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

[MediumTex]

What about the relationship between "money printing" (or swapping ) and the value of the dollar.  I know that Japan has gotten away with it in the past, but isn't that because they were the only developed country with a low interest rate, which made their currency attractive to foreign banks/investors, ie the so called Yen Carry Trade?

Not sure I understand what you're saying. I'm pretty sure low interest rates make a currency less appealing — since one would get less return when interest rates are low. Isn't that why people would rather hold gold than a currency with such low real interest rates? And isn't Japan trying to weaken their currency? So, if the Fed conducts POMO or QE to lower interest rates, that makes a currency weaker — which is what the Fed wants to do anyhow. Every country is trying to weaken their currency right now.

I was always under the impression that if a country decides to "print" more money (increase the money supply) then this would result in a weaker currency, but not necessarily result in inflation.  Does this fit in with what was being discussed in this thread?  Or am I off in LaLa Land?

I'm seeing a few comments saying that deficits doesn't matter because it won't necessarily result in inflation, but won't it result in a decreased value of that countries currency?  There has to be some sort of restraint on the countries printing press (or adding zeros to bank accounts)...right?

Remember that we are in a secular deleveraging trend.  In this kind of environment governments and central banks can get away with things they couldn't get away with if private sector credit was expanding.

[Gosso]

Remember that we are in a secular deleveraging trend.  In this kind of environment governments and central banks can get away with things they couldn't get away with if private sector credit was expanding.

Right.  So the government is taking over for the private sector, otherwise we'd be caught in a deflationary spiral, which would in turn increase the value of the currency.  And then the hope is that once "confidence" has returned then the government will pull back and allow the private sector to leverage the current money supply.  I guess that is classic Keynesian Economics.  But this can go screwy when politicians and the public begin to worry about the size of the deficit. 

Does this mean that the size of the deficit only matters when the banks/businesses/public are willing to leverage the current money supply?  The leveraging of the money supply acts as a pseudo printing press, and acts to increase the velocity of money, which then may lead to inflation.

[moda0306]

Gosso,

Your questions go directly to what a lot of the debates within MMT/MMR are circling around right now... What is the behavior of credit in different economic enviornments?  What is the behavior of base money in different economic environments?  What happens when the government puts people to work when there's idol capacity vs when there isn't?

Basically, MMR describes it as a society's will to "net-save" during a given period, some periods much greater than others.  "Net saving" is saving net of investment, and can't really be done with the private (domestic) sector, alone.  In a world where there is no fiat currency issued by government, saving always equals investment.  (Saving being a flow, not a stock.. like in 2011 you earned $50,000 after tax and "saved" $5,000).  In a world with no government base money (dollars and treasury bonds), society can't save without investing... which sounds fine in normal environments (in fact, the idea of being able to "save" without some sort of corresponding "equal-and-opposite" force happening in the economy is somewhat unintuitive, but I'll get to that).

However, people tend to collectively want to be able to save in excess of investment.  Thinking of savings & investment as a stock (my "savings" of all my years equals $100,000, and my factory built a few years back is a remaining investment), society doesn't want all of their savings value to be dependent on future consumption of others (which most investment tends to be... you don't "invest" in a factory unless you think you'll have steady demand from it).  People want something more stable to represent part of their savings (thinking of it all as a stock, not a flow).  Another way to think of it is in terms of "flow."  In a given year, especially during times like now, society is trying to save significantly more than it invests.  Like I pointed out before, without deficits, this is impossible.  This means deficits will be met without inflation, because, like I just said, this net saving (gov't "dissaving") is exactly what society is "trying to do."

Now this gets to the question, how can government really provide net savings?  Is it a mirage?  Is fiat money without some productive backing not just a gimmick that is another word for "debasement?"  I deeply don't think so.  First off, investment and demand are two sides of the same coin of prosperity.  Investment doesn't like a monetary system that depends 100% on investment... investment likes somewhat predictable future demand.  I tend to think that "net-savings" (dollars and t-bonds), and more importantly, our government's ability to supply them and remove them as the economy goes through cycles, represent our collective ability to buy things when we are far enough under capacity that it won't create inflation.  That kind of flexibility not only leads to more stable savings, but it actually leads to more investment, as stable demand is a pretty big prerequisite to building a factory... Hope this helps... for more, go to monetaryrealism.com.  There's some wonkish stuff there, but some very accessible stuff as well.

[Gosso]

Moda0306,

It looks like I'll have to check out that website and possibly reread some of the threads on this forum.  I think I understand it, but haven't worked out how it fits together.

[Gumby]

I was always under the impression that if a country decides to "print" more money (increase the money supply) then this would result in a weaker currency, but not necessarily result in inflation.  Does this fit in with what was being discussed in this thread?  Or am I off in LaLa Land?

Except that you are equating printing and swapping as if they are the same thing. The Fed isn't allowed to recklessly "print" money into the private sector in the way "printing" suggests. Printing implies that the Fed is giving money to the private sector and taking nothing in return — thus weakening the currency. In reality, the Fed is making an exchange when it conducts its operations. It conjures up base money — out of thin air, yes — and exchanges it for equal financial assets in the private sector. The Fed doesn't do helicopter drops.

An easier example is to imagine that the government minted 800 quarters and swapped those 800 quarters for the $200 that were in your pocket. Did the government really give you anything that could weaken the currency? No. So, the Fed isn't "printing" money in the way you are suggesting or imagining. But, in reality it's only slightly different since what they've done is swapped an asset that has a promised return for one that does not — and that causes people to make different decisions about what to do with the money they are left with... which affects interest rates and the way people move credit around the private sector (credit, by definition, is the majority of what we call the money supply). It's not unlike when a company does a stock buyback. The stock's value may rise temporarily, but the fundamentals of the company are still the same.

When people say that the Fed is "increasing the money supply" what the Fed is doing is swapping base money for Treasuries (both are forms of money) and this causes interest rates to change — which affects how much private credit is created or not created. The increase or reduction of private credit is the key change to what we call the money supply (though, we should probably call it the "credit supply"). More importantly, the change in real interest rates causes the currency to either become more appealing or less appealing. If real interest rates plunge, the currency becomes less appealing, and people want to hold it less (and buy other things with it... gold, copper, stocks, other currencies, etc). This is by design. That's what the Fed does. They can't print money, so they make the currency more or less appealing by changing interest rates and promising to change interest rates — both have huge effects on the market and the dollar.

I suppose some of the confusion on what the "money supply" is stems from the fact that most people don't equate Treasuries as being a form of money, but they really are (even though officially they are not). We on this forum happen to know that Treasuries are a form of money because when we allocate our PP's cash into short term Treasuries, we call it our "Cash". You can have your entire cash position in a Treasury Money Market Fund and your purchasing power is no different than having a standard checking account. You can even write a check from your Treasury Money Market Fund and give it to someone else with a Treasury Money Market Fund and the entire transaction is settled in the blink of an eye. So, Treasuries are certainly a form of money — even though most people don't think of Treasuries as being a part of what we think of as the money supply. Treasuries just represent our nation's "savings" — much like a savings account at the bank. Cash is just slightly more liquid than Treasuries are.

I'm seeing a few comments saying that deficits doesn't matter because it won't necessarily result in inflation, but won't it result in a decreased value of that countries currency?  There has to be some sort of restraint on the countries printing press (or adding zeros to bank accounts)...right?

Well, perhaps deficits and QE reduce real interest rates — making a currency less attractive. But that's not necessarily a bad thing. Aren't "real" interest rates what really affect whether a currency is desirable or not? Having a large deficit does not necessarily mean that real interest rates will be negative — there are other factors at play. Japan has an enormous deficit, but their high real interest rates make the Yen quite attractive as a store of value. As I was saying, perhaps the large deficit is intended to bring those real interest rates back down and affect the way people hold onto their money and create private credit.

Anyway, since private credit makes up the majority of our money supply, you need to look at how healthy a country's credit market is (and real interest rates are) before you can even begin to tell if printing deficit-dollars is good or bad for a currency. If we have a severe depression, credit markets will seize up and the private credit-based money supply will shrink considerably. What do you replace that shrinking credit-based money supply with? Printed base money (from Treasury deficit dollars) and converting Treasuries into base money (through Fed asset swaps). And doing so, lowers real interest rates to (hopefully) make people more likely to create private credit and move their money around.

I think when you're talking about a debt-based and credit-based money supply, then most monetary decisions are really all about the private credit market — particularly when base money is what backs private credit. Creating or destroying base money is just a way to help the private credit market run more smoothly — to fill the void when necessary. If you think about it, sometimes you can have lots of base money and not enough private credit. If you're in a severe deflation, private credit will be hard to come by (and loans will be difficult to pay back without more private credit or more base money). I mean, who is going to lend money to someone for a house or business if the house or business will likely be worth less in a few years? So, increasing the base money supply, lowering interest rates, and weakening the currency may not be all as terrible as it sounds in that situation.

[Gumby]

Does this mean that the size of the deficit only matters when the banks/businesses/public are willing to leverage the current money supply?  The leveraging of the money supply acts as a pseudo printing press, and acts to increase the velocity of money, which then may lead to inflation.

It's probably not inflation that we need to worry about, since high unemployment will likely be with us for a very long time. As I said before.... 50 years ago, Minsky predicted that growing deficits would eventually cause a more and more fragile economy over time. So far he's been right. Why? It's not because of inflation. The reason why deficits can be "bad" is because Treasuries are too safe and too plentiful. So, big banks take those huge piles of safe, risk-free Treasuries and use them as a platform to super-leverage credit and create larger and larger credit-based asset bubbles. Since the bubbles are credit-based, they can easily pop and implode causing the economy to become more and more fragile and unstable as these assert bubbles expand and crash.

See: YouTube: Crash Course on Hyman Minsky, by L. Randall Wray

You'll have an easier time grasping this if you stop worrying about inflation. Inflation is probably the least of our worries right now.

[Gosso]

So the world central banks are attempting to achieve negative real interest rates, which then decrease the value of their currency. Aren't there other factors that play into the currency value as well, for example Canada's currency is said to be backed partly by commodity prices?

So what we have is a nicely contained monetary system, based on a monetary base created by the Fed/Treasury, which can then be leveraged by the banking/business sector.  When leverage gets too crazy then the Fed/Treasury will cut back on the monetary base by swapping assets from bank balance sheets back to the Fed...not sure i got that right...maybe explain specifically how the monetary base is adjusted...is it just cash for treasuries?

So does this mean that Keynes was right?  And does this mean that Minsky was also correct, and that our system is primed for a "reset" (I only know Minsky from that 4 minute clip).

Why do I feel like the little guy here:

[Gumby]

So the world central banks are attempting to achieve negative real interest rates, which then decrease the value of their currency. Aren't there other factors that play into the currency value as well, for example Canada's currency is said to be backed partly by commodity prices?

Well, as I was trying to say, it really depends on the credit market of each individual country. Not ever country is looking to have negative real interest rates. All I'm saying is that it doesn't do a country very much good if the real interest rates are too high when their credit markets are struggling. If the credit markets are too active and overheating, then having high real interest rates may be desirable.

It all depends on what the private credit market is doing. You can't just look at the base money supply and deficit and make a snap judgement. The majority of the money supply is private credit.

So what we have is a nicely contained monetary system, based on a monetary base created by the Fed/Treasury, which can then be leveraged by the banking/business sector.

As the short Minsky video pointed out, it's the Treasury bonds that get leveraged — since they are so safe. That's the growing problem, over time. The base money supply really just backs bank credit and helps with transfers between banks and paying back bank loans — especially when credit isn't moving smoothly.

When leverage gets too crazy then the Fed/Treasury will cut back on the monetary base by swapping assets from bank balance sheets back to the Fed...not sure i got that right...maybe explain specifically how the monetary base is adjusted...is it just cash for treasuries?

Sort of. Not so much the leverage getting too crazy, but the private credit market in general. Remember most of the bank money supply is just bank credit. Credit is the life-blood of our economy. The money in your bank account is just a line (of credit) on your bank statement — you're really just sharing the bank's base money with other bank customers. The only time it becomes real (base) money is when you make a payment or transfer to another bank (or the Treasury). As I mentioned earlier in the conversation, if you want to know how the Fed adjusts the money supply (in layman's terms) watch this...

http://finance.yahoo.com/blogs/daily-ti ... 33185.html

So does this mean that Keynes was right?  And does this mean that Minsky was also correct, and that our system is primed for a "reset" (I only know Minsky from that 4 minute clip).

Not sure where Keynes was "right" in that, but perhaps you can elaborate. As for Minsky, the private credit market does seem to be getting more fragile and unstable, slowly, over time. Only time will tell how this all plays out.

Why do I feel like the little guy here

Because we are basically living in a Plutocracy (i.e. government by the wealthy). Marx, Thomas Edison, Henry Ford and many others believed that a debt-based and credit-based monetary system caused the private sector to become enslaved by the rich.

http://en.wikipedia.org/wiki/Debt-based_monetary_system
http://en.wikipedia.org/wiki/Criticism_ ... ve_banking

The entire money supply (except coins) either comes from public debt or private credit. When the private credit markets are "healthy" the entire private sector is actually in debt to the banks — which just makes them wealthier and more powerful over time. And any bonds, base money, or interest that the Treasury pays out just allows the banks to create more credit. So, the private sector is constantly paying the banks interest on a Macro level. We get smaller every year and the system gets a little more unstable.

But, Minsky was an optimist. He believed that we could persevere with better regulation and less risky behavior by the FIRE sector.

From The New Yorker:

The greatest need is for intellectual reappraisal, and a good place to begin is with a statement from a paper co-authored by Minsky that “apt intervention and institutional structures are necessary for market economies to be successful.”? Rather than waging old debates about tax cuts versus spending increases, policymakers ought to be discussing how to reform the financial system so that it serves the rest of the economy, instead of feeding off it and destabilizing it. Among the problems at hand: how to restructure Wall Street remuneration packages that encourage excessive risk-taking; restrict irresponsible lending without shutting out creditworthy borrowers; help victims of predatory practices without bailing out irresponsible lenders; and hold ratings agencies accountable for their assessments. These are complex issues, with few easy solutions, but that’s what makes them interesting. As Minsky believed, “Economies evolve, and so, too, must economic policy.”?
Source: The New Yorker: The Minsky Moment

[Gosso]

Thanks Gumby Yoda 

The most important question of all, does this impact the way we view the four major economic scenarios and therefore the Permanent Portfolio?

How will this system break?  Is hyperinflation or high inflation a possibility?  Is deflation possible with this fiat currency system?

It seems that a contracting and expanding economy is built into the system, so we're covered by the PP in that respect.

[Gumby]

Thanks Gumby Yoda  ;D

It's worth pointing out that I could be wrong about all this — we could all be wrong about all this — and maybe nobody knows anything. Years from now, we may look back at this conversation and look at the monetary system in a completely different way. We are all constantly learning all the time.

The most important question of all, does this impact the way we view the four major economic scenarios and therefore the Permanent Portfolio?

How will this system break?  Is hyperinflation or high inflation a possibility?  Is deflation possible with this fiat currency system?

It seems that a contracting and expanding economy is built into the system, so we're covered by the PP in that respect.

All of my reading and research on the monetary system has given me even more confidence in the Permanent Portfolio strategy. I now feel like I understand why Treasuries are such a key part of the PP (50%!). The PP does an excellent job of reducing credit risk — and it does it with very little overall volatility — which is extremely important for a world that may be getting more unstable over time.

As for how this all plays out, there is no way to predict the future. Anything is possible. Our military could fail and that would likely make our currency less stable. A major energy breakthrough could come along and drive us into a period of prosperity and positive real interest rates. Anything could happen.

But, what I do know is that one of four things will likely happen over the long term...

Inflation
Deflation
Prosperity
Recession

I give each one about a 25% chance

[Gosso]

Thanks Gumby Yoda  ;D

It's worth pointing out that all of us could be wrong about all this — maybe nobody knows anything. Years from now, we may look back at this conversation and look at the monetary system in a completely different way. We are all constantly learning all the time.

There is something that bothers me about this MMT/MMR -- maybe it's that it claims to have the answers, but I have a feeling it is more complicated and dynamic.  Although I haven't the slightest clue what the real story is...maybe it just boils down to how productive a society is, and from this the monetary system will account for this productivity in whatever way it can.

The most important question of all, does this impact the way we view the four major economic scenarios and therefore the Permanent Portfolio?

How will this system break?  Is hyperinflation or high inflation a possibility?  Is deflation possible with this fiat currency system?

It seems that a contracting and expanding economy is built into the system, so we're covered by the PP in that respect.

All of my reading and research on the monetary system has given me even more confidence in the Permanent Portfolio strategy. There is no way to predict the future. Anything is possible. Our military could fail and that would likely make our currency less stable. A major energy breakthrough could come along and drive us into a period of prosperity and positive real interest rates. Anything could happen.

But, what I do know is that one of four things will likely happen over the long term...

Inflation
Deflation
Prosperity
Recession

I give each one about a 25% chance

Okay good, I can now retreat into my blissful ignorance and focus on my other interests.

[Gumby]

There is something that bothers me about this MMT/MMR -- maybe it's that it claims to have the answers, but I have a feeling it is more complicated and dynamic.

Well, MMT/MMR is incredibly complex. So, I wouldn't say that it's a simple take on the monetary system. If anything, it shows us that most people's simple conclusions about "printing" and how the size of the monetary base relates to inflation are just too simplistic.

What comforts me is that MMT/MMR dives much, much deeper into Treasury and Fed operations than other economic frameworks do. That tells me that MMT/MMRers have done their homework. When pundits or critics of MMT/MMR claim that the Fed and Treasury are going broke or "printing" or "monetizing the debt," they never talk about the specifics of Treasury and Fed operations — and why our "bankrupt" nation always has oversubscribed Treasury auctions or why QE hasn't resulted in very much inflation. Other economic frameworks tend to gloss over those operational details that so key to answering those questions.

And let's be frank, here. MMT/MMR are the only economic frameworks that describe a fiat monetary system. Keynesian and Austrian economics are based on monetary systems with reserve constraints. Fiat monetary systems don't have reserve constraints!

Scott Fullwiler's papers on Fed and Treasury operations — which support MMT/MMR — are very specific and thorough. He's one of the leading Treasury and Fed experts in the country. I haven't seen anything even remotely close to that level of operational detail from other economic frameworks. And as I said before, MMT/MMR seems to do a much better job of forecasting the reactions to monetary changes than other economic frameworks do, especially under the recent and extreme stress in the financial markets:

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

MMTers have had a lot of success with their economic models over the years. Warren Mosler has done particularly well on what others perceived as very risky calls...

This insouciance towards debt opens up Mr Mosler’s ideas (which he used to call “soft currency economics”?) to all sorts of criticism. But its application has made him a lot of money. He turned a profit of over $50m for his fund and his clients buying Italy’s lira bonds in the early 1990s, when prominent economists flagged the danger of default. In 1996 he earned them over $100m after he pledged to buy more of a certain type of Japanese paper than the government had issued. And his bank made a monthly return on required equity of over 10% in 2011 largely by buying American Treasury bonds, betting against celebrated investors like Bill Gross of Pimco, the world’s largest bond fund, who sold his fund’s Treasuries in early 2011 before recognising his mistake later on.
Source: http://www.economist.com/node/21542174

Although I haven't the slightest clue what the real story is...maybe it just boils down to how productive a society is, and from this the monetary system will account for this productivity in whatever way it can.

Well, it would depend on how much money there is to support (and not overwhelm) that productive capacity. That's why this is so complex.

Okay good, I can now retreat into my blissful ignorance and focus on my other interests.

Amen!

[Gosso]

And let's be frank, here. MMT/MMR are the only economic frameworks that describe a fiat monetary system. Keynesian and Austrian economics are based on monetary systems with reserve constraints. Fiat monetary systems don't have reserve constraints!

That's a really good point.

How does M1, M2 and M3 play into all of this?  Are these relics of the old system?  I like to use Shadow Stats to look at these charts. (I'm aware that John Williams is a hyperinflationist).

And how do I exploit this knowledge to make MILLIONS!!  Buy bonds from countries that are at "risk" of default, but have the debt denominated in their own currency?

[Gumby]

How does M1, M2 and M3 play into all of this?  Are these relics of the old system?

They are very important. That's what I was talking about when I said that you need to look at private credit. Think of M0 as being "base money" and M1, M2 are just different levels of private (bank) credit that are included in the money supply. The higher the "M" number the more different types of private credit that are included in that money supply. M3 really isn't used anymore since it's so abstract that it often causes confusion.

See: http://en.wikipedia.org/wiki/Money_supp ... l_measures

But the credit markets extend beyond this. There is shadow banking too, which is how companies leverage credit with each other. Much of it is unregulated and impossible for anyone to understand (derivatives, credit default swaps, mortgage-backed securities, etc). Many money market funds tends to invest in shadow banking assets. The shadow banking system is much larger than the fractional reserve banking system. But, the important thing to realize is that it's all debt-based and credit-based money. And private credit all has the potential to become unstable (meaning Treasuries are really the safest form of dollars). So, as you can see, this is all way more complex than just looking at the base money supply and drawing a simple conclusion about inflation.

I like to use Shadow Stats to look at these charts. (I'm aware that John Williams is a hyperinflationist).

Do yourself a favor and don't look at ShadowStats. If Shadow Stats was accurate, we'd all be swimming in money and inflation by now. Ever notice that ShadowStats hasn't raised its subscription fees over the past few years — not even a penny — while simultaneously screaming about how much inflation we have?

See: PragCap: Why Is There Deflation in Hyperinflation Forecasts?

And how do I exploit this knowledge to make MILLIONS!!  Buy bonds from countries that are at "risk" of default, but have the debt denominated in their own currency?

Sort of. Of course, next time a sovereign fiat currency currency is supposedly on the verge of implosion (Japan, the US or the UK), take a look at what the MMT/MMR guys are saying first and make your own decision from there. Personally, I don't gamble on those sorts of things. Too risky for my blood. I just find it interesting to see where the economy is headed. For instance, if you use MMR to guide forecasts, you can come to the following conclusion about what might happen to the economy in 2013:

http://pragcap.com/cbo-budget-deficit-t ... -stability

It might not come true, especially if the governments decides to spend more than it is forecasting right now. But, it gives you a unique perspective on how government spending can affect the private sector.

[MediumTex]

I think Gumby has been taking mental steroids.

Thanks for providing all of this great perspective.

[Gumby]

I think Gumby has been taking mental steroids.

Thanks for providing all of this great perspective.

I barely knew what a bond was two years ago. I hope someone else can corroborate what I've written. This is just how I've come to see our monetary system after reading different perspectives. If Bernanke were reading this, I'm sure he might have some disagreements with some of the things I've said. As I said before, we may discover years from now that everyone was completely wrong about everything.

[moda0306]

I agree with almost all of what Gumby is saying... I'm not entirely sure of describing the banks as "leveraging safe assets" is right, though... though it's probably more right in principal that Gumby's even saying.

Basically, MMR is starting to come to more and more of the conclusion that because banks are "CAPITAL" constrained, not reserve constrained, it implies that as long as banks have good loans on their balance sheets, the fed will let them access the window at reasonable prices. 

However, of course, when you leave it up to banks to decide how good their own loans are, this process is flawed.  However, it tends to dispell the idea that reserves have much to do with bank lending, and therefore T-Bills probably have little to do with it either, besides setting a base rate at which the bank will not go lower with lending to Joe Borrower.

I think in a perfect world of assessing risk and accountability this could actually work ok, as all bank loans would be "supported" not by reserves (one measurement of stability), but the real value of the loans based on repayability & collateral value.  Of course, we don't have that perfect world of risk-measurement and accountability.  However, we DO have a world where the fed is obligated not just to ensure treasury auctions don't fail, but that the payment system doesn't fail, and MMR is arguing that this implicitly means that their fed window will always be willing to supply more reserves if the banking system as a whole appears reserve-constrained, and that means banks aren't really leveraging their ability to fund sound investment (or at least defraud their way to making them appear so).

[Gumby]

I'm not entirely sure of describing the banks as "leveraging safe assets" is right, though... though it's probably more right in principal that Gumby's even saying.

I got that from the L. Randall Wray in the short Minsky video. Can you clarify how that is incorrect?

See: http://youtu.be/gRE-IDYfi8Y

I know you can't view the video at work, so here is the key quote:

"[Minsky] warned that what would happen is, gradually over time, debts in the private sector would tend to build up. That increasingly risky financial innovations — they had already started to occur in the late '50s — and that those would increase over time. That stability itself is destabilizing. He's very famous for this statement that although things appear very stable now — he's warning in the late '50s — gradually over time that stability will build confidence to take increasingly risky positions in assets, so that all of the new deal structure that had been put in place in the economy, during the Great Depression, the tremendous build-up of government debt in WWII... which we can talk more about this, but this is Minsky's view, government's deficits are very different from the mainstream's view... that all of this debt gave a very safe asset for the financial sector, for the private sector, and that this would be, in a sense, leveraged. Safe government debt would serve as the basis for leveraging an increasing private sector debt. So that gradually, over time, financial innovations, getting around the regulations of the New Deal, would lead to a fragile financial structure." — L. Randall Wray
Source: http://youtu.be/gRE-IDYfi8Y

Isn't all private (bank) credit backed by base money and Treasuries? That's what the entire fractional-reserve banking is! It's just many customers all sharing the same pile of base money and Treasuries. And all of these financial innovations (CDS, MBS, derivatives, etc) are just credit vehicles that are backed by increasingly complicated forms of credit that are ultimately backed by Treasuries and base money.

So, I'm not sure why it's wrong to say that banks are leveraging safe assets. That's what banks do in a debt-based and credit-based monetary system!

[moda0306]

Gumby,

I think it's gotten to the point where banks are beyond leveraging the CURRENT amount of reserves in the system, and are instead "leveraging" the expected future amounts, which, as MMR describes, is whatever the banking sector's capital health can absorb and needs.

It's probably what Minsky was saying, but on steroids today because the banking system knows that they're not reserve-constrained individually and not reserve constrained in aggregate.  They can either get base money from each other or the fed, as long as their capital levels are healthy.  MMR points out that if you aren't "reserve-constrained," is it accurate to really say that you're "leveraging those reserves?"  Not really, they say (and it tends to make sense).  What is the real constraint?  The quality of the loans.. often based on the collateral or soundness of the business/household you loaned to.  That means that banks are moreso leveraging their ability to make good loans, or, as I said before, defraud their way into making the system think they're good.

[Gumby]

Very interesting. So, it's even worse than I thought.

Thanks, moda. I do need to follow up and read more MMR. Though, I do believe I did my best to clarify that the loans they are leveraging are ultimately backed by M0 in an abstract sense. What you're saying is that there no limit to the amount of M0 that can be made available, if need be.

[moda0306]

Ha, Gumby... Exactly!  That's where I why I was trying to tell you that it's worse than what you're saying...

I think Cullen has actually said that he thinks that calling our system a "Fractional Reserve" system is no longer the right way to look at it.  Keep in mind, you're about 5 days behind my understanding of this, so I could be slaughtering it.

Either way, this isn't to take anything away from Minsky... it's just that things have changed.  And, yes, by now you probably know videos can't get watched until night time for me!

[moda0306]

Now, with banks that are too big to fail, we have to ask ourselves whether these banks are even capital constrained, or whether the fed will buy their junk from them at face value at some point...   .

In any way, it's great to have discussions about this stuff that are free of the natural biases that Keynesianism and Austrianism hold, or peoples' rigid politics for that matter.  I feel like I started learning 10x more than I was before when I was trying to follow Paul Krugman and (Insert wacky Austrian economist here)'s description of things.  Until we look honestly at the way these pieces behave with each other, we can't really honestly assess the nature of the system, and what needs to be fixed.  We can debate about the latter, but it's pretty useless to debate if nobody know's what they're talking about... that's why you'll see a lot of the debates at the MMR site happen in a way that appears that most people there are questioning themselves as much as lecturing others.

monetaryrealism.com

[Gosso]

This whole MMT/MMR stuff is quite terrifying, since basically what it is saying is 99% of the population is completely wrong about how the monetary system works. 

I can accept that the Fed is not the printer of money but rather the controller of interest rates through swapping assets with the private banks.  So this means that QE is actually how things normally work and happens all the time, but for some reason the media went ape-shit when they heard about it.

So the real printer of money is the Treasury which creates bonds to pay for the government deficits.  Without these deficits we would outgrow our monetary base and would then result in a mild deflation.  But since deflation scare people this would reduce confidence and result in a lost desire to leverage the current monetary base, resulting in a depression.

Therefore the government must run a deficit to increase the monetary base.  So all it would take to induce a deflationary depression is to elect a government that runs a surplus.  The way to induce inflation is to run a deficit that exceeds the ability of the economy to absorb that extra base money.  Also inflation could result from private credit going out of control, and the Fed being too slow to increase rates by swapping (giving) the private banks higher interest treasury's.

Is there anything incorrect with what a wrote above?  I realize it can get more complicated, but I just want the rough outline of what's going on.

[Gumby]

This whole MMT/MMR stuff is quite terrifying, since basically what it is saying is 99% of the population is completely wrong about how the monetary system works.

I wouldn't say it's the population's fault. It's intended to be confusing. Most people don't even think about where money comes from. And the media just reports on whatever politicians say to each other. The media doesn't really question what politicians are saying. And politicians use myths (knowingly or unknowingly) about the money supply to promote their agendas.

I can accept that the Fed is not the printer of money but rather the controller of interest rates through swapping assets with the private banks.  So this means that QE is actually how things normally work and happens all the time, but for some reason the media went ape-shit when they heard about it.

Precisely. QE was just a huge amount of POMO (Permanent Open Market Operations).

So the real printer of money is the Treasury which creates bonds to pay for the government deficits.  Without these deficits we would outgrow our monetary base and would then result in a mild deflation.  But since deflation scare people this would reduce confidence and result in a lost desire to leverage the current monetary base, resulting in a depression.

Yes. Also, private interest payments generally require an ever-growing money supply so that the private sector doesn't default on itself. Since the majority of the money supply is credit-based, the interet can't really be paid without new money (or at least new credit) being constantly issued. So, a credit-based monetary system in the private sector generally requires increasing deficits to satisfy all those private interest payments.

Therefore the government must run a deficit to increase the monetary base.  So all it would take to induce a deflationary depression is to elect a government that runs a surplus.  The way to induce inflation is to run a deficit that exceeds the ability of the economy to absorb that extra base money.  Also inflation could result from private credit going out of control, and the Fed being too slow to increase rates by swapping (giving) the private banks higher interest treasury's.

Is there anything incorrect with what a wrote above?  I realize it can get more complicated, but I just want the rough outline of what's going on.

That's pretty much it in a nutshell. As you said, it is more complicated than that. But, you're definitely a fast learner!

[moda0306]

If it makes any difference, I did scour google to find a good explanation of how printing money worked, and how the fed worked, and how the treasury worked, and how the U.S. dollar worked, and until I came upon Cullen Roche's "Understanding the Modern Monetary System" (http://monetaryrealism.com/understanding-mmr/) I felt like I was getting half-baked or politically charged answers everywhere else.

Then I read that document and my mind melted a little bit, though I was still profoundly confused and unsure.  But there was something in my head telling me that this guy had finally put together what I was looking for.

So it wasn't out of political ideology or predisposed beliefs that I came accross this stuff... I just was simply unable to find the answers anywhere else in such a concise way.  You should have seen the debates on here before MMT... none of us really knew wtf was going on, what our constraints were, why the gov't had debt, what "printing money was."  It was, looking back, incredible to see all this curiosity bubbling up as a result of HB's assertion that treasuries were free of default risk.  That's what started most of it.  A libertarian Austrian preaching a pillar of MMR/MMT in the friggin' 80's as an investment strategy driver!!  This was no small accident.  Do you think HB would have called T-Bills "cash" if the gov't would default?  That's part of the reason I love that guy because unlike Schiff, he can set aside his philosophy when reviewing risk.  Many of his individual philosophies are pretty invaluable IMO, and that applies to the most hardened socialist.

Cullen could be wrong, but by all means he puts himself out there just like Gumby and brings on the debate.  He doesn't hide from it, and neither do his colleagues.  Plus, they don't agree on everything.  It's a lot like this board over there... though things can get a bit more heated.

I think I can speak for Gumby when I say we both just wanted a description of the system, and didn't find anything even close anywhere else... yeah, it's fun to throw in a bit of editorial, and we do, but for the most part it's about the way it all works.