Monday, December 1, 2014

Angst in Freedonia: are there no alternatives to austerity?

As neighboring countries, the Kingdom of Moronia and the republic of Freedonia could not have had more different monetary systems. What wasn't apparent at first was just how significant those differences were when it came to how they could deal with both difficult and prosperous economic times. 

Moronian austerity

Moronia, with its gold-based money, was constantly at risk of the depletion of their reserves of gold. This occurred especially when the nation desired to import more goods than it exported (since it had to pay for them in gold) - and this almost always happened when Moronia was at war (Moronians often waged war). To stem the outflow of gold, wages would plummet, rations would be imposed, imports would be minimized, and after a painful adjustment they would start exporting again to restock the gold reserves. 

Over time, the people of Moronia noticed that every time this happened, the large industrial business owners would end up with more and more profits, while the workers never recovered their wages from the downturn. They weren't too happy with all the wars and falling incomes. 

To avoid revolt, the king of Moronia consulted his advisers and business leaders, and they came up with a clever strategy: they would broadcast repeatedly through all possible media the message that "There Is No Alternative" (they called the propaganda campaign TINA, which was later satirized by a popular folk band). The message was harsh, but (so it went) the alternative would be much worse. The only way to survive and compete in a global economy is with lower wages and higher productivity (i.e. longer hours and worse worker conditions) in order to keep the nation's economy strong. 

The Moronians, who were accustomed to suffering (many believed it was virtuous), thought the logic was irrefutable and they dutifully accepted the King's meme. They held out hope that perhaps one day they would join the ranks of the wealthy if they just worked hard enough.


Meanwhile, Freedonia was experiencing a very different dynamic. The had set up their currency (the "Liberties") based not on a promise to convert to gold (a promise they knew they could never keep permanently, especially if they were forced into war -- Freedonians hated war), but on the simple notion that a tax imposed on the population would drive demand for the newly created currency (you can read that story here).

Freedonia traded with other nations (even Moronia), but they always preserved their sovereign right to protect national interests by limiting trade when necessary. Rather than using gold, goods and services were bought and sold at the going currency exchange rate between them and their trading partners. Other nations had followed their lead in forming their own national money of account, and each currency would fluctuate in relation to the others based on a variety of factors. Usually, this took the form of Freedonia's national bank holding onto currency reserves of the nations they sold goods (in selling them goods, they were "buying" that nation's currency), and the reverse would hold for nations they mostly imported from.

Over time, Freedonia became prosperous and also a net importer. They were sending more Liberties abroad than they were receiving back. Their trading partners were holding more and more Liberties (usually in the form of interest-earning government bonds). It looked like they had a mountain of debt owed to other countries but they understood that it simply represented their trade partners' desires to hold their currency in exchange for selling them products. Of course, this also meant that Freedonia was able to keep more of their nation's resources and production for their own enjoyment, in addition to receiving the work product of other nations.

But then came the big recession. 

Banks were in trouble, and the economy was hurting. People were losing their private sector jobs as businesses tightened their belts (fortunately, most found temporary work & a basic income through the national job guarantee program). Businesses stopped investing, and there were some saying the government should also pull back on many of its ambitious projects, especially the national high-speed electric rail system powered mostly be renewable energy. To many, stopping spending just seemed to be the logical response when times are tough. At least, that's what businesses and households do. 

Do sovereign nations with their own currency have to behave this way too?

The export debate

Like all freedom-loving peoples, Freedonias had a lot of opinions across a wide spectrum of values and ideals. One such group, which after the crisis became a fairly vocal minority, emphasized the values of discipline, hard work, & self reliance. Many of them had started their own businesses and had succeeded, or had overcome obstacles in their lives and moved on to success in various fields. They looked over at Moronia and began to wonder if they had something right. 

Perhaps what was needed, they proposed, was to lower wages, work harder, and boost exports to earn the way back to prosperity. They began to question whether the job guarantee should be taken away since it provided a base wage that the private sector couldn't really go below. Seeing an opportunity to lower costs and boost profits, some of Freedonia's leading CEOs and business organizations joined the chorus. 

TINA was a hot topic of debate in bars across the land. 

Many others in Freedonia were more concerned about the darker side of the policies across the border in Moronia. Since the great recession, unemployment had skyrocketed and was taking a very long time to recover. Wages were falling and more and more people were losing their life savings just to stay afloat. Many were no longer able to provide an adequate living from the jobs that were available, and were relying of food pantries and donations for assistance. Crime, domestic abuse, and even mental illness were on the rise. Youth were dropping out of universities because they couldn't afford to stay in school. This wasn't the land of liberty the people of Freedonia wanted. 

Was there really no alternative, they wondered?

So they turned again to study how their monetary system could be used to help them recover from the recession and grow their economy. Did they really need to take the austerity path in the hope their suffering will lead to more exports and, one day, higher wages again?

What they discovered surprised them.

Comparing exports to government purchases

They decided to run an experiment. Freedonia was very good at making trains, so they compared what would happen if:

  1. a new train was exported to Moronia, or 
  2. a new train was bought by the Freedonian government.

Option 1: 

  • Moronia places an order for a train with a large train manufacturer in Freedonia
    • Moronia only has gold, but the businesses wants Liberties to pay suppliers and employees, so the Bank of Freedonia takes the Moronian gold and then issues new Liberties by crediting the bank account of the train manufacturer. 
  • A number of businesses in Freedonia work together to make the train (there are many small and medium businesses involved in the supply chain)
  • These businesses have to hire additional good paying jobs
  • The businesses see profits increase
  • Finally the train is shipped off to Moronia

The end result is that there is a NET INFLOW of Liberties into the economy from outside the Freedonian domestic private sector economy.

Great, this is exactly what the supporters of the Moronia Austerity Plan predicted!

Option 2: 

  • The Freedonian government places an order for the same train. 
    • In this case, the Government simply credits the bank account of the train manufacturer with newly created Liberties, which only the Bank of Freedonia can issue. 
  • The same manufacturer and suppliers make the train.
  • The same number of new, higher paying jobs are created.
  • The same profits made and workers paid. 
  • The train, however, stays in Freedonia to the benefit of the people

So once again, the end result is still a NET INFLOW of Liberties into the economy from outside the Freedonian domestic private sector economy.

What's the difference? 

  • In money terms, there is none! Fiscal policy has virtually the same effect as foreign trade in stimulating the economy.
  • In "real" terms, one could argue that the Freedonian's are actually better off having worked to produce a train they use themselves rather than one that is sent to help Moronians (especially since Moronian trains are mostly powered by non-renewable energy, which has been causing pollution in the neighboring regions of Freedonia!)

Some still worried about the so-called "national debt"? It seemed to be a big issue for Moronia with their gold-based money. So once again, they set out to evaluate the two scenarios to see how they impacted Government Bonds. 

Option 1:

Moronia used gold to pay for the train so the Bank of Freedonia now has a stock of gold as an asset on its balance sheet, but it also issued new Liberties (a liability in accounting terms) to the train manufacturer. All just entries in a computer - keeping track of money units.

If the buyer was another nation, the Bank of Freedonia would hold an account of that nation's currency instead of gold. 

In some cases, the buying nation might already have Liberties accumulated from selling goods to Freedonia. In this case, those Liberties would have been converted into a government bond so they earn interest. That nation would then sell some of its stock of Government Bonds to make the purchase. Who will buy those Government Bonds? Quite simply, the train sale caused bank accounts in Freedonia to increase. This causes bank reserves to increase, and banks prefer to earn interest on excess reserves, so they buy bonds in equal portion to the injection of Liberties - i.e. exactly the same number that the other nation sold to make the purchase.

In an economy like Freedonia where money is issued by the government, there are ALWAYS enough buyers for any Government Bonds because the money has been injected into the banking system first. 

Option 2:

Well, you may have figured this out what the Freedonians discovered: the same bank accounts are credited for the sale with new Liberties, which causes the same increase in bank reserves, which creates the same demand for an interest-earning alternative to holding excess reserves, which leads to the same Government Bond being purchased as in Option 1.

In other words, it makes no difference whether Liberties came from trading with another nation (exports) or from a government purchase (fiscal policy). 

And Freedonians already knew that what Moronians called "government debt" was simply a record of all the interest-earning injections of money - whether initiated through foreign trade or from direct purchases from their government. In both cases someone in the Private Sector increased their savings via an investment in Government Bonds!

Austerity angst abandoned!

Freedonia had their answer! 

  • They didn't need to take away the job guarantee that was providing essential income and work for those who lost jobs in the recession. 
  • They didn't need to lower wages and join the austere Moronians in a race to the bottom of worker pay in order to sell exports cheaper than other nations.
  • They didn't need to cut funding for education or research that were part of their vision to have Freedonians lead the world in innovative ideas and technologies.
  • And they didn't need to stop investing in their important infrastructure projects that were laying the groundwork for a prosperous future.

Of course, this wasn't about digging holes in the ground and filling them up to create work. The train was needed, along with so many other things. The question was whether they had to "get money" from someone else to help their economy or whether they had the ability to help themselves. 

How did the train get built? They simply created the money by crediting bank accounts, because Freedonians had a sovereign currency. And it works just as well as exporting!

With this debate settled, the Freedonians began to think again of all the things they wished to do as a nation that they would have done of they had a booming export business and money flowing in to their economy. 

They remembered again why it was that they created the sovereign currency in the first place. It was for exactly this moment - so they could fully deploy their national resources in ways that were to the benefit of their people and that the private, profit-seeking entrepreneurs and businesses couldn't do themselves. 

Rejecting austerity and carefully investing in their people and nation, through good times and bad, was the fiscally responsible thing to do.