Monday, June 30, 2014

More on Argentina and the Vulture Funds and the sanctity of contracts

So the Argentine government decided to negotiate with the Vulture Funds to avoid a default, which is eminent if no agreement is reached, well, basically today. This is not necessarily bad news, given the potential consequences of a default. It is also one of the frustrating results of the decision of the very Conservative (and pro-bussiness) Roberts Supreme Court. To preside over the negotiations Judge Griesa chose a Wall Street lawyer (who boasts in his CV to have sued Elliot Spitzer for exceeding his authority in investigating Wall Street fraudsters). Argentina is trying to pay today to the ones that renegotiated, but whether that will happen is still not clear (apparently without success).

Note that the consequences of the default could be dire indeed. It would put more pressure on the exchange rate, lead to further depreciation that would be both inflationary, and contractionary, since it would basically reduce real wages. The economy would be forced to continue to grow at very low levels, as it has done since 2011, to avoid a current account crisis. In part, the problem exists even if Argentina does NOT default. Meaning the current account is already close to its limit and the reserves are not sufficiently high (around US$ 28 billions or so), and that's the reason the government has tried to finish negotiations with creditors that did not enter the previous debt reschedulings, including the Paris Club.

The notion is, arguably, that in a world with significant amounts of liquidity, and the chance that low rates of interest in international markets will continue for a while, access to international financial markets would be a reasonable solution for the Argentinean current account constraint. In fact, Brazil has financed a larger current account deficit with little or no problem (maybe the rate of interest is too high, and could be lower, but that's another discussion).

This does not necessarily mean that the Kirchner government has backtracked on previous policies, at least not completely. Reducing foreign indebtedness, after the default and the renegotiation, was the rational choice, and the commodity boom basically provided the policy space for it and for the accumulation of reserves. But borrowing in international markets, when the current account and reserves do not allow for continuous growth, might be fine too if borrowing is done on a sustainable basis. In other words, if the Argentinean government manages exports and imports (import substitution here plays a role as much as export promotion) to allow for the service of debt.

Also, renegotiation of debts (and default might be just a phase in a renegotiation process) are common, and do not show that (as some angry and, quite frankly, not very informed readers suggest in comments on posts on the default, not just in this blog) Argentina is a "deadbeat country and nobody should ever lend to them again." Note that defaults are actually quite common in history.

For example, Cipolla (1982) describes the bankruptcy of the banking houses of a developed country associated to the default of a developing and 'deadbeat' country. What countries are these, you ask. England and Italy, and of course England is the deadbeat one. According to Cipolla (1982: pp. 7-8):
“The large companies of the dominant economy (Florence), which operate in the underdeveloped country (England), have a vital interest in securing the local raw material (wool) for the home market. By logic of events they are led to grant increasingly larger credits to the local rulers, on whose benevolence the licenses for the export of raw material ultimately depend. The rulers of the underdeveloped country, however, instead of using the credit to finance productive investment, squander the funds in war expense and are soon forced to declare bankruptcy.”
So in the mid-fourtenth century the banking houses of Bardi and Peruzzi were brought down by the sovereign default in England and, hence, Florence, more accurately than Italy, was hit by the default. And there are several other countries that would now be considered developed (e.g. Germany) that defaulted before, without being excluded forever from financial markets.

Most countries that default do pay eventually, just at a new rate with extended periods. Renegotiations are normal, and the basis for them is the ability to repay, since it would be better for creditors to receive something. Note also, that creditors (as a whole, not an individual creditor per se) seldom make losses, and that is why all countries after a shorter or longer spell come back to international financial markets. The reason is not difficult to understand, since developing countries pay risk premiums well above the safe assets (Treasury bonds), the advantage of holding developing country debt even for a short while is sufficient for compensating default risks. And besides most savvy investors try to get out before the default (or in the case of Vultures, enter afterwards, to buy debt at the bottom, and make a kill in the courts; it is a good business model, if nothing else).

Changing the terms of contracts, which is basically what a default and renegotiation does, is not new and not the privilege of debtors. In fact, when the credit card company sends a "change of terms notice" to their cardholders, increasing fees or directly the interest rate, it is basically renegotiating unilaterally your contracts. So that is a normal market practice, and Argentina is not violating the sanctity of contracts, and is at least trying to honor its debts, as it has done for the last two hundred years.

Finally, beyond Argentina the consequences of the Robert's Court for international financial markets have been well summarized by UNCTAD, namely:
  • First, by removing financial incentives for creditors to participate in orderly debt workouts, the rulings will make future debt restructuring even more difficult, in particular for outstanding bonds without a Collective Action Clause, the actual amount of which is unknown but is likely to be large.
  • Second, obligating third-party financial institutions to provide information about assets of sovereign borrowers will have a significant impact on the international financial system as it forces financial service institutions to provide confidential information on the sovereign borrower's global financial transactions to facilitate the enforcement of debt contracts for the creditors.
  • Third, the ruling will erode sovereign immunity.
In other words, reduces the chances of debt renegotiations, and of sovereign governments to manage its international reserves, reducing policy space. The question here is not if or whether Argentina should pay, which it was already doing, but at what cost, and who would benefit. The Robert's Court went with Wall Street, and that's no surprise. Interestingly this might hurt even Wall Street. Oh well.

Cipolla, C. (1982), The Monetary Policy of Fourteenth-Century Florence. Berkeley: University of California Press.

Thursday, June 26, 2014

Mark Weisbrot - Who Shot Argentina?

By Mark Weisbrot
When Cristina Kirchner first ran for president of Argentina in 2007, she had a campaign commercial with adorable young children answering the question, “What is the IMF (International Monetary Fund)?” They offered cute little ridiculous answers like “The IMF is a place where there are many animals,” and the punch line from the narrator was: “We have succeeded in making it so that your children and grandchildren won’t know what the IMF is.” To this day, there is no love lost between the IMF and Argentina, since the fund presided over Argentina’s terrible economic collapse of 1998-2002, as well as numerous failed policies in the years prior. But when the U.S. Court of Appeals for the Second Circuit ruled in favor of vulture funds trying to collect the full value of Argentine debt that they had bought for 20 cents on the dollar, even the IMF was against the decision.
Read rest here, and for another piece by Weisbrot, see here, and for posts on the issue by Matias, see here & here

Jörg Bibow on Draghi's negative rate of interest

Jörg Bibow's letter (subscription required) in the Financial Times argues that the negative deposit rate and other measures by Draghi's ECB will fail to increase inflation. In his words:
"The driving force behind the eurozone’s disinflation process is wage repression – exercised to a brutal degree across the currency union. In fact, wage repression – joined by fiscal austerity – is the eurozone’s official policy meant to resolve the euro crisis; even if it is euphemisms such as structural reform of labour markets and welfare systems that usually make the headlines instead."
Very classical (as in the old classical political economy) diagnosis of the causes of inflation (and income distribution), and compatible with Keynesian interpretations of the causes of the Euro crisis. As I noted before, this New Keynesian nonsense that central banks can induce higher expectations of inflation and lead to increased consumption is dangerous, and has substituted the old and clear logic of the multiplier. Lower and stagnant wages means no spending. Oh well.

Monday, June 23, 2014

ISLM, ISMP, DSGE and other models

From the Google Ngram Viewer.

Note that even though the ISLM is from 1937 (and yes it is in the GT, and Keynes did endorse Hicks formalization, as discussed here, and here), it is only in the 1970s that the term takes off. The ISMP, which substitutes a monetary policy rule for the LM, and includes as a result endogenous money into mainstream models (note again endogenous money is not central for heterodox models, since orthodox ones can incorporate it, as discussed here) takes over in the 2000s, as does the Dynamic Stochastic General Equilibrium models, in which the IS with a multiplier is substituted by a Ramsey model. So, given the trends, you should miss the good old ISLM indeed.

On the blogs

Sunday, June 22, 2014

Mark Weisbrot - The Debt Vultures' Fell Swoop

By Mark Weisbrot
Last week, the United States Supreme Court decided not to review a ruling in the Second Circuit Court of Appeals whose effect is that Argentina must pay “holdout” creditors who refused to participate in debt restructuring agreements that Argentina reached with the majority of bondholders following the 2001 default on its sovereign debt. Argentina’s lawyers warned that the court’s decision created “a serious and imminent risk” that the country would again be forced to default. But the ruling also has profound and disturbing implications for the functioning of the international financial system, and even the United States would most likely be adversely affected. Parties as diverse as the International Monetary Fund and leading religious organizations wanted the Supreme Court to overturn the decision, and briefs supporting this position were filed by the governments of France, Brazil and Mexico, as well as by the Nobel Prize-winning economist Joseph E. Stiglitz. The I.M.F. — which has had mostly sour relations with Argentina since its involvement in that country’s 1998-2002 recession — was also planning to file a brief on Argentina’s side to the Supreme Court, but was blocked by the American government from doing so. This action may have influenced the court’s decision not to hear the case.
Read rest here, and for recent posts on the topic by Matías, see here & here

Wednesday, June 18, 2014

What is 'Dollar Hegemony'?

Fields, David (Forthcoming), “Dollar Hegemony,” Edward Elgar Encyclopedia on Central Banking, edited by L.P. Rochon et. al, Edward Elgar

Today, the world economy operates under the artifice of US hegemony, fortified by the US dollar as an international reserve and vehicle currency. How did the United States arrive at achieving such pre-eminence?

From 1944 to 1973, the financial architecture of the world economy centered on a US engineered Keynesian accumulation agenda as a response to the devastation wrought by the Great Depression. The capitalist institutional structure, or social structure of accumulation (see Kotz et al., 1994), rested on finance being subservient to the promotion of industrial enterprise.

With socially-engineered capital–labour compromises in developed countries, neo-colonial governing institutions in the Third World, active State regulation in decisions with respect to capacity utilization, and a co-respective form of competition among large corporations set by regulations that brought together monetary authorities, large banks as well as large industrial capitalists, the post-World-War-II system was the era of “regulated capitalism”. Altogether, the world system was underpinned by the Bretton Woods arrangement, which called for globally fixed exchange rates against the US dollar tied to the price of gold and capital controls.

The international political-economic conditions were such that domestic macroeconomic autonomy, specifically with respect to monetary policy, for aggregate demand management could be feasible. Capital controls were seen as essential to reduce the volatility of capital flows and allow for low interest rates with the objective of pursuing full employment. As Keynes (1980, p. 276) argued, “we cannot hope to control rates of interest at home if movements of capital moneys out of the country are unrestricted.”

By the 1960s, however, US officials began to actively encouraging the growth of the Euromarket, that is, the pool of unregulated US dollar reserves concentrated in the City of London (Helleiner, 1994). With traditionally marginalized segments of the population in developed countries, particularly in the United States and in Western Europe, demanding social, political, and economic rights, and with national liberation movements in the Third World overthrowing US-supported oppressive governments, calls for an expanded role of the State in meeting citizens’ needs dramatically circumscribed global capital accumulation owing to heightened nominal wage–price spirals. Consequently, the global capitalist rate of profit fell (Duménil and Levy, 2004, p. 24). The Euromarket thus became the means for international financial markets to re-establish their influence, lost as a result of the Great Depression, and allow industrial enterprise to rebuild the conditions for future profitability via offshoring.

Speculative capital flows, however, began to undermine the capacity for the United States to guarantee the convertibility of US dollars into gold at fixed parity (Triffin, 1960). Even though the US dollar was the key international currency, it was fixed to gold. As such, debt was ultimately redeemable in an asset that was not directly controlled by the US monetary authority. Default was a possibility, even if a remote one, since through manipulation of the rate of interest, and through coercion and cooperation with other central banks in the world economy, the stability of the system could be maintained. With the globalization of finance via the Euromarket, nevertheless, speculation against the gold–dollar parity proliferated, making functional finance on a worldwide basis difficult to manage.

In 1971, Nixon closed the gold window and loosened capital controls. American officials concluded that it was no longer in their interests to maintain the linchpin relation between gold and the US dollar, and ipso facto withdrew support for the Bretton Woods system by which exchange rates were fixed and flows of capital were to a large degree controlled (see Helleiner, 1994; Vernengo, 2003; Ingham, 2008). The deregulation of financial markets established a global market of mobile financial capital, and the US dollar established itself as a global fiat-money standard. The world economy moved from a fixed dollar standard to a flexible dollar standard (Serrano, 2003).

For the first time in history, it is possible for the hegemonic country, in this case the United States, to be a global debtor, as national States are within their domestic economies, and to provide a default-risk-free asset to facilitate global capital accumulation. The risk that the United States would be unable to expand demand globally, because it is forced to maintain a fixed exchange rate between its currency and an external asset, is thus non-existent. It is true, however, that foreign countries and agents may show unwillingness to hold US-dollar-denominated assets, but, as in the domestic case, the US Federal Reserve (Fed) can always monetize public debt. This would be inflationary and lead to a run on the US dollar only if there is currency substitution on a massive scale, which would require a credible alternative to the US dollar (which does not exist yet). As such, the United States can therefore incur foreign debt without any reasonable limit.

Global imbalances, in particular the large US current account deficits that reflect their so-called “exorbitant privilege”, are instrumental for the functioning of the world economy, as evidenced by the dominance of the US dollar in international trade (Fields and Vernengo, 2013). An important part of this is associated to the fact that key commodities, like oil, are priced in US dollars in international markets. This not only implies that there cannot be an insufficient amount of dollars for the United States to import key commodities, but also that a depreciation of the US dollar does not reduce US imports necessarily (Parboni, 1981).

In fact, the Fed is the world economy’s central bank, which acts as the safety valve for mass amounts of international liquidity (Arrighi, 1999). The hegemonic position of the US dollar structures the world economy in such a fashion that the United States determines the international transmission mechanism for global economic activity. Hence, the role of the US dollar in international markets, and the advantages that come with it, are the spoils of structural power. The provision of this asset allows the United States to become the source of global demand, and to insulate itself from fluctuations and contradictions of perilous cumulative disequilibria that may arise in the world economy. The US dollar enables the United States to set the global social, political, and economic conditions, within which the transmission of misery (contagion) between countries, and between global and national levels, is essentially regulated.


Arrighi, G. (1999), “The global market”, Journal of World Systems Research, 5 (2), pp. 217–51.

Duménil, G. and D. Lévy (2004), Capital Resurgent: Roots of the Neoliberal Revolution, Boston: Harvard University Press.

Fields, D. and M. Vernengo (2013), “Hegemonic currencies during the crisis: the dollar versus the euro in a Cartalist perspective”, Review of International Political Economy, 20 (4), pp. 740–59.

Helleiner, E. (1994), States and the Reemergence of Global Finance: From Bretton Woods to the 1990s, Ithaca: Cornell University Press.

Ingham, G. (2008), Capitalism, Cambridge: Polity Press.

Keynes, J.M. (1980), The Collected Writings of John Maynard Keynes, Vol. XXV: Activities 1940–1944. Shaping the Post-War World: The Clearing Union, London and Cambridge: Macmillan and Cambridge University Press.

Kotz, D., T. McDonough and M. Reich (eds) (1994), Social Structures of Accumulation: The Political Economy of Growth and Crisis, Cambridge: Cambridge University Press.

Parboni, R. (1981), The Dollar and Its Rivals: Recession, Inflation, and International Finance, London: Verso.

Serrano, F. (2003), “From static gold to floating dollar”, Contributions to Political Economy, 22 (1), pp. 87–102.

Triffin, R. (1960), Gold and the Dollar Crisis: The Future of Convertibility, New Haven: Yale University Press.

Vernengo, M. (2003), “Bretton Woods”, in J. King (ed.), The Elgar Companion to Post Keynesian Economics, Cheltenham, UK and Northampton, MA, USA: Edward Elgar, pp. 30–34.

What is the 'Classical Dichotomy'?

Fields, David (Forthcoming), “Classical Dichotomy,” Edward Elgar Encyclopedia on Central Banking, edited by L.P. Rochon et. al, Edward Elgar

The classical dichotomy (Patinkin, 1965) refers to the idea that real variables, like output and employment, are independent of monetary variables. In this view, the primary function of money is to act as a lubricant for the efficient production and exchange of commodities. This conception of money rests on “real analysis”, which describes an ideal-type economy as a system of barter between rational utility-maximizing individuals (Schumpeter, 1994, p. 277).

In this sense, money is “the unpremeditated resultant, of particular, individual efforts of the members of society, who have little by little worked their way to a determination of the different degrees of saleableness in commodities” (Menger, 1892, p. 242). Hence, money is considered simply as a social technology for the adjudication and determination of “terms of trade”, which are inherently specific to individual dyadic economic exchanges (Dodd, 1994, p. 6). It is thus a social “vehicle” that has no efficacy other than to overcome transaction costs concerning the inconveniences of barter, which result from the absence of a double coincidence of wants (Jevons, 1875, p. 3).

The classical dichotomy is, essentially, a derivation of the quantity theory of money, which is captured by the formula MV = PY, where M stands for the money stock, V is the velocity of money circulation, P is the price level, and Y is the level of income. The monetary value of output (PY) is thus equal to overall aggregate monetary expenditure. Exogenous changes in the money supply (M) ultimately condition the price level for a given level of economic activity. If an economic system is at full employment, the only effect of increases in the money supply is a proportionate increase in the domestic price level, which gives rise to a depreciation of its currency’s exchange rate. The direction of causality runs therefore from an exogenous money supply to the price level.

This is intrinsically connected to the so-called “natural rate of interest theory” of New Keynesian economics (see Woodford, 2003). A natural rate of interest is determined in the long run by the equilibrium of savings and investment. This is a full-employment position for a given economy. A market interest rate that is either above or below this natural rate is a disequilibrium situation, which is eventually equilibrated through a long-run process of market clearing.

Exogenous changes in the supply of money are what shift market rates of interest. This is the process by which discrepancies between market rates and the natural rate of interest are generated. A market rate of interest below the natural interest rate occurs when investment exceeds savings. Firms will demand more credit for investing. The result is an excess of investment over savings. If the economy is at the full-employment position, defined by the natural rate of interest, a cumulative process of inflation unfolds. The rise in the price of consumption goods leads to a decrease in consumption; involuntary savings rise until the excess of investment over savings is eventually eliminated. If market rates of interest are above the natural rate of interest, by contrast, savings exceed investment and a cumulative process of deflation ensues.

From a heterodox perspective, however, the natural rate of interest is a conventionally-determined exogenous distributive variable. The implication is that it is strictly a monetary phenomenon. For a given level of output, the price level is the result of distributive conflict between capitalists and workers. Hence, the net impact on the general price level depends on the effects the central-bank determined interest rate exerts on aggregate demand. If a restrictive monetary policy, via higher market interest rates, leads to a higher price-to-wage ratio, a lower inflation rate will result if the workers’ bargaining power is weakened, ensuing nominal wage reductions.

Further, if conventional rates of interest are artificially set high and effective demand is not sufficient for businesses to meet profit expectations, and for governments to afford deficit spending, there is an actual possibility of an unemployment equilibrium. Deflation that is caused by higher real interest rates does not produce a wealth effect that offsets increased costs of production through the expansion of consumption. This puts pressure “on those entrepreneurs [and consumers] who are heavily indebted […] with severely adverse effects on investment” (Keynes, 1936, pp. 262–4). If the interest rate is set low and is followed suit with appropriate fiscal policy via aggregate demand management, any so-called burden of private and public debt accumulation is sustainable, and, as a result, provides impetus for output and employment expansion (Domar, 1944).

In conclusion, the classical dichotomy implies that real variables and monetary variables are independent of each other. From a heterodox perspective, by contrast, both kinds of variables are explained by the relationship established between the central bank, bank lending, and entrepreneurs’ “animal spirits” every time effective demand is deemed profitable, reversing thereby the causality of the quantity-theory-of-money formula.

Dodd, N. (1994), The Sociology of Money, New York: Continuum.
Domar, E. (1944), “The ‘burden of the debt’ and the national income”, American Economic Review, 34 (4), pp. 798–827.
Jevons, W.S. (1875), Money and the Mechanism of Exchange, London: Appleton.
Keynes, J.M. (1936), The General Theory of Employment, Interest, and Money, London: Macmillan.
Menger, K. (1892), “On the origins of money”, Economic Journal, 2 (6), pp. 239–55.
Patinkin, D. (1965), Money, Interest and Prices, New York: Harper & Row, second edition.
Schumpeter, J.A. (1994), A History of Economic Analysis, London and New York: Routledge.
Woodford, M. (2003), Interest and Prices, Princeton: Princeton University Press.

Monday, June 16, 2014

On the blogs

Supreme Court Sides with Vulture Funds in the case of Argentina

Very briefly, since I've to go teach (more later today this week). The Supreme Court has sided with the Vulture Funds and denied Argentina's appeal judge's Griesa's infamous decision requiring it to pay the last holders of bonds on which it had defaulted (almost 93% had already renegotiated, after Argentina's agreement with the Paris Club). The problems this will cause transcend Argentina, and are a blow for any debt renegotiation worldwide. Who will accept a renegotiation knowing that the Supreme Court can decide that some have to be paid according to the original agreements?

In the case of Argentina, the efforts to finalize the renegotiation with debtors, that culminated with the Paris Club agreement, and which intended to normalize the relation with international capital markets, and allow a reentry of the country into those markets on a more favorable footing are gone. A very likely outcome will be a technical default, that is, for lack of payment even though the Central Bank does have funds to pay.

On an interesting note, 'liberal' judges Breyer and Kagan voted with the conservative majority, and only Ginsburg dissented (Sotomayor did not vote).

Thursday, June 12, 2014

Employment is finally reaching the pre-crisis level

The level of employment is finally after 5 years or so close to the pre-crisis levels. Note that unemployment is considerably down, from around 10 in mid-2009 to 6.3 last May according to the Bureau of Labor Statistics (BLS). The growth in employment has more or less kept pace with the growth of population, while the size of the labor force has been almost stagnant, as seen below.
In other words, what has been growing is the number of workers not in the labor force, which are not counted as unemployed. In other words, not a very good picture.

Wednesday, June 11, 2014

EPI | Over 1/4 of men 25-34 years old earned poverty-level wages in 2013

By Elise Gould
In honor of Father’s Day, we looked at the wages of male workers at the prime age for raising young children. While women have always been more likely to earn poverty-level wages than men (wages less than what a full-time, year-round worker needs to sustain a family of four at the official poverty threshold), women have seen some improvement over the last three-and-a-half decades, as their rates of poverty-level wages have declined, especially among those 35 to 44 years old. On the other hand, men between 25 and 44 have seen precipitous increases in the share working at such low wages, with the share more than doubling between 1979 and 2013. This trend has been particularly stark among the younger age group. The figure below shows the share of male and female workers between 25 and 34 and between 35 and 44 years old who earn poverty-level wages. In 2013, that hourly wage was $11.49. Over one-fourth of men 25-34 years old earned poverty-level wages in 2013. The bottom line is there are a great many adults, and an increasing share of men, stuck in very low-paying jobs, and they are the same people who are responsible for raising the next generation.
See rest here.

The Paris Club, Vulture Funds and global debt restructuring

Argentina has finalized a deal with the Paris Club two weeks ago. And tomorrow, if I'm not wrong, the case against the Vulture Funds will be finally decided by the Supreme Court. On the first one, Argentina signed an agreement with the Paris Club that implies the country will pay around US$9.7 billions in the next 5 years.

There is an interesting twist in the agreement with the Paris Club. The agreement was reached without accepting an IMF program, which have traditionally been part of all such negotiations. The Club and the IMF used to be joined at the hip. Two Paris Club chairmen, Jacques de Larosière and Michel Camdessus, became later managing directors of the IMF. So in a sense, the idea was that austerity at home was essential for repayment abroad. Here it is important to note a traditional confusion in the conventional view about the role of austerity.

Note that fiscal austerity can only have an indirect impact on repayment of a debt in foreign currency. You don't need more revenue in pesos (from taxes) to pay interest on foreign denominated bonds, but external revenue from exports, or capital inflows, or accumulated reserves. So austerity helps if it leads to reduced demand for imported goods and services, and more dollars left for repayment.

In all fairness, not having an IMF program is good, but it is NOT a sufficient condition to guarantee that austerity measures will be discarded altogether. I had discussed this before here, but it is far from clear that the Argentinean government will continue to promote a fiscal strategy associated with expansion, which more or less characterized the 2003-2008 boom, and the fast recovery from the 2009 crisis. And while the agreement is also good from the point of view of closing the mess caused by the 2002 default, the problem will not be completely resolved until the Vulture Fund issue is sorted out.

The dangers associated with the Supreme Court's decision are difficult to exaggerate. The Supreme Court may lead Argentina to a new default, not so much because the country can't pay, but because it will not pay (correctly so, in my view). At any rate, worth remembering that creditors have a Club and negotiate from a position of strength, while debtors negotiate one at a time, without the force of collective power. Perhaps the time has come for a Club of Debtors; the Club of Athens might be an appropriate name.