Gyroscopic Investing

http://www.cnn.com/2012/04/05/opinion/g ... ?hpt=hp_c1

Perhaps a good selling point to get in the PP?

That's an interesting article, but I think that it overlooks a couple of important items:

1. Many of the problems that Europe is facing are the result of the boneheaded nature of the EU.  As long as this arrangement is in place, problems will continue.  Imagine how goofy a rowing team made up of people with dramatically different strength levels, experience and body mass would look.  If the rowers weren't careful, the boat might just go in circles.  That's the EU.  Apparently no one noticed this when the EU was conceived because all of the members were perceived to be pretty good rowers.  During good economic times, even idiots can look like geniuses.

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.

Yeah, there's really no comparison between Eurozone countries (currency users) and the United States or Japan (fiat currency issuers). A Eurozone country — much like a local or State government — can run out of money. But, the Federal government can't run out of money — it will always be able to pay its bills.

Although, over 50 years ago, economist Hyman Minsky suggested that the main problem with large Federal deficits in the United States is that it gives the FIRE sector enormous amounts of risk-free assets to leverage off of — causing more unstable private-credit bubbles in the private sector and a more fragile economy over time. So far, he seems to be right.

Bonafede wrote: http://www.cnn.com/2012/04/05/opinion/g ... ?hpt=hp_c1

Perhaps a good selling point to get in the PP?

cnn article wrote:An 11-year-old Dutch boy, Jurre Hermans, entered a serious economics competition with a plan for bringing the Greek economy back from the brink.

And not one mention of a finger in a dike? I'm disappointed.

Gumby wrote: But, the Federal government can't run out of money — it will always be able to pay its bills.

Hmmm. Seems like just yesterday they were almost out of money. I remember Obama saying they might not even be able to send out Social Security Checks.

jackh wrote:

Gumby wrote: But, the Federal government can't run out of money — it will always be able to pay its bills.

Hmmm. Seems like just yesterday they were almost out of money. I remember Obama saying they might not even be able to send out Social Security Checks.

You're referring to the debt-ceiling, which is a self-imposed spending limit. The only way Congress is unable to pay its bills is if Congress refuses to do so. But, let's be clear... Congress can spend/borrow as much as it wants to. Eurozone countries cannot, as they are reserve constrained.

jackh wrote:

Gumby wrote: But, the Federal government can't run out of money — it will always be able to pay its bills.

Hmmm. Seems like just yesterday they were almost out of money. I remember Obama saying they might not even be able to send out Social Security Checks.

I think that the larger point is that when your money supply is fundamentally based on an abstraction (rather than some tangible item), it's inconceivable that you could "run out of it."  Dollars are sort of like dreams or good intentions--they are abstract, ethereal and fundamentally without limit.

The noise about running out of money last summer was, IMHO, mostly theater, and the bond market saw it for what it was.

For an interesting case study in how a country that apparently controls its own money supply can nevertheless default, Russia in the 1990s is a good example.  The article linked below is a pretty good overview.

http://pragcap.com/the-russian-default-what-happened

The bottom line appears to be that currency pegs are rarely a good idea if you're trying to maintain the strength of your currency.  If you're trying to keep your currency weak, a peg might make more sense.

Gumby wrote: You're referring to the debt-ceiling, which is a self-imposed spending limit. The only way Congress is unable to pay its bills is if Congress refuses to do so. But, let's be clear... Congress can spend/borrow as much as it wants to. Eurozone countries cannot, as they are reserve constrained.

Yes, that is what I am referring to and yes, congress can spend/borrow as much as it wants but only until the next election, at which time the American people might elect a Congress that refuses to limit the debt ceiling. Then what happens? Is it therefore really accurate to say the federal government can never run out of money and will always be able to pay its bills?

jackh wrote:

Gumby wrote: You're referring to the debt-ceiling, which is a self-imposed spending limit. The only way Congress is unable to pay its bills is if Congress refuses to do so. But, let's be clear... Congress can spend/borrow as much as it wants to. Eurozone countries cannot, as they are reserve constrained.

Yes, that is what I am referring to and yes, congress can spend/borrow as much as it wants but only until the next election, at which time the American people might elect a Congress that refuses to limit the debt ceiling. Then what happens? Is it therefore really accurate to say the federal government can never run out of money and will always be able to pay its bills?

If I am selling servings of "good luck" from a stand in front of my house with the option of a "small" portion for $7, a "medium" portion for $11 and a "large" portion for $15 and I announce one day to my customers that I am "out" of the medium size portions of good luck, it will certainly be true that I may lose some sales (assuming my medium portions had been good sellers), but it doesn't mean that my inventory of good luck was actually depleted.

There are many Republican politicians today (ironically just like there were in the late 1930s) who have an almost pathological fixation on the "budget deficit" and "national debt" that is hard to explain in a world where the money in which these abstractions are denominated is itself an abstraction.

I'm not suggesting that the government doesn't need to reduce its footprint in society or that some streamlining of its functions wouldn't be good, I'm just saying that a political decision to destabilize markets by intentionally failing to place the equivalent of a few extra pallets of "medium sized portions of good luck" in the warehouse of good intentions is ultimately probably an exercise in political stupidity rather than political wisdom.

Stated differently, a government that controls its own currency and has not attempted to maintain a peg to other currencies can default on its debt, it would just require a combination of ignorance and stupidity that I like to think wouldn't be able to infect a majority of Congress at the same time.

The Euro was always a bad idea. I should be more diplomatic, but it really was cooked up by people that don't understand human nature. If I had to enter a contest to solve the Euro crisis it would be this:

End the Euro.

Simple. It's going to end eventually so just wind it down calmly instead of in a huge calamity.

For a while I was hearing things from Austrians about the US succumbing to an international currency.  Given the vehimence the left-leaning economists are saying that each sovereign country has to control its own currency, I'm now much less worried about that.

The Euro may have been a failure, but it should stave off any will for the US to join an international currency for a LONG time.

While I agree that raising taxes in a recession is a bad idea, slashing spending can work great if it's accompanied by dramatic tax cuts to spur the economy.

Warren G. Harding pulled off this trick in the face of a very nasty recession in 1920: he lowered taxes, enormously reduced government spending, and paid down the debt.  More or less the complete opposite of what we or any of the Eurozone countries have done.  Politically difficult, but it was a huge success.

Clive wrote: "...Net treasury debt amounts to 8.6 per cent of GDP. If 61 per cent of that figure is caused by printing money, it means that about 5.3 per cent of US economic output is now being driven by the Federal Reserve’s printing presses. This is reminiscent of Argentina in its 1980s heyday, and is extremely worrying.
The report also reveals that the US is more dependent on short-term funding than Ireland, Greece, Spain and Portugal. The average maturity of the US government’s debt was 62.8 months. That means the US has to rollover a whopping 71 per cent of its debt pile – $5.9 trillion worth – over the next five years...."

Yes.  Given facts like these, I'm always surprised by all of the whistling past the graveyard on the debt issue.

When the current deleveraging process has run its course, that enormous debt is still going to be there.  And with 71% of US debt essentially on an adjustable-rate mortgage, we will be looking at very high interest payments when rates rise.

LW,

Are you worried more about 1) Insolvency, 2) Transfer of wealth to foreign countries via interest payments, or 3) Self-fulfilling inflation as high rates mean higher deficits and more fiat savings instruments in the system?  Or some combination of the three?  Something else, entirely?

Can I assume we've gotten past #1, and that we know the gov't can't go bankrupt?

#2 is worth considering, though about 2/3 of the debt is held domestically, so it'd be interest payments, mostly, to our own citizens... that said, this is a point worth returning to.

#3 gets a little complicated... usually, the fed will engineer negative real risk-free rates to get the economy moving, but if things are at full steam, they'll keep treasuries at positive real interest rates to slow velocity.  That last part is where things start to get confusing in macro... MORE interest means MORE money in the system... but it's a "reward" for holding savings so it slows credit and velocity, reducing inflation and economic activity... at least in the short-term.  So, I'm having trouble wondering what to worry about?  Can you really worry about inflation if the government is paying positive real interest rates?  Negative real rates can cause inflation, but how does that really have anything to do with the actual quantity of debt and interest payments?

Lone Wolf wrote:Warren G. Harding pulled off this trick in the face of a very nasty recession in 1920: he lowered taxes, enormously reduced government spending, and paid down the debt.  More or less the complete opposite of what we or any of the Eurozone countries have done.  Politically difficult, but it was a huge success.

Harding reduced the debt by a third, and a few years later we were in a Great Depression. When you reduce the amount of government debt in a debt-based monetary system, such as ours, you are just reducing the amount of base money in the private sector. If you reduce the amount of base money in an economy that is still growing, it forces the private sector to seek larger amounts of risky private credit — which is what lead to the Great Depression. There's a reason why every reduction of the national debt has soon been followed by a severe recession or depression. Our money supply is debt-based. We need public and private debt for our money supply to exist. When you reduce the public debt, you are reducing the private sector's money supply, which causes deflationary pressure. (Though, as I've said before, having too much government debt also gives the private sector bankers more risk-free assets to leverage off of...so it's a bit of a Catch-22).

Eurozone nations are currency users (much like a state or local government) and have to balance their budgets. So, it isn't a very good comparison.

Was the US in a debt-based system back in 1920?

moda0306 wrote: So, I'm having trouble wondering what to worry about?  Can you really worry about inflation if the government is paying positive real interest rates?

If interest rates are high (or even right along the post-war average of 5%-ish), the burden of servicing the debt will increase dramatically.  When this happens, unless spending is reduced, it means higher taxes or even greater levels of borrowing (in which case the problem worsens.)

You can attempt to force interest rates down but the harder the Fed works at this the more likely it is to cause inflation.  Holders of debt then tend to demand higher interest rates as compensation, making it very hard for the Fed to "stay ahead".  We saw this in the 1970s with high inflation, high unemployment, and high nominal interest rates (but negative real rates.)

Positive real rates (the historical norm) would likely keep inflation from getting out of hand but also mean a very large debt service burden.  The bigger our debt, the worse this will be.

Gumby wrote: Harding reduced the debt by a third, and a few years later we were in a Great Depression. When you reduce the amount of government debt in a debt-based monetary system, such as ours, you are just reducing the amount of base money in the private sector — forcing the private sector to amass larger amounts of private credit — which is what lead to the Great Depression.

The money supply is controlled by the Federal Reserve, not by the size of the US's debt (and certainly not by Warren Harding nine years prior.)  The Fed allowed the money supply to contract by 30% in 1928.  I've forgotten who was Chairman of the Fed at that time but given that Harding died in the early 20s, I'm pretty sure it wasn't him. 

LW,

http://krugman.blogs.nytimes.com/2012/0 ... n-harding/

Krugman points out that the spending-austerity (see graph) happened immediately after the end of WWI in 1918, and had utterly collapsed by the start of what is referred to as the "depression" of 1920.  This depression went on until mid-year 1921.  I could definitely attribute some of this depression to the retooling after the war, and the economic adjustment that had to take place, but I'd say it's pretty obvious that, if anything, the crash in spending was more likely to have been a cause of the depression than a solution or non-event to the depression.

http://www.ctj.org/pdf/regcg.pdf

Not only was the timing way off on spending cuts, this shows that the tax cut was in 1922... this is AFTER the recession ended in July of 1921.   though I think something similar today would be great... but as you'll notice, there was a very gradual progressivity of the tax that eventually reached 58%.  With the exception maybe of that nice 12.5% cap gains rate, a tax plan like Harding's NEVER would pass todays congress.

So what do we have here... austerity + post-war adjustment causing a depression-shock, a year-and-a-half long depression, and 6 months after the depression ended, a nice big tax cut.... one that even socialists like Gumby and myself would probably agree with, mind you  ;).  I don't think all this is evidence of anything that you thought it was.

All in all, back then, post-war economies were kind of oddball things.  Spending naturally falls significantly, along, hopefully, with taxes, and the economy has to re-tool itself back into private-sector good-time prosperity.  It's hard to look at it like a normal economy.

Lone Wolf wrote:

moda0306 wrote: So, I'm having trouble wondering what to worry about?  Can you really worry about inflation if the government is paying positive real interest rates?

If interest rates are high (or even right along the post-war average of 5%-ish), the burden of servicing the debt will increase dramatically.  When this happens, unless spending is reduced, it means higher taxes or even greater levels of borrowing (in which case the problem worsens.)

You can attempt to force interest rates down but the harder the Fed works at this the more likely it is to cause inflation.  Holders of debt then tend to demand higher interest rates as compensation, making it very hard for the Fed to "stay ahead".  We saw this in the 1970s with high inflation, high unemployment, and high nominal interest rates (but negative real rates.)

Positive real rates (the historical norm) would likely keep inflation from getting out of hand but also mean a very large debt service burden.  The bigger our debt, the worse this will be.

Gumby wrote: Harding reduced the debt by a third, and a few years later we were in a Great Depression. When you reduce the amount of government debt in a debt-based monetary system, such as ours, you are just reducing the amount of base money in the private sector — forcing the private sector to amass larger amounts of private credit — which is what lead to the Great Depression.

The money supply is controlled by the Federal Reserve, not by the size of the US's debt (and certainly not by Warren Harding nine years prior.)  The Fed allowed the money supply to contract by 30% in 1928.  I've forgotten who was Chairman of the Fed at that time but given that Harding died in the early 20s, I'm pretty sure it wasn't him.  :)

LW,

It would take an awful lot of economic growth to get us to where 5% interest rates are even considered by the fed or anywhere near justified on behalf of savers when there's no demand for loanable funds in relation to supply (temproarily using the loanable funds model here).  That growth will alter the debt-to-GDP ratio.  Even if this wasn't true, I don't see how you can say that the problem with debt is if rates go up there will be more debt and if rates go up there wil... yada yada... the problem is inflation, pure and simple.  We have the monetary and fiscal tools to manage it.  As long as our economy grows with the overall money supply in the long-term, we likely don't even have to get too crazy with exercising those tools.  Even Harry Browne showed us that we are probably 90% free if we allow ourselves to be.  In many ways I'm a huge optimist about our productive potential.  In fact, I see that, not QE or deficits, as the true thing to focus in in terms of inflation.  If we have the potential for great things going forward.  I think the money will find a productive home.

Also, bonds are money.  If you take a dollar from one person, issue them a bond, and spend a dollar, you've created money.  The fed can only trade one form of money for another.

Lone Wolf wrote:The money supply is controlled by the Federal Reserve, not by the size of the US's debt (and certainly not by Warren Harding nine years prior.)

Sorry, but that's incorrect. The Fed can only conduct asset swaps with the private sector (i.e. swap bonds for dollars). The Fed can't add net financial assets to the private sector. So, when you reduce the Federal debt, you are just sucking base money and net financial assets out of the private sector — which is a deflationary pressure. The Fed can only change the composition of net financial assets in the private sector.

Lone Wolf wrote:The Fed allowed the money supply to contract by 30% in 1928.  I've forgotten who was Chairman of the Fed at that time but given that Harding died in the early 20s, I'm pretty sure it wasn't him.  :)

While the Fed did not change the net financial assets in the private sector, they did tighten monetary policy. But, let's be clear, the Fed did not reduce the amount of net financial assets in the private sector. Here's what Bernanke said about 1928 in 2004...

This tightening of monetary policy in 1928 did not seem particularly justified by the macroeconomic environment: The economy was only just emerging from a recession, commodity prices were declining sharply, and there was little hint of inflation. Why then did the Federal Reserve raise interest rates in 1928? The principal reason was the Fed's ongoing concern about speculation on Wall Street. Fed policymakers drew a sharp distinction between "productive" (that is, good) and "speculative" (bad) uses of credit, and they were concerned that bank lending to brokers and investors was fueling a speculative wave in the stock market. When the Fed's attempts to persuade banks not to lend for speculative purposes proved ineffective, Fed officials decided to dissuade lending directly by raising the policy interest rate.
Source: http://www.federalreserve.gov/boarddocs ... efault.htm

This is exactly what I was talking about. When you pay down the Federal debt, you are, without a doubt, taking net financial assets (in the form of base money) out of the private sector. This is a deflationary pressure — there's no way to argue around that. So, when Harding did us the wonderful service of paying down the Federal debt, all he did was force the private sector to find riskier forms of money (i.e. private credit). In 1928, the Fed "tightened" monetary policy by raising interest rates to slow down this risky private credit bubble that had formed, and that brought on the crash.

The point of all this is that reducing the Federal deficit is a deflationary pressure when your entire money supply comes from debt. Harding's debt-reduction plan forced the private sector to resort to riskier and larger forms of credit to fuel the economy. And that set the stage for the private sector to default on itself during the Great Depression.

It's best to pay down federal debt when the economy is overheating, and you need to reduce the net financial assets in the private sector.

moda0306 wrote: Krugman points out that the spending-austerity (see graph) happened immediately after the end of WWI in 1918, and had utterly collapsed by the start of what is referred to as the "depression" of 1920.  This depression went on until mid-year 1921.

Of course -- there was a post-war spending collapse and the recession began shortly after.  As you point out, it's natural for spending to collapse when the citizens of the world stop trying to kill one another.

But I'm talking about what happened after the recession began.  There were further drastic reductions in government spending right into this recession.  (A reduction from $5.1 billion in 1921 to $3.3 billion in 1922.)  That's a nearly 35% reduction in government spending with a huge recession underway!  It's so different from what we see today that it's difficult to even imagine it.

You're correct to point out that recovery had begun before tax rates were slashed but it strengthened greatly through 1923, with unemployment coming down to just over 2% (versus 12% in 1920.)  Pretty impressive IMO.

Gumby wrote:

Lone Wolf wrote:The money supply is controlled by the Federal Reserve, not by the size of the US's debt (and certainly not by Warren Harding nine years prior.)

Sorry, but that's incorrect. The Fed can only conduct asset swaps with the private sector (i.e. swap bonds for dollars).

If you believe that the Federal Reserve is powerless to expand or contract the money supply, we probably won't make much progress discussing this further.  Our worldviews are set up to talk past one another.

Lone Wolf wrote:

Gumby wrote:

Lone Wolf wrote:The money supply is controlled by the Federal Reserve, not by the size of the US's debt (and certainly not by Warren Harding nine years prior.)

Sorry, but that's incorrect. The Fed can only conduct asset swaps with the private sector (i.e. swap bonds for dollars).

If you believe that the Federal Reserve is powerless to expand or contract the money supply, we probably won't make much progress discussing this further.  Our worldviews are set up to talk past one another.

Well, you're not listening to what I'm saying.

I didn't say that the Fed can't affect monetary policy and change the composition of money in the private sector. They can. But, they can only do so by swapping assets with the private sector. So, when they expand or contract the number of raw dollars in the private sector it has no net effect on the amount of net financial assets in the private sector. Do you not believe that?

Lone Wolf... I think it's also important to understand that the Fed does not print our money. The US Treasury does — which is what I've been saying all along. Our money comes from the Treasury.

The Federal Reserve explains:

"The Federal Reserve Banks distribute new currency for the U.S. Treasury Department, which prints it."
Source: http://www.ny.frb.org/aboutthefed/fedpoint/fed01.html

The Fed doesn't print money. It doesn't. When people say that the Fed is expanding or contracting the money supply, what they mean is that the Fed is swapping base money for financial assets (mainly Treasuries) with Primary Dealers so as to affect interest rates as well as how much private credit can be created.

So, the term "money supply" refers to base money + private credit. The Fed doesn't actually print any money — the Treasury does. And the Fed can only swap assets with Primary Dealers, to affect how banks create private credit.

Furthermore, the Fed wouldn't be able to swap assets with the private sector if the federal debt didn't exist in the first place. The Fed swaps one financial asset (base money) for another financial asset (Treasury Bonds, or other financial assets). When the Fed creates base money, it is purposefully sterilized by removing an asset of equal value from the private sector. Therefore, only the Treasury can add net financial assets to the private sector.

...and the Federal Reserve Bank provides a number of resources that also prove all this:

http://www.federalreserve.gov/faqs/money_12853.htm

...and here's a transcript of the video from that page:

http://www.federalreserve.gov/mediacent ... 110228.pdf

You may wonder how the Fed pays for the bonds and other securities it buys. The Fed does not pay with paper money, instead the Fed pays the sellers bank using newly created electronic funds and the bank adds those funds to the sellers account.
Transcript: http://www.federalreserve.gov/mediacent ... 110228.pdf

So, the only time the Fed is creating something out thin air is when it creates "electronic funds." But, these electronic funds only change the composition of the money supply (i.e. making it more liquid) since the funds are used to buy financial assets from the private sector. Hence, nothing has actually changed in the private sector other than the liquidity of the private sector's financial assets have changed.

And here's a short video from Yahoo! Finance to explain it in more simple terms....

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

So, the Fed expands and contracts the "money supply" (i.e. 'base money' + 'private credit') by doing asset swaps. The Fed doesn't create currency — the US Treasury does. Base money comes from public debt, and private credit comes from private debt that is backed by public debt. Hence, our entire money supply (except coins) is debt-based.

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

Make sense?

LW,

Well we can agree that tax cuts will strengthen an economic recovery coming out of a recession... I just wanted to point out how late in the game the tax cuts were.  I agree that they did help.  I agree that they would help, today.

Krugman's chart seems oddly under-reported for spending, so I went here:

http://www.whitehouse.gov/sites/default ... st01z1.xls

I realize we're trying to argue around a war that we both disagree with here, and that can be clumsy, but I think the facts are pretty easy to read out:

The last "untainted" year of non-war in the US was 1916.  Spending was $713 Million and that was steadily up for over a decade so it wasn't an outlier.  The worst year was $18,493 Million in 1919, at which point it bounced back to $6.4, $5.1 and $3.3 Billion in 1920, 1921, and 1922, respectively... bobbing around $3 Billion every year until the depression started.  That's $3 billion in spending where $713 Million used to be, pre war.

So, yes, you could say there were still "drastic cuts," but drastic cuts to amounts that we SIGNIFICANTLY higher than pre-war spending.  So, in essence the massive, massive deficits during the war created equal private-sector net-savings, so it wasn't a surprise that it took a decade of surpluses to cause a true strain on the savings of the private sector.  Same thing with WWII... MASSIVE deficits in the years of war can create enough base money to allow many, many years into the future of balanced budgets.

I mean look at that site... look at those deficits.  The deficit-to-GDP ratio during WWI and WWII is simply astonishingly large.  That doesn't only affect the current year.  That's money in peoples' pockets.  That affects the economy for years to come.  So, once again, in retrospect, spending wasn't really "cut."  From 1917 to 1922 spending went up almost 5 fold.  Harding was no Paul Ryan!  

I will hand you that we could definitely take a decade of harsh spending cuts, if you'll allow me 3 years of 5 trillion dollar deficits before hand.  ;D

It's kind of funny that people have been led to think we need to eliminate the federal debt — as if we get some kind of prize for doing so.

The only "prize" we get is a depression when there isn't any debt-based base money left in the private sector to back the private credit system with.

The only way to eliminate the debt — without eliminating the base money supply in the process — is for the Treasury to issue debt-free money (i.e. fiat Greenbacks or large-denomination coins).

Gumby...

Yes... we have to get rid of this link between spending and our debt.  It creates way too many preconceived notions and misunderstandings.  If the gov't would break that off, and then build a CPI-discounter into capital gains (wait, it'd have to be some shadow-stats index) to keep the Austrians able to save in any way they see fit without saying that taxation of inflated gains is manipulating everything, I think we'd be great.

This isn't to say the gov't shouldn't use interest rates to manage horizontal money to some degree... and give people savings instruments that are risk-free... but this system just isn't efficient or effective.