Mr Schaeuble and G-20 Leaders: Consider the Following

It has been reported on the BBC news that Mr Schaeuble has said:

a)   Criticism that the (German) government was not spending enough was justified, and that;

b)  Any improvement in spending would not be made at the expense of a balanced budget.

According to the BBC report the German economy has contracted and exports have fallen.

The Eurozone countries, including the core countries, are sliding into recession or depression.  The deflation tendency is spreading.

Sirs and Madam, Germany has the capacity to be a powerful locomotive force for the Eurozone countries.  Germany has both a budget surplus and a current account surplus. Germany remains highly competitive within the Eurozone.  Lower inflation in Germany means that the periphery countries have to endure even greater deflation.

On the eve of the G-20 meeting the situation is dire.  Fiscal austerity has failed and the policy of internal devaluation has failed.  Monetary policy can achieve no more.  The application of quantitative easing in the Eurozone would be a failure, as it has been in the United States and Japan.  Quantitative easing, massive as it has been, has nowhere raised business investment or consumer price inflation.

Sirs and Madam, Germany has a vital role to play in lifting aggregate demand, but the periphery countries can also contribute to the solution.

There are only two ways to increase spending without increasing public debt (the objectives of Mr. Schaeuble).

The first way is to increase spending and finance it from future taxation.  In current circumstances of weak aggregate demand this approach would be disastrous.  Japan has just attempted such a strategy, and the Japanese economy is slipping back into recession as a consequence.

The second way is to create new money to finance the increased public spending or tax cuts.  This policy is called ‘overt money financing’ (OMF).  OMF has been advocated by Abba Lerner, Henry Simon, Irving Fisher, Milton Friedman, Maynard Keynes and Ben Bernanke.  More recently Richard Wood, Biagio Bossone, Lord Adair Turner, Willem Buiter, McCulley and Pozsar, and others have recommended this approach.  OMF is the most powerful possible combination of fiscal and monetary policies.  Not only will it raise consumer demand without increasing public debt but it will be relatively quick in checking the deflation tendency.

As you know, Hjalmar Schacht issued special bonds in the 1930s.  This OMF operation succeeded in pushing the German economy through a speedy recovery, reaching full employment without inflation.

Sirs and Madam, we all know that the hyperinflation in Germany was the result of the grossly excessive application of OMF.   That operation was conducted by a private central bank.  Such excesses should never be permitted to occur again.

Consequently, any OMF operation today must be conducted under strict guidelines.  Ministries of Finance could develop such guidelines.  For instance, OMF could be limited to 7 per cent of GDP.  This would deliver a stimulus without any increase in public debt.

It is imperative that the slide into depression and deflation be halted.  Germany has a role to play.  The ECB, or the individual central banks of periphery countries, could also potentially play a part.  The simplest solution, however, may be that the Ministries of Finance of periphery countries create the new money needed to finance increased spending in their domains.  This approach would circumvent article 123 of the Lisbon Treaty.

Currently, the G-20 plan is to embark on more than 900 supply-side policies.  The G-20 meeting to be held in Australia next month should also include a requirement that the IMF urgently develop a plan for fiscal and monetary policies to boost aggregate demand.  If this recommendation is not included in the G-20 Communique then the G-20 leaders and their officials should never be forgiven by their populations and their constituencies.