Cullen Roche interview

[whatchamacallit]

whatchamacallit,

Again, the proper accounting is found here:

http://brown-blog-5.blogspot.com/2013/0 ... asing.html

Thanks. That did help but I was trying to figure out where the reserves asset comes from right before the bond purchase.

I know the Fed would have no use for holding reserves themselves and it would just cancel out, but the instant right before they buy the bonds they need the reserves to do so.

So it helps it make sense to me to think of the Fed loaning themselves the reserves so that the assets and liabilities are equal.

[Gumby]

whatchamacallit,

Again, the proper accounting is found here:

http://brown-blog-5.blogspot.com/2013/0 ... asing.html

Thanks. That did help but I was trying to figure out where the reserves asset comes from right before the bond purchase.

I'm pretty sure they just conjure the reserves out of thin air the instant they are transferred to the bank's reserve account, by tapping a few keystrokes (money printing). By doing so, they've simply created a liability (the deposit for the bank in their reserve account at the Fed) and received an asset (the bond).

[Tom Brown]

TennPaGa,

I left a response on my blog to a comment there that I think is yours. But briefly, just think of all financial assets (bonds, cash, Fed deposits, bank deposits) as being IOUs. Every IOU is conjured out of thin air (e.g. you get out your pen and write an IOU), and every one has a debtor (the entity that wrote the IOU) and a creditor (the entity that received the IOU). The creditor status can be transferred from one entity to the next. On balance sheets each financial asset then is entered once in the left hand column for the creditor as an "Asset" and once in the right hand column for the debtor as a "Liability." So there are two views of each financial asset. When a debtor receives his IOU back again, he "tears it up" and the financial asset ceases to exist, and thus both views of it are eliminated.

Fed deposits are this kind of financial asset. So are bank deposits. So are loan documents. In the following example I assign a unique color to each financial asset. You can see this in both views of the asset in the balance sheets: one in the right column, one in the left:

http://brown-blog-5.blogspot.com/2013/0 ... posit.html

So on that first step, the loan is yellow and the deposit is green. The loan is the borrower's IOU (the loan docs he signs) and the deposit is the bank's IOU. Essentially they exchange IOUs. Keep in mind that these two financial assets are independent of one another: Each one has a life of its own, and each will continue to exist independently until it is returned to its originator. For example, suppose the bank charged the borrower a $100 fee for taking out the loan: if the borrower paid that, then the deposit would cease to exist, but the loan would live on. Conversely the bank might pay the borrower $100 for some sort of service (plumbing perhaps?), and then if the borrower paid off the loan, then the loan would cease to exist but a deposit would live on. I try to show that here:

http://brown-blog-5.blogspot.com/2013/0 ... erest.html

The only exception to this kind of accounting for financial assets (BTW, I call them "assets" as a short hand, even though they generally are an asset to one party and a liability to another) is coins. From the moment coins are minted by the Mint (a part of Tsy) they become a financial asset ONLY (they are not a liability to anybody). Now Tsy actually loses money on some coins because they are more expensive to mint than their face value (pennies and nickles), but otherwise they can turn a profit by selling coins. That profit is seigniorage (sp?). However, the Tsy must accept the coins back again for their face value when they are damaged or worn out, so the are called an off balance sheet "obligation" of Tsy for that reason. I like to think of them as representing small loans to Tsy, that will be repaid once they are returned to Tsy.

Paper reserve notes are also physically created by a branch of Tsy (the Bureau of Engraving and Printing or "BEP"), but they are sold the the Fed for their production cost, not their face value. While sitting at the Fed, notes have no face value and don't appear on any balance sheets. It's not until they are sold to another entity (e.g. commercial banks) that they take on their face value and become liabilities of the Fed (and assets to the party which holds them). The lose their face value (and thus their liability status at the Fed) when they are sold back to the Fed. Literally reserve notes are paper IOUs distributed by the Fed. I try to map out the relationships here:

http://brown-blog-5.blogspot.com/2013/0 ... abels.html

The one form of money that I don't cover there is a very rare form of paper money called "US Notes." US Notes are direct liabilities of Tsy (instead of the Fed), but there's only a small $ amount still in circulation (they were last printed in 1971).

[Kshartle]

There's a distinction between the IOU that's denominated in dollars and the liability of the FED for the dollars they create. Who do they "owe" this to?

We are all required by law to accept dollars as repayment of debt and we must pay taxes in them. No one is required to accept an IOU as payment as far as I know.

This is a huge distinction that is glossed over when people percieve the money supply as static when dollars are traded for bonds by the FED.

Bonds are not used to purcahse anything other than dollars as far I know. Nothing is priced in Bonds. 

The government borrowing 1 trillion by selling bonds doesn't add 1 trillion to the money supply anymore than me borrowing $100 from you adds to the money supply.

The FED printing 1 trillion out of thin air and essentially transferring interest free to the government via the banks does add it.

You can take a look at any given part of the process and conclude it didn't add but when you look in total I don't see how this can be denied.


Before the government borrows - assets only:

Bank                    Government
$100                          $0

After the government borrows:

Bank                    Government
$100 bond                  $100 

After QE:

Bank                    Government
$100                          $100


The only way you can imagine this is non-expansionary is if you count the bond as a government liability that will actually be paid off at some point. I suppose this is where we dissagree. I don't think the FED will ever demand repayment. They will just roll over.....unless or until there is a crisis. if they do stop rolling over the debt we get a different crisis.

[moda0306]

Kshartle,

So if we know that the fed, the very entity that issues money, uses the treasury bond market (mostly) to do so, would you blame society and the markets for acting as if they were all-but equal, even if they trade one for the other right before buying bread?

The demand for savings is so high at this point, and interest rates are so low, that people really see little distinction between their dollars and their savings bonds.  Neither does the market.

If you still want to stick to the idea that bonds are promises to repay gold or something that they were in the past but are not anymore, you can, but the market is going to operate understanding how they are used today... what they fundamentally promise/mean today.

[Kshartle]

Kshartle,

So if we know that the fed, the very entity that issues money, uses the treasury bond market (mostly) to do so, would you blame society and the markets for acting as if they were all-but equal, even if they trade one for the other right before buying bread?

The demand for savings is so high at this point, and interest rates are so low, that people really see little distinction between their dollars and their savings bonds.  Neither does the market.

If you still want to stick to the idea that bonds are promises to repay gold or something that they were in the past but are not anymore, you can, but the market is going to operate understanding how they are used today... what they fundamentally promise/mean today.

I would never blame society for anything for the same reason I would never blame a dragon or a unicorn for anything.

I don't understand the rest of your comments. I've never insisted that bonds are promises to repay gold or that they should be.

What do you mean the demand for savings is high? What does that mean?

People see little distinction between their savings bonds and dollars? That has nothing to do with anything. The bond is someone else's liability. I can't go out and spend my savings bond unless someone gives me cash for it. They now have less cash. It can bounce around like a hot potato but can never be spent....until the gubmit steals, prints or borrows the cash to pay it off. It's not money...doesn't matter what people think. What they think doesn't change reality.

[moda0306]

You deem bonds to be fundamentally different from dollars based on what they are promising you... but they're just promising you dollars, and the fed engineers certainty of their ability to pay.

Savings is income not spent... You can then choose how to invest that savings. People "want" more savings every year given their financial difficulties, but savings requires investment, and because we're still not at full capacity, investment is weak. So if I'm up to my ears in debt, and I "saved" $10,000 this year, I really don't care if it's in cash or a bond... just that it's on my balance sheet...  You still seem to have some trouble understanding human nature and financials within a balance-sheet recession.

To your last paragraph, if people see little distinction between treasury bonds and dollars, that will affect their motivations, and they'll willingly trade the two in a liquid manner to make payments.

So do you think if the government made treasury bills/bonds legal tender, you'd have a massive change of heart on QE?

[Kshartle]

You deem bonds to be fundamentally different from dollars based on what they are promising you... but they're just promising you dollars, and the fed engineers certainty of their ability to pay.

Savings is income not spent... You can then choose how to invest that savings. People "want" more savings every year given their financial difficulties, but savings requires investment, and because we're still not at full capacity, investment is weak. So if I'm up to my ears in debt, and I "saved" $10,000 this year, I really don't care if it's in cash or a bond... just that it's on my balance sheet...  You still seem to have some trouble understanding human nature and financials within a balance-sheet recession.

To your last paragraph, if people see little distinction between treasury bonds and dollars, that will affect their motivations, and they'll willingly trade the two in a liquid manner to make payments.

So do you think if the government made treasury bills/bonds legal tender, you'd have a massive change of heart on QE?

If they made T-bonds legal tender why would there be any QE? The government would no longer be borrowing money, it would just be printing it everytime they borrowed.

This makes no sense. If their debt is money then it's not debt.

[Kshartle]

You deem bonds to be fundamentally different from dollars based on what they are promising you... but they're just promising you dollars, and the fed engineers certainty of their ability to pay.

A dollar is obviously different from the promise to pay a dollar because the promise requires the debtor to get dollars it doesn't have.

If the FED is going to engineer the certainty of the government re-paying....then you agree with me they will not shrink their balance sheet. If they will never shrink their balance sheet.........the government's liability to repay does not really exist and they essentially got free money, making QE nothing more than the government de facto printing money.

This is what I've been saying all along. I'm glad we finally agree.

[Tom Brown]

There's a distinction between the IOU that's denominated in dollars and the liability of the FED for the dollars they create. Who do they "owe" this to?

Kshartle, while I tend to agree that there's a special role for the medium of account (MOA), in that its price is by definition fixed at unity (so that if its "value" rises, this just means every other good's numerical price drops, and vice versa), I still think that people and businesses tend to spend from a sense of their wealth (equity) and anticipation of future income contributing to that equity, in comparison to their concerns about expenses and debts. So for example, if you were paid handsomely at work, but 75% of your pay was in valuable company stock (say at a nice stable company), you might be very well inclined to spend more than if you made one third as much, but were paid entirely with cash. Sure to spend out of your stock, it would be necessary to first convert it to cash, but this can be done on an incremental basis.

In your example, the equity is transferred to the private sector (from Tsy, which accumulates offsetting negative equity) when the Tsy deficit spends, not when the Fed trades Fed deposits (MOA) for the bonds. So while I agree with your point about the money supply, I think the equity supply is far more important.

That's why I think it's important to keep track of the liabilities side of balance sheets: otherwise you don't know the equity position of each player. Even for the Fed this is important just because the Fed is not supposed to lose equity: it's supposed to stay close to $0 equity. Otherwise it might need a gov bailout which would be politically unacceptable. Nor should it acquire a large surplus (positive equity).

And the bond is a gov liability that will be paid off at some point, even if held to maturity by the Fed. When the principal is paid off (for a bond maturing at the Fed), it's as if the Fed and the Tsy return IOUs to each other and then tear them up.

[Kshartle]

And the bond is a gov liability that will be paid off at some point, even if held to maturity by the Fed. When the principal is paid off (for a bond maturing at the Fed), it's as if the Fed and the Tsy return IOUs to each other and then tear them up.

This is the difference Tom.

I don't believe the FED will ever demand repayment since the government will have to either borrow, print or steal the money from someone other than the FED (someone with actual $$$, not ones conjured up out of thin air).

The first option will cause rates to go up and the government will have to pay interest. The second option will make the inflation obvious with all the associated problems to the dollar. The third option.....well i imagine you know the consequences to the economy of increasing taxes.

None of those options are palatable. That's why I think the FED has no intention of not rolling over the debt (essentially providing the government free money) until there is a crisis. I could be wrong.

Where do you think the government can get the money to pay off the bonds held by the FED? What do you think the consequences will be if they do that and what is the likelihood?

[Kshartle]

And the bond is a gov liability that will be paid off at some point, even if held to maturity by the Fed. When the principal is paid off (for a bond maturing at the Fed), it's as if the Fed and the Tsy return IOUs to each other and then tear them up.

Does this....."tearing up"...shrink the money supply?

[Tom Brown]

... so from the non-bank public's point of view, their "money on hand" comes down to:

L + B + F = cash + bank deposits

Where

L = loans
B = bank held Tsy debt
F = Fed held Tsy debt

But the public's financial equity (not counting real assets like houses) is still just

T = total Tsy debt

So if the Fed or the banks were to buy up more of the public's Tsy debt it wouldn't change the public's equity position, but it would increase their money position. And from the public's point of view it doesn't matter whether it's the Fed or the banks doing the buying. It's up to the public how to proportion their assets between money and other financial assets, but again, it has no immediate effect on their overall wealth.

http://brown-blog-5.blogspot.com/2013/0 ... lance.html

[Tom Brown]

Kshartle, sure "tearing up" shrinks the money supply since Fed liabilities decrease.

Tsy debt owned by the Fed matures all the time. The Tsy pays this off all the time. This is not an unusual circumstance. The Tsy gets the money where they always get it: taxes or more bond sales. The "rolling over" is done from the Tsy side: they decide to sell more bonds to cover maturing one, regardless of who owns the maturing ones. The Fed buying or selling bonds doesn't have anything to do with the rolling over process.

All else being equal (no further purchases of bonds by the banks or the Fed), if the Tsy were to simply deficit spend such that the total gov debt were to climb at a constant rate, then this has no effect on the money supply at all. It does have an effect on the net financial assets held by the non-bank public. Essentially the Tsy would be taking $ from A to pay B with no change in the total $ amount. It's like they are recycling $, and in the process issuing bonds to A. Now independent of this gov deficit spending, the pubic could be taking on more loans, in which case the M1 supply could grow via that mechanism. Or shrink, if they were net paying down loans.

[Tom Brown]

TennPaGa,

Yes, it's as if instead of physically tearing up the paper IOUs, the Fed simply puts them in a drawer to be used again some day if need be, but they are essentially valueless while sitting in that drawer, just like you might have an IOU that you wrote returned to you (at which point, regardless of what you do with it, it is valueless). Only when the notes become unusable or outdated (lacking the latest security features) do they actually "tear them up."

In contrast, coins sitting at the Fed still have their face value, and actually appear as assets on the Fed's balance sheet. It's kind of a historical oddity I think. It probably goes back to the days when coins were made from gold or silver and reserve notes were still redeemable in these coins.

[Kshartle]

Kshartle, sure "tearing up" shrinks the money supply since Fed liabilities decrease.

If paying off the bonds the FED holds with dollar shrinks the money supply......then the FED printing money and buying the bonds increases it. What difference does it make if the banks act as an intermediary?

If the banks were completely by-passed as the Treasury borrowed directly from the FED....would it not be exactly the same as if the Government sold the bonds to the bank first and then the FED bought them from the banks?

[Kshartle]

I appreciate the dialogue Tom. We are all trying to understand this better. I am less interested in mechanics as I am effects but I think having an intelligent discussion about this is very helpful, especially to people looking in and reading.

[Tom Brown]

Kshartle, thanks, I enjoyed the convo too.

Re: banks as intermediaries: I'm not sure why you brought this up. I guess because I wrote that as far as the non-bank public is concerned it doesn't matter if the Fed or the banks buy their Tsy debt. In that case I wasn't referring to the banks as an intermediary (although it's true that they often do serve as one), I meant the banks as permanent holders of Tsy debt. So again, the public's stock of money is:

L + B + F

So the only thing of concern here regarding Tsy debt is the (B + F) component, and all that ultimately matters to the public is this sum, not the individual components (B and F).

For a fixed level of total Tsy debt (T) and commercial bank loans (L), the public's money supply can be anywhere between L and L+T depending on how much of T is owned by the banks and the Fed (i.e. how close B+F is to T).

And from Tsy's point of view, the only difference in who owns the Tsy debt is whether or not they get the bulk of the interest back again. Of course if the Fed owns the debt, then Tsy will get something like 96% of their interest back again (remitted).

But regarding the principal amount of the Tsy debt, it doesn't matter who owns it: Tsy still has to pay it off in full.

In terms of concern over monetization of the debt (because the Fed purchases Tsy debt), I think this would be a big concern if there was no market for US Tsy debt, and the Fed were the only buyer. But that's not the case: there's a healthy market for Tsy debt. Plus, because the Fed doesn't take orders from Tsy, Tsy has to be prepared that the Fed might sell all of their Tsy holdings at any time, which means no more remitted interest payments.

BTW, Market Monetarists generally like the idea of monetary policy being conducted through open market operations (OMOs) with Tsy debt (since it's a purely financial asset and a very safe one), but they by no means think this is necessary. The Fed could buy & sell just about anything with OMOs and still be able to conduct effective monetary policy. Nick Rowe has an article up right now in which he considers what the system would look like if the Fed purchased and sold land instead.

I've seen all kinds of opinions on this "monetization" question. Some folks think that having a healthy market in Tsys doesn't matter: it's still monetization and thus it's still bad. Some think that because a market for Tsys is still present, that monetization is not an issue (that'd be Cullen's view I think). Some say "Who cares!... if the gov can monetize and we're still undershooting our inflation targets, ... and more importantly our nominal GDP targets (aggregate demand targets), then monetize away! Far better to 'monetize' than let AD slip." (that's the view of Benjamin Cole, who's a Market Monetarist who sometimes writes guest articles for people like Marcus Nunes).

I tend to agree with Mr. Cole on this one, but I also think it's a lot less distressing given that there does appear to be healthy demand/market for Tsy debt.

Those warning of the dangers of monetization may have a point though... who knows when the market for Tsy debt might gradually slide to a place where the Fed starts buying more and more to keep the gov afloat, somehow creating a positive feedback loop / death spiral as investors start to suspect this and then enter panic mode. My opinion is that this seems a little far fetched right now. But who really knows with this stuff? It's a mystery to me. Vincent Cate is an amateur blogger who seems to enjoy finding scenarios in which our fiat system collapses and we enter into a hyperinflation nose dive.

I think the hyperinflationists have taken a pretty good beating over the last five years though: especially when they've got advocates on their side like Peter Schiff who has has kept saying that hyperinflation was right around the corner. When confronted on this by Larry Kudlow, Schiff said that his definition of hyperinflation doesn't have anything to do with price levels, rather it's defined by the size of the monetary base, and thus all his predictions were accurate. Kudlow mocked him for this*... I think rightly: it seems like a definition tailor made for Schiff to save face on TV.

*paraphrasing, Kudlow said something like "So Peter, you've been warning all of us for five years now that if the Fed keeps creating base money this will lead to higher levels of... ...base money?!? Lol"

Opinions seem to be all over the map, but it seems to me that only a subset of Austrians and perhaps a very few traditional monetarists are concerned that further QE type "monetization" will lead to disaster. PKers, MMers, and NKers all think it's at least fairly benign. Nobody seems to be a huge fan of QE though either: even MMists who claim that the only reason QE was so big with such little to show for it is because the Fed refused to clearly and credibly articulate what their goal was with it. If they'd been more clear a much smaller QE would have done the trick. That's what they call the "Chuck Norris Effect." Chuck can clear a room w/o throwing a single punch, by just being extremely clear that he wants people to leave.

[Kshartle]

Schiff has said hyperinflation is inevitable if the FED never stops increasing the rate of monetary expansion. He expects them to end it before then though and the result will be a deflationary recession/depression. That's his prediction. It's the same thing Harry Browne said in his books plenty of times.

So then you agree Tom that QE is inflation? Maybe we don't agree on the definition of inflation. Do you agree that QE expands the money supply? You must since you said the reverse of it......the government paying off the bonds held by the FED contracts the money supply.

[Gumby]

Schiff has said hyperinflation is inevitable if the FED never stops increasing the rate of monetary expansion. He expects them to end it before then though and the result will be a deflationary recession/depression. That's his prediction. It's the same thing Harry Browne said in his books plenty of times.

So then you agree Tom that QE is inflation? Maybe we don't agree on the definition of inflation. Do you agree that QE expands the money supply? You must since you said the reverse of it......the government paying off the bonds held by the FED contracts the money supply.

KShartle.... I don't think you and Schiff don't get to have it both ways. You don't get to say that inflation is just defined as "increasing the monetary base" and then predict that never stopping the increase of the monetary base will result in a "hyperinflation" where the definition of inflation suddenly changes to an increase in price levels when it's convenient and back to "I just meant increasing the monetary base" when it's inconvenient. You have to pick a definition. Repeating Schiff's "increasing price levels is a symptom of an increasing monetary base" isn't exactly supported by much evidence given the dramatic increase in the monetary base and virtually no corresponding response from inflation.

And, furthermore, Tom was pretty clear that QE increasing the monetary base doesn't increase overall wealth in the private sector. So, maybe you can explain how hyperinflation (of price levels) can take place if nobody in the private sector is any wealthier and nobody feels any richer or has more "equity"?

You are basically trying to get Tom to admit that moving money from a Savings account to a Checking account should make people feel richer and spend money on goods/services. But, nobody has any more purchasing power after such a transaction!

[Kshartle]

And, furthermore, Tom was pretty clear that QE increasing the monetary base doesn't increase overall wealth in the private sector. So, maybe you can explain how hyperinflation (of price levels) can take place if nobody in the private sector is any wealthier?

Wow.

Everyone with a basic grasp in reality knows that printing slips of paper doesn't create wealth.

Hyperinflation doesn't happen when people are wealthier. I can't believe you would ask this question. You must have meant to ask something else. Unless you think the guy in Zimbabwae with 100 quadrillion dollar wallpaper was wealthy.

[Gumby]

And, furthermore, Tom was pretty clear that QE increasing the monetary base doesn't increase overall wealth in the private sector. So, maybe you can explain how hyperinflation (of price levels) can take place if nobody in the private sector is any wealthier?

Wow.

Everyone with a basic grasp in reality knows that printing slips of paper doesn't create wealth.

Hyperinflation doesn't happen when people are wealthier. I can't believe you would ask this question. You must have meant to ask something else. Unless you think the guy in Zimbabwae with 100 quadrillion dollar wallpaper was wealthy.

KShartle, I'll ask you, kindly, to please stop with the derision and verbal abuse. You know what I meant.

As Tom said (his words) nobody has any additional "equity" after a QE transaction. So, how can they possibly feel like spending more to create price inflation?

[moda0306]

Redefining inflation is one of the most annoying aspects of the inflation/deflation debate

When gold is rising, gold is the measure of inflation (though never-mind when it falls in nominal terms consistently for two decades).

When the monetary base is rising, the monetary base is the measure of inflation.

When discussing CPI, shadow-stats is the proper measure of inflation.



Kshartle,

When Gumby says that "nobody feels wealthier," he means from a nominal point of view.  People's nominal balance-sheets don't improve. 

[Kshartle]

And, furthermore, Tom was pretty clear that QE increasing the monetary base doesn't increase overall wealth in the private sector. So, maybe you can explain how hyperinflation (of price levels) can take place if nobody in the private sector is any wealthier?

Wow.

Everyone with a basic grasp in reality knows that printing slips of paper doesn't create wealth.

Hyperinflation doesn't happen when people are wealthier. I can't believe you would ask this question. You must have meant to ask something else. Unless you think the guy in Zimbabwae with 100 quadrillion dollar wallpaper was wealthy.

KShartle, I'll ask you, kindly, to please stop with the derision and verbal abuse. You know what I meant.

As Tom said (his words) nobody has any additional "equity" after a QE transaction. So, how can they possibly feel like spending more to create price inflation?

You're assuming I'm smarter than I probably am. I thought you actually thought people had to be wealthier or even feel wealthier to create hyperinflation.

[Gumby]

Wow.

Everyone with a basic grasp in reality knows that printing slips of paper doesn't create wealth.

Hyperinflation doesn't happen when people are wealthier. I can't believe you would ask this question. You must have meant to ask something else. Unless you think the guy in Zimbabwae with 100 quadrillion dollar wallpaper was wealthy.

KShartle, I'll ask you, kindly, to please stop with the derision and verbal abuse. You know what I meant.

As Tom said (his words) nobody has any additional "equity" after a QE transaction. So, how can they possibly feel like spending more to create price inflation?

You're assuming I'm smarter than I probably am. I thought you actually thought people had to be wealthier or even feel wealthier to create hyperinflation.

No... I was simply telling you what Tom Brown said:

... so from the non-bank public's point of view, their "money on hand" comes down to:

L + B + F = cash + bank deposits

Where

L = loans
B = bank held Tsy debt
F = Fed held Tsy debt

But the public's financial equity (not counting real assets like houses) is still just

T = total Tsy debt

So if the Fed or the banks were to buy up more of the public's Tsy debt it wouldn't change the public's equity position, but it would increase their money position. And from the public's point of view it doesn't matter whether it's the Fed or the banks doing the buying. It's up to the public how to proportion their assets between money and other financial assets, but again, it has no immediate effect on their overall wealth.

http://brown-blog-5.blogspot.com/2013/0 ... lance.html

For some reason you chose to jump down my throat when I use "wealth" in a sentence. Not cool.