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This is a collection of my various writings and some ideas are
repetitive. * To: a-list@xxxxxxxxxxxxxxxxxxx <mailto:a-list@DOMAIN.HIDDEN> * Subject: Re: [A-List] The Peso is a "Derivative" of the Dollar * From: "Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx <mailto:hliu@DOMAIN.HIDDEN>> * Date: Mon, 19 Aug 2002 22:56:23 -0400 There are fundamental faults with specie money. To begin with, specie money must be based on a comoditiy of limited supply. There was a time when new gold was discovered so abundantly in the New World that gold was the cause of inflation in Europe. Thus an effective specie money by nature cannot support optimum economic growth, because its function is to preserve the value of money. In a high growth economy, such as most modern economies aspire to be, the limited supply of gold cannot meet the necessary monetary expansion, thus gold backed money will be deflationary and counter growth. In real terms, if the dollar were to be gold backed today, it would have to be valued at $35,000 per onze. Two things will immediately happen: the equity market will fall in price by 100 fold with the DOW at 80, and Russia and other gold producers will instantly emerged as new superpowers. Money is not a storer of value, it does not need to have any intrinsic value at all to be accepted. Gold coins circulated only in markets beyond the political influence of the currency issuer. Minsky is correct that money is created whenever credit is granted. Thus anyone can create money while legal tender can only be issued by government. Capitalism is a game for those who has capital. Under capitalism, money is a unit of account of capital. Before capitalism, taxes were paid with agricultural produce, livestock and textile under feudalism. Under capitalism, money is not the root of all evil, but the lack of it is. The challenge of the capitalist regime is to deliver money to as many of the population as possible without debasing the value of money or causing inflation. This logic was operative under industrial capitalism, because capital then performed a function of increasing the productivity of labor. But this function had a limited lifespan. Capital formation soon reduced labor's share of the wealth created by increased productivity to the point of retarding the growth of aggregate demand to keep abreast of productive capacity. Marx's insight of surplus value being the cancer of capitalism is based on this cause-effect. The purpose of government are two fold: 1: to prevent revolution (the overthrow of government) and 2: to institute policies that deliver money to the population through employment in the non- government sector (not necessarily private). This is done by granting credit (a form of money creation) to the economy through government debt which in turn is serviced by taxes. When a government runs a budget surplus, it is essentially draining credit from the economy, thus slowing it down. When government desires a growth economy, it has no business running a suplus. The tax rate is not a critical as long as tax revenue is not used to reduce the national debt. A high tax rate, provided it is not conficatory, will lead to a more dynamic economy because capital cannot afford to be idle and enjoy gain merely from passive investment. A government deficit is a way of correcting market failure, by government spending on parts of the economy that the market ignores, such as health, education, infrastructure, pollution control and environmental protection, security and research with no short term profit. Any government that incurs foreign currency sovereign debt should be impeached. The IMF notion of austerity conditionality of increasing unemployment to service foreign currency government debt is self defeatingly irrational. Full employment with high wages strengthens sovereign credit rating through high demand in an overproduction economy to generate needed tax revenue. There is no positive policy effect in pursuing unemployment and tax reduction, the darlings of supplysiders. The Austrian School formulated their precepts during a very peculier period of European history, the hyperinflation periods following the two World Wars. It preyed on US phobia against revolution by promoting a fear of hyperinflation. The Austrians propose sound money and free markets as a deterent against revolution, but they want to achieve it by making money scarce and by shutting off all unprofitable economic activities. This creates widespread provety which leads directly to revolution. Money is more valuable when more people have more of it, not the other way around. End of post. Government bonds are debts, because the selling of bonds soaks up money (sovereign credit) from circulation. Money is sovereign credit because it soaks up sovereign or private debt when used to buy bonds (debt) and inject credit into the financial system. Sovereign debt is never needed to finance domestic development, which can be financed with sovereign credit. Government issues sovereign credit so that a private debt market can work without specie money. Sovereign credit is the benchmark of all credit ratings. Swapping of bonds is a common practice in finance, particularly in structured finance where a bond can be stripped in many different ways to meet the varying requirements of different buyers. The technical term is unbundling. These unbundled bonds all have one thing in common with sovereign debts, i.e. they entitle the holder at maturity to receive payment in money directly or indirectly from the Treasury, retiring the debt with sovereign credit. When that happens, the retired bond disappears from the debt market. Repo contracts from the Fed are short-term borrowings from the central bank using government bonds as collateral. The Fed gives the repo borrowers money with an agreement for the borrower to repossess the bonds by paying off the short-term loan with money. The process generally can be rolled over with only an interest rate risk. Private repo contract between counterparties do not involve the Fed, but are subject to interest rates target set by the Fed. Repos do not cancel any collateralized bonds, they only monetize the bonds for the duration of the repo agreement. The monetized amounts then become bank deposits, which generate broad money through partial reserves. Government bonds when traded or use as loan collaterals between private or public entities beside the issuer can generate broad money creation, but not high power money creation. At the initial issuance of the government bond, the money supply is reduced by the discounted amount of the bonds, because money is withdrawn from the market. But if the Treasury deposits the proceeds from the bonds in banks, then the deposits will generate broad money through bank lending. Trading of debt does not turn debt into credit because the owner of a debt is the creditor, and the holder of a government bond is a creditor to the government. At maturity, the debt is payable in fiat money. But the holder of fiat money is only an agent of the government and not a creditor to the government, because the holder of fiat money is only entitled to replacement by government of the same money. Changing money for itself is not a financial transaction. Changing bonds into money at maturity is a financial transaction between government and bond holders, in which government-issued sovereign credit is exchanged for sovereign debt. A debt instrument, even a government debt instrument, can be used as a credit instrument by the creditor. In that case, the transaction is an assignment. The original buyer of the bond has paid money (a government credit in his possession) for the government bond (a government debt). The bond holder can trade away the government debt to another party by transferring or assigning the right to receive money from the government (government credit) at maturity of the bond. Nevertheless, the debt is cancelled only at bond maturity, not sooner, regardless how many times it is traded and with whom. Although government-issued money is not a government debt, a government credit instrument can be used by market participants in the private sector either to issue credit or to assume debt. The payer of money for services not yet received is a creditor. The receiver of money for services not yet delivered is a debtor. Government, when issuing money, expects no goods and services other than the future payment of taxes in the form of money. Thus government-issued money is a credit instrument for taxes not yet received. When government buys good and services with money, it is spending its tax credit. The transaction does not make money a government debt. Fiat money is government credit and fiat money in the hands of a private entity makes the holder an agent of the government, the ultimate creditor. Holders of fiat money acts as an agent for government credit. The money holder earned the right to be a government credit agent by providing goods and service in exchange for the money, or becoming indebted to a bank who acts as an agent of government credit. Money paid for tax liability is government credit cancelled. Money spent for goods and services is assignment of government credit to the money receiving party. Credit drives the economy, not debt. Debt is the mirror reflection of credit. Even the most accurate mirror does violence to the symmetry of its reflection. Why does a mirror turn an image right to left and not upside down as the lens of a camera does? The scientific answer is that a mirror image transforms front to back rather than left to right as commonly assumed. Yet we often accept this aberrant mirror distortion as uncolored truth and we unthinkingly consider the distorted reflection in the mirror as a perfect representation. Similarly, we reflexively accept as exact fidelity the encrypted labels assigned to our thoughts by the distorting mirror of language. Such habitual faulty acceptance is consequential because it is through language that ideas are transmitted and around language that culture develops. In the language of economics, credit and debt are opposites but not the same. In fact, credit and debt operate in reverse relations. Credit requires a positive net worth and debt does not. One can have good credit and no debt. High debt lowers credit rating. When one understands credit, one understands the main force behind the modern economy, which is driven by credit and stalled by debt. Behaviorally, debt distorts marginal utility calculations and rearranges disposable income. Thus debt turns more commodities into Giffen goods, whose consumption increases when their prices go up, and creates what US Federal Reserve Board Chairman Alan Greenspan calls "irrational exuberance", the economic man gone mad. The Foreign Capital Hoax The Chartalist theory of money claims that government, by virtual of its power to levy taxes payable with government-designated legal tender, does not need external financing. Accordingly, sovereign credit should enable the government to act as employer of last resort to maintain full employment even in a regulated market economy. The logic of Chartalism reasons that an excessively low tax rate will result in a low demand for currency and that a chronic government budget surplus is economically counterproductive and unsustainable because it drains credit from the economy. The colonial administration in British Africa learned that land taxes were instrumental in inducing the carefree natives into using its currency and engaging in financial productivity. Thus, according to Chartalist theory, an economy can finance its domestic developmental needs, to achieve full employment and maximize balanced growth with prosperity without any need for sovereign debt or foreign loans or investment, and without the penalty of hyperinflation. But Chartalist theory is operative only in closed domestic monetary regimes. Countries participating in neo-liberal international “free trade” under the aegis of unregulated global financial and currency markets, cannot operate on Chartalist principles because of the foreign-exchange dilemma. Any government printing its own currency to finance legitimate domestic needs beyond the size of its foreign-exchange reserves will soon find its currency under attack in the foreign-exchange markets, regardless of whether the currency is pegged at a fixed exchanged rate to another currency, or is free-floating. Thus all non-dollar economies are forced to attract foreign capital in dollar to meet domestic needs. But countries must accumulate dollars before they can attract foreign capital. Even then, with capital control, foreign capital will only invest in the export sector where dollar revenue can be earned. But the dollars that accumulate from trade surpluses can only be invested in dollar assets in the United States, depriving local economies of needed capital. The only protection from such attacks on domestic currency is to suspend full convertibility, which then will keep foreign investment away. Thus dollar hegemony starves the non-dollar economies of needed capital by depriving their governments of the power to issue sovereign credit domestically. Precisely to prevent such currency attacks, tight control on the international flow of capital was instituted by the Bretton Woods system of fixed exchange rates pegged to a gold-backed dollar at $35 per ounce after World War II. Drawing lessons from the prewar 1930s Depression, economics thinking prevalent immediately after WWII had deemed international capital flow undesirable and unnecessary. Trade, a relatively small aspect of most national economies, was to be mediated through fixed exchange rates pegged to a gold-backed dollar. The fixed exchange rates were to be adjusted only gradually and periodically to reflect the relative strength of the participating economies. The impact of exchange rates were limited to the finance of international trade, and was not expect to dictate domestic monetary policy, which was crucial to domestic development and regarded as the province of national autonomy. Under principles of Chartalism, foreign capital serves no useful domestic purpose outside of an imperialistic agenda. Thus dollar hegemony essentially taxes away the ability of the trading partners of the United States to finance their own domestic development in their own currencies, and forces them to seek foreign loans and investment denominated in dollars, which the US, and only the US, can print at will. The Mundell-Fleming thesis, for which Robert Mundell won the 1999 Nobel Prize, states that in international finance, a government has the choice between (1) stable exchange rates, (2) international capital mobility and (3) domestic policy autonomy (full employment/low interest rates, counter-cyclical fiscal spending, etc). With unregulated global financial markets, a government can have only two of the three options. Through dollar hegemony, the United States is the only country that can defy the Mundell-Fleming thesis. For more than a decade since the end of the Cold War, the US has kept the fiat dollar significantly above its real economic value, attracted capital account surpluses and exercised unilateral policy autonomy within a globalized financial system dictated by dollar hegemony. The reasons for this are complex but the single most important reason is that all major commodities, most notably oil, are denominated in dollars, mostly as an extension of superpower geopolitics. This fact is the anchor for dollar hegemony. Thus dollar hegemony makes possible US finance hegemony, which makes possible US exceptionism and unilateralism. The Foreign Exchange Carnage Finance capitalism has operated on fiat money issued by governments worldwide ever since Nixon abandoned in 1971 the Bretton Woods regime of fixed exchange rates based on a gold-backed dollar. Beginning in the early 1960's, with the growth of Eurocurrency markets where banks in one European country could take deposits and make loans in currencies of other countries, the tight controls of international flow of capital set up by the Bretton Woods system of fixed exchange rates after World War II were effectively bypassed. When the fixed exchange rate system set by Bretton Woods finally broke down by 1973, with a gold-backed US dollar that became fatally wounded in 1971 by decades of US fiscal irresponsibility, the developed countries abandoned capital controls officially. In the late 80's, many developing countries followed suit. Growing from $190 billion at the beginning of the 1990s, daily turnover of foreign exchange grew almost one hundred fold to $1.5 trillion in unregulated foreign exchange markets. Only 5% of theses transaction is related to trade and others trade-associated transactions. The other 95% are financial transactions to facilitate international flow of funds, much of which involve speculative plays as traders bet on exchange rate fluctuations and interest rate differentials between currencies. This kind of financial speculation plays havoc with national budgets, macroeconomic planning and rational allocation of resources. Governments, businesses and individuals have become increasingly frustrated with the whimsical and often irrational activities in global financial markets that have such influence over national economies and are seeking some means to curb damaging and unproductive speculative activities. By 1996, some $350 billion of private capital flowed into emerging markets, a seven-fold increase in 6 years. The bulk of this inflow went through global commercial banks. After July 1997, the bulk of the outflow left in the form of sudden withdrawal also through commercial banks. For the two decades before the Asian Financial Crises that began in 1997, technical imbalances between interest rates set by different central banks for funds in different currencies distorted capital flow around the world from economic fundamentals. The resultant inflow of capital into Asia through inter-linked financial markets around the globe outstripped the region's viable absorption rate. Financial institutions took advantage of low cost funds denominated in currencies of select countries, namely Japan, Germany and the United States, to make loans at higher interest rates denominated in local Asian currencies. These institutions sought to strategically profit from recurring technical imbalances in global finance by assuming currency risks, rather than from traditional direct investment returns. Economists call this activity international arbitrage on the principle of open interest parity. In banking parlance, this type of activity is known as "carry trade". This abusive speculation was by no means limited to emerging economies. Corporation in developed economies routinely engaged in global financial and stock manipulative speculation at the expense of sound investment/production strategies. The public announcement of plans to open new factories in emerging markets in Asia and Latin America predictably lifted share value in home markets, regardless of such factories being risky loss-makers, for the loss would be more than offset by the increase market capitalization resulting from the publicity of a presence in an emerging market. Corporate borrowers in Asia, attracted by low rates in some foreign currency loans, have also assumed currency risks, at times even bypassing local banks to borrow directly overseas in global debt markets. Borrowers, anticipating asset inflation brought on by runaway growth, also succumbed to the irresistible temptation of borrowing short-term to finance long-term projects, thus adding to the risk they assumed. Simultaneously, many Asian banks have taken local currency deposits at low saving rates (in Hong Kong at times at negative interest rates - depositors pay the bank to keep their money in local currency) to invest overseas in risky foreign currency instruments yielding higher returns, engaging in carry trade. Local banks in turn replenished the depleted local capital pool with low-cost foreign currency loans from international banks, taking on both economic and currency risks. Borrowing low and lending high is the basic business of banks and there is nothing wrong with it if the activities occur within a well-regulated market in a bank's domicile community. With the advent of deregulated global banking, however, the unregulated internationalization of finance has created perilous systemic stress. Banks began to act as international loan brokers, profiting from interest rate spreads between local and foreign funds, often booking the risk premium added to over-valued currency interest rates as legitimate loan profits. These banks also began to maximizing their profits by maximizing loan volume, abrogating their traditional economic function as responsible financial pillars of local economies to ensure the productive allocation of capital. In time, local banks de-coupled their business self-interest from the economic impacts of their loans on the local economies, because they hedged the risk in such loans by passing it to overseas hedge funds which became the real loan originators to whom the banks themselves lend the funds. Western and Japanese international banks in turn provided funds to the local broker banks in Asia whose credit ratings were considered acceptable because the borrowers' exposures were hedged by instruments designed to transfer risk to other international institutions. In effect, the widespread transfer of business risks into currency risks forced the governments of the affected currencies to become lenders of last resort. This is the real economic effect of Hong Kong's, Argentina’s and other currency peg regimes to the US dollar. To increase returns, banks also creatively skirt regulation through structured finance devices such as collateralized mortgage obligations (CMO) which releases pressure on capital requirements. CMOs are essentially new junior debts secured by old senior debts that takes advantage of the theory of large numbers and hierarchy of risk. Similarly, corporations issue convertible bonds that do not appear on the corporation's balance sheets, but expose the borrower to instant repayment requirements should its share value drop below the specified amount. So in an era of allegedly increased transparency, layers of opaqueness are introduced through structured finance. The unbundling of risk acts as a disguise of risk. Hedging does not eliminate risk, it merely passes risk along to other parties. In fact, complex hedging schemes, with the effect of reducing the risk exposure of individual lenders and inflating the credit worthiness of the hedged individual borrowers, when widely practiced, actually increase systemic risk exposure, initially of regional financial systems and ultimately of the global system. Yet the soundness of financial institutions continue to be assessed singularly without regard to counterparty credit worthiness and the breakdown of insularity within national borders, while financial markets have become intricately linked globally. A poor credit rating seldom means the denial of credit. It only means a higher interest rate which actually attracts more eager lenders who rationalize that the high risk has been compensated for by the increased lending rate. Junk bond rates are calculated from historical industry-wide default frequencies. Through extensive hedging, private financial risks have been largely socialized globally, while profits from systemic efficiencies remain in private hands. The ingenious layering of protection against risk, while providing comfort to individual players, buys such comfort at the expense of the security of the total global system. At some point, the strained circular chain breaks at the weakest link and panic sets in. That break occurred in Thailand on July 2, 1997. When the Asian financial crises began in Thailand, it had not been triggered by hyperinflation or a sudden drop in corporate earnings. It was triggered by a collapse of an over-valued Thai currency pegged to the US dollar, the defense of which drained the Thai central bank of its foreign exchange reserves. In hindsight, it is indisputable that the conditions that led to the Asian financial crises were: unregulated global foreign exchange markets; the widespread international arbitrage on the principle of open interest parity (carry trade); short term debts to finance long-term projects; hard currency loans for project with only local currency revenue; overvalued currencies unable to adjust to changing market values because of fixed pegs and, above all, instant massive movement of funds that was susceptible to herd panic, known as contagion. Under these conditions, when a threat of currency devaluation caused by a dwindling of reserves appeared, the entire financial house of cards collapsed, causing havoc in connected economies in a chain reaction, called contagion. Collapse of one currency then quickly grew into regional economic crises within weeks, then turned global, eventually hitting Russia, Brazil, Argentina and Turkey. Because of this circular system of global hedging, the economic crises in Asia inevitably spread worldwide. The regional crises, each with unique local characteristics, are merely early symptoms of a ticking global time bomb constructed out of the complex calculus of inter-linked financial markets in which countless individual credit risks are legally masked as sound transactions through sophisticated hedging. Derivatives, financial instruments which derive their value from other underlying financial instruments or benchmarks such as stock indices or exchange rates, are the cards in the fragile house of cards built by a financial specialty known as "structured finance". Sovereign Credit (Part
1) By Henry C.K. Liu Credit drives the
economy, not
debt. Debt is the mirror reflection of
credit. Even the most accurate mirror does violence to the symmetry of
its
reflection. Why does a mirror turn an image right to left and not
upside down
as the lens of a camera does? The scientific answer is that a mirror
image
transforms front to back rather than left to right as commonly assumed.
Yet we
often accept this aberrant mirror distortion as uncolored truth and we
unthinkingly consider the distorted reflection in the mirror as a
perfect
representation. Most monetary economists view government-issued
money as a
sovereign debt instrument with zero maturity, historically derived from
the
bill of exchange in free banking. This
view is valid for specie money, which is a debt certificate that can
claim on
demand a prescribed amount of gold or other specie of value. Government-issued fiat money is not a
sovereign debt but a sovereign credit instrument. Sovereign
government bonds are sovereign debt
while local government bonds are institutional debt, but not sovereign
debt
because local governments cannot print money.
When money buys bonds, the transaction represents credit
canceling
debt. The relationship is rather
straightforward, but of fundamental importance. If fiat money is not sovereign debt, then the
entire
conceptual structure of finance capitalism is subject to reordering,
just as
physics was subject to reordering when man's worldview changed with the
realization that the earth is not stationary nor is it the center of
the universe.
For one thing, the need for capital
formation for socially useful development will be exposed as a cruel
hoax. With sovereign credit, there is no need
for
capital formation for socially useful development. For
another, private savings are not necessary
to finance socio-economic development, since private savings are not
required
for the supply of sovereign credit. Sovereign
credit can finance an economy in which unemployment is unknown, and
wages constantly
rising. A vibrant economy is one in
which there is labor shortage. Private
savings are needed only for private investment that has no intrinsic
social
purpose or value. Savings without full
employment are deflationary, as savings reduces current consumption to
provide
investment to increase future supply.
Say's Law of supply creating its own demand is a very special
situation
that is operative only under full employment.
Say's Law ignores a critical time lag between supply and demand
that can
be fatal to a fast moving modern economy.
Savings require interest payments, the compounding of which will
regressively make any financial system unsustainable. The religions
forbade
usury for very practical reasons. Fiat money issued by government is now legal tender in all modern national economies since the collapse of the Bretton Woods regime of fixed exchange rates linked to a gold-backed dollar in 1971. The State Theory of Money (Chartalism) holds that the general acceptance of government-issued fiat currency rests fundamentally on government's authority to tax. Government's willingness to accept the currency it issues for payment of taxes gives such issuance currency within a national economy. That currency is sovereign credit for tax liabilities, which are dischargeable by credit instruments issued by government in the form of money. When issuing fiat money, the government owes no one anything except to make good a promise to accept its money for tax payment. A central banking regime operates on the notion of government-issued fiat money as sovereign credit. Thomas Jefferson prophesied: "If the American people allow the banks to control the issuance of their currency, first by inflation, and then by deflation, the banks and corporations that will grow up around them will deprive people of all property until their children will wake up homeless on the continent their fathers occupied ... The issuing power of money should be taken from the banks and restored to Congress and the people to whom it belongs." This warning applies to the people of the world as well. (759 words) Sovereign Credit (Part II) By Henry C.K. Liu Government levies taxes not to finance its
operations, but
to give value to its fiat money as sovereign credit instruments. If it chooses to, government can finance its
operation entirely through user fees, as some fiscal conservatives
suggest. Government needs never be
indebted to the public. It creates a
government debt component to anchor the debt market, not because it
needs
money. Technically, government needs
never borrow. It issues tax credit in
the form of fiat money. And only
government can make fiat money as sovereign credit. Sovereign debt is a pretend game to make private
debts
tradable. The relationship between assets and liabilities is expressed
as
credit or debt, with the designation determined by the flow of
obligation. A
flow from asset to liability is known as credit, the reverse is known
as debt. A creditor is one who reduces his
liability to
increase his assets, which include the right of collection on the
liabilities
of his debtors. The state, representing the people, owns all
assets of a
nation not assigned to the private sector.
Thus the state's assets is the national wealth less that portion
of
private sector wealth after tax liabilities, and all other claims on
the
private sector by sovereign rights. Privatization generally reduces
state
assets. As long as a state exists, its
credit is limited only by the national wealth.
If sovereign credit is used to increase national wealth, then
sovereign
credit is limitless as long as the growth of national wealth keeps pace
with
the growth of sovereign credit. When the state issues money as legal tender, it
issues a
monetary instrument backed by its sovereign rights, which includes
taxation.
The state never owes debts except specifically so denoted voluntarily. When a state borrows in order to avoid
levying or raising taxes, it is a political expedience, not a financial
necessity. When a state borrows, through
the selling of government bonds denominated in its own currency, it is
withdrawing previously-issued sovereign credit from the financial
system. When a state borrows foreign currency,
it
forfeits its sovereign credit privilege and reduces itself to an
ordinary
debtor because the state cannot issue foreign currency. Government bonds can act as absorber of credit
from the
private sector. US Government bonds,
through dollar hegemony, enjoy the highest credit rating, topping a
credit risk
pyramid in the international debt market.
Dollar hegemony is a geopolitical phenomenon in which the US
dollar, a
fiat currency, assumes the status of primary reserve currency of the
international finance architecture. Architecture
is an art of aesthetics in the moral goodness sense, of which the
current
international finance architecture is visibly deficient.
Thus dollar hegemony is objectionable not
only because the dollar usurps a role it does not deserve, but also
because its
effect on the world community is devoid of moral goodness, because it
destroys
the ability of sovereign governments to use sovereign credit to
development
their economies. Money issued by government fiat is a sovereign
monopoly
while debt is not. Anyone with
acceptable credit rating can borrow or lend, but only government can
issue
money as legal tender. When government issues fiat money, it issues
certificates of its credit good for discharging tax liabilities imposed
by
government on its citizens. Privately
issued money can exist only with the grace and permission of the
sovereign, and
is different from government-issued money in that privately issued
money is an
IOU from the issuer, with the issuer owing the holder the content of
the
money's backing. But government issued
fiat money is not an IOU from the government because the money is
backed by a
potential IOU from the holder in the form of tax liabilities. Money issued by government by fiat as legal
tender is good by law for settling all debts, private and public. Anyone refusing to accept dollars in the US
is in violation of US law. Instruments
used for settling debts are credit instruments.
Buying up government bonds with government-issued
fiat money
is one of the ways government releases more credit into the economy. By
logic,
the money supply in an economy is not government debt because, if
increasing
the money supply means increasing the national debt, then monetary
easing would
contract credit from the economy.
Empirical evidence suggests otherwise: monetary ease increases
the supply
of credit. Thus if money creation by government
increases credit, money issued by government is a credit instrument,
quod erat
demonstrandum. (735 words) Sovereign Credit (Part III) By Henry C.K. Liu American Economist Hyman Minsky rightly said that
whenever
credit is issued, money is created. The
issuing of credit creates debt on the part of the counterparty; but
debt is not
money, credit is. Debt is negative
money, a form of financial antimatter.
Physicists understand the relationship between matter and
antimatter. Einstein theorized that
matter results from concentration of energy and Paul Dirac
conceptualized the
creation of antimatter through the creation of matter out of energy. The collision of matter and antimatter
produces annihilation that returns matter and antimatter to pure energy. The same is true with credit and debt, which
are related but opposite. They are
created in separate forms out of financial energy to produce matter
(credit)
and antimatter (debt). The collision of
credit and debt will produce an annihilation and return the resultant
union to
pure financial energy un-harnessed for human benefit. Monetary debt is repayable with money. Government does not become a debtor by
issuing fiat money, which, in the US, takes the form of a Federal
Reserve note,
not an ordinary bank note. The word "bank" does not appear on US
dollars. Zero maturity money (ZMM) in
the dollar economy, which grew from $550 billion in 1971 when President
Nixon
took the dollar off a gold standard, to $6.333 trillion as of June
2003, is not
a federal debt. It amounts to over 60%
of US GDP, roughly equals to the national debt of $6.67 trillion at the
same
point in time. Sovereign credit is what gives the US economy its
strength. A holder of fiat money is a holder of sovereign
credit. The holder of fiat money is not a
creditor to
the state, as many monetary economists claim.
Fiat money only entitles its holder a replacement of the same
money from
government, nothing more. The holder of fiat money is acting as a state
agent,
with the full faith and credit of the state behind the instrument,
which is
also good for paying taxes. Fiat money,
like a passport, entitles the holder to the protection of the state in
enforcing sovereign credit. It is a
certificate of state financial power inherent in sovereignty. The Chartalist theory
of money
claims that government, by virtual of its power to levy taxes payable
with
government-designated legal tender, does not need external financing. Accordingly, sovereign credit enables the
government to finance a full-employment economy even in a regulated
market
economy. The logic of Chartalism reasons that an excessively low tax
rate will
result in a low demand for currency and that a chronic government
budget
surplus is economically counterproductive and unsustainable because it
drains
credit from the economy. The colonial administration in British Africa
learned
that land taxes were instrumental in inducing the carefree natives into
using
its currency and engaging in financial productivity. Sovereign Credit (Part
IV) By Henry C.K. Liu Under principles of
Chartalism,
foreign capital serves no useful domestic purpose outside of an
imperialistic
agenda. Dollar hegemony essentially taxes away the ability of the
trading
partners of the United States to finance their own domestic development
in
their own currencies, and forces them to seek foreign loans and
investment
denominated in dollars, which the US, and only the US, can print at
will. China's excessive dependence on foreign trade has
significantly
distorted the country's economy, as indicated by the percentage of
total
foreign trade volume to its gross domestic product (GDP), which
amounted to 60
per cent in 2003. China’s economically advanced
regions, largely in East and South China, depend heavily on foreign
trade. The average rate of foreign trade
dependence
of the 12 provinces and municipalities in East and South China was 74.5
per
cent in 2000 while the rate in the 19 provinces and autonomous regions
in the
central and western regions was only 10 per cent. In
2003, Shenzhen and Shanghai 356.3 and
148.7 per cent of the trade reliance rate respectively. Much
of this trade takes the form of assembly
for re-export although the trend is changing toward vertically
integrated
manufacturing. Henry C.K. Liu Gary Santos wrote: > I don't know how many of you have read the book "Understanding Modern > Money" or have read of its theses. Among these is one that says that > deficits don't matter as long as fiat money is used. It is so because > deficits are self-funding. Money supply does not expand since the > deficits, showing up as excess reserves in the system, are drained by > bond selling. This allows the Fed to maintain interest rates are > their desired level. I have a conceptual problem with this as some of > you know. > > But, I have another conceptual problem, encountered in the later > chapters. It is this: > > One thesis is that it is necessary for the government to never go > into a prolonged fiscal surplus since a surplus drains reserves from > the system. In order to maintain the desired interest rate, a surplus > will necessarily involve the injection of reserves via open market > purchases of Treasury bonds or via the discount window. > > However, it occurred to me that a prolonged fiscal surplus is > possible since taxes can be paid with bank created money. As the > surplus continues, banks simply expand their balance sheet, lending > to the private sector. Since these new loans makes use of reserves > and, in fact, may cause a shortage eventually of reserves, banks can > simply discount these new loans at the Fed. For as long as the Fed is > willing to discount these tax loans, the surplus can continue. In a > way, the Fed is being paid for taxes not with bank created money but > by consumer overdrafts. The point is made clearer if one imagines the > Fed purchasing these loans from the banks instead of discounting > them. > > > |
- Re: [A-List] Understanding Modern Money, (continued)
- Re: [A-List] Understanding Modern Money, Henry C.K. Liu Wed 23 Jun 2004, 02:35 GMT
- Re: [A-List] Understanding Modern Money, Gary Santos Wed 23 Jun 2004, 04:38 GMT
- Re: [A-List] Understanding Modern Money, Gary Santos Wed 23 Jun 2004, 15:51 GMT
- [A-List] Understanding Modern Money, Gary Santos Sat 26 Jun 2004, 04:00 GMT
- Re: [A-List] Understanding Modern Money, Henry C.K. Liu Sat 26 Jun 2004, 18:58 GMT
- Re: [A-List] Understanding Modern Money, Gary Santos Sun 27 Jun 2004, 02:37 GMT
- Re: [A-List] Understanding Modern Money, Gary Santos Sat 26 Jun 2004, 18:59 GMT
- Re: [A-List] Understanding Modern Money, Henry C.K. Liu Sat 26 Jun 2004, 19:43 GMT
- Re: [A-List] Understanding Modern Money, Gary Santos Sun 27 Jun 2004, 02:34 GMT