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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.

Twin deficit terrorists Ferguson and Buiter

Posted by WARREN MOSLER on June 14th, 2009


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This is the exact same line Niall Ferguson is spewing.
He also says the two choices are inflating or defaulting.

The inflation would be from too much aggregate demand and a too small output gap.

That would mean that fatefull day would be an economy with maybe 4% unemployment and 90%+ capacity utilization and an overheating economy in general.

Sounds like that’s the goal of deficit spending to me- so in faccct he’s saying deficit spending works with his rant on why it doesn’t.

And if we do need to raise taxes to cool things down some day, we can start with a tax on interest income if we want to cut payments to bond holders.

Regarding the supposed default alternative to inflation, in the full employment and high capacity utilization scenario that might call for a tax increase to cool it down, I don’t see how default fits in or why it would even be considered.

In fact, with our countercyclical tax structure, strong growth that follows deficits automatically drives down the deficit, and can even drive it into surplus, as happened in the 1990′s. In that case one must be quick to reverse the growth constraining surplus should the economy fall apart as happend shortly after y2k.

Feel free to pass this along to either.

The fiscal black hole in the US

June 12 (FT)—US budgetary prospects are dire, disastrous even. Without a major permanent fiscal tightening, starting as soon as cyclical considerations permit, and preferably sooner, the country is headed straight for a build up of public debt that will either have to be inflated away or that will be ‘resolved’ through sovereign default.


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87 Responses to “Twin deficit terrorists Ferguson and Buiter”

  1. Rob Says:

    Is there ever a point where control is lost? Can debt service payments get so large that inflation can’t be stopped without severe tax increases?

    I lump debt service together with deficit spending, but goverment doesn’t get to decide where debt service goes. So high debt service would also be a loss of control about who got the deficit spending.

    Reply

    no more disney trips Reply:

    Rob an article where british and swiss banks are refusing to do business with americans or anyone who has even vacationed in america for an extended period of time because of onerous tax sillyness:

    http://www.bogleheads.org/forum/viewtopic.php?t=39006&mrr=1245040255

    A similar article where south american banks are refusing to do business with Americans for similar concerns:

    http://www.321gold.com/editorials/casey/casey033009.html

    I remember reading how in the last days of Rome the wealthy land owners moved as far away from Rome as they could to escape all the excessive taxation. Free roman citizens gave up thier rights and willingy threw themselves into slavery under these large landowners to escape starvation and excessive taxation.

    If you can’t vacation to Disney in Florida for too long, how will mickey buy minnie a new hat? The last time I was at Disney it was mostly foreigners, USA folks could no longer afford it. Lets get the US government involved, it should be a law that every kid in the whole wide world gets 2 weeks at disney.

    Reply

    warren mosler Reply:

    only if the total spending shrinks the output gap meaning unemployment gets down to maybe 4% and growth up to 5% or more.

    but that’s what deficit spending is supposed to do.

    and if that happens and we want to cool things down we can always tax interest.

    Reply

  2. Scott Fullwiler Says:

    Debt service is a policy variable, since interest on the national debt is effectively set by monetary policy. See “interest rates and fiscal sustainability” at http://www.cfeps.org.

    Reply

    jcmccutcheon Reply:

    Scott, in that paper, you talk about arbitrage opportunities between short term and long term treasury rates as the mechanism that keeps long term rates aligned to short rate policy expectations. How would the arbitrage work between short term and long term rates? Maybe a simple example would help.

    Reply

    Scott Fullwiler Reply:

    The classic example is something like this: if the 10y Tsy is at 10%, but I can borrow for one year at 5% and expect the one year to continue to be at 5% for the next 9 years. In the real world, what the mkt expects the st rate to be in the future will be reflected in, say, Eurodollar futures and swap rates, so one can in most cases fix the borrowing rate to eliminate risk.

    Reply

    Curious Reply:

    Scott,

    if I understand your example correctly: I borrow $100 at 5% and invest it in 10y Tsy. When my debt is due in 1 year, I collect my $10 interest on the Tsy, repay $5 interest on my loan, repay the principle with new $100 borrowing for 1 year 5%, and pocket the $5 interest differential. And so on until maturity of the 10y Tsy. Correct? How do I use eurodollar futures or swaps to hedge the risk of 1 year rates going up?

    Scott Fullwiler Reply:

    You have to roll over the st debt, and the st rates may have changed. Something like a futures or swap can offset any changes that ultimately occur in these actual rates.

  3. Bill Gross Says:

    “We can start with a tax on interest income if we want to cut payments to bond holders.”

    Hi, I am Bill Gross of Pimcrony, and the government has appointed me to manage many accounts. I have the government deciders doing these things in my pocket. Any silly futile theories you have about hurting me or my bondholders, I can assure you will never take hold in the current government/political structure you exist within. If you will care to look at the public financial disclosures of the past and current presidents and white house staff and also most of the current and past congressmen, you will find lots of their “wealth” invested in things like vanguard total bond fund. Stop being silly.

    “Regarding the supposed default alternative to inflation, in the full employment and high capacity utilization scenario that might call for a tax increase to cool it down, I don’t see how default fits in or why it would even be considered.”

    When people like william black were calling for a “cooldown” in housing sillyness, liar loans, instead of higher taxes, I saw more incentives and tax breaks. Already with too much housing supply I see incentives for tax credits going from 8K to 15K. Your theories are interesting, but in the real world with corrupt people, it doesn’t seem they will ever gain any real traction. The founding fathers said the constitution would only work for a moral and just people, hmmm. I do agree, ever since we delinked from Gold, the only thing that could cause default was energy constraints or paper supply. We can keep those printing presses zooming and digital zeroes in the online computers going for a long time. I went to south america to visit my girlfriend and buy her some dresses, we went to a shop that would not take my USA green pieces of paper, only euros or the local currency, so in a sense hasn’t there already been a default of my money? I went to the money changers locally, and they wouldn’t exchange my currency – oops! I didn’t get any nookie that night :(

    “In fact, with our countercyclical tax structure, strong growth that follows deficits automatically drives down the deficit, and can even drive it into surplus, as happened in the 1990’s.”

    Several years ago Warren you told me the removal of PAYGO would have consequences, now that it is being pitched to reinstate it, how does all this countercyclical deficit stuff work?

    ” In that case one must be quick to reverse the growth constraining surplus should the economy fall apart as happend shortly after y2k.”

    I onced watched the Cirque Du Soleil gymnast balance the tightrope for a long time, but eventually fell down, because the constant balancing got to be too much. When you say the words “quick” and government policy I don’t know wether to laugh or cry. I think of hank paulson holding a bazooka to congress’s head and all of them signing off on stuff they haven’t even READ. Then I think of what you said about congressional investigations into looking into teenagers getting locked up in for PROFIT prisons and how that probably WON’T be quick like it SHOULD be and just start singing with smokey – the tears of a clown.

    Reply

  4. bb Says:

    if we agree or not with warren taxes going up now and govt reducing spending means the stock market and economy are headed down. If obama decides on pay as you go for govt expenditures deflation is coming back in a big way now. time to short commodities

    Reply

    Bill Gross Reply:

    During the sp500 ride from 4 digits down to 666, warren was a cheerleader for how good things were most of the way down – or should I say he said they weren’t so bad. To take warren’s economic advice and then try to trade using it, is destined for failure.

    Here is Obama’s financial disclosure – he has money with Gross of Pimco.

    http://www.opensecrets.org/pfds/candlook.php?CID=N00009638

    You can also find most everyone else’s “wealth” in US government. A lot of congressmen, staff, former and current have much of their money in these investments that warren says we can tax in the future. I don’t believe Warren. I don’t see all these congressmen past and present voting and lobbying for TAX INCREASES on their own financial assets, that is BS. Cheney and Bush before this administration also had a lot of their “wealth” in similar assets.

    Reply

    warren mosler Reply:

    agreed

    Reply

  5. jcmccutcheon Says:

    What taxes? What are you talking about? Seems like all of your arguments are anecdotal instead of academic. Can you make any dissenting argument against soft-currency economics that is academic in nature?

    Reply

    warren mosler Reply:

    i didn’t move any of that to the usvi

    michael is taking this post down tomorrow afternoon

    Reply

  6. zanon Says:

    WARREN: How does this fit with stagflation in the 70s and 80s? We had high unemployment, low growth, and inflation. Some of this was “cost push” inflation (aka high oil prices), but there was also wage spiral with unions etc.

    Anyway, my point is that unemployment was high, but we saw inflation.

    Reply

    warren mosler Reply:

    the inflation was primarily cost push and though wages went up they didn’t keep up.

    this can happen again if crude keeps going up, but the saudi’s statement today that this was about the right price makes me watch for crude to stabilize for a while

    Reply

    Break the Windows Reply:

    50 american cities to be bulldozed, I guess this will provide temporary work and help with employment numbers short term, but what a disgrace.

    Bernie Lo on asia confidential the other night said we need to lift H1B Visa restrictions on chinese citizens, and let them move into all these dying cities in the USA. I would much rather have an educated chinese engineer living next to me in detroit than an uneducated drug dealing thug that wants to rape my mother.

    http://www.businessinsider.com/will-obama-bulldoze-50-american-cities-2009-6

    Reply

    Mike S Reply:

    Hi Warren,

    I have this same question and think a 1 sentence response is not enough. A white paper on this topic would be better as it will be among the first questions curious people will ask.

    Reply

    Mike S Reply:

    So if I am reading the words “cost push” correctly, this would mean that we should have deficit spent more AND that this deficit spending would not have impacted inflation.

    We were going to have this cost push inflation anyway due to supply disruption caused by OPEC, so additional deficit spending would have first impacted slack U.S. production capacity and not impacted overall price levels?

    I just want to be clear about the meaning of “cost push” because it is important to address this recent history. This history runs contrary to the basic assumptions of the monetary model that we are using here.

    Dave Begoka Reply:

    They may be trying to flush all of the reserves many are holding?

    Reply

  7. warren mosler Says:

    michael is taking this down.

    obviously you know better and are just being disruptive

    Reply

    Bill Gross Reply:

    No I am not being disruptive, I am providing empirical proof to one of the other posters that said my anecdotal evidence was BS. All those incentives for USVI economic growth, and your own personal example shows you are just milking it for the tax advantages, you have not removed jobs from florida to give to USVI – proving the point you told me earlier, the congresspeople don’t really care about REAL economic growth in the USVI that serves public purpose and helps the locals. That congresspeople will alter taxes in ways that hurt thier own wealth to help the poor is not something I see backed up by any real evidence save maybe some government paid academia trying to make the system that funds them happy.

    Reply

    Mike S Reply:

    No you are being disruptive. I once had the purple hair and still listen to art-school music and all of that, so I know the intentionally offensive attitude when I see it.

    You are being intentionally offensive and you should be banned.

    Reply

    Break the Windows Reply:

    Stop attacking me, and start attacking my points. Warren has not moved jobs from florida to USVI(related to the bank and car company right?), but he does go to great lengths to LIVE in the USVI for the tax advantages, do you agree or disagree? Warren has also said congresspeople shown PROOF that certain tax strategies serve NO PUBLIC PURPOSE don’t seem to influence these congresspeople, do you agree or disagree? Warren also points out along this same meme that Art Laffer goes on kudlow every night and lies to me and millions of others about things relating to taxes and inflation, which seems to support this whole “crony capitalism” meme that warren is exploring here on this blog, do you agree or disagree? Wether I have pink hair or am bald shouldn’t matter when asking wether you agree your disagree with the points should it?

    However if you wake up dreaming about kafkaesque societies and want to ban dissenting comments so you can only live in a harrison bergeron world, the IRS is asking for YOU dear citizen to turn in people that make certain accusations against the US government and their cronies. Now I am not going to turn Warren in even though many of his comments here could be construed to come under this request, are you going to turn me in?

    http://www.businessinsider.com/the-government-wants-the-name-of-anti-fed-newspaper-commenters-2009-6

    Reply

  8. Break the Windows Says:

    Further on wages and jobs. Michigan is going to stop paving roads and instead turn them into gravel roads. This requires more maintenance = more jobs. Also this should slow down the vehicles, achieving another one of warren’s policy objectives, why not make the whole USA gravel? Lots more jobs and everyone driving slower?

    http://tech.slashdot.org/story/09/06/15/1641219/Broke-Counties-Turn-Failing-Roads-To-Gravel

    Reply

  9. bb Says:

    warren once again can you explain why you are not concerned about doubling of feds monetary base and huge bank reserves for a future inflation.

    Reply

    Scott Fullwiler Reply:

    Hi. Not to butt in (though it appears Warren may be away from web access at the moment), but you might look at “quantitative easing for dummies” in the mandatory readings. Banks don’t use reserves to make loans/deposits; loans create deposits, therefore the quantity of reserves is irrelevant. In Canada, reserves have been zero for a decade now, with no irregularities in bank lending as a result. In Japan under quantitative easing, they were about 3x as large as a % of GDP compared to the US now, with obviously no inflation there.

    Reply

  10. bb Says:

    ok read quantitative easing. So if fed balance sheet growth is not the creation of money unless banks lend and banks not lending and obama institutes pay as you go this rally in commodities is toast and gold is headed way down

    Reply

    Scott Fullwiler Reply:

    Pretty much, though I’ll leave the gold predictions to others, since it can move for so many different reasons (all of them related sentiment, of course, but there are many sentiments to factor in).

    Reply

    Break the Windows Reply:

    Bb, is housing done deflating? The median price for foreclosed homes in detroit is 6K. 6 thousand us green pieces of paper.

    Are global human population levels ever going to inflate at rates compared to the previous 50 years?
    I don’t think so, all the girls I have tried to get pregnant told me to go jump off a bridge.

    There is more debt on this planet denominated in US currency than anything else no? Just because a few trillion is pumped into the monetary base, how does that affect 500 trillion in abstract financial instruments that are possibly collapsing? There was an old saying in my granpappy’s day, money’s short, and times are hard – and that was when hoover had the printing presses going at warp speed – it just wasn’t enough to stop all the debt that had expanded in a virtuous cycle that was imploding from the vicious cycle.

    If you can’t get the money to repay the debt, you default on the debt no? Roubini says deflation in oil prices is in our near future, he was earlier than most in point out this financial blowup.

    Reply

    Break the Windows Reply:

    Scott, this whole gold bug meme has to be one of the dumbest things I have ever witnessed in my entire life. It fascinates me that so many human minds spend day after day watching shiny metal statistics on a bloomberg terminal so they can click buttons back and forth trading it. Look at the hedge fund guy Paulson, allocating billions to a gold mine, how does that make the world better?
    And then Warren wasting brain cycles trying to figure out tax strategies buying gold mines too (sigh)

    That money could go to research scientists all over the world for so many things to advance our science and knowledge of the universe.

    Hoarding or trading gold does not put these human minds to productive use building stargate atlantis cities, finding cancer cures, inventing 3d solar cell technology, etc etc.

    In the 1920′s during all the turmoil in china there was a temporary acting emporer – Eugene Chen – he ruled a few days when Dr. Sun Yat Sen was conflicting with the communists.

    He has been honored as one of the 10 greatest citizens in chinese History, he didn’t even speak chinese, he was educated in england and spoke only english, but was a constant aggravation to the western powers and considered a great hero.

    http://www.achamchen.com/eugene_bernard_acham-chen.htm

    One of his grandsons lives in tobago now and has many political and economic ties to china. Jay Chen, you can go over to http://www.siliconinvestor.com and look for a poster called tobagojack. He has pumped this gold meme bug to his chinese friends and the internet in general for over a decade now. He has convinced many chinese government officials that all world currencies are going to go BOOM and gold is the only sound money and to hoard as much of it as possible. Arguing with religious zealots, wether it be about XENU from scientology, or gold bugs, is such a waste of time. What is sad is chen used to be an electrical engineer in a former life and used to make advances to our science in knowledge on this planet, but somehow he got TRICKED into this whole financial economy BS and now clicks buttons on a bloomberg terminal back and forth everyday and no longer contributes to mankind’s science and knowledge – sad.

    Clicking buttons back and forth on a bloomberg terminal doesn’t bring about cancer cures from what I see.

    All this brain power applied by warren and so many others trying to figure out tax strategies and trading gold mines, imagine if we instead had it all going into research, what a different world we would have, disgraceful.

    Reply

    jcmccutcheon Reply:

    Common, Warren has spoken out against it for a long time.

    warren mosler Reply:

    yes, my point exactly.

    the financial sector is a lot more trouble than it’s worth, and the largest waste of human endeavor in history

    and, sadly, it’s the only way i can pay my bills.
    my current goal is to reduce expenses to free up my time for other things.

    Pay Bills Reply:

    Warren could you elaborate more? What are these huge bills keeping you a slave to the status quo? I am going to move to the USVI very soon, I assumed the bills were very minimal, you have your own refinery there after all. Is it insurance, upkeep, taxes? My philosophy professor said all you need is a staff and a cloak. Before I become your neighbor, I need more illumination on these high bills. In florida you have no property tax if you are a disabled vet, does the USVI offer a similar program?

  11. bb Says:

    by the way this is the arguemnet of robert prechter who is a big deflationist. He understands reserve accounting

    Reply

    Mike S Reply:

    I am not sure he does. Robert Prechter has been a gold bug and inflation hound too for a long time.

    Reply

  12. warren mosler Says:

    on the road, will be back on line in a couple of days with longer responses.

    Reply

  13. knapp Says:

    Scott,

    I would love to get your thoughts on Buiter’s/ Mankiws proposal for negative nominal rates via, for example, a currency tax.

    http://blogs.ft.com/maverecon/2009/05/negative-interest-rates-when-are-they-coming-to-a-central-bank-near-you/

    Another blogger, Chicago schooler Scott Sumner, recommends charging interest on excess reserves, the opposite of your preferred policy.

    http://blogsandwikis.bentley.edu/themoneyillusion/?p=1565

    My novice assessment is that both of these proposals- negative nominal rates and charging interest on reserves- are simply inefficient forms of taxation and reserve drains, thus unhelpful.

    Reply

    Scott Fullwiler Reply:

    Hi Knapp,

    Yes, both of these are silly ideas, in my opinion.

    Regarding negative interest rates, there are 2 points. First, regarding currency, if you tax that, then what you end up with is everybody holding non-currency substitutes like money market funds. If you tax those substitutes, then you just get continued innovation until there is something that can be held w/o being taxed. So what? It misses the basic point that the problem isn’t people not spending the liquid balances they have but rather it is that their incomes are not high enough for them to feel comfortable spending in the first place and they are deleveraging to boot.

    Second, regarding negative interest rates for reserves, etc., the overall point is that you are raising the income of the borrower (the Fed pays banks for their overdrafts). The end effect is that the Fed’s profits are less and it returns less to the Treasury, so all you’ve really done is increase the deficit. Seems the better way to do that–and the more politically legitimate way–is via direct fiscal stimulus, such as Warren’s plans for payroll tax holiday, transfers to states, ELR, etc.

    As an overarching point on the negative interest rate, it always amazes me that mainstreamers, and monetarists in particular, don’t see that if the central bank actually DID create money and drop it from a helicopter (or likewise pay people to borrow money), this is really a fiscal transfer; the questions remain “who should get the transfer, and how much should they get?” I don’t understand why anyone would think the central bank is the appropriate institution for making those decisions compared to a democratically elected government (however flawed).

    Regarding Sumner, he’s demonstrated time and again (and admitted, as well) that he doesn’t understand reserve accounting or how loans create deposits. He doesn’t realize that the central bank would still have to give an overdraft to banks in order to hit its overnight target. Not much else to say, aside from the obvious fact that he’s out of paradigm (money multiplier is a gold standard view model).

    Reply

    Scott Fullwiler Reply:

    To clarify, my basic point regarding Sumner is that he’s trying to get banks to eliminate their excess reserves because he probably thinks they are holding them rather than “lending” them out. Pure money multiplier view, and completely inapplicable. If banks end up with excess reserves, to pay the tax they would either debit the reserves (as you note) or receive an overdraft from the Fed at the Fed’s stated rate. In both cases, it is likely that the Fed would then have to add reserves to hit its target if banks were holding reserves at desired levels relative to the target beforehand.

    Reply

    knapp Reply:

    Scott

    Thanks for the great clarification of the issues.

    The mainstream appears to have a mental block when it comes to fiscal policy.

    Reply

    Break the Windows Reply:

    “It misses the basic point that the problem isn’t people not spending the liquid balances they have but rather it is that their incomes are not high enough for them to feel comfortable spending in the first place and they are deleveraging to boot.”

    Scott, in florida recently I see old people working all over the state. Their golden years have been robbed from them and they are doing jobs they hate just to have medicine and air conditioning bills paid. So for me to have “faith” to spend again, I am going to have to see a lot of old people (my future) out living the high life of retirement. So make all drugs to old people free, and have the US government pay all their utility bills and perhaps I will “feel” better about my own retirement, is this feasible?

    “Second, regarding negative interest rates for reserves, etc., the overall point is that you are raising the income of the borrower (the Fed pays banks for their overdrafts). The end effect is that the Fed’s profits are less and it returns less to the Treasury, so all you’ve really done is increase the deficit. Seems the better way to do that–and the more politically legitimate way–is via direct fiscal stimulus, such as Warren’s plans for payroll tax holiday, transfers to states, ELR, etc. ”

    Scott, how will the crony bankers who make all the big lobbying contributions compete in that system? For that matter how will knowledgeable people like Warren figure out complicated tax strategies to get more of the pie compared to joe 6 pack? This goes back to arnold klings point, there is too much power in too few hands and government is too small for the population it represents.

    Reply

    warren mosler Reply:

    the problem is the admin thinks the problem is people aren’t spending enough.

    I see that as a good thing. It means govt can lower taxes until spending resumes at reasonable levels.

    In otherwords, ‘low spending’ and ‘low confidence’ means the same amount of govt spending can be supported with lower taxes.

    It’s just another example of the administration getting it totally wrong.

    Reply

  14. Scott Fullwiler Says:

    Sorry, forgot to also mention the obvious fact that Sumner’s plan REDUCES aggregate demand, which is probably the most important point, since it is clearly a tax on banks.

    To pay the tax on ER, banks debit reserve accounts and retained earnings (reduced profits) from capital.

    The Fed debits its reserves and credits its capital account (retained earnings frmo raised profits). But then the Fed transfers this to the Treasury’s account since it always sends the Treasury its profits.

    So, there you have it. A tax on excess reserves is just a fiscal tightening that reduces aggregate demand by transfering income from the banks to the Treasury, whereas Sumner was actually trying to raise aggregate demand with the proposal. Wouldn’t seem to be a good idea at all given the current status of the banking system, would it? (!!!!) Once again, why anyone thinks the central bank is the appropriate institution for running fiscal policy is beyond me.

    Lastly, I just want to say that anyone who can make his/her way around a balance sheet would never propose something so silly and counterproductive. But that’s the state of monetary economics at the U of Chicago, apparently.

    Reply

    jcmccutcheon Reply:

    Scott, when the FED “capitalized” banks using TALP, TARP, etc. This capital went into the banks’ capital accounts, yes? Not reserve accounts?

    Reply

    Scott Fullwiler Reply:

    When you buy bank equity, like preferred equity that the govt purchased with the TARP, it adds to capital AND to the reserve account simultaneously, since they purchased the equity with a reserve account credit. Double-entry accounting, so you have to change both sides of the balance sheet, or offset the change on one side.

    Reply

    Jim Baird Reply:

    As Scott says, whenever the govt or fed spends, it does so by cerditing reserves. The TARP was a way to change numbers on banks balance sheets in order to be able to pronounce them “solvent” according to banking regulations. The same thing could have been done much more efficiently (and without giving the impression we were “spending $700B” and feeding the conspiracy theories of the Ron Paul contingent) by simply changing or temporarily suspending the capital requirements. It’s not clear to me whether the architects of this plan understood that and thought the idea of a government “investment” in the banks was an easier political sell than a lowering of standards, or they are just clueless.

    I lean toward clueless, since changing the capital rules could have been slipped through in an innocuous rider to some other bill without attracting the sturm und drang of the TARP. I am forced to conclude we are ruled by morons.

    Reply

    Matt Franko Reply:

    Jim,
    Agree that would have been much simpler.
    I think the original plan for the 700B was targeted/quick purchases of “toxic assets” by the Treasury as individual banks ran into trouble (I dont think they foresaw the systemic issues that would eventually develop). They probably thought they needed to do this quickly and the appropriation route was path of least resistance in Congress. There was some open ended language in the law and remember Paulson quickly went to “Plan B” after it passed.
    If we “go down” again here in the next few months, I dont see such a ready response this time and the pain may be worse than last fall before meaningful help from Congress arrives.
    Resp,

    Break the Windows Reply:

    “Once again, why anyone thinks the central bank is the appropriate institution for running fiscal policy is beyond me.”

    Scott, warren says the fed boys are totally beholden to congress, who are totally beholden to crony banker’s money and lobbyists. Where is joe 6 pack in the equation? Who is beholden to him?

    “simply changing or temporarily suspending the capital requirements.”

    We went from 12 to 1 to 40 to 1 and that got us in the mess, why would that get us out? Furthermore, the first paulson plan didn’t have all that pork in it, funny how the second version of the bill with all the congressional pork could get passed without anyone even reading it. Who is congress beholden too?? The banker with the bazooka or the voting joe 6 packs?

    Jim Baird Reply:

    BTW/whatever else your name is today:

    I didn’t mean to give the impression that suspending capital requirements would have been my choice, either. I would have taken them over and ridden the execs out of town on a rail. But given that they weren’t going to do that, their preferred method for the “rescue” was a stupid and politically idiotic way to do it – brought about by their lack of understanding of their own banking and monetary system.

    warren mosler Reply:

    I vote for clueless.

    I’m hearing others more and more suspecting subversive

  15. Dave Begoka Says:

    The FED changing numbers on a balance sheet = Inflation = BAD FOR MAJORITY!?

    Scott how is this so complicated that only you can figure it out?

    Reply

    Scott Fullwiler Reply:

    How does changing numbers on the Fed’s balance sheet create inflation? Changing the numbers by 3 times as much as a % of GDP didn’t create inflation in Japan. Did you read “quantitative easing for dummies” in the mandatory readings?

    Reply

    jcmccutcheon Reply:

    Dave, Inflation cannot occur until people exchange money for goods and services. That simple. Changing entries on a balance sheet is not exchanging money for goods and services.

    Reply

    Curious Reply:

    Once the banks clean up their balance sheets, could they use the new reserves to purchase assets in the open market, thus increasing asset prices and creating inflation?

    Reply

    Jim Baird Reply:

    The “new reserves” do not add any net assets to the system (at least in the case of QE – the TARP is a bit different, but TARP has become so toxic I doubt any bank will want to buy any assets until it can rid itself of the TARP money). The Fed credits the bank’s reserve account and moves the bank assets to it’s own balance sheet (essentially removing them from the private economy). Any interbank transactions withe the reserves will just move assets around it doesn’t add to demand.

    Curious Reply:

    Jim,

    for example: if there is $100 worth of assets in the economy and $100 of reserves. The fed buys $20 worth of assets. Now there is $80 worth of assets and $120 of reserves, no?

    Jim Baird Reply:

    Precisely.

    Curious Reply:

    Jim said: “The “new reserves” do not add any net assets to the system…”

    In my example the new reserves added $20 to net financial assets. (In addition they removed 20% of real assets)

    Jim said: “Precisely.”

    What am I missing here?

    warren mosler Reply:

    I think you meant real assets from subsequent postings.

    the answer is yes, banks purchasing real assets like housing
    and pencils bids up prices. But banks don’t run out and do that
    just because there balance sheets are ‘clean’ and even if they wanted to buy real estate having or not having reserves isn’t a constraint.

    If you meant buying financial assets in the market place, like securities, that’s just an exchange of financial assets and net financial assets remain unchanged

    Curious Reply:

    Warren,

    I wasn’t really differentiating between real and financial assets. Why separate assets into these groups?

    “…buying financial assets in the market place, like securities, that’s just an exchange of financial assets and net financial assets remain unchanged”

    an example:

    Economy with 2 banks, each bank has $10 of reserves and $10 worth of securities.

    Total fin. assets = $40.

    The fed purchases $10 worth of securities from bank A for $10. Bank A now has $20 in reserves and decides to bid on a security that bank B owns. Bank B doesn’t want to sell, so A raises their bid and buys for $11.

    Ending fin. assets:
    Bank A = $9 reserves + $11 worth of securities
    Bank B = $21 reserves

    Total fin. assets = $41

    Reply

    Scott Fullwiler Reply:

    “I wasn’t really differentiating between real and financial assets. Why separate assets into these groups?”

    You differentiate b/n real and financial assets because it is IMPOSSIBLE not to.

    Real assets (houses, cars, etc.) show up only on the asset side of the holder. Financial assets (stocks, bonds, deposits, etc.) show up as an asset of the holder but on the liability/equity side of the issuer.

    This is by definition. If you are not distinguishing between real and financial assets, then you are doing the accounting wrong.

    Scott Fullwiler Reply:

    Your example makes my point below (? or above? Not sure where this comment will be placed). The original issuer of the security that B sold to A now has seen the market value of its liability rise by $1, so while you raised B’s assets by $1, the NET financial assets of the private sector have not changed.

    jcmccutcheon Reply:

    Scott, If the security were a bond isn’t the liability fixed within the bond contract?

    Curious Reply:

    “The original issuer of the security that B sold to A now has seen the market value of its liability rise by $1, so while you raised B’s assets by $1, the NET financial assets of the private sector have not changed.”

    That makes sense. Thanks for explaining it Scott.

    Jim Baird Reply:

    “isn’t the liability fixed within the bond contract?”

    If you owe an outstanding bond with a face value of $100 but S&P has downgraded you to junk and it’s trading on the open market for $50, your liability is $50, not $100. Since you could go into the open market and buy the bond back for $50, that’s what it would take to cancel the obligation.

    jcmccutcheon Reply:

    Jim, I see , (similar to options trading) thanks!

  16. Scott Fullwiler Says:

    For those interested, I just posted “Don’t Fear the Rise in the Fed’s Reserve Balances” to the new KC economists’ blog.

    neweconomicperspectives.blogspot.com

    Reply

  17. Dave Begoka Says:

    Sorry I just don’t get it, inflating the money supply dilutes its worth.

    As far as comparing the US to Japan, Apples to HORSE APPLES!

    Japan does not have the defense spending budget, has not and did not participate in false flag terrorism on its own citizens.

    Here are two for you http://911scholars.org/
    http://stj911.org/

    I agree that we need to fix the system from the bottom up like Warren says, Education is where it starts. YOU! Economics is EVERYTHING and not looking at everything makes you UNINFORMED!

    Reply

    Scott Fullwiler Reply:

    whatever . . .

    Reply

    Matt Franko Reply:

    Dave,
    For me its been helpful to just try to forget about what I have “learned” over the years about “money supply”, M1/M2, etc.. and any relationship I may have thought existed between inflation and reserve balances. Im trying to re-train my thinking to look at reserve balances as just accounting numbers that the Fed uses to sort of quantify its relationship with the private banks/banking system, am making some progress.

    These reserve balances are often subject to analysis/interpretation by people who from what I can tell are just working from some set rulebook where “if M1 plus M2 is greater than % of GDP then that means inflation” or whatever rule that they learned and memorized long ago; not a true quantitative assessment. Hope this may help.

    That said, I thought you may enjoy this link here.

    (I never knew Obamas Mom worked for Gethners dad! Small world.)
    Resp,

    Reply

    warren mosler Reply:

    matt, Jim(s), Scott, you are getting good at this, thanks for carrying the ball while i’m away
    :)

    Reply

    warren mosler Reply:

    Dave,

    Inflating the ‘money supply’ as you state can cause inflation but first you have to have the ‘right’ definition of ‘money supply’ and it’s not M1, M2, M3 or any of the other commonly used monetary aggregates. In fact, the monetarists have been trying to find an aggregate that ‘works’ and haven’t yet.

    What does work for ‘money supply’ is ‘net financial assets’ which is the cumulative amount of deficit spending, and the concept of aggregate demand. that’s what this website is all about. increasing the deficit increases aggregate demand and if pushed hard enough can cause inflation as well as too much spending power chases too few goods and services, to put it in those terms. and not enough deficit spending is deflationary when savings desires are high.

    Reply

    Dave Begoka Reply:

    Sounds like trying to be the throttle man on a cigarette boat with no rev-limiter!

    Warren I do believe if you were in charge the system would work, however a lot of entities on this page seem to believe everything is hunkey dory in the government.

    I believe the same people who are doing all of the other bad things in our government have the same control over the FED and fixing one flat tire when you have three more does not make any sense.

    Scott I still think you are smart or whatever…..

    Reply

    Curious Reply:

    “What does work for ‘money supply’ is ‘net financial assets’ which is the cumulative amount of deficit spending, and the concept of aggregate demand.”

    Warren, if you stopped after “…deficit spending” it would make sense to me. How does the aggregate demand increase the ‘money supply’?

    Reply

  18. Scott Fullwiler Says:

    Curious

    When we talk of net financial assets, we mean on the balance sheets of the non-government sector, collectively. So, in your example, the cb bought $20 in financial assets (I’m assuming you meant financial assets) and paid for it by crediting bank accounts with $20 in reserves. For the non-government sector, their net financial assets are unchanged, only the relative quantities of non-reserves and reserves. The cb’s balance sheet has increased in size, as it has added the $20 in assets and the $20 in reserves to its liability side, though its NET financial assets are unchanged, as well.

    Am I getting your example right?

    Reply

    Jim Baird Reply:

    Exactly – that’s what I was assuming in Curious’s example: that the bank’s assets are financial assets (loans, bonds, etc. – which is for the most part what banks are allowed to own) If the government is going out and buying real assets (houses, cars, gumball machines) that is fiscal, not monetary.

    Reply

    Curious Reply:

    Scott,

    thanks for clarifying it. Now I see what Jim meant, when he said “Precisely”. My apologies for confusing the issue.

    So to restate my original question, is it possible that as the relative quantity of reserves to non-reserves increases, that the reserves will be used to bid up the prices of the non-reserves (bonds, loans, etc. – not only owned by banks, but in general) and thus create inflation?

    Reply

    Scott Fullwiler Reply:

    Yes, it is possible. That is the monetarist “wealth effect” transmission mechanism. Central bank’s usually don’t do that, though, and even if they did (some argue that would be the way the BOJ’s quantitative easing could work) it’s a very indirect way to try and stimuluate spending . . . I don’t know of any economic study that would suggest the link between income derived from capital gains and spending/prices is even close to precise, even though it’s certainly there. If the goal is to raise aggregate spending and prices, raise income directly via transfers or tax cuts, or simply raise government spending. (I know you weren’t necessarily advocating such actions, but couldn’t stop myself.)

    Reply

    warren mosler Reply:

    but the action the cb takes to increase reserve balances doesn’t alter net financial assets so theres no wealth effect apart from modest relative appreciation of longer term securities due to modestly lower longer term interest rates.

    and savers suffer the opposite way as they lose their investment and reinvestment opportunities?

    Scott Fullwiler Reply:

    Agree . . . that’s why I said it’s “possible” but that the relationship is anything but precise, contrary to monetarist thinking.

    Curious Reply:

    “…modest relative appreciation of longer term securities due to modestly lower longer term interest rates.”

    Isn’t the causation reversed (they bid up the price, which causes the yield to drop, no?)? Also why longer term? Why not shorter term?

    “and savers suffer the opposite way as they lose their investment and reinvestment opportunities?”

    When the banks have a higher reserve to non-reserve ratio, they themselves can start to bid up the prices of non-reserves (not just the cb doing it). This would not remove any (re)investment opportunities, would it?

  19. zanon Says:

    Sumner is a total hack. He stretched “monetary policy” to ridiculous lengths. He says that Ben Bernanke, throwing newly minted dollar bills out of a helicopter, is “monetary policy”, albeit “unconventional monetary policy”.

    Ridiculous. He should simply admit it is fiscal, and see why his pet theories don’t work.

    He’s promised a post on why he’s not a neo-keynesian, but given his crazy definitions (see above) I’m not holding my breadth.

    Reply

  20. bb Says:

    warren and other posters please read this well thought out arguement as to why inflation is inevitabable and the issue of future bank lending.

    PUSHING ON A STRING
    Back in 1973, gold standard advocate John Exter made a phrase famous in hard-money circles: “Pushing on a string.” Exter argued that prices of all assets except gold (he ignored silver) would someday collapse because of the pyramiding of debt. Banks would eventually cease to lend, out of fear of default. That would cause the default.

    The FED would inflate the monetary base, he said, but this would not reverse the price decline. The commercial banks would not lend. The FED would therefore push on a string. Its attempt to inflate would fail.

    Exter had been a central banker (Sri Lanka) and a senior officer at Citibank. He was the first deflation predictor in the hard-money movement. He was soon joined by C. Vern Myers.

    His argument remains the central pillar of the deflationist camp — a tiny band of intrepid non-economists who have seen their founder’s prediction refuted by the facts in every year since 1973. But economic events since mid-2008 seem to indicate that Exter may have been right, they insist. They continue to predict price deflation. The FED is at long last pushing on a string.

    I still predict price inflation, just as I did in 1963, 1973, 1883, 1993, and 2003.

    A GRIDLOCKED DEBATE

    The debate between those who predict price deflation and those who predict price inflation is gridlocked today. The rate of price increases — both the CPI and the Median CPI — in May 2009 was 0.1% per annum. That is as close to zero as statistical indicators get. The CPI has been showing slight price deflation this year. The Median CPI has been showing slight price inflation. Statistical sampling errors and theoretical conceptual errors can affect the outcome of either indicator. What we have seen is essentially a flatlined price level.

    As I have previously written, to decide which is coming — a 2% fall in prices or a 2% increase — flip a coin. Nobody in either the deflationist camp or the inflationist camp is playing Cassandra based on 2% moves. Nobody cares about 2% moves — not Congress, not the FED, not the general public, and not investors.

    What matters is the sustained direction of prices, year after year, at rates above 2% per annum. If prices fall, long-term debt contracts favor creditors. These contracts become oppressive. Consider 30-year bonds. Corporations and the U.S. Treasury will be paying appreciating money for old debt. Corporations can recall the debt by borrowing money and paying off old bondholders. This is why corporate bonds are asymmetric. Bondholders get killed during price inflation, with the accompanying rise in long-term rates. They get killed in price deflation because of pre-payment. With U.S. Treasury bonds, pre-payment has never taken place previously. But it could.

    If prices increase above 2% per annum, then previous contracts favor borrowers, who pay off in depreciating money. There are more borrowers who vote than creditors who vote. This is why democratic politics always favors long-term price inflation.

    Inflationists point to the increase of the balance sheet of the Federal Reserve System, which has shot up faster than at any time in the post-World War II era. See for yourself:

    http://www.garynorth.com/public/5084.cfm
    They conclude: serious price inflation lies ahead.

    Deflationists point to the M1 money multiplier, which is headed sharply down. See for yourself:

    http://www.garynorth.com/public/5070.cfm
    This is the result of decisions by commercial bankers to lend money to the public (no) vs. pile up excess reserves at the FED (yes). Banks are not lending. Deflationists conclude: serious price deflation lies ahead.

    Inflationists respond to the falling M1 money multiplier along these lines. “Bankers must pay depositors a rate of return. The banks are being paid by the FED for excess reserves, but only at the federal funds rate: barely above 0%. If banks do not start lending, they will be bled dry by payments to depositors. The bankers at some point must lend, if only to buy Treasury bonds that pay more than what banks pay depositors.”

    Deflationists reply along these lines. “Bankers are afraid of losing money. They will not lend until the economy turns up, but it cannot turn up unless borrowers apply for loans and banks respond by lending. Meanwhile, real estate prices continue to fall, foreclosures continue to increase, and banks continue to lose capital, thus lowering their balance sheets. They will not lend. The M1 money multiplier will stay low, offsetting increases in the FED’s balance sheet, which serves as the banking system’s legal reserves.”

    Who is right? We don’t know yet. Neither does Bernanke.

    Is the FED impotent? Is it trapped in a corner, frantically pushing on a string? Is price deflation an irreversible force? I don’t think so. Here’s why.

    CENTRAL BANK BALANCE SHEETS: BOTH DEBT AND EQUITY

    Every school of economic thought except the Austrian School trusts either the government or the central bank to “kiss it and make it all well” when the economy stumbles. The greenbackers and populists trust the government. Everyone else trusts the central bank.

    The whole world is committed to monetary inflation as the supreme cure-all for bad economic times. Whenever the economy slows, the printing presses speed up.

    Those forecasters who are predicting price deflation argue that monetary inflation will not be powerful enough to overcome price deflation. Nobody is predicting an actual decrease in the money supply, short of some sort of banking gridlock and a complete breakdown of monetary transactions, which no conventional analyst even considers, since it is just too pessimistic to consider seriously, like nuclear war.

    If a central bank can legally monetize debt — create new money by buying ownership of debt — then why not the monetization of equity? Do you think a central bank won’t have eager sellers of depressed shares? When sellers of anything need money, they don’t care who will buy their assets with money. Only when they suspect that the prevailing monetary unit will not function as money in the near-term future will they refuse an offer to buy. This takes place in the final stages of what Ludwig von Mises called the crack-up boom: the mass inflation-generated collapse of the division of labor.

    Why anyone worries about price deflation is a mystery to me. With the power of money creation through the purchase of assets, there is no theoretical limit to how high prices can rise. Because people associate rising prices of whatever they sell or own as a sign of prosperity, there is always support for fiat money.

    The deflationist says, “the banks can create credit, but people may decide not to borrow.” This is true. But why wouldn’t they borrow? Because of their fear of falling prices — debt repayment. Well, there is nothing like a little mass inflation to chase away the fear of falling prices! If people are afraid of falling prices, and therefore refuse to borrow money even at 0% interest, then the central bank can do the buying directly. Eliminate the middlemen! If businessmen won’t borrow money to produce future goods, the central bank can go out and contract to buy commercial goods directly, or else get the government to do this with newly created money. This is the Keynesian solution.

    Could the FED buy up all of the shares listed on the New York Stock Exchange? Legally, yes. What about buying up all of the mortgages held by Fannie Mae and Freddy Mac? Of course. But wouldn’t this be a financial revolution? Not conceptually, only pragmatically. The idea is inherent in central banking, which stretches back to 1694: the Bank of England. If a bank can legally create money to buy an asset, there is no theoretical limit to the kind of asset involved.

    I wish people were willing to think through these implications, but this is not an easy thing to do, especially in the area of central banking, where deliberate deception is fundamental to the entire operation. (Thibaut de Saint Phalle, THE FEDERAL RESERVE: AN INTENTIONAL MYSTERY [Praeger, 1985].)

    My point is simple: at a 0% interest rate, people will usually borrow money to buy things. But people who are in a financial jam will sell assets for money. If central bankers can’t get producers to borrow money at 0%, they can probably persuade consumers to borrow at 0%. But even if they can’t persuade consumers to buy, they can lend money to the government, which will send the money to special- interest groups. Those groups will take the money. They will spend it.

    At some low price — such as “free” — people will take the money. That’s why price inflation is in our future. Price deflation isn’t, short of a banking gridlock, which is quite possible, but an unpredictable event.

    Here is the fact of facts regarding central banking: the central bank can buy any asset with its fiat money. The stock market can fall, and I believe it will. But it can be saved from total collapse by FED purchases. The FED can buy up America’s capital on the cheap with fiat money. The bond market can also fall, and will if the FED starts buying equities on a mass scale.

    There is nothing like free money to persuade people to buy and others to sell. The worse the economy gets, the more willing hard-pressed capital owners will be to sell. That points to two events: (1) a stock market sell-off and (2) the FED’s eventual purchase of capital assets in order to prevent that most feared event among central bankers, a banking gridlock, where bank A cannot settle with bank B because bank C has not paid bank A.

    General deflation? Don’t bet on it. Fiat money moves the merchandise.

    [Long-time subscribers to my newsletter, "Gary North's Reality Check," may have a sense of deja vu. That is because the previous section appeared in the October 7, 2002 issue. This time, I dropped a brief paragraph about Japanese central bank policies. I also skipped a section on real estate, in which I was bullish -- not a radical position in 2002. I reversed that position in late 2005, and warned my readers. But every word was extracted from that issue. I reprinted it here because it sounds as though I composed it today. Events have caught up with my predictions.]
    THE GREAT EQUITY FIRE SALE HAS BEGUN

    The Federal Reserve is not yet buying equity. It is instead lending to the Federal government, which is buying equity. The government is buying equity on a scale never before seen in American history. It is buying equity in the financial industry: banks. It is buying equity in the automotive industry: Chrysler and General Motors. The precedent has been set. Voters overwhelmingly oppose this policy, but Congress ignores the voters. So does the Obama Administration (autos). So did the Bush Administration (banks).

    This is not happening only in the United States. In a long, detailed, and funny article that appeared in late May in the “London Review of Books,” John Lanchester surveyed the transfer to the government of both risk and ownership of the largest banks in Great Britain. The article was titled, “It’s Finished.” What was he referring to? Confidence in Thatcher’s capitalism. But there is nothing to take the place of this confidence, he says.

    Of course there is: the economic ideology that has reigned supreme since the 1930′s. I refer to Keynesianism. The mixed economy never went away. Neither did academic Keynesians.

    Economic growth has yet to reappear anywhere in the West. The rate of contraction is higher in Japan and Europe than in the United States. Trade is falling rapidly. Unemployment in the United States is shooting upward, with no end in sight. No one is predicting a reversal of this trend in 2009. Optimists think it may stabilize by mid-2010. I am not one of the optimists.

    In this scenario, the Federal government is expanding its percentage of the economy. With at least a $1.8 trillion deficit this year, and perhaps an equally large deficit next year, the government is absorbing the net new capital of the nation. The private sector cannot compete with the Treasury. The rollover of existing Federal debt, coupled with the deficit, totals over $4 trillion a year. Where will capital come from to finance the recovery? It won’t.

    The Federal government is now the spender of last resort. It is buying equity in firms regarded as too big to fail.

    So far, commercial banks are not buying Treasury debt. They prefer to keep excess reserves at the FED. This is unprecedented in American banking history. Here are bankers, lending money to the FED at 0.15% or thereabouts, who could lend to the U.S. Treasury to buy bonds at 2.5% (5-year T-bonds) or 4.5% (30-year T-bonds). They refuse. They are so fearful of the U.S. government’s promise to pay that they have decided to stick with 0.15%. They trust the FED far more than they trust the Treasury.

    Keynesianism teaches that the government is the borrower of first resort in order to be the spender of last resort. Keynesians cheer the Federal deficit. They want the government to replace private borrowers as the borrower of last resort. They do this because Keynes and his disciples have believed that spending, not saving, is the heart of economic progress. They believe that consumer demand is the heart and soul of economic growth, not per capita productivity. They do not worry much about private investment in private enterprise, which they do not trust during recessions. They have faith in aggregate spending, and they fully understand that when it comes to spending, the national government is the undisputed champion. When it comes to writing blank checks, nothing matches the Congress of the United States.

    THE MAGNITUDE OF THE DEFICIT

    The magnitude of the Federal deficit this year is beyond comprehension. If the economy produces the estimated $14 trillion in goods and services this year, the government’s $1.8 trillion deficit constitutes almost 13% of the economy. But this is way too optimistic. Government spending at all levels constitutes at least 40% of the American economy. Deduct most of this from the total output — maybe 35%. (Lew Rockwell would say to deduct the whole 40%.)

    This cuts national productivity to $9.1 trillion. The deficit then constitutes about 20% of the private sector’s total output. That’s just the deficit. That does not count this year’s share of the rollover of the existing Federal debt: at least another $2.5 trillion. The average maturity of the national debt is now 48 months.

    http://www.ustreas.gov/press/releases/tg10.htm
    The debt is $11.5 now trillion. But I am taking the pre- Obama debt of $10 trillion. Whatever is tacked on this year must be rolled over next year.

    Where will this borrowed money come from? These are the main sources:

    1. Private American investors and their agents
    2. Foreign private investors
    3. Foreign central banks (Japan and China)
    4. The Federal Reserve System
    That’s it: a short list. If these four do not fork over the money, the U.S. government will be forced to default on some portion of its debt. At some price — higher interest rates — they will fork it over. Rising Treasury debt rates will suck in more money from the first three. But before rates rise too far, the fourth will intervene to buy more of this additional debt. Why? Because of the effect on the capital markets of rising Treasury debt rates: a deeper recession. Think “higher mortgage rates and housing prices.” Think “stock market.” Think “corporate bond market.” Think “projects postponed.”

    The Federal government will absorb any net increase in private thrift this year, next year, and the year after. All of it. There isn’t a high enough rate of saving in the country to fund the Treasury’s debt. The Federal debt is a black hole.

    The question is this: Will the loss of new savings at the margin force down the other capital markets: stocks, bonds, and real estate? I think it will. I suspect that the deflationists think so, too.

    WHEN WILL BANKS START LENDING?

    There is no answer from economic theory. Their willingness to lend will depend on these factors:

    1. Their balance sheets
    2. Their fear of private borrowers’ defaulting
    3. Their fear of T-bonds (rising rates, falling prices)
    4. Their fear of running out of income to pay depositors
    5. The rate of interest on excess reserves (FedFunds rate)
    6. Their fear of nationalization
    At this point, I offer my central response to the deflationists.

    The Federal Reserve System can force the hands of commercial bankers at any time by charging interest on excess reserves for “safekeeping.” The fact that the FED has not done this indicates that it accepts the present situation: a collapsing M1 money multiplier. It accepts the string.
    Let me put it even more sharply: “The string is central to Federal Reserve policy today. It is not the FED’s nemesis. It is the FED’s ally.”

    The present economy is the result of Federal Reserve policy. Bernanke tried to pop Greenspan’s bubbles, but without creating a major recession. That policy failed, as I predicted it would from late 2006 until late 2008.

    The FED decided to lower the federal funds rate. This is what it has always done in the past. I predicted it would.

    It also decided to swap Treasury debt for the banks’ toxic assets. I did not predict this. This is Bernanke’s uniquely innovative policy. But this policy has not led to a revival of bank lending. The FED is pushing on a string.

    This does not mean that the FED’s expansion of the monetary base is impotent. On the contrary, it means that the FED can buy Treasury debt, hold down Treasury interest rates, and enable the Federal government to buy equity in American businesses. The government can lend, as it lent TARP funds, at 5% per annum. The government can remain the spender of last resort. It can become the investor of last resort. This has already begun.

    The FED knows it is pushing on a string. It loves that string. Why? Because that limp string — no commercial bank lending — delays the advent of price inflation. This has enabled the FED to achieve the following by doubling the monetary base (the FED’s balance sheet):

    1. Bail out the big banks (asset swaps)
    2. Keep the banking system from imploding
    3. Bail out the Federal government
    4. Bail out Fannie Mae and Freddie Mac
    5. Keep real estate from collapsing
    6. Slow price inflation to close to zero
    7. Keep T-bill rates under 0.5%
    At what cost? Unemployed workers. That is a small price to pay if you are a high-salary central banker with a fully funded pension.

    The FED’s policies have not failed. They have succeeded beyond Bernanke’s wildest expectations. Greenspan’s bubbles are all popped. Price inflation is gone. There is no price deflation, either. For the first time since 1955, the FED has attained its mandate from Congress: price stability.

    Greenspan’s FED never attained the power over the economy that Bernanke’s FED now possesses. The FED has been given almost complete regulatory control over the financial system. Congress buckled. Bernanke has been given a free ride. The Federal government now owns General Motors. Keynesianism is having its greatest revival in 30 years.

    So far, the FED has won. Yet deflationists argue that the economy is in a deflationary spiral that the FED cannot prevent. They do not know what they are talking about. They never have.

    CONCLUSION

    The Federal Reserve can re-ignite monetary inflation at any time by charging banks a fee to keep excess reserves with the FED.

    Anyone who predicts an inevitable price deflation does not understand that the present scenario is the product of legitimately terrified bankers and the Federal Reserve’s Board of Governors. At any time, the FED can get all of the banks’ money lent. But the FED knows that this will double the money supply within weeks. This will create mass price inflation.

    This is the central fact in the inflation vs. deflation debate. Until the deflationists answer it with a unified voice, they will remain, as their predecessors remained, people with neither a theoretical nor a practical case for their position.

    So, the FED waits. Meanwhile, the Federal government’s share of the economy rises relentlessly because of the deficits. This is not going to change in the next few years.

    We are seeing Keynesianism’s last stand. When it fails, the FED will force the banks to lend. Then we will see mass inflation.

    Mass deflation? Forget about it.

    Reply

    Scott Fullwiler Reply:

    “The Federal Reserve can re-ignite monetary inflation at any time by charging banks a fee to keep excess reserves with the FED.”

    WRONG. That’s the money multiplier framework, and it’s inapplicable to a non-gold standard monetary system like ours. As I explained above, this would actually be DEflationary, though the effect would probably be quite small.

    The rest of the piece is only slightly less bad.

    Reply

  21. warren mosler Says:

    the fed is always pushing on a string when hiking or cutting rates.

    fiscal policy is what does the inflation/deflation trick.

    plus your post is way too long and misguided. I don’t recommend anyone read it.

    Reply

  22. Deflation Ahead Says:

    Even with deficit spending, it seems the credit collapse is currently a more powerful force.

    http://globaleconomicanalysis.blogspot.com/2009/06/flow-of-funds-report-offers-hard.html

    Excluding public sector borrowing (by the Treasury, government agencies, states, and municipalities), private sector credit was reduced at a mindboggling pace of $1,851.2 billion per year!

    And even if you include all the government borrowing, the overall debt pyramid in America shrunk at an annual rate of $255.3 billion (line 1)!

    Warren said:
    “Inflating the ‘money supply’ as you state can cause inflation but first you have to have the ‘right’ definition of ‘money supply’ and it’s not M1, M2, M3 or any of the other commonly used monetary aggregates. In fact, the monetarists have been trying to find an aggregate that ‘works’ and haven’t yet.

    What does work for ‘money supply’ is ‘net financial assets’ which is the cumulative amount of deficit spending, and the concept of aggregate demand.”

    Warren I went to louis vitton in Miami this week, they had a handbag that was many thousands of dollars. I went to books-a-million and the newest investment book arguing markets are inefficient was less than 100 bucks. I am confused why a fashion accessory costs so much more than a tome of knowledge with the latest science.

    I hope louis vitton prices deflate.

    Reply

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