Will the US turn into a modernWill the US turn into a modernday Weimar Germany?day Weimar Germany?

Marshall Marshall AuerbackAuerback

Why do we tax Why do we tax –– Reason 1 Reason 1

““The modern state can make anything itThe modern state can make anything itchooses generally acceptable as moneychooses generally acceptable as money……ItItis true that a simple declaration that suchis true that a simple declaration that suchand such is money will not do, even ifand such is money will not do, even ifbacked by the most convincingbacked by the most convincingconstitutional evidence of the stateconstitutional evidence of the state’’ssabsolute sovereignty. But if the state isabsolute sovereignty. But if the state iswilling to accept the proposed money inwilling to accept the proposed money inpayment of taxes and other obligations topayment of taxes and other obligations toitself the trick is done.itself the trick is done.””- Abba Lerner- Abba Lerner

Why do we tax? Why do we tax? –– Reason 2 Reason 2

Taxes serve to regulate aggregate demand. NotTaxes serve to regulate aggregate demand. Notto raise money to so that government canto raise money to so that government can““affordafford”” to spend. to spend.

"The central idea is that government fiscal policy, its spending and"The central idea is that government fiscal policy, its spending andtaxing, its borrowing and repayment of loans, its issue of newtaxing, its borrowing and repayment of loans, its issue of newmoney, and its money, and its withdrawaalwithdrawaal of money, shall all be undertaken with of money, shall all be undertaken withan eye only to the results of these actions on the economy and notan eye only to the results of these actions on the economy and notto any established traditional doctrine about what is sound orto any established traditional doctrine about what is sound orunsound.unsound.““ –– Abba Lerner Abba Lerner

So we look at the EFFECTS and IMPACTS of government spendingSo we look at the EFFECTS and IMPACTS of government spending..But acknowledging this operational reality does NOT create theBut acknowledging this operational reality does NOT create theconditions for hyperinflation.conditions for hyperinflation.

Weimar Germany Weimar Germany vsvs USA USAWeimar Germany faced large foreign claims from warWeimar Germany faced large foreign claims from war

reparations, as well as exploding budget deficits.reparations, as well as exploding budget deficits.By 1919, it is reported By 1919, it is reported the German budget deficit wasthe German budget deficit was

equal to half of GDPequal to half of GDP, and by 1921, war reparation, and by 1921, war reparationpayments represented payments represented one third of governmentone third of governmentspending.spending.

Projected fiscal deficits are as high as 7-8% for the US inProjected fiscal deficits are as high as 7-8% for the US in2009, so the scale of the fiscal responses, though large,2009, so the scale of the fiscal responses, though large,is not nearly as large as the undertaken by the Socialis not nearly as large as the undertaken by the SocialDemocratic Party as they attempted to quell socialDemocratic Party as they attempted to quell socialunrest following the Revolution of 1918 with a variety ofunrest following the Revolution of 1918 with a variety ofsocial benefit programs.social benefit programs.

Foreign debt Foreign debt vsvs domestic debt domestic debt

•• Weimar German government was forced to pay extremely large warWeimar German government was forced to pay extremely large warreparations in foreign currencies which they didn't have, so reparations in foreign currencies which they didn't have, so theytheyhad to aggressively sell its own currency and buy thehad to aggressively sell its own currency and buy theforeign currency in the financial markets.foreign currency in the financial markets. This relentlessThis relentlessselling continuously drove down the value of its currency, causingselling continuously drove down the value of its currency, causingprices of goods and services to go ever higher in what became oneprices of goods and services to go ever higher in what became oneof the most famous inflations of all time.of the most famous inflations of all time.

•• The US only issues debt in its own free floating, non-convertibleThe US only issues debt in its own free floating, non-convertiblecurrency. When a government issues debt in its own free-floatingcurrency. When a government issues debt in its own free-floatingcurrency, there is no financial constraint on the ability of thatcurrency, there is no financial constraint on the ability of thatsovereign nation to deficit spend, and there is no EXTERNALsovereign nation to deficit spend, and there is no EXTERNALconstraint along the lines faced by Weimar Germanyconstraint along the lines faced by Weimar Germany

US US –– where where’’s the pricing power?s the pricing power?

•• German trade union membership quadrupled from 1914 to 1920, and theGerman trade union membership quadrupled from 1914 to 1920, and the1918 revolution ushered in a government led by a Social Democratic party1918 revolution ushered in a government led by a Social Democratic partythat instituted an 8 hour work day and provided social benefits in order tothat instituted an 8 hour work day and provided social benefits in order toreduce social unrest. Many unions were able to negotiate cost of livingreduce social unrest. Many unions were able to negotiate cost of livingadjustments in their wage packages after the mark fell in 1921, creating anadjustments in their wage packages after the mark fell in 1921, creating anautomatic feedback mechanism from price inflation to wage hikes.automatic feedback mechanism from price inflation to wage hikes.

•• Absent such mechanisms, nominal wage and salary growth cannotAbsent such mechanisms, nominal wage and salary growth cannotkeep up with rising consumer prices. Real wages fall, householdkeep up with rising consumer prices. Real wages fall, householdpurchasing power is undermined, and the volume of outputpurchasing power is undermined, and the volume of outputhouseholds can claim diminishes unless consumer credit facilitieshouseholds can claim diminishes unless consumer credit facilitiescan fill the gap. This is the situation in the US today.can fill the gap. This is the situation in the US today.

•• The new US administration does display a social democratic rhetoric, but soThe new US administration does display a social democratic rhetoric, but sofar, redistributive policies have primarily benefited financial institutions.far, redistributive policies have primarily benefited financial institutions.

Weimar Germany operated in aWeimar Germany operated in agold standard world. The US doesgold standard world. The US doesnotnot

The May 1921 so called London ultimatum required annual installmentpayments of $2b in gold or foreign currency, in addition to a claim on justover a quarter of the value of German exports. Germany attempted toaccumulate foreign exchange by paying with treasury bills and commercialdebts denominated in marks, but the mark simply went into free fall onforeign exchange markets as this ploy fell flat. The January 1923 occupationof the Ruhr by Belgian and French troops seeking to secure reparationpayments in goods – since the mark was nearly worthless - was the finalstraw. German production was lost as workers employed a passiveresistance response, and money was printed by the Weimar government tocontinue to pay workers despite their production halt. Within months, theGerman monetary system collapsed.

USA USA vsvs Zimbabwe Zimbabwe

•• Zimbabwe had a civil war Zimbabwe had a civil war –– huge chunk of huge chunk ofthe economythe economy’’s productive capacity wass productive capacity wasdestroyed even before the onset of landdestroyed even before the onset of landreform.reform.

Zimbabwe prior to Land reformZimbabwe prior to Land reform

Land reform disasterLand reform disaster

The whites in Zimbabwe had always been reluctant to share with themajority blacks and ultimately reaped the nasty harvest they sowed.

From an economic perspective though the farm take over and collapseof food production was catastrophic.

Unemployment rose to 80 per cent or more and many of thoseemployed scratch around for a part-time living.

So the land reforms represented the first big contraction in potentialoutput. A rapid demand contraction was required but impossible to

implement politically given that 45 per cent of the food output capacitywas destroyed.

Source: Bill Mitchell - http://bilbo.economicoutlook.net/blog/?p=3773

Zimbabwe Manufacturing OutputZimbabwe Manufacturing Output

Manufacturing output fell by 29 per cent in 2005,

18 per cent in 2006

28 per cent in 2007.

End result: no foreign currency to buy raw materials, so Bank of Zimbabweuses foreign reserves to import food.

Causality: Land reform destroys domestic food production.Foreign exchange used to buy food to prevent starvation.

No funds left to import raw materials and manufacturing output collapses.

End result: 80% unemployment

In

Government Response:Government Response:

Buy political favours by increasing net spending withoutadding to productive capacity.

Result? Inflation and then hyperinflation.

ConclusionsConclusions

•• THERE IS NO VALID BASIS OF COMPARISON BETWEENTHERE IS NO VALID BASIS OF COMPARISON BETWEENTHE US AND WEIMAR GERMANY OR ZIMBABWETHE US AND WEIMAR GERMANY OR ZIMBABWE

•• BAD GOVERNMENTS WILL WRECK ANY ECONOMY IFBAD GOVERNMENTS WILL WRECK ANY ECONOMY IFTHEY WANT TOTHEY WANT TO

•• A WISE GOVERNMENT USING THE FISCAL CAPACITYA WISE GOVERNMENT USING THE FISCAL CAPACITYPROVIDED TO IT BY A FIAT MONETARY CURRENCYPROVIDED TO IT BY A FIAT MONETARY CURRENCYSYSTEM CAN ALWAYS GENERATE FULL EMPLOYMENTSYSTEM CAN ALWAYS GENERATE FULL EMPLOYMENTYET SUSTAIN PRICE STABILITYYET SUSTAIN PRICE STABILITY

ConclusionConclusion 1. If labor does not have a bargaining mechanism, like a cost of living1. If labor does not have a bargaining mechanism, like a cost of living

adjustment (automatic COLA), or infinite access to credit, wage gains willadjustment (automatic COLA), or infinite access to credit, wage gains willnot keep up with escalatingnot keep up with escalating price inflation.price inflation. The hyperinflation will flame outThe hyperinflation will flame out- it will not be sustained. Clearly, in the US and elsewhere, labor has very- it will not be sustained. Clearly, in the US and elsewhere, labor has verylow bargaining power, COLAs are visible only in government benefits, andlow bargaining power, COLAs are visible only in government benefits, andhousehold credit household credit acceesaccees is negligible at best. is negligible at best.

2. Beyond the demand side components, there is almost always a supply2. Beyond the demand side components, there is almost always a supplyside capacity destruction issue fueling the latter stages of hyperinflation.side capacity destruction issue fueling the latter stages of hyperinflation.Whether it is the ravages of war, occupation of existing plant andWhether it is the ravages of war, occupation of existing plant andequipment by foreign forces (French in the Ruhr Valley), failure to reinvestequipment by foreign forces (French in the Ruhr Valley), failure to reinvestprofits made during hyperinflation episodes in tangible capital equipment,profits made during hyperinflation episodes in tangible capital equipment,or the flight of entrepreneurs to speculation in durable assets that are notor the flight of entrepreneurs to speculation in durable assets that are noteasily reproduced (near vertical supply curve, as in ancient Chineseeasily reproduced (near vertical supply curve, as in ancient Chineseporcelains, etc.), hyperinflations usually require a supplyporcelains, etc.), hyperinflations usually require a supplyrestriction/destruction component. At the moment, we have a global glut ofrestriction/destruction component. At the moment, we have a global glut ofexcess capacity in a number of industries and sectors.excess capacity in a number of industries and sectors.

3. Inflation is ultimately about competing distributive claims over real3. Inflation is ultimately about competing distributive claims over realresources. The main limitation then, or rather the determinant of the limitsresources. The main limitation then, or rather the determinant of the limitsof a "sustainable" fiscal policy, especially with respect to hyperinflationaryof a "sustainable" fiscal policy, especially with respect to hyperinflationaryrisks, have to do with real resource constraints, not "running out of money"risks, have to do with real resource constraints, not "running out of money"or absence ofor absence of government financing, for countries possessing sovereign government financing, for countries possessing sovereigncurrencies.currencies.