Is the World Bank going to impose sanctions?  Why should we care?  

Will the US remain the world's largest consumer economy? Well, we might have some difficulty getting our beloved Mid East Oil.  The Kingdom and the Emirates might take default personally.

With other trading partners can we take the position: We are your largest market. Consider the hit as a cost of doing business and the market is open.  Promise not to do it again. If so, then I would truly know WHY I AM PROUD TO BE AN AMERICAN!

If the US defaulted how much of a world economy would remain?

I can see that it would stop the accumulation of wealth by the top 1% in its tracks.  DEFAULTS FOR ECONOMIC JUSTICE!  

As a practical matter we may have to forgive our debtors.  The Lord's Prayer as Economic Policy! This is getting good.

But I still would like to know what Keynes would say.  Can anyone channel JMK?

If sanity be culturally normative, then by the norms of this culture I claim insanity.

The Eurozone's Growth and Stability Pact commits Member States to running no more than a 3% GDP budget deficit.

They are forbidden by the U.S. Constitution from imposing import or export duties.

European Union Member States cannot restrict the flow of goods, services, people or capital among themselves, and import or export duties with third-party states are probably harmonized via the EU which negotiates before the WTO on behalf of the Member States.

Capital markets and most large banks are, at minimum, national in scope. They can charter banks that are confined to their states.

The scope of retail banks in the EU is still only a member state (even when a bank owns a subsidiary in a neighbouring state, it operates as a different bank - examples I am familiar with include NatWest operating in Spain and Raiffeisen in the Czech Republic, but I don't know what the situation is between two Eurozone countries). Capital markets are still at most regional. Euronext integrated Paris, Brussels and Amsterdam, and there were talks of a merger between Deusche Börse and the London Stock Excange, but that's about it, other than that the markets cover single member states.

States do not issue currency, though I do not know if they are specifically precluded from doing so. They can issue bonds.

It is unclear to me how the issuing of currency works within the Eurozone, but each Eurozone member state can issue its own bonds. The Member States' central banks still exist and retain a certain set of competences, and only some of the powers have been transferred to the European Central Bank. There is a "European System of Central Banks" which gathers the ECB and all the Eurozone member states' central banks.

It seems to me the Eurozone is almost there if we aren't there already.

When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done. — John M. Keynes

I'm asking because there were reports of budget shortfalls in several US states. If they can't run deficits, in case of a surprising drop in tax revenue, they have to cut immensely in their spending?

Lich King/Caribou Barbie 08
Pain brings Katharsis

It is, of course, a fuzzy question the extent to which a discounted peg is neo-mercantalism, and the extent to which it is just what a country has to do if it is trying to maintain a peg.

That is, if there is a cut-throat, non-cooperative international exchange rate system, then a country whose industrial development requires the stability of pegged exchange rates is forced to a discounted peg. A peg that is neutral "on average" will require as much defense from short-term downward pressure as from short-term upward pressure. And while a country defends a peg against upward pressure using its own currency, which it can create as required, defense against downward pressure requires the use of foreign exchange reserves, which cannot be created as required.

So a nation that needs to peg in the current, non-cooperative exchange rate system, needs to establish a discounted peg.

However, when the peg is arguably in the range of a 30% to 50% discount, such as the Chinese Yuan/Renminbi, there is no doubt that this is beyond the technical demands of a peg that can be defended, and into the range of pursuing a deliberately undervalued currency in an effort to export unemployment to overseas trade partners.

(1) Here in the US, our current combination of policies is pursuing short term profits for large corporations, by going along with the Chinese efforts to export unemployment and using the threat and reality of Chinese competition to squeeze down costs from competitive supplier networks across the board.

(2) The value of US investments in China is not a big issue, since the US has not had a substantial surplus on the capital account in the period since it has been possible to engage in foreign direct investment in China. And even for Japan, which has been in a position to accumulate FDI assets in China, the primary purpose has been to cement relationships with Chinese suppliers, and the benefits of the FDI are gained from the profitability of the operations at the final stages of the supply chain, rather than from repatriating profits from the Chinese operations.

(3) China knows perfectly well what they are doing ... they are doing it, after all, as deliberate policy established after much internal deliberation, study and debate, while in the US the complementary policy has been established on the basis of interest groups introducing enough noise and confusion in the political process that they can get the individual deals or individual loopholes that they require to play their part in the Chinese policy.

So its not a matter of the Chinese "realizing they are getting screwed", but rather the Chinese deciding that the situation has changed, and that their interest no longer lies in an exchange rate that is steeply discounted against the US$. I previously diaried on one scenario for that ... where the Chinese decide that imported inflation for Energy and other commodities is a more serious issue than their competitiveness in the US market, and decide to go for a partial revaluation of the yuan/renminbi.

If that happened, the US$ would drop, the US would gain new non-traditional export markets in various parts of the world ... though probably very little in the neo-mercantalist zone ... there would be some partial recovery at the margins of domestic production that has been under heavy pressure from import competition - though more in terms of things like machine tools and agricultural machinery than in terms of things like textiles ... the US mean standard of living would take a hit, and employment and economic would benefit, so that the median standard of living would either remain fairly stable or quite possibly rise.

The combination of some mild benefit to the majority of Americans and a big hit to the economic power of the US$ earnings of the top 1% would be portrayed in the US media as a massive crisis in US standard of living, and given the tendency of media to focus on mean averages rather than median averages, there would be all sorts of numbers floating around to persuade people that their personal experience of things being not so bad after all were only unusual special circumstances.

(4) It isn't like the median US citizen has decided to go along with the Chinese policy of exporting unemployment to the US ... when given an opportunity to vote against that policy, they do so. However, the example of this year tells the tale of the tape on that fight ... the nominees of the two parties for President this year only differing in terms of how enthusiastically to participate in the export of unemployment from China to the US. So the only votes that can be cast "against" are meaningless protest votes.

(5) All the big transnationals that benefit from a wage squeeze and weak organized labor in the US benefit from this policy. Its a big part of how they were able to accomplish a decade in which all the gains from productivity increases went to profits, instead of being split roughly fifty fifty as in the previous half century.

(6) There is nothing at all strenuous in this for a General Theory based Keynesian economics. Its only the cluster of traditional marginalist economic approaches that struggle to make sense of this, since they start at the outset with models in which the natural thing to happen is for foreign exchange rates to take the future trajectory of various economic paths into account, and therefore have baseline foreign exchange rates and domestic discount rates established at "fair prices" for both lender and borrower.

The fact that there is intrinsic uncertainty might be acknowledged by a traditional marginalist, but with modeling focusing on reactions to forces, there is no formal vocabulary for modeling the impact of true uncertainty in terms of the "universal" unaccounted for downside is always greater than the "universal" unaccounted for upside. The party accumulating net obligations ... the net "long" side ... is intrinsically more exposed to systematic risk from unforseen shocks.

All that is, of course, perfectly straightforward in a General Theory system, so its not like "no economic theory can cope with it", but rather that the economic theory that can cope with it has low social standing within the profession and therefore has relatively few people exploring its implications, bringing it up to date to the evolution of domestic economies and the international order, etc.

Utsukushikereba sore de ii

A fixed point peg can be defended from speculation, so long as the side under pressure to devalue is defended by the other central bank ... because the other currency is under upward pressure, and that central bank can create its own currency to defend against upward pressure.

When the pound was forced out of the ERM, the Bundesbank did not want to defend the ERM exchange rate of the pound, AFAIR because it was faced with the inflationary impact of the integration of East and West Germany, and the side effect of pushing down against that upward pressure is an increase in supply of reserves, pushing down the floor inter-bank reserve lending rate.

And the Bank of England AFAIR did not want to defend the pound by increasing interest rates, AFAIR because the UK was coming out of a recession, so as it defended the FXR with purchases of pounds using foreign exchange reserves, at the same time it issued pounds as reserves domestically to keep the interest rate down.

To be able to defend a system of pegged exchange rates, you either need the central banks on either side of the peg to put first priority on defending the exchange rates, or regulatory controls on flows of financial capital across international boundaries, or both. The EU eliminated the capital controls in transactions between ERM members, and as it turned out when push came to shove, the priority on defending the ERM was not there.

The break-down of Bretton Woods was similar ... in the original Bretton Woods system, all currency pegs were to gold, and net clearances were in gold. The use of US$ for clearances was a convention that developed, to avoid the inconvenience of net clearances between reserve banks in gold.

When France refused to accept that the US$ in the early 70's was at the correct peg to gold, and demanded clearances in gold, the US was faced with either an ongoing series of devaluations by the USG, a radical change in economic policy to reduce the downward pressure on the dollar which showed up in the requirement to pay net clearances, or else an abandonment of the Bretton Woods system. In the end, though it took a little while to play out, the last course was taken.


Utsukushikereba sore de ii