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sent 6 February 2001
Re: "Surplus to America's economic requirements," by Amity Schlaes,
Financial Times, 30 January 2001.
Lesson in deflation from the last US debt pay-off
Sir,
Amity Shlaes correctly observes that "no economic theory can suit all
periods" ("Surplus to America's economic requirements," January 30). The more
precise observation would be that current economic theories represent a fixed
exchange rate paradigm, even though big currencies have been floating for
nearly 30 years. Ms Shlaes describes the confusion over the
US fiscal surplus in terms of politics, yet there is an equally important
economic argument.
The idea that debt is somehow "bad" and a surplus somehow "good" is a
throwback to a fixed exchange rate framework. Managing a fixed rate currency
requires a government to maintain a given level of reserves to assure
convertibility. In this model, an excess supply of local currency leads to
excess demand on reserves, often leading to currency devaluation. Taxes in the
fixed rate model serve to remove convertible currency that could drain
reserves. Government spending leads to a reduction in reserves, but by selling
government bonds the exchange of convertible currency for securities defers
convertibility until the bonds mature. A government surplus with a fixed
exchange rate requires the non-government sector to "sell" the reserve
currency to the central bank in exchange for local currency to discharge tax
liabilities, building reserves at the central bank.
But the world's biggest economies abandoned this system ages ago. With
floating -- or fiat -- currencies, the risk of losing exchange
reserves is not applicable, because the government does not guarantee
convertibility. This affects many dynamics, including the imperatives of
government securities, the nature of unfunded liabilities, and the
determination of interest rates. With floating currencies, taxes create a
notional demand for the currency. Without taxes, and without convertibility,
there would ultimately be no reason to hold the currency.
Ms. Shlaes overlooks historian John Steele Gordon's description of the
last US debt pay-off. Andrew Jackson, who viewed debt as a "national curse",
completely eliminated the national debt in 1835. He deposited federal surplus
funds in his state-chartered "pet banks", causing money supply to grow
rapidly as banks increased notes in circulation. This led to enormous land
speculation. Horrified by the bubble, Jackson insisted the Land Office accept
payment only in gold or silver.
Such a deflationary move brought the speculation to a grinding halt but was
also the catalyst for the 1837 Wall Street crash. What followed was a 72-month
depression that Gordon called "the most protracted period of continuous
economic contraction in US history".
Warren B. Mosler
Chairman, AVM Associates
250 S Australian Avenue
W Palm Beach, FL 33401 USA
Eileen M. Debold
Vice-president, The Bank of New York
32 Old Slip, New York, NY 10286, USA
Copyright: The Financial Times Limited
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