“Sovereign Default” is an Oxymoron With Fiat Money

Again, there is no risk – none, zip, nada – of default by the US (or any other currency sovereign nation) on their government bonds.  This does not mean that these governments can run unlimited deficits of unlimited amounts without any consequences.  It means the consequences don’t include default on government bonds.  If the government spending were truly too much, the consequence would be an overstimulated economy where aggregate demand exceeds available real resources. It does mean that the national debt does not ever have to be “paid off”.  It also means that deficits now do not imply “higher taxes in the future”.

Today’s support comes from Bill Mitchell ‘s Billy Blog and  Steven Major of the Financial Times.

In his FT article – ‘True sovereigns’ immune from eurozone contagion – HSBC economist Steven Major opens with the following statement:

There are plenty of doomsayers who think it is only a matter of time before the sovereign risk crisis spreads from the eurozone to other countries, including the US, UK and Japan.

This is not going to happen in my view. That is because the obsession with public debt ratios fails to distinguish between different levels of sovereignty. The US, UK and others can maintain high public debt ratios for longer, especially given the amount of deleveraging being carried out by the private sector.

Not all sovereigns are the same. The US, UK, Japan and Canada are examples of what I call “true sovereigns”. For these countries there is zero default risk. Investors should not worry about credit fundamentals, as they will always receive their coupons and original investment on redemption.

This is so contrary to what is being peddled each day in the financial press that a medal for bravery should be awarded. I just did that Steve(!)

Steven Major chooses to term a government in the former category a “true sovereign” because it:

… can issue freely in its own currency, has full taxing power over the population and ultimately, if required, can create more of its own money. None of this means that true sovereigns can afford to be profligate, far from it, but it does mean there is no externally imposed timetable on fiscal retrenchment.

I am 100 per cent in agreement with this construction.

Behavioural Economics

The majority of what is taught in Principles of Economics courses, both macro and micro, reflects what should properly be called "Neo-classical" economics. Despite the imperial claims of neo-classical economists, it is not the only game in town. Neo-classical economists like to claim that they practice "positive economics". By positive economics, they mean that the models and theories created are value-free and simply scientific attempts to create models that predict actual human behavior. In practice however, all neo-classical models start with the assumption that humans, all humans, make rational, optimizing decisions. Examples of this are the textbook examples of profit-maximizing firms and utility-maximizing consumers.

An alternative to the neo-classical economic approach is Behavioral Economics. Behavioral economics starts by collecting empirical, factual evidence of actual human behavior. Then the behavioral economist attempts to construct models or theories that explain or predict that behavior in more general circumstances. Behavioral economics collects data from both observations of normal economic activity (such as employment data or sales data) and from economic experiments. In this way, behavioral economics shares much with sociology and market reserch.

Consider the following as an example of how the two approaches differ. Suppose a couple goes to a restaurant. They decide to order a bottle of wine. The restaurant has essentially two types of wine available: $10 bottles and $25 bottles. These two aren’t real wine connoisseurs, so they economize and choose the $10 bottle. Now consider an alternative scenario: suppose they were to go to the restaurant and instead of two prices on wine, the restaurant has 3 bottles: the same $10 and $25 bottles. bit in addition they now offer a high-end $100 bottle. Repeated economic experiments and also market research indicates that now the couple would most likely order the $25 bottle. Neo-classical economics assumes this won’t happen – if the $10 bottle was the right choice (rational choice) the first time, then adding another more expensive choice shouldn’t change anything. But experience says it does. Why? Because people are not rational maximizers in the real world.

For an easy-to-read further introduction to Behavioral economics, check out this factsheet.

Again on Measuring GDP (a.k.a., “The Economy”)

When most people refer to “the economy”, they are generally referring to either: 1. the job market (this happens usually when someone’s looking for work), or 2. (the more common usage) that bundle of economic activity that we measure using GDP. Unfortunately, our obsession with “the economy” has misled us into thinking that anything that boosts the measure (GDP) is good. It’s not necessarily. GDP is actually are terrible, terrible way of trying to measure standard of living or how-well-off-are-we. Unfortunately, it’s the best quantitative measure we’ve got so far. Maybe some really smart folks in the future will come up with better (I hope), but it’s what we have now.

Over the recent decades, popular discourse, politics, and culture has come to reify the concept “the economy”. Instead of “the economy” being the actual quality of life we live, it has become some objective “thing” to which we must sacrifice. As Yves Smith at Naked Capitalism remarks:

Price is Not Value, and Other Reasons Metrics Mislead

Economists have been rewarded all too well for fetishing numbers and mathematics. The self-conscious effort within the discipline to turn it into a science (a goal most real scientists would deem to be impossible, given the fickle nature of human behavior), which meant making it more mathematical, has resulted in economists being better paid than other social scientists and having a seat at the policy table.

The result is that this methodological bias (which we discuss at some length in ECONNED), has had the unfortunate effect of blinkering the discipline. Economists have exhibited a great disinclination towards considering the idea that markets and economies could be unstable, first, because the mathematics that can characterize instability are fairly daunting and second, economists would have much less to say about them (as in the range of possible outcomes quickly becomes large). And this love of quantification has been taken up with even more enthusiasm by businessmen, with equally questionable outcomes (some of the most important aspects of business performance may note be readily quantified, but the obsession with measurement means those behaviors will be overemphasiszed).

Some within the academy have started to question the biases that result from focusing on what can be easily measured versus richer, more nuanced appraisals. For instance, Joseph Stiglitz and Amartya Sen have argued that GDP is a poor metric of economic progress, and are working to develop better measures.

John Kay at the Financial Times has some musings along these lines. He offers a defense of the value of the arts (in a UK context, where it is often subsidized) which might strike some flat notes with US readers, but his underlying reasoning has merit.

From the Financial Times:

Many people underestimate the contribution disease makes to the economy. In Britain…. [i]llness contributes about 10 per cent of the UK’s economy: the government does not do enough to promote disease.

Such reasoning is identical to that of studies sitting on my desk that purport to measure the economic contribution of sport, tourism and the arts. These studies point to the number of jobs created, and the ancillary activities needed to make the activities possible. They add up the incomes that result….to persuade us….that they contribute to something called “the economy”.

The analogy illustrates the obvious fallacy. What the exercises measure is not the benefits of the activities they applaud, but their cost; and the value of an activity is not what it costs, but the amount by which its benefit exceeds its costs. The economic contribution of sport is in the pleasure participants and spectators derive, and the resulting gains in health and longevity…..Similarly, the economic value of the arts is in the commercial and cultural value of the performance, not the costs of cleaning the theatre… Good economics here, as so often, is a matter of giving precision to our common sense. Bad economics here, as so often, involves inventing bogus numbers to answer badly formulated questions.

But good economics is often harder to do than bad economics. It is difficult to measure the value of a Shakespeare play…..The relevant economic questions are whether the cultural and commercial value of the performance offsets these costs and whether these benefits can be translated into a combination of box office receipts, sponsorship and public subsidy. The appropriate economic criterion, everywhere and always, is the value of the output.

But bad economics has been allowed to drive out good. I am sympathetic to the well-intentioned people who commission studies of economic benefit, though not to those who take money for carrying them out. They are responding to a climate in which philistine businessmen assert that the private sector company that manufactures pills is a wealth creator, but the public sector doctor who prescribes them is not. Extolling the virtues of manufacturing, they value the popcorn sold in the interval, but not the performance of the play, arguing that the vendor of consumer goods creates resources, which the subsidised theatre uses up. People who work in the theatre, hospitals or education are often forced to listen to this nonsense. It should be no surprise that so many of them despise business and the values such business espouses. If these values were truly the values of business they would be right to despise them….

We need to put out of our minds this widely held notion that there is such a thing as “the economy”, a monster outside the door that needs to be fed and propitiated and whose values conflict with things – such as sports, tourism and the arts – that make our lives agreeable and worthwhile. Activities that are good in themselves are good for the economy, and activities that are bad in themselves are bad for the economy. The only intelligible meaning of “benefit to the economy” is the contribution – direct or indirect – the activity makes to the welfare of ordinary citizens.

Yves here. If you don’t like the arts example, consider childrearing. If you were to adopt a purely GDP perspective, unpaid child care (mothers staying at home to raise their kids) has no value (save maybe in a discounted NPV of child’s future earnings, but discounting cash flows that don’t begin for 20 more years produces a surprisingly low number).