Article: Europe's pain is coming America's way

[Gumby]

But, moda... it's likely meant to be confusing, by design. You get that some people (such as Edison, Ford, Marx, etc) believe that a debt-based monetary system was initially designed to transfer wealth, via interest payments, from people who don't have money to people who do (i.e. bankers), right? I tend to believe that's actually true on a macro level.

[moda0306]

Gumby,

Even without the debt/interest part, I think we could still have big problems in the FIRE sector.  The fed/treasury basically operates via a strong link to the banking industry.  Paying them interest for what they should be doing anyway is one thing, but "stabilizing the system" when it's stressed is another.  I think the distribution of land and control of money are two things that make it EXTREMELY easy to allocate wealth to the few from society as a whole.

...nothing on my 1920's analysis?  To put it in WWI terms, I feel like I just beat an Austrian army in battle .

[Gumby]

...nothing on my 1920's analysis?  To put it in WWI terms, I feel like I just beat an Austrian army in battle .

Goes without saying, Moda. Nice data! I just think that even if you show LW the facts, he won't understand them until he acknowledges that fact that our entire money supply comes from debt — it's "debt-based" money we're talking about here. You can either have public debt or private credit — there is no debt-free money right now (other than coins). If you don't have enough public debt to back your private credit, it makes private credit much riskier and unstable. If you have too much public debt, it causes inflation and too many opportunities to leverage off of risk-free Treasuries. The trick is to have the right amount of public debt and private credit in a debt-based monetary system.

[moda0306]

“With one brief exception, the federal government has been in debt every year since 1776. In January 1835, for the first and only time in U.S. history, the public debt was retired, and a budget surplus was maintained for the next two years in order to accumulate what Treasury Secretary Levi Woodbury called “a fund to meet future deficits.”? In 1837 the economy collapsed into a deep depression that drove the budget into deficit, and the federal government has been in debt ever since. Since 1776 there have been exactly seven periods of substantial budget surpluses and significant reduction of the debt. From 1817 to 1821 the national debt fell by 29 percent; from 1823 to 1836 it was eliminated (Jackson’s efforts); from 1852 to 1857 it fell by 59 percent, from 1867 to 1873 by 27 percent, from 1880 to 1893 by more than 50 percent, and from 1920 to 1930 by about a third. Of course, the last time we ran a budget surplus was during the Clinton years. I do not know any household that has been able to run budget deficits for approximately 190 out of the past 230-odd years, and to accumulate debt virtually nonstop since 1837.

The United States has also experienced six periods of depression. The depressions began in 1819, 1837, 1857, 1873, 1893, and 1929. (Do you see any pattern? Take a look at the dates listed above.) With the exception of the Clinton surpluses, every significant reduction of the outstanding debt has been followed by a depression, and every depression has been preceded by significant debt reduction. The Clinton surplus was followed by the Bush recession, a speculative euphoria, and then the collapse in which we now find ourselves. The jury is still out on whether we might manage to work this up to yet another great depression. While we cannot rule out coincidences, seven surpluses followed by six and a half depressions (with some possibility for making it the perfect seven) should raise some eyebrows. And, by the way, our less serious downturns have almost always been preceded by reductions of federal budget deficits. I don’t know of any case of a national depression caused by a household budget surplus.”?

Well this one helps put things in perspective every once in a while.

[Gumby]

Well this one helps put things in perspective every once in a while.

Yep. That's a good one, from L. Randall Wray.

http://www.nakedcapitalism.com/2010/02/ ... old-budget

But, again, once LW sees that the "money supply" is either just base money (from public debt)...or private credit (that's backed by base money and public debt), then it should start to make some sense to him.

[murphy_p_t]

2. I admit that I used to think that government deficits and government debt levels mattered in some objectively verifiable way.  I have since come to realize that they don't.  It is certainly true that high debt and deficit levels may create very serious problems in the future, but who knows when that will be?  Japan suggests that the party can continue for at least twice as long as anyone would have ever imagined.  In other words, saying that government deficits are unsustainable is like saying that we're all going to die one day.  It's probably true, but it tells you virtually nothing about how to spend the rest of today or how to plan for next week, next month or next year.

isn't there a fairly well-established "tipping point" in a nation's economy when the debt/GDP ratio reaches a certain level? I thought this was shown to be the case in many other countries...I think I read some article to this effect...I think Japan would be an exception...but hasn't this been shown to be the case in many instances? It sounds like I need to watch the IOUSA video I have laying around here...

[MediumTex]

2. I admit that I used to think that government deficits and government debt levels mattered in some objectively verifiable way.  I have since come to realize that they don't.  It is certainly true that high debt and deficit levels may create very serious problems in the future, but who knows when that will be?  Japan suggests that the party can continue for at least twice as long as anyone would have ever imagined.  In other words, saying that government deficits are unsustainable is like saying that we're all going to die one day.  It's probably true, but it tells you virtually nothing about how to spend the rest of today or how to plan for next week, next month or next year.

isn't there a fairly well-established "tipping point" in a nation's economy when the debt/GDP ratio reaches a certain level? I thought this was shown to be the case in many other countries...I think I read some article to this effect...I think Japan would be an exception...but hasn't this been shown to be the case in many instances? It sounds like I need to watch the IOUSA video I have laying around here...

I'm not sure that we are far enough into a post-gold standard world to know the answer to this question yet.

I think that it is Reinhart and and Rogoff's research that shows the relationship between excessive government debt levels and stagnating GDP, but again I don't know how relevant gold standard examples of this phenomenon are in a post-gold standard world.  Japan is obviously the case that makes you wonder what the future might look like for the rest of the developed world.

Even if we say that there definitely IS some tipping point, who knows where it will be?  If it's 10 years from now and only AFTER 30 year yields have dropped below 2%, a lot of gains will have been missed by people waiting for the debt bomb to blow up.

[Gumby]

isn't there a fairly well-established "tipping point" in a nation's economy when the debt/GDP ratio reaches a certain level? I thought this was shown to be the case in many other countries...I think I read some article to this effect...I think Japan would be an exception...but hasn't this been shown to be the case in many instances?

Robert J. Shiller — who is one of the more well respected economists out there — took those tired Reinhart and Rogoff arguments to task over the absurdity of magical debt thresholds:

Debt and Delusion

by Robert J. Shiller

Economists like to talk about thresholds that, if crossed, spell trouble. Usually there is an element of truth in what they say. But the public often overreacts to such talk.

Consider, for example, the debt-to-GDP ratio, much in the news nowadays in Europe and the United States. It is sometimes said, almost in the same breath, that Greece’s debt equals 153% of its annual GDP, and that Greece is insolvent. Couple these statements with recent television footage of Greeks rioting in the street. Now, what does that look like?

Here in the US, it might seem like an image of our future, as public debt comes perilously close to 100% of annual GDP and continues to rise. But maybe this image is just a bit too vivid in our imaginations. Could it be that people think that a country becomes insolvent when its debt exceeds 100% of GDP?

That would clearly be nonsense. After all, debt (which is measured in currency units) and GDP (which is measured in currency units per unit of time) yields a ratio in units of pure time. There is nothing special about using a year as that unit. A year is the time that it takes for the earth to orbit the sun, which, except for seasonal industries like agriculture, has no particular economic significance.

We should remember this from high school science: always pay attention to units of measurement. Get the units wrong and you are totally befuddled.

If economists did not habitually annualize quarterly GDP data and multiply quarterly GDP by four, Greece’s debt-to-GDP ratio would be four times higher than it is now. And if they habitually decadalized GDP, multiplying the quarterly GDP numbers by 40 instead of four, Greece’s debt burden would be 15%. From the standpoint of Greece’s ability to pay, such units would be more relevant, since it doesn’t have to pay off its debts fully in one year (unless the crisis makes it impossible to refinance current debt).

Some of Greece’s national debt is owed to Greeks, by the way. As such, the debt burden woefully understates the obligations that Greeks have to each other (largely in the form of family obligations). At any time in history, the debt-to-annual-GDP ratio (including informal debts) would vastly exceed 100%.

Most people never think about this when they react to the headline debt-to-GDP figure. Can they really be so stupid as to get mixed up by these ratios? Speaking from personal experience, I have to say that they can, because even I, a professional economist, have occasionally had to stop myself from making exactly the same error.

Economists who adhere to rational-expectations models of the world will never admit it, but a lot of what happens in markets is driven by pure stupidity – or, rather, inattention, misinformation about fundamentals, and an exaggerated focus on currently circulating stories.

What is really happening in Greece is the operation of a social-feedback mechanism. Something started to cause investors to fear that Greek debt had a slightly higher risk of eventual default. Lower demand for Greek debt caused its price to fall, meaning that its yield in terms of market interest rates rose. The higher rates made it more costly for Greece to refinance its debt, creating a fiscal crisis that has forced the government to impose severe austerity measures, leading to public unrest and an economic collapse that has fueled even greater investor skepticism about Greece’s ability to service its debt.

This feedback has nothing to do with the debt-to-annual-GDP ratio crossing some threshold, unless the people who contribute to the feedback believe in the ratio. To be sure, the ratio is a factor that would help us to assess risks of negative feedback, since the government must refinance short-term debt sooner, and, if the crisis pushes up interest rates, the authorities will face intense pressures for fiscal austerity sooner or later. But the ratio is not the cause of the feedback.

A paper written last year by Carmen Reinhart and Kenneth Rogoff, called “Growth in a Time of Debt,”? has been widely quoted for its analysis of 44 countries over 200 years, which found that when government debt exceeds 90% of GDP, countries suffer slower growth, losing about one percentage point on the annual rate.

One might be misled into thinking that, because 90% sounds awfully close to 100%, awful things start happening to countries that get into such a mess. But if one reads their paper carefully, it is clear that Reinhart and Rogoff picked the 90% figure almost arbitrarily. They chose, without explanation, to divide debt-to-GDP ratios into the following categories: under 30%, 30-60%, 60-90%, and over 90%. And it turns out that growth rates decline in all of these categories as the debt-to-GDP ratio increases, only somewhat more in the last category.

There is also the issue of reverse causality. Debt-to-GDP ratios tend to increase for countries that are in economic trouble. If this is part of the reason that higher debt-to-GDP ratios correspond to lower economic growth, there is less reason to think that countries should avoid a higher ratio, as Keynesian theory implies that fiscal austerity would undermine, rather than boost, economic performance.

The fundamental problem that much of the world faces today is that investors are overreacting to debt-to-GDP ratios, fearful of some magic threshold, and demanding fiscal-austerity programs too soon. They are asking governments to cut expenditure while their economies are still vulnerable. Households are running scared, so they cut expenditures as well, and businesses are being dissuaded from borrowing to finance capital expenditures.

The lesson is simple: We should worry less about debt ratios and thresholds, and more about our inability to see these indicators for the artificial – and often irrelevant – constructs that they are.

Robert J. Shiller is Professor of Economics at Yale University.

Source: http://www.project-syndicate.org/commen ... 78/English

There is no magic GDP/debt threshold — particularly for a currency issuer such as Japan or the US.

It sounds like I need to watch the IOUSA video I have laying around here...

The IOUSA movie is chock full of fallacies about the national debt. The movie was funded by politically motivated deficit hawk, Pete Peterson, and is designed to make you think that federal debt is bad and needs to be paid off and that we need to call up China to lend us money (we don't). (Peterson actually takes huge tax breaks that add millions to the national debt). The movie fails to mention the fact that debt is actually necessary in a debt-based monetary system.

[murphy_p_t]

Gumby...that Schiller article seems compelling...and for me to say that is saying something, considering my personal bias. Do you have any articles which address what is the practical (or safe) limit to the amount of debt/deficit a national government like US/Japan can run? Is there no down-side to running large deficits and increasing the national debt?

[Gumby]

Gumby...that Schiller article seems compelling...and for me to say that is saying something, considering my personal bias. Do you have any articles which address what is the practical (or safe) limit to the amount of debt/deficit a national government like US/Japan can run? Is there no down-side to running large deficits and increasing the national debt?

In terms of servicing debt, there is no limit. When a fiat country is the sole issuer of a currency, owes no foreign-denominated debt, and has a free floating currency (i.e. Japan and the US) then there is no limit to how much of it's own debt it can service. There is no issue of solvency under those circumstances. None. The only issue is inflation.

See: YouTube: The US Debt is a Myth!

Secondly, our money supply comes from debt. We have a "debt-based" monetary system. Our money supply wouldn't exist without public debt and private credit.

And finally, it's important to understand that from an operational standpoint, fiat government debt-auctions are designed not to fail. In the US, the Federal Reserve is not allowed to purchase Treasuries directly from the Treasury. The Fed must purchase its Treasuries from the private sector — via Primary Dealers (i.e. big banks). The Primary Dealers are legally obligated, by contract, to provide a market for government debt — agreeing to funnel their excess reserves into Treasury bonds. This is something that they want to do — since they don't want to hold on to excess reserves. So, even if no one wants to buy our debt, as long as Americans are storing their money in banks, the banks will gladly buy the Treasury bonds on behalf of the savers. This is why every Treasury bond auction is always oversubscribed. As long as there is a desire to save, there is always a market for Treasury bonds.

In Japan's case, their Fed operates a little differently. The government-owned Bank of Japan has the authority to buy government bonds directly from Japan's Treasury (known as the Ministry of Finance). And, of course, any interest payments on the bonds is refunded back to the Treasury. The BOJ holds Japanese government debt equal to 100% of the nation’s GDP. And since the government owns the bank, the loan is always interest-free and can be rolled over indefinitely. An interest-free loan rolled over indefinitely is the equivalent of printing fiat money. And of course, like the United States, Japan's Treasury is where Japan's spending comes from.

It is well known that the Japanese people own a lot of their national debt as well. But the reason they own so much of the debt has a lot to do with the Post Bank. The Post Bank started in Japan's post offices and offered a very easy way for Japanese citizens to save their money through highly popular savings accounts. The money was obviously invested in risk-free Japanese Government Bonds. Today the state-owned bank is currently the world's largest holder of private savings and the world's biggest deposit holder — holding over 1/5th of the entire Japanese national debt and becoming the nation's largest employer. The Post Bank actually became more popular than the post office and had to open up more branches than the post office!

So, you can see where this is going... The Ministry of Finance (the Treasury) can spend and issue as much debt as it wants to, since the BOJ can purchase the interest-free debt directly. There is no theoretical limit. The only limits are self-imposed — to prevent themselves from causing inflation too quickly. And the Ministry of Finance can sell trillions of government bonds to the Post Bank because that's where the Japanese are stashing all of the cash that was spent by the MOF. So, Japan's debt will simply continue to grow and grow, and it won't make a difference. They will have no problem servicing their debt.

The fundamental difference between the Fed and the BOJ is that the Fed can't buy Treasuries directly from the Treasury itself — the Fed must go through the Primary Dealers. And the only way the Primary Dealers would have the cash reserves to purchase Treasuries in the first place is if the reserves existed in advance of the bond auctions (occasionally with the help of the Fed's repos, and short term loans, when necessary). And the only way the cash reserves can exist before the bond auctions (other than repos) is if the Treasury spent money into existence — since you can't use bank loans to purchase Treasuries. And since the Treasury doesn't except bank credit, the funds to pay taxes and buy government securities can only come from previous government spending.

What's also clear is that the Fed and the BOJ can't just add money into the private sector without removing an equal financial asset from the private sector (i.e. an asset swap). So, in both cases, all of the net spending all comes from the Treasury. Which makes total sense, since the politicians are deciding what the money should be spent on.

This entire song and dance is really just used as a way to move freshly printed money into risk free assets and control interest rates in the process. In terms of remaining solvent, fiat governments can do that as much as they want to. However, there are some downsides. Issuing too much debt-based money could cause inflation, if done too quickly. And large amounts of debt tend to give the banks in the private sector too much leverage — causing instability and a fragile economy. The important thing to realize is that there is no issue of solvency with a fiat currency, unless the government decides to be insolvent.

You can learn more at: http://pragcap.com/understand-the-moder ... ary-system

...but I'll warn you that it can take a few weeks (or months) to really digest it all.

[jackely]

The important thing to realize is that there is no issue of solvency with a fiat currency, unless the government decides to be insolvent.

I get your point that the system works as long as people don't muck with it. A point I was making earlier is that people do tend to muck with it as recently demonstrated in the debt-ceiling fiasco.

A while back I was digging into the sustainability of social security since I am nearing retirement age. As I understand it, the social security trust fund consists of some kind of special government bond and would therefore be considered a government debt but it is one that the supreme court has ruled the government is not legally obligated to pay. I found perfectly sensible arguments on both sides of the issue, that the math doesn't add up and the system is unsustainable but also that there really is no problem and it's no big deal.

The most sensible and simple conclusion I found however is that the social security checks will keep coming as long as the American people are willing to keep sending them. Will the American people ever decide to do a strategic default on social security? Who knows? I hope not but I'm saving all the money I can in my PP just in case.

[moda0306]

Warren Mosler has pointed out that the real constraint of Social Security is the ability and motivation of the productive part of the population to take care of the elderly.  Basically, to say that we have that constraint and to also worry about high unemployment is a bit of a paradox.  A world where we struggle to produce the real resources our elderly need will be one where we likely have full employment and inflation.  Of course, this is all assuming we continue to live in a country that HB would point out that you can live "90% free."

Some say the trust fund is a myth, but I don't like to completely ignore it.  It is a reminder of how over-funded SS has been over the years, which is a reminder of the payroll tax loan on the middle class this whole time that some people like to ignore when talking about "who pays income taxes"... but that's a different issue.

[jackely]

Some say the trust fund is a myth, but I don't like to completely ignore it.  It is a reminder of how over-funded SS has been over the years, which is a reminder of the payroll tax loan on the middle class this whole time that some people like to ignore when talking about "who pays income taxes"... but that's a different issue.

I was thinking for a moment that I was hi-jacking this thread by bringing up the social security trust fund and then I re-read the title of "Europe's pain is coming America's way" and it seems entirely appropriate.

I was reading some comments posted to an article about social security the other day and I couldn't believe some of the vitriolic statements about fat, lazy "old geezers" collecting social security checks that I was reading. This was a rather eye-opening experience for me. We old geezers were led to believe that we had been pre-funding our social security benefits by "over-funding" SS as you described it, for the past 30 years or so since they "saved" SS by raising the payroll tax. It always did seem to me that this was mostly a fraudulent accounting gimmick but now it seems like the the younger generation might be catching on to the chicanery too.

So, on one hand you have a bunch of bonds in the SS trust fund backed by the "full faith and credit of the U.S. government" and a younger generation getting angry about having to pay for the debts incurred by their elders.

If the economy hums along it could all work itself out, or it could get very ugly. 

[murphy_p_t]

i think this article on zerohedge contributes to the discussion...if for no other reason that he seems to exhibit HBs humility in not knowing the future. I also find it interesting his tying in the idea about madness of crowds.

The first part of article...he talks about drinking the Kool-Aid about the housing market. Later, he moves on to the possibility of a failed Treasury auction.

"Neither I nor any other person on the face of the planet knows exactly what's going to happen to interest rates in the next 2 seconds, let alone 2 months or 2 years.  So much is happening and changing at such a rapid pace, thinking that anything will "never" or "always" happen strikes me as pure, unadulterated hubris.  The madness of crowds."


http://www.zerohedge.com/news/guest-pos ... ntil-there


however, I acknowledge this seems like an extremely unlikely event, considering that the Fed can monetize the debt, as its doing currently.

[Gumby]

i think this article on zerohedge contributes to the discussion...if for no other reason that he seems to exhibit HBs humility in not knowing the future. I also find it interesting his tying in the idea about madness of crowds.

The first part of article...he talks about drinking the Kool-Aid about the housing market. Later, he moves on to the possibility of a failed Treasury auction.

That's just fear-mongering.

For an explanation, see: When Will The Bond Auctions Begin to Fail?

There is no operational reason for Treasury auctions to fail. None. Treasury officials don't hold Treasury auctions until they've coordinated with Fed officials — who coordinate with the Primary Dealers — to find and target the necessary excess reserves, in advance, to purchase all of the Treasuries without anyone else's help if need be. They literally double-check with each other before every auction. It's a rigged auction. That's why the auctions are always oversubscribed. Fed and Treasury officials would know about a failed auction before it even started — in which case they would just reschedule the auction (which has happened before).

See also: Breaking News: "Bankrupt" Nation's Bond Auction 3x Oversubscribed

And if an auction did fail, they would just reschedule the auction and try again. The world wouldn't end.

The important fact here is that the money the Treasury has spent has ended up in the banking sector as excess reserves and the Fed is simply issuing securities to soak up those reserves and maintain their overnight rate.  It’s that simple.  The auctions never fail because there is always excess reserves if there is deficit spending.

This doesn’t mean that auctions can’t fail.  The Fed could fall asleep at the wheel and stop contacting the Treasury.  The bankers could be out playing golf all day and forget that they can earn a few extra bps on their reserves if they so choose.  But in reality, auctions should never fail.  The savvy market readers will note that a UK bond auction technically “failed”? in March of 2009.  But what happened after this failed auction?  Absolutely nothing.  In fact, almost every single risk asset on the planet was not only bottoming but was on an upward trajectory.  Credit markets were in the beginning stages of one of the greatest recoveries in the history of markets.  The next few UK auctions were oversubscribed and their government was able to continue soaking up reserves after the banks foolishly failed to trade in their excesses at that particular auction.

So next time you hear someone hyperventilating over a US bond auction failure (please bear in mind that the Euro currency system is different and that bond auction failures very much matter there) give them a paper bag.  Tell them to breathe into it for 10 minutes and then tell them that everything is going to be okay.  Bond auctions have no operational reason to fail.  In fact, the only reason for them to fail in the USA is due to excessive golf playing – but considering the banks have traded in their 3-6-3 model in favor of the Enron banking system I think there’s no need to worry about that.
Source: When Will The Bond Auctions Begin to Fail?

however, I acknowledge this seems like an extremely unlikely event, considering that the Fed can monetize the debt, as its doing currently.

That's a fallacy. A myth. The Fed does not monetize the debt.

See: The Fed Is Not Monetizing the Debt

It would actually be impossible for the Fed to monetize the debt since the Fed cannot purchase Treasury Bonds directly from the Treasury. Japan's central bank can purchase Treasuries directly from their Treasury, so Japan's central bank can (and does) monetize their debt.

The Fed can only swap assets with the Primary Dealers (i.e. the largest banks in the private sector), and the private sector must acquire the funds to purchase Treasuries before the Fed can even think of buying them from the Primary Dealers. The Fed can provide short term loans (or repos) to the Primary Dealers, but that's about all it can do. And those loans need to be paid back with base money (i.e. deficit dollars). Either way, the funds to buy Treasuries (and pay taxes) can only come from deficit dollars that were spent into existence by the Treasury. This is especially true since the Treasury doesn't accept bank loans or private credit as a form of payment.

[murphy_p_t]

Gumby,

I read the link The Fed Is Not Monetizing the Debt , http://pragcap.com/pomo-flip-matter
with great interest. Additionally, I watched three of his introductory videos to his website.

The author makes some pretty bold claims, including that most everyone, in effect, does not know what they're talking about when referring to QE. Including FOMC members and venerable news outlets such as Bloomberg. Bold claim indeed.

I'm open to gaining an accurate understanding of how this all works...and I have some questions.

To get started, I'm wondering if you have direct professional experience in these matters...perhaps you work at the Fed or Treasury?

Can you provide any primary sources to confirm and document the claims of the author, especially since the claims deviate so wildly from the commonly held view?

If the claims of the author are accurate, why does the federal government have taxation, including personal income taxation? More to the point, why would it be looking to increase taxes during the current recession/depression we are enduring? Taxes during economic contraction are then counter-productive. If these claims are true, why haven't all politicians made it their number one priority to destroy the widely held view that there needs to be constraints on federal spending, short of avoiding hyperinflation?

If, as the author claims, that “Congress is the entity that prints money via deficit spending”?, why is the currency in your pocket a Federal Reserve Note...rather than a US Treasury Note? Didn't Congress delegate currency to the Fed? (Granted, the Dept of Engraving physically prints the notes.) As a counterpoint, JFK ordered Treasury to print Treasury notes (silver certificates -- Executive Order 11110) before his assassination, which were quite distinct from FRNs.

Why does the Treasury conduct bond auctions at present, during this recession/depression, if the only reason is to soak up reserves? Isn't this totally counter-productive as there seems to be no danger of hyper-inflation at present?

As you probably gather from my questions, I am highly skeptical of the claims of this author. However, I'm keeping an open mind and I look  forward to your reply.

[Storm]

Gumby, that Shiller article is amazing.  Debt to GDP is a ridiculous ratio.  Imagine your typical American household with a $200,000 mortgage and no other debt.  If they had an annual income of $200,000, you could say they had a debt to GDP ratio of 100%!  Even though a $200K income and only $200K in liabilities would be pretty great, financially.

[Gumby]

The author makes some pretty bold claims, including that most everyone, in effect, does not know what they're talking about when referring to QE. Including FOMC members and venerable news outlets such as Bloomberg. Bold claim indeed.

That's right. Not only does he point out that most people do not understand the operational realities of the Fed and Treasury, but most people look at the monetary system as if there is still a convertibility to gold. Essentially, we became fiat in 1971 and the laws were never changed on how we create money. Instead of depositing gold into Fort Knox, and handing out gold certificates and borrowing when we run out of gold, we now just print more paper bonds instead and issue new cash. Many people know that we longer have gold backing our currency, but the truth is that economics textbooks and the media still view the monetary system as if there is convertibility to gold and they imagine there are reserve constraints where none exist.

To get started, I'm wondering if you have direct professional experience in these matters...perhaps you work at the Fed or Treasury?

No. No experience. I was motivated to learn more about this to understand why Treasuries work within the PP so well. Treasuries are a very unique asset — that is for sure.

Can you provide any primary sources to confirm and document the claims of the author, especially since the claims deviate so wildly from the commonly held view?

Sure thing. I'll give you a quick background.

A lot of the information I'm telling you is based on Modern Monetary Theory (MMT) and Modern Monetary Realism (MMR). Modern Monetary Theory is essentially a theory about how government can maximize its productive output by figuring out how much money a fiat country should print so as to foster growth, and provide jobs to the population, without promoting high inflation. MMT is a theory that was invented in the late 1800s, when people wanted more fiat Greenbacks and were concerned that tying the currency to gold would cause problems with deflation and monetary contraction (when more liquidity was needed in certain parts of the country). The theory was further refined in the 1940s by Abba Lerner. Lerner and Keynes were colleagues, and supposedly Lerner's theories helped influence Keynes. Anyway, Lerner's theories on a fiat monetary system were largely left on a dusty shelf for a few decades until Warren Mosler started picking them up again. In the 1970s and 80s, Mosler became a quite wealthy by figuring out how the international bond market worked. He's literally made hundreds of billions of dollars in the funds he's managed. Over time, by working on Wall Street, he realized how money was moving through the Fed and Treasury in a way that didn't correlate with the way the media and economists described it.

For instance, occasionally the Treasury would accidentally deposit a millions of dollars into Mosler's firm's account that shouldn't have been there. A few days later the Treasury would realize its mistake and correct the error. But, after this happened enough times, he began to realize that the Treasury wasn't taking this money from anywhere. They were just adding and deleting it from the account. After awhile he began to formulate how the monetary system worked and only later discovered that much of what he realized was true had been described by Lerner decades earlier — namely that a country that is the sole issuer of its own currency, and owes no foreign debt, and has a free floating exchange rate (i.e. no peg to any other currency or commodity) can never run out of money and that printing money does not necessarily result in inflation under certain situations. Mosler called his ideas "Soft Currency Economics" at the time.

Keep in mind that our monetary system did a complete 180º in 1971, when Nixon removed convertibility to Gold, and nobody changed the laws on how money and bonds were issued and nobody in the mainstream media and economics community really seemed to change their models. And yet, we no longer needed to "borrow" money, and yet we still have bonds. Where does this money we borrow come from? We make it and the government borrow's the money from its own banking system.

So, Warren Mosler just looked at the monetary system from a post-1971 viewpoint and used Lerner's writings to formulate and refine the views of MMT on how productive capacity for a nation could be optimized.

See: http://moslereconomics.com/

Mosler has an excellent book that you can download here:

http://moslereconomics.com/wp-content/p ... s/7DIF.pdf

And then there are some economists, professors, and some bloggers who have also reached some of the same conclusions as Mosler and Lerner.

- James Galbraith, Former Executive Director, Joint Economic Committee and Professor at The University of Texas, Austin.

- Dr. Matthew Forstater, Professor of Economics, University of Missouri, Kansas City

- L. Randall Wray, Professor of Economics, University of Missouri, Kansas City
http://www.economonitor.com/blog/author/rwray/

- Bill Mitchell, Research Professor in Economics and Director of the Centre of Full Employment and Equity (CofFEE), at the University of Newcastle, NSW Australia.
http://bilbo.economicoutlook.net/

- Scott Fullwiler, Ph.D. is Associate Professor of Economics and James A. Leach Chair in Banking and Monetary Economics at Wartburg College, Research Associate at the Center for Full Employment and Price Stability, and Director of the Social Entrepreneurship Program at Wartburg College. His research expertise is in: central bank operations, Treasury operations, and monetary economics.

http://neweconomicperspectives.org

Scott Fulwiler was asked to testify before Congress, about QE — unfortunately, they cancelled his testimony before he was scheduled to appear.

If you really want an detailed description of how the Treasury and Fed work together, see the following two articles from Scott Fullwiler:

http://www.moslereconomics.com/wp-conte ... lwiler.pdf
http://neweconomicperspectives.org/2010 ... tions.html

It's difficult to read those two article and not be persuaded that most people do not fully understand how the system really works.

- Cullen Roche, an investment partner who blogs about Macro and the monetary system.

http://pragcap.com
http://monetaryrealism.com/

Most of the people I've listed above are not "MMTers" per se. You can understand and agree with the operation realities and fundamentals of the Fed and Treasury without subscribing to the MMT theories of employment and production. Cullen Roche started documenting "MMR" for those who wanted to understand the monetary system and did not want to deal with the untested theories of MMT.

If the claims of the author are accurate, why does the federal government have taxation, including personal income taxation?

It's a legacy system left over from our convertibility to gold — when our government needed to borrow money from the banking system to keep that convertibility reconciled. Taxes are useful for destroying money in the private sector (to prevent inflation). Taxes also legitimize the currency — since you need dollars to pay your taxes. I believe Moda may have some additional perspectives on this (since he's read more about MMR than I have).

More to the point, why would it be looking to increase taxes during the current recession/depression we are enduring? Taxes during economic contraction are then counter-productive.

Right. We wouldn't want to increase taxes right now. Most politicians are completely clueless and think we will run out of money when we can't. Other politicians are worried about inflation, even though that seems unlikely with so much unemployment.

If these claims are true, why haven't all politicians made it their number one priority to destroy the widely held view that there needs to be constraints on federal spending, short of avoiding hyperinflation?

Because politics is about giving money to your political base — either through tax cuts or handouts. What better way to do this than by perpetuating the myth of reserve constraints when none exist? But, the truth is that many politicians are just clueless, since the obsolete gold-standard line of thinking is so widespread. Even President Obama (publicly) thinks that we are going to run out of money.

If, as the author claims, that “Congress is the entity that prints money via deficit spending”?, why is the currency in your pocket a Federal Reserve Note...rather than a US Treasury Note? Didn't Congress delegate currency to the Fed? (Granted, the Dept of Engraving physically prints the notes.) As a counterpoint, JFK ordered Treasury to print Treasury notes (silver certificates -- Executive Order 11110) before his assassination, which were quite distinct from FRNs.

As I understand it (and I could be wrong), Federal Reserve Notes are liabilities of the Fed — backed by Treasuries on the Fed's balance sheets. The Treasury prints them and The Federal Reserve Bank actually distributes the note through its Federal Reserve Banks (and holds the Treasuries to back the notes). All deficit spending is done by the Treasury writing money into the reserve accounts of individual banks that are held at the Fed. The Fed just moves the money around for the Treasury. The other notes you're referring to (Treasury Notes, Greenbacks, etc) were notes that were distributed by the Treasury, thus bypassing the Federal Reserve System altogether.

Why does the Treasury conduct bond auctions at present, during this recession/depression, if the only reason is to soak up reserves? Isn't this totally counter-productive as there seems to be no danger of hyper-inflation at present?

Banks don't want excess reserves.

http://en.wikipedia.org/wiki/Excess_reserves

They'd rather have Treasuries that they can leverage off of.

As you probably gather from my questions, I am highly skeptical of the claims of this author. However, I'm keeping an open mind and I look  forward to your reply.

I was the same way, but the deeper I looked, the more sense it began to make and more evidence I found to support these claims. And the market made a lot more sense when I looked at it from a post-1971 perspective as well...

http://mikenormaneconomics.blogspot.com ... thing.html

[murphy_p_t]

Gumby...thats a lot of homework you've assigned me!

Let me clarify one question for now...by "primary source" I meant an explanation from the Fed or Treasury or some government agency of how their system actually works...not something interpreted/developed by others. Are you aware of anything of this nature?

[moda0306]

murphy,

Can't say much right now, but even Ben Bernanke seems to have trouble correctly recognizing how the system as it actually works... or at least as Gumby and I interpret it to work based on smarter men than us.  Normally, one could assume that it's because we're wrong, not the fed chairman... but from what I've seen I just can't buy the deficit hawkery.

So, no, the gov't probably doesn't have a nice primer on this stuff.  Maybe it's because we're wrong, but I have seen MMT/MMR disect the living hell out of arguments of prominent economists and BB... I have not seen the reverse happen to what I believe is anywhere close to the same degree.  If it weren't for this fact I'd feel a lot less confident in our position.

Gumby, you really are a patient man.

[MediumTex]

Gumby's post above is really outstanding.

Thanks for the effort that I'm sure went into that.

[moda0306]

MT,

Gumby, MMT, and MMR, are all so thorough it's hard to really mount much of a defense... I'm still absorbing a ton of this... more recently, some debate has been going around about whether or not banks are truly "reserve-constrained," or rather "captital-constrained".... and that the fed will accomodate lending as long as banks capital ratios are appropriate.

The discussion around this has been mind-boggling... just as I'm starting to think I understand one aspect of this, another pops up... and you'd think they'd eventually be subjects that aren't very important but clarifying even small details of the system does tend to eventually paint a very different picture of the relation between the treasury, fed, banks and investing public.

The thing most telling is that everyone seems to think "printing money" is a quantity-based monetary tool (looking at the exploding M1 charts), when it's really more of a velocity-based tool.  IE, we have the same amount of nominal fiat wealth after QE as we did before QE... The quantity hasn't changed (unless QE is used to buy mortgage junk at face value... putting this on the back burner for now).  What QE really does is make people/banks/institutions look at the risk-free rate they can earn on their money, get a little disgusted with it, and look elsewhere, either buy lending it to a corporation or municipality or increasing its velocity.  Even so, in a balance sheet recession it may not even have this effect.

[murphy_p_t]

however, I acknowledge this seems like an extremely unlikely event, considering that the Fed can monetize the debt, as its doing currently.

That's a fallacy. A myth. The Fed does not monetize the debt.

See: The Fed Is Not Monetizing the Debt

It would actually be impossible for the Fed to monetize the debt since the Fed cannot purchase Treasury Bonds directly from the Treasury. Japan's central bank can purchase Treasuries directly from their Treasury, so Japan's central bank can (and does) monetize their debt.

The Fed can only swap assets with the Primary Dealers (i.e. the largest banks in the private sector), and the private sector must acquire the funds to purchase Treasuries before the Fed can even think of buying them from the Primary Dealers. The Fed can provide short term loans (or repos) to the Primary Dealers, but that's about all it can do. And those loans need to be paid back with base money (i.e. deficit dollars). Either way, the funds to buy Treasuries (and pay taxes) can only come from deficit dollars that were spent into existence by the Treasury. This is especially true since the Treasury doesn't accept bank loans or private credit as a form of payment.

The following is from http://www.federalreserve.gov/faqs/money_12850.htm, a primary source of information, the Federal Reserve's own website.
It seems to directly contradict the statement above. From the Fed's own statement, we are told that the Fed
1. has an existing Treasury portfolio
2. is going to expand that portfolio by "purchasing" more Treasuries 
3. intends to influence interest rates through the "purchase" of Treasuries

Please note that there is no mention of "swaps" to acquire these treasuries, but rather the statement clearly states that the Fed is to "purchase" these Treasuries.


How does this statement on the Fed's own website correlate with your claims? Is the Fed misrepresenting what it is doing and how it does it? Is this intentional misinformation? If so, why? If Ben Bernanke came before Congress and testified that the Fed has purchased Treasuries, is he committing perjury?



Here's the quote:

"Why did the Federal Reserve begin purchasing a lot of Treasury securities in November 2010?

The Federal Open Market Committee (FOMC) announced a program to expand its portfolio of longer-term Treasury securities in November 2010 in order to promote a stronger pace of economic recovery and to help ensure that inflation and unemployment, over time, return to levels consistent with the Federal Reserve's statutory mandate. This program was completed at the end of June 2011, with purchases totaling $600 billion in longer term treasury securities.

In November 2010, despite the moderate increase in economic activity in 2010, the FOMC viewed the pace of recovery in output and employment as disappointingly slow and measures of underlying inflation as somewhat low relative to levels judged to be consistent, over the long run, with its dual mandate of maximum employment and price stability. With a target range for the federal funds rate set at 0 to 1/4 percent, short-term interest rates were already about as low as they could go. In these circumstances, the FOMC decided in November 2010 to increase its holdings of longer-term Treasury securities with the intent of lowering longer-term interest rates to help promote a stronger recovery with stable prices. "

[murphy_p_t]

Gumby, further challenging your previous statement that the Fed can't buy treasuries, from a link you gave me
http://www.moslereconomics.com/wp-conte ... lwiler.pdf

"...MMT’ers are keenly aware that governments can and do write laws that their treasuries’ operations be legally bound in certain ways.  For instance, the Fed is constrained by law to only purchase Treasury securities in the “open market,”?...

Do you wish to elaborate?

[Gumby]

Please note that there is no mention of "swaps" to acquire these treasuries, but rather the statement clearly states that the Fed is to "purchase" these Treasuries.

Exactly. When the Fed purchases Treasuries, it exchanges them for dollars. That's a swap. The private sector is left with the exact same amount of wealth as it had before the transaction started.

How does this statement on the Fed's own website correlate with your claims? Is the Fed misrepresenting what it is doing and how it does it? Is this intentional misinformation? If so, why? If Ben Bernanke came before Congress and testified that the Fed has purchased Treasuries, is he committing perjury?

The Fed does purchase Treasuries. I never said that they didn't. But, at the end of the day, the Primary Dealers aren't any richer from the transaction because they don't own the Treasuries anymore. It's a swap.

"Why did the Federal Reserve begin purchasing a lot of Treasury securities in November 2010?

The Federal Open Market Committee (FOMC) announced a program to expand its portfolio of longer-term Treasury securities in November 2010 in order to promote a stronger pace of economic recovery and to help ensure that inflation and unemployment, over time, return to levels consistent with the Federal Reserve's statutory mandate. This program was completed at the end of June 2011, with purchases totaling $600 billion in longer term treasury securities.

In November 2010, despite the moderate increase in economic activity in 2010, the FOMC viewed the pace of recovery in output and employment as disappointingly slow and measures of underlying inflation as somewhat low relative to levels judged to be consistent, over the long run, with its dual mandate of maximum employment and price stability. With a target range for the federal funds rate set at 0 to 1/4 percent, short-term interest rates were already about as low as they could go. In these circumstances, the FOMC decided in November 2010 to increase its holdings of longer-term Treasury securities with the intent of lowering longer-term interest rates to help promote a stronger recovery with stable prices. "

I'm not sure why you see this as conflicting with anything I said. These are swaps. The Fed conjures up money out of thin air and uses it to buy Treasuries from the Primary Dealers. The Primary Dealers basically sell one form of cash for another. It's a swap.

Hypothetically speaking, if the Federal Reserve were to write you a check for $200 in exchange for 800 Quarters, would that be the equivalent of printing money into the private sector? No, of course not. Because you are no richer or poorer after the transaction takes place. It's a swap.

Gumby, further challenging your previous statement that the Fed can't buy treasuries, from a link you gave me
http://www.moslereconomics.com/wp-conte ... lwiler.pdf

"...MMT’ers are keenly aware that governments can and do write laws that their treasuries’ operations be legally bound in certain ways.  For instance, the Fed is constrained by law to only purchase Treasury securities in the “open market,”?...

Do you wish to elaborate?

Nothing you've mentioned has contradicted anything I've said. The Federal Reserve may only swap assets (i.e. "purchase" and take away) with Primary Dealers. The Primary Dealers represent the private sector — as they are "private" banks after all. Nobody else can do business with the Primary Dealers. And I specifically mentioned that the Fed cannot purchase Treasuries directly from the Treasury (as Japan's central bank can do). If the Fed was able to purchase Treasuries directly from the Treasury and roll over the bonds indefinitely, that would be pure monetizing of the debt (as Japan does). The Fed doesn't have that ability.