In the 1990s, the Clinton Administration amassed a great deal of experience fighting financial crises around the world.
Some of the U.S. Treasury’s specific advice was controversial – e.g., pressing Korea to open its capital markets to foreign investors at the height of the crisis – but the broad approach made sense: Fix failing financial systems up-front, because this is the best opportunity to address the underlying problems that helped produce the crisis (e.g., banks taking excessive risks). If you delay attempts to reform until economic recovery is underway, the banks and other key players are powerful again, real change is harder, and future difficulties await.
In a major retrospective speech to the American Economic Association in 2000, Larry Summers – the primary crisis-fighting strategist – put it this way:
“Prompt action needs to be taken to maintain financial stability, by moving quickly to support healthy institutions. The loss of confidence in the financial system and episodes of bank panics were not caused by early and necessary interventions in insolvent institutions. Rather, these problems were exacerbated by (a) a delay in intervening to address the problems of mounting nonperforming loans; (b) implicit bailout guarantees that led to an attempt to “gamble for redemption”; (c) a system of implicit, rather than explicit and incentive-compatible, deposit guarantees at a time when there was not a credible amount of fiscal resources available to back such guarantees; and (d) political distortions and interferences in the way interventions were carried out…” (“International Financial Crises: Causes, Prevention, and Cures,” American Economic Review, May 2000, p.12; no free version is available, unfortunately: http://www.jstor.org/pss/117183)
Now, of course, Summers heads the White House National Economic Council and is the Obama administration’s economic guru-in-chief. He is surrounded by experienced staffers from the 1990s, including Tim Geithner (then Assistant Secretary at Treasury, heavily involved in the details of the Asian financial crisis; now Treasury Secretary) and David Lipton (then Undersecretary for International Affairs; now at the National Economic Council and National Security Council). (Paul Blustein’s The Chastening is the best available account of the personalities and policies in the 1997-98 “emerging market” crises.)
If we look back over the past 12 months, has this crack team of crisis fighters applied what they learned from the 1990s?
They pushed early and hard for a fiscal stimulus – and this has played the same role in stabilizing spending in the US economy as properly scaled IMF lending does for weaker economies. At this level, the Summers group drew sensible lessons from the experience of the 1990s – listening finally Joe Stiglitz (then chief economist at the World Bank and now at Columbia), who stressed the importance of easing fiscal policy in the face of a financial crisis.
But in terms of their handling of the financial system, the Summers-Geithner-Lipton approach this time around is at odds with their views and actions a decade ago.
In the 1990s, they were completely opposed to unconditional bailouts, i.e., providing money to troubled financial institutions with no strings attached – at one point deriding Madeleine Albright, then Secretary of State, for proposing such an approach to Korea (Blustein, p. 138). The Treasury philosophy was clear and tough: “a healthy financial system cannot be built on the expectation of bailouts” (Summers, 2000, p.13).
No modern economy can function without a financial system, so some form of rescue that restored confidence in our banks was necessary – just as it was in Thailand, Indonesia, and Korea in 1997. But in any rescue, the governments with deep pockets (i.e., the economic strategists deciding how to deploy US fiscal resources now and in the 1990s) choose the strings to attach – and the approach adopted for the U.S. has been one of the least conditional and softest ever on troubled banks.
In the 1990s, the US – working closely with the IMF – insisted that crisis countries fundamentally restructure their financial systems, which involved forcing out top bank executives. In the US during 2009, we not only kept our largest and most troubled banks intact (while on life support), but allowed the biggest six financial conglomerates to become larger than they were before the crisis, both in absolute terms and relative to the economy. In 2007 the combined balance sheets of these entities were just under 60 percent of Gross Domestic Product, while through the 3rd quarter of this year they stood at 63.5 percent of GDP (source: 13 Bankers, forthcoming 2010).
We are still waiting for a full explanation of why the management of major troubled US banks were treated so gently – given their self-inflicted problems and desperate circumstances; if you doubt that these banks were close to failing, read some of the leading blow-by-blow accounts. Rick Waggoner, the head of GM, was forced out earlier this year, but the administration has not pressed major bank chief executives hard.
Presumably, this time around, the Summers-Geithner-Lipton group will argue there was no way to restore financial market confidence other than through the kind of unconditional and implicit bailout guarantees they opposed in the 1990s.
If true, this has a terrible implication. The structure of our financial system has not changed in any way that will reduce reckless risk-taking by banks that are large enough to cause massive damage when they threaten to fail. The logic and 1990s experience of Summers and his colleagues suggest serious problems lie in our future.
The reform legislation they have placed before Congress could still address “too big to fail” issues in principle, but attempts to limit the power of – and danger posed by – our largest banks have bogged down in heavy lobbying. Postponing reform attempts until the banks were out of intensive care was a mistake – and just what today’s economic leadership used to warn against.
By Simon Johnson
An edited version appeared this morning on NYT’s Economix; it is used here with permission. If you would like to republish the entire post, please contact the New York Times.
168 thoughts on “Lessons Learned From The 1990s”
It is difficult to argue that the US has not deffered our problems (banking, national debt, unfunded liabilities) to a TBD future date of reconning. As has been argued by BS before, if one had described the US financial crisis in oblique terms without mentioning the troubled country’s name, no one at the IMF, and certainly Sumner and those mentioned above, would proscribe appropriate remedy as the pain medication that was applied to the US financial system. The Cancer is now masked, and is spreading through the patient as the pain med/punchbowl is consumed. The resulting hangover and realization of advanced, perhaps inoperable 4th stage fiscal cancer will leave some of us unsurprised, most of us much worse off, and the patient asking why we didn’t operate or do the radiation treatmetns when they had a chance to work.
With people like Larry Summers and Janet Napolitano running things I sleep very well at night. I mean what could possibly go wrong??? The cartoon below is by Kevin Siers of the Charlotte Observer
“In the 1990s, the US – working closely with the IMF – insisted that crisis countries fundamentally restructure their financial systems, which involved forcing out top bank executives. In the US during 2009, we not only kept our largest and most troubled banks intact…”
Our government has been captured. Foreign institutions fare better these days with the right counterparty exposure, however.
“I can’t stand pain. It hurts me.”–Daffy Duck & bank execs
Well the difference between then and now, is that Summers and his team could extract NO personal benefit by being partial to Korea. Quite the opposite: they had interest to show professionalism. Moreover, it helped American bankers, and they had little consideration for the public suffering, especially in strange and alien lands. And it worked: they are back at the White House, mesmerizing the naive president.
Nowadays, the future immense riches of these happy few, and the aura they already have with fat cats bonus bankers, insure that their best interests lay in doing the exact opposite of what is good for the public. And why would they care? Are not profits everything, for those who do not have higher principles? As far as they are concerned, they could make theirs Louis XV’s of France famous quip: “Apres moi, le deluge!” (“After me, The Flood”)
Bankers Get $4 Trillion Gift From Barney Frank: David Reilly http://www.bloomberg.com/apps/news?pid=20601039&sid=a48c8UpUMxKQ
So much for lessons learned. It seems that the biggest lesson of all is to continue the bailouts for “too big to fail”.
“It authorizes Federal Reserve banks to provide as much as $4 trillion in emergency funding the next time Wall Street crashes. So much for “no-more-bailouts” talk. That is more than twice what the Fed pumped into markets this time around. The size of the fund makes the bribes in the Senate’s health-care bill look minuscule.”
Could you give us an EXAMPLE of the foreign institution and it’s related counterparty??? Other than being highly annoying you are the Queen of Vagueness.
These blatant dual standards are just expression of the market and other power of the USA, who can get away with what Korea could not.
Also of the USA industrial policy: GS, Citi, … are the USA’s national champions implementing USA’s industrial strategy for finance, and they deserve every subsidy and protection; the USA could not care less about Korea’s national champions.
“In the 1990s, the US – working closely with the IMF – insisted that crisis countries fundamentally restructure their financial systems, which involved forcing out top bank executives.”
It wasn’t just the financial systems that the U.S. and IMF forced crisis countries to restructure. Something that has always troubled me about Professor Johnson’s posts about the IMF is how he consistently fails to acknowledge the IMF’s role in pressuring developing nations to scale back or eliminate entirely social safety net and other welfare or income-redistribution type programs. The citizens of developing nations don’t hate the IMF because the IMF was audacious enough to stand up and tell their corrupt leaders they had to mend their ways, they hate the IMF because many of the policies the IMF forced developing nations to adopt caused a lot of pain and suffering for regular people who had nothing to do with causing the problems that got their country into trouble in the first place. I don’t know if Professor Johnson had anything to do with crafting or implementing those policies, but nevertheless he should acknowledge their existence.
I’m sorry; I figured most people would find that statement uncontroversial. Many of AIG’s top counterparties were foreign banks, such as Societe Generale, Deutsche Bank, and UBS.
It should be remembered the Rick Waggoner example was followed by cries of a “socialist takeover” of the economy. Pretty much forestalling any move against the bank execs.
The Glenn Beck’s of the world who decry bailouts to Wall Street are also against curtailment of Wall Steet and their executives. People up in arms for ex post facto tax the bonuses of Wall Street, and even lynching, are against any tax increases on the highest tax bracketed individuals.
There is no outside political driver, such as the IMF, to push through the dichotomy of our political class and the media demagogues. We are more like Japan in not taking outside advice than the other asian countries of the 90’s.
To be read in conjunction with Joseph Stiglitz, “Harsh lessons we may need to learn again” (12.31.09).
Needs to be addressed.
And Just why did the same people who recommended strict policy for the emerging world reverse course when faced with the same problems in the US? I doubt this was an “honest mistake” or a rethinking of their position. Double standard based on intellectual bias?
Unfortunately, lessons from the 1990’s may not be as instructive as we’d like to think. With the fall of Communism, no significant terrorist threat, oil prices well contained, and our only major international competitor, Japan, imploding, the US had little to concern itself other than doing whatever it wanted to do.
Timmy and Larry may be on the wrong track, but looking back to a time when there were few constraints will not be helpful.
Since when has the USA not had double standards?
“The citizens of developing nations don’t hate the IMF because the IMF was audacious enough to stand up and tell their corrupt leaders they had to mend their ways, they hate the IMF because many of the policies the IMF forced developing nations to adopt caused a lot of pain and suffering for regular people who had nothing to do with causing the problems that got their country into trouble in the first place.”
Wrong! The citizens most often hate the IMF because that´s what they have been told to do by the populist politicians for whom IMF is a godsend scapegoat.
hugo chavez has told his followers that he will not increase the price of gas from the about US$ 8 cents per gallon he currently gives it away for because he is the representative of a sovereign state and refuses to heed those neo-liberal prescriptions given by the IMF… and with that hugo chavez robs the poorest of the poor in Venezuela and hands over about 10 percent of its GDP to those who drive cars.
Indeed “having” to bail out some major institutions, has a terrible implication. But more than stress the importance of easing fiscal policy in the face of a financial crisis as you refer Joe Stiglitz does I would stress the importance of counter-cyclically easing regulatory policy in the face of a financial crisis.
To trust government bureaucrats to spend us out of a crisis more than we trust the remaining financial system to help out giving credits is plain stupid and seems only designed to serve a big government agenda.
The failure of a private sector bank does not in any way sense or shape signify an increase in a public sector bank´s possibilities to get it right… which is what many here wants us to deduct.
…my 2 cents (that’s what it says on my tax returns), best political statement of the year:
“We have it in our power to begin the world over again.” – Thomas Paine, 1776
Yeah, lets have big business save America, oh wait, it is business that is trying to destroy America. When will Wal-Mart,Google and General Electric start creating their own armies and making you a renter?
The real problem is the disinvestment in public goods and the destruction of the American Nation. Yet, knowing your type, you would relish that.
I am not going to defend Summers, but it’s very hard to compare the Asian currency crisis (see a timeline here) with the recent global crisis. Among other things, the 1997 crisis never sparked a worldwide demand collapse. Among others, the countries in question never controlled so much demand that a massive “austerity” program the likes of which was imposed by the IMF in exchange for modest loans (and they were rather modest, all things considered) could threaten other countries with insolvency.
I think – in retrospect – we certainly should have passed TARP with restrictions, although Congress’ grandstanding in rejecting the first TARP attempt without an attempt to actually AMMEND the thing (which induced a market crash) ended up causing even more problems.
It would have been a lot easier to solve the recent crisis if the US could have rebuilt its economy through job-intensive export led growth… (with, you know, the rest of the world running massive trade deficits). But, alas, that’s just not reality, is it?
Also, it’s important to recognize that Summers didn’t really enter the picture until Jan 20 2009, two months after TARP etc. There were subsequent rounds of funding (particularly for citigroup and AIG) but one can argue that these “second-rounders” have actually seen some discipline (more, at least, than JPMorgan).
Finally, it’s easy with 20/20 hindsight to criticize (although, to give SJ credit, he did argue for stricter conditions way back when – I recall the Rahm Emanuel “Don’t Waste a Crisis” post), but it’s also highly likely that if the administration had not squandered the last 6 months passing an abomination of a health care “reform” act, it could have won a lot of public approval by passing some real financial reform. THEN it could have executed health care reform.
Who says a word about big business saving America? I am referrring to saving the small businesses and the entrepreneurs and the smaller banks and the community banks, who are all these are the ones who suffer the most when in a crisis everyone shouts “more regulation”. Big businesses, well they always get along quite nicely with the big governments.
Ummm, no. Financial reform will be opposed and demonized with lies the same as health care reform. We may, at some point, have a reasonable plan (like Wyden-Bennett) available, but the total opposition from the right will mean 60 votes will be needed. That means another bill crafted to please the 58th, 59th and 60th senators. Another mediocrity is in the works.
I don’t see how your comments about Hugo Chavez show that I am wrong to claim citizens of the developing world have legitimate grievances against some of the policies the IMF has pressured their governments to accept. There’s a lot of anger out there against the IMF. Is it all the result of people being duped by populist demagogues? Certainly the IMF is scapegoated by populist demagogues like Chavez, but I don’t think they’d be so successful if much of people’s anger didn’t have a basis in reality. Like Bob Marley said, you can fool some people sometimes, but you can’t fool all the people all the time.
Your original point was about foreign institutions faring better. I am trying to figure out: How Deutsche Bank and other foreign institutions benefitted more than Goldman Sachs, Morgan Stanley, or other American counterparties to AIG????
I am sure since you work in finance you can explain that to us. Unless of course what you said is a lie.
That is not what I wrote. Of course they have many legitimate grievances against IMF and I myself have argued many of them. That was not what I objected to. I objected to the “they hate the IMF” part, since the hate, if it really is present, most have not the faintest idea what the IMF really does, has been seeded there by persons pursuing other agendas… like the power grabbing agenda of that petro-autocrat I referred to.
NKlein1553: “Like Bob Marley said, you can fool some people sometimes, but you can’t fool all the people all the time.”
Great President, Bob Marley!
“The citizens most often hate the IMF because that´s what they have been told to do by the populist politicians for whom IMF is a godsend scapegoat.”
I took that to mean you feel the people of the developing world are being manipulated by populist demagogues to hate the IMF when they really don’t have any reason to be upset. Maybe hate was not the right word, but certainly many people have very strong negative feelings towards the IMF. Here are just a few examples:
Professor Johnson has himself stated in many posts here at the baseline scenario that the IMF has almost no credibility left in the developing world because of the perception that its policies are meant to enrich industrialized nations at the expense of the poor. You obviously know much more about these things than I do so maybe I’m wrong, but I think there is a solid basis in reality for that perception. All I was trying to say in my original post was that Professor Johnson should acknowledge that the “restructuring,” the IMF pressured developing nations to undergo had serious negative consequences for many people in the developing world. I would also be curious to know what role Professor Johnson played in creating or implementing these policies. Since we seem to agree that many of the IMF’s policies have been problematic, I don’t really know what we’re arguing about here. So I’m going to stop. Happy New Year Per Kurowski, and thank you for all of your interesting comments over the course of the year. You, probably more than any other contributor here at the baseline scenario, have made me think the hardest about the true causes of this mess we Americans have created for ourselves. Thank you.
I’ll say one thing: if Bob Marley were President at least we wouldn’t have the ridiculous war on drugs. With that, I’m off to celebrate the new year. Happy New Year everyone!
Right, it was mostly one word that set us apart, but for me “hate-preaching” is the worst kind of crime against humanity I know and so I react immediately to the word “hate”… even when it really does not mean hate. Happy New Year!
One piece of good news as we end the 2009 Year. Many people now are confused because economic times are tough, and it’s hard to make sense of some of the financial instruments that caused the crisis and hard to read the economic numbers that forecast the future.
Some people don’t know who to vote for because it seems sometimes (a la Melissa Bean) that Republicans and Democrats are almost the same. I have good news. Tidings of Joy. Now there is an alternative: Newt Gingrich and Karl Rove are starting a new Conservative Pro-divorce party. Membership requires you need to have divorced at least twice and belong to either the Catholic or Episcopalian faiths.
4 Trillion = 4000 Billion
Have we become numb to the magnitude of these amounts.
This is insanity.
In the US, we now officially live in an Orwellian Wonderland, with more grift-n-graft at every turn.
The message is: it depends entirely where you sit, if a pol, how you see things (or say how you see things). I can’t figure out why the views have changed so dramatically (NOT)! But we must look to find new leadership in our elected and appointed representatives. Money buys influence, and great money buys (obviously) absolute influence. Not just in finance, but in health care, energy, military matters, etc., etc., etc. All I can say is that with the public animus toward Washington AND BOTH major parties, it will be interesting to see how many potential political candidates in 2010 actually declare their independence from the major parties and opt to get their campaign contributions from the oligarchs and go to the grass roots, like Obama so successfully did in his campaign.
It’s time for real reform, and, even to the most casual observer, it is patently obvious it ain’t coming from the currently elected shlumps and their cronies. Time to move before this country is fully destroyed by greed and corruption.
Very timely post, Simon. I hope Summers reads it. :)
My disappointment in the Obama administration now reminds me of how I felt about the Kennedy one when the best and the brightest came to naught in the sixties.
Plus ca change.
My point was that the US is less demanding of foreign institutions than it was in the 1990s. In a sense, US leaders are not demonstrating a double standard with the recent bailouts, because they just give taxpayer dollars away with reckless abandon these days.
With AIG, for example, we had no problem bailing out foreign institutions without requiring them to make any sacrifices or change their behavior. SocGen made a complete mockery of our crisis experts, and I believe they did actually receive more than the company’s American counterparties, although these companies are so intertwined it is would be difficult to make a case for which one was the greatest beneficiary of our government’s largesse. That is more or less why a double standard cannot exist when large foreign institutions are involved anymore. Regardless of whether our domestic financial institutions have captured our government (and I’d agree that they have), to the extent that foreign institutions have become transactionally interconnected with our domestic financial institutions, our leaders’ bargaining power in providing assistance to foreign institutions is diminished.
Good comments Bond Girl. Interesting and insightful as usual. Thanks
NKlein1553: “if Bob Marley were President at least we wouldn’t have the ridiculous war on drugs.”
One of the reasons given for repealing prohibition in 1933 was that it would create jobs. Think of the stimulus to the economy from legalizing marijuana! ;)
Don’t hold you breath. Err, I mean, do hold your breath. ;)
“Timmy and Larry may be on the wrong track, but looking back to a time when there were few constraints will not be helpful.”
What surprised me during the ’90s was our self restraint in the international sphere. :)
“To trust government bureaucrats to spend us out of a crisis more than we trust the remaining financial system to help out giving credits is plain stupid and seems only designed to serve a big government agenda.”
Historically, during financial crises we have had private bailouts and public bailouts. Currently the U. S. has had a public bailout, and now the private sector is digging in its heels. Based on history we should expect that to continue for at least another year. As far as public policy is concerned, the problem lies not with the bureaucrats but with the legislators. The Fed has flooded the banks with money, but the banks are just sitting on it. It may be stupid to expect anything to happen in the near future, unless things go south again. But what is even more stupid is the internecine bickering when we need to pull together.
Why are the banks, flooded with money sitting on it? Simply because they do not have the bank equity that is required to lend out that money.
You see if they use that money and relend it to the government then they are not required to have any equity at all. If they lend it out to the disappearing AAA breed then they need to have only 1.6 percent in equity but, if they lend to a small business or an entrepreneur, then they are required to have 8 percent in equity.
Yup. Banks are capital constrained in lending, not liquidity constrained. Excess reserves are not there to be lent out. They are there because the Fed expanded its balance sheet wildly to get the dreck off the banks books “temporarily.”
The problem is two fold: One, the banks are capital-impaired, and two, there are few creditworthy borrowers who want to borrow in this environment, even with the Fed making liquidity awash and setting the overnight rate at the lower bound.
Banks are just going to use the Fed largesse to rebuild capital with free money from risk-free interest and also through leveraged prop trading.
Yes, and there is absolutely nothing that would stop the regulators from temporarily lowering the capital requirements of banks for instance to only 5 percent when lending to small businesses and entrepreneurs, and so allowing the banks to lend more… but no, they prefer the “wise” government bureaucrats to build up government debt and spread out the funds. Truly absurd!
Per Kurowski: “Why are the banks, flooded with money sitting on it? Simply because they do not have the bank equity that is required to lend out that money.”
A couple of questions about that.
First, is bank equity unambiguous, or does it depend upon the evaluation of “toxic assets”? Aren’t the regulators allowing the banks to value toxic assets optimistically?
Second, Paulson claimed that the bailout was so that the banks could start lending again. That was a lie, but I thought it was a white lie. However, if the bailout was insufficient, it was a whopper, wasn’t it?
Third, Brad DeLong says that the banks got too much. If it was too much, why can’t they start lending? There is, at the very least, a difference of opinion here.
Fourth, from what I hear, in normal times banks lend even if they do not meet the regulatory requirements. After the loan they borrow money to fulfill the regulatory requirements, borrowing from the central bank if necessary. Under current conditions, wouldn’t the Fed make the loans? In fact, wouldn’t the Fed be happy to do so?
Fifth, if things are still so bad that the banks cannot conduct their normal business, why are they paying such big bonuses?
Tom Hickey: “The problem is two fold: One, the banks are capital-impaired, and two, there are few creditworthy borrowers who want to borrow in this environment, even with the Fed making liquidity awash and setting the overnight rate at the lower bound.”
The question of creditworthiness is not a simple one. Many who were creditworthy a couple of years ago are not now, not because of any change in them, but because of the change in the economy. If the money supply now were the same as it was then, then most of them would be creditworthy again. The banks could increase the money supply by lending, but they do not, because of the lack of creditworthy borrowers. Etc., etc. A Catch-22.
Now, you can see why a single bank would hesitate to start lending on its own initiative. If the other banks do not follow suit, the risk is too high. But even if all the banks acted in concert, there is no guarantee that things would improve.
Whatever you may think of the government, the private sector has not done squat in the current crisis, and is unlikely to do more in the short run.
Bank equity like all equity is of course quite ambiguous.
Paulson. I am a foreigner so I leave the qualifications in your hands. That said, the bailout had only to do with some big banks and these banks, even though they were bailed out, faced increasing capital shortages as credit ratings headed south and portfolio turned sour, which has blocked their credit activity, especially to those clients, like the small businesses and entrepreneurs that suck up a lot of capital according to the requirements. Think also about the European banks for instance those (same Basel regulations) which have lent out money to Greece, Spain, Italy… all AAA sovereigns for which no capital was required… what are they to do now when credit ratings of sovereigns start to tumble?
Brad DeLong “banks got too much”? Absolutely! They got too much of the wrong support but too also too little of the right support. You see the problem is that the current regulatory pillar is so fundamentally flawed that the regulators, first do not want to even talk about it, so that they do not have to explain the how-come, and, second, because they do not really know or have the guts to abandon the paradigms even when they know they are faulty.
“ in normal times banks lend even if they do not meet the regulatory requirements” I don´t understand what you refer to.
Big bonuses? Some banks have been taken over by apparatchiks who have a vested interest in big bonuses to other in order to justify big bonuses for themselves. But let us also not forget that the majority of bankers do not earn big bonuses and are in fact quite often poorly paid.
Great post, Mr. Johnson!
I repeat again my clarion call to Mr. Johnson, Mr. Kwok et al., and remind them that playing inside the system is not working, to wit:
-it is time to stop taking seriously, phoney arguments about too-big-to-fail.
-it is time to act more like Robert Skidelski and less like Paul Krugman.
-it is necessary to continue to sound the alarm about the danger of a second Great Depression.
-it is time to argue for Social-Democratic reforms, not just for the financial sector, but for the economy as a whole.
-it is time to get the unions and working people involved, we need some way politically to pressure both the Republicans and the Democrats.
-time to advocate for a permanent extension of unemployement benefits in the United States.
The world cannot bear the catastrophe of another Depression!
Mr. Johnson, Mr. Kwok and the others:
You are “insiders”, you must now become “outsiders”.
You know what to do!
You are absolutely right, life is no easy game, but the fact remains that among the thousands of small banks you do have, many of them are not lending to “sort of reasonable borrowers”, because they cannot find the capital for it in times when bank equity is so scarce… and baseline-blogs make it more difficult to get badmouthing banking and bankers in general.
Bayard, I hate to admit it but changing the actors or the institutions from bad guys to good guys changes nothing.That kind of thinking is with all due respect either hopeful, meretricious, or delusional. We have gone from a productive economy which had good paying middle class jobs to a financial economy which trades paper, fundamentally a trading and now casino economy. We tax productive workers and companies and don’t tax or even regulate the paper economy. You need to tax things you don’t want and don’t tax what you do want. Don’t like pollution and imported oil:tax it. Don’t like unregulated derivative trading, and bogus trading and zillion dollar banker and hedge fund salaries, TAX them. As long as the banking industry can get 0.25% money and buy treasuries and get likely 5% from the FED printing press, why would they invest in a company or an industry even if they produce jobs.Hey let’s leverage those securities 10:1 with more borrowed free fed money, now we get 50% with virtually no risk.Of course they will not lend to the productive economy! The incentives and tax system are so totally wrong. We had the most productive middle class and productive companies in the 1950’s and ’60’s and the upper income tax rates were very high 70-90 % so rich people and banks invested their money in productive activity to cur down their tax burden and the economic results were without parallel. They produced jobs too! When you are lost in the woods, the best thing is to backtrack to someplace familiar instead of going forward. This change to a paper pushing “economy” was an unmitigated disaster and there is no sign that these very intelligent and unbelievably stupid Harvard educated Goldman Sachs banksters know what damage they are doing to the country. Or do they?
I think that any financial entity that couldn’t have survived without government assistance should have been 100% socialized, if salvageable, to the state and sold after the mess was solved.
How much will the TARP etc cost in the long run as it’s beneficiaries create drag to the growth?
There is nothing Americans can learn from the 1990’s after the first completed decade of the 21st century. The US has lost too much manufacturing, is too far in debt to other nations (China), is even more regulated, and is directionless. The 1990’s are now relegated to history with most Americans never to see thaht sort of prosperity again. As former President Clinton used to say that the 1990’s were “building the bridge to the 21st century.” Well, we have have crossed that bridge and are 10 years into the 21st century with not alot to brag about. Look to the future and not the past!
Danny L. McDaniel
About lending without meeting reserve requirements and borrowing later:
“This first major paper on this approach, “The Endogenous Money Stock” by the non-orthodox economist Basil Moore, was published almost thirty years ago. Basil’s essential point was quite simple. The standard money multiplier model’s assumption that banks wait passively for deposits before starting to lend is false. Rather than bankers sitting back passively, waiting for depositors to give them excess reserves that they can then on-lend,
“In the real world, banks extend credit, creating deposits in the process, and look for reserves later”.
Thus loans come first—simultaneously creating deposits—and at a later stage the reserves are found. The main mechanism behind this are the “lines of credit” that major corporations have arranged with banks that enable them to expand their loans from whatever they are now up to a specified limit.
If a firm accesses its line of credit to, for example, buy a new piece of machinery, then its debt to the bank rises by the price of the machine, and the deposit account of the machine’s manufacturer rises by the same amount. If the bank that issued the line of credit was already at its own limit in terms of its reserve requirements, then it will borrow that amount, either from the Federal Reserve or from other sources.
If the entire banking system is at its reserve requirement limit, then the Federal Reserve has three choices:
refuse to issue new reserves and cause a credit crunch;
create new reserves; or
relax the reserve ratio.
Since the main role of the Federal Reserve is to try to ensure the smooth functioning of the credit system, option one is out—so it either adds Base Money to the system, or relaxes the reserve requirements, or both.”
This back and forth between Min and Per Kurowski illustrates quite nicely some of the problems I have with pure monetarists like Scott Sumner. My understanding is Sumner believes that if the Fed could just print enough money to ensure a NGDP target of 4-6% everything will turn out all right. This view seems to me to be overly optimistic about the chances the newly minted money will be well spent. In the past StatsGuy has talked about “leaks,” from international trade imbalances and temporal arbitrage by TBTF market makers like Goldman Sachs:
Now we have Per Kurowski pointing out that under the current capital reserve guidelines much of this money is being directed to fund various governments’ sovereign debt obligations. Fiscal policy solutions have their drawbacks too, i.e. a huge debt burden on future generations. It’s all really very confusing and I’m not sure I think there are any right answers. I do tend to agree with Per Kurowski that the government should get out of the business of assessing risk. Instead, I think it should aggressively invest in ensuring transparency. The S.E.C. has failed miserably to ensure transactions are conducted in a fair and open environment. Maybe instead of worrying about how much capital banks should keep on hand for different types of investments, regulators should concentrate on ensuring that the assets being traded are what they purport to be.
NKlein1553 “I do tend to agree with Per Kurowski that the government should get out of the business of assessing risk.”
Well I do not really care much if the government wants to assess risk or not… if it wants to do so, let it… but what it absolutely should not do is to interfere in the markets by means of introducing a regulatory bias in favor of what is perceived as low risk.
When the regulators decreed that an AAA rated investment or borrower generated only a 1.6 percent capital requirement for the banks, while an unrated small business or entrepreneur caused an 8 percent requirement the regulators helped the already benefitted AAAs to access credit on relatively cheaper terms. How could regulators have been allowed to stimulate the banks to go into AAA businesses? Are the banks not really supposed to help risky non AAAs to grow and become the AAAs of tomorrow? Well they stimulated the AAAs so much that the AAAs became the most dangerous game in town.
I am amazed at how a blog that attacks so much the too large to fail banks does not criticize the support given to the “too safe to default”. The only explanation I can find is that the producers and owners of baseline have a bias against bankers and in favor of regulators.
And of course I wholeheartedly endorse “I think S.E.C. should aggressively invest in ensuring transparency”
Could you please define what you mean with “should have been 100% socialized”
The point to understand is that the relationship between government and non-government is vertical and that between the financial system and non-government is horizontal.
What this means is that while commercial banks can increase the money supply measured in M1, M2, and (previously) M3, all commercial transactions net to zero as a matter of double entry accounting. The commercial banks cannot affect non-government net financial assets (NFA). Conversely, the government operates vertically with respect to commercial banking. Through deficit spending government increases non-government NFA and through taxation decreases non-government NFA, as measure by M0 AKA base money and high-powered money.
What many people fail to take into account is that since August 15, 1971, the US government is the monopoly provider of a non-convertible floating fx currency of issue, hence, is not financially constrained and doesn’t need to tax or borrow to finance its deficit spending.
The analogy between government and firms, households and states in the US breaks down because the former is the currency issuer and the latter are currency users.
The only constraint on currency issuance is real. If the government issues currency in excess of real output potential, then inflation results, and if the government doesn’t issue enough currency sufficient for the purchase of real output capacity, then deflation results. The government must issue the appropriate amount of currency to keep nominal aggregate demand in balance with real output potential to avoid price instability.
The fiscal scolds are thinking in terms of rules that applied under the gold standard, when US currency was convertible and exchange rates were fixed. That is now obsolete, providing new flexibility and new opportunities about which many are unaware.
See the L. Randall Wray, Warren Molser, Bill Mitchell, Scott Fulwiler, Marshall Auerbach, and Winterspeak, for example.
Tom Hickey “since August 15, 1971, the US government is the monopoly provider of a non-convertible floating fx currency of issue, hence, is not financially constrained and doesn’t need to tax or borrow to finance its deficit spending.”
Man, are you up for a surprise!
If you don’t fully understand what I wrote, then you don’t get how the modern monetary system works. This is not theory based on assumptions. It is based on standard national accounting principles and stock-flow consistency.
You might try starting with Bill Mitchell’s post, “Stock-flow consistent macro models.”
A good introduction is Understanding Modern Money: The Key to Full Employment and Price Stability by L. Randall Wray (1998), available to read online at Google Books.
After my debate with zannon over the merits of creating a consumer financial protection agency a few weeks back:
I started reading about some of the modern money theorists Tom Hickey refers to above. Maybe it’s because my background is in economic history and teacher education, but I find a lot of what they write to be rather confusing. I frequently come away from reading posts by modern money theorists not knowing exactly what policies they are advocating. However, I’m pretty sure this is just because I’m dense, not because of the quality of their writing. A lot of what they write seems very interesting, it’s just I need to spend more time thinking through the logic. A course in accounting might help too.
I was going to insert this above but the discussion has moved forward. Comments are made that the banks cannot loan to the general economy for reasons other than the most obvious. While the banks have Cash Items at December 31, 2008 of $1184.2 bn on their Balance sheets, these same banks have $1025.3 bn on deposit at their Federal Reserve Banks. This number includes deposits at the FRb and vault cash. Simply put, the FRB’s are unable to transfer much of the balances on deposit to the credit of their member banks. The FRB’s have no way to practically generate the funds needed to honor a request for a wire transfer by member banks beyond normal workday needs.
Consider this. The member banks all wire out their deposit balances the same day because their vault cash exceeds reserve needs. Prior to September 2008 this was normal practice and total member bank deposits to their credit at the FRB’s rarely exceeded a total of $10bn. Last night total deposits of member banks were $1025.3 bn.
OK, FRB’s wire it all out to us! What might the FRB’s wire out? Nothing unless they sell all of their holdings of MBS’s which they carry at par ( principle) plus accrued interest. This total as of last night was $908.3 bn . Consequently, the FRB’s would need to sell their Agencies to make up the difference if they sold all the MBS’s for their Balance Sheet value. That is they must sell their Agencies to the tune of $117bn to cover with proceeds.
Of course, the FRB’s might also send out currency as well but they have less than $200 bn on hand. They cannot sell Treasuries because the Federal Reserve Note liability outstanding is $889.7 bn and that must be covered.
What the banks carry as Cash and Equivalent on their Balance sheet at December 31, 2009 of $1184.2 bn is almost all a combination of Vault Cash and deposits at their Federal Reserve Bank. Prior to september 2008, this was not the case. Deposits at their FRB were nominal leaving only vault cash as a sequestered item.
The banks are not flush with liquidity in terms of real world meaning. Since the MBS’s are carried at cost plus accrued interest room for sale at a loss is almost nonexistent since the total equity of all the FRB’s is a paltry $52 bn. If you track the depositary account of the Treasury on the Books of FRBNY and the interbank accounts it is obvious that most of the interest earned on those $908.3 bn MBS’s flows to the Treasury account as it should. Thus, in a pinch, the MBS’s could be sold within a loss parameter of cumulative earnings on the MBS’s credited to the Treasury. There, I believe , is the reserve for losses on dumping MBS’s. That gives BB and Company a reserve of around $180 bn that will grow at around $5 bn a month plus loan payoffs and principle reductions less write offs net of recoveries.
So, after all, the banks sold at cost in 2009 and over the years any losses will be borne by the central banks. They do intend to run off these assets.
In short though, the bulk of cash of banks is really sequestered and should be considered to be mostly a sequestered cash account.
My hat is off to BB for being able to stop the panic with almost no tools but a bluff that most people do not understand central banking. All he had in the fall of 2008 was bluff as an arrow in his quiver as I see it.
My numbers here came from the December 31, 2009 Federal Reserve Board Statistical Release. H4.1 and H 8.
Jerry, if I understand you correctly, you mean by the FRB’s “wiring out” reserves (which are deposit accounts of commercial banks at the FRB) is that the reserves enter the commercial banking system. That’s not the way the reserve system works.
Bank reserves don’t enter the commercial banking system directly other than by being exchanged for the collateral that the banks put up at the Fed and which appears as an asset on the Fed balance sheet. The reserves system is entirely interbank, involving settlement (clearing checks) and interbank loaning of reserves to meet reserve (liquidity) requirements.
The Fed can and does always enable banks to meet reserve requirements if they do not borrow reserves from other banks just by a computer stroke (at the going interest and possibly a penalty if the discount window is used.). There can never be too little reserves available with the Fed as currency issuer, the Fed not being financially constrained. The issue is not the availability of reserves but the interest rate the banks pay to borrow required reserves as needed, which the Fed sets as a target (FFR) and meets through OMO.
It remains to be seen what would happen if securities the banks have put up as collateral at the Fed default. Technically, these are temporary transactions and the Fed has a claim on the bank against an unfunded liability. Whether the Fed would ever choose to collect on this is another matter. The purpose was to get the dreck off the banks’ books at least until they are recapitalized.
MMT is actually pretty simple to understand even if one doesn’t understand very much about micro, macro, or finance. It does help to have a basic understanding of double-entry account principles, but only a very basic understanding is required to get the underlying concepts. One may have to read some things over several times. I know I do, but it has always been worth it.
Economists often have a more difficult time getting MMT than non-economists because they have have a set way of looking that they have to get beyond. Many find this difficult. Moreover, a lot of economists don’t know much about the details of finance, and especially central bank operations, but think they do. (Even Ben Bernanke seems to be in the dark about some of this, for example, when he says that banks land out reserves. They don’t. Or they let the president say that the country can “run out of money.” It can’t.) Finally, a lot of economic principles were developed under gold standard thinking and these haven’t been revised or adapted, for the most part. Lots of fundamental misunderstanding among economists persists, and it is affecting policy.
Those interested in IMF policy might be interested in Bill Mitchell’s “IMF agreements pro-cyclical in low income countries” about the damage it continues to do
Think about it, there cannot be anything more pro-cyclical than favoring with regulations those currently rated AAA
Read it… you are saying that “the US government is not financially constrained and doesn’t need to tax or borrow to finance its deficit spending”. Have you asked the Chinese or the gold price lately?
How to begin again: To finish my point about President Obama being so weak-kneed to the banking lobby, CEOs, corporate America, The Rs, Blue Dogs Dems, etc. etc. President Obama sought the advice of President Bill Clinton, knowing the dynamics of being the first AA president. The White House receives millions of emails daily but I would strongly suggest to readers of this blog to email President Obama (as corny as that may sound!). I have emailed to the White House through their link on several occasions, knowing it would probably end up in a “black hole” unless I was another good example for their political public relations opportunism. But you never know, as I had done the same, emailing to President Clinton back in the early 1990s and actually received a signed letter in the mail from him–however, this was before President Clinton sullied his personal reputation and was later disbarred for lying to the Grand Jury.
That was a really spectacular post! I’m going to be adding professor Mitchell’s blog to my regular reading list.
Tom Hickey, what I am saying is that if all the banks withdrew most of their reserve deposit accounts in the past they would be funded by proceeds of asset sales by the FRB. If at the end of the day, they needed $5 bn to cover deposit withdrawls outside of currency requests , the FRB’s would sell some Treasuries and wire the proceeds received for these sales to the banks to cover their deoposit account withdrawls.
Now let’s assume the entire deposit balances of the banks were going to be withdrawn. The FRB’s would be required to sell assets to generate proceeds received in payment of those asset sales in order to wire the proceeds to the banks.
Trying to show here that the 100 fold increase in member bank reserve deposits is a frozen item for the bulk of the value, yet all of the value is included in cash and equivalents of the banks.
Naturally, in the workaday past before September 2009, the FRB’s could generate funds other ways to service net reductions in member bank reserve demand deposit accounts.
The idea that the FRB’s can create funds with the click of a computer does not work here because the first principle of central banking is that all funds generated are a liability that is backed by assets.
Let’s look at the bookkeeping entry. Combined entry all transactions as if they settled instantly. All member bank deposits are to be wired out.
Debit Member Bank Deposit Liability $1025.3 bn
What is the credit?
There are only two legal choices.
Credit Assets Sold namely MBS’and Agencies $1025.3 bn
OR Credit Currency liability for currency shipped to the banks of $1025.3 bn
Of course, if it were legal, the entry could well be a key stroke summarized as follows:
Debit Member bank demand deposit $1025.3 bn
Credit Funds created liability outstanding $1025.3 bn
Note that this would require no asset sales because demand deposits liability would go to zero and the funds created liability account would increase by 41025.3 bn.
What almost no one understands is that the magnitude of the balance sheet change renders aanks deposit balance at the FRB mostly, say 80 % , a frozen long term item. They have cash they cannot withdraw . All it takes to change that is a law change allowing electronic funds for general circulation backed the same way as currency.
Until September 2008, the outstanding currency liability was always the 90 % item plus of the FRB total liabilities. If I remember correctly the average member bank deposit liability for the first half of 2008 was around $7 bn. The current balance is 150 times that average.
It took the Federal Reserve System 66 years to generate an outstanding currency liability of around $350 bn before all United States Notes could be withdrawn. It took that long to generate the assets backing their currency liability. Now we exceed total currency liability of $889 bn with frozen demand deposit accounts.
The change since September 2008 is so vast that few understand that size changes everything.
By the way, the FRB’s could get rid of the MBS’s very easily by selling them back to the banks at their cost fully laundered to extingish the banks demand deposit accounts.
Here is the same entry on the banks books if the banks did that.
Debit MBS’ bought $ 1025.3bn
Credit Reserve Demand Deposit at FRB $1025.3 bn
After giving effect to this set of transactions the banks have virtually no cash and equivalents and much of this is vault cash.
So, the transactional entries work for either party to the transactions.
Zimbabwe never run out of money….right?
Answer to this very simpel question:
Can governments print capital?
Happy New Year!
But is it not possible that the only way to bring the world up to the next level of development, like for instance finding the new energy source that will allow growth without climate change, is elevating on a pro-cyclical bubble? How do you know a bubble you want to prick from one you want to keep? In the case of the subprime mortgages it was clear, the world was not to gain much from a house bubble in the US… but in other circumstances it is not so clear. Is it not a human right to have bubbles even though they explode?
Here’s how it works briefly. Deficit spending increases non-government net financial assets and taxation reduces them. They have opposite functions in the money system. Taxes do not “fund” spending. This is a mistaken idea arising from comparing government finance with private finance. It’s not how the system actually works because the government is the currency issuer and the non-government sector (private sector and state and local governments) are currency users. This is basic national accounting.
Borrowing doesn’t “finance” government spending either. Current US law requires a $-4-$ offset of spending with borrowing. What happens as a matter of accounting is that the Fed increases the Treasury’s deposit account at the Fed, then the Treasury writes checks and spends the funds, putting money into the economy that has no offsetting liability in the non-governmental sector. It is an increase in net financial assets. The settlement process in which the government spending checks are cleared increases bank reserves at the Fed. What this means is that the Treasury’s reserve account is decreased and the various banks reserve accounts are increased. This increases excess reserves, since no reserves are required here, unlike commercial bank lending. Then the Treasury issues debt (interest-bearing bills and bonds) which the banks buy and pay for from their reserve accounts. This is just trading one asset for another, effectively a “demand deposit” (reserves) for a “time deposit” (bills, bonds). The debt is paid for from the reserves created by the spending. It doesn’t matter who buys the debt, it eventually is settled through a bank with an account at the Fed.
There is no financial necessity to borrow to spend. This is a voluntary constraint that is the result of a political decision, not a financial constraint. What actually happens is that the deficit spending creates excess reserves that would be used for interbank lending. This could make it difficult for the Fed to hit its overnight target through OMO, so the borrowing assists the Fed by draining these reserves to “time deposits.” However, this is unnecessary and could be done more directly by paying interest on excess reserves to turn them into time deposits directly.
As I said, if you don’t understand national accounting, don’t jump to conclusions without doing some homework.
Have you ever heard of a loss of faith in a currency?
It can happen and it has happened.
” The FRB’s would be required to sell assets to generate proceeds received in payment of those asset sales in order to wire the proceeds to the banks.”
That’s not the way it works. This all happens in the interbank reserves system that is limited to member banks. Other banks go though member banks in dealing at the interbank level.
The Fed doesn’t “wire funds” to banks.
Bill Mitchell has anticipated you. See “Zimbabwe for hyperventilators 101”
Happy New Year to you!
Anyone who thinks that their dollars are going to zero any time soon can send them to me and I promise to properly dispose of them. I’ll even pay the postage.
“I find a lot of what they write to be rather confusing…I need to spend more time thinking through the logic.”
Don’t waste your time! Read “The Science of Money” by Alexander Del Mar. You will never be confused again. A just monetary system is easily understood and will produce a more just society when implemented.
I finally found that blurb: It was from the Nightly Business Report, Dan Gersh interviewing Dr. Johnson on being “populist”> GERSH: You’ve been making this argument that it was the financial oligarchs who created this problem and are now standing in the way of the solution. Explain that. That sounds very much like a populist argument.
JOHNSON: Well it has some dimensions of populism, I’ll agree. I’m not a populist per se myself. I’m a very centrist kind of character. I was chief economist of the IMF. They ask you on the entrance exam for that position how populist you are. So you can be pretty sure. I’m very centrist. But I think you’ve got to recognize what’s happened to our financial sector. ….. If you were walking into another country where you didn’t have emotional ties. It wasn’t your country and you look around at the structure we have, you’d say wow, these guys really has an oligarchy.”
Perhaps the Obama Administration can follow the above example from Simon Johnson, offering the realities of the times whenever someone tries to pin you down with labels, but that wouldn’t be self-serving to the political class – fractional banking in single digits ;-)
The problem with the approach of changing the system is that it would be a political nightmare to accomplish, just in the US. Morevoer, the US linked into the international monetary system and that would also have to be revamped. Possibility of that happening any time soon is zilch.
We have a monetary system capable of working fine if properly understood and implemented. That will take some reeducation but it is doable.
This conversation pretty much epitomizes the problems modern monetary theorists are going to have convincing people to listen to them. Having graduated college myself fairly recently I can tell you that JerryJ’s statement:
“the first principle of central banking is that all funds generated are a liability that is backed by assets,”
is very much in line with what is taught to people studying most branches of economics at the university level. From my roughly two and a half weeks of studying their views, the modern monetary theorists seem to be arguing that central governments are not really constrained by “assets,” or really anything else outside the possibility that money creation outstrip demand. This point of view is very attractive, but controversial. Then again, maybe I’m misinterpreting what I’ve read about modern monetary theory. At the very least I am definitely going to be thinking about this topic more in the new year.
I’ve also never understood all the harping on Zimbabwe. Zimbabwe is nothing at all like the United States. Japan would be a much better example. Japan had a speculative bubble followed by a spectacular crash which then lead to years and years of deficit spending to contain the pain. The result: ten straight years of pretty much constant deflation.
I understand that FRB’s do not wire funds. Bank demand deposit balances are now about 100-150 times historical norms. OK, let’s assume the banks want to take down their reserve demand deposits to historic levels and all at once. How do they do it legally? Property must be distributed to the banks in exchange for the reduction in deposit values owed the banks by their FRB. What is the property? It may only legally be currency in historical terms in exchange for the value reduction they seek or it is other property in kind like a swap of Treasuries . These the banks can sell and would be able to invest the generated funds as loans. Then, post 2009 , the FRB’s could and would be forced to distribute Mortgage Backed Securities or be legally empowered to issue electronic funds on the same basis is they presently handle currency. One way or another they must distribute property.
Prior to September 2008, bank cash and equivalents of banks reported to the FRB were in the area of $500bn with around $7- 10 bn of reserve demand deposits included in these totals. That is around 1 to 2% generally. As of last night the reserve demand deposit account was 86 %.
In the real world that 86 % deposit value is too material to be considered as a cash and equivalent. It is not “spendable” as cash would be. The banks cannot lend it out unless they receive “proceeds” that create transferable funds that can be lent. So either the FRB distributes the MBS as property or it sends over currency which would really create a problem.
Again , my point here is that the banks have very little free cash and equivalents compared to the end of august 2008. The auditors , now that it is after 2009 should require sequestration of this cash because in the real world it is an ” account receivable”. The bank is owed the balance. Previously, the reserve account balances could always taken as currency. Can the banks take currency of $1025.3 bn when there is only one fifth of that amount even on hand. and that one fifth to be issuable must be backed by added asset purchases. That tells the practical world that the Reserve Demand Deposit Account has changed character. By that I mean that portion of the demand deposit liability of the FRB backed by the MBS total is not a cash or equivalent. In short it is obvious that substantially all of that Reserve Demand Deposit is not a cash or equivalent on the books of the bank but a mere account receivable.
I have often thought that the reason the balances of bank reserve demand deposits are taken down is that there is literally no way of doing so
short of just moving the MBS’s back to the banks whose reserve demand deposit account was increased when they were bought. If so, these balances are not a cash and equivalent.
I would love for the big economic/ banking guru’s to present a detailed schematic of how the bank members present deposit balance may be taken down in one fell swoop other than mere transfer of the mortgages back to those that sold them in the first place. They would get them back at par.
“OK, let’s assume the banks want to take down their reserve demand deposits to historic levels and all at once. How do they do it legally?”
They could shift their excess reserves into Treasuries (“deposit account” to “time account”), they could exchange the excess reserves for the collateral they provided the Fed and which the Fed is carrying on its balance sheet, or they could exchange their excess reserves (not which they now receive interest) for Fed notes to hold as no-interest vault cash, or they could convert the excess reserves to required reserves through loans if they have the requisite capital, or decide to raise it by diluting their equity or else their operations are extraordinarily profitable, which they are, as current bonuses show. Or a combo of all of these.
From the side of the Fed, if the Fed wants to drain excess reserves to take back control of setting the overnight rate to raise it, it can do this with reverse repo’s, which is what Bernanke is talking up now.
Everything having to do with the central bank happens in at the interbank level. In the US, the Federal reserve system, the FRS is made up of the Federal Reserve Board, the Federal Reserve Banks, and the their member banks. It’s all done in digital accounts with keystrokes. The effects of this spread out through the commercial banking system through the member banks and the regionals and locals associated with them that don’t have accounts with the FRS.
OK, let’s assume the banks want to take down their reserve demand deposits to historic levels and all at once. How do they do it legally?
This is gold standard thinking, i.e. a convertible currency that is “backed” by something other than the currency. Presently, the US dollar is not convertible at the central bank into anything but other dollars $-4-$.
The constraint on money creation is real output potential, as well as the floating exchange rate. The floating exchange rate is immaterial for the US, which would like to see the dollar drop further to make US exports more competitive. That’s why other countries will intervene to prevent it from falling so far that their exports are damaged. This is called a “beggar-thy-neighbor” policy. It’s a hidden tariff.
Right now the US government doesn’t face a real constraint from inflation, with an output gap of about 30% and unemployment/underemployment approaching 20%.
The problem is that increased consumer saving and delevering, a structural current account deficit, and weak business investment the face of weak nominal AD threaten deflation. That is the real constraint at present. Since monetary policy is ineffective in a liquidity trap to stimulate lending, only fiscal policy can effectively deal with the situation by increasing non-government net financial assets, and thereby nominal AD. This is accomplished by automatic stabilizers that involve deficit spending and tax reduction, supplemented by the stim, but that’s not yet closing the output gap quickly enough to prevent economic hardship and an underperforming economy that comes at great cost in foregone potential.
Oops. I got the paste wrong in the first sentence in the comment above.
It should be “the first principle of central banking is that all funds generated are a liability that is backed by assets,”
Thanks, on whose books do the mortgage backed securities wind up on? Property was transferred to create the increased Reserve Demand Deposit Account layer attributable to Mortgage Backed Securities.
The summary entry on the banks was :
Debit Reserve Demand Deposit Account at FRB $1025.3 bn
Credit . MBS’s owned $1025.3 bn
That value has simply sat in the Fed account. Now I want to take out the proceeds of my sale to invest elsewhere. Transfer me Treasuries and agencies to cover.
The banks as a whole again make this entry;
Debit: Treasuries / Agencies Owned $1025.3 bn
Credit: deposit at FRB $1025.3
Now it gets dicey. The FRB’s only have $918.043 bn of Treasuries and Agencies so they cannot cover. They go out and buy the difference for currency to keep it simple . A total of $107.228 bn
That means the Federal Reserve Banks ( consolidated) have no Treasuries on their books and that the assets backing the issuance of Federal reserve Notes consists of Mortgage Backed Securities , the Special Purpose Entity holdings, some Repos and assorted other assets. I ignore the Gold Certs because any increase in value would accrue to the Treasury from what I understand.
Again my point here is that changed circumstances render the banks treatment of their Reserve Deposits as a cash equivalent as subject to reclassification to an account receivable due to it’s illiquid nature. It is fiscally obvious that settling the Reserve Demand Deposit liability with Treasuries and Agencies would break the entire central banking system. The FRB’s cannot settle the item out and that forces a re-evaluation of the Reserve Account as a cash and equivalent.
The change in assets in 2009 of the Federal Reserve banks, New York in particular, requires that banks no longer carry most or all of their reserve deposits as a cash or equivalent item.
Not that this would ever happen, of course. Compared to before September 2008, the member banks have very low working cash and equivalents. Less than $200 bn. ( I am using the numbers in the December 31, 2009 combined balance sheets of the banks, h8 Line 25.)
The Federal Reserve Banks do not have sufficient liquid assets to cover a depositary take down and still be presentable to the world.
What I am attempting to get at here is the lack of ability of the FRB’s who hold the banking assets to supply financing to the real economy as everyone comments. In real world terms the best the could do is increase currency in circulation to the tune of around $90 bn since August 2008 and a goodly chunk of that resides in vault cash.
Again it seems to me that a primary reason for buying these Fannie and Freddie guaranteed mortgage backed securities was to remove them from mark to market problems and later resell them back in the next year or two cleansed in ways where they will be carried at par. But either way there is a change of character in the cash and equivalents of the member banks.
Jerry, it is a non-issue. If the dreck on the Fed’s books goes bad, they will write it off instead of the banks. I suspect that was the intention all along. But in the meanwhile Bernanke is doing all he can to reflate those dogs.
In the end, a lot of bad debt is going to have to be written off, and since it is in the financial system, a lot of that will fall to the government guarantees already in place to stabilize the system. Suitable “arrangements” will be made to make it legal, just as Bernanke has used his emergency powers so far.
The government is the house and it has unlimited chips at its disposal. It will do the necessary, and take care of the accounting details later, if need be. The Fed doesn’t ever have to “go out and buy currency.” They issue the currency, and there is no financial constraint on this. It’s just key strokes.
Government buys the company at $0 per share.
Way to expensive! Creditors would love you. The day after the US entering Iraq the value of Iraq debt in the market shot up.
Tom Hickey “The floating exchange rate is immaterial for the US, which would like to see the dollar drop further to make US exports more competitive”
Only within some very constrained ranges… you do not want to have to pay US$ 7.000 per barrel of oil just because de US$ is considered worthless.
Tom – thanks for the lead to bilbo (hidden Lord of the Rings reference??)… this is the first I have heard of Modern Monetary Theory, and it is very counter-intuitive for this post-20-year-econ grad…. I’d be very interested in hearing the BS thoughts on MMT, as I would like to hear the MMT opinion on TBTF.
Tom Hickey “The government is the house and it has unlimited chips at its disposal.”
Though I have not heard of one house that has unlimited chips at its disposal… a sort of “Vegas can´t go broke” I must say that for a foreigner it would seem that you have then deviated quite a bit, probably much too much, from what we can read in your declaration of independence with respect “Governments are instituted among Men, deriving their just powers from the consent of the governed”
As a citizen from an oil-cursed country let me assure you that when government holds all the chips they do not care one iota about the citizens.
Per, the US would not mind too much if oil got way up. What most people don’t realize is that the US physically holds about 1/12 of the world’s known oil, and probably more if the price goes high enough to recover the slag. In addition, US companies have a lot of profitable deals and leases around the world. The US oil industry would do very well, thank you.
Many of the left would like to see the price of oil a lot higher, too, since it would spur investment in energy alternatives.
Oil producers are also constrained on how much they can charge, since their economies are dependent on exporting petroleum.
Teotac, check out Warren Mosler, “Fixing the economy.”
Behind all the mumbo jumbo, the IMF simply represents the long arm of corporatism. The idea is quite simple: use any crisis in an ’emerging market’ or ‘developing country’ (or whatever the current colonial euphamism) to increase corporate priviledge.
” I’d be very interested in hearing the BS thoughts on MMT, as I would like to hear the MMT opinion on TBTF.”
Many economists don’t understand finance and national accounting, so they attack MMT because it denies some major assumptions of orthodox economics. So their objections are superficial rather than in terms of what MMT is actually saying about the operation of the monetary and fiscal system, and the implications of this for economics and political economy.
However, having been chief economist of the IMF, I sure that Simon understands government finance very well. I would love to hear his take on MMT, too.
BTW, MMT is descriptive not normative. It can be applied in a conservative way by emphasizing tax reduction to increase nominal AD when there is an output gap, or in a liberal way by emphasizing deficit spending. Warren Mosler tends to come down the conservative side and Bill Mitchell on the liberal side, for instance.
Per, somebody always holds the chips. I’d rather have it be an elected government that the people can replace instead of a plutocratic oligarchy of financiers and rentiers that is entrenched in wealth and power.
Of course, a plutocratic oligarchy now controls the US political process through campaign finance, lobbying, and the revolving door, which is why we need to get the money out of politics and shut that door, too. But this is at least doable at the ballot box, even if almost impossible. Conversely, overthrowing a tyranny requires a revolution.
Any power of that sort you describe as “limitless” will be misused… even against those original Dr. Frankenstein´s who created it.
Hey, you are talking to a Jeffersonian here. Couldn’t agree more.
However, the solution is not to stick one’s head in the sand or complain about it, but try to harness it for the good.
Right now that power is being used not to promote “socialism” but corporate statism.
While all the patriots are concerned that the road to serfdom lies through socialism, the corporate state has taken over while the patriots were looking in the other direction.
Could you give examples of these lies and provide sources?
What happened to all those productive middle class and companies during the 70’s when the top tax rates were still very high? Just trying to follow the logic, thanks.
I can see my writing skills are not up to the subject relating to the massive change BB instituted after August 2008. Governments will do what the controlling elites desire until they cannot. When that happens their system goes down as I fully expect will happen to a capitalist system of any stripe over time. So maybe Ravi Batra will be on target as to the dissolution of western finance capitalism after all. He predicted 2010 plus or minus ten years as I remember.
The one thing I keep getting out of financial system discussions is that complex financial organization financial statements are of little value to investors. FAS 157 has introduced uncertainties about whose mark to market valuation was used. Their fantasy versus my evaluation of reality or my fantasy versus their reality. At least with cost one could make his/her own qualitative adjustments from a common base. Then, banking is not the same as being a merchant at the same time on the same asset types. Banking going concern requires loaning to term not to sell except nominally. Merchandising the same assets is simply going to destroy going concern of banking. That is what we are observing now. That is banks that merchandise securities instead of loaning to term are no longer banks. Might doctors also be undertakers in the same business?
Given that banks when they lend to the governments need no capital, and when they lend to an AAA rated corporation they need only 1.6 percent in capital, but that when lending to an unrated small business, entrepreneur or ordinary citizen they are required to come up with 8 percent, which favors those already favored in the market… what we could have is neither socialism or corporative statism but a fusion of them both… A sort of G rated Joseph S. & Benito M. get-together.
Per, the oligarchs running the corporate stater know that to stay on top they have to provide bread and circuses for the masses. It’s a small price to pay in their eyes.
When they forget it, they get into trouble. That may be happening. There’s a lot of overreach now that they have opened a backdoor to the US Treasury.
Tom, your efforts here are well appreciated; don’t get discouraged by the hostility.
As a minor aside, I think many critics are conscious of the govts ability to print money, and hence have focused on hyperinflationary fears – which are overblown (at least in the next 5 years). [If the Fed had kept on its aggressively deflationist path for much longer (instead of a neutral price path, which is probably still too low) we’d have almost certainly doomed ourselves to very high inflation due to the accumulation of govt. debt and low NGDP growth. Events are now less certain.]
IMHO, the massive nominal debt overhang is a huge factor to prevent de-anchoring. Hyperinflation is very unlikely (contrary to what folks who frequent ZeroHedge and ShadowStats like to claim). The primary de-anchoring risks are inflation-indexed govt transfers and imports (especially commodities).
ShadowStats has moved up his timetable for the collapse of the US dollar to 2010 – this year.
Apparently, it was one of the top ten articles at ZeroHedge ever.
I just wonder whether – when 2010 ends without hyperinflation – ShadowStats will publish a public mea culpa, and take its rightful place in a cardboard box on the street corner with its everpresent doomsday placard.
“Postponing reform attempts until the banks were out of intensive care was a mistake – and just what today’s economic leadership used to warn against,” that about sums it up, well put Mr Johnson.
I’d be curious to read a Baseline-review of Niall Ferguson’s 2009 predictions, and how they played out in your opinion: read http://www.ft.com/cms/s/2/1be84cc4-cc0d-11dd-9c43-000077b07658.html?catid=120&SID=google. For instance, Ferguson predicted that, in looking back by the end of 2009, we would be able to agree and declare that “in relative terms the US gained, politically as well as economically.” The Dollar exchange rate versus the Major world currencies looks compelling and strengthening towards that argument; but, the Dollar versus All world currencies is apparently another story. Maybe it’s a question of comparing nominal terms against real terms? Or maybe it’s a matter of “choose your variable?”
For an Atlanta-based economic view of 2009 in review, I have pulled together a final year-end account, here: http://economer.wordpress.com/2010/01/01/lords-of-finance-2009/.
Keep up the good work in 2010 and beyond!
The president isn’t naive, he knows exactly what he’s doing: pandering to the elite to secure himself a bright post-presidential future. Just like every president for the last 30 years has.
I do not like the word oligarchs because it is to laden with darkness and the current crisis more than the result of any dark planning was mostly the result of some very stupid regulations brought upon us by some very arrogant regulators who thought themselves Gods able to control for the risks they wanted to control for.
I almost wish I hadn’t read that. The string of expletives that ran out of my mouth as I perused the article would make a sailor puke in a bucket from sheer discomfort.
Right. However, Japan ran huge deficits relative to GDP and the yen did fine and interest rates on government debt stayed low, contrary to all the hyperventilation about loose monetary and fiscal policy.
Bill Mitchell comments:
“US financial market commentator and investment advisor Tom Nugent wrote elegantly about this (Source):
‘One can also see that the fears of rising interest rates in the face of rising budget deficits make little sense when all of the impact of government deficit spending is taken into account, since the supply of treasury securities offered by the federal government is always equal to the newly created funds. The net effect is always a wash, and the interest rate is always that which the Fed votes on. Note that in Japan, with the highest public debt ever recorded, and repeated downgrades, the Japanese government issues treasury bills at .0001%! If deficits really caused high interest rates, Japan would have shut down long ago!'”
I think Bond Girl clearly got it correct.
Um, I’m not sure that cartoon makes the point you were aiming at.
The decade since the end of the Clinton Administration has brought out a level of greed and corruption in this country that has not been seen since the 19th century. Summers and Geithner merely reflect that mores that are dominant in Washington. Behavior which was previously not acceptable has now been given tacit permission. The cynicism of the Bush Administration served to accelerate the downward spiral.
Ya, the cartoon changes intermittently at that link. It was a caricature of Napolitano with her trousers on fire saying “The system worked!!!…..until the pants caught on fire…….”
I should have stopped reading that article you linked when the author stated: “Inflation is the continous rise in the price level.” and “Hyper-inflation is just inflation big-time!” Ouch….
However I did read it till the end…
So let’s clear some misconceptions:
– Hyperinflation is not the ugly child of high inflation, actually the only thing that inflation and hyperinflation have in common is the “inflation” word.
Hyperinflation is the total loss of confidence in the fiat currency of that particular country, the famous “crack-up” boom. Hyperinflation can be more related to an initial period of deflation in a fiat currency regime than inflation.
– Zimbabwe is not your typical piss-poor hopeless African country.
In the past was well known as the bread basket of Africa, very high productivity, good infrastructure (by African standards) and a good university system.
In the early ’80s one Zimbabwe dollar was exchanged for over 1.40 USD.
– Let’s not focus only on Zimbabwe or the Weimar republic…what about well developed, relatively technologically advanced (and with a large middle class) countries like Brazil in the 1980s or Argentina (twice) in the ’90s and the beginning of the 2000s??
– The comparison of US with Japan doesn’t make any sense, it’s apples to oranges.
Japan external debt it’s only 34% of the GDP Vs. 95% for the United States.
Japan had a significant trade surplus Vs. the US chronic deficit.
Japan has a very high saving rate Vs. the US where up until very recently, it was actually negative.
So some governments can afford to go deeper in debt than others because the market has more faith in that particular nation output capabilities. Remember it’s all matter of trust and perception….one you lose it you cannot get it back.
That said, it doesn’t mean that Japan is not making monumental mistakes….it’s just that their economy, sa far, can take the hit of insane policies…again so far…
Furthermore, Japan has dumped an anormpous amount of money into infrastructure related projects compared to us where we basically only bailed out the financial oligarchy and implemented idiotic initiatives like cash for clunkers…the best way to deal with people with too much debt is to get them even deeper in debt….ok got that…
So the land of rising sun, at least, has something to show for it, few bridges to nowhere here and there that, overall, could actually have improved productivity.
-There is so much “faith” in the fiat currency of US that the long end of the UST yeld curve is going ballistic…..
– Tom you said: “Anyone who thinks that their dollars are going to zero any time soon can send them to me and I promise to properly dispose of them. I’ll even pay the postage.”
Well, so far, we are at 97% loss of purchasing power since 1913….that is what I call a strong hint…;-).
Do you believe the official inflation numbers??
By the way, to me sky high equity prices (with no relation to fundamentals) and oil at $80 a barrel in a supposedly depressed economic picture, is high inflation….let’s remember that inflation is an increase in the money supply that can show up in different places (asset prices, consumer prices, etc…)
– The author of that article says: “Zimbabwe is an African country with a dysfunctional government.”
We do have that in spades…..political system capture by the financial interests, official statistics that did become a travesty, a whole bag of accounting tricks and an extend and pretend policy, etc…
And we do not produce almost anything anymore, we are a nation of paper pushers and too many managers.
Remember Simon Johnson’s article about the suggestions that IMF would offer to countries in financial crisis about severing the ties with the special interests?? And you remember when he said that this should apply to us at the present day??
Have you noticed the amount of “silent” QE that the Fed is implementing?? Some food for thought, read this excellent piece of financial investigative work
Click to access 12_2009_MAAG.pdf
Remember, it’s all about trust and faith…once you lose it, once the dam breaks in the sovereign debt markets it’s impossible to go back without significant pain.
With all this I’m not saying that the US will necessarily end up like Zimbabwe or Argentina of Brazil in the 1980s…what I’m saying is that it could happen…never say never….and the idea that a country can go in debt indefinitely is asinine at best.
Dominic, if you are a market player, you know everything rides on whether there will be inflation or deflation as far as asset prices and interest rates are concerned. You make your decision and place your bets. Good luck to you, man.
As far as policy goes, the Obama administration is apparently siding with the fiscal scolds and is ready to tighten. Good if inflation is looming, disastrous if not. We’ll see.
2010 has some stories to tell.
As far as your comments on Bill Mitchell’s post(s), Bill is very kind about responding to comments and questions at his blog, if you care to pursue this with him directly. As far as IMF goes, Bill is not only an economics prof but also serves as an advisor to emerging countries, so he is very knowledge about the consequences of IMF policy.
Winterspeak just posted an interesting on Japan in relation to the US from the MMT perspective.
I take it, that everytime you have been wrong, you have published a public mea culpa and taken your rightful place in a cardboard box on the street corner?
You said: “The constraint on money creation is real output potential”
Yes it’s true…but only in theory, unfortunately, history has demonstrated that fiat currency systems end up being abused…always…
Remember we are under the current fiat system since only 38 years and counting…and it’s already bursting at the seams…
We cannot have an infinite monetary system with finite world resources.
You said also: “The floating exchange rate is immaterial for the US, which would like to see the dollar drop further to make US exports more competitive.”
That is exactly the problem with the folly of the unredeemable fiat currencies…a destructive debasement war starts with disastrous consequences for everybody in the end.
With a non manipulable currency system in place, (backed by gold, silver, energy, sea shells, whatever) China could not have accumulated that enormous trade surplus….the unbalances would automatically (more or less) correct themselves and an equilibrium would be reached.
“Right now the US government doesn’t face a real constraint from inflation, with an output gap of about 30% and unemployment/underemployment approaching 20%. ”
If we would have left the market find its natural price level (housing, wages, etc..) we would have experienced an extremely painful but short recession, growth would resume quickly at a price level the market can bear…..but politically is unacceptable, and that is the problem…someone (corporations, labor special interests, financial oligarchs) need to be “sheltered” more than others so it’s a slow drag for everybody…
Deflation (the natural consequence of an economic correction) it’s intolerable to the government and the financial interest because when money is created as debt, debt repayment of repudiation “destroys” money….it vanishes into thin air as is created in the same way.
Hyperinflation is the final stage of a fiat currency…good for debtors but the credibility of the system is wiped out…..the ideal outcome for TPTB is slow insidious inflation (the frog in a cooking pot principle) supported by good statistic massaging of reported inflation.
Remember we did not have real free market (far from it) in this world as much as we did not have real keynesianism either (Keynes called for spending restraint during good time….let that to politicians…)
The sad truth is that corporations the last thing they want is real free competition…if they can they will knock at the government door for protection.
Unfortunately the kooks that had the upper hand in the last 30 years were the monetarists.
What I do not accept is the misrepresentation of Austrian economic principles as corporativism and far right wing gibberish.
Austrians are against for too big to fail (what a foreign concept nowdays!!), military adventures, special interests, natural monopolies, fiat currencies and a fractional banking system (a sound money regime with a FBS tend to be instable anyway)
We stand for personal responsability, real innovation, continuous productivity improvement (the real source of wealth, not the printing press) and real capital formation.
Dominic I agree that comparing US and Japan does not make any sense now, it is like “apples and oranges”… though, long term, all fruit rot.
Now with respect to the Eric Sprott & David Franklin article quoted it reports that “Commercial Banking were buyers of approximately $80 billion”. Given the zero capital requirements for banks when buying Treasuries and the need to park liquidity because of lack of bank equity that figure sounds low and could be part of the unexplained “Household Sector a catch-all category. But also ask yourself what would have happened to the demand of US Treasuries by the banks if these investments had generated the same capital requirements than the lending to an ordinary citizen.
And if this happens with Treasuries imagine what goes on in the US Bond market where banks would not be able to make any spread if required to hold any capital. Government bails out the banks, so that banks can bail out the government?
One part of the trap where you have fallen because of current bank regulations is that the demand for Treasuries and Bonds, just as the demand for AAA rated investments, has been artificially bolstered by the low capital requirements for banks, which means you have no idea of the real underlying interest rates required to sustain the demand of Treasuries and Bonds… which means you are navigating with instruments that are quite unreliable.
I have been writing about this for a long time on Baseline but this has been of no interest for the producers of the blog who seem to be more interested in bank bashing to the choir…. Is BASELine just the frontline of BASEL?
A sign of the economy growing or of after Christmas excess inventories?
The long end of the yield curve is so high partly because the Fed continues to hold short term NGDP growth low, and partly due to Congress’ inability to deal with demographic trends and medical costs.
Short term deflation makes long term default/hyperinflation more likely.
“the idea that a country can go in debt indefinitely is asinine at best”
Well, from a national accounts perspective, printed currency is exactly that. So are you for a return to gold? (If so, I know to stop wasting my time arguing with you.)
“we are at 97% loss of purchasing power since 1913”
Really? So the average (or median, if you prefer) individual in the US is consuming 97% less than in 1913? Why do I care about the value of the dollar over 100 years, instead of the value of the real economy? I take it you disagree with this then:
Finally, how (precisely) would you advocate altering the trade deficit without devaluing the dollar? (Congressionally legislated tariffs? Congressionally legislated domestic productiong subsidies? Congressionally legislated anything?)
Maintaining the purchasing power of the dollar over a long period of time is not the end all and be all of monetary policy. Yes, the ability of a single dollar to purchase a given basket of goods and services has declined significantly since 1913. But so what if it takes more dollars to purchase the same amount of (higher quality) goods and services? It’s not as if the cost of printing dollars is going to bankrupt us. Certainly not when compared to the resource cost of producing gold. Milton Friedman estimated the cost of maintaining a full gold coin standard for the United States in 1960 to be more than 2.5 percent of GNP. That would be 300 billion in today’s dollars (and that’s assuming the cost of extracting gold hasn’t gone up, which in fact it has considerably). Are you trying to argue that because we need more dollars to purchase the same amount of goods and services our standard of living hasn’t improved since 1913? That would be absurd.
Rather than look at the purchasing power of a single dollar a much better metric to gauge the success or failure of a nation’s monetary policy is price stability. In economic history a common measure of price instability is something called the “coefficient of variation.” This is the ratio of the standard deviation of annual percentage changes in the price level to the average annual percentage change. The higher the coefficient of variation the more instability there is in price levels. For the United States between 1879 and 1913, the coefficient of variation was 17.0, which is quite high. Between 1946 and 1990 it was only 0.88. In the most volatile decade of the gold standard, 1894-1904, the mean inflation rate was 0.36 and the standard deviation was 2.1, which gives a coefficient of variation of 5.8; in the most volatile decade of the more recent period, 1946-1956, the mean inflation rate was 4.0, the standard deviation was 5.7, and the coefficient of variation was 1.42 (source: Bordo, Michael “The Classical Gold Standard: Lessons for Today.” Federal Reserve Bank of St. Louis Review 63, no. 5: 2-17. Sorry no link, I’m using a packet of readings from a college course I took a few years ago).
People trying to argue the gold standard will ensure price stability tend to focus only on increases in the price level, not decreases. But stability is a two way street. Economies operating under the gold standard were enormously vulnerable to real-output shocks. Throughout the eighteenth and nineteenth centuries there were frequent recessions that were both deep and long lasting. No, long-run inflation was not as much of a problem during the years the gold standard was in effect, but the trade off was much higher levels of unemployment as a result of deflationary pressure. What’s worse is contrary to popular opinion economies under the gold standard were subject to monetary shocks as well. I’ve mentioned the example of the rapid increase in the price level after the Spanish Conquistadors’ pillage of South America on this website several times now so let’s try a different example, the California Gold Rush of 1848.
Estimates vary, but the discovery of gold in California in 1848 effectively increased the money supply in the United States by as much as thirty percent (Source: Eichengreen, Barry and Ian McLean. “The Supply of Gold under the Pre-1914 Gold Standard.” Economic History Review 47, no. 2: 288-309). This in turn raised domestic expenditures and nominal income. Although the initial effect of the gold discovery was to increase real output (because wages and prices did not immediately increase), eventually the full effect was on the price level alone. So you see inflation is still possible even under a sound money system. Part of the reason why gold was such a safe store of value in the early nineteenth century is because Western European nations were able to use force to monopolize its production and distribution so well. This is no longer the case. In fact, in today’s world of fierce competition over scarce resources I’m pretty confident a sudden shift back to the gold standard (or any other commodity backed monetary system) would lead to massive price instability. This article provides a good case in point:
Granted, events like the California Gold Rush and the Spanish invasion of South America are rare, but that’s not the point. The point is that gold, or any other commodity for that fact, is not a stable standard when measured in terms of other goods and services. On the contrary, it is a commodity whose price is constantly buffeted by shifts in supply and demand that have nothing to do with the needs of the world economy.
In conclusion, I don’t disagree with you that responsible fiscal policy is the hallmark of price stability. It’s just that I highly doubt going back on the gold standard will automatically lead to the price stability you desire. For all its drawbacks, government control over the money supply is the best way to ensure stability. In a democracy it is the responsibility of citizens to ensure the government uses its power wisely. Part of that responsibility includes balancing the dangers of both inflation and deflation.
Per, you are assuming that sale of government securities comes from loanable funds and crowding out takes place. MMT points out that the bonds are bought with bank reserves created by the reserves added to the system by deficit spending. It is a wash that stays entirely in the interbanking system (FRS).
The Fed just puts the reserves that will clear the Treasury’s checks for spending into the Treasury’s reserve account. Bonds are issued to offset the spending as required by law, not a financial need, since the Fed just creates the reserves. When the primary dealers buy the bonds, which they are obligated to do as primary dealers (if they don’t want to do this, they drop out as PD’s). The sale of bonds reduces bank reserves by the exact amount of deficit spending. That’s really how it works.
This borrowing is done in order to reduce reserves so that the Fed can control the overnight rate. If there are excess reserves, the interbank market rate drops to zero, unless the Fed pays interest on reserves. The Fed doesn’t care about excess reserves now since it is setting its rate at ZIRP and paying a minimal interest on reserves.
The only potential real problem with the government’s issuing bonds is that the resulting interest payments are spending that adds to the net financial assets of non-government. But this is only undesirable when nominal AD is at the point of exceeding real output capacity. As far meeting the principle, the Fed can always do this with a keystroke adding reserves to the bank selling the bond.
There is zero problem here as long as nominal AD is in balance with real output potential, and we are a long way from there now.
What about all the dollars awash in the world? As the provider of the world’s reserve currency, the US has the obligation not only to manage its own economy, it has to provide enough reserves for world fx trading and commerce. There are ordinarily too few dollars rather than too many, since most countries carry stock of dollars to manage their own fx rates. The Asian countries learned this lesson in the Asian currency crisis.
Actually, the Fed builds a little inflation (about 2%) into the system in order to spur investment. If money were perfectly stable, then there would be no pressure not to hold it for interest instead of risking it in investment or consuming more. So the Fed adds a bit of “healthy” pressure to invest and consume rather than save to stoke growth. 2% per annum inflation adds up over almost a century, especially when there are exogenous shocks that drive up prices, too, like the oil shock of the early ’70’s,
Dominic, MMT and Austrian economics are at opposite ends of the spectrum. I’m afraid we’ll have to respectfully agree to disagree.
I would add, however, that the assumption that there could have been an immediate liquidation at the outset of the financial crisis that would have resulted in a recession and quick recovery is not supported by anyone but Austrians. Others pretty well agree that the financial system was locked up after the failure of Lehman and the world was staring Great Depression II in the face on Monday AM if something weren’t done immediately to prevent a financial panic. I agree, although I think that the plan adopted was a sell-out to the financial oligarchy and should have been designed and implemented differently.
As for the Austrian call for return to sound money through re-adoption of a commodity standard (gold, silver, whatever), and convertibility and fixed exchange rates, it’s just not going to happen, IMHO.
Better to figure out how the system in place works optimally, and the way to do this is to look at how the system works in actual practice (national accounting, stock-flow consistency, verticality of government and non-government). That is what MMT is all about. MMT is not an economic theory based on assumptions. It is a description of the functioning of government and non-government finance in relation to each other and to the real economy.
Tom. If you do not believe that a safe haven can become overcrowded extremely fast when everyone is looking for a safe-haven and the safe-haven managers want to capitalize on the looking for-safe-haven’s boom so as to pay themselves extraordinary political bonuses…then I fully understand your sounding like those “What me worry?” who thought risks had been completely diversified and diluted in the global oceans or placed in the hands of those able to handle risks.
Perhaps it might be timely to share with you my letter of the last day of the 00’s in the Financial Times http://bit.ly/4CDxpa
I wasn’t trying to argue perfect price stability would be a good thing, only to point out that I doubt reinstating gold standard would lead to such stability.
The more government involves itself in the economy, the more big business will mess with government because government must be managed to ensure profits. This is the missing piece in Simon Johnson’s analysis. We can demonize bankers all we want but banks will buy the political center, as they have in the US, so long as banks are heavily regulated. The more discretion regulators exercise over the financial sector the more profits will depend on controlling the regulatory process. Regulatory reform should focus on simplicity, transparency and a return to the rule of law. The key is a capital structure for commercial banks with automatic mechanisms for converting bank debt to equity whenever market capitalization falls into the danger zone combined with segregating investment banking from commercial banking.
Per, the problem with proposing this kind of radical shift, abstracting from its merits, is that it just isn’t going to happen without a serious global breakdown and we aren’t there yet and hopefully won’t get there. There is no reason to, if governments wake up in time, realize how the international monetary system works under a non-convertible floating rate regime, and use that knowledge to avoid monetary instability.
I know. I was amplifying on what you said, not correcting you.
Charles, I largely agree with what you say here. I would add this, however, since it seems that a lot of people miss this key point.
In the present (fiat) system, sovereign governments (unless they give up this prerogative like the EMU countries to the ECB), are the monopoly providers of their currency of issue, on which non-government currency users depend for commercial transactions. This establishes two things.
First, it establishes government/non-government monetary verticality. The government creates the currency (M0, base money, high-powered money AKA HPM), which, in the US, is composed of Federal Reserve notes, coin, and bank reserves. Commercial banks cannot create money in this sense. They can only create credit money in the sense that loans create deposits, which net to zero. Only government by issuing currency and spending it into the economy can create non-government net financial assets (NFA), and only government can reduce non-government NFA by taxation. The government can create full employment with price stability by balancing nominal AD with real output capacity by adjusting non-government NFA and regulating commercial leverage though the Fed control of the overnight interbank rate (FFR), which is the base rate against which spreads are calculated.
Secondly, government’s prerogative as the monopoly provider of the currency of issue for use by non-government has a corresponding responsibility associated with it. This responsibility is to provide enough net financial assets to non-government and regulate leverage through the base rate to allow the economy to utilize real output capacity. Too much and inflation results, so that prices and wages rise, devaluing the currency. Too little and deflation results so that the output gap increases and unemployment/underemployment rises and recession sets in.
So that while keeping government and business separate is a desirable thing, just as is separating church and state, so too there are public utilities, such as money, that fall to government to manage as a key responsibility in “providing for the general welfare,” given its constitutional prerogative as monopoly currency issuer.
Can you explain how “real output capacity,” is measured and how a government could know if the amount of money it creates exceeds demand for money given the economy’s real output capacity? Is it just capacity utilization? Then again I’ve never really had a firm grasp on how utilization rates are measured either.
There are obviously a lot of factors, but MMT holds that price stability/volatility is not a matter of nominal factors alone, like monetary aggregates, but the relation of nominal to real.
MMT takes employment to be a key indicator of the real. When nominal AD is in balance with real output capacity, then full employment results. MMT considers full employment as no structural or cyclical unemployment/under-employment, only frictional unemployment, e.g., transferring between jobs. This is about 2%, not the 6% of NAIRU. (The permanent excess stock of labor under NAIRU serves to undercut labor’s bargaining power and is unnecessary for price stability according to MMT.) As you may have noticed, Randy Wray’s book Understanding Modern Money is subtitled, “The Key to Full Employment and Price Stability.”
If you head over to Bill Mitchell’s blog at http://bilbo.economicoutlook.net/blog/ and ask him in the comments section of his current post, you will get responses not only from him but other knowledgeable people. Also check out his full blog list here at http://bilbo.economicoutlook.net/blog/?page_id=1667 Warren Mosler also generally answers on his blog, too. http://moslereconomics.com/
The way to look at this is through Y=C+I+NX+G. If there is a growing propensity to save among the public, decreasing spending by firms, or there is a CAD, then NAD will be less than necessary to support real output capacity, and an output gap will occur, along with rising unemployment. If there is price pressure at the producer level along with full employment, inflation is beginning to take hold.
That’s just a thumbnail, of course. A lot of articles have been written around this issue which are freely available as working papers at The Levy Economics Institute of Baird College (http://www.levy.org), and The Center of Full Employment and Price Stability (www.cfeps.org/pubs/)
The banks decide if they want to hole excess reserves at the Fed. Not the Fed. If they want the money back they take it.
All those things you mention “time deposits” “repos” etc are things the Fed is trying to do because they don’t have the money to return to the banks. They already lost it when they overpaid for a trillion worth of MBS.
As to printing: Sure the government prints all the money it spends – of course they don’t wait for taxes to pile up in a bank account before writing a check. But that doesn’t mean that if all the banks in the US went from 10x leverage to 20x leverage that there isn’t inflation. There is and was. Deflation is occuring due to this deleveraging of the private sector.
And in response to the government controls everything so we won’t have deflation:
You already answered this. We have a democracy. The people are not that stupid. The problem is there is a delay. Do not mistakenly think because there is a delay that the people won’t react to having their savings stolen from them. The government could have done a lot more if they didn’t fear the backlash.
“Banks decide if they want to hold excess reserves, not the Fed.”
This is an economic decision on the part of the banks since reserves are bank assets. Usually banks want to either lend their reserves at interest in the interbank overnight market or switch them to interest-bearing bonds. The reason that there are excess reserves is that the Fed exchanged the banks dreck for reserves, adding liquidity to the market. The Fed usually doesn’t (can’t) do this but used its emergency powers. However, the securities are collateral for loans at the Fed (Fed asset and bank liability), the corresponding reserves are a bank asset and Fed liability). The Fed did not buy them and can make the banks take back the collateral they put us at nominal value of loan — if the Fed chooses not to eat them itself to save the banks solvency, which it may do, although they would have to find a legal way to handle this without the banks’ actually going under.
You are confusing the vertical relationship of govrnment and banks (members of FRS) with the horizontal relationship of commercial banks and firms and public. If the commercial banks go to higher leverage by creating loans against capital, it adds zip NFA to the private sector since loans create deposits and these net to zero as a matter of accounting. The commercial banks can create credit money through loans but not issue currency as can the government. This increases velocity but not non-government NFA (The government controls this extension of credit through setting the base rate.) Because of national accounting only the government can increase or decrease non-government net financial assets. That’s just how the accounting works.
The government didn’t steal the savings of the people. It was the fraud and sharp practices of the non-government financial system, as well as people gullible about risk, coupled with lax oversight and failure to hold them accountable. The government hasn’t checked the financiers because the oligarchs have bought the system, and reform isn’t on the horizon.
I sign up on all this but adding the need of always keeping in mind what we are regulating for… just stopping banks from failing does absolutely not qualify as an objective… unless all we want to do is to end up substituting for ATMs.
“if the Fed chooses not to eat them itself to save the banks solvency, which it may do, although they would have to find a legal way to handle this without the banks’ actually going under”.
Tom: given your MMF perspective, how does the Fed clean the “drecks’ off it’s books? From my perspective, it seems that the Government (via Fannie and Freddie) have transferred the risk systemic risk onto govenment, and is preventing/limiting the market correction from wiping out those that should be to allow for stablization in pricing. The bubble hasn’t burst, its been swallowed by the government where it will fester…
The immediate liquidation would have caused a lot of pain, no question about it. Unemployment would have skyrocketed.
But with market clearing price level, everybody lifestyle would have been adjusted….to make an extreme example, who cares if my income has been cut by 75% if a I can buy a house for 30K.
I concede that a “lockup” is still possible with a fractional reserve banking with a high level of debt…that is the reason why a sound money regime with a FBR is still unstable.
Unfortunately I think you could be right that a return to a non manipulabe currency may be far fetched but I do not think we will remain on the dollar standard for long….the famous “exorbitant priviledge of the United States”.
I do not advocate a pure Austrian scenario either…. I think it’s sensible for the government to help you with your health issues if you do not have the means to pay for it…and to support you in obtaining a higher level od education, again, if you cannot afford it (the real wealth of a nation is in its productive citizens)
However I do not think it’s a duty of the government to protect your cushy union job, to keep you in your overextended mortgage for your McMansion, to protect your company or your category from competition.
Remember, there are people that face the real Austrian Free Market scenario everyday with no government support.
I don’t know Teotac. When a bank becomes insolvent, the FDIC puts it into resolution, and if there are deposit losses that are covered by the FDIC guarantee, then the FDIC picks them up. But I’m not sure how the Fed would deal with defaults of stuff it holds as collateral on its books, and the bank whose collateral it is, is not technically insolvent (or the Fed doesn’t want it to become insolvent). The Fed is mandated to accept only Treasuries as collateral, but it has emergency powers now. This is a special situation, and I’m not clear on the law and regs about this eventuality. But the Fed is the lender of last resort, and I assume it will find a way to absorb losses of the TBTF banks in order to prevent them from becoming insolvent, to “save the system.”
The Fannie/Freddie issue is entirely different. Fannie and Freddie are the basis of the US mortgage industry. Without it, the US would be much more a nation of renters than owners, because the purpose of Fannie and Freddie is take mortgages of the banks books to free up bank capital for more loans. Basically, what happens is that banks “factor” their mortgages with Frannie and Freddie securitizes them. Before the present bubble, they were the primary agencies in this field. However, when housing took off, the commercial banking industry want in and developed its own securitization. So a lot of the mortgage backed securities (MBS) came out of commercial banking instead of with Fannie and Freddie. Blaming the crisis on Fannie and Freddie (and CRA) alone or primarily has been shown to be erroneous.
I’m not defending all the action of the government, but there is a problem in liquidating too quickly because it can destabilize the system and result in a deflationary spiral that is difficult to reverse and well as a lot failures that affect the real economy, explode unemployment, impoverish innocent people, and lead to social unrest. The government’s primary responsibility is to prevent this from happening, even if some of the bad guys don’t get theirs the way they should.
That said, many people have observed that this could have been done differently with a better result economically and a fairer result socially. This would also have been good politics, but it would have made enemies of the oligarchs who control the political process with money and influence.
Then I think we are on the same page, Dominic. I urge you to investigate MMT. Read the blogs of posts of L. Randall Wray and Scott Fulwiler at Economic Perspective from Kansas City and Marshal Auerback at New Deal 2.0, as well as the blogs of Bill Mitchell and Warren Molser. They show how these things we want to see are entirely possible with the system now in place. Funding is not the real problem, as is made out. All that has to happen is for people running things to understand how the system actually works instead of believing in myths with no basis in fact in a non-convertible floating rate fx global monetary regime.
I have to answer to your replay to my post here because at that indentation level for some reasons there was no reply button..sorry about that.
“The long end of the yield curve is so high partly because the Fed continues to hold short term NGDP growth low, and partly due to Congress’ inability to deal with demographic trends and medical costs.”
The long end of the yield curve is high because investors see nflation in the future…and I’m not so sure the Fed doesn’t manipulate that part of the curve with “silent” buying
“Well, from a national accounts perspective, printed currency is exactly that. So are you for a return to gold? (If so, I know to stop wasting my time arguing with you.)”
Yes, nominally, a country with a fiat currency will never default on its debt…however ask the Brazilians in the 1980s, the Argentinians (twice) or the Zimbabweans hwo that worked for them…I can send you some beautiful and colorful 100 Trillion Dollar notes I bought on ebay….the mechanism is wonderful until foreign investors say “no mas”…
I’m sure the London School of Economics or Harvard educated Brazilian or Argentinian economy plannes though they could get away with it…until they couldn’t
“Really? So the average (or median, if you prefer) individual in the US is consuming 97% less than in 1913? Why do I care about the value of the dollar over 100 years, instead of the value of the real economy? I take it you disagree with this then:
Yes really….in the 1950’s one average middle class salary was sufficient to sustain a middle class living standard (for that era) for the family (and sending kids to college), try that now….the GDP grew (and we are not going to discuss how the GDP is calculated nowdays..that is a discussion for another day) slower than the depreciation in the currency…
Remember, in an increasing productive economy price should head lower not increase…In the 19th century we had vigorous growth in a deflation environment….deflation is not bad when the debt is low.
“So are you for a return to gold? (If so, I know to stop wasting my time arguing with you.)”
I’m for a return to sound not manipulable money..we can discuss at the best way to reach it….nobody can argue with the fact that during the post WWII “gold plated” (it wasn’t a real gold standard) monetary system we had widespread prosperity and less wealth disparity in the western world (we had other problems but let’s not digress)
And I’m not going to waste my time either arguing with someone that refuse to recognize that fiat currencies, so far, always failed in the end…we have ample historical (thousands of years) evidence….so the last 38 years (of financial crisis with increasing frequency) are not very supportive of a “make believe” money system.
“Finally, how (precisely) would you advocate altering the trade deficit without devaluing the dollar? (Congressionally legislated tariffs? Congressionally legislated domestic productiong subsidies? Congressionally legislated anything?)”
You see that is the problem…with the entire world in a fiat currency regime we will likely experience destructive “debasement wars” that will lead to nowhere.
A sound money system is self balancing…no country can run trade surpluses (or deficits) for too long
Thanks Tom, you’re really quite a patient fellow. As I said before in response to that fantastic article about IMF policy you linked to, I’m definitely going to be adding Professor Mitchell’s blog to my regular reading list. I got a 3/5 on one of the Saturday quizzes he gives. Looking forward to getting a a perfect score!
IMF blunders in Asia were so serious that if you mention the word IMF in that part of the world, you have to duck for cover….those countries will never ever put their neck in the IMF noose again.
When you are Bill’s place, don’t pass up the comments. JKH, Scott Fulwiler, Winterspeak, Ramanan and others who comment there are very knowledgeable, too. They pitch in answering questions.
For those who think that Simon’s position is too centrist regarding the IMF (he admits to being a centrist), Bill Mitchell is out with a great post today based on MMT, which is value-neutral, but with a decidedly leftie spin from Bill.
“One should become more radical as one grows older”
Dominic “I’m sure the London School of Economics or Harvard educated Brazilian or Argentinian economy planners though they could get away with it…until they couldn’t”
Last year in a Brookings conference an Argentinean Harvard PhD was asked (by yours truly) why he believed the foreign exchange markets trusted the US$ so much. His answer “The markets trust the American taxpayer”…. An embarrassed silence ensued.
The reason there was an embarrassed silence is probably (or should have been) that it was an incredibly stupid answer for an economics to give. In a fiat system, taxpayers do NOT fund either government borrowing or spending. If he had said the the world was not concerned that the US government might dilute the dollar by issue that much currency, he would have been correct.
A sovereign government that is the monopoly provider of a non-convertible floating fx currency of issue is not financially constrained. If the exchange rate does not fall precipitously, interest rates rise precipitously, or inflation skyrocket, then the presumption is that the country is not issuing too much. What’s so hard to understand about this that even PhD economists can’t get it?
I’m not that sure you can always buy higher quality goods as “payback” for an inflating dollar.
Few examples…many of the food items you could buy several decades ago today would qualify as “organic” and cost you even more.
Several (if not the majority) of manufactured goods, actually, have the tendency to degrade in quality over time….look at furniture, home construction, appliances, toys, etc to name a few.
Let’s not confuse more features (especially for the electronic/mechanic industry) with quality…two very different concepts.
Sorry but that doesn’t pass the smell test…ever visited an IKEA store??
“Milton Friedman estimated the cost of maintaining a full gold coin standard for the United States in 1960 to be more than 2.5 percent of GNP. That would be 300 billion in today’s dollars (and that’s assuming the cost of extracting gold hasn’t gone up, which in fact it has considerably).”
A rather smaller price to pay compared to the enormous amount of malinvestments and unnecessary military spending…..the Iraq adventure alone is close to pass the 1 Trillion mark….
It is true that new gold discovery can lead to increase in money supply…however as you already mentioned, these events are rare not the norm as in a fiat monetary system.
Sorry but I do not buy the price stability theory either, especially in light of the way inflation is measured which today degenerated into a complete travesty (geometric weighting, substitution, Hedonics, CPI minus food and energy anyone?).
Again, real life test…grocery stores, everyday expenses, bills to pay, fees everywhere.
Housing skyrocketed in the western world after 1971.
Yes we had a blessing with the enormous amount of mostly Asian cheap labor entering the work force that kept a lid on several categories of manufactured goods (even if often of inferior quality)….that allowed the money printers to extend the game quite a bit.
Techonological progress and productivity improvement is fundamental to improve human life…and that happened both under a gold standard and the current fiat system….so it’s not like the gold standard prevented progress…actually quite the contrary…..the most innovative and life changing technological breakthroughs happened under the gold standard (recently, the green revolution, space exploration, electronics, microprocessor, etc…) when actually you had to really innovate to make a profit rather than playing at the Wall Street casino.
Deflation should actually be welcomed as general decreasing price level because of increased productivity….but deflation is anathema to a debt based fiat monetary system.
As I said before, gold is not perfect and we can definitely discuss what would be a better system.
And a gold standard with a fractional reserve banking system is not that much better than what we have…it is still prone to booms and busts.
“Economies operating under the gold standard were enormously vulnerable to real-output shocks. Throughout the eighteenth and nineteenth centuries there were frequent recessions that were both deep and long lasting. ”
Again, a gold standard with a FRB is still vulnerable to boom and bust cycles..the nature of the beast.
However the vast majority of recessions in the 19th century were brief….overall in the 1800s we had growth and deflation (due to technological progress and productivity improvement)
Keynes called for fiscal restraint and discipline during the good times and we all well known our political system (not only in the US) is incapable of that.
I just do not trust anyone with a printing press and the evidence, so far, prove the Austrians right.
A gold standard is not perfect but it’s better than what we have.
“government control over the money supply is the best way to ensure stability.”
As I already said, we have no price stability except for certain categories of goods despite a fiat monetary system not because of it.
“In a democracy it is the responsibility of citizens to ensure the government uses its power wisely. Part of that responsibility includes balancing the dangers of both inflation and deflation.”
Unfortunately our democratic institutions have been almost entirely captured by special interests and the government demonstrated that cannot use its power wisely.
When we are talking about government debt, the vast majority of investors still think in terms of taxpayer money….they think real productive capital is at the end of the hook.
You, I and many others know very well that you are right….in a fiat currency system a government (its Central Bank to be precise) that has the monopoly to issue currency will never run out of money, technically…..still the investor trust the “faith and full credit of United States Government” that means taxpayers.
They trust that the US will not resort to printing like a South American Banana Republic but actually force its citizens to make sacrifices to honor its obligations.
Why do you think the Fed is so byzantine in its machinations to hide covert direct buying (we officially disclose only part of it…it’s genial….we admit it but not the full story…we are covered)
If Bernanke would come out publicly tomorrow morning with your statement: “A sovereign government that is the monopoly provider of a non-convertible floating fx currency of issue is not financially constrained.” (read: I’m free to print at will as much as I want and I do not need taxpayers or increase in output) the US dollar would be toilet paper by dinner time.
Tom “In a fiat system, taxpayers do NOT fund either government borrowing or spending”
No much the opposite! In representative money you have the backing of something, in a fiat system you have the backing of someone meaning “In God We Trust” meaning government and citizens. If you think that a tax-revolt, meaning that the citizens are not prepared to back up the spending of government, does not affect the trust the markets place in the currency then I am not so sure we can go much further in the discussions… notwithstanding that you strangely enough declare yourself to be a Jeffersonian… though you might be a Jeffersonian provocateur :)
Dominic, at a Congressional hearing Bernanke was recently asked whether the money to pay for the rescue package programs was coming out of taxes.
He answered, No, it’s just the stroke of a computer key.
Regardless of how upset anyone of us gets, if the floating rate of the dollar doesn’t tank, and interest rates and inflation don’t skyrocket, the people holding all the wealth in the world don’t care about the amount of keystrokes the Fed is using, and, I am sorry to say, they are the only one’s who really count in this game.
Per: “No much the opposite! In representative money you have the backing of something, in a fiat system you have the backing of someone meaning “In God We Trust” meaning government and citizens. If you think that a tax-revolt, meaning that the citizens are not prepared to back up the spending of government, does not affect the trust the markets place in the currency then I am not so sure we can go much further in the discussions…”
Yes, if you think that taxing and borrowing are related to US spending and debt, then we have no further to go. They are apples and oranges in a fiat system.
“notwithstanding that you strangely enough declare yourself to be a Jeffersonian… though you might be a Jeffersonian provocateur :)”
Per, I believe that we can work through the present system to produce a fair and just system that is not controlled by a plutocratic oligarchy. I assure you, it doesn’t matter what we use from money if the oligarchy controls it for their advantage. The US and world were on a gold standard in the McKinley-Hoover years and we (and the world) ended up in the Great Depression and then had a big war. “Sound money” didn’t help then. I don’t know why anyone is so attached to it now, after that precedent. In addition, the US had plenty of panics before the Great Depression. That’s why the Fed was founded as a central bank. Getting rid of the Fed is no panacea either.
“in the 1950’s one average middle class salary was sufficient to sustain a middle class living standard (for that era)”
Primarily because the living standard for the 1950s was so much lower. Consider the #sq feet of living space per person. Lifespan. Access to telephones, schools, etc.
The relevant comparison is between 1972 and now… There are legitimate arguments on both sides, and certainly the living standard today is lower than it SHOULD be (if we had made proper investments). But to go back to 1913 and make a ridiculous comparison to claim that because the dollar had dropped 97% in value we’re all doomed is the height of silliness.
In terms of stability of the financial system and the gold standard, perhaps you have not yet seen Brad DeLong’s cute chart:
(Note the French line – stuck with gold right up till it got overrun by Germany.)
Per Kurowski: “Is it not a human right to have bubbles even though they explode?”
It would be except for the externalities. Bursting bubbles harm a lot of people who have not benefited from the initial boom. If bubbles and bursts are intrinsic to the current system, they are a way of privatizing profits and socializing risk.
“How do you know a bubble you want to prick from one you want to keep?”
You do not have to. As Soros points out somewhere, the regulators can take small steps when they smell a possible bubble. Having a speed limit does not prevent truckers from delivering their goods.
“But is it not possible that the only way to bring the world up to the next level of development, like for instance finding the new energy source that will allow growth without climate change, is elevating on a pro-cyclical bubble?”
I think that the history of such things in the modern world is that governments provide or subsidize research and development. As for peak oil (and other resources) Nick Rowe has pointed out that economic growth does not require increasing energy expenditure. OC, shifting our expectations and behavior could be a problem, at least in the short term. And eventually we will exist in energy balance with the environment — or perish.
Bubbles have taken you to where you are… without bubbles and risk taking progress would have been slower. If you think having all stay in bed will avoid fatalities… think again.
Tom writes “Per I believe that we can work through the present system to produce a fair and just system that is not controlled by a plutocratic oligarchy. I assure you, it doesn’t matter what we use from money if the oligarchy controls it for their advantage”
Charles R. Williams said below “The more government involves itself in the economy, the more big business will mess with government because government must be managed to ensure profits.
And I agree fully with that the more power you give a government, in this case fiat money, the more will it be controlled by those who have special incentives in how that power is exercised.
By the way I am not arguing for a return to gold standard but what I do believe is that the more flexible the instrument at hand, fiat currency, the more you have to make sure that those managing it will do so with careful discipline… and not as it so often seems that you place it in the hands of those most willing to exploit its flexibility.
This guy took his wheelchair-bound son to a political rally to accuse his local congressman of plotting to remove his child’s healthcare because he wasn’t “productive” enough. That qualifies as a lie. And demonization. And political theater. And, oh yeah, please see my source–you’ll see Fox hyping this agitation propaganda.
But do you really need to look that hard? Do you actually think the far right wouldn’t use dirty tricks on financial reform? Why? Do you think all the demonstrably false issues raised by the far-right, from Swift Boating Kerry right through to Obama being a Muslim born in Kenya were one-off isolated events?
Per: “By the way I am not arguing for a return to gold standard but what I do believe is that the more flexible the instrument at hand, fiat currency, the more you have to make sure that those managing it will do so with careful discipline… and not as it so often seems that you place it in the hands of those most willing to exploit its flexibility.”
I agree with you on this. The problem we are now facing is that the system is being run for the plutocratic oligarchy. Loose financial practice got us into the financial crisis, and deregulation, lax oversight and failure to investigate and prosecute crime was the government’s part, due to intellectual capture, the revolving door, and money in politics.
My point is that we cannot fix this without (1) getting the money out of politics and closing the revolving door, and (2) putting people in charge of the management of money creation as a public utility for public purpose who actually understand how the system works and are committed to managing the system based on distributive justice.
The US is the epitome of a capitalistic country. Capitalism is about the formation and deployment of capital for profit. That’s what happens here. Everything is oriented to that, and the bailouts of capital in the crisis are the proof of it, if anyone questions it. The country is run for capital and the rest is trickle down. There must be a permanent stock of unemployed to undermine the bargaining power of labor to keep wages down, for workers are the principal expense of business.
The situation now is like the McKinley years that ended in Hoover and the Great Depression, when excess leverage took the system down and debt deflation ensued. The world was in the struggle between two models then, capitalism in the West and communism in the East. The New Deal was possible because the rich were willing to make concessions to avoid a worse fate. But they immediately began working to reverse those policies and legislation. That happened in earnest when the Soviet Union fell and China adopted market socialism. Then the gloves came off and the New Deal was under direct attack. A lot has been done already to dismantle it, but Social Security and Medicare remain on the agenda to get rid off.
Both political parties are agents of the elite. Those on the right want an immediate take down of “socialism,” as their base wants, while the agents of the center want to move more slowly so as not to rock the boat of their base. There is no significant party of the left in the US at present.
It took an economic disaster that resulted in social catastrophe to change the system last time. The same will be required again. I have little doubt that this in the cards at this point. The elite of the right is too strong and is committed to equating economic efficiency with political policy. The problem with this is that they have the economics all wrong and are are rushing headlong into another debt deflation fueled by excess leverage that will take down not only the US but also the world economy under Western leadership. What will emerge from the ashes is anyone’s guess. There is no force capable of preventing this at this point.
The wild card is EROEI — energy returned on energy invested. This has been in decline for petroleum, the major source of transportable energy. (See “An EROEI Review” at Oil Drum for the basics.) What is happening is that the poor countries are transferring energy to the rick countries, so that the the per capita use of energy in the West is high, while the rest of the world has been low. That is changing and it is unsustainable, especially since the cost of energy is going to rise as externalities are used to compute true cost, which is necessary to address global climate change. This is going to have serious repercussions economically, and it has already begun. We are getting some respite due to the economic contraction, but as soon as the world begins to recover, energy prices will inevitably rise, drastically changing the standard of living for all but the wealthy.
The final grab is on, and the elite are making sure that they not only get the lion’s share but also keep it by increasing security. It is now possible for the president to legally disappear anyone he designates a terrorist, and Total Information Awareness is also in place, so that it is now impossible to organize effectively. Etc.
But don’t worry, the voters will be provided with bread and circuses to keep them distracted,
Per Kurowski: “Bubbles have taken you to where you are… without bubbles and risk taking progress would have been slower. If you think having all stay in bed will avoid fatalities… think again.”
First, there is a difference between staying in bed and having sensible regulations. Also, I note that you did not address the main point about having a right to bubbles, that you do not have the right to harm others.
As for the claim that bubbles have been good for progress, how about some references? (I take it that “Extraordinary Popular Delusions and the Madness of Crowds” will not be on the list. ;)) Many thanks. :)
Bernanke was talking about the money used for the rescue package…not the backing of the entire US government debts…it’s a big difference.
Again, if a country state publicly (or act in obvious overt way a la Zimbabwe) that his debt is only backed by the printing press its currency is gone.
We know that that is the way it is, many people know it but still there is tha generally accepted belief of taxpayer liability….you are right, it’s a confidence game…once that is gone….it’s gone.
The gold standard was not abandoned in the 30’s. We switched to a gold-exchange system.
And we paid very dearly for that “recovery”…with WWII (the real recovery arrived only with war spending)…think about it.
The 1950s middle class living standard was the best that particulary technological era could offer to us.
Housing size won’t tell the whole story (the average home size was well sufficient for a family)
Look at the quality of the construction…look at the quality of food. You would get fresh milk delivered to your front door every day.
You could go to college without going deeply in debt.
Health insurance costs were very easily affordable.
Let’s switch to the ’60s…improved living standards (now we had color TVs and more than one set in almost every house, more families had 2 cars, more telephones, the jet age cheapened travel cost, etc…)
Still on the Gold standard…..technology progress and productivity improvement have nothing to do with a fiat monetary system…actually I argue that the easy money era chocked off real innovation.
“The relevant comparison is between 1972 and now… There are legitimate arguments on both sides, and certainly the living standard today is lower than it SHOULD be (if we had made proper investments).”
You are absolutely right there, I agree totally….The Wall Street casino enabled by cheap fiat currency discouraged productive investments.
It makes me laugh when “experts” argue about the unsustainability of the Chinese boom (bank deposits are growing faster than lending..a simple math exercise not many have undertaken)
At least they are building the infrastructure they need for the future..it is brand new….fast trains, world class airports and public transportation systems and so on.
Will they have tough economics times?…sure they will..nothing goes up (or down) in a straight line.
But I take 1000 bridges (or railways) to nowhere any time of the day over saving TBTF financial institutions so they can resume their gambling addictions.
“But to go back to 1913 and make a ridiculous comparison to claim that because the dollar had dropped 97% in value we’re all doomed is the height of silliness.”
We are not doomed.
We still have the country and we can rebuild our productive capacity.
We just need to get rid of the parasitic financial system that is sucking the life out of us.
If we keep going this way the future is bleak.
Just for your information….foreign CBs are net buyer of gold lately totally reversing the previous historical trend…..will we go back to a pure Gold standard?? I do not think so…again we can discuss about the best sytem to replace what we have…but we have to agree that the current one isn’t working.
Gold is becoming again an increasingly important reserve asset for the world CBs…this switch in mindset is extremely important.
Tom I cannot understand how you intend to combine (1) getting the money out of politics and closing the revolving door, with (2) putting people in charge of the management of money creation that are committed to managing the system based on distributive justice. And, if those managers belong to those that in relation to public debt feel that taxes and interest rates do not matter, then I at least would get truly nervous. Offering populism to the majorities is just as dangerous in the long run as politicking with the plutocrats.
On the rest my feeling is perhaps that the biggest danger your country faces is getting trapped, not between a rock and a hard place, but between an extreme rock and an extreme hard place… because the sensible way forward is always firm and calm thinking, not obfuscated with right left terminology. (As a disclosure my not issue specific personal blog is titled “A view from the radical middle” or the “extreme center” if you prefer that http://perkurowski.blogspot.com/)
I disagree that is is a big difference. I will take you seriously when I see the evidence in floating fx $ rate falling precipitously and inflation measured in terms of rising nominal AD relative to real output capacity at full employment, not essentially irrelevant monetary aggregates. Instead, lots of people are betting on a dollar rally, and PIMCO is betting on disinflation right now by going to cash (dollars, that is).
Per:” I cannot understand how you intend to combine (1) getting the money out of politics and closing the revolving door, with (2) putting people in charge of the management of money creation that are committed to managing the system based on distributive justice.”
It took the Great Depression the last time that significant social change was enacted across the board, and even then it was very limited and the oligarchs came out on top again in the end. I expect that it will take something similar the next time. Hopefully, it will be more thorough.
In the meanwhile, the US (and world) will remain in the tight grip of the oligarchs. If the same policies continue and it seems they will, the next crisis will be even bigger, and that may be the straw that breaks the camels back. But in Germany and Italy, it lead to the rise of fascism, so nothing is guaranteed. This is a tightrope we are walking.
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