Do I owe this woman an apology?

[moda0306]

Gumby,

Wouldn't trading reserves for MBS's give the banks something to pay taxes in in the short-term?  I agree with you, but I think where LW is getting cought up is he sees M0 as the "money supply," and isn't fully grasping why purchasing power, not minor liquidity quibbles, is truly what drives this machine.

[Gumby]

Wouldn't trading reserves for MBS's give the banks something to pay taxes in in the short-term?  I agree with you, but I think where LW is getting cought up is he sees M0 as the "money supply," and isn't fully grasping why purchasing power, not minor liquidity quibbles, is truly what drives this machine.

Sure.. but his idea simply boils down to a society where everything is constantly nationalized by the government so that the economy and money supply can grow. Nobody wants to live in a country where everything needs to be nationalized to grow.

It doesn't even make any sense in a capitalist democracy. Why would anyone want the Fed to own America?

[moda0306]

LW,

Try this mental exercise... we can agree that bringing in a fiat currency brings in an unintuitive line of thinking.  There'd be no way to give it value if we didn't tax it.  So what if, at issuance, in a hypothetical society, people were given $10k each in dollars, and $5k in 1-5 year treasury bonds that will eventually be dollars when the fed/treasury pushes the magic "asset swap" button.  The tax rate gives the currency value.  These treasury bonds in this society CAN'T be used to buy things.  They're only for saving.

Imagine a different society a few hundred miles away that's EXACTLY the same, where tax rates are the same, everything in the economy is the same, but only the $10k in cash are issued.  No bonds are issued.

For purposes of simplicity, for a second, let's pretend making loans is illegal.   Only M0 is money.  

In your line of thinking, these societies will have the same price levels because they both have $10k of cold-hard cash.  Gumby and I disagree... we say that the $5k in treasuries give them future purchasing power only limited by liquidity considerations (we can't use bonds to buy bread).  This will affect their purchasing decisions at present day.

Any other promises made in the society are products of the free market, and any swaps of cash for bonds are simply changing the liquidity of the purchasing power the gov't dreamt up.  The fact that there were $5k per person of bonds in society #1 with everything else being equal will result in more purchasing power or inflation.  If they had only given out $2k in treasury bonds and $3k of additional cash, things wouldn't have changed much at all vs having $5k in bonds... that's what QE is.

This is what Gumby and I are trying to get at.  What really drives debasement of US paper is the government issuing more without a like-kind pull-back of some other paper asset.  Deficit spending achieves this.  QE does not.  Deficit spending in any additional amount will have drastically more affect on GDP/inflation than QE of the same amount.  Any time you pull some paper asset back out of the economy for cash, you are offsetting the purchasing power with equal amounts.  Somebody's balance sheet didn't really fundamentally change, and they're not going to go on a spending spree.

You can see that, though, in real life, treasury bonds are so liquid that they may as well be pure cash (HB said so).  There is no "pause" button on that purchasing power.  These asset swaps only increase the "money supply" if you don't consider bonds "money," but these bonds are just savings accounts instead of checking accounts.

[Gumby]

...and don't forget that each year, the two societies are having their M0 reduced by a constant rate of taxation.

[moda0306]

If it weren't for legal tender laws and common practice, one could think of treasury bonds as fiat cash that bleeds fiat cash at a certain rate every year.

Our will to save in the common currency comes not from the existence of bonds, but, simply, our will to have liquid, sustained purchasing power (even if it loses 1-3% to inflation annually).  Bonds are icing on the cake.

[Lone Wolf]

If the government takes in more taxes than it spends (a surplus), then by the laws of logic and mathematics the private sector will be losing more base money than it receives from the government. When the amount of base money recedes, it reduces the amount of loans that can be procured. And eventually there wouldn't be any base money left to back any loans.

The Federal Reserve would not sit idly by and allow the money supply to dwindle away to nothing.  If the gradual retirement of the national debt caused the money supply to shrink, the Federal Reserve would make whatever asset purchases or other adjustments were necessary to maintain it.  This can be literally any kind of asset, from precious metals to MBS's to foreign currencies to stocks.

Set aside for a moment even the idea of paying off the national debt (because the idea feels unfathomable.)  Consider if you simply don't make it any bigger.  The money supply can and will be expanded as necessary.

I'm not saying that buying a lot of MBS's is a good idea.  I'm simply trying to illustrate that the Federal Reserve can create money in the presence of a government surplus, a government deficit, or a balanced budget.  It just doesn't matter.

False. The money multiplier is currently below 1.

Isn't the multiplier we're talking about the difference between M2 and M0?  M2's something like $10 trillion and M0's well under $3 trillion.

[moda0306]

LW,

The fed could print money, but can if they buy a different kind of money back (MBS's), will that create inflation?  Wasn't this the original discussion?  That massive QE would cause crazy inflation, and Gumby and I disagreed, that it probably wouldn't do much?

You can print money and buy MBS's, but you haven't affected the balance sheets of the holders of those MBS's much... why would they go drum up inflation?  They'll look at their balance sheets, see $xx,xxx in cash where the same amount of bonds used to be and shrug their shoulders.

Why would you skew the private bond market for fear of deficit spending... the thing that really gives people the balance-sheet boost that will affect demand/inflation.

[Lone Wolf]

Sure.. but his idea simply boils down to a society where everything is constantly nationalized by the government so that the economy and money supply can grow. Nobody wants to live in a country where everything needs to be nationalized to grow.

It doesn't even make any sense in a capitalist democracy. Why would anyone want the Fed to own America?

I hope I'm being clear that I don't endorse the specific idea of buying mortgage-backed securities.  I'm trying to zero in on what's required to expand the money supply.  I think it's clear that deficit spending is not needed.

I'm pointing out that there are many ways that the money supply can grow without further deficit spending.  MBS's are an example from recent history where the Fed expanded its balance sheet without needing deficit spending.  There are a lot of other ways that the money supply can be expanded.

Let's try another.  What if, for example, the Fed purchases foreign currencies or the debt of another government?  Does the "deficit spending" count if it's done by foreign nationals using other currencies??

The fed could print money, but can if they buy a different kind of money back (MBS's), will that create inflation?  Wasn't this the original discussion?  That massive QE would cause crazy inflation, and Gumby and I disagreed, that it probably wouldn't do much?

Not QE.  Long ago, we were debating whether it would be inflationary if the Fed were to print up $15 trillion to buy a handful of coins from the Treasury, thus evaporating the national debt.  Let's let that discussion be. 

[Gumby]

Set aside for a moment even the idea of paying off the national debt (because the idea feels unfathomable.)  Consider if you simply don't make it any bigger.  The money supply can and will be expanded as necessary.

So, you have the Fed swapping cash for everything and the Treasury collecting taxes the entire time. You're still losing net financial assets to taxation in your example. Unfortunately, you still haven't proved that net financial assets can be maintained (let alone expanded).

I'm not saying that buying a lot of MBS's is a good idea.  I'm simply trying to illustrate that the Federal Reserve can create money in the presence of a government surplus, a government deficit, or a balanced budget.  It just doesn't matter.

That's totally incorrect. The Fed can't create money without removing assets from the private sector. In your example, net financial assets aren't being changed by the Fed, and meanwhile the Treasury is reducing net financial assets by taxation.

False. The money multiplier is currently below 1.

Isn't the multiplier we're talking about the difference between M2 and M0?  M2's something like $10 trillion and M0's well under $3 trillion.

M2 represents money and "close substitutes" for money. Unfortunately, you can't pay taxes with "close substitutes" for money — my question about taxation was the whole point of you citing the money multiplier in the first place.

[Gumby]

I'm trying to zero in on what's required to expand the money supply.  I think it's clear that deficit spending is not needed.

Unfortunately you still haven't proven that. The Fed can't introduce new net financial assets to the private sector. It can't. And if the Treasury is constantly removing net financial assets, via taxation, then you are constantly losing net financial assets from the private sector. You need to find a way to replace the net financial assets lost to taxation.

I'm pointing out that there are many ways that the money supply can grow without further deficit spending.  MBS's are an example from recent history where the Fed expanded its balance sheet without needing deficit spending.

You don't seem to take taxation into account in your scenario. Taxation would be constantly dwindling the assets in the private sector. The Fed doesn't create new net financial assets — only the Treasury does. Does that not make sense to you?

What if, for example, the Fed purchases foreign currencies or the debt of another government?  Does the "deficit spending" count if it's done by foreign nationals using other currencies??

You mean swap lines? The Fed already does this, but the swaps are temporary and the risks can be very high — particularly if they aren't backed by other assets. If the other currency were to fail, or fall greatly in value, the effects would be highly inflationary. You're showing me loopholes that Congress would never allow on such a large scale. Show me real examples where taxation is included in your model.

[Lone Wolf]

So, you have the Fed swapping cash for everything and the Treasury collecting taxes the entire time. You're still losing net financial assets to taxation in your example.

No, because with a balanced budget the government is spending the same amount that it takes in via taxation.  The government isn't "burning" the money that it collects in taxes.  It spends it to buy stuff like bombs or prescription drugs.

You could pay off the debt, too, but no need to cloud the issue with that.  The point is that you don't need to keep running deficits.

You don't seem to take taxation into account in your scenario. Taxation would be constantly dwindling the assets in the private sector. The Fed doesn't create new net financial assets — only the Treasury does. Does that not make sense to you?

We're talking about a deficit of 0 and a surplus of 0.  Tax money gets collected and spent back into the economy.  No money getting sent into shredders.  (As you know, government eagerly spends every dollar it receives in taxation!)

You mean swap lines? The Fed already does this, but the swaps are temporary and the risks can be very high — particularly if they aren't backed by other assets. If the other currency were to fail, or fall greatly in value, the effects would be highly inflationary.

I'm not asking you to like any particular idea.  I'm just trying to prove with these examples that it can be done and that this notion that deficits are required has to be false.

And are the risks of buying a basket of currencies any higher than owning MBS's?  (Which we already do, unfortunately!)

[Gumby]

So, you have the Fed swapping cash for everything and the Treasury collecting taxes the entire time. You're still losing net financial assets to taxation in your example.

No, because with a balanced budget the government is spending the same amount that it takes in via taxation.  The government isn't "burning" the money that it collects in taxes.  It spends it to buy stuff like bombs or prescription drugs.

You could pay off the debt, too, but no need to cloud the issue with that.  The point is that you don't need to keep running deficits.

You've only proven my point. As I've said a dozen times already, "The funds to pay taxes and buy government securities come from government spending." That's exactly what your example shows. I tend to avoid using the word "deficits" because a fiat government can't ever meaningfully borrow or save its own currency. Not to mention that MMT shows us that taxing more than spending is how we delete money from the private sector.

So, how does your government get to a monetary base of, say, $800 Billion? Are you suggesting that the Fed needs to have purchased up $800 Billion of assets? That's not capitalism. The Fed would own a large piece of the country. An ever-growing Fed would undermine the very freedoms that this country protects (States rights, private ownership, etc). Americans want a smaller government. Not a larger one. Most people already distrust the Fed.

Anyway, your scenario is a fantasy. The operational reality of our country is that the Treasury expands the base money supply through government spending. You may not like the way it sounds, but that's how Congress set it up. The funds to pay taxes and buy government securities come from government spending.

You don't seem to take taxation into account in your scenario. Taxation would be constantly dwindling the assets in the private sector. The Fed doesn't create new net financial assets — only the Treasury does. Does that not make sense to you?

We're talking about a deficit of 0 and a surplus of 0.  Tax money gets collected and spent back into the economy.  No money getting sent into shredders.  (As you know, government eagerly spends every dollar it receives in taxation!)

I don't think you can have it both ways. It would be a schizophrenic government. You can't have a government that increases its money supply by buying everything away from the private sector on one hand and then pretends to have a small government with a balanced budget on the other hand.

You mean swap lines? The Fed already does this, but the swaps are temporary and the risks can be very high — particularly if they aren't backed by other assets. If the other currency were to fail, or fall greatly in value, the effects would be highly inflationary.

I'm not asking you to like any particular idea.  I'm just trying to prove with these examples that it can be done and that this notion that deficits are required has to be false.

In every example, you're using a Central Bank's balance sheet to undermine the rights of private ownership and State/local independence as a way to prove that deficits aren't required? All that proves is that you can technically have a poorly run Central Bank.

And are the risks of buying a basket of currencies any higher than owning MBS's?  (Which we already do, unfortunately!)

They are both risky. Again, I don't think you can have it both ways. You originally offered buying foreign currencies as solution to continuously increasing the money supply. It's not a good idea. Keep in mind that the Fed didn't want to buy those MBS's — it only bought them because it had a gun to its head.

With this scenario you've invented, you seem to have convinced yourself that the Fed should be in charge of growing our economy in some weird sanitized fashion. That's not the role of the Fed. Congress already has the power to grow our economy and increase the base money supply accordingly. Why would you prevent them from doing so? It's as if you've invented this ridiculous Fed policy just to get out of admitting that our money supply comes from government spending.

Once again... The funds to pay taxes and buy government securities come from government spending.

[Gumby]

Lone Wolf, there's something else you're not considering...  Interest payments on private bank loans.

Here is one of the key criticisms of the fractional reserve banking system:

One criticism posits that since debt and the interest on the debt can only be paid in the same form of money, the total debt (principal plus interest) can never be paid in a debt-based monetary system unless more money is created through the same process. For example: if 100 credits are created and loaned into the economy at 10% per year, at the end of the year 110 credits will be needed to pay the loan and extinguish the debt. However, since the additional 10 credits does not yet exist, it too must be borrowed. This implies that debt must grow exponentially in order for the monetary system to remain solvent. This was the argument of the Social Credit movement of the 1930s, who proposed to remove the job of money creation from banks and give it to governments

Source: http://en.wikipedia.org/wiki/Criticism_ ... ve_banking

Now, there is a situation that the critics overlook: It's technically possible to pay off the 110 credits if the creditors are willing to pay the debtors for some goods and services while the loans are in the process of being paid off. But, if the creditors don't play ball, and the economy slows, the base money supply would have to grow by 10 credits in order for the debtors to not default. If the base money supply doesn't grow, then additional loans and interest would need to be obtained to pay off the loans. And that would only increase the need for a larger money supply — since there would be more and more interest payments pending, with money that does not yet exist in the private sector.

If the money supply is truly multiplying, as you say it is, then the money supply would need to keep growing and growing to pay off the interest on all of those loans if creditors aren't constantly stimulating the economy by paying for goods and services.

So, the interest payments on private loans often play a part for constantly needing to increase the money supply.

[MediumTex]

Imagine that there are $5 trillion in financial assets in the economy and due to a financial panic they are suddenly marked down to $3 trillion. 

From the Fed's perspective, $2 trillion in value has been erased from the private economy, which would normally be deflationary.

If, however, the Fed in a coordinated effort with the Treasury, Congress and FASB set about to prevent this deflation by allowing financial services companies to carry the $3 trillion in assets on their books as if they were worth $5 trillion (i.e., mark to market accounting gives way to mark to book value accounting), and the Fed then proceeds to buy a lot of these assets based upon the inflated valuation, hasn't the Fed sort of prevented the destruction of private sector wealth (which was its goal to start with)?

This is the same point I was making earlier, but it seems like a viable way for the Fed to cross the monetary equivalent of the blood-brain barrier.

[moda0306]

MT,

Private sector financial assets have offsetting liabilities, so there's no net affect on financial wealth.  What can change, for good or for bad, are the value of real assets in the economy.  Propping up certain categories of financial assets can cause misallocation of resources into the associated real assets, though.

At least that's how I see it.

[Gumby]

It's a tough call. I think it can make sense for the Fed to prevent a disaster with a mulligan that way. There is no way for the Fed to know how much contagion would result from a highly-levered multi-trillion-dollar hole in the banking system. (It's just a shame that the system was allowed to take on that much risk in the first place).

[MediumTex]

MT,

Private sector financial assets have offsetting liabilities, so there's no net affect on financial wealth. 

If an asset is worth $20 in the private sector and the government pays me $50 for it, isn't that one way for the government to inject $30 into the economy in a sneaky way?

[Gumby]

MT,

Private sector financial assets have offsetting liabilities, so there's no net affect on financial wealth.  

If an asset is worth $20 in the private sector and the government pays me $50 for it, isn't that one way for the government to inject $30 into the economy in a sneaky way?

Yes, but it probably can't be done too much. Otherwise it would encourage more dangerous risk taking. Capitalism without default is like Catholicism without Hell. I see that policy only useful for an isolated mulligan.

[MediumTex]

I see that policy only useful for an isolated mulligan.

Like 2008-present?

[AdamA]

If an asset is worth $20 in the private sector and the government pays me $50 for it, isn't that one way for the government to inject $30 into the economy in a sneaky way?

They mostly buy at a mark up from banks, though, right?  And aren't the banks still basically too scared to really loan it out to anyone?

[Gumby]

I see that policy only useful for an isolated mulligan.

Like 2008-present?

Yeah. Sorry, I meant that the policy is only useful as a catalyst for improving the banking system (i.e. reducing systemic risk) if it doesn't become common practice. But, theoretically they can continue that policy for a long time. Not sure people would support it though.

[Lone Wolf]

So, how does the government get to a monetary base of, say, $800 Billion? Are you suggesting that the Fed needs to have purchased up $800 Billion of assets??? That's not capitalism.

Unfortunately, it's too late -- the Fed already did a lot more than that when they purchased over a trillion in MBS's.  "In total, $1.25 trillion in agency MBS were purchased between January 2009 and March 2010, when the purchase phase of the program was complete."  Link

I can only say it so many different ways: I am not defending or judging what the Fed will or won't do.  I'm simply trying to point out examples that show the Fed has the ability to conduct its business with or without a supply of ever-expanding government debt.

It's starting to seem to me that MMT assumes that central banks are only permitted to expand the money supply by purchasing government debt.  If that's the only way that MMT's accounting tautologies hold up then, yes, I guess that by definition the model requires the existence of government debt.  Central banks have a lot more latitude than this, though.  It certainly doesn't apply to the Fed or the Bank of Japan.

If MMT requires the central bank to exclusively purchase government debt in order to offer a meaningful model, just say so.

With this scenario you've invented, you seem to have convinced yourself that the Fed should be in charge of growing our economy in some weird sanitized fashion. That's not the role of the Fed. Congress already has the power to grow our economy and increase the base money supply accordingly.

I didn't invent the scenario and I don't think this.  The Fed actually bought $1.25 trillion in MBS.  This really happened.  Was this money that was previously "spent into existence" via deficit spending?  Obviously not.

As for the moral argument, I agree that this should not be the Fed's role.  However, nor should it be the Fed's role to simply print up money for the government to spend as it wishes, bidding against the private sector for our scarce pool of resources and labor.  (And I also disagree that it should be Congress's role to "grow the economy".)

It's as if you've invented this ridiculous Fed policy just to get out of admitting that our money supply comes from government spending.

The ridiculous Fed policy of purchasing MBS's?  Did I bend time and space, return to 2008, and sleep with Ben Bernanke to convince him that he should buy MBS's?  I can neither confirm nor deny.

Central banks already purchase gold, mortgage-backed securities, foreign currencies, and lately even stocks, corporate bonds, REITs, you name it.  You don't have to be psyched about any of this.  I'm just trying to demonstrate why the world doesn't end when the big deficits stop.

It's trivial to bulk up the Fed's balance sheet.  Gold alone could even do it.

[stone]

The most important point IMO is that nominal growth of the economy is neither necessary nor sufficient for prosperity/real economic growth. There could be only one remaining USD. Technology could have improved in leaps and bounds. We could all be tended by robots, flying around on hoverboards or tele-porting or whatever and all transactions could be conducted in units of one trillionth of a dollar.

I think what finance is all about is offering a quick fudge to sidestep the massive inefficiencies caused by wealth inequality. The joke is that every time we adopt that quick fudge we further build wealth inequality.

Banking can string things along for so long. But banking is limited by capital requirements (banks can only make loans of a certain multiple of the assets owned by the bank) and (in times of stress) by liquidity of reserve transfers between different banks. Deficit spending by governments can string the banks along further by increasing net financial assets. BUT at the end of the day any process that HAS to increase exponentially to stay solvent will come unstuck unless inflation is perfectly even across the economy and pacing that increase. Neither of those things are true.

I guess 2008 was about the banks having rolled over loans to provide money to service the loans they had previously made etc. The banks were limited in the rate that they could expand in that way by the capital requirement regulation. Let's say banks had to hold one dollars worth of assets (eg MBS) for every ten dollars they conjured up as loans. They had to use the profits from the interest (or trading or whatever) to buy more MBS to give a capital base to enable an enlargement of their loan book. Basically that enlargement trundles on until people can not service the loans and/or the assets that the banks hold as capital collapse in value. Both limitations kicked in together in 2008. What the Fed did was to artificially prop up the MBS values so that the banks were not compelled to shrink the balance sheets in order to stay within the capital ratio requirements.

IMO it is all nonsense. The finance system is basically an administrative burden on the economy. It makes no more sense to have an ever increasing administrative burden in the form of banks than it does in any other way.

In the UK there is a large successful retail chain called the John Lewis Partnership. It was a private company until the 1920s (I think) when the eccentric owner donated it to the employees. Ever since then it has been 100% employee owned. It does very well. To me that is an example of how much of the economy could be run if we so chose.

[Gumby]

Unfortunately, it's too late -- the Fed already did a lot more than that when they purchased over a trillion in MBS's.  "In total, $1.25 trillion in agency MBS were purchased between January 2009 and March 2010, when the purchase phase of the program was complete."  Link

Sorry, you misunderstood me. Let me rephrase. My $800 Billion was for a hypothetical country that only had an $800 Billion base money supply and no other form of savings. In reality, our country has about $3 Trillion in base money, but our private sector also has about $15 Trillion in risk free Treasuries — which are really the savings of our economy. So for you to say that we bought $1 Trillion in MBS when the private sector owns well over $15 Trillion in risk-free assets isn't saying much.

Anyway... Here's the problem with your proof. In your scenario, the Central Bank is backing all of its currency with assets. But that's not a fiat currency. That's an asset-backed currency. For the currency to be fiat, it should be backing the currency with its own imaginary paper. Our currency has well over $15 Trillion in risk-free savings, backed by confetti — not assets.

I'm simply trying to point out examples that show the Fed has the ability to conduct its business with or without a supply of ever-expanding government debt.

Again, you're proving your point with an asset-backed currency. In a fiat government — which is what we have — the money is backed by thin air (i.e. government paper).

It's starting to seem to me that MMT assumes that central banks are only permitted to expand the money supply by purchasing government debt.

Yes! Now you're starting to understand. That's what a fiat currency is. The examples you've given aren't fiat.

It has less to do with whether they are permitted to or not. It's just that purchasing government paper is the policy of what's most efficient for a fiat government (i.e. no assets are needed). It what makes the currency fiat in the first place!

If that's the only way that MMT's accounting tautologies hold up then, yes, I guess that by definition the model requires the existence of government debt.

Yes. And all we've been saying all along (in previous conversations) is that the government doesn't have to issue "debt" to be fiat. The Treasury can simply print and not issue Treasuries, if Congress allowed it to. As long as the government provided a form of risk-free savings, the effect would be the same.

Central banks have a lot more latitude than this, though.  It certainly doesn't apply to the Fed or the Bank of Japan.

No one is disputing that. But, they have far more freedom to buy an endless supply of its own fiat government paper.

If MMT requires the central bank to exclusively purchase government debt in order to offer a meaningful model, just say so.

It doesn't require it exclusively. But, if the government is fiat, that's exactly what happens. And it's far easier and efficient for it to buy its own risk-free paper — particularly when it comes to setting interest rates and conducting monetary policy.

It's trivial to bulk up the Fed's balance sheet.  Gold alone could even do it.

But that wouldn't be a fiat currency. If we're going to discuss a fiat currency (which is what MMT does) then you shouldn't be giving examples of a currency that needs to be backed by tangible assets.

LW, I think you are so close to figuring out how a fiat currency works. You just need to stop thinking about fiat currencies as being backed by anything. Well done!

[stone]

Is it worth considering how the bank of England started? I'm not properly familiar with it but I think it sprung from the tally stick system. When the Bank of England started, there was a non-expanding fiat system based on tally sticks that were all regularly collected as tax. The people who started the Bank of England bought shares in it using tally sticks. They then made interest bearing loans the English government. I suppose the government were bamboozled into thinking that it would provide a way to make a fiscal boost or something. We basically had a transition from a debt free fiat system to an indebted fiat system. The gold standard was bolted on much later. Perhaps someone else here is more clued up on this than me?