Posts Tagged ‘krugman’

Fears of Insolvency/Monsters vs. Actual Insolvency/Monsters: Case Studies

August 12, 2011 5 comments

Kids are afraid of things that don't exist - and this has real world impact on famlies

Oliver, from the Comments:

“A market commentator here said the other day, after news that the SNB had suffered a massive loss last year, that, as a national bank, the SNB was not ‘really’ subject to the same kinds of constraints as other financial institutions. This put a smile on my face although I bet the significance of the comment was lost on most viewers.

Seems the art of central banking nowadays lies in fathoming the degree to which irrational fears among the population can be circumvented through either secrecy or technical gibberish to be able to pursue a rational agenda, whereas the art of politics lies in tapping these same fears for short-term political gains. I.e. they’re moslty working against each other.”

I have a 7 year old son.  He’s actually afraid of monsters – not horribly afraid, but this fear sometimes keeps him up at night.

It keeps him up at night even though monsters do not exist.

Still despite monsters not existing, monsters impact his and my world.  His fear of something that does not exist has real world repercussions for him – and for our entire family.

When he’s afraid, he doesn’t fall asleep right away, so he might stay up until midnight in his bed.  This results in him not getting enough sleep, so he’s a somewhat of a jerk the next day. He’s tired and cranky for the entire next day.   This manifests in him crying really easily, and having a bad time almost no matter what he does.

Of course, this is hard on me and Ms. Traders Crucible.   He’s more insufferable as the day goes on, so as we’re getting tired, he’s getting totally jerkish.  It can be tough.

He’s a great kid overall, and the “afraid of the dark” phase is really common with kids.  He’ll grow out of it.

So here we have a situation where fear of something that does not exist have negative repercussions on the real world.

Colorful Swiss franc notes aren't even the cheapest way to make money. Its even cheaper just to change the numbers in the computer system

In the world of Central banks and interventions, we have a similar dynamic.  They cannot “go broke”:  There is nobody with authority to shut them down.  They have unlimited firepower – it’s nearly costless for them to create more computer entries that top up their accounts.

Central bankers suspect this is the case.  But they are constrained by political concerns.  They could intervene in truly massive size, but the political side makes it tough.

And people who are not economists might have real fears about insolvency.  Politicans exploit this all the time – and it makes us all poorer in the real world than we should be.

For example, in the 1920’s with the French franc, the population had fears about insolvency.  While this insolvency was probably impossible – it appears that the franc was a full fiat currency at that point – people still thought there was a possibility of a default.

The franc devalued.  The economic reason it devalued was people wanted less savings in French francs than the amount of French francs available for saving.

The reason this saving preference changed was people had an irrational fear about insolvency.  But the economics don’t give out a satisfaction survey after you try to get rid of your currency. It only cares about the actions, not the reasons those actions were taken.

No matter how irrational the reason people wanted less francs, the only thing that mattered was they wanted less francs.

Now, somehow this is supposed to be taken as proof MMT isn’t valid.  Frankly (heh!) I’d use this as nearly a perfect case study of why MMT is such a powerful model for thinking about money.

After you understand that default is impossible, but debasement is possible, the next thing you’ll think is that the inflation rate must depend on the relationship between the deficit and net demand for savings in that currency.

And you’re then walking the MMT path.

What I am afraid of is that the economics profession will not grow out of this fear of insolvency.  It is August 2011.

When will economics grow up and stop being afraid of a monster that does not exist?  When will they grow up and start dealing with the monsters that do exist – unemployment and inflation?

[Update: Oliver points us to the current colorful Swiss script.]

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Paul Krugman does not get MMT. But he will take the plunge today.

August 11, 2011 16 comments

Paul Krugman goes after MMT again today.[h/t to the tireless Prag Cap]

Fortunately, the example he provides is basically a great supporting historical fact for MMT.  France had a bout of inflation after a huge runup in debt.

Since the franc was a sovereign currency, there was no chance of default.  But of course, there was the potential for inflation.

After people changed their savings preferences, the value of the French franc plummeted.  The reason why people changed their franc savings preferences lower is not as important as the change itself.

This is exactly what MMT says can happen.

This gets back to my rant about Solvency and Debasement.

Debasement is possible.  Insolvency is impossible.  Insolvency is not possible even if people believe its possible.

The consequences of this distinction are huge – thanks again SWR:

“[T]he impossibility of insolvency does not mean the fiat currency will have value. A government might be fully solvent even with a worthless currency… This distinction between insolvency and debasement is at the heart of MMT…

Why is the Traders Crucible going nuts…about the difference between insolvency and debasement?

Well, we can directly observe the debasement of a currency in an economy through the inflation rate. We can directly observe the process of debasement and loss of value of the currency through inflation.

We cannot directly observe the risk of insolvency — it must be inferred from bond price action… the resulting process is one of guesswork, misstatements, boneheaded plans, wild specualtion, and dumbassery, because there is no way to observe the risk of insolvency directly even though it is one of the ideas that govern our spending. …

[B]y removing the fear of insolvency, we can more directly observe the risk of debasement…

[W]e don’t need to rely on the bond market to “give us signals” about the potential loss of access to their club to determine if we need to lower spending, or raise spending. We can just witness inflation and unemployment and make decisions on these two variables, instead of the three variables of unemployment, inflation, and insolvency… This is a much simpler task, and is perhaps the core strength of the MMT paradigm.”

I left a message there, I hope he clicks through.

[Update:  Mosler has an awesome rant on a similar topic. But you already knew this.]

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