Keynes and his contemporaries did not share our present day casual attitude to the imbalances we see in international trade. The monthly, or quarterly, trade figures were a regular and prominent feature of our business news, at one time, but we have to look much harder to find those same figures now.
Keynes’s proposal that international trade be separated from domestic trade by the use of a separate international currency, the Bancor, formed part of the official British proposals at the 1944 Bretton Woods conference which set the international financial and monetary arrangements for the post war period. Unfortunately this was a step too far for the Americans at the time. The proposal, had it been adopted, would have penalised the surplus nations, making it less attractive for countries to run large export surpluses and would have encouraged the deficit nations to re-align their currencies to reduce their deficits.
Keynes understood, what we seem to have forgotten, that if any particular country, as a whole, has a net deficit trading position with the rest of the world then either the government of that country, or the inhabitants of that country, have to fund that deficit by borrowing. In other words, the internal deficits run by governments, and the extent of the debts which can accumulate in the private domestic sector, are directly related to the external deficits caused by a trade imbalance. So, we can see that countries such as Germany, Switzerland, Holland and Denmark which run large trading surpluses do not have any of the public or private sector debt problems which we see in the UK or USA which run large trading deficits. Unfortunately, though, the solution to world debt problems cannot be for everyone to run a trading surplus!
George Osborne’s proposals for reducing the government’s deficit simply do not take these fundamental relationships into account. Transferring the burden of debt, necessary to sustain the current UK trading imbalance, from government to the private sector is going to do less than nothing to solve the economic problems of the country. If he wants to reduce his government’s deficit, without crashing the economy by imposing an unrealistic debt burden on everyone else, he has to acknowledge that this can only be done by reducing the external or trade deficit too. He has to start to tackle the problem from both ends.
* Peter Martin is not a LibDem party member but has voted LibDem in previous elections.
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25 Comments
Interesting article. It’s certainly true that Bretton Woods was approached very much from an imperial mindset by all the major nations; and not with an open mind about how to increase prosperity in the developing world (not even by Keynes).
I fear it’s not quite as simple as you suggest though. If trade deficits simply represent cash flow out of the country (and economy) then it wouldn’t be a problem to simply print money forever to cover those deficits, because that printed money wouldn’t be inflationary in the UK economy – it would be inflationary in the destination economy only.
This would descend very quickly into a new form of “beggar thy neighbour” as any trade surplus would become an instant source of inflation (which of course raises the question: if this is so, why aren’t trade surpluses sources of inflation in Germany, etc). You might argue that this would force surplus nations to try to avoid big surpluses, but I don’t think that kind of financial warfare would be very popular with other countries…
From what I understand, Bretton Woods set the ground rules for the prosperity that emerged from the chaos of war. The IMF and the World Bank are just two concrete examples.
Perhaps we need a new Bretton Woods before we are run completely by the multi nationals. However, as in 1944, would the Americans play ball?
Two observations: Firstly, cutting the government’s deficit does not mean *UK* households have to borrow more. Instead it is more likely that we borrow less from overseas. People who don’t want to face up to the necessity of cutting government borrowing often come up with the argument that “you’re just forcing the private sector to borrow instead”, ignoring the difference between the UK private sector and the overseas private sector.
Secondly, reducing the trade deficit is dependent on external demand being there for UK goods and services. Most of our deficit is with the European Union. Until the Euro zone economy recovers and/or the Euro rises against the pound, this situation is not going to be solved.
Furthermore, we need to move away from controlling consumer spending, the housing market and inflation by using interest rates. The first effect of any interest rate rise is to force up the pound, kill exports and suck in imports. So every time consumer spending goes crazy, manufacturing gets clobbered. Until we find other ways of limiting overspending, we are going to be condemned to repeat this cycle, destroying our export sector and remaining industrial base with the blunt instrument of interest rates rises.
Peter
“If he wants to reduce his government’s deficit, without crashing the economy by imposing an unrealistic debt burden on everyone else, he has to acknowledge that this can only be done by reducing the external or trade deficit too. He has to start to tackle the problem from both ends.”
Is this possible under the rules in place for the free global market and our membership of the EU – and won’t this be made even more difficult once TTIP & TTP are ratified?
Cllr Mark Wright,
You’re on the right track. There is always a problem collecting all the figures in any case. If money as cash was used as part of a big international drug deal, say, and that cash just sat in an offshore safe then an equivalent amount of money could simply be reprinted and used by Govt with no inflationary effects. But if the drug dealers put that money into their bank accounts, it would be swapped on the FX markets, and eventually any surplus of pounds would be used to buy gilts (by the central banks of the big exporters). So, the money then returns ‘home’ in a more conventional way.
The reason excess money, from their huge trade surplus, (7% of GDP) isn’t a source of inflation in Germany is because the Germans are big savers! They still run an almost balanced budget. If they saved less then they’d have to be taxed more or we’d have more inflation in Germany. This wouldn’t please many there but the inflation would mainly be in net wages and salaries. Prices couldn’t rise too much because of the euro. They’d just end up importing more, so arguably this would be beneficial for the rest of the EZ.
@RC,
“Firstly, cutting the government’s deficit does not mean *UK* households have to borrow more. Instead it is more likely that we borrow less from overseas.”
It could work like that, theoretically, agreed. But does it in practice? There was some progress (if that is the right word) in reducing the government’s deficit in the last Parliament, but still the trade deficit (or more accurately the current account in the balance of payments) rose. If it had instead fallen, there could have been more progress without encouraging too much private sector borrowing. So I’d ague there was no real progress at all. Govt simply forced the transfer of some of the borrowing away from itself and has created a perilous situation of a huge credit created asset bubble in the property market.
“Govt simply forced the transfer of some of the borrowing away from itself and has created a perilous situation of a huge credit created asset bubble in the property market.”
The government hasn’t “forced” the UK private sector to borrow more by itself borrowing less. It just doesn’t work like that.
The idea that cutting the government deficit can increase the balance of payments deficit is just plain wrong. If anything it is the other way round: cutting the deficit reduces demand and therefore cuts imports, as has happened in some Eurozone countries.
@RC,
“The idea that cutting the government deficit can increase the balance of payments deficit is just plain wrong.”
But that’s exactly what DID happen between 2010 and 2015.
You are misrepresenting my argument by your phrasing, though. I’m not arguing there is a causal link in the way you suggest. There are always numerous other factors, besides govt fiscal policy, which affect the current account in the balance of payments or trade gap, for short.
On the other hand we can’t assume a causal link in the other direction either. Reducing the govt’s deficit may not reduce the trade gap, if interest rates are kept too low, which simply allows too much private borrowing to occur. So you’re right, in a way, that the government aren’t ‘forcing’ anyone to borrow too much.
But, if young people want to get a foot on the housing ladder, what other choice do they have?
@RC,
cutting the deficit reduces demand and therefore cuts imports, as has happened in some Eurozone countries.
Like Greece or Spain you mean? That may be one solution to the problem but it isn’t going to win too many votes for anyone advocating it.
There is a general assumption the UK, if we could just find the right policies, can have a high pound (selling as many gilts to the world as it cares to buy), a successful economy at full employment, low inflation, a low govt deficit and low trade deficit all at the same time.
Sadly not. We can have some of those things but not all. It’s going to be politically unpopular to say it, but the reality is: to have a low government deficit, a successful economy and a low external deficit all at the same time requires the pound to be much lower than it presently is.
The politics of my younger days – say up to the 1970s- was obsessed with balance of payments deficits and availability of credit to ordinary people. We got away from the first when we discovered ‘invisible exports’ – sales of services, rather than goods, although no-one seems to publish statistics as clear about this as about visible trade balance.
The control of personal debt – which was implemented by ‘credit squeezes’ – was lost after the mass introduction of credit cards in the 1960s, followed by relaxation of their conditions. No longer was taking on a debt a formal matter for a set amount and time. After the relaxation of exchange controls in the early 1970s, it was no longer clear in which country your personal creditor was.
If those who think government deficits don’t matter were right, if you took non-mortgage debt between 2010 to 2012, and compared it to 2012 to 2014, I’d have expected it to have risen significantly. Instead, according to the ONS “The average (median) amount of financial debt held by a household in Great Britain was £3,400 in 2012 to 2014, compared with £3,500 in 2010 to 2012.”
See http://visual.ons.gov.uk/debt-awareness-week-5-facts-about-debt-in-great-britain/
I’d also expect personal debt in the UK and the USA to be smaller than in the surplus countries like Germany and China. That doesn’t seem to be the case.
http://prntscr.com/9y1qle
http://www.cityam.com/1411501631/debt-map
As is often the case, the statistics seem to be all over the place. If anything, they seem to indicate that there is a link between high government deficits and high personal debt, but the link isn’t consistent. I suspect, if I worked hard enough at looking for selective data, I could find links to confirm the theory that government deficits don’t matter, but I fear I could also find links to prove the opposite.
I’m inclined to agree with RC. I suspect, that if a government runs a big deficit, it stimulates the economy, sucking in exports. It makes consumers feel better about the economy, so they use credit to buy more imports. And that, far from a large government deficit reducing personal debt, in the long run, it may increase it.
My impression is that that only countries to take a relaxed attitude to government deficits are those like Venuzuela. http://prntscr.com/9y1sxf Venuzuela appears to have assumed that, with its vast oil reserves, it didn’t need to worry about financial restraint. Obviously, the collapse in the oil price has harmed them greatly. But I bet there are a lot of Venuzuelans wishing they’d followed the policies of Norway. http://prntscr.com/9y1tmx
http://www.bbc.co.uk/news/world-latin-america-34983467
If there were a consensus of economists (as there is over climate change) saying that what I’ve said above is incorrect, then I’d be happy to take their word for it that I’m wrong.
But there’s no consensus. Economists seem to be utterly at odds with each other over this question.
George,.
I wouldn’t hold your breath waiting for economists to come to a consensus! If you want to understand how the system works you’ll need to figure it out for yourself. We now think of Keynes as an economist but his degree was in mathematics. He certainly didn’t take his economics from the ‘consensus’ of the time. He developed his theories for himself. We are fortunate that he wrote them all down. Maybe not so fortunate though that his style of prose doesn’t make for easy reading. You might want to read Abba Lerner first. He says pretty much the same thing in an easier style.
I’d argue that economists should adopt the scientific method. There’s no point saying that the euro ‘should’ work, for example, if it clearly doesn’t. On that basis, any economists who say the euro, and in particular the rules of the so-called stability and growth pact, is fundamentally flawed, ie the post Keynesians, are clearly right and the neo classical economists are clearly wrong. Theory has to fit observations. Period. (as our US friends like to say). The neo-classicists should hang their heads in shame over their claim that events like the GFC are non-predictable. That’s just nonsense!
So can a high government deficit be a problem? Well yes it can. It can produce too much inflation. Keynes saw that happen in the WW1 period and that was again starting to happen in the early years of WW2. The neo-classicals had no suggestions other than that the government had to cut spending and so lose the war! Keynes had better ideas.
Unfortunately mainstream economics has drifted back to neo-classicism. It didn’t work in Keynes’ time and it doesn’t work now.
So, George, put your thinking cap on! Figure out, for yourself, why Keynes was right and the mainstream economists of his era, and now, were and are wrong!
PS You might want to start at the beginning by understanding what a pound or a dollar actually is. Why can we use money to buy things when it’s just an IOU with no convertibility to any precious metal?
George,
I don’t want to go through your comment in detail. Your first sentence is bad enough.
“If those who think government deficits don’t matter were right….”
Who’s saying they don’t matter? It’s how they matter which is the issue.
Also, if you are going to discuss private sector debt, why leave out mortgage borrowing? Past Labour, Tory Govts, and Coalition govts have relied on that to keep the economy buoyant.
Peter,
I’m sorry you think I’ve not been putting my thinking cap on. In my opinion, I’m not waiting for a consensus to appear. I’ve been writing at length, here and elsewhere, as to what I think. It’s just that I’ve come to different conclusions from yourself.
I’d link to some of the lengthy conversations we have had on Facebook, but, frustratingly, they are no longer accessible. Which is pretty annoying, considering how much time I spent on them.
Generally, I’m a Keynesian, but I don’t dismiss Hayek. In that, I’m in good company, because Keynes was a great admirer of Hayek.
One thing I strongly disagree with you on, is the implication that economists can adopt the scientific method in the way that hard science can. In my degree, we were constantly warned of the dangers of relying on quantitative techniques in situations where they aren’t appropriate.
While quantitative techniques can help us understand economics, I’m sceptical that they will tell the full story any time soon. If they could, then someone somewhere would have produced a reliable economic model. So far, they haven’t.
The problem with economics is that it involves human behaviour. Hard science works well when human beings aren’t involved, but as soon as human behaviour gets involved, disciplines become harder and harder to model. It’s difficult enough to analyse an individual, let alone the behaviour of billions of people.
Maybe, one day, the psychohistory described in Isaac Asimov’s Foundation series will exist, and will be able to model the behaviour of societies. But I’d want to thoroughly test that model before I believed it.
For now, I don’t expect economics to do more than give indications of how the economy will behave. Useful, the best we have, but only indications. For the time being, I think the animal passions of markets, the unpredictable panics of financial markets, the whims of political leaders, and the unexpected consequences of unforeseen technological change will mean those indications only indicate what will happen, they won’t predict it.
My favorite quote from Vince Cable is:
“When my job was attempting to predict future economic developments for the Shell oil company, I was frequently reminded of an Arabic saying: ‘Those who claim to foresee the future are lying, even if by chance they are later proved right.'”
George Kendal writes :
“The problem with economics is that it involves human behaviour.”
Yes,….And that one crucial fact is the one constantly overlooked. These, intricate and deep debates’ about debt/deficit, never factor in that one problem, which is ‘human nature’. Whether it be ‘ $ reserve’, the ‘Bancor’, or the newly proposed IMF ‘Special Drawing Rights’, we never take the trouble to embed a security mechanism into a world currency, whereby, some person, or group of persons cannot *mess with it*, to their advantage, and conversely, to the disadvantage of everyone else.
Is it beyond doubt that a financial system [or any system], that can be manipulated by the greed of a group of human beings,.. will, with 100% certainty,..eventually,..be manipulated? So I think it’s fair to say that the debt/deficit financial woes we have today, were baked into the cake by our own failings decades ago.
I suspect we are witness to the ghost of a prediction foreseen, by pretty much everyone who understands human nature, except for fashionable modern monetary economics. In their giddy hubris, many economists feel that Nixon liberated the worlds currency in 1971. In fact Nixon probably injected a fatal virus into the worlds currency, and that virus is called ‘human nature’. But please don’t take my word for it, listen to De Gaulle in 1965.
http://www.nysun.com/editorials/waiting-for-de-gaulle/87456/
George and Indigo,
It sounds like you are both attempting a sort of because-we-don’t-know-everything-therefore-we-know-nothing argument.
Accountancy is nothing if not precise. If the Government’s deficit is £NN.PP then everyones else’s surplus £NN.PP too. Everything matches to the penny. We can separate ‘everyone else’ into domestic and overseas and come up with some useful information on the relationship between savings (borrowings) and the relationship between the internal and external deficits of any economy.
We can all have our theories as to the way our economy works. If the economy behaves as our theory predicts when we make changes , like tax rises or spending cuts, then we have reason to believe our theories may be correct. However, if it doesn’t and we end up with undesired outcomes such as severe recession and credit booms and busts, or whatever, then we should, as rational people, revise or discard those theories. It doesn’t matter what we think should happen. It is what we observe that does happen and which does matter.
That’s the scientific method.
George,
“because Keynes was a great admirer of Hayek.” ???
You mean the Keynes who wrote ” The book [Hayek’s Prices and Production] as it stands, seems to me to be one of the most frightful muddles I have ever read ??
Either you are generally in agreement with Keynes or you’re in agreement with Hayek. You can’t have it both ways, George.
Peter, you said ‘You mean the Keynes who wrote ” The book [Hayek’s Prices and Production] as it stands, seems to me to be one of the most frightful muddles I have ever read.’
Yes the same.
But of course he is also reported in the following way by his biography, Lord Skidelsky:
“Keynes cordially welcomed Hayek’s Road to Serfdom: ‘It is a grand book…Morally and philosophically I find myself in agreement with virtually the whole of it; and not only in agreement, but in deeply moved agreement’.”
If you want a fuller description of what I mean, Keynes and Hayek had major disagreements, but they also admired each other.
Hi Peter, you said: “However, if it doesn’t and we end up with undesired outcomes such as severe recession and credit booms and busts, or whatever, then we should, as rational people, revise or discard those theories. It doesn’t matter what we think should happen. It is what we observe that does happen and which does matter. That’s the scientific method.”
As Krugman, Stiglitz and Piketty acknowledge in this youtube https://www.youtube.com/watch?v=Si4iyyJDa7c , that they didn’t predict the great recession, and say that no one did. Apart from people who predicted a lot of other things that didn’t happen, so that doesn’t count.
If they are right, and I’m inclined to believe them, then if economics follows the scientific method, then all the models that should have predicted the Great Recession failed, and need to be revised or discarded.
There will, doubtless, be many other models that their advocates will claim would have predicted the Great Recession. I may be wrong, but my prediction is that, even if they can predict the past, they’ll fail to predict the future.
@ petermartin2001
“It sounds like you are both attempting a sort of because-we-don’t-know-everything-therefore-we-know-nothing argument.”
Errr,..Absolutely not. Any monetary system,.. if it can be manipulated by humans, ..*will* for sure, be manipulated by greedy unscrupulous humans. That must surely be a given ? Also,..any monetary system that has no peg to reality, will,.. due to human nature, get bloated exponentially, into unreality,.. which is frankly, exactly where we find ourselves here in 2016, with a currency pegged to… *nothing*.?
This monetary system we use today, became freed from a gold peg since 1971, and now finds itself with an exponentially derived, and un-payable …..$200 trillion in global debt.? How did that madness happen? Clue ~ Human nature!!
Once you drop the idea that you have to peg a monetary system to some form of physical asset, you are then candidly, in the twilight zone. And the next rung in this ladder of madness, is ‘printing cash out of thin air’. Bluntly,.. at this point financial madness has spiralled into psychosis. We have naively allowed ourselves, globally,.. to play a 41 year old game of pretend with our finances, and there is frankly, no way out but facing reality.
Facts to be mindful of :
The average longevity of all historically known global *fiat currencies* is about 37 years.
Only one sustainable *money* system has been globally acceptable, ubiquitous, and lasted, 5,000 years plus.
@ George,
You’re right if you are saying that predicting the GFC had to be for the right reasons and not a lucky guess.
Steve Keen was perhaps the best known for getting it right. See here. Steve Keen is the best known modern day proponent of Irving Fisher’s theory of debt deflation.
Wynne Godley got it right on the basis of his work on sectoral balances
These showed that the private sector (the blue sector in the graph) in the USA had been in deficit for the best part of a decade before the GFC. That was indicative of far too much private sector borrowing.
The penny hadn’t quite dropped with me, on all this, prior to the GFC. I knew that something was wrong when house prices were rising so quickly. I also knew that a bust invariably follows a boom but I wasn’t alone in thinking that. I now have a better understanding of why that always happens.
Since then I’ve the importance of the sectoral balances, which isn’t a difficult concept. The private sector in the UK is now in the red BTW. Which is why I’ve been harping on about the importance of government not simply shifting its debt obligation to the private sector by encouraging too much private sector borrowing to occur.
George,
I’ve had a go at explaining what Keynes was really about as I understand him. I’ve had four articles (I think) published here. Maybe you’d like to have a similar try at explaining Hayek to the rest of us?
Hi Peter, probably best if the person explaining Hayek was an expert on Hayek, and actually was a Hayekian.
George,
Well I’d still encourage you to have a try. I approach economics with the view that I’m no genius in the subject and so I have to distill the concepts so well that even I can understand them. Once I’ve done that, I have some hope of explaining them all to others.
In other words, the problem with experts is that they often have trouble getting their ideas across clearly and concisely in the 600 or so words we are allowed on LDV.
I think you’re right, that I could do a decent job giving a very broad summary Hayek’s ideas.
But if I did, I know what would happen. Some people wouldn’t read it properly, and would assume that meant I agree with Hayek. Some people would know I didn’t, but would misrepresent me as a Hayekian. And I’d never hear the end of it.
It’s sad. But it’s the reality of the public internet 🙁