Great Leap Forward



They’re at it again. Moody’s is threatening to downgrade the US Federal government if it does not adopt fiscal austerity. Moody’s as well as other credit ratings agencies already have the US on a negative watch. Yes, the same raters who happily gave Triple A ratings to the trashiest mortgages the world had ever seen warn about rising default risk of sovereign currency issuing government. That’s clueless.

It is very hard to know how much of this is just political posturing–an attempt to push Congress and the President to use austerity as a way to push through the Neoconservative agenda. Since the ratings agencies played a huge role in creating the real estate bubble and bust–that helped to move all wealth to the top 1%–we probably should assume that a lot of this is pure politics.

Sovereign government cannot be forced to default on its own floating currency debt. The only risk is a voluntary default. Moody’s is all in a huff about a Federal government debt to US GDP ratio of about 100%. Japan’s is double that. And what do markets think about the default risk? Nada. I know that some people claim that while the US or Japan cannot be forced to default, their politicians might choose voluntary default. I don’t believe it, nor do markets. When the raters downgrade Japan or the US, the market just goes Ho-Hum and ignores it. Interest rates don’t move. And if Moody’s does downgrade the US this time, markets will ignore it again. They know that even the craziest Bozos we’ve got in Washington are not going to let Uncle Sam miss debt payments.

With the election over, Washington has turned to the “looming fiscal crisis” that supposedly faces the Federal government. Suddenly the same politicians who wrote the legislation that created the “fiscal cliff” by writing into law automatic spending cuts are huffing and puffing about how it’d be a catastrophe to let their law determine the cuts. I’ll say more about all this posturing later.

But here’s the bigger takeaway. Yes, the budget deficit is large, due to the automatic stabilizers. It won’t shrink, and shouldn’t shrink, until we have a robust recovery. I think that is months and probably years away. Meanwhile, the deficit is helping to prevent this downturn from becoming a full blown Great Depression. The trillion dollars or so of deficits means by identity that the nongovernment sector is running a surplus of a trillion dollars. While a small portion of that leaks out of the US (due to our current account deficit), most of it stays home, where it helps firms and households to rebuild their balance sheets.

Anyone who argues for cutting Federal deficits now must be arguing for cutting the nongovernment’s surplus. Dollar for dollar. Anyone who wants to reduce the Federal debt outstanding must be arguing for cutting the private sector’s net wealth. Dollar for dollar.

And here’s another point. Budget deficits create profits for firms. Dollar for dollar. If you are against deficits, you must be anti-business! You are a profit destroyer.

This might not be intuitive but it results from a macroeconomic identity called the Kalecki Profits Equation.

Here’s a graphic that shows the derivation:


If that, too, is opaque, there is a very nice explanation here:

Here are the key paragraphs:

In the post-war era, government deficits have played a more supportive role in terms of offsetting the retrenchment in private investment during economic downturns. When private investment was buffeted by the financial crisis in 2008 and corporate profits plummeted, the massive increase in government deficit spending allowed a quick recovery in profits during 2009.

According to the Congressional Budget Office (CBO), fiscal austerity measures related to the fiscal cliff would result in a more than $500 billion reduction in the government budget deficit in 2013. Given the negative influence of government savings (reduced deficits) on profits, this would mathematically decrease the source of corporate profits by a substantial amount. According to the profit equation, if the full fiscal cliff were to occur, the significant contraction in the government deficit from 2012 to 2013 would cause a 31% decline in 2013 corporate profits (see chart below).

And here is the key chart:

(If the charts are too small, click on them and they should get big enough to read them.)


Finally a note on moderation of the comments section. Yes, I know it has been a big pain in the arse. I didn’t want to do it but the Trollers forced it. The “intense debate” app is a nightmare. I’ve asked our techies at Economonitor to drop it from my blog. Even I couldn’t post comments (poetic justice, I’m sure the Trolls would say!). And comments that got approved for posting would somehow go off into the netherworld, never to be seen again. Some that got posted would suddenly disappear. What a mess. So, I am hoping things improve now. There will still be light moderating. Negative comments are welcome, but those that stoop to name-calling will be edited or trashed. Hint: comments that are signed with a real name will go through with the least moderation. If you are willing to put your name to your comment, we are willing to post it. Finally, I’m still looking for contributions to Troll Friday.


olly100November 8th, 2012 at 4:49 pm

three problems:

1. 4 trillion of the debt is due to the Iraq and Afghanistan wars. A waste of money.

2. I don't know how much was spent in total on propping up the corrupt banking sector but again a waste of money.

3. Most of the domestic non-government surplus seems to be sitting in corporate bank accounts. A waste of money?

kgeakinNovember 8th, 2012 at 7:41 pm

Clearly, you are in the Keynesian camp, as are most academics these days, unfortunately. After numerous massive national debt increasing stimuli, you guys keep singing the same old song. These actions fit the definition of insanity. You do realize, I hope, that even when freshly printed money is used to incur even more debt, that debt must eventually (in theory anyway) be repaid by………somebody. I guess that is just that unfortunate somebody's problem though. Your arguments are so weak and have been refuted by so many, I won't even bother to do so here. But, since you brought up Japan as an example, let me point out that they have now had nine rounds of "easing" or "stimulus" and they are still in a world of poo and are circling the drain right now. Is that what you want for the USA? I sure don't. I do not pretend to know what the best course for our nation is at this point. I actually am pretty sure that the opportunity for non-disastrous outcomes has already passed, sadly. However, I am quite certain that printing more money so the Fed can buy (monetize) more Treasury debt will just delay even greater pain. I am sure you are aware that there is already over TWICE as many US dollars in circulation than before the financial crisis and that in spite of that fact the velocity of many has DECREASED. This is a complete failure of the Fed's Keynesian policies. Got any other ideas?

olly100November 9th, 2012 at 12:22 am

Japan has an old population and very low birth rate and they don't spend their income, they just save it. The economy has low GDP growth but overall is not nearly as bad as some people make out. Unemployment is 4.2%, GDP per capita (PPP) is about the same as the UK, for example.

L. Randall WrayNovember 9th, 2012 at 2:21 am

Keynesian camp? Yes, Guilty. Glad to use economics of the 20th and 21st century rather than the tired old economics of the 19th.

But talk about a weak argument! Japan followed every half-hearted stimulus with sharp austerity that killed every incipient recovery. Yes there’s loads we can learn from Japan’s case, but I guess you missed the lessons.

Maybe you want to go for an extended piece on Troll Friday?

jonf34November 9th, 2012 at 3:38 am

I see the stock market is down again rather significantly for the second straight day. I also noted yesterday that our friend from the house, Boner or something, said the Rs would accept some increase in revenues so long as entitlements were fixed, or something like that. Obviously bait for the President to "negotiate". I hope he lets them sweat until after the first of the year.

But then there will be the spectacle of the debt limit and Moody's is planning a party. I know it doesn't fit in with your ideas, but personally I would like to see the taxes go up. That would at least spoil the Moody's party and make me feel really good.

I'm not usually a conspiracy theorist but I wonder if the market isn't related to these "negotiations" in some way.

Aegean1972November 9th, 2012 at 11:39 am

all very good points^^

Back in 2002 when i was openly saying that the Iraq/Afghan war was going to bankrupt America, many called me not-patriotic…un-american…

Aegean1972November 9th, 2012 at 11:42 am

great article

I think it ll take a few years until we see a real recovery. Maybe even a decade, if theydont act fast. And since we re talking about politicians here (and lobbies) i dont any major changes in the near future. Just kickin the can further.

But kickin the can further means no jobs for the middle and low class, shrinking economy and defaulting on debts. If they are dumb enough to add taxes and austerity to the package, then a Greek-style depression is almost guaranteed.

austerity is NOT solution.

L_Randall_WrayNovember 9th, 2012 at 8:08 pm

Guilty as charged. I prefer 20th and 21st century economic theory to tired old 19th century thinking.

Japan's experience is well understood. Yes they would try a tepid stimulus but then quickly impose austerity to try to reduce deficit; that would destroy any incipient recovery, and then the deficit would actually increase.

Maybe you should try to write up a coherent argument for Troll Friday?

kgeakinNovember 9th, 2012 at 9:46 pm

Hmmmm, I don't think the age of an idea necessarily has much bearing on it's value. If that were the case what would it mean for religion? Or geometry? Or the ideas from guys like Plato, Aristotle, DaVinci, etc. I would be happy to make a submission as soon as you let me know what I get paid per word. I am sure you don't work for free……and neither do I. Being serious for a moment, I have read and appreciated a number of your other articles; however, this one seemed to border on government propaganda. Best regards.

olly100November 9th, 2012 at 9:56 pm

Randall, have you read this paper? :…

What do you think about Benes/Kumhof's description of government-issued money as 'equity' rather than 'debt?

It seems to me that the word 'equity' fits Knapp's theory of govt-issued money more closely than than the word 'debt' does.

Government-issued money as 'debt' seems to be something which Innes came up with.

In fact, in "The State Theory of Money" Knapp specifically states that government-issued money is NOT a debt of the government.

But he doesn't specify what it is exactly (from an accounting perspective). Instead he just refers to it as the "true definitive means of payment" established by law.

What was Keynes' view on this?

kgeakinNovember 9th, 2012 at 9:59 pm

Quite right you are. Unfortunately that aging population is much like our boomers – in the process of moving from a career which enabled savings (most of Japan's debt is held by it's citizens) into retirement where they will use those savings. Which means they will need to sell those government bonds. This is very bad news for Japan. They will simultaneously experience a reduction in income tax revenue and buyers for their bonds. They have also recently experienced severely depressing events in the form of the Fukushima disaster, which is far from over, and a massive drop in exports due, among other things, to their spat with China. Japan is in BIG trouble.

L_Randall_WrayNovember 12th, 2012 at 4:51 pm

Uhm, no, not paid for this and we don't pay for contributions to Troll Friday either. We rely on people being committed enough to their own ideas that they wish to devote some time to explicating them.

L_Randall_WrayNovember 12th, 2012 at 4:53 pm

jon: Simple math; if you start with the identity you will see that the profit equation finally turns out to be

profit = investment + govt def + net exports + consumption out of profit – saving out of wages

we often assume capitalists don't consume and workers don't save so we can drop the last 2 terms to simplify things. Or leave in capitalist consumption and you get Kalecki: "capitalists get what they spend"

L. Randall WrayNovember 12th, 2012 at 4:54 pm

Olly: I didn’t read the paper, but met Kumhof in Berlin 2 weeks ago. Interesting stuff; combining DSGE models with the old 100% money proposal. We discussed MMT and he followed the arguments. He agreed that 100% reserves alone will not eliminate financial instability, so we’ll still need to regulate and supervise the other financial institutions.

L_Randall_WrayNovember 12th, 2012 at 4:56 pm

ALL: WONDER OF WONDERS! The "intense debate" bugs seem to have been sorted out. I found a number of your comments that got lost in the stratosphere and have got them posted up. So, as far as I can tell you just need to join up (register) then login and you should be able to post comments. Again, we moderate only nasty comments; and less moderation if you use your real name.

kgeakinNovember 12th, 2012 at 5:02 pm

Actually, I am curious as to why You invited me to contribute to Troll Friday. It would appear you are inferring that I am a troll. If disagreeing, in a civil fashion I might add, with your opinion makes me a troll, then apparently you are looking for acolytes – not independent, reasoning readers. Good luck with that.

L_Randall_WrayNovember 12th, 2012 at 5:40 pm

Put it this way: would you turn to flat earth theory to triangulate a Mars mission? If so, I hope you pilot that ship alone! 19th century neoclassical theory (on which current mainstream theory such as RBC, NMC, and NC–and even much of the NK theory is based) is flat earth economics, thoroughly routed by Keynes. So, yes, I'm a proud Keynesian, as are all competent economists today. DaVinci was a great artist for all times and a great scientist for his times, but I'd rather have today's scientists design the next generation of flying machines.

L. Randall WrayNovember 12th, 2012 at 6:48 pm

No, not at all. Anyone can be a Troll on a Friday–including me. But preferably not me. Troll Friday is for guest posts, preferably by dissenters. Who are unpaid but have a contrary point they want to make that cannot fit into a brief comment format. Unlimited space to make your point in as complete and as coherent a manner as you can.

kgeakinNovember 12th, 2012 at 8:21 pm

You make statements as if they were facts when they are actually your OPINIONS. Your comment above is a very good example of this. Human behavior is a large component of economics. Basic human behavior has changed little, if any, over the ages. Also, I hope this isn't too much of a shock to you, but astrophysics and geometry belong to the realm of science. Economics, on the other hand, does not. Good luck with your "blog".

kgeakinNovember 13th, 2012 at 2:04 pm

You are simply amazing. Well, I guess it takes one to know one. And since you are clearly the Troll King I guess you would know. You get wise with people that leave reasonable opinions, but contrary to yours, and that makes them a troll. You have obviously been living in the pearl tower of academia for far too long. You do realize that I am not one of your submissive students trying to suck up for a good grade right? With your attitude you should contact the RNC. I am sure they would be thrilled to support a guy like you for the next presidential election. I would recommend contacting Obama and throwing your hat in the ring to take Timmy Geitner’s place, but I think you lack the qualifications. Oh, and by the way, I have no interest in seeing this in print on your pathetic yes man blog, so F**K YOU!!!!!

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Håvard Halland Håvard Halland

PHåvard Halland is a natural resource economist at the World Bank, where he leads research and policy agendas in the fields of resource-backed infrastructure finance, sovereign wealth fund policy, extractive industries revenue management, and public financial management for the extractive industries sector. Prior to joining the World Bank, he was a delegate and program manager for the International Committee of the Red Cross (ICRC) in the Democratic Republic of the Congo and Colombia. He earned a PhD in economics from the University of Cambridge.