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An Alternative View of Finance, Saving, Deficits, and Liquidity

Author

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  • L. Randall Wray
Abstract
This paper contrasts the orthodox approach with an alternative view on finance, saving, deficits, and liquidity. The conventional view on the cause of the current global financial crisis points first to excessive United States trade deficits that are supposed to have "soaked up" global savings. Worse, this policy was ultimately unsustainable because it was inevitable that lenders would stop the flow of dollars. Problems were compounded by the Federal Reserve's pursuit of a low-interest-rate policy, which involved pumping liquidity into the markets and thereby fueling a real estate boom. Finally, with the world awash in dollars, a run on the dollar caused it to collapse. The Fed (and then the Treasury) had to come to the rescue of U.S. banks, firms, and households. When asset prices plummeted, the financial crisis spread to much of the rest of the world. According to the conventional view, China, as the residual supplier of dollars, now holds the fate of the United States, and possibly the entire world, in its hands. Thus, it's necessary for the United States to begin living within its means, by balancing its current account and (eventually) eliminating its budget deficit. I challenge every aspect of this interpretation. Our nation operates with a sovereign currency, one that is issued by a sovereign government that operates with a flexible exchange rate. As such, the government does not really borrow, nor can foreigners be the source of dollars. Rather, it is the U.S. current account deficit that supplies the net dollar saving to the rest of the world, and the federal government budget deficit that supplies the net dollar saving to the nongovernment sector. Further, saving is never a source of finance; rather, private lending creates bank deposits to finance spending that generates income. Some of this income can be saved, so the second part of the saving decision concerns the form in which savings might be held—as liquid or illiquid assets. U.S. current account deficits and federal budget deficits are sustainable, so the United States does not need to adopt austerity, nor does it need to look to the rest of the world for salvation. Rather, it needs to look to domestic fiscal stimulus strategies to resolve the crisis, and to a larger future role for government in helping to stabilize the economy.

Suggested Citation

  • L. Randall Wray, 2009. "An Alternative View of Finance, Saving, Deficits, and Liquidity," Economics Working Paper Archive wp_580, Levy Economics Institute.
    • Handle: RePEc:lev:wrkpap:wp_580
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    File URL: http://www.levyinstitute.org/pubs/wp_580.pdf
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    Cited by:

    1. Faruk Ülgen, 2012. "Financial instability and functional finance : a Lerner-Minsky perspective," Post-Print halshs-00843754, HAL.
    2. Jafri, Juvaria, 2014. "Should we be Austere? A Normative look at Public Debt," MPRA Paper 63337, University Library of Munich, Germany.
    3. Telma Barrantes-Fernández & Esteban Cruz-Hidalgo & José Francisco Rangel-Preciado & Francisco Manuel Parejo-Moruno, 2023. "Decommodify the 2030 Agenda: Why and How to Finance What Is Not Profitable?," Sustainability, MDPI, vol. 15(5), pages 1-16, February.
    4. Sergio Cesaratto, 2012. "Controversial and novel features of the Eurozone crisis as a balance of payment crisis," Department of Economics University of Siena 640, Department of Economics, University of Siena.

    More about this item

    Keywords

    Finance; Saving; Budget Deficits; Current Account Deficits; Financial Crisis;
    All these keywords.

    JEL classification:

    • E12 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Keynes; Keynesian; Post-Keynesian; Modern Monetary Theory
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements

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