The can down the road...

[doodle]

This modern monetary theory is something I have glanced at but seems to overlook two things in my mind.

#1 - The value of money is derived not just by the coercive force of government to demand taxes to be paid in a certain manner, but by the productive capacity of the economy to which those paper notes are tied. MMT gives me the impression that government can print money irrespective of the underlying economy to back it up with productive capacity.

#2 - The money that we use must be understandable to the people who use it. MMT (although maybe factually accurate) seems to overlook the fact that humans view money in a simple manner. If the system gets so complicated that they cannot understand what "money" means any more then this would introduce instability, confusion, and doubt into the system.

[moda0306]

I think it's a very succinct, if somewhat simplified version of saying that if you can't trust your government with the currency, then a gold standard is pointless... it means nothing.... you've already admitted that they'll break the standard when need-be if they have the power to, and having a gold standard doesn't pursuade our leaders to be any more honest or responsible than they otherwise would be.

[Gumby]

This modern monetary theory is something I have glanced at but seems to overlook two things in my mind.

#1 - The value of money is derived not just by the coercive force of government to demand taxes to be paid in a certain manner, but by the productive capacity of the economy to which those paper notes are tied. MMT gives me the impression that government can print money irrespective of the underlying economy to back it up with productive capacity.

I think there's more to it than that. They worry about inflation when unemployment is low and deficits are high. But that's not a problem right now. So, MMT'ers worry that the deficit isn't big enough right now!

#2 - The money that we use must be understandable to the people who use it. MMT (although maybe factually accurate) seems to overlook the fact that humans view money in a simple manner. If the system gets so complicated that they cannot understand what "money" means any more then this would introduce instability, confusion, and doubt into the system.

They would probably argue that it doesn't matter. You need the currency to pay your taxes (or face the consequences). And people have faith that the Treasury coupon payments will continue — no matter what — so the risk is virtually nil. Furthermore, they argue that the rating agencies are meaningless — which is really a representation of the perception of doubt or faith.

For example, Japan's debt has been downgraded consistently since the 90's, but the yields have continued to drop despite those poor ratings.

Here's a brief rundown of Japanese government debt downgrades:

In April 1998, Moody’s changed the yen-denominated JGBs ratings from Aaa stable to Aaa negative. Moody’s simply explained that uncertainty had increased as to whether it would be possible for the Government to achieve its central aims, economic growth and fiscal improvement. In June 1998, Moody’s released a detailed report analyzing the Japanese economy. This report emphasized three factors destabilizing the Japanese economy: fiscal deficits, surplus in the balance of payments, and deflationary pressure. Eventually, Moody’s downgraded yen-denominated Japanese Government Bonds to Aa1 in November 1998, to A2 in September 2000, to A3 in December 2001, and A2 in May 2002. Similarly, S&P downgraded yen-denominated JGBs from AAA to AA+ in February 2001, to AA in November 2001, and to AA- in April 2002. Fitch also downgraded yen-denominated JGBs from AAA to AA+ in June 2000, to AA in November 2001, and to AA- in November 2002.

As of August 2005, yen-denominated JGBs have been assigned A2 ratings by Moody’s. Among the G-7 countries, Japan has the lowest ratings and the second lowest is Italy with Aa2, which is 3 notches higher than A2. Other G-7 countries have AAA grade ratings. Countries that have been given the A2 grade include Israel, South Africa, Poland, Mauritius, Kuwait and Latvia.

Source: CREDIT RATINGS IN THE JAPANESE BOND MARKET

According to orthodox monetary theory, the rates should have gone up — as we would certainly expect with a country like Greece. But, the rates went down. It seems backwards, yet it seems to validate MMT in some respects. (Note: Japan is currently at Aa2, by Moody's).

Likewise, as the deficit grows faster and faster in the US, our Treasury yields drop. As crazy as MMT sounds, I think deserves further investigating. The market seems to follow it's logic.

[Tortoise]

I think it's a very succinct, if somewhat simplified version of saying that if you can't trust your government with the currency, then a gold standard is pointless... it means nothing.... you've already admitted that they'll break the standard when need-be if they have the power to, and having a gold standard doesn't pursuade our leaders to be any more honest or responsible than they otherwise would be.

The phrase "if they have the power to" in your quote above is the key.

In the absence of a central bank, the gold in a nation under a gold standard is generally spread out across countless private banks, institutions, businesses, and individual safes and safe deposit boxes. That makes widespread confiscation of the gold by the government very difficult.

Before the government has the ability to confiscate most of the nation's gold, it must find a way to gradually collect most of those decentralized gold holdings into centralized vaults. How is that accomplished? It's a big reason why central banks were created: to convince people to convert their gold coins into central bank notes bearing the confidence-inspiring imprimatur of the federal government--mainly for convenience. Then the gold, pooled in the central bank's vaults, became much easier for the government to confiscate.

A relevant passage from Murray Rothbard's What Has Government Done to Our Money? (boldface added):

A Central Bank attains its commanding position from its governmentally granted monopoly of the note issue. This is often the unsung key to its power. Invariably, private banks are prohibited from issuing notes, and the privilege is reserved to the Central Bank. The private banks can only grant deposits. If their customers ever wish to shift from deposits to notes, therefore, the banks must go to the Central Bank to get them. Hence the Central Bank's lofty perch as a "bankers' bank." It is a bankers' bank because the bankers are forced to do business with it. As a result, bank deposits became redeemable not only in gold, but also in Central Bank notes. And these new notes were not just plain bank notes. They were liabilities of the Central Bank, an institution invested with all the majestic aura of the government itself. Government, after all, appoints the Bank officials and coordinates its policy with other state policy. It receives the notes in taxes, and declares them to be legal tender.

As a result of these measures, all the banks in the country became clients of the Central Bank. Gold poured into the Central Bank from the private banks, and, in exchange, the public got Central Bank notes and the disuse of gold coins. Gold coins were scoffed at by "official" opinion as cumbersome, old-fashioned, inefficient--an ancient "fetish," perhaps useful in children's socks at Christmas, but that's about all. How much safer, more convenient, more efficient is the gold when resting as bullion in the mighty vaults of the Central Bank! Bathed by this propaganda, and influenced by the convenience and governmental backing of the notes, the public more and more stopped using gold coins in its daily life. Inexorably, the gold flowed into the Central Bank where, more "centralized," it permitted a far greater degree of inflation of money-substitutes.

In the United States, the Federal Reserve Act compels the banks to keep the minimum ratio of reserves to deposits and, since 1917, these reserves could only consist of deposits at the Federal Reserve Bank. Gold could no longer be part of a bank's legal reserves; it had to be deposited in the Federal Reserve Bank.

The entire process took the public off the gold habit and placed the people's gold in the none-too-tender care of the State--where it could be confiscated almost painlessly. International traders still used gold bullion in their large-scale transactions, but they were an insignificant proportion of the voting population.

[...]

Before the Central Bank began, banks kept their reserves in gold; now gold flows into the Central Bank in exchange for deposits with the Bank, which are now reserves for the commercial banks. But the Bank itself keeps only a fractional reserve of gold to its own liabilities! Therefore, the act of establishing a Central Bank greatly multiplies the inflationary potential of the country.

[moda0306]

Tortoise,

Thanks... extremely interesting.

I am not saying I approve of anything done in the 1913 or the 1930's... in fact I feel like I don't even fundamentally understand what happened when we "created a federal reserve" or "broke the gold standard" (though your post helped, Tortoise).

I guess, at this point, I see a well-run fiat system as most-likely the best option.  That doesn't mean I approve of what was done in the past or ever doing that again in the future.  Though, of course, once all the gold is confiscated, then they hold the trump cards for eternity and they don't have to actually ever do anything so confiscatory again.

[moda0306]

doodle,

MMT is remarkably simple in some ways (and mind bogglingly difficult to accept in others).

All I need to know about my currency is that my government IRS agents have the clout to take me to jail... that's all the game requires for a currency to have value.  Regarding the bond demand, the fed could (though they don't, currently, and I'm confused as to why) literally buy bonds directly from the government.

The issuance of bonds was never necessary in the first place, but since you've got foreign savers that want a ROI, it may or may not make sense for the fed/treasury to oblige them.

I realize the bond piece complicates it, especially with so many foreign holders of US debt, but to me when push comes to shove our currency still has the trump card... if foreigners want to net expel (read: spend) their US dollars, then they have to net-spend it in the United states (otherwise it will just end up in another country's bank).  Does this sound like the worst thing that could happen?

Here's an interesting simplification of MMT... really I'd have much more difficulty being a treasurer in a gold-standard government than a fiat government, methinks.

http://bilbo.economicoutlook.net/blog/?p=1075

[Gumby]

Moda. I suppose that may be an oversimplified version of MMT, but that was an excellent explanation. It made it much easier to digest. I'm sure I won't ever fully understand MMT, but the more I look at the bond market, the more I see validation of modern monetary theories (i.e. lower bond yields coinciding with ballooning deficits in fiat economies).

There was a time that the fear-mongering of the deficit hawks made sense to me. After all, the deficit hawks are actually correct when it comes to governments that don't control their own currency (local governments, Euro zone, etc)...

...but then someone pointed out to me that all politicians, pundits and deficit hawks are simply referring to economics textbooks from the gold standard era — when our currency had actual value — and applying those same gold-standard economics to our fiat currency.

It's a lot easier to convince the public to follow certain agendas when politicians and pundits argue with talking points from a time when our currency had real value. And in fact, we now see that both Republicans and Democrats generate very large deficits — the only difference is that the two parties hand the currency over to different people.

[moda0306]

Gumby,

I, too, used to be a defecit hawk because I likened it to my own finances... this stuff is hard for fiscally responsible people to swallow... I'm still far from completely buying it 100%.  It's just a game set up by the government that only a government could ever really set up, since it involves needing the permanent clout to collect a tax at the point of a gun.  It's interesting that often people who want to abolish the IRS are also harp about a pending dollar collapse (I'm not saying taxes aren't repressive, but they are our biggest tool to give the $ value).

Yes, it leaves out open market operations and fractional reserve banking and bailouts, but it really does get down to the core mechanics of fiat currency and debt... I believe those other things are built on top of this... they don't change the fundamentals of national debt, defecits, etc. (ie, fractional reserve banking probably inflates malinvestment, but ones that could very well have happened on their own).

One could add that once you add fractional reserve banking to that card system, it changes all the rules.  While I do think the populace is pretty complicit in fractional reserve banking (they'd rather earn interest less whatever their share of the FDIC insurance premium is as opposed to have the bank actually store all their dollars and have to pay them), this does hold some weight given our government's subsidy to that process.

Of course, the FDIC, once in existance, barely has to do anything, because them simply saying they'll cover a run (if they always have clout) will prevent there from ever being one... this is obviously simplified and could be challenged with "ifs" and "buts," but you guys get my drift.

I consider that another level of economic decision we have to make, though... aka, "we've already chosen to use a fiat system... should we implement some form of national insurance to encourage fractional reserve banking??"

Another one for you, Gumby....

http://bilbo.economicoutlook.net/blog/?p=7864

[moda0306]

I am starting to collect my thoughts on the challenges of foreign currency/debt holders of our government bonds.  I think those of us that think there will be some kind of mass-exodus out of the dollar or a large decision to not buy our bonds are not quite realizing the mechanics of how all this would have to work.

Right now, the only reason that China can buy our debt is because their banks hold $$ from us buying stuff from there... lots of stuff, in fact.  They then can either choose to buy something from the U.S. with those dollars, or they can buy bonds with them to at least get some interest in the mean-time.

For China to quit buying our debt, they'd have limited options... they could just sit on cash earning zero interest (which, let's admit, is even worse than owning short-term debt), or they would actually have to start purchasing from us.... buying goods that they deem useful (because they "can't stand our confetti anymore").  This is what would cause the eventual inflation people speak about, but it's really kind of funny, because when you walk through the logic of it, one realizes that to even get to high inflation, much less hyperinflation, China's going to have to start net-purchasing from the US... which means our balance of trade has now gone positive to China.  This probably means our factories are working overtime to make non-leaded toys and decent electronics for their now-pickier consumers.

Take that internationally, and one will realize that the narrative of "the world just quits buying our debt" is tantamount to saying "we now have 2% unemployment because we can't make this stuff fast enough."

Will that 2% unemployment be because of malinvestment?  Well maybe China will be buying stuff that's malinvestment for them, but is it malinvestment for us to supply their spending habits?

If I'm missing something, someone please explain, because I see no other mechanism for 1) super high inflation, or 2) foreign countries "getting sick of our confetti" besides massive swings in balance of trade, which can't be that bad considering where we're at right now, unemployment-wise.

[Jan Van]

Here's an interesting simplification of MMT... really I'd have much more difficulty being a treasurer in a gold-standard government than a fiat government, methinks.

http://bilbo.economicoutlook.net/blog/?p=1075

Thanks for that link, Moda0306. That blog can keep me reading for weeks...

[doodle]

We got a little bit off topic with MMT, but back to the original discussion.... I am raising my default polito-meter to a 50% chance of gov't shutdown....Minnesota style..... I think the GOP might actually  take the chance that the negative effects of not raising the debt ceiling could come back to harm Obama more than it does them.

Minnesota is facing the same situation that we are as a country (Dem governor and Rep legislature) and look at how that has ended up.

[moda0306]

You asked if there was a crisis looming doodle... I think the MMT discussion has to be a part of that.

According to MMT, there is no "kicking the can down the road," since debt isn't really debt.  I'm not saying I'm 100% behind this, but I have yet to hear truly substantive rebuttals to the idea that our national finances are fundamentally different than a Euro country or one with a gold standard.

[Jan Van]

And, according to MMT, a debt ceiling crises would be voluntary, self imposed. The US would choose to default on it's debt, not because it can't pay, but because we don't want to pay. We can always come up with the money to pay, having a fiat currency...

[melveyr]

If i am understand MMT right, then the whole debt ceiling fiasco could potentially be a monetary problem, not a fiscal problem. Not being able to issue debt gives the treasury/fed less flexibility when trying to absorb liquidity in the system.

By logical extension, could the debt ceiling not being passed be a good thing in the short term?

If our economy needs some incentive to spend, why are we sopping up liquidity by selling bonds to the private sector?

BTW, thanks a billion for posting that blog. I have never read anything about macro that makes as much sense as this blog.

[moda0306]

Running deficits while QE is simultaneously buying up bonds like crazy has the net effect of getting money into the economy without pulling money back out at the same time.

Problem is, QE only works when there is demand for debt... right now, overleveraged players are trying like mad (well, not mad enough) to pay down debt, so reserves are up.  

If the fed were to directly finance about $10k per adult in government-issued debit cards I wonder what the short- and long-term dynamics of that would be.  Probably a lot of continued debt-paydown, which is good in the long-term, but maybe enough short-term demand-sustenance to keep our factories operating at a decent enough capacity to keep people working.

I tend to think hard-dollars in our populations' hands, not "loose credit," is going to probably be the best way for us to pull out of this thing with repaired balance sheets but still keep up enough demand so our current businesses and employed population don't suffer a long period of deep recession.  I find it interesting that the MMT'ers are vehimently against most bailouts that happened.

They tend to show signs of hyper-keynesianism with a strong dash of Austrian.  I really love reading their work.

[melveyr]

I really like the focus on unemployment with MMT.

Instead of handing out money in the form of debit cards, the idea of providing minimum wage work rebuilding our nations infrastructure sounds brilliant to me.

If you think about it our current situation is insane. We have work that needs to be done, people that need to work, but "not enough money." Oh, but we actually have an infinite amount of money....

I can't believe MMT is not more mainstream. It talks about the monetary system that we actually use. It's rather frightening that I just learned about it from this forum after being interested in finance for years...

[moda0306]

melveyr,

What makes me nervous is the possible malinvestment of a policy of constant full employment.  I agree that I like how that's their focus, but that's just something I worry about.  Also, I agree that some work needs to be done, but I default to "debit cards" because I feel like that's something that inspires more private sector, not public sector, growth.

Even if MMT isn't correct, it sure shines a bright, bright light on how our monetary system works... and how it maybe SHOULD be viewed as completely different as a household.

Lastly, I don't like the idea of trying to socially engineer economic growth beyond what is actually demanded by the people in the population.  I like prosperity, but find a lot of the consumerism, even if on just an environmental level, is a little bit out of control. 

[melveyr]

I feel very similar. I am always leery of government run projects because the incentives for efficiency are not as strong as they are for the private sector.

I am going to spend some time reflecting on how to combine the ideas. It would be nice to have a spending program that targeted unemployment, but possibly with private employers. Basically, I like when greed is the motivator for efficiency (and effectiveness if possible).

MMT is exciting stuff.

[doodle]

If you hand out 10,000 dollars to Americans you are going to get a lot of "investment" in fancy rims, flat screen tv's and restaurant meals. That is not the kind of investment that we need to increase our long term productivity.

I agree that govt is not always efficient but there are certain large infrastructure, education and research and development projects that they are capable of funding which will employ people and contribute to our long term productivity.

[AdamA]

If you hand out 10,000 dollars to Americans you are going to get a lot of "investment" in fancy rims, flat screen tv's and restaurant meals. That is not the kind of investment that we need to increase our long term productivity.

My bet is that a lot of them would try to pay of debt with the money.  Probably have a different effect than rims and TVs.

[moda0306]

I think a 2-year payroll tax holiday for employers, employees and self-employed individuals would be a good way of engineering a private-sector, middle-class solution.

I tend to think of ss and medicare as popular programs whose direct funding today is pretty unrelated to the taxes that are supposed to be funding them.

[moda0306]

doodle,

That's my worst fear/concern... that any "stimulus" now is just supporting completely flawed spending and financial priorities.  Maybe, in that sense.

Wouldn't it be an amazing time for us to finally make the conversion to the metric system?

[stone]

I agree with the MMT description of what is going on but kind of think it may be a futile attempt to put off an inevitable impass. The economy seems to be based on most people becoming increasingly indebted to a few people. Without  government debt (aka net private savings) increasing, that scenario would quickly lead to a crunch. With increasing government debt, the situation can extend ever further. MMT advocates say that the economy does not get distorted by having  net private savings ever increasing even though those private savings tend to concentrate with ever fewer people. I'm not convinced. I think the underlying conundrum of ownership tending to concentrate over time is something that really isn't faced up to. You can't maintain a customer base by lending money to customers  to buy what you sell. Over the years we have moved taxes from being predominately asset taxes to being things like sales taxes. I can't see how the economy can be sustained in that way. If things do continue along the same lines I wonder whether the consequence will not be increased interest rates or consumer price inflation as deficit hawks claim but rather continued below inflation interest rates and ever fiercer asset and commodity price volatility. The crazy volatility of silver shows what happens when lots of money tries to squeeze into a small space. Will all commodities and assets become like that as there is more and more purchasing power with investors relative to the purchasing power of consumers? 

[moda0306]

stone,

Regarding forms of taxation, I find it funny that advocates of a national sales tax really don't hit on what sales should be taxed, and what about a sale makes it taxable vs not in a fair world... why shouldn't the following be subject to the sales tax?

Real Estate?

Stocks?

Bonds?

Closely-held Businesses?

Futures/Options?

I'm not trying to go on a populist tirade here, but simply stating that I don't know what it is that makes buying a car a taxable event, but buying a house a non-taxable event.

And on a really confiscatory note, I wonder if a 1-time (or supposedly so) national wealth tax will be imposed to even out the playing field a bit?

[stone]

Moda, in the UK we have stamp duty (sales tax) on shares (but not derivatives or gold) and real estate. It is only 0.5% though (I think) whilst sales tax on a car is 20% (I think). The MMT advocates say that as net savings occur, they need to be matched by government deficits so as to avoid unemployment. I've wondered whether, if the whole tax burden was transfered to just being an asset tax, then there would be no such need for government deficits? Wouldn't an asset tax be less distorting than transaction taxes? To my mind it is important to have a tax system that is neutral. A flat asset tax would let people make whatever investments gave sufficient yield such that they could afford to pay the tax and not need to sell off assets. On the face of it that comes across to me as aligning incentives with what the economy needs?