, even sustained price increases. So Keynes had this definition, “true inflation”. True inflation only occurs when aggregate demand is too high, that is where you’ve already fully employed your resources and you continue to increase spending. That is true inflation, and the way to fight that is by reducing aggregate demand. So that is when you need to raise taxes, cut government spending, or somehow get the private sector to stop spending, maybe clamp down on banks so they can’t lend, so people can’t borrow and spend. Okay. That’s how you fight that. [00:49:44]

Now what happens if you have an oil price shock? Do you fight that by reducing demand? No, that would not make any sense. You have to find another method. Now, as Bill keeps alluding to, in the kinds of institutional arrangements we have in the United States, an oil price inflation is going to end itself very quickly, because we don’t have very much indexing of wages in our society, or of government spending in our society, that is going to cause an oil price shock to lead to a wage-price spiral, or something like that. But we could have those and if we did, then the way to fight that is through institutional change, not by clamping down on aggregate demand. You want to change the institutions, maybe centralize wage bargaining would be a way to do it, and figure out how you’re going to share the costs of adjusting to higher oil prices. [00:50:41]

So we really need to identify why we got the inflation. If it’s because the currency is depreciating, again, in the United States this isn’t very plausible; in a country like Mexico, they have very high feed-through impacts of currency depreciation into rising prices, so they’ve got to deal with that problem, something that we don’t have to deal with. And then finally, what everyone is talking about is the current outlook, the current situation in the United States, it’s just about impossible to identify a way that we could get inflation going even if we wanted to. And this is where Japan has been for a very long time. We have to remember that we just had two billion people come into the market economy, and they all want to produce stuff and sell it to us, and they’re willing to work at very low wages, and their firms are willing to sell at very low prices. It’s just not a plausible argument, even if we got closer to full employment, that we’re going to get significant inflation pressures, other than, yes, commodities prices could go up and we could have a very short-term increase of prices, which is what Bill was trying to get to, that’s not inflation, but it is going to cause a redistribution of income. [00:52:03]

Bill Mitchell: I think it’s really telling that — and it’s sort of building on Warren’s point — that we’re always talking about inflation threats, when you’ve got, maybe — I’m not sure in America, it’s about 17.2 percent currently, I’m not sure, you use six measures? In Australia it’s 13.2. In some countries, in Spain it’s at least 30 percent once you add in underemployment — of your labor resources unemployed. And we’re worried about inflation. I mean, one of the greatest successes of the neoliberal period has been able to convince us, and as relates to — Marshall said that the risks are just asymmetric, well, so are the costs. The costs of unemployment dwarf any other economic costs you can possibly identify. And this goes back to a famous interchange between the American economists Arnold Harberger and Arthur Okun, and I think it was Tobin who said it, yes?, “How many Harberger triangles can you fit into one Okun gap?” And, for non-economists, the Harberger triangles were these measures of inefficiencies, microeconomic inefficiencies, of the sort that you might get with some inflation. And the Okun gap was the lost output from having unemployment below — above full employment. And the answer to the question, “How many of these microeconomic inefficiency measures can you fit into one macroeconomic inefficiency measure,” the answer is “Lots.” [laughter] And the point about it is that the macro costs of unemployment and lost income and all of the related social pathologies and intergenerational pathologies that follow are massive. And you’re sitting here in this country, and my country, and other countries idly sitting by wasting forever billions of dollars of income generation every day. And the only thing you can come up with is worrying about inflation. Even if inflation was a risk I wouldn’t worry about it right now because the relative costs are just not even commensurate. And that’s the big success of the neoliberal era, to get us to, to disabuse us of the notion that unemployment is a cost, and unemployment should be a policy target. We now under our central banking inflation-targeting, inflation-first type policy emphasis, we now use unemployment as a policy tool. We’re now using the most costly pathology of market-based economies as a tool to discipline something that is nowhere near the scale of cost. And that’s the success of the neoliberal era, and it’s a damn shame. [00:55:15]

L. Randall Wray: You’re giving our presentation.

Bill Mitchell: Sorry. [laughter] [applause] [00:55:20]


Warren Mosler: It’s probably fair to say that the losses from unemployment over the last two years just in terms of lost output are far higher than all the costs of all the wars the US has ever fought in its history combined. Seriously. That’s just gone forever. Plus the ongoing losses because it’s all path-dependent. Once you change your path, you’ve lost it, the growth rates have to be much higher to get back onto path. [00:56:00]

Bill Mitchell: And millions and millions of dollars a day, every day, our countries are forgoing. Millions of dollars a day. Inflation will never go anywhere near that.

Warren Mosler: Well, if we have twenty percent unemployment, I known not everybody’s equally valuable, but it wouldn’t surprise me if the losses are twenty percent of GDP every year, or something close to it. [00:56:20]

Bryce Covert [??]: Maybe that’s the graph we need.

Warren Mosler: Yeah, well, the output gap. So what they do, is when they compute the output gap, is they assume some minimum level of unemployment for inflation control. So even the output gaps, which are huge now, far underestimate what the actual output gap is if they didn’t have that artificial constraint of five percent unemployment, for what they call the NAIRU. And now they’re talking about moving that up to six and seven and eight percent, where Europe’s been at nine for how long? Forever, right? Ten, yeah. [00:56:54]

Unidentified: I think it was Keynes who used the example of paying people to dig ditches and then paying other people to fill them up again, and I always thought it was curious that it was politically acceptable to discuss something as useless as that in a serious idea, and I gather that one of the reasons for that is that the thought of government paying people to do something useful which would compete with the private sector is kind of what makes you go into that sort of nonsense realm. And basically what I’m thinking is that there is a sort of minimum profit margin that the private sector demands, and they don’t want government competing and employing people and lowering their profit margins. And where I’m going with this is that we have repealed the laws against usury and made profit margins in certain financial endeavors very very high, and everything pales in comparison. People who would become engineers instead become bond traders. And if we’re ever going to focus people on doing useful work at perhaps lower margins, don’t we have to get a handle on usury? [00:58:11]

Warren Mosler: I’ll be the first to say that the financial sector is, by and large, a total waste of human endeavor [laughter], but I’ll let Randy — my tag line is “the financial sector’s a lot more trouble than it’s worth” — but I’ll let Randy comment on putting Keynes in context. But the other thing is, the size of government is a political choice, how much we want, and it’s there for public infrastructure. Digging holes and filling them in is not public infrastructure. Go ahead and put Keynes in context. [00:58:41]

L. Randall Wray: He was being sarcastic, he was saying, if you guys are so stupid you can’t think of anything useful for these people to do, we could at least hire them to dig holes and bury money, so that wasn’t his prooposal. He wanted to hire people to do useful things. And let me just tell you, the next panel we’re going to talk about the job creation program, and so the people will do useful things. But the other thing is, they won’t compete with the private sector. You want to ensure that they won’t compete with the private sector; you want to complement the private sector. So I just want to clear that up, but that will be addressed in the next panel. [00:59:16]

Unidentified: Do you have any notion that by repealing the laws against usury is part of what’s wrong?

L. Randall Wray: Well of course, what Keynes wanted was full employment, and euthanasia of the rentiers. Euthanasia of the rentiers. He wanted to drive the overnight interest rate down to zero, and I think many of us up here support that. And I think that that is a way to put finance back into its place. It’s only part of the answer. So downsizing finance, we agree with you, well I think we all agree with you, probably all of us. [00:59:50]




Continue to Session 5…..




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