sustainability of government debt
The following discussion took place between Onur Ozgode and myself. (Please keep in mind that he did not have time to write out full responses.)
Onur quotes a WSJ article and comments: "An interesting perspective on how much of government debt is sustainable in the aftermath of shocks to the national economies."
Onur - Wow that's crazy! I had no clue their debt/gdp ratio was so high! but then again the key is the fact that 95% of their debt is held by domestic investors, so it seems as long as they can preserve domestic balance, they are fine... The question is whether the US can do the same in the international scene.
Me - It should not matter whether the debt is held by domestic investors or not. The credit worthiness of the debtor is usually independent of the credit worthiness of the creditor. (Of course there are always some closed loops in this vastly complex network of who-owes-who.)
It does matter whether the debt is denominated in domestic currency or not. This is where your reference to "preservation of domestic balance" comes into play. Countries tend to default more often on their "external" debt for the obvious reasons. On the other hand, internal debt can always be "implicitly" defaulted on via inflation.
I do not understand what is meant by "unstable" in the WSJ article quoted above: "Also working in Japan's favor is the fact that nearly 95% of its outstanding government debt is held by domestic investors, a group who has few other investment options. In the U.S., foreigners hold roughly a quarter of the outstanding Treasury notes, making the market inherently more unstable."
1) Efficient pricing entails volatility. That is normal.
2) Having more customers is always a good thing.
3) If more bonds are changing hands more often, that means the market is more liquid. People prefer to pay more for things that they can get rid of efficiently in case the need arises.
4) In every securities market, there are long-term "passive" investors and short-term "active" investors. The article seems to suggest that the US and Japanese bond markets differ with respect to this composition. It also seems to imply that the greater the percentage of bonds that is being actively traded, the more unstable is the underlying market. This may or may not be true. Here is a reason for believing the opposite: Lesser the number of bonds trading, the more likely that the market price will be affected by erratic factors. Here I am referring to factors which are not "fundamentally" related to the valuation of the security that is being traded. For example, an investor may feel the need to dumb your bonds for liquidity purposes. (He may need cash for some reason.) If the market is "thin", his action may create a downward pressure on the prices. Meanwhile practically nothing has changed about your creditworthiness. Of course this downward pressure may not be long-lasting, but it nevertheless "destabilizes" the market price.
Onur - Merhaba Tarik, nice to hear from you after so many years!
And thanks a lot for this nuanced and technically rich response. we, the ppl who live in the earthn, need these explanations as to why we actually need efficient and deep markets especially in these times where it has become a virtue to bash markets for all the ills of collective life.
Nevertheless I have to respectfully disagree with your intervention, not b/c it is irrelevant or wrong, but because it is an incomplete account of the reality in the ontological sense. The problem is not whether you are simply right or wrong, or whether neo-classical theory of markets is a good theory of how markets function or not. Neither is it the simply the case that whether the inefficiencies due to the materiality upon which markets are constructed are an enough of a source of error to make efficient markets hypothesis invalid or not. We all know that the theory of markets do not match perfectly well onto the way in which markets work in reality on the ground in everyday basis. This divergence from the theory of markets due to the inefficiencies and frictions inherent into the world is not my real concern.
For me the real issue in both the case of Japan and the US seems to be not about the technicality of how to make markets work efficiently, but about the institutional configurations upon which markets are inserted to reach a certain goal by the state. To put it more simply, it is a question of political economy and not simply good economics or financial theory.
I would not want to pretend that political economy is a force that is in direct opposition to the market, at the end of the day which is a techno-political technology of government anyways. I think what matters is how markets are integrated into an institutional configurations, be it the international monetary system or the national state-private sector structure.
So, what I mean by "domestic balance" in the case of Japan's state-private sector structure which to my knowledge is very corporatist to this day. I am not an expert on this but as far as i understand the liberal set up of strict state-capital differentiation does not apply to way in which the japanese capital is organized and how that organization relates to the state. that is probably why japan can keep carrying such high levels of debt-gdp ratio to begin with. in a way it might be interesting to compare it to the war economies in liberal western countries such as UK and US during and in the aftermath of world war II where capital has vested interest in supporting the deficits of governments for an extended period of time without much hesitation.
In the case of the US, on the other hand, we have to not forget much of the creditworthiness of the US is derived from its position within the political economy of the international monetary system. Not only the dollar is the most dominant reserve currency, but also it is the only currency through which oil can be traded. Furthermore, this structure is enhanced further by a US-China tacit agreement over financing the ever-growing american deficit. So, in my mind the question of stability drives at a much deeper level than that of the market stability. In other words, it is a matter of structural stability of the global political economy as opposed to the market stability. We are already seeing movements that try to even out these imbalances in the structure of the international monetary system. afterall you should not forget that markets are integrated into the system only after the system is constituted in a particular configuration and as that configuration changes the markets will have to adapt too.
Logan - I won't pretend to have the same understanding of finance and economics as you two, but isn't the WSJ article simply suggesting that when sovereign debt is held domestically, the creditors have a greater interest in the stability of the bond market, since they live and work in -- and rely on the economic stability of - the country they are lending to? Whereas the US bond market is dominated by foreign investors who may have less of an interest in that stability -- or might even use it as a tool of foreign policy?
Is this a point you've already made, Onur? I am sorry if I missed it.
In any case, I find this debate very interesting and don't mean to interrupt it.
Me - I did not mean to get in to the technical details. But unfortunately the devil usually resides in the details.
My thinking may have resembled the neoclassicists'. However the resemblence is only at a superficial level. I did not make any ideological claim. I did not refer to any complex phenomenon that admit more than one coherent interpretation.
All I did was to point out some almost-tautologically-true facts. (e.g. Holding everthing else constant, having a more liquid bond market and having more demand for your bonds are good things.) Yes, my use of the word "efficient" was referring to the Efficient Markets Hypothesis of the Neoclassical School. But again the reference was rather superficial. I do not need to convince you that values of goods naturally fluctuate. Even if you do not believe in the existence of a fundamental value and even if you do not believe in the capability of free markets to reveal this value, you will still admit that prices in healthy markets fluctuate. In some sense even wild fluctuations are more natural then no-fluctuation-at-all. There is something inherently unstable about values of goods. The source of this instability probably goes beyond economics and politics.
Here is a list of responses/observations/suggestions. (There is no natural flow to it. Sorry.)
1) I am not expert on this issue. But I bet that all government bond markets today enjoy similar legal frameworks. These frameworks cater to the big participants. If you want money, the easiest way to obtain it is to create an institutional framework that caters the investors. Of course, you can also print money, but then you will have to face the consequences.
2) You can start with the same configuration and end with two different market structures. the composition of the participants with respect to active vs passive investor types is one of the parameters that the two structures can different among. These differences are simply due to the fact that you can not configure everything if you also want to give participants some degrees of freedom.
3) You tend to used the word "organised" for both the framework and the activity that is being frameworked. (e.g. "...the japanese capital is organized...") Once you set the framework, the capital flows freely among the participants. To call the resulting total structure organized can be misleading.
4) Here is a point you may find interesting. Institutional frameworks rest on laws. Due to the extremely large spectrum of possible events, laws can never totally specify the courses of action to be taken should any of these events arise. In other words, institutional frameworks are by definition "incomplete." Hence even if you have the perfect execution system, there will be smart people who will be able to game the framework. That is essentially the job of many tax experts in investment banks. It would not be wrong to say that, on average, those who try to cheat the system are smarter than those who build/revise/run the system. (In fact, this was the opinion of a tax expert who spent some time on the government side. I am willing to take his word. The mentioned asymmetry is essentially due to salary differences.)
5) When you make a cross-country analysis of economic organizations, you have to be really careful. When you make a cross-country and cross-time analysis, you have to be even more careful. Two illustrations:
5a) If people want to save, you can not force them to spend money. If companies do not want to invest no matter how low the interest rates are, you can not force them to invest. (Of course you can order the government-owned companies to invest. But at the end of the day, you can not force the end-consumers to buy the goods that these investments will produce. In other words, if you make a decision against the market today, you will suffer the financial consequences sooner or later.) This is partly the case in Japan where there has been a "savings-glut" for years. Hence country-specific, non-organizational issues are extremely important. You can have the exact institutional framework as Japan's, but an entirely different Debt-GDP ratio.
5b) Of course you have to bring "time" into your analysis at some point. For example, high public debt that Japan has accumulated today is partly due to the political decisions that were taken in the past for the sake of stimulating the domestic economy.
5c) During times (e.g. war) when there are great uncertainties and unstabilites, capital flows to the safest places. People will not desire to invest, because there are too many unknowns and it is impossible to make calculated guesses. People will not want to consume because they are worried about future. They will simply convert their wealth into extremely liquid and safe items such cash, gold or government bonds. All these dynamics are behavioral. They have nothing to do with the organizational aspects of the economy. (Of course we take into granted the freedom to make decisions about one's own money. You could count that freedom as part of the economic framework. But I doubt whether that would be of any use. The frameworks that do not grant individuals this freedom would be very uninteresting indeed.)
6) "The credit worthiness of the US is derived from its position within the political economy of the international monetary system." This sentence unfortunately does not explain anything. It is almost tautological. You could have said the reverse too: "The position of US within the political economy of the international monetary system is derived from its creditworthiness." Perhaps we differ on how we define credit worthiness. I take it as a very general notion, almost equivalent to the word "trust".
7) "Not only the dollar is the most dominant reserve currency, but also it is the only currency through which oil can be traded." Two points:
7a) I think you are getting the causal arrows in the wrong direction here. US is not creditworthy because US Dollar is the dominant reserve currency. It is exactly the opposite. US Dollar is the dominant reserve currency because US is the most creditworthy. For example, Central Banks of the developing countries (with floating currencies) are not coerced to accumulate dollar reserves. They make free decisions based on past experiences. If their own citizens view USA as the most creditworthy country and switch their holdings to US dollars during times of domestic crises, then the Central Banks have no choice but to accumulate US dollar reserves for the bad times. If they do not, then they will face the prospect of a potential run on their currency by their own people.
7b) Dollar is not the only currency that oil can be traded in. You can trade oil in any currency you want. Iron is also priced in the world markets, in US Dollars. When people locally trade iron in Turkey, they take these the world price as a benchmark, but they conduct the actual transaction in Turkish Liras. You do not need US Dollars to trade anything. However you cannot escape from the fact that most commodity prices are determined in world markets which by definition need to be denominated in some currency. There are some restrictions here of course. You do not want the denomination to be in the currency of a country which is run by a money-printing maniac. If you do, then the commodity prices will be destabilized by the monetary choice made there. The price signals will be fuzzy. It will be very painful to distinguish which fluctuation is due to the underlying supply/demand situation of the commodity, and which fluctuation is due to concerns about the value of the currency that the commodity is being traded in.
8) "Furthermore, this structure is enhanced further by a US-China tacit agreement over financing the ever-growing american deficit." You seem to believe that history proceeds in a very calculated fashion. Unfortunately things are not that simple. Nobody made such an agreement behind closed doors. There was probably time in the history when the dynamics could have taken a different direction. However after a certain threshold, things get locked into a trajectory. Call it an equilibrium, a tacit agreement, whatever you want. (People usually tend to choose words that reflect their ideological leanings.)
9) "We are already seeing movements that try to even out these imbalances in the structure of the international monetary system." Who is trying to do this? How credible are their efforts? I do not think you gave enough thought to this. It is extremely tough to re-orient an export-dependent, investment-driven economy to a domestic-demand-dependent, consumer-driven one. You can not expect China to perform such a trick over night. Even over a decade! It would be a wild social experiment to try to achieve this. Things can unravel in very unpredictable ways.
10) Imbalances are not bad. They are bad only in the sense that they introduce fragilities into the system, and fragilities tend to create problems during times of stress. I tend to think of US-China as separate political entities but as interwined economic entities. They both need each other.
11) "When sovereign debt is held domestically, the creditors have a greater interest in the stability of the bond market, since they live and work in -- and rely on the economic stability of - the country they are lending to?" I have a simple question for you Logan. Let's say you are holding a Turkish government bond, and you hear from a very reliable source that tomorrow there will be a coup d'etat. Will you dump your bond today or not? Bond markets do not create instabilities. Usually it is the other way around. Bond prices reflect realized or potential instabilities.
11a) A subtle point: Collectively rational outcomes may be impossible to achieve since decision-making actually takes place at the individual level. Let's assume that the economy is in a crisis, and it is in the interest of the nation as a whole to increase consumption and investment levels. Will you be the first stupid guy stepping ahead and spending your savings? Of course not! Why? Because the others may not follow you. If they don't, the general economic distress will linger on, and by the time there is a recovery you will be bankrupt. Even if you care about your country, you may not be able personally to shoulder the risks associated with the consequences you may face if others do not act as patriotic as you do.
11b) Another subtle point: It is never in the interest of the current holders of a security to introduce new sources of unstability into the market where that security is being traded. (Here you can take security to mean a piece of paper of some value.) Once that happens the price will go down. Why? Because now it is more risky to hold that piece of paper.
11c) Combining the two subtle points: Sometimes you will see crowd-behavior in securities markets. Instability breeds itself. This is really a human phenomenon that is not restricted to domestic nor international investors. People panic because they can. (This includes everybody, especially the regulators who create the "framework".)
12) My interpretation of the concept of economic value probably differs from yours. I should have used a less contaminated word (like utility) instead. You can control prices but you can not control how much people value things. That is essentially why command economies face extremely tough problems while trying to eliminate shortages and surpluses. (Here I use the word shortage in a very general sense. There may a shortage of X even if X does not exist. This is essentially why innovation is important for economic growth.)
Onur - Tarik your points are very interesting, but unfortunately I don't have the time to respond to them seriously. I will just say this: 1) My initial point is still there, despite all you say about the markets, there are different ways in which you can organize these technologies depending on political environment and desire-this is not to say this is desirable or good, but it is just to acknowledge that markets dont exist in a vacuum. 2) I think it is rather presumptuous to think that I have a particular ideological leaning, whether it is marxist or keynesian, just because I used the term "political economy" and referred to a domain outside of the market. I think you are reading too much into differences in the mode of registry due to disciplinary differences and forget that different disciplines carry with them different modes of inquiry. So, for me the question is not so much what I believe in, but analyze what exists out there; and to me for good or bad does not matter, what exists out there is not simply markets, whether they are really as you characterize them or not, but markets along with other mechanisms deliberately created by the states to manipulate the outcome of the markets toward their own interests. This does not mean I believe it is a good thing to do that, I actually think it is a dangerous thing as we see in the Greek case right now... In short, you would be surprised how much we agree than we disagree.
Me - I myself have used the term `political` in reference to Japan`s past macroeconomic policies. That issue about `the ideology-based choice of vocabulary`was referring to something else. Nevertheless you are right. It was an offensive and unrelated comment on my part. (I think I was just too absorbed and got carried on.)
Yes. States do set the rules. Often they directly manipulate characteristics of their economy. In some sense this is their job. Markets can not achieve efficient outcomes without the proper framework. (An obvious example would be the perpetual poverty of corrupt states.) But even more importantly, macroeconomic policies have wealth redistributionary consequences. Hence politics and economics inevitably get intermingled.
My desire was to solely focus on the issue of macroeconomic stability. I do not know how much I managed to do this in my previous post...
Except for a few parties, it is in the interest of everyone to make sure that economies growth takes place without its sudden and painful swings. However for some reason, the history just keeps repeating itself. No matter what changes are introduced into the framework, economic shocks can not be avoided. In my personal studes, I was shocked to realize how stupifyingly hard it is to achieve stability without making other sacrifices. (Hence my skeptical attitude.)
In your previous post, you had mentioned the following: `So, in my mind the question of stability drives at a much deeper level than that of the market stability. In other words, it is a matter of structural stability of the global political economy as opposed to the market stability.` This is probably the main point of our disagreement. There are many complicated dimensions to this topic of stability. But the `abyss` moment really comes at the level of psychology. Most of the puzzles boil down to bizarre questions about human psyche. You can build better organizational structures, but the real sources of instability will stay there.
That is all I wanted to say. Hopefully we can continue our discussion in the future. These topics interest me greatly and I have good reasons to believe that we have a lot to learn from each other.
Onur quotes a WSJ article and comments: "An interesting perspective on how much of government debt is sustainable in the aftermath of shocks to the national economies."
Onur - Wow that's crazy! I had no clue their debt/gdp ratio was so high! but then again the key is the fact that 95% of their debt is held by domestic investors, so it seems as long as they can preserve domestic balance, they are fine... The question is whether the US can do the same in the international scene.
Me - It should not matter whether the debt is held by domestic investors or not. The credit worthiness of the debtor is usually independent of the credit worthiness of the creditor. (Of course there are always some closed loops in this vastly complex network of who-owes-who.)
It does matter whether the debt is denominated in domestic currency or not. This is where your reference to "preservation of domestic balance" comes into play. Countries tend to default more often on their "external" debt for the obvious reasons. On the other hand, internal debt can always be "implicitly" defaulted on via inflation.
I do not understand what is meant by "unstable" in the WSJ article quoted above: "Also working in Japan's favor is the fact that nearly 95% of its outstanding government debt is held by domestic investors, a group who has few other investment options. In the U.S., foreigners hold roughly a quarter of the outstanding Treasury notes, making the market inherently more unstable."
1) Efficient pricing entails volatility. That is normal.
2) Having more customers is always a good thing.
3) If more bonds are changing hands more often, that means the market is more liquid. People prefer to pay more for things that they can get rid of efficiently in case the need arises.
4) In every securities market, there are long-term "passive" investors and short-term "active" investors. The article seems to suggest that the US and Japanese bond markets differ with respect to this composition. It also seems to imply that the greater the percentage of bonds that is being actively traded, the more unstable is the underlying market. This may or may not be true. Here is a reason for believing the opposite: Lesser the number of bonds trading, the more likely that the market price will be affected by erratic factors. Here I am referring to factors which are not "fundamentally" related to the valuation of the security that is being traded. For example, an investor may feel the need to dumb your bonds for liquidity purposes. (He may need cash for some reason.) If the market is "thin", his action may create a downward pressure on the prices. Meanwhile practically nothing has changed about your creditworthiness. Of course this downward pressure may not be long-lasting, but it nevertheless "destabilizes" the market price.
Onur - Merhaba Tarik, nice to hear from you after so many years!
And thanks a lot for this nuanced and technically rich response. we, the ppl who live in the earthn, need these explanations as to why we actually need efficient and deep markets especially in these times where it has become a virtue to bash markets for all the ills of collective life.
Nevertheless I have to respectfully disagree with your intervention, not b/c it is irrelevant or wrong, but because it is an incomplete account of the reality in the ontological sense. The problem is not whether you are simply right or wrong, or whether neo-classical theory of markets is a good theory of how markets function or not. Neither is it the simply the case that whether the inefficiencies due to the materiality upon which markets are constructed are an enough of a source of error to make efficient markets hypothesis invalid or not. We all know that the theory of markets do not match perfectly well onto the way in which markets work in reality on the ground in everyday basis. This divergence from the theory of markets due to the inefficiencies and frictions inherent into the world is not my real concern.
For me the real issue in both the case of Japan and the US seems to be not about the technicality of how to make markets work efficiently, but about the institutional configurations upon which markets are inserted to reach a certain goal by the state. To put it more simply, it is a question of political economy and not simply good economics or financial theory.
I would not want to pretend that political economy is a force that is in direct opposition to the market, at the end of the day which is a techno-political technology of government anyways. I think what matters is how markets are integrated into an institutional configurations, be it the international monetary system or the national state-private sector structure.
So, what I mean by "domestic balance" in the case of Japan's state-private sector structure which to my knowledge is very corporatist to this day. I am not an expert on this but as far as i understand the liberal set up of strict state-capital differentiation does not apply to way in which the japanese capital is organized and how that organization relates to the state. that is probably why japan can keep carrying such high levels of debt-gdp ratio to begin with. in a way it might be interesting to compare it to the war economies in liberal western countries such as UK and US during and in the aftermath of world war II where capital has vested interest in supporting the deficits of governments for an extended period of time without much hesitation.
In the case of the US, on the other hand, we have to not forget much of the creditworthiness of the US is derived from its position within the political economy of the international monetary system. Not only the dollar is the most dominant reserve currency, but also it is the only currency through which oil can be traded. Furthermore, this structure is enhanced further by a US-China tacit agreement over financing the ever-growing american deficit. So, in my mind the question of stability drives at a much deeper level than that of the market stability. In other words, it is a matter of structural stability of the global political economy as opposed to the market stability. We are already seeing movements that try to even out these imbalances in the structure of the international monetary system. afterall you should not forget that markets are integrated into the system only after the system is constituted in a particular configuration and as that configuration changes the markets will have to adapt too.
Logan - I won't pretend to have the same understanding of finance and economics as you two, but isn't the WSJ article simply suggesting that when sovereign debt is held domestically, the creditors have a greater interest in the stability of the bond market, since they live and work in -- and rely on the economic stability of - the country they are lending to? Whereas the US bond market is dominated by foreign investors who may have less of an interest in that stability -- or might even use it as a tool of foreign policy?
Is this a point you've already made, Onur? I am sorry if I missed it.
In any case, I find this debate very interesting and don't mean to interrupt it.
Me - I did not mean to get in to the technical details. But unfortunately the devil usually resides in the details.
My thinking may have resembled the neoclassicists'. However the resemblence is only at a superficial level. I did not make any ideological claim. I did not refer to any complex phenomenon that admit more than one coherent interpretation.
All I did was to point out some almost-tautologically-true facts. (e.g. Holding everthing else constant, having a more liquid bond market and having more demand for your bonds are good things.) Yes, my use of the word "efficient" was referring to the Efficient Markets Hypothesis of the Neoclassical School. But again the reference was rather superficial. I do not need to convince you that values of goods naturally fluctuate. Even if you do not believe in the existence of a fundamental value and even if you do not believe in the capability of free markets to reveal this value, you will still admit that prices in healthy markets fluctuate. In some sense even wild fluctuations are more natural then no-fluctuation-at-all. There is something inherently unstable about values of goods. The source of this instability probably goes beyond economics and politics.
Here is a list of responses/observations/suggestions. (There is no natural flow to it. Sorry.)
1) I am not expert on this issue. But I bet that all government bond markets today enjoy similar legal frameworks. These frameworks cater to the big participants. If you want money, the easiest way to obtain it is to create an institutional framework that caters the investors. Of course, you can also print money, but then you will have to face the consequences.
2) You can start with the same configuration and end with two different market structures. the composition of the participants with respect to active vs passive investor types is one of the parameters that the two structures can different among. These differences are simply due to the fact that you can not configure everything if you also want to give participants some degrees of freedom.
3) You tend to used the word "organised" for both the framework and the activity that is being frameworked. (e.g. "...the japanese capital is organized...") Once you set the framework, the capital flows freely among the participants. To call the resulting total structure organized can be misleading.
4) Here is a point you may find interesting. Institutional frameworks rest on laws. Due to the extremely large spectrum of possible events, laws can never totally specify the courses of action to be taken should any of these events arise. In other words, institutional frameworks are by definition "incomplete." Hence even if you have the perfect execution system, there will be smart people who will be able to game the framework. That is essentially the job of many tax experts in investment banks. It would not be wrong to say that, on average, those who try to cheat the system are smarter than those who build/revise/run the system. (In fact, this was the opinion of a tax expert who spent some time on the government side. I am willing to take his word. The mentioned asymmetry is essentially due to salary differences.)
5) When you make a cross-country analysis of economic organizations, you have to be really careful. When you make a cross-country and cross-time analysis, you have to be even more careful. Two illustrations:
5a) If people want to save, you can not force them to spend money. If companies do not want to invest no matter how low the interest rates are, you can not force them to invest. (Of course you can order the government-owned companies to invest. But at the end of the day, you can not force the end-consumers to buy the goods that these investments will produce. In other words, if you make a decision against the market today, you will suffer the financial consequences sooner or later.) This is partly the case in Japan where there has been a "savings-glut" for years. Hence country-specific, non-organizational issues are extremely important. You can have the exact institutional framework as Japan's, but an entirely different Debt-GDP ratio.
5b) Of course you have to bring "time" into your analysis at some point. For example, high public debt that Japan has accumulated today is partly due to the political decisions that were taken in the past for the sake of stimulating the domestic economy.
5c) During times (e.g. war) when there are great uncertainties and unstabilites, capital flows to the safest places. People will not desire to invest, because there are too many unknowns and it is impossible to make calculated guesses. People will not want to consume because they are worried about future. They will simply convert their wealth into extremely liquid and safe items such cash, gold or government bonds. All these dynamics are behavioral. They have nothing to do with the organizational aspects of the economy. (Of course we take into granted the freedom to make decisions about one's own money. You could count that freedom as part of the economic framework. But I doubt whether that would be of any use. The frameworks that do not grant individuals this freedom would be very uninteresting indeed.)
6) "The credit worthiness of the US is derived from its position within the political economy of the international monetary system." This sentence unfortunately does not explain anything. It is almost tautological. You could have said the reverse too: "The position of US within the political economy of the international monetary system is derived from its creditworthiness." Perhaps we differ on how we define credit worthiness. I take it as a very general notion, almost equivalent to the word "trust".
7) "Not only the dollar is the most dominant reserve currency, but also it is the only currency through which oil can be traded." Two points:
7a) I think you are getting the causal arrows in the wrong direction here. US is not creditworthy because US Dollar is the dominant reserve currency. It is exactly the opposite. US Dollar is the dominant reserve currency because US is the most creditworthy. For example, Central Banks of the developing countries (with floating currencies) are not coerced to accumulate dollar reserves. They make free decisions based on past experiences. If their own citizens view USA as the most creditworthy country and switch their holdings to US dollars during times of domestic crises, then the Central Banks have no choice but to accumulate US dollar reserves for the bad times. If they do not, then they will face the prospect of a potential run on their currency by their own people.
7b) Dollar is not the only currency that oil can be traded in. You can trade oil in any currency you want. Iron is also priced in the world markets, in US Dollars. When people locally trade iron in Turkey, they take these the world price as a benchmark, but they conduct the actual transaction in Turkish Liras. You do not need US Dollars to trade anything. However you cannot escape from the fact that most commodity prices are determined in world markets which by definition need to be denominated in some currency. There are some restrictions here of course. You do not want the denomination to be in the currency of a country which is run by a money-printing maniac. If you do, then the commodity prices will be destabilized by the monetary choice made there. The price signals will be fuzzy. It will be very painful to distinguish which fluctuation is due to the underlying supply/demand situation of the commodity, and which fluctuation is due to concerns about the value of the currency that the commodity is being traded in.
8) "Furthermore, this structure is enhanced further by a US-China tacit agreement over financing the ever-growing american deficit." You seem to believe that history proceeds in a very calculated fashion. Unfortunately things are not that simple. Nobody made such an agreement behind closed doors. There was probably time in the history when the dynamics could have taken a different direction. However after a certain threshold, things get locked into a trajectory. Call it an equilibrium, a tacit agreement, whatever you want. (People usually tend to choose words that reflect their ideological leanings.)
9) "We are already seeing movements that try to even out these imbalances in the structure of the international monetary system." Who is trying to do this? How credible are their efforts? I do not think you gave enough thought to this. It is extremely tough to re-orient an export-dependent, investment-driven economy to a domestic-demand-dependent, consumer-driven one. You can not expect China to perform such a trick over night. Even over a decade! It would be a wild social experiment to try to achieve this. Things can unravel in very unpredictable ways.
10) Imbalances are not bad. They are bad only in the sense that they introduce fragilities into the system, and fragilities tend to create problems during times of stress. I tend to think of US-China as separate political entities but as interwined economic entities. They both need each other.
11) "When sovereign debt is held domestically, the creditors have a greater interest in the stability of the bond market, since they live and work in -- and rely on the economic stability of - the country they are lending to?" I have a simple question for you Logan. Let's say you are holding a Turkish government bond, and you hear from a very reliable source that tomorrow there will be a coup d'etat. Will you dump your bond today or not? Bond markets do not create instabilities. Usually it is the other way around. Bond prices reflect realized or potential instabilities.
11a) A subtle point: Collectively rational outcomes may be impossible to achieve since decision-making actually takes place at the individual level. Let's assume that the economy is in a crisis, and it is in the interest of the nation as a whole to increase consumption and investment levels. Will you be the first stupid guy stepping ahead and spending your savings? Of course not! Why? Because the others may not follow you. If they don't, the general economic distress will linger on, and by the time there is a recovery you will be bankrupt. Even if you care about your country, you may not be able personally to shoulder the risks associated with the consequences you may face if others do not act as patriotic as you do.
11b) Another subtle point: It is never in the interest of the current holders of a security to introduce new sources of unstability into the market where that security is being traded. (Here you can take security to mean a piece of paper of some value.) Once that happens the price will go down. Why? Because now it is more risky to hold that piece of paper.
11c) Combining the two subtle points: Sometimes you will see crowd-behavior in securities markets. Instability breeds itself. This is really a human phenomenon that is not restricted to domestic nor international investors. People panic because they can. (This includes everybody, especially the regulators who create the "framework".)
12) My interpretation of the concept of economic value probably differs from yours. I should have used a less contaminated word (like utility) instead. You can control prices but you can not control how much people value things. That is essentially why command economies face extremely tough problems while trying to eliminate shortages and surpluses. (Here I use the word shortage in a very general sense. There may a shortage of X even if X does not exist. This is essentially why innovation is important for economic growth.)
Onur - Tarik your points are very interesting, but unfortunately I don't have the time to respond to them seriously. I will just say this: 1) My initial point is still there, despite all you say about the markets, there are different ways in which you can organize these technologies depending on political environment and desire-this is not to say this is desirable or good, but it is just to acknowledge that markets dont exist in a vacuum. 2) I think it is rather presumptuous to think that I have a particular ideological leaning, whether it is marxist or keynesian, just because I used the term "political economy" and referred to a domain outside of the market. I think you are reading too much into differences in the mode of registry due to disciplinary differences and forget that different disciplines carry with them different modes of inquiry. So, for me the question is not so much what I believe in, but analyze what exists out there; and to me for good or bad does not matter, what exists out there is not simply markets, whether they are really as you characterize them or not, but markets along with other mechanisms deliberately created by the states to manipulate the outcome of the markets toward their own interests. This does not mean I believe it is a good thing to do that, I actually think it is a dangerous thing as we see in the Greek case right now... In short, you would be surprised how much we agree than we disagree.
Me - I myself have used the term `political` in reference to Japan`s past macroeconomic policies. That issue about `the ideology-based choice of vocabulary`was referring to something else. Nevertheless you are right. It was an offensive and unrelated comment on my part. (I think I was just too absorbed and got carried on.)
Yes. States do set the rules. Often they directly manipulate characteristics of their economy. In some sense this is their job. Markets can not achieve efficient outcomes without the proper framework. (An obvious example would be the perpetual poverty of corrupt states.) But even more importantly, macroeconomic policies have wealth redistributionary consequences. Hence politics and economics inevitably get intermingled.
My desire was to solely focus on the issue of macroeconomic stability. I do not know how much I managed to do this in my previous post...
Except for a few parties, it is in the interest of everyone to make sure that economies growth takes place without its sudden and painful swings. However for some reason, the history just keeps repeating itself. No matter what changes are introduced into the framework, economic shocks can not be avoided. In my personal studes, I was shocked to realize how stupifyingly hard it is to achieve stability without making other sacrifices. (Hence my skeptical attitude.)
In your previous post, you had mentioned the following: `So, in my mind the question of stability drives at a much deeper level than that of the market stability. In other words, it is a matter of structural stability of the global political economy as opposed to the market stability.` This is probably the main point of our disagreement. There are many complicated dimensions to this topic of stability. But the `abyss` moment really comes at the level of psychology. Most of the puzzles boil down to bizarre questions about human psyche. You can build better organizational structures, but the real sources of instability will stay there.
That is all I wanted to say. Hopefully we can continue our discussion in the future. These topics interest me greatly and I have good reasons to believe that we have a lot to learn from each other.
