Admittedly, I Don’t Really Know What I’m Talking About, But… (Part II)
Reader A.M. wants answers I can’t really provide:
We should recapitalize the banks with printed money. (Nationalizing them first, of course–we wouldn’t want shareholders benefiting.)
Here’s the logic:
Given:- The banks need to be recapitalized in order to be non-zombies.
- The government will provide the capital one way or another.
- We ALSO are on the edge of a deflationary spiral. Krugman has been warning us about this.
- One sure-fire way to get inflation going is to use seigniorage–print money!–to pay for government expenditures.Therefore:
- We should print money to recapitalize the banks! (I guess the Fed would do it?)
The result is:
- The recapitalized banks can be re-privatized and function as solvent, independant institutions.
- The taxpayer doesn’t pay for it.
- People freak out a bit about printing money to pay for stuff, so “expected inflation” goes away from the edge of zero-to-negative.Would this work or would it immediately cause a Weimar-republic-style hyperinflation? I ask you because you:
- like to think about these types of things
- are willing to consider crazy ideas just for the sake of argument
- have the power to get the attention of actual blogging economists.
I don’t think I fully understand all the issues here. But my guess is that we can’t do this. The reason we can’t do this is that one thing we enjoy as a country is the ability to borrow money in our own currency. That means that we’re not subjected to all kinds of crazy currency shocks and the need to maintain massive reserves and yen and euros to stabilize things the way a small and/or untrustworthy country would be. And I think we’d like to keep it that way. My suspicion is that repaying US banks’ creditors with funny-money would put an end to this quickly. That, in turn, would be a huge problem the next time we need to roll over our federal debt payments. The main reason we’re able to contemplate bigger short-term budget deficits is that at the moment we’re paying a low interest rate to borrow. Adopt this proposal, and we’d find financing the deficit much more difficult.
77 Responses to “Admittedly, I Don’t Really Know What I’m Talking About, But… (Part II)”
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March 4th, 2009 at 2:49 pm
Matt, I think you should start titling all your posts this way.
Except the ones about philosophy, of course.
March 4th, 2009 at 2:52 pm
The problem the Weimar republic had, of course, was that the Allies figured they might inflate and so they made the reparations payable in gold and other things that wouldn’t change in value. But the Germans couldn’t pay them and so they printed tons and bought as much as they could before the hyperinflation set in.
But…just theoretically speaking, we don’t have the gold problem. Our national debt is in US dollar bills, yes? I’m sure there has to be some really obvious problem, but would there be anything stopping the printing of 10 trillion dollars, paying off whoever it is we actually owe, and then renorming the currency for the resulting inflation? Other than the massive destabilization of the world economy, of course.
March 4th, 2009 at 2:55 pm
Yeah, last time I got my buddy to accept repayment in stale dope so you can imagine his response when I next hit him up for a loan.
March 4th, 2009 at 2:56 pm
Money is fungible, and since the government has already engaged in printing press financing (”quantitative easing”) and will presumably continue to do so, I reckon we will end up paying for a portion of bank recapitalization via the printing press. Just not particularly large portion, due to to the fact that not very many of the government’s creditors are fond of being ripped off.
March 4th, 2009 at 2:56 pm
I think the problem with this is just that it would destroy our reputation and future borrowing power. We’d be treated like a country which had gone bankrupt and no one would lend us money.
March 4th, 2009 at 2:57 pm
JT’s metaphor is apt. This would work great in a vacuum, but in the system we actually have, the entities we owe money to would be furious.
March 4th, 2009 at 2:59 pm
I don’t understand the distinction between “printing money” and borrowing money at zero interest. It seems like a distinction without a difference. The Fed can either press a button that adds x billion dollars to the economy, or they can raise x billion dollars by borrowing money at very low interest. Right now we’re obviously borrowing huge amounts to pay for all this. TARP is just the tip of the ice berg. I don’t see how printing money to pay for it is any different from very low interest borrowing. Both increase the money supply.
March 4th, 2009 at 3:01 pm
To Blake:
Theoretically, the difference is that we have to pay the money back. So because of that the expectation is that the money won’t be there forever, so prices don’t get raised that much. In other words, there is a flipside to the infustion->inflation, which is payback->deflation.
Printing money puts it in the country permanently which raises prices.
March 4th, 2009 at 3:07 pm
This would give Ron Paul a heart attack.
March 4th, 2009 at 3:08 pm
Of course, if we nationalize all private debt(as we appear to be doing by backstopping AIG), we may find ourselves being on the hook for more debt than we can service. And then we can’t borrow anymore anyway. It all comes around to hoping that the total amount of debt the American taxpayer is being asked to guarantee is actually a serviceable amount. If it isn’t, then we’ll be in the same spot as we would be with inflating.
March 4th, 2009 at 3:13 pm
No, Blake is right. In fact this proposal is kind of a crude description of what bank nationalization is.
The one part that’s wrong is “the taxpayer doesn’t pay for it.” In fact, the taxpayer does. If you think it through you will see why.
When a bank is taken into receivership, Treasury (via some intermediary, e.g. the FDIC) is then on the hook for their debts and other liabilities. In other words their balance sheet becomes backed by the full faith and credit of the United States Government.
That phrase might ring a bell. A dollar bill says nothing beyond “Treasury says you have a dollar.”
March 4th, 2009 at 3:13 pm
DTM is right that seignorage imposes costs on current holders of dollars (not unlike the dilution of stock value that occurs when new stock is issued). But people don’t use paper money for transactions today in the way they did during Weimar, for example. Issuing more paper money might just mean more vault space is tied up holding piles of paper money. How did money get from the printing presses to the streets during Weimar? Do we still operate that way?
March 4th, 2009 at 3:15 pm
Well, now Matt’s gone and adopted the long-discredit Treasury view!
Matt, remember, you are committed to the idea that there can be no crowding out. So obviously the government can borrow at low rates regardless of what we do to our currency.
March 4th, 2009 at 3:16 pm
That such a proposal is even being considered is a measure of how far gone this country really is.
March 4th, 2009 at 3:16 pm
It’s posts like this that make me want to unsubscribe. You’re like the annoying kid who raises his hand in a 600 person lecture. PLEASE–Ask these questions off-line, and then link to someone who knows what they’re talking about. Don’t drag us all through your accelerated course in macroeconomics.
March 4th, 2009 at 3:20 pm
DamnYankees:
Thanks, that makes sense. But I guess it depends on how you handle the national debt. If you actually intend to pay down the debt, then, yes you will unwind the inflationary pressure of the added money. But what if you don’t intend to pay down the debt; you just assume the economy will grow enough that the debt will shrink significantly as a share of GDP. Then you’re basically enabling the inflation you brought on to reduce your debt. And in that case, the printing money v. borrowing money distinction is less clear. What’s the difference between printing money, and causing inflation, and borrowing money that you don’t pay back? None, it seems.
March 4th, 2009 at 3:20 pm
@DamnYankee, I don’t think that’s right. The Fed *is* pouring huge amounts of money into the system through its stealth recapitalization program. (See this chart.) When those assets spike up, the other side of that exchange is more dollars circulating among banks. Printed cash doesn’t make any difference.
March 4th, 2009 at 3:22 pm
Off topic: As long as you do not understand the money creation process, this is going to seem as though we have to pay for it.
The economists that say “The fed buys treasuries to make new money” have no idea that this violates basic, 101 level accounting.
Because this “lost” money has already made its way into the financial system and the loss is in the unrealized side, the asset side, and not the money side, printing dollars will not cause inflation.
So your basic premise is incorrect because it uses traditional assumptions. If you doubt this, look to Japan. They have printed tons of money for about a decade – and they are not experiencing hyper-inflation. All the economist thought they would, but they are not. The reason the economists have been so wrong is that they do not understand the money creation process, so they do not understand the root cause of inflation.
On topic: Of course, this money is already lost and it does not even matter anymore who lost it. If they cannot pay the money, then somebody else who thought they had a contract is now on the hook. At some point, people are going to realize that the final holder, the last person in line who “lost” this money is the banks.
As the money is not there, I suggest that we just follow the logic in this post, just print the money. It it will not cause inflation.
March 4th, 2009 at 3:33 pm
Mike S:
As DTM and others have mentioned, this is basically what we are already doing. Printing actual money and loaning money at zero interest are, from the government’s POV, identical actions.
The question is whether banks can remain for-profit enterprises during this process. The people who want to nationalize – me included – say no.
March 4th, 2009 at 3:36 pm
MY, I think your fear about “funny-money” is misplaced. The amount of money needed to capitalize the banks is tiny compared to amount the treasury already borrows, so it’s impact would simply be a nudge in the direction of inflation while there are other massive deflationary pressures.
When printing money goes bad in Latin America, it’s because the government is already spending way too much, adding demand where it isn’t needed, causing inflation and rising interest rates. They print money because they can’t pay the debt, but this causes an upward spiral. Since inflation and interest rates are virtually zero, the U.S. gov can (still) pay the debt and demand is too low, that shouldn’t be a problem.
March 4th, 2009 at 3:36 pm
Printing money — physical paper bills — is done by the Bureau of Engraving and Printing, which is part of the Treasury Dept. When people talk about the Fed “printing money” they’re using a metaphor.
March 4th, 2009 at 3:37 pm
And that method of taxation may or may not be preferable to the alternatives.
Also, inflation is a ‘flat tax’. It’s non-progressive nature is somewhat mitigated by the fact that there’s large amount of debt out there in the local economic stratums. But it’s countermitigated by the fact that a lot of it isn’t in ‘good’ long term fixed rate instruments, but short term, adjustable and/or revolving debt instruments.
This is why the proliferation of ‘inflation doves’ not only bothers me, it perplexes me. We’re no longer a nation of grangers borrowing seed money. The modern hoi polloi with their passbook savings accounts, their monthly rents, and in many cases, modest fixed incomes, are most hurt by inflation.
March 4th, 2009 at 3:43 pm
As Blake and Mike S have said, this is more or less what’s going to happen eventually, and there really isn’t any reason to think it will be inflationary-in-a-bad-way. Think about it like this: according to Noriel Roubini, US financial institutions are looking at further aggregate losses of about $1.5 trillion. So, to follow A.M.’s plan, the Fed would increase the monetary base by $1.5 trillion, using the cash to pay off the banks’ liabilities. Currently, the monetary base is about $1.7 trillion, so this would roughly double the existing monetary base. But guess what? Between July 2008 and now, the monetary base has already doubled from around $800B to $1.7T. That increase, obviously, has not produced inflation, a run on the dollar, or even an increase in the Treasury’s borrowing costs. Indeed, over this time the yield on 10 year T notes has fallen by a full % point. That doesn’t mean that the print money approach won’t be inflationary, but that it will combat some pretty intense disinfationary/ deflationary pressures, so the overall impact on the price level is likely to mild. Even if you don’t think its a good idea, there’s just no reason to think this would spark a catastrophe.
March 4th, 2009 at 3:43 pm
“the local economic stratums.” – > ‘in the lower economic stratums’
March 4th, 2009 at 3:46 pm
The risk everyone is mentioning is inflation, but how big a threat is that, really? We’re looking at deflation; trillions of dollars of value have vanished.
March 4th, 2009 at 3:46 pm
anomymous Jon:
It’s posts like this that make me want to unsubscribe. You’re like the annoying kid who raises his hand in a 600 person lecture. PLEASE–Ask these questions off-line, and then link to someone who knows what they’re talking about. Don’t drag us all through your accelerated course in macroeconomics.
And you’re like the annoying, spoiled, rich nerd in the school cafeteria who gets punched in the face and has his lunch money stolen.
(okay done venting)
March 4th, 2009 at 3:46 pm
I’m the dude who emailed Matt the question. I was thinking that inflation would be a feature, not a bug.
Core inflation was under 1% last quarter. If we could get inflation up to, say, 2.5-3% it would lower real interst rates, get homeowners out from being “underwater” and lower real wages where they need to fall to get things going again.
Now, I’m pretty sure there’s some reason this is a dumb idea (since no actual economists are proposing it) but I was thinking inflation can’t be why since a bit of inflation would help and deflation would be devastating.
Is the problem that spending “printed” money to recapitalize banks rather than buy bonds or other assets would cause inflation much higher than 2-3%? Or what?
March 4th, 2009 at 3:56 pm
AM: The point I was trying to make is that (I think) we are recapitalizing banks with printed money right now. The problems you raise about inflation may become problems. But yours is not a novel policy idea. This is what we are already doing. We’re borrowing a lot of money for free and pumping it into the financial system. To me, that sounds like “printing money.”
March 4th, 2009 at 4:05 pm
AM:
Increasing M0, the supply of paper money, is not inflationary. Increasing M3, the total monetary base, can be inflationary.
The problem when interest rates are zero is that increasing M0 doesn’t affect M3 at all. In fact, nothing the Fed does can affect M3. That’s the whole problem in a deflationary spiral.
The one institution that can still affect the money supply is Treasury. It does this through deficit spending. Could Treasury use deficit spending to just hand the banks money until they are solvent again? Sure. But you’re talking about a LOT of money. And it would have to be paid back later.
Remember, again, what a dollar is. It’s a note that says “The US Government (that is, the Treasury) backs this note with real resources.” So every dollar in circulation is essentially a Treasury liability. It’s, to put it in sort of an absurd way, a zero-interest T-bond.
From Treasury’s point of view, handing out free money and issuing zero-interest loans are the same thing.
March 4th, 2009 at 4:06 pm
Blake, I don’t think this is what we are doing now. We are currently borrowing money at low interest, but we still have to pay back the principal. What about just printing the money used to recapitalize the banks? It’s the difference between a zero interest car loan and having a car just appear in the garage. (Or is it? That’s what I want to know!)
Again, I expect that this is a dumb idea, but I thought it might be fun to find out why.
March 4th, 2009 at 4:12 pm
DTM,
In fact, nothing the Fed does can affect M3
So could the Fed just buy assets (say, a paperclip and a ham sandwich) from the big banks for whatever it takes to recapitalize them?
It’s quantitative easing and bank recapitalization all in one?
This is all based on my (probably wrong) understanding of what a liquidity trap is: we can’t cause inflation no matter what we do because we’re in a liquidity trap. So why not go nuts with quantitative easing and solve our bank crisis?
March 4th, 2009 at 4:15 pm
AM, inflation would definitely be a feature in this kind of economy. The problem, upon a closer reading of Matt’s criticism, is that government debt is really good for banks. The USG is the banks’ best customer and most everything is denominated in US dollars because we are the largest borrower in the world, which gives us a lot of benefits. Instead of borrowing, we would circumvent the banks by “printing” money.
Of course, this would only be a tiny blip, which wouldn’t really change things, but the psychology of banking’s best customer looking elsewhere at this time would be scary. “Printing money” carries the same kind of taboo as “nationalization,” which is why serious economists aren’t proposing it, but in these dire times your proposal might be the kind of “going big” the Krugman’s of the world are calling for.
March 4th, 2009 at 4:18 pm
Matt,
You’re right in spirit, if not technically.
When Krugman writes about a “liquidity trap” he’s talking exactly about why this won’t work. That is to say, the main “mechanisms” with which the federal reserve controls the monetary base (money supply) are more or less useless at stimulating the economy when interest rates are at or near zero.
March 4th, 2009 at 4:21 pm
Ape Man, I think you’re on the right page. But I’m not sure what you mean “nothing the fed does can affect M3.” I thought the Fed sets M3. Aren’t they the ones who control the money supply? I know that it can’t really lower the interest rate anymore. But can’t they also just add cash to the system?
AM, if we’re going to borrow the money, and we don’t intend to reduce the absolute size of our debt over the long term (as opposed to reducing its relative size by growing the economy) , then there’s no difference between borrowing and printing. It’s printing by a different name. Just as sweet.
March 4th, 2009 at 4:25 pm
From everything I have read recently, any possible move of this sort would require the approval of the Chinese government! I’m not sure they would have a problem with it, since a diminished real return on their holdings of US government paper would be offset by a reflation of the US economy.
March 4th, 2009 at 4:34 pm
DTM,
Yeah, sorry about the misattribution.
Ok, so you’re saying that the problem is inflation. I’m saying we want a bit of inflation right now because inflation is too low (or maybe just threatening to be too low). So, is the problem that we can’t have the inflation when we want it (now) and will end up having it when we don’t want it (any time other than now)?
March 4th, 2009 at 4:35 pm
Devaluing government debt by intentionally creating inflation would damage the creditworthiness of the government and devalue the dollar. Intentionally devaluing the currency by X% would have all the same bad effects as defaulting on the loans by refusing to repay X% of them, with the added bad effect that you’d also be fucking with the terms of many private loans.
March 4th, 2009 at 4:48 pm
I think I may have found (one of many) things wrong with the idea of using quantitative easing to buy assets from the banks at inflated prices, thus recapitalizing them. The problem is that the federal reserve only has like $800 billion in assets.
So maybe it would screw things up to have a federal reserve system that only has a ham sandwich for assets. (Something to do with its credibility as a money-supply-reducer.)
March 4th, 2009 at 4:50 pm
Wait, that didn’t make any sense. I think I’d better stop now…
March 4th, 2009 at 4:55 pm
It’s worth noting that the Cuno government destroyed the Mark on purpose. By the beginning of 1923 Germany already had suffered pretty dreadful inflation, but the crazy “people taking shopping carts full of cash around; money’s nominal value worth less than the paper it was printed on” business was a result of conscious policy choice to cut off Germany’s nose to spite its face. That’s why it’s such a unique event – many countries have had inflation problems, very few have had happen what happened in Germany in 1923.
March 4th, 2009 at 4:59 pm
I’m honestly surprised that there doesn’t seem to be any mention of Scott Sumner’s proposal for inflationary monetary policy exactly as proposed in the post. His response to the hyperinflation worry rests mainly on the central bank being fleetfooted enough to respond to changing conditions.
March 4th, 2009 at 5:06 pm
johnleemk,
Not quite the same thing. Sumner suggests we “commit to buying however much medium, and then long term debt is required.”
But what we’re talking about here is not just any old debt. I’m talking about buying a ham sandwich from the big banks for billions of dollars (whatever it takes to recapitalize and de-zombie them).
You get two birds with one stone: a functioning banking system AND the quantitative easing that Sumner calls for.
I’m sure this is a bad idea. But Sumner suggests that low-to-moderate inflation is perhaps a danger worth risking to get us out of the trouble we’re in. Is there another reason that this is a dumb idea? Would the dollar drop too far? Would inflation hit 8% instead of 3%?
March 4th, 2009 at 5:09 pm
to be clear: I’m talking about THE FED buying a ham sandwich from the big banks for billions of dollars (whatever it takes to recapitalize and de-zombie them).
No debt to pay back. You get your quantitative easing (which we want anyway). You get your banking system free of zombies. What’s not to like? (Seriously, I’m interested.)
March 4th, 2009 at 5:16 pm
Ape, Blake and Rich,
Glad you all agree with me – thanks. This is nothing that has not been talked about before. I disagree with the M0 and M3 assessment as it does not take into account the difference between bank money and deficit spent money. Bank money nets to zero by accounting identities – the bank lends with assets to back it up.
Now that one side has defaulted, the banks are out of balance, but the net money creation is still zero. It does not matter who right now is holding the money, no net money is created by the banking process. This includes fed activity, like buying treasuries.
You two need to read Warren Mosler
The traditional view that you two are talking about is incorrect. That is why the stimulus effect of these actions (ie. the fed monetizing all this debt) has been so weak.
Money is created by deficit spending, not the “fed enlarging the monetary base”. As a result, the recent attempts by the fed to spur inflation by growing the monetary base have been ineffective.
We need for the government to deficit spend between 2 and 3 trillion extra before this crisis is going to go away. Until that day, we are going to face low growth and a deflationary spiral. I hope it is sooner rather than later.
March 4th, 2009 at 5:29 pm
We increase currency by about 9%/year. The M2 money supply increases by roughly 6% per year. It isn’t a taboo to increase the money supply.
Our credit worthiness to our debtors is not part of the question. They lent us money assuming we would adopt policies that tended to set inflation around 2-3% and unemployment around 5%. If we adopt policies to push inflation up to 2-3%, we are doing exactly what is expected. Such actions will not affect our ability to borrow nearly as much as if our GDP continues to shrink at an alarming rate.
The only question is if it is efficacious. If the government creates more money, what will be done with it?
March 4th, 2009 at 5:38 pm
Where to begin?
The one thing the Fed cannot do is just print money and drop it out of a helicopter. They cannot do this because of legal restraints.(The Treasury in theory just print money but not the Fed) The Fed must buy an asset, or lend against it taking it as collateral, and them ‘print the money and give it to the seller or borrower. The asset they buy or lend against is a credit instrument. A bond or loan receivables of some sort. (They are getting close to taking physical assets as collateral I will admit. Imagine the assets of the central bank being cars and refrigerators. Well it’s absurd but on the very edges this is almost happening)
In other words all money in our system is created out of debt. Money is debt. Work this over in your mind until it becomes second nature. If this is not understood then it’s useless to even begin to discuss these issues.
March 4th, 2009 at 5:51 pm
rapier,
Your first paragraph is exactly right, but your second one is not true. Banks including the fed create money with debt, but the Treasury just creates money if it deficit spends.
Because Bernacke does not understand this process, he and the fed think that opening the window to all securities is a way to put money into the system. It is not. It is exchanging term money for a zero term monetary instrument, in other words money tomorrow for money today. The net amount of money created by debt driven processes is zero.
Our problem is that we are facing deflation, where dollars are worth more every day you hold them. This can only happen if there are too few net dollars chasing too many assets. The value of a dollar goes up in these circumstances, which is known as deflation.
We need to deficit spend to create net money. I do not know why the treasury does not just deficit spend this year and have about 1/2 of this amount printed directly. Our problems with deflation risk would be over, but we would still be very far from hyper-inflation.
March 4th, 2009 at 5:55 pm
DTM,
I know you are explaining the traditional view of inflation, but it simply does not work that way. That is why we have messed up our economy so badly.
seigniorage happens when deficit spending exceeds GDP growth plus the net desire for savings. If we deficit spent exactly growth plus net new desire for savings, there would be no debasement of the currency as supply would exactly equal demand at the beginning of the period and end of the period.
March 4th, 2009 at 6:06 pm
DTM @54,
First of all, thanks for taking the time to respond in detail.
Ok, you said:
Why can’t the Fed just sell $X in assets again? Also, why would inflation necessarily go up by Y? Does the market’s inflation expectation somehow take into account the amount of assets the Fed has compared to the monetary base?
I think your model assumes there is a one-to-one mapping of the monetary base and the inflation rate. I don’t think that’s right given that expected inflation is a major component of actual inflation. But I could be wrong.
March 4th, 2009 at 6:22 pm
I think Krugman had a paper on why this wouldn’t get you out of the liquidity trap. The problem is that people start to expect the dollar to be more valueable in the future. You have to convince people that the government will create inflation in the future so its mostly a confidence issue.
March 4th, 2009 at 6:40 pm
Here I think this explains the issue.
http://krugman.blogs.nytimes.com/2009/03/03/hey-who-you-callin-neo-wicksellian-wonkish/
March 4th, 2009 at 6:59 pm
Mike S:
With respect, I think that while what you’re saying is true, it may be unnecessarily complicating the question we’re dealing with here.
Under Mosler’s model, the natural interest rate of government lending and borrowing is zero. I agree with that in the abstract, and if you accept that convention then it’s true to say that the Fed cannot actually expand the money supply – it can only shrink it by charging an unnaturally high rate of interest.
However, most people don’t use that convention and it’s confusing to put things in these terms. I think there’s a balance to be struck between relying too heavily on analogies – that’s my weakness – and being so married to precision that you put things in terms that aren’t accessible to people who don’t already understand the concepts you’re describing.
March 4th, 2009 at 7:29 pm
Eh, I changed my mind. Mike S. is on to something.
People should read Warren Mosler; it makes it a lot easier to understand this stuff. Some of it comes off a bit wild at first but he does as good a job of anyone explaining why government’s relationship with money is fundamentally different than a private firm or individual’s relationship with money.
One of the key points he makes a lot is that if you pay the government in cash, the government shreds the money. If you think about that fact it helps you understand monetary policy probably better than reading a textbook would.
March 4th, 2009 at 7:45 pm
Ape man,
This is exactly what I am saying. Fed actions have no or little impact on the net money supply. Their only impact is through the indirect channel of impacting bank lending through setting the overnight rate. They may be able to impact lending through having a overly high or low overnight level of interest rates, but that does not change the NET amount of money, only the lending that takes place. Lending created money must net to zero by accounting identities.
The convention is wrong and it needs to be changed. I know most people do not use Mosler’s thinking as the model for money creation. But it is the correct model and it is simple to understand. Mosler’s model is simpler to understand than the traditional model. I know the change is coming slowly, but 10 years from today, what I am saying now that is so confusing will be considered to be self-evident.
Please spend the time over there understanding his two basic premises:
1. Deficit spending is the only way to create net currency and is necessary for a growing economy
2. Taxes drive demand for the currency
Because Moslers model is not understood or even thought about by economists, people think balanced budgets are good and surpluses are better. I thought balanced budgets were great for the economy for the last 20 years. This thinking is incorrect and has dangerous real world political implications.
Take a look at Mankiw’s or Cowen’s blog and see how up in arms they are about the future taxes to pay for the deficits Obama will run. They have real fear of these situations, due to the fact they do not understand the money creation process. Keynes statement about men being followers of some dead, discredited economist is particularly insightful here.
Additionally, the traditional model is essentially Milton Friedman’s model of money creation. Therefore, using his model, we are forced to operate on the terms of the monetarists and conservatives. Using Mosler’s model and forcing people to recognize that it is both a simpler and more accurate model for money creation pushes the conversation to ground that is much more favorable to progressives.
Surpluses are horrible for an economy. The two asset bubbles we had since our surplus years were attempts to create enough money for our economy to survive. The inevitable collapse of these alternative forms of money due to lack of demand for these alternative monies had horrible real world effects for our economy.
March 4th, 2009 at 7:57 pm
Printing money solves a liquidity crisis, which is a shortage of liquid assets by solvent firm.
Printing money does not solve a solvency crisis, because money from the Fed does not generate income for commercial banks. The fundamental problem of the commercial banking system is that that they pursued higher income by pretending that high risk, high yield assets were low risk, high yield assets, and so the contingency reserves that they should have been building up based on the massive systemic risks in their portfolios were instead distributed as if it was profit income.
What we need are commercial banks that are both solvent and liquid and that not only can but will lend to business and consumers once the recession bottoms out so that it is possible for injections in addition to government spending to be pumped into GDP.
And we need to do it on the basis of stable leverages and growing incomes … growing leverage on the back of stagnant income has been tried and has been found wanting.
March 4th, 2009 at 7:58 pm
Ape man,
lol – I did not see the post you put before I posted mine.
I am a CFA and CAIA charterholder and have spent years looking at the interest rate and money markets in a variety of roles. Not quite a PHD economist, but in someways I am an expert in the markets, and in particular the interest rate markets. Finance in general has a much more sophisticated view of the processes than economists, which has good and bad parts to it.
I happen to know a person who is friends with WM and he recommended him to me. In less than a year of knowing this, I have completely changed my view on deficits and the fed.
Randall Wray has also written some very good stuff. “Understanding Modern Money” is a must read for progressives.
March 4th, 2009 at 8:26 pm
Agreed; Mosley is, along with Taleb and to some degree Bob Kuttner (whose Everything For Sale sort of introduced me to modern economics), one of the people who has most influenced how I think about risk, scarcity, and money.
It’s interesting that so much of what Mosley and to some degree even Taleb talk about seem to have been better understood in other times and places. It calls into question the foundational assumptions we tend to have about how knowledge is inexorably advancing at all times.
So to reiterate and expand upon, perhaps unnecessarily, my agreement with Mike S:
From the Mosleyan point of view, finance crises are somewhat imaginary – the government can spend as much money as it wants and nothing bad will happen.
Thus all the talk about “taxpayers getting their money’s worth” on the bank recapitalization is a bit misplaced – Treasury, paradoxically, has no use for money.
The reason you nationalize is that there’s no reason to subsidize the shareholders or the management of a failed bank. Beyond that Treasury and the Fed don’t need to turn a profit or even break even on their venture; it doesn’t impact anything.
Again I want to stipulate that Mosley’s view is not a widely held view among economists. However, it does have the benefit of being true.
March 4th, 2009 at 9:11 pm
When the Fed buys securities that do not return the purchase price or when the Fed buys treasuries and returns the interest to the Treasury they are creating money. It does not net to zero.
The treasury has not issued money since they stopped issuing silver certificates after 1957.
When a bank issues debt it does not create net money if the loan is paid back. If the loan cannot be paid back, they have created money, which is inflationary. This is what happened in the housing market.
Inflation does not happen everywhere at once.
If a bank has a portfolio of loans worth less than its equity, it is insolvent, at which point the fdic will take it over and create net money by creating new money to give to the depositors to replace the money that the bank lent but did not get back.
The reason why the current deficit spending and actions of the Fed might not be inflationary yet is that they are backstopping the inflation that already occurred in the housing and financial markets. They are trying to maintain the bubble although it depended on loose lending and is not sustainable without personal incomes rising just as fast as home prices.
The risk of inflation comes from the new money not staying contained to sustained the previously inflated prices, but spilling into the economy at large.
March 4th, 2009 at 9:28 pm
“Please spend the time over there [Warren Mosler] understanding his two basic premises:
1. Deficit spending is the only way to create net currency and is necessary for a growing economy
2. Taxes drive demand for the currency ”
The first is true, money [debt] grows when an entity deficit spends, through credit. All sectors do this, not just government.
The second is true is also true for all entities, in order to buy stuff one has to get cash in a cash economy. They are truisms, worthless.
Mr. Mosler likes to assume that only one entity needs to do this, government. But government actions need to increase output. It is the increasing of output by the debtor that leaves excess money in the economy. So, government is still stuck, it has to produce more goods with less effort, or convince others to do so.
The rule for evaluating economists is to ask, Do they treat government as an external entity or just another economic sector?
The demand to get cash and pay taxes is exactly the same as the demand to get cash to make a car payment, both are required via a contract the consumer agreed to.
March 4th, 2009 at 9:41 pm
It is just insane to say the treasury could issue as much debt as it wants and have the fed monetize it all and nothing “bad” would happen. I agree that the Fed does not need any kind of return and can endlessly create money to inject into the economy. This is not true for the Treasury however. The treasury borrows money from more places than the Fed. The treasury really does need to pay that money back either by extracting wealth from the citizens or by borrowing more, sometimes from the Fed.
This has an effect however, which we would have discovered sooner if we did not have the luxury of having the sole right to create dollars and the unique position of having the rest of the world willing and able to lend the treasury dollars. If all the bondholders had was a promise that the central bank would create more money to give the treasury to pay them back, they would not be so willing to lend. This is obviously true for every nation other than the U.S.
Say for a thought experiment the treasury decided to deficit spend to make a grant to everyone in Iowa of $10,000,000 each and the only buyer for these billions of Iowa stimulus bonds was the Fed. Is it not obvious that this would have an inflationary impact on prices of goods and services in Iowa, with it spilling over to other places too?
The problem with runaway deficits and the Fed’s willingness to buy any asset or bad loan is the threat it creates to the dollar’s unique position in the world. If the world loses confidence in the dollar, we are all going to find out we are a lot less wealthy than we seem
March 4th, 2009 at 10:35 pm
Crazy proposal ? Wild far out idea ? What exactly do you think we’re doing ?
I’d say that except for the sensible proposal to
nationalizepre privatize, your correspondent is describing current US policy.It’s just that it’s done in two steps.
1) Treasury bails out the banks with money obtained by selling Treasury bills notes and bonds.
2) the Fed buys these bonds with magic money created out of nothing.
The Fed obligations used to buy Treasury securities in open market operations aren’t actually printed. They exist mostly in computer memories. However, they are high powered money. Really just like million dollar bills as far as anyone knows ,in any case assumed by economists to be just like cash and freely exchangeable for cash at will. You will notice the money say “Federal Reserve Note” in big letters above The United States of America. It means that the bill amounts to the Fed owing you … something somehow (it used to mean they owed you gold).
So we have been printing money like crazy, faster than a speeding printing press actually.
The amount of money that has been printed is, for serious purposes, total liabilities of the Federal Reserve, which are equal to total assets of the Federal Reserve.
As of February 26 these were 1,952,216 million dollars, that is about 2 trillion. Of total assets, the Fed has 11,041 million in gold. It is possible that some of the Fed’s foreign currency holdings are old convertible (for all I know some country is still on the gold standard). Rather less than the over 68 billion in “mortgage backed seccurities” or the over 38 billion in “Credit Extended to American International Group Inc” (that is in addition to money put in by the Treasury).
In contrast on Feb 15 2007 total assets (and liabilities) were
890,690 million so in the past 2 years the Fed has electronically printed up 1 trillion 260 odd billion dollars more than doubling the high powered dollar supply.
That hasn’t been enough to cause a hyperinflation or rejection of dollar denominated assets. It hasn’t been enough to keep interest rates on Treasury securities consistently above zero or make sure that we have any inflation at all.
I’m not sure there has been a larger expansion in money supply in world history (in real value). I’m pretty sure that, without wanting to, the Fed has obtained more seignorage that the German central bank ever obtained during the hyperinflation (oh hell or in it’s history).
March 4th, 2009 at 10:36 pm
mattyoung,
This is simply not true:
” The demand to get cash and pay taxes is exactly the same as the demand to get cash to make a car payment, both are required via a contract the consumer agreed to.”
because you are confusing the need to get some currency in general with the need to get a specific currency. Why do we use U.S. dollars? Your assumption is the conventional one, that consumers want to acquire dollars because of tradition. However, one cannot pay taxes in anything but government script. So no matter what currency you exchange for goods, you need some U.S. currency at the end of the year to pay taxes. Mosler’s basic idea is much different than your idea as it provides a direct link between taxes and initial demand for a currency.
The government is unique in that it can create money out of thin air with no backing assets. In normal channels, you need some type of balancing asset, even if it is just your future time. For the government, the only requirement is that there is enough demand for the currency created by taxation for people to want to do work for the government in return for that currency. There are constraints to this government spending, because if the spending is too far in excess of taxation, nobody will want the currency, but this is far from our current situation. That the government can do this is how it is different than every other sector, individual, and corporation.
You do not understand these “worthless truisms”. It is so critically important to understand the difference between bank/credit created money and government created money. Not understanding that private sector bank money must net to zero is what got us into this credit mess in the first place. For bank money, every asset is a liability in another account. Due to the velocity of money, it can seem like the money supply is expanding when in fact it is not. When a recession comes and loans come due, that money goes away, and deflation or dis-inflation happens.
Doug,
Treasuries do not have to exist. Treasuries exist to help set the term value of money. The feds true job is to set the treasury yield curve by managing supply and demand for treasuries. If the treasury repays the debt or rolls it to a different entity then no net money is created.
Now in the particular case of the fed returning the interest to the treasury, how does the fed then balance their accounts?
It is insane to think that the treasury could issue whatever it wants and nothing bad will happen. The treasury is constrained by the demand for savings and other factors. In our particular crisis, those other factors are not in play because we have so much excess capacity.
March 5th, 2009 at 1:06 am
I don’t understand the distinction between “printing money” and borrowing money at zero interest. It seems like a distinction without a difference.
correct, there is no difference.
March 5th, 2009 at 8:24 am
RobertWaldman,
You say:
I am the correspondent, and I don’t think that’s what i am describing. In the two step process you describe, the national debt is higher at the end because the Fed is buying new bonds created to fund bank recapitalization. I am describint the Fed buying something worthless (say, a ham sandwich) directly from the banks. Treasury does not have to issue new bonds for this operation.
This may not be a good idea (for reasons I am trying to discover), but it is not what we are currently doing.
March 5th, 2009 at 8:27 am
MQ,
I don’t think that’s right. If I give you $120 but you have to pay me $10 per month for a year (paying back at zero interest), that’s really, really different than if you printed $120 in your basement (leaving aside counterfeiting and legality issues). When you borrow with zero interest, you still have to pay back the principal. When you print money you don’t pay anything. You DO risk causing inflation, but this whole discussion is predicated on the idea that increasing the money supply does not really cause inflation in our current special situation (liquidity trap).
March 5th, 2009 at 9:51 am
“The government is unique in that it can create money out of thin air with no backing assets.”
The government has one real big asset, the power to appropriate, police power or power of enforcement.
If you look at legislatures, I think you find in general that normal laws of supply and demand occur. When the legislature raises taxes, there is usually a near concurrent reduction in spending. I think the federal government generally gets about 19% of the revenue, and this is usually close to a trend.
Try this thought experiment. Imagine that the legislature decides to flatten the yield curve a bit. Can this be done by accounting only? No, because that involves Congress changing its production system as Congress tries to manage short term budgets. One would get a restructuring of the federal government to produce the term structure it had defined by accounting.
March 5th, 2009 at 12:20 pm
Mike S,
The fed does not control the supply and demand of treasuries, they do not buy enough of them yet, but they might. The fed does return interest earned on its treasuries to the treasury, 34 billion or so last year http://www.federalreserve.gov/newsevents/press/other/20090109a.htm
The fed’s accounts do not balance that way because they are creating money. Alternatively you could say that they overstate the value of the assets they have on their balance sheet and when that value evaporates, it makes clear they have created money.
Also the demand for dollars is not driven by the need to pay U.S. taxes, that may be true for some economies, but not ours, we have a unique advantage put in place by the Bretton Woods agreements that we are in the process of squandering.
As of 2002 about 350 billion in actual federal reserve notes was held overseas. This is the majority of actual paper outstanding. Also global commodity markets use dollars for payment. Also foreign central banks holds hundred of billions of dollars as part of their reserves, not to mention the entire economies of Ecuador and El Salavador which are officially dollarized.