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MOSLER'S LAW: There is no financial crisis so deep that a sufficiently large tax cut or spending increase cannot deal with it.

Re: What about the Depression?

Posted by WARREN MOSLER on December 26th, 2008


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Yes, and gasoline consumption went up a bit as well. Down only 4% year over year.

The deficit is also ‘automatically’ getting larger as well.

We could stop declining as fast and just go into ‘muddle through’ mode at higher levels of unemployment.

And this could encourage the mainstream to do what it can to minimize any fiscal response as the await ‘market forces and monetary policy kicking in.’

Obama recently stated we needed a fiscal stimulus to get things going, but then focus on ‘fiscal responsibility’ when the economy is growing again.

And they all say one of the major problems of the US government is the high level of debt.

Obama is also backwards on trade, as he talks about protecting US workers and opening new markets for US exporters.

Still hoping for the best!

Merry Christmas!

>   
>   On Thu, Dec 25, 2008 at 1:37 PM, mauer195 wrote:
>   
>   Everybody keeps focusing on the disastrous season that
>   retailers are supposed to be having, but then there’s this
>   news:
>   

Consumers Spend More As Gasoline Prices Fall

By Annys Shin

Consumers increased their spending last month for the first time since spring, as falling gas prices helped boost their purchasing power, new data showed yesterday.

On an inflation-adjusted basis, consumers spent 0.6 percent more in November than they did the month before, the Commerce Department reported, the first increase since May. Disposable income also rose on an inflation-adjusted basis, by 1 percent, compared with an increase of 0.7 percent in October.

But even as consumers returned to stores and shopping malls, analysts cautioned that the data did not signal the start of a turnaround for the economy. Because energy prices are unlikely to sink at the same clip they have over the past few months, Americans won’t be able to pocket much more savings at the pump.


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63 Responses to “Re: What about the Depression?”

  1. Mike Sankowski Says:

    Hi Warren,

    You may want to look at econbrowser

    http://www.econbrowser.com/archives/2008/12/federal_reserve_1.html

    There is a discussion there about money creation, the fed balance sheet, and what creates demand for a currency.

    Reply

  2. warren mosler Says:

    thanks, mostly garbage, until mickslam chimes in at the end.

    :)

    Reply

  3. Scott Fullwiler Says:

    Yeah, thanks for the link, though I’m glad I stopped reading his blog during the holidays or it would have driven me crazy. Mickslam did a nice job. Also, Hamilton repeated the gold standard view that reserves are inflationary but bonds are not, which it appears none of the commenters disagreed with specifically (didn’t read all the posts, though). Several posting there that have demonstrated in their published research that they don’t understand sovereign currency.

    Reply

  4. knapp Says:

    Scott,

    It seems to be a pretty common view that reserves but not bonds are inflationary. Is it challenged anywhere in the mainstream?

    My own investigations have led me to John Hussman, a fund manager and economist, who gets closer than most to ‘paradigm’ when he says “Inflation is ultimately always and everywhere a fiscal phenomenon”.

    http://hussmanfunds.com/wmc/wmc070910.htm

    Reply

  5. Scott Fullwiler Says:

    I haven’t seen anyone in the mainstream get beyond the gold standard when they speak of money vs. bonds. The basic framework, the government budget constraint and the intertemporal budget constraint, both along with loanable funds market, assumes that money adds purchasing power and bond sales reduce it.

    Hussman has the overall point, which, as you note, is a bit of an improvement, but has a lot of intermediate steps wrong, as you probably already noticed, too. Also thinks there would be massive inflation if China weren’t buying Tsy’s. Thanks for the link . . . always interesting to see how people with nothing but the mainstream paradigm start trying to work their way through inconsistencies they see between the paradigm and the real world.

    Reply

  6. warren mosler Says:

    mainstream economics is a disgrace to the profession

    this stuff isn’t that hard.

    Reply

  7. knapp Says:

    Warren,

    Do any chief economists/ strategists on Wall Street understand and fully agree with SCE?

    I noticed in the past some correspondence between Levy and Jan Hatzius at Goldman. He seems better than most but appears to view monetary policy as a strong force vs your weak force.

    And Bob Barbera spoke at the Levy Institute’s Minsky conference but his fiscal policy sounds more ‘fine tune-ish” than “structuralist”.

    How else?

    Reply

  8. warren mosler Says:

    not that i know of.

    I know Jan and he seems fully aware that solvency isn’t an issue for the govt in its own currency. and he uses the fiscal balances as a guide. and yes, he sees interest rates as a stronger force than i do.

    I haven’t read anything by him lately. He was extremely negative for the first half of 08 when I saw him in January based on lost bank capital. I explained why I didn’t think that mattered, and why I was in the ‘muddle through’ camp for the first half of 08.

    The second half was weak as he suggested but for different reasons as circumstances changed.

    don’t know Bob Barbera.

    Reply

  9. knapp Says:

    Thomas Edison, America’s great inventor, in 1921, sounding like a proto-Post-Keynesian:

    “Now, as to paper money, so called, every one knows that paper money is the money of civilized people. The higher you go in civilization the less actual money you see. It is all bills and checks. What are bills and checks? Mere promises and orders. What are they based on? Principally on two sources – human energy and the productive earth. Humanity and the soil – these are the only real bases of money.

    “Don’t allow [the bankers] to confuse you with the cry of ‘paper money’. The danger of paper money is precisely the danger of gold – if you get too much it is no good. They say we have all the gold in the world now. Well, what good does it do us? When America gets all the chips in a game the game stops. We would be better off if we had less gold. Indeed, we are trying to get rid of our gold to start something going. But the trade machine is at present jammed. Too much paper money operates the same way. There is just one rule for money, and that is, to have enough to carry all the legitimate trade that is waiting to move. Too little or too much are both bad. But enough to move trade, enough to prevent stagnation on the one hand and not enough to permit speculation on the other hand, is the proper ratio.”

    Concerning interest, he said, “… That is the terrible thing about interest. In all our great bond issues the interest is always greater than the principle. … Under our present system of doing business we simply add 120 to 150 percent to the stated cost.”

    Speaking for debt free money, Edison is quoted, “But here is the point: If our nation can issue a dollar bond it can issue a dollar bill. The element that makes the bond good makes the bill good, also. The difference between the bond and the bill is that the bond lets the money brokers collect twice the amount of the bond and an additional 20 percent, whereas the currency pays nobody but those who directly contribute to the [projects] in some useful way.

    “… There is a difference [between currency and bonds], but it is neither the likeness nor the difference that will determine the matter; the attack will be directed against thinking of bonds and currency together and comparing them. If people ever get to thinking of bonds and bills at the same time, the game is up [for the bankers].”

    Reply

  10. warren mosler Says:

    his context was the gold standard of the time.

    Reply

  11. knapp Says:

    Warren

    Edison’s anti-banking sentiment is shared by other endogenous money groups roaming the internet, such as the Georgists (Henry George).

    Are you familiar with Stephen Zarlenga? He wrote “The Lost Science of Money”. He defends Knapp’s State Theory of Money and argues for a version of Function Finance (although his terminology differs, calling it a return to Greenback finance) that would eliminate the Fed and grant Treasury the right to spend money into existence.

    He departs from SCE (and sides with the Austrians) in calling for a 100%-reserve banking system, but backed by fiat money not gold. He sees banking as a “creature of the state” and “fractional reserve banking” as the cause of much of the mischief on Wall Street (the horizontal tail wags the vertical dog).

    To me, this sounds like a fiat money system with gold standard-like constraints on the banking system, a more direct way of constraining the banks vs. our current regulatory apparatus.

    Here is my question: under this system it appears that “deposits create loans”, does this in any way contrain gov’t spending itself? Can Functional Finance/Greensbacking really work under these institutional arrangements?

    Also, would 100% reserving really constrain bank credit expansion? Or would the crafty bankers just “innovate” around the constraints?

    Reply

  12. Scott Fullwiler Says:

    Ex ante fractional reserves–whether 1% or 100%–can only be enforced where banks are not given credit or basic overdrafts with the central bank, as in the gold standard or currency board. Otherwise, you have ex post fractional reserves. But with ex ante fractional reserves, you inevitably run into problems with payment system disruption, if you don’t run into other problems first.

    Reply

  13. Scott Fullwiler Says:

    Sorry . . . didn’t see that was intended for Warren till after posting it.

    Also, I said that partly wrong. Obviously 100% reserves is a situation where those institutions aren’t lending to the private sector at all unless there are some portion of their liabilities that do not require reserves. In fact, some Minsky followers support having a portion of the financial system be 100% reserves.

    Reply

  14. knapp Says:

    Scott,

    Thanks for your insights. Please chime in anytime to my comments.

    The Plan as I understand it is to reserve 100% against demand deposits and lend out bank capital + time deposits dollar for dollar.
    Sounds like a “Narrow Bank”.

    And it turns out there is nothing new under the sun as this is a reformulation of Irving Fisher’s Chicago Plan from the 1930s.

    From the book “Chicago Plan & New Deal Bank Reform” by Ronnie Phillips:

    As stated by Irving Fisher: “The essence of the 100% plan is to make money independent of loans; that is to divorce the process of creating and destroying money from the business of banking. A purely incidental result would be to make banking safer and more profitable; but by far the most important result would be the prevention of great booms and depressions by ending chronic inflations and deflations which have ever been the great economic curse of mankind and which have sprung largely from banking.”

    BTW, Hyman Minsky wrote the foreword to the book so it is not surprising that some of his followers support some form of 100% reserve banking.

    Reply

  15. Scott Fullwiler Says:

    Yes, Ronnie is one of the colleagues I’m referring to. I was discussing 100% money with several from Levy a few months ago in KC. The idea there, and the claim was that it came from Minsky or was at least “Minskyan,” was to protect basic depositors without the need for deposit insurance and the large, overlapping, strange commercial bank regulatory apparatus (you probably already know this . . . though not all in attendance were on board with the plan). Of course, you can still get endogenous money if they are allowed to have liabilities w/o 100% reserve requirements. And there would still be investment banks or whatever FIs were established (or left standing, as the case may be) to create credit to promote private sector business and its expansion. Consequently, seems to me Minskyan financial innovations wouldn’t go away unless you regulated them away (easier said than done, obviously, and even then, Minsky argued they wouldn’t ever really go away). And you would need to figure out whether investment banks (or whatever FIs were creating credit) had reserve accounts and access to cb pmts system and cb credit, and if not, who would step in in the event of a pmts disruption in that sector, and so on.

    That’s my 2 cents, though my thoughts on all this are evolving in real time.

    Reply

  16. warren mosler Says:

    best i can tell, with a non convertible currency/floating fx reserve requirements are a bank tax and don’t constrain lending, as Scott indicated.

    the various reserve proposals are only applicable to fixed fx of one kind or another.

    Reply

  17. Jim Baird Says:

    I’m trying to wrap my head around the mechanics of this 100% reserve idea. So is the idea that there would be a set quantity of reserves at any given time, and banks would have to have “reserves in hand” in order to lend them out? So I could find myself going to a bank and being told, “Sorry, no money today, try again tomorrow”?

    But wouldn’t bankers be tempted to make commitments to loan out funds that they are pretty sure they are going to be able to get, setting the stage for regular panics when they can’t get them? And wouldn’t the amount of reserves still fluctuate wildly as the Treasury spends and taxes? And wouldn’t interest rates be subject to wild swings? I must confess I don’t quite understand how such a system is supposed to work, unless it’s the same as the current system with a higher “reserve tax” in which case it really makes no difference…

    Reply

  18. Scott Fullwiler Says:

    Jim,
    100% reserves–in the most extreme case–means that you aren’t making any loans at all. The balance sheet basically has deposits and savings accounts on the liability side (and a bit of equity paid-in) and vault cash (for customer withdrawals), reserves (for electronic pmt settlement) and Treasuries on the asset side (and a bit of fixed capital). Banks basically take on deposits and hold them as vault cash or in govt accounts. It’s one step removed from having the Tsy offer checking and saving accounts to the public. Then you don’t need deposit insurance for these banks.

    My larger point is you still need some entity to make loans within the private sector, obviously. So . . . there are either separate institutions to do this (where loans create deposits, or whatever you call the liabilities of these institutions), or the banks holding 100% reserves against deposits and savings can also offer other liabilities that do not require 100% reserves. And, consequently, you will eventually find that you need some entity to manage pmts settlement for these financial institutions (who will be the banker to these institutions, in other words, providing them with overdrafts and longer-term credit, at a minimum), in which case you either end up with a central bank like the Fed or you end up with a gold standard/currency board framework. You haven’t eliminated the need to make that choice, in other words.

    If someone can show that this isn’t the case, I’d be most interested in seeing that.

    Reply

  19. jcmccutcheon Says:

    Scott, Is there a difference between vault cash and reserves?

    Reply

  20. zanon Says:

    Scott:

    With FDIC insurance isn’t that essentially what happens now? Since retail deposits are FDIC insured, end customers *are* essentially having their checking accounts parked directly with the Government (the bank provides some services, but the credit risk individuals take on when they lend their money to a bank is the Govt’s credit risk, not the banks).

    Banks make loan to the private sector, but borrow directly from the Fed to do it. You don’t need deposits to make loans.

    If all of this was formalized it would be much easier to see, but fractional reserve banking is this weird halfway house that kind of behaves like we’re on a gold standard (you have to keep *some* reserves!) and kind of behaves like we have fiat money (you don’t need that much in reserves!) and makes no sense in either system.

    Reply

  21. knapp Says:

    Found this today, but it was posted yesterday:

    http://billtotten.blogspot.com/2009/01/1930s-chicago-plan-and-american.html

    … it turns out, in a very strange coincidence, this blogger was posting about Zarlenga and the Chicago Plan at almost the exact time of my original post.

    Reply

  22. Scott Fullwiler Says:

    JMC . . . sorry . . .vc and reserve balances are together usually called reserves, but because everyone gets so sloppy and uses reserves when they mean to say reserve balances, I follow along some times. So . . . what I meant to say was that banks hold vault cash to meet cash withdrawals and reserve balances to settle electronically debited pmts, just as now.

    Zanon . . . yes, as Warren says, functionally the same thing. With 100% reserves, though, no need for deposit insurance or regulation of bank assets. However, under 100% reserves in the most strict case, banks aren’t allowed to hold any liabilities other than deposits or savings accounts, and both of these carry 100% reserve requirement. So these banks do not make loans at all. They are basically piggy banks.

    Knapp . . . thanks for the link. The following is copied from there, and my response begins with a **.

    “SECOND: The Plan separated the loan-making function, which can belong in private banks, from the money-creation function, which belongs in government. Lending was still to be a private banking function, but lending deposited long-term savings money, not created credits. In this way they’d restrict an unstable practice known as borrowing short and lending long – making long term loans with short term deposits. Some variations proposed this be done through mutual fund-like mechanisms, or by chartering entirely new types of banks.”

    “THIRD: The proposal recognized the distinction between money and credit, which had been confused through fractional reserves and what was called the “real bills doctrine”. The confusion was seen as one of the causes of the depression, because when businesses reduced their borrowings on commercial bills which occurs during any downturn, parts of the money supply had been automatically liquidated. The Chicago Plan saw the instability of this – that it aggravates a downturn.”

    **I would say that these two points demonstrate a lack of understanding of how credit creation actually works, and the role of the central bank (via the exchange rate regime) in the monetary system. What he’s essentially saying is that those non-bank financial institutions would offer, say, mutual funds, and these funds would be invested in support of business expnasion by these financial institutions. But . . . who is the banker to these institutions? And what are the terms of credit/overdrafts they are provided with? Without explicitly explaining this, you haven’t explained if the system is a gold standard or flexible exchange rate system. Didn’t have time to read further . . . perhaps it was detailed somewhere.

    Reply

  23. jcmccutcheon Says:

    Scott, so how do banks get their hands on vault cash? Do they exchange reserves for vault cash?

    Reply

  24. Jim Baird Says:

    JCM -

    Yes, they order it from the fed when they need some:

    http://www.federalreserve.gov/pf/pdf/pf_7.pdf

    Reply

  25. Scott Fullwiler Says:

    JCM . . . are we talking about in the real world or under 100% reserves?

    In the real world, as Jim says. And they “pay” for it with reserve balance debits from reserve accounts.

    Under 100% reserves, it would be pretty much the same. Reserves and deposits created by govt net spending . . . depositors withdraw which the bank provides via vault cash. Banks obtain more vault cash from whomever the monetary authority is in that system by debiting reserve accounts.

    Reply

  26. zanon Says:

    Scott/Jim: No reason we cannot separate savings (keeping your money in a piggy bank) and the business of making loans and investing.

    The combination of the two in an institute currently called a “bank” is a left over from the days of a gold standard.

    Instead, you’ll have one entity that essentially keeps cash in a vault and charges you for money management services like checking etc. And you have another entity(ies) that borrows money from the Fed and uses it to make loans.

    Reply

  27. Scott Fullwiler Says:

    No disagreement, except that the entity borrowing from the Fed doesn’t “use it to make loans.” Loans create deposits, by definition, of course. If these institutions are provided w/ overdrafts at the Fed as current banks are and as you suggest, then you aren’t anywhere close to the Bill Totten ideal. Using Warren’s terminology, Totten wants a horizontal component that is driven by savings, not loan creation, because of the perceived evils of “fractional reserve banking” (whatever that is). That’s different from the system you’re talking about.

    In Totten’s case, where I imagine that they don’t have access to Fed overdrafts (haven’t read all the way through, though, so could be wrong), that’s like a currency board. In that case, (1) I still don’t think it will work anything like he suggests (loans still create deposits, again by definition), (2) if it does, it will be susceptible to basic payments disruptions (US financial system in pre-Fed and flex exchange rate times couldn’t withstand something as simple as a poor harvest).

    Reply

  28. knapp Says:

    Does it matter whether loans create deposits if those deposits are time deposits? As I understand it, demand deposits would simply be “warehoused” and just sit in the vault. Under 100% reserves, bank lending is Quantity constrained by having to be financed by more costly and hard to get time deposits. This would, it is argued, indirectly improve the Quality of bank assets.

    Most 100% reserve advocates see today’s horizontal activity as not only unproductive, but also as either fraud or an unfair special privilege. On the other hand, those who view horizontal activity less suspiciously and, in fact, see it as a necessity for growth, would rather just focus regulatory efforts directly on the Quality of bank lending. Seems like the old quantity/quality rules/discretion debate but with a legal/moral twist: is funding with demand deposits just?

    Reply

  29. Scott Fullwiler Says:

    Are offshore banks issuing $ time deposits (or Euro time deposits, or Yen time deposits, or time deposits in any other currency) constrained by the fact they don’t have a cb giving them overdrafts? You can issue a time deposit to anybody you want to; the key is being able to meet the customer’s demand to convert into demand deposit or currency. Sure, you could constrain institutions in the sense that banks in Argentina had to be concerned with withdrawals under the currency board arrangement (since they had no access to cb credit), but loans still created liabilities there. You haven’t gotten rid of so-called fractional reserve banking, just moved it to those institutions w/o 100% reserves. I’m also struck by the Austrians lack of belief in the abilities of these institutions to innovate on their liability sides, as they already understand so well that every firm motivated by profits seeks to innovate (perhaps I’m imposing too much Schumpeter on Austrians here).

    The view that horizontal money is the root of all evil is particularly strange. First, as Wray’s edited volume “Credit and State Theories of Money” details, credit money pre-dates commodity money by thousands of years. Second, horizontal expansion occurs throughout the hierarchy of money. Should a department store be banned from offering customer credit? Should suppliers be banned from offering trade credit? Should workers be banned from “allowing” their employers to wait to pay them every week or month? Should the government stop allowing households to put off paying taxes until April? How different are these examples from, say, a bank financing a company’s inventories? Where is the prior “savings” in any of these cases? Where is the evil? Would a world where prior deposits or liabilities fund loans (assuming for the sake of argument that it’s possible) really be able to handle (let alone, promote growth given) the complexities of a modern capitalist economy where production takes time? Perhaps I’m misrepresenting their argument.

    The neo-Chartalist view (with a good bit of Minsky included), on the other hand, recognizes credit money as inherent to capitalism in the first place. 100% reserves (supported by some in this camp, but not all and maybe not even a majority) are simply to protect depositors without the need for deposit insurance or an additional layer of regulation (Minsky went to U Chicago, after all, and then did his dissertation under Schumpeter—though he died before Minsky could finish). It’s accepted that loans will create liabilities in the non-100% reserve financial sector, and that financial stability requires a central bank setting the price of refinance (at least) and letting quantity of reserves fluctuate. To reduce the likelihood of boom-bust cycles, asset-side regulation and supervision is the preferred method (more to it, obviously, but that’s the heart of it).

    Reply

  30. zanon Says:

    Scott: The Totten piece is long and hard to read through. From the first few graphs, it does not make sense to me.

    1. Totten is right to separate savings from investment, that should be done, but then he talks about lending “long term savings”. This is a flat contradiction — savings is savings and should not be leant out. Under FDIC this is essentially the case, but it’s hard to see.

    Long term loans should be backed by long term investments. Maturity match both sides of the loan (or investment) and be done with it. Maturity matching is not a gold standard thing, or a fiat thing, or a paradigm thing. It just takes bank runs out of the system, which is only a good thing. It also reduces liquidity, but I don’t think liquidity is an unalloyed good either.

    2. Yes, loans create deposits, and banks would take out loans from the fed, lend them out, and they would end up as deposits somewhere else. Am I saying something different? I think we’re on the same page here.

    Totten seems to both want savings to be savings, and for “long term savings” to fund “investment”. These two are contradictor. I agree with this first point, and I think that investments should be maturity matched, but I don’t think of long term savings as being investments. They are investments.

    Reply

  31. Scott Fullwiler Says:

    I’ll respectfully take a third view. Much as there is no way in the aggregate to increase reserves or currency without either a previous govt deficit (increased liabilities of Tsy) or borrowing from the cb (or otherwise raising the cb’s assets), there is no way in the aggregate for there to be an increase in bank liabilities without either trading in govt reserves or currency OR raising bank sector assets (bank lending). Loans create deposits. Individual transactions simply transfer existing bank sector liabilities among individuals in the private sector. In other words, absent an increase in govt debt, there is no such thing as prior savings in the aggregate leading to an aggregate rise in bank sector (broadly defined) liabilities and assets (one caveat–foreign saving can raise aggregate bank liabilities/assets, but even foreign saving is usually driven by domestic debt creation).

    A few other comments, which may miss your point in some cases (apologies if so):
    1. Regarding maturity matching: obviously, it’s inherent to capitalism to require a LOT of short term lending, since production takes time, suppliers must be paid, workers must be paid, taxes must be paid, etc, and these outflows don’t necessarily match the pace of cash inflows.

    2. Banks don’t lend out reserves from the Fed. Fed overdrafts simply enable banks to settle pmts made by customers (after a loan occurs) without worrying about holding a buffer in their reserve accounts or in some private bank account, absent the Fed. They don’t enable lending . . . loans create deposits. Absent such overdrafts, banks have to hold a buffer and consider how large the buffer will be and how they can acquire such a buffer when setting their loan creation strategy, but getting rid of the Fed doesn’t stop this sort of ex post “fractional reserve” banking from happening.

    Reply

  32. zanon Says:

    Hi Scott:

    I don’t understand how my position on loans creating deposits is any different from yours.

    1. Yeah, capitalism requires a lot of short term lending, but it requires a lot of medium term and long term lending too. Factories don’t get built in a day. Are you arguing that it needs *more* short term lending than long term lending? Do you have any data to back this up? People also want lots of short term deposits, btw, so I don’t see any problem here to maturity match.

    2. I am unclear on the mechanism by which the Fed channels money to banks, (if it does so at all) or how banks get the money to make loans to individuals. So, I will ask you: where do banks get money to loan out? Or do they just increase both sides of their balance sheet ex nihilo, constrained only by legal requirements?

    Reply

  33. Scott Fullwiler Says:

    Hi Zanon

    My point on short-term lending was merely that it seemed the inherent need there was being overlooked, not that it’s any more important. The other point was that short-term credit creation that clearly has nothing to do with prior savings is also inseparable from a modern capitalist monetary system.

    To use your words, banks increase both sides of their balance sheet ex nihilo, and it’s only ex post that any sort of legal requirements can be said to be correlated with deposit creation. Central bank reserves settle payments only (cover withdrawals made by depositors, if you like), and where applicable, meet reserve requirements. It is for these two purposes that the Fed supplies reserves on demand at the target rate (or at the rate charged on overdrafts or on overnight credit). But reserves are NEVER a pre-requisite for creating a loan, and there’s no bank loan officer anywhere that consults with the liquidity manager to see if there are enough reserves before approving a loan.

    Hope that makes some sense.

    Reply

  34. zanon Says:

    Hi Scott:

    Thanks for your response.

    I’m not sure why you think that the need for short term lending is being overlooked. There are a whole host of facilities around to do exactly this–what additional gaps would you like to see filled?

    I am on board with the fact that short term credit creation does (and should) have nothing to do with savings. That’s why I’m struggling to see where we differ on this point.

    I would also add that there is a whole lot of long term borrowing going on that’s been dressed up as short term borrowing, with the plan being to keep rolling over the debt when it matures. This is why I support full maturity matching.

    Also that you for your clarification re: banks. I assume that it’s part of the special legal charter that banks employ which enables them to expand both sides of their balance sheet from nothing (since I certainly cannot do that). Do I have that right?

    Also, am I correct in understanding that the Central Bank basically just covers the retail deposits (via FDIC, and then to settle payments) and also lends money to meet (artificial at archaic) reserve requirements? If reserve requirements were done away with, then banks would just make loans on credit risk. Is it equivalent to set reserve requirements to zero and the Federal Funds rate (the rate at which the Fed lends to banks) to zero?

    Reply

    warren mosler Reply:

    i see no problem with banks making long term floating rate loans and having short term funding on the other side of the ledger. The function of deposit insurance and the Fed in general is to make sure the liability side of banking is not used for ‘market discipline’

    What should not be allowed and isn’t allowed is interest rate risk, aka ‘gap’ risk. This is where a bank has fixed rate loans and floating rate liabilities.

    It’s not the law that allows banks to expand as they do, it’s just accounting.

    Net reserves for reserve requirements or anything else can come only from the Fed itself. It’s just a simple spread sheet.

    So if the Fed raises reserve requirements for the system it has to somehow provide those balances, either via lending or via purchases (generally of financial assets). That’s called ‘offsetting operating factors’ with reserve requirements an operating factor.

    With or without reserve requirements the CB still sets whatever structure of risk free term rates it wants. If it wants 0 rates it’s just as ‘easy’ with or without reserve requirements.

    Reply

    Scott Fullwiler Reply:

    “It’s not the law that allows banks to expand as they do, it’s just accounting. ”

    As usual, you can say in a few words what takes me several paragraphs.

    Reply

    warren mosler Reply:

    I’m exceptionally lazy…

    thanks!

    Jim Baird Reply:

    Isn’t the real “specialness” of banks not their ability to create money from nothing (which, as you state, anyone can do by issuing an IOU), but to have their liabilities freely convertible at par to Fed liabilities? I seem to remember from my banking history that back in the era of “free banking” banknotes would be redeemed at various discounts, depending on the perceived stability of the issuing institution – so if you tried to pay with a South Carolina bank’s note in New York you might only get 95 cents on the dollar – if they took it at all. It’ funny how the Fed’s functions as a clearinghouse are seen as almost incidental, these days – boring regulatory stuff – but that’s really the life blodd of the institution in some ways…

    Reply

    Scott Fullwiler Reply:

    Yeah, I would just add that the federal govt accepts checks drawn on these accounts as payment for taxes, too (though the bank is still liable for debiting its reserve account for final settlement).

    As Minsky said, anyone can create money . . . the trick is getting it accepted.

    Agreed on Fed’s settlement activities as the “life blood.” That’s the essence of central banking, in fact. $120 billion peak overdrafts each business day–that’s when there’s no unusual circumstances like now–is boring stuff to most for some reason. At least on this side of the Atlantic, the story got very muddled by the misguided focus on reserve requirements.

    warren mosler Reply:

    the way i see it, having their liabilities ‘convertible to par’ falls under the broad concept of ‘deposit insurance’

    note bank liabilities other than insured deposits are not ‘convertible at par’ but often trade at substantial discounts.

    For example, a check drawn on a bank checking account is accepted and exchanged at ‘par’ while that same bank’s subordinated debt might exchange at a price of 50.

    And, to qualify even that, cashing a check is usually problematic, as most banks will wait for the check to clear before giving you good funds, which means even bank checks don’t trade at par. Banks and others often wait until they get credit from the Fed for your check before they give you funds you can access.

    It’s all about pricing risk.

    Including interest rate risk. Bank time deposits will trade at discounts if rates go higher, for example.

  35. Scott Fullwiler Says:

    The points on st lending were aimed more at the discussion of 100% reserves and the Austrian proposals, not you necessarily. It was intended to show that there is a need for credit in daily commerce unrelated to savings. In particularly, I brought this up in regard to Austrian views that horizontal expansion is considered “evil” by many in that camp. Sorry about the confusion . . . I may have interpreted your comments within that context when it wasn’t actually appropriate to do so.

    Regarding bank lending, actually you CAN do that. You could provide your neighbor with a loan and a deposit in “Zanon deposits.” The issue, of course, is that they would try to withdraw the Zanon deposit in the form of currency or bank deposits, since Zanon deposits don’t generally circulate to settle transactions (too bad you can’t impose a tax). For that you would need to hold bank deposits yourself to meet withdrawals, or have access to overdraft facilities. In the case of US banks, the Fed provides these overdraft facilities at a fixed price. Obviously this analogy is rough around the edges, but it’s not completely off, either. And if Zanon deposits were federally insured, things could change, too.

    I’m not quite understanding the questions in your final paragraph. Sorry.

    Reply

  36. zanon Says:

    Hi Scott:

    Thanks for clarifying re: st lending. The Austrians are in some ways insane, but in other ways quite sound. Demand savings *should* be in 100% reserve accounts ie. not in what we think of as “banks” at all. But I can also see a large market for 1mo, 2mo, 3mo, 6mo, 9mo, 1 year etc. CDs where people can park near-demand money that would also fund st borrowing needs.

    FRB is funny — it makes no sense in the Paradigm, but it also makes no sense in a gold standard.

    And yes, the Austrians think horizontal expansion is evil, they are against expanding the money supply at all. I’m actually sympathetic to this view, but Austrians would have the total money supply collapse to m0 while I would expand m0 to the current total money supply before freezing it. (If I wanted to move to a fixed money supply).

    As for “Zanon deposits”, yes I could do it in theory but in practice I need an overdraft facility at a currency issuer (as per your explanation, banks are $ currency issuers). Is the “fixed price” banks have for this overdraft the Fed funds rate?

    Let me rephrase my final para: the question was — what does a CB actually do then? It sounds like they lend money to banks so they can meet their reserve requirements. If one did away with reserve requirements, they would not even need to do that, yes?

    Also, is eliminating reserve requirements the same as having the price at which banks use CBs overdraft facility at 0% (Federal Funds rate be zero percent)? In my understanding, both would enable banks to lend unhindered by anything other than credit concerns of the loans themselves. Is that right?

    Thank you for your help and explanation!

    Reply

  37. warren mosler Says:

    So far I haven’t heard anything about Austrian monetary understanding or policy that makes sense for floating fx/non convertible currency?

    The $US is nothing more than ‘spread sheet’ entries on what can be considered a big T account.

    Govt is necessary (whether via the fed or not) to run the books either directly or indirectly. And as part of public purpose it has decided that deposit insurance is the only way to go given basic political/human objectives. Both practice and theory agree on this.
    All payment system failures have been related to fixed fx/convertible currency policies.

    Deposit insurance means you can transfer your funds out of any fdic insured bank, which means govt will clear your checks written on any fdic insured bank.

    This further means govt must regulate and supervise fdic insured banks as there is no market discipline from the liability side.

    There are plenty of non bank lenders, which i’d guess is what austrians would prefer? These include hedgefunds, which ‘lend’ only the funds they take in as ‘equity’ or take in as ‘loans,’ which makes them 100% ‘reserved’ with no monetary assistance from the govt. Nuff said???

    Reply

  38. Scott Fullwiler Says:

    Warren

    Seems to me that Austrians believe that non-bank lenders couldn’t create loans without previous funding from liabilities if those evil banks weren’t granting them credit, who in turn are able to do so because they are getting credit from the evil central bank.

    I think your point above says most succinctly what I’ve been trying to get across for the past few days: “It’s not the law that allows banks to expand as they do, it’s just accounting. ”

    Reply

    warren mosler Reply:

    Got it.

    In which case the only ‘money supply’ would come from govt deficit spending for a non convertible currency, which they don’t want either, right?

    or, in the case of a gold standard, for example, from the quantity of actual gold.

    Does that mean ‘commodity money’ only as suggested earlier?

    Reply

  39. zanon Says:

    Scott/Warren:

    Austrians want a fixed money supply, which is not compatible with floating fx/non convertible currency. Everyone’s a currency user, no one is a currency issuer.

    Bank is a confusing term in the Austrian model, as it would look very different that what we think of as a bank today. It would be split into two different kinds of entities, one of which provided essentially just a safety deposit box, and the other would run a book matching borrowers and lenders, ensuring that the maturity of the loans were matched, but could also aggregate/disaggregate loans (so long as maturities stayed matched). There would be no central bank, there would be no need for one.

    Finally, I would love an answer to my question: is eliminating reserve requirements the same as having the price at which banks use CBs overdraft facility at 0% (Federal Funds rate be zero percent)?

    Reply

  40. warren mosler Says:

    thanks, answered my previous question!

    commodity money only, which means barter until govt. gets involved with taxation, which means horrendous ‘panics’ and depressions with actual supply side constraints on the means of payment. As Keynes and others have pointed out, with a gold standard changes in net savings desires for financial assets are highly disruptive as the supply of net financial assets is fixed and equals the gold reserves.

    It’s a system the works operationally but falls short of meeting the economic objectives of sustained output and employment. It also trades off real economic stability for nominal price stability.

    Agreed no actual need for a central bank.

    And govt hoards gold (like everyone else) in an attempt to preserve liquidity and spending power, further adding to the deflationary forces.

    No, the CB can/does still set rates at any level it wants. Canada has a zero reserve requirement, for example. The CB can easily get the system in overdraft, and it tends to go there anyway with cash demands, for example, and then set the rate for getting reserve balances back to 0.

    Reply

  41. Scott Fullwiler Says:

    Right . . . cb can set bid/ask for reserves at any rate it wants, whether there are reserve requirements or not.

    I still maintain that Austrians simply don’t understand that even if they could get rid of the central bank or any other govt entity providing overdrafts, and even if you set up a % of the system with 100% reserves for the purpose of being piggy banks to the public, even with all this you would still have financial innovation and you would still have loans creating deposits, private sector interbank markets, etc. and thus horizontal expansion. For some reason, they don’t think that banks and other financial institutions are profit making entrepreneurs that innovate even as they nearly worship the innovation of non-bank entrepreneurs.

    Also, as Warren said, it’s a system that would be prone to depressions and disruptions in the pmts system due to rather simple events.

    Reply

  42. knapp Says:

    It’s true that Austrians don’t think in terms of floating fx. They think in terms of loanable funds (commodity-based) money vs. fiat money (vertical) and “fiduciary media” (horizontal) money. All Austrians are against fiat and favor gold. But there is discord as to whether banks should create money. The 100% reservists (modern day Currency School) led by Rothbard and now Hulsman, Salerno and Shostak say no. The Fractional Reservists (Banking School) led by Lawrence White and George Selgin say yes.

    The 100%’ers see demand deposits as a bailment, not a loan, so money is a warehouse receipt and lending out that money is equivalent to your dry cleaner lending out your leather jacket until you pick it up ( which was actually a very funny Seinfeld episode). It’s just the fungability character of money that makes it appear less of a crime.

    The 100%’ers see no problem with non-bank credit expansion as it represents a shift in savings not “created credit”, “out of thin air” from pyramided fiat money.

    For those interested, Shostak has a short piece here on Non-Bank Credit, and Selgin has a longer piece on Should We Let Banks Create Money:

    http://mises.org/story/363

    http://www.independent.org/pdf/tir/tir_05_1_selgin.pdf

    The two camps disagree about the stability of fractional reserve banking but both agree that fiat money is destabilizing.

    The bottom line is that Austrians of all stripes see the gold standard and its constraint on government as a force of stability that would bring about what Mises called an Evenly Rotating Economy. It’s a view of the economy as endogenously stable if not for the corrupting forces of gov’t institutions, and certainly not a system prone to depressions and panics. Obviously Keynesians don’t see it that way.

    The problem is that history provides no guide. True laissez faire implies no govt. As long as gov’t exists (and it always has in modern history) and has the power to “rewrite the dictionary” and “go off gold” then a true free market is purely an abstraction, not something that actually ever existed in history. Keynesians can’t claim the End of Laissez Faire when there was never a real beginning. Austrians, even if we grant their assumptions, must recognize that a gold standard is a false constraint, and a potentially destabilizing one, until the political culture is ready for a tiny govt, which it currently is not.

    Inherently Unstable or Endogenously Stable ???

    Reply

    knapp Reply:

    my prior post got delayed (probably because of links).

    Zanon- i think you captured the Austrian view of natural deflation
    accurately. But many Austrians make no distinction between the productivity-only deflation (good deflation) that would occur in their free market model, and the more destabilizing Minsky-Fisher credit deflation(bad deflation) we are now experiencing. To them, its all good deflation. This hurts the Austrian cause by making them sound like heartless liquidationists; its not good economic analysis either.

    But debates about free banking and gold standards will never be resolved until there is agreement on the fundamental cause of market instability. Is it institutional or inherent? chicken or egg?

    Reply

  43. zanon Says:

    Hi Scott/Warren:

    I think Austrians would disagree with you about “loans creating deposits” in their fixed money supply world. Money supply is fixed by the physical quantity of Gold, which yes increases slowly, but is actually pretty much fixed. Loans and Deposits come into being simultaneously as a borrower looking to have $100 for three years would be matched with a lender looking to loan $100 for three years. The “coordinator” would simply match these two, like an equity bookmaker matchers buyers and sellers in the stock exchange. The “coordinator” does not have a balance sheet. The lender cannot give out money he does not have. There is no currency issuer, everyone is a currency user.

    That said, there is lots of room for financial innovation here — finding better matches between would be investors and entrepreneurs is hard and important!

    And yes, Warren, this is essentially a barter economy with the currency acting as something that aids in coordination.

    But maturity matching actually dramatically reduces the panics and depressions. This is something that creates instability whether you are in fiat money or “commodity” money, and both system would do well to be rid of it.

    WARREN: As Canada has zero reserve requirements, what limits the size of banks’ balance sheets?

    Reply

    warren mosler Reply:

    Yes, i can see how banks could be limited to intermediating those with actual gold certificates and those wanting to borrow them, matching maturities precisely, etc.

    The problem with a gold standard is the problem of hoarding unspent income that reduces aggregate demand and sets a deflationary spiral in motion.

    And a govt. that taxes and spends in that gold backed currency exacerbates the desire to accumulate the gold certificates by not spending income. People tend to desire to accumulate the thing they need to pay taxes and can quickly get to the point where they won’t lend their funds on any terms.

    We are seeing some of that today with non convertible currency with the govt. rapidly adding to supply. It gets a lot worse with convertible currency and the govt. not able to add to supply.

    Reply

  44. Scott Fullwiler Says:

    Thanks, Zanon

    You had banks creating loans without first having gold deposits under gold standards, too. Yes, it doesn’t increase the qty of gold, and can create difficulties for the banks in meeting withdrawals of customers, but the point still stands. In HK with the US$ currency board, banks can increase loans/deposits in HK$ without first having US$ deposits, but they just can’t go to the cb for help if the depositors want to withdraw more US$ than they have in reserve.

    Canadian banks are constrained the same way US banks are . . . capital requirements and bank regulation. Reserve requirements are NEVER an ex ante constraint if you’re not under a gold standard or the equivalent. (Sorry . . . I know that was intended for Warren.) Canada’s just one of several without reserve requirements.

    Reply

  45. Scott Fullwiler Says:

    Sorry to keep posting on this . . . but it sure seems like for a bunch of free marketers Austrians want to put a whole lot of regulation into the monetary system. Imagine how much regulation you would need to ever get it to work the way Zanon described in his last post. So much for trusting in “market forces.”

    Reply

  46. zanon Says:

    WARREN: Yes, there would be hoarding, and that would cause deflation. That said, Austrians would argue that, in a world with fixed money supply *and* technological progress, money *should* (slowly) increase in value, ie. there should be gentle but pervasive deflation. A mildly deflationary world should be as benign, indeed more benign, than a mildly inflationary world.

    SCOTT: It is totally unclear how much (or how little) regulation you would need, especially compared to the amount of regulation we have now, which can fill many warehouses.

    You would need a rule saying you have to match maturity. Banks would not have access to a CB — indeed, there would be no CB. Interest rates would be set by market forces (for better or for worse). Redemptions would be harder for investors *but this is a feature, not a bug*. If you want easy redemption, put your money in a vault and pay the annual security fee.

    It’s a *very different* system from the current one, but there have been systems in the past that have had elements of this. Yes, they have gone the way of the dodo, but all fiat currencies have gone the way of the dodo too, and the world seems to switch reserve currency every few hundred years as well.

    SCOTT/WARREN: OK, so with no reserve requirements, you just have capital requirements, which keep the banks for expanding their balance sheets too much. I’ll bite though — what is the difference? Isn’t the degree of leverage measured off deposits? Doesn’t that make reserve requirements can capital requirements the same thing?

    Also, I understand that Fed Funds rate is independent of reserve requirements (or lack thereof). Thanks!

    Reply

  47. warren mosler Says:

    you have both capital requirements and regulated assets as to quality and diversification.

    and yes, capital is ‘endogenous’in theory the same way reserves are. That is, there is always a price for capital, from which banks can set spreads on loans, etc. to achieve the return necessary to raise capital.

    But raising capital can be problematic and restrictive in the short and medium term.

    With non convertible currency as we have today, reserve requirements are not a constraint as previously discussed. That’s why dropping them to 0 changes nothing of substance.

    Dropping capital requirements to 0 coupled with insured deposits is a ‘free bet’ for a banker. Heads you win, tails the FDIC loses.

    Reply

  48. John Rogers Says:

    Is fractional reserve banking a moral system?
    If I “loan” out money I don’t have isn’t that akin to counterfeiting?

    Reply

  49. warren mosler Says:

    No, why would it be?

    And fractional banking as you are no doubt using the term is applicable only to fixed exchange rates systems like the gold standard.

    with today’s non convertible currency it’s a moot point.

    Reply

    zanon Reply:

    Totally clear on capital requirements vs. reserve requirements. Thanks!

    Also, interesting to see countries who bank in non-domestic currencies deal with this crises — it’s not pretty! Sadly, it isn’t pretty in countries who bank in domestic currencies either.

    Reply

    jcmccutcheon Reply:

    What is the best moniker for the banking system of today if not ‘fractional reserve banking’

    Reply

  50. Scott Fullwiler Says:

    don’t know about Warren, but I just refer to it as the way banking actually works under a non-gold standard or non-currency board fx system. You need a gold standard or currency board for fractional reserve banking as commonly defined. So, the key characteristic seems to be the fx system.

    Reply

    zanon Reply:

    jcmccutcheon: Good question. We *do* have FRB though, it just doesn’t work the way anyone thinks it does.

    I might call it a fiat money system. Everyone agrees that, in a fiat system, the Government can print money. No one takes the next step and asks: “if the Government can print money, why does it tax me?”

    that paradox helps people become open to the paradigm. You can move directly from that to “if the Govt prints money, and people put it under the mattress, how will that money ever show up as inflation?” Instantly, we have the Federal deficit funding private savings. Priceless.

    Reply

    jcmccutcheon Reply:

    Yes I usually throw in the phrase “fiat money” when I try to explain this web site to people.

    Reply

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