Federal Taxation (for Dummies)
Posted by WARREN MOSLER on July 17th, 2009
Federal Taxation (for Dummies)
So why does the Federal Government tax us?
No, not to get money to spend!
In fact, if you pay your taxes with actual cash, they give you a receipt, a thank you, and then throw that cash into a shredder.
True!!!
So how does taking your cash and shredding it pay for anything??? It doesn’t!
And suppose you pay by check.
When the check clears, all the Federal Government does is change the numbers in your checking account downward for the amount of the check. They don’t ‘get’ anything.
And so how does the Federal Government actually spend?
When they write you a check, and when the check is deposited, they change the numbers in your bank account upward by the amount of the check. This doesn’t ‘use up’ anything.
They just change numbers.
Just like when you score a touch down and get 6 points. The stadium gives you 6 points. But those points don’t ‘come from’ anywhere and the stadium isn’t ‘using up’ some pile of points it has when it gives you 6 of them.
Federal Reserve Chairman Bernanke made this exact point when Congress asked him where the money for the banks was coming from. He told them the Fed just changes the numbers in their Fed bank accounts.
So this means, operationally, Federal spending is in no case dependent on tax revenues (or borrowing).
The Federal Government can’t ‘run out of money’ as the President has been telling us. It doesn’t have any to run out of. All it does is change numbers in our bank accounts.
So then why does the Federal Government tax us?
Answer: to take away some of our spending power.
Why would it want to do that?
Because if it didn’t, then our spending of all the income and profits we make, plus all the Federal Government’s spending, would overwhelm the markets and cause prices to go higher and higher. There would be too much spending power chasing too few goods for sale. That’s called inflation.
So what does government do?
They tax us to take away some of our spending power, so their spending, combined with our spending, doesn’t cause inflation.
That’s why the Federal Government taxes us. Not to get money for them to spend. They don’t ‘use’ money when they spend. They just change numbers in our bank accounts.
So what’s the right amount to tax?
If they tax too much, we don’t have enough spending power to buy what’s left for sale after the Federal Government is done with its spending.
And that’s exactly what’s happening now. We can build a lot more cars and houses and other goods and services that we’d then like to buy.
But the Federal Government has taxed away too much of our spending power, so sales are way down and unemployment sky high.
Can the Federal Government go broke or run out of money if it taxes less then it spends and runs a deficit?
How can it? It’s just changing numbers in our bank accounts in its own monetary system run by its own Federal Reserve.
Why do they say deficits are bad?
Because they don’t understand their own monetary system and it’s ruining our lives!
Will lower taxes today mean higher taxes later?
Every year, taxes can be adjusted to make sure we have enough spending power to buy whatever we can produce and want to have.
Taxes only have to be raised if we have too much spending power, and the economy is doing so well and unemployment is so low we want to cool things down with a tax increase, to keep inflation where we want it.
So lower taxes today mean prosperity today, and higher taxes later only if things get ‘too good’ and we get worried about inflation.
July 17th, 2009 at 2:03 pm
Another way to think about this is that the federal government treasury function is operationally seamless with its central bank. The government itself has the potential to draw down an implicit central bank credit line via overdraft, and monetize all of its expenditures. Taxation then becomes the government’s own mode of the central bank “sterilization†function, withdrawing excess cash from the system in order to avoid inflation, in the same way that the bank does system reverses to withdraw cash. That positions both government expenditures and central bank asset purchases on equal footing as potential/actual creators and destroyers of money.
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winterspeak Reply:
July 17th, 2009 at 3:27 pm
JKH: That is correct. “Sterilization” is exactly how I think about taxation, and this seems to make sense with out-of-paradigm folks who know a lot about finance.
This is also where monetarists are “almost” correct in saying that sufficiently aggressive monetary policy can cure what ails us. Unfortunately, once the CB starts making purchases in earnest, monetary policy starts looking just like fiscal policy. Exhibit A: Is paying interest on reserves monetary or fiscal?
In real terms it’s even starker. Real income is everything the private sector produces. Taxation makes the private sector unable to purchase all of its own output. This makes space for Government to take that extra output without causing inflation.
Government expenditures and central bank asset purchases are both equal creators of money, in that their “paid out” equity is what will remain if all private credit creation cancels out and falls to zero. The total private sector balance sheet cannot shrink beyond the total paid out capital from Govt and CB.
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JKH Reply:
July 17th, 2009 at 4:12 pm
Winterspeak:
I should have noted that taxes are the equity sterilization component; there’s also the debt sterilization component of bond issuance, which is closer as an instrument to the corresponding central bank function.
This is all consistent with our earlier discussion and your “paid-out†idea here.
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winterspeak Reply:
July 17th, 2009 at 10:34 pm
JKH: Let me make sure I understand the difference you are making between debt and equity.
On fiscal policy, Government spending (paid-out capital) essentially creates the “paid-in” capital that exists on the liability side of private sector balance sheets, and cash on the asset side.
By bond issuance, I assume you mean that Treasury issues Treasuries drain the bank reserves at the Fed, and thus enable interest rates above zero? And increase in treasuries “sterilizes” an increase in reserves — is that right?
I’d love to know how Canada manages non-zero interest rates as it has no reserve requirements. How does the central bank of canada set rates?
Scott Fullwiler Reply:
July 18th, 2009 at 12:55 am
Not to butt in, but I have written elsewhere–as both of you do here–that most of the monetarist mechanisms are more appropriately fiscal in nature. Dropping money from a helicopter would be a fiscal transfer. If the central bank carries out open market operations aimed at raising the value of Treasuries, then this is an increase in the value of the national debt. Interest payment on reserve balances is similar, since under normal circumstances (not current circumstances) it would raise the demand for reserve balances and thereby result in fewer Treasuries circulating in turn (that is, the overnight reserve balances would replace the “time-deposit” Treasuries), and (2) it could enable the entire national debt to be held as reserve balances while the central bank could still set its target rate.
So . . . I agree.
Mike S Reply:
July 17th, 2009 at 5:26 pm
I’ve found that finance people tend to understand quickly once you ask them “Where did the first U.S. dollar originate?”. That question allows people to think it through – that of course government spending came before borrowing dollars.
Also, it tends to take a few exposures to this thinking. It is so outside of what is usually talked about that few people can understand it at all the first time you tell them something like “Government deficits are necessary if you ever want to save money” or “We need deficits and taxes otherwise our money would be worthless” or “The U.S. government cannot go broke because it can always print money to pay off the debt.” People just don’t understand it, despite the simplicity of the language, because of a century of goldbugism.
Economists have a real hard time understanding this because they don’t know about accounting. To them, it is some algebra they passed over in 202 and don’t think about again because it doesn’t involve fancy maths.
The people that have the hardest time with this is Rush Limbaugh conservatives, because usually they are small business owners so never spend more than they take in, and think everyone should be like them anyway.
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Matt Franko Reply:
July 17th, 2009 at 11:30 pm
Mike,
Perhaps nail on the head: “To them, it is some algebra they passed over in 202″.
Im starting to think that the folks who can understand SCE have higher math aptitudes (it would be interesting to do math SAT sampling) than those that dont. And this is where the conflict/misunderstandings start. They just cant “see” it, like we who do take it for granted.
resp,
Jim Baird Reply:
July 18th, 2009 at 7:54 am
Matt –
I’m not sure about the “higher math aptitude” – in some ways, I think that the problem with many economists is too much fancy mathematical thinking. As Mike said, it’s mostly about accounting – and accounting is mostly fairly simple arithmetic. Just keeping track of double-entry balances seems too plebian for people used to symbolic multivariable calculus…
Lower Math Aptitude Reply:
July 18th, 2009 at 2:17 pm
“Im starting to think that the folks who can understand SCE have higher math aptitudes”
I remember Rubin commenting on the math wizards who ran Long Term Capital Management. He said they counted on the world bailing out a nuclear armed state (russia) and miscalculated. All that high level math and everything rested on the false belief that we wouldn’t let a nuclear armed state default. So much for higher order math from smart professors (sigh)
Matt Franko Reply:
July 18th, 2009 at 9:10 pm
Dissent,
Maybe I misspoke. (High math/Low Verbal on my SATs!). Im trying to say its easier for folks who sort of have a very quantitative thought process to understand SCE. Take Warren for example, when he writes about his cars here, Ive noticed that he often focuses on the horsepower to weight ratio, the important point is not that he can solve the equation: BHP/GVW, its that he “sees” the importance of that quantitative ratio in producing a higher performance car.
Mike Norman has posted a new video where he is explaining how Govt deficits provide the savings, by shooting down the explanation that “we’re just spending less and saving more” via merely citing the Govt data that savings have increased by $700B but sales have only decreased by $60B and incomes have actually fallen….get it? I bet that Larry Summers may not. Mike might as well be speaking Klingon language to these people because their minds are just not wired to be able to quickly “see” the quantitative evidence/significance.
Resp,
Rush Limbaugh Reply:
July 19th, 2009 at 1:44 am
“The people that have the hardest time with this is Rush Limbaugh conservatives, because usually they are small business owners so never spend more than they take in, and think everyone should be like them anyway.”
Rush Limbaugh recently moved away from new york because he said the taxes were too high. Soon I think maybe he may move to the USVI to get 4% taxes and perhaps like warren even invest in gold mines to even further his tax advantages, but on to my point.
If I leave the USA and earn money in other places as a USA citizen, the IRS can still tax me. Why then, does it make sense, for Rush Limbaugh to leave new york, and then all claims on taxing him are gone? If it is good enough for the USA to tax you when you leave, why not for a state to also tax you when you leave? Or even the city or county?
Or reversely, if it is a good idea to not allow new york to tax you when you move away, why is it a good idea for the USA to still get to tax you if you move away?
Further Mike S, as a small business person who buys “made in china” products and services, I am VERY CONCERNED when my government starts taking actions that may make my purchasing power go way down. My standard of living for me and my shopping machine princess daughter will go way down if those chinese goods and services start going up in terms of US dollars. Is my political power to influence 500 congressmen to keep inflation at bay and hurt millions of unemployed greater than the political power of millions of unemployed who would benefit from policies that could stoke inflation? Votes can be bought with money, and broke voters can vote my money out from under me through government policies, so we have this huge war who can influence the politicians more.
Finally Matt:
“trying to say its easier for folks who sort of have a very quantitative thought process to understand SCE. ”
Matt you should listen to http://www.financialsense.com – this weeks audio program has a guest from a strong quantitative background, he admits this quantitative background and his being a strong quantitative thinker actually made it difficult for him to write his new book about energy obesity. “The end of energy obesity”
“Take Warren for example, when he writes about his cars here, Ive noticed that he often focuses on the horsepower to weight ratio,”
Yes, moller – the guy making the flying cars is using a lightweight ferrari, but moslers car is even lighter than that ferrari and would be a better fit for mollers flying cars.
“the important point is not that he can solve the equation: BHP/GVW, its that he “sees†the importance of that quantitative ratio in producing a higher performance car.”
Do you remember mark spitz who won all those gold medals in the olympics a few decades back? His coach started thinking in terms of vortex flows in fluids and designed a new way to swim and move your arms through the water.
“Mike might as well be speaking Klingon language to these people because their minds are just not wired to be able to quickly “see†the quantitative evidence/significance.”
The human brain is just a biological computer, a very advanced one with quantum computing, but a computer with algorithms that will eventually all be understood. As certain neurons link up to other neurons, certain algorithms that run on certain brains get reinforced over time. To “unwire” these heavily reinforced molecular fences is very difficult, perhaps even impossible with an old human whose brain has started to crystallize.
Spock once said, IDIC, infinite diversity, Infinite combinations. I don’t like summers, but just because one human has a very good “quantitave” wiring in his brain isn’t more valid that a human who has other kind of wiring to interpret their reality. It is the chorus of brains, with all kinds of different wiring, that will make our borg great – as the author I mentioned above admits – quantitative wiring can have it’s drawbacks.
July 17th, 2009 at 2:08 pm
“…our spending … plus all the Federal Government’s spending, would overwhelm the markets and cause … inflation.”
This makes sense.
Corollary:
1. If the government spends less than it taxed, deflation results.
2. If the government spends exactly what it taxed, prices unchanged.
3. If the government spends more than it taxed, inflation results.
Yet it is my understanding that the experience in Japan (huge deficit spending, no inflation) contradicts this. Can someone explain?
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SENATOR Al Franken Reply:
July 17th, 2009 at 2:53 pm
Curious, I thought it was the combination of private and government spending. Private spending contracted more than government spent. 100 year multi-generational loans were made to keep japanese citizens in thier houses – that means the grandson, son, and grandfather all had to sign the note. That is the only way the banks would lend to some families.
Similar thing happened here in the USA in the depression no? Private contracted more than the government expanded. The collapse in credit is going to be greater than government is willing to spend.
Warren says: It doesn’t have any to run out of. All it does is change numbers in our bank accounts.
Yes Warren, Paulson was supposed to change numbers in bank accounts for homeowners so they could stay in homes. Instead he changed numbers in goldman sachs bank accounts so traders could keep clicking buttons back and forth on a terminal. One of those actions had a MUCH MORE USEFUL effect for tens of million of joe6packs. You keep being pennywise and poundfoolish – until we restructure government, non of your economic policies are going to be put into action.
Warren says: So then why does the Federal Government tax us?
Warren I saw on cspan where 300 million dollars was given to a 25 year old massage student to sell crappy old guns to the afghanistan war effort. Government taxes us to keep their power and control over us, and with 550 congressmen, that is far TOO MUCH POWER and too few hands. They also showed where the F22 airplane is getting lots of congressmen wanting to keep the billion dollar planes being built, even though many people agree there is no need.
Warren says: Because if it didn’t, then our spending of all the income and profits we make, plus all the Federal Government’s spending, would overwhelm the markets and cause prices to go higher and higher.
Yet my banker friends have said for a long time the government needed to get out of fannie mae and freddie because they were making house prices go too high!
Warren says: There would be too much spending power chasing too few goods for sale. That’s called inflation.
Thomas Jefferson to Ron Paul to Von Mises have all agreed inflation cannot be controlled by a crony corrupted government – they don’t care if they hurt thier citizens – look all around you for empirical evidence of that truth. They all say that making money out of stuff that is not easy to inflate is the only way to control this demon.
Warren says: They tax us to take away some of our spending power, so their spending, combined with our spending, doesn’t cause inflation.
Yes, they take my taxes, and give to a shopping machine princess to go buy more louis vitton handbags. I am tired of it myself and feel like the founding fathers felt, want to get away from all that oppression I don’t agree with, coming to the USVI to be your neighbor and get some of those 4% tax rates!
Warren says: So what’s the right amount to tax?
Sometimes towers of babel get too high, and decisions made way out in mt. olympus 5000 miles away from the trenches are too inefficent. Sometimes smaller government that is more locallly aware is better, and a big ole national government is not.
Warren says: If they tax too much, we don’t have enough spending power to buy what’s left for sale after the Federal Government is done with its spending.
1 big ole government over 300 million can’t be as efficient or less corrupted than 500 local governments making the local taxing decisions. Too much power concentrated in too few hands is always a bad idea.
Warren says: But the Federal Government has taxed away too much of our spending power, so sales are way down and unemployment sky high.
The solution is to do like california, print your own currency, succeed from the untion, and quit depending on a big corrupted central government to be your nanny and do for yourself!
Warren says: Every year, taxes can be adjusted to make sure we have enough spending power to buy whatever we can produce and want to have.
I opt for the founding fathers plan – LEAVE that government, escape it’s taxation – kinda like you have done in the USVI Warren.
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zanon Reply:
July 17th, 2009 at 3:32 pm
CURIOUS: Japan has still failed to fund it’s citizen’s desire to net save. Japan has the highest savings rate in the world.
The real question is, why does Japan bother to collect tax at all?
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SENATOR Al Franken Reply:
July 17th, 2009 at 5:58 pm
Why does Japan bother to collect tax at all? I have your answer friend. There are billions of people on this planet who are pretty much useless to humanity’s future. A future involving progress and science and stargate atlantis cities. These people need useless busywork to keep them occupied so that the rest of us can do usefull things. Otherwise those restless masses might start killing us off or wearing us down with their useless drama.
So a more specific answer to your question, why does the Japanese government bother to tax? Because it keeps lots of people doing useless busywork and out of the friggin way of the rest of us. Unfortunately, some of these useless busywork government workers sometimes get too full of themselves and decide they want to impede the productive. That is when you turn them against themselves and fight fire with fire. Kinda like wells fargo suing itself and all the lawyers and congress bickering with all the other lawyers in congress. Or all the useless economists bickering with all the other useless economists. Their internanl struggles for identity, recognition, meme advancement, ties up the time of these fools while the really productive people go out and build stargate atlantis cities, life extension bioscience technologies, and 3d energy solar panels – the stuff that will really help our future.
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warren mosler Reply:
July 19th, 2009 at 2:02 am
yes, except the marginal propensity consume isn’t zero, and there are all kinds of ‘demand leakages’ such as the taxed advantage savings plans like pension funds, ira’s, etc. as well as insurance reserves, etc.
so that usually, but not always, means a balanced budget is way too tight. Eyeballing the data tells me a 4% deficit may have been the neutral point for the US on average. But it’s definately a moving target
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July 17th, 2009 at 2:51 pm
Then why do they need to sell government bonds?
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zanon Reply:
July 17th, 2009 at 3:30 pm
They don’t. UK is considering exactly this move.
They do it, operationally, to drain excess money from reserve accounts (moving them to Treasury accounts) which means banks need to lend reserves to each other overnight to meet their mandated reserve targets. Overnight lending is what sets the Federal Funds Rate, which is how the Fed tries to influence the yield curve.
If this sounds like a complicated way for the Government to set interest rates on bonds that IT issues, you are right! It’s like McDonalds giving out and taking in hamburgers so that it’s Big Mac costs exactly $2.99 when it can simple say “Big Macs: $2.99. How many do you want?”
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SENATOR Al Franken Reply:
July 17th, 2009 at 6:10 pm
But UNEMPLOYMENT is very critical to a government. If you only have people giving out hamburgers and not another group taking in hamburgers, you have much less unemployment levels. Look at all useless busywork that gets employment levels up by overproducing hamburgers, distributing too many hamburgers, taking back too many hamburgers, all the administration that involves taking back hamburgers, the disposal and recycling of too many hambugers!! GOOD LORD MAN! If we ran government like you want, 500 million jobs would vaporize tomorrow be replaced by 1 efficient hamburger maker that doles out only what is really needed and consumed! What do you propose to do with those 500 million useless hamburger collectors and destroyers that are currently occupied in useless busywork?
Keynes said it best, we have jars of money that half the people bury in the ground, and the other half dig back up. He was being sarcastic, but I think in reality, at some abstract level, that is EXACTLY what is happening in the world today. Billions hoarding virtual jars of money, and Billions more trying to dig it up. Goldman sachs traders trying to outclick warren and mike norman on the trading terminal and all of them trying to beat the nanosecond trading algorithms in the dark pools! UGGGH! None of this makes stargate atlanits cities happen. What a freaking waste, disgraceful!!
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July 17th, 2009 at 8:22 pm
Ok Warren, I’ve been following your RSS feed for a couple of months now, and I get that fiat currency means there need be no money shortages and therefore no supply constraint on aggregate demand other than by intentional policy to restrain inflation.
But I’m not yet convinced your model is safe to apply beyond the confines of this thought-experiment discussion space. Certain issues still bother me when I do my own thought experiments. So it seemed time for me to speak up.
Before I attempt to present some of my loose ends however, I want to offer an observation about a way in which your focus when explaining your ideas seems to be mis-applied:
You have devoted many posts to repeating your explanation of how money is created and moved electronocally and the fact that it is not constrained in that respect, as though you believe that is where the apparent lack of understanding of policy makers, economists and the general public is centered. It’s probably a true enough fact to merit some of your attention, but I get the sense that you are conflating that cause with the mere semantics of how money is conventionally spoken about and that is keeping you from addressing the other reasons people speak about spending or debt constraints.
I believe this error is similar to concluding that just because it is conventional to speak about the sun going ‘up’ and ‘down’ the people who use such expressions are not aware that the earth is actually spinning on it’s axis relative to the sun to create the subjective experience they describe in up and down terms. Yes, some people probably don’t know the underlying facts, and as with the gold-backed ancestry of today’s dollar there is a historical aspect to why that language developed. But in both instances many people are less ignorant about the underlying facts than a literal overhearing of their talk gives evidence for.
So for purposes of the discussion I’d like to initiate with you, I’ll stipulate to the mechanics of money creation and circulation so we can move on to explore some of the less obvious (to me) implications of applying your model.
The first place I get lost is in the extended implications of the government bond market as the channel for enabling deficit spending. If your model were being applied directly, with the government simply deficit spending at will and taxing as needed to regulate the overall money supply, I’d be focused more on the issue of whether one can reasonably rely on government to do that job honestly and competently, but lets not go there just now. One of the comments above mine has focused on that question already.
Since the part of government spending which is not conventionally accounted for by tax receipts is raised in the debt market rather than simply ‘printed’ as needed without that step, the artifact of an ever growing accounting remainder (the accumulated debt + interest) by implication if not theoretical necessity seems over time to grow toward infinity.
I’m not claiming that as a problem in the sense of running out of numbers, or computers which can remember and add them. And I understand that the interest income to those holding government debt can be taxed to regulate the increase in money supply.
Rather it is the fact that government debt in turn underlies the entire edifice of financialized, collateralized, repo-ed, derivitivized shadow money (with accrual profits taken on a forward basis on the expected cash flow) which sits atop that core of government debt — and importantly, the interest payments which must flow from that debt — that represents an ever growing claim on the future productive output of the real economy. In other words, because the entire money supply is debt based, and that debt must be serviced, it looks to me in aggregate like unsustainable pulled forward demand.
In that sense, even though our currency itself may now be fully ephemeral, rather than gold-based, the debt-based way in which it is issued and distributed means there are still finite constraints imposed by the ability of the real economy to service its own aggregate (private) debt.
I think I understand how your model works with regard to treating money as an expandable and contractible stock in an imagined ever-in-balance present, but in terms of it’s flow attributes it seems that treating money as something which can grow arbitrarily is still eventually limited by the fact that it’s debt-service attribute consumes all the resources of the economy (until default).
Similarly with the US’ long term contingent liabilities, the problem is not the inability to create the money to make those payments. It’s the fact that if you simply monetize those payments without the sterilizing offsets of taxes or more debt issue you get inflation, as you seem to agree. But if you do not monetize, the constraint is not money per se, but rather the magnitude of claims on future productive output which can be made without making the eventual present only about servicing the commitments made in the past.
Now in fairness, I don’t think your model imposes the credit problem I am describing. But it doesn’t address it either. And a lot of what you write gives the impression that you are very comfortable with doing a lot less sterilization then the politics and markets of the day find acceptable. Your message reads, “jump in and spend, there’s no constraint.”
And here I think we get to the semantics issue. When Obama says ‘we’re out of money’ somehow I doubt that he means it literally. I think he’s aware of how it’s made. He’s addressing himself in colloquial terms to the politics and geopolitics of the situation.
On this last point, I think for your model to even conceivably work as a way to frame mainstream policy, the US would have to be a closed system (or have a world government and single currency if you prefer).
As a current account deficit economy dependent on oil and other resource imports from countries running their own currencies I’m having trouble seeing how you avoid capital flight when even US citizens with savings to protect begin to worry about getting out of the dollar — nevermind the foreign creditors.
This went on a lot longer than I intended. I’ll stop here. Thanks for the forum.
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zanon Reply:
July 17th, 2009 at 10:39 pm
Are you asking why the Government bothers to issue debt?
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SENATOR Al Franken Reply:
July 17th, 2009 at 11:32 pm
Steve says: “the US would have to be a closed system (or have a world government and single currency if you prefer).”
I am convinced Bhagwati (krugman’s econ professor) and many others at the CFR are working towards this assumption. I have read a few econ journals predicting by at least 2050 we will have a one world currency and many are taking steps to make this happen. As a network engineer who was around from the early days of the internet, I think having diversity makes the planet robust. One government and one currency can take the lemmings over the cliff without any dissenting voices. I have read several psychiatric journals promoting similar ideas about groupthink being a damaging force in the macro sense – the “madness” of crowds if you will.
Steve says: As a current account deficit economy dependent on oil and other resource imports from countries running their own currencies
Steve I want you to look at the below graph from Setsers blog and explain how turkey and brazil are so correlated and one is an energy exporter and one is an energy importer with oil going from 40 to 140 and back – it seems counterintuitive doesn’t it?
blogs.cfr.org/setser/2009/07/09/the-lunch-may-be-free-but-how-much-is-it-worth/
Perhaps the world is already one big correlated financial junk pile :( Down here in florida Dow Chemical just gave a lot of money to grow Algae that can be used for fuel. How does saudi arabia grow algae in the desert? Florida has lots of seawater to grow algae no? Ever heard of redtide? We wouldn’t even have to massage mother nature all that much.
http://science.slashdot.org/story/09/07/16/2027230/Novel-Algae-Fuel-Farming-Method-Gets-Big-Backing?art_pos=1
Steve says: I’m having trouble seeing how you avoid capital flight when even US citizens with savings to protect begin to worry about getting out of the dollar — nevermind the foreign creditors.
LOL! Warren left the mainland USA a long time ago to get off to his island. My expat friends said they hope the private space companies succeed because they are ready to settle on the moon and floating space stations to escape the long arm of the USA IRS taxman. Anyways this is a good article from some former CIA guys who say to get your money out of the USA and FAST – what do you think?
http://www.321gold.com/editorials/casey/casey033009.html
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warren mosler Reply:
July 18th, 2009 at 11:48 am
Hi Steve,
A lot there, so let me start by commenting on the following and take it from there:
“Rather it is the fact that government debt in turn underlies the entire edifice of financialized, collateralized, repo-ed, derivitivized shadow money (with accrual profits taken on a forward basis on the expected cash flow) which sits atop that core of government debt
YES, AS I’VE MENTIONED ELSEWHERE, THE OUTSTANDING ‘GOVERNMENT DEBT’ IS THE FINANCIAL EQUITY THAT SUPPORTS THE ENTIRE CREDIT STRUCTURE.
CREDIT IS ALSO SUPPORTED BY INCOME AS WELL (AND FRAUD, BUT THAT’S ANOTHER STORY)
— and importantly, the interest payments which must flow from that debt — that represents an ever growing claim on the future productive output of the real economy.
THIS MAY BE THE KEY ISSUE. THE FUNDS REPRESENT THE ABILITY TO MAKE FUTURE PAYMENTS TO GOVERNMENT, AND NOT NECESSARILY A ‘CLAIM ON THE FUTURE PRODUCTIVE OUTPUT OF THE REAL ECONOMY.’
AND THAT SPEAKS TO THE POINT THAT THE ‘RISKS’ ARE ‘INFLATION’ AND NOT FEDERAL SOLVENCY.
In other words, because the entire money supply is debt based, and that debt must be serviced, it looks to me in aggregate like unsustainable pulled forward demand.”
YES, IT LOOKS LIKE PRICE STABILITY MIGHT BE UNSUSTAINABLE, BUT THAT’S A DIFFERENT ISSUE FROM SOLVENCY.
AND, WITH THE CURRENT DEFLATIONARY ENVIRONMENT COEXISTING WITH ‘RECORD’ FEDERAL DEFICITS THERE IS OBVIOUSLY MORE TO THAT RELATIONSHIP THAN SIMPLY THE SIZE OF THE DEFICIT. IN FACT, IN ‘SOFT CURRENCY ECONOMICS’ I GO INTO HOW THE ‘DEMAND LEAKAGES’ LEAD TO THIS OUTCOME.
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steve gelmis Reply:
July 18th, 2009 at 10:08 pm
Thanks for your response Warren. I’ve put SOFT CURRENCY ECONOMICS in my reading queue. And I certainly look forward to seeing anything more you may want to add on other points in my original comment.
I should have included the obvious ‘US gov’t can’t become insolvent’ item in my ‘stipulated to’ list last time. My oversight.
I’ve thought of a number of new questions that would help me to flesh out the practical implications of applying your ideas to policy. If it’s impertinent to put forth more questions before doing my reading assignment, please feel free to ignore the rest of this comment.
What I’m still trying to understand is what Mosler policy looks like (yes, a payroll tax holiday, but until when/what metric is achieved? — growth rate x? savings rate y? inflation rate z? output gap closed? unemployment rate drops to n?) and whether that policy carried out on the scale you think appropriate creates, if not inflation itself, then an inflation scare/interest rate spike in the markets, whether you see a large or small devaluation effect on USD FX rates, what that likely means for commodity prices, the formation of new asset bubbles, and so on. Is there risk of a spiral in any of this, or is the deflationary counterweight too powerful to make that a worry — i.e. commodities initially spike like last year, but then drop again as demand contracts?
From a policy perspective, would I be correct is assuming that you are aligned with Richard Koo when it comes to dealing with a so called ‘balance sheet’ recession? He speaks in more conventional terms, but he seems to support the same sort of approach as you.
Would you mind offering a quick explanation of why you think large scale deficit spending by Japan did not lead to inflation but did do so in Argentina’s case? In what sense were the results similar or different with respect to the consequences for the FX value of their currencies?
Is the US case more like ‘we borrow in our own currency’ Japan or ‘we’re a current account deficit economy’ Argentina, or neither ‘being the reserve currency source makes us unique’?
If Japan were to grow its public debt-to-GDP ratio from the current 200%(?)to 1000% would there still be a functioning JGB market, or would crossing some threshold on the way to that level have resulted in everything having to be monetized? Would interest rates at that ratio likely be higher or lower than they are today? Would JPY FX rates be higher, lower or uncorrelated?
…and two cheeky questions to wind up:
1) What did Zimbabwe get wrong about how to balance the reality that they could never become insolvent in their own currency, but still knowing and respecting the practical limits which constrain monetary and fiscal policy beyond that? What’s the Mosler formula for not crossing the inflation spiral threshold?
2) How has your approach to economics informed your personal investment profile and how have your results been over the past several years? Did you ride the bubble up, or steer clear? Did you make or lose money last year? (I’m trying to understand the predictive utility of your approach here, not pry or be a smartass)
Thanks again.
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Lower Math Aptitude Reply:
July 19th, 2009 at 12:53 am
Steve to answer number1 regarding zimbabwe – you must quote Moslers’ Law – there is no financial crisis deep enough that a large enough increase in net public spending cannot deal with it. I hear lots of people don’t want Mugabe’s government growing though.
To number2 Steve I don’t know how to find the post, but Warren recently already admitted he lost about 30% last year. To take that in context though, some smart goldman sachs customers lost 43% in the same time period, the link is in the same thread I believe and it came from clusterstock – this is more fascinating when you realize many of goldman sachs customers are former goldman sachs partners. I made a profit for the same time period, so why did you address all of warren’s questions but none of mine? ;) I guess having your own blog amongst millions of others counts for something.
Another interesting piece of history for you since you are new here, When Paulson was buying up all those goldmines in africa and spending billions for them. Warren postulated doing something similar, buying goldmines, but for a tax strategy play because I guess the 4% he pays in the USVI is too much (sigh).
Steve, how does warren spending lots of time figuring out very complicated tax strategy trades involving gold mines make the world better? No one here has answered that for me.
On still another note, Steve, I would WARN you about finding “experts” that have great personal investment gains. Often at diehards.org, a website dedicated to the vangaurd mutual funds, the greybeards trot out study after study that it’s a loser’s game. Over time the few winning investors that substantially succeed, it is more from luck than skill, so there is no system or pattern for you to follow to improve your investment gains as a small independent investor. This decades star investors and traders will be next decades losers.
Warren buffet is often used as the model of the pro investor that no average investor can defeat. However Warren Buffet made many bad investments recently and did lose. If you watched Paulson’s testimony in the house last week though, you would have seen how Warren Buffet made up for those losses. He got much better terms for his money to goldman sachs than the US taxpayer did and one of the congresswomen grilled him for it, can someone here tell me why it was necessary for buffett to get a better deal than the taxpayer?
warren mosler Reply:
July 19th, 2009 at 11:36 am
COMMENTS IN CAPS:
What I’m still trying to understand is what Mosler policy looks like (yes, a payroll tax holiday, but until when/what metric is achieved? — growth rate x? savings rate y? inflation rate z? output gap closed? unemployment rate drops to n?)
YES, A FULL PAYROLL TAX HOLIDAY, $500 PER CAPITA FOR THE STATES, AND AN $8/HR JOB THAT INCLUDED FEDERAL HEALTH CARE FOR ANYONE WILLING AND ABLE TO WORK.
THAT EFFECTIVELY CLOSES THE OUTPUT GAP TO NEAR 0 BY DEFINITION AS MOST OF THOSE CURRENTLY CONSIDERED UNEMPLOYED WILL TAKE THE $8 JOB, BEST GUESS. SO THE UNEMPLOYMENT RATE QUESTION SHIFTS TO THE QUESTION OF THE SIZE OF THE EMPLOYED BUFFER STOCK POOL. IT’S A POLITICAL CHOICE, BUT MY GUESS IS IT CAN BE WELL UNDER 5% WITHOUT AN INFLATION ISSUE FROM THAT SOURCE.
IN MY LIFETIME, HOWEVER, US ‘INFLATION’ CAN BE LARGELY TRACED TO CRUDE OIL PRICES, AND THAT’S ANOTHER STORY
and whether that policy carried out on the scale you think appropriate creates, if not inflation itself, then an inflation scare/interest rate spike in the markets,
INTEREST RATES ARE UNDER THE CONTROL OF THE FED. I’D LEAVE THE CURRENT 0 RATE POLICY AS IS PERMANENTLY. SEE ‘ZERO IS THE NATURAL RATE OF INTEREST’ ALSO UNDER ‘MANDATORY READINGS’ ON THIS WEBSITE.
whether you see a large or small devaluation effect on USD FX rates,
FX RATES VS THE DOLLAR ALSO SEEM TO BE LARGELY A FUNCTION OF CRUDE PRICES AS SET BY OPEC/SAUDIES AS THEY SET PRICE AND LET QUANTITY ADJUST, WITHIN A RANGE, AND TRY TO DISGUISE WHAT THEY ARE DOING AS WELL.
LONGER TERM THE EMPLOYED BUFFERSTOCK SHOULD RESULT IN MORE PRICE STABILITY THAN THE CURRENT UNEMPLOYED BUFFERSTOCK POLICY, SO THE CURRENCY SHOULD BE MORE ‘INTERNALLY STABLE’ AND FX MOVES MORE A FUNCTION OF WHAT OTHER NATIONS ARE DOING.
what that likely means for commodity prices,
RELATIVE VALUE SHIFTS WITH TECHNOLOGY, SOME COMMODITIES UNDER MONOPOLY CONTROL OUTPERFORMING PERHAPS, AND MORE CONSUMERS COMPETING FOR NATURAL RESOURCES RESULTING IN ALL KINDS OF CHANGES VIA ‘PRICE SIGNALS.’
the formation of new asset bubbles,
YES, HUMANS AND THE NON GOVT SECTORS ARE NATURALLY/NECESSARILY PRO CYCLICAL.
and so on. Is there risk of a spiral in any of this, or is the deflationary counterweight too powerful to make that a worry — i.e. commodities initially spike like last year, but then drop again as demand contracts?
YES, HARD TO SAY. LOTS OF CROSS CURRENTS
From a policy perspective, would I be correct is assuming that you are aligned with Richard Koo when it comes to dealing with a so called ‘balance sheet’ recession? He speaks in more conventional terms, but he seems to support the same sort of approach as you.
YES, WE ARE NOT IN DIRECT CONTACT BUT SEEMS WE BOTH AGREE IN JAPAN, FOR EXAMPLE, THAT WHILE FISCAL ADJUSTMENTS WERE INSUFFICIENT TO RESTORE GROWTH AND EMPLOYMENT BUT DID HAVE A MAJOR IMPACT, AND ‘MONETARY POLICY’ VERY LITTLE. I THINK WE DO HAVE DIFFERENCES ON MONETARY OPERATIONS BUT NOT SURE.
Would you mind offering a quick explanation of why you think large scale deficit spending by Japan did not lead to inflation
WASN’T ENOUGH TO RESTORE AGG DEMAND TO EVEN A 0 ‘OUTPUT GAP.’
but did do so in Argentina’s case?
THAT WAS A FIXED FX POLICY THAT IMPLODED. DOLLARIZING ALWAYS CARRIES THAT RISK AND AT BEST REDUCES THE REAL STANDARD OF LIVING.
In what sense were the results similar or different with respect to the consequences for the FX value of their currencies?
AS ABOVE.
Is the US case more like ‘we borrow in our own currency’ Japan
YES.
or ‘we’re a current account deficit economy’ Argentina,
WE WOULD BE IF WE HAD A CONVERTIBLE CURRENCY LIKE THEY DID
or neither ‘being the reserve currency source makes us unique’?
JAPAN.
THE FACT THAT SOME NATIONS ACCUMULATE DOLLARS AS RESERVES ALLOWS US TO ENJOY LARGER TRADE DEFICITS/SUPERIOR REAL TERMS OF TRADE.
If Japan were to grow its public debt-to-GDP ratio from the current 200%(?)to 1000% would there still be a functioning JGB market,
NO REASON WHY NOT. BUT THAT WOULD BE VERY DIFFICULT TO HAVE HAPPEN AS GENERALLY THE MOVE IN THAT DIRECTION PRODUCES SUFFICIENT ‘INFLATION’ TO KEEP THE % OF GDP FAR LOWER THAN THAT.
or would crossing some threshold on the way to that level have resulted in everything having to be monetized?
‘MONETIZED’ IS A GOLD STANDARD TERM WITH DIFFERENT APPLICATION WITH NON CONVERTIBLE CURRENCY.
IT MEANS ‘TURN INTO MONEY’ MEANING ANY REAL GOOD AND SERVICE IS ‘MONETIZED’ BY GOVT WHEN IT BUYS IT.
BUT WHEN THE FED, FOR EXAMPLE, BUYS TSY SECS, THEY AREN’T ‘MONETIZED’ IF YOU INCLUDE TSY SECS IN YOUR DEFINITION OF ‘MONEY’ WHICH THE FED DOES, FOR EXAMPLE, IN SOME OF ITS BROADER MONETARY AGGREGATES. BUT IN ANY CASE IT’S JUST AN EXCHANGE OF FINANCIAL ASSETS.
Would interest rates at that ratio likely be higher or lower than they are today? Would JPY FX rates be higher, lower or uncorrelated?
THAT’S A MATTER OF THE CENTRAL BANK’S REACTION FUNCTION.
…and two cheeky questions to wind up:
1) What did Zimbabwe get wrong about how to balance the reality that they could never become insolvent in their own currency, but still knowing and respecting the practical limits which constrain monetary and fiscal policy beyond that? What’s the Mosler formula for not crossing the inflation spiral threshold?
I DON’T KNOW THE DETAILS THERE, BUT I WOULD GUESS POLITICAL INTERESTS WERE SELLING LOCAL CURRENCY FOR FX ON A CONTINUOUS BASIS UNTIL OTHER POLITICAL INTERESTS TOOK OVER…
2) How has your approach to economics informed your personal investment profile and how have your results been over the past several years? Did you ride the bubble up, or steer clear? Did you make or lose money last year? (I’m trying to understand the predictive utility of your approach here, not pry or be a smartass)
I LOST A LOT LAST YEAR WITH INVESTMENTS I MADE FOR NON ECONOMIC REASONS. AND I LOST A LOT WITH INTEREST RATE HEDGES ON FUNDING A LOT OF THOSE INVESTMENTS I FELT COMPELLED TO MAKE.
I HAVEN’T DIRECTLY MANAGED THE III FUNDS SINCE 1997. I’M THE MAJORITY SHAREHOLDER OF ENTERPRISE BANK IN NORTH PALM BEACH WHICH HAS ABOUT $35 MILLION IN CAPITAL. IT’S A SUB S BANK AND I EXPECT PRETAX RETURNS ON EQUITY WILL BE RUNNING NORTH OF 30% FOR THE REST OF THIS YEAR WITH NO MAJOR SURPRISE CHARGE OFFS IN THE LOAN PORTFOLIO. WE TOOK SOME MARK TO MARKET CHARGES OVER THE LAST YEAR BUT NONE OF THOSE SECURITIES HAVE BEEN IMPAIRED SO FAR AND ARE PAYING AS SCHEDULED.
July 18th, 2009 at 9:29 am
Winterspeak,
“Let me make sure I understand the difference you are making between debt and equity.â€
At the risk of getting carried away on this, here’s my first attempt in some time at reviewing it:
If you recall our long discussion on Interfluidity, I used the idea of government equity to make the government balance sheet representation congruent with the private sector one. So the consolidated government/central bank balance sheet generally consists of debt and equity, like the private sector. In the case of the consolidated GCB, debt forms include bills, bonds, and the monetary base.
Consolidated GCB equity is generally negative. That means it appears either as a negative item on the right hand side of the balance sheet, or alternatively, as a positive item on the left hand side of the balance sheet. While the latter representation may seem counterintuitive, it depicts the amount of future equity that would have to be forthcoming (i.e. “dueâ€) in order to make a balance sheet solvent in book value terms.
In the case of the corporate sector, negative equity would mean future equity issuance or internal capital generation. This idea more generally has been relevant most recently in the case of interpreting the solvency of the big banks during the credit crisis, where some consideration is warranted in acknowledging the power of future operating earnings apart from write downs, over the expected duration of the crisis, in order to avoid overestimating the expected “insolvency†of such institutions by the time the crisis has run its course.
In the case of the government, the representation of negative equity as an asset suggests a requirement for future equity accumulation equal to the present value of future taxation less future expenditures. Note, I say “suggestsâ€. I’m not concerned with strict equivalence here, just the general idea of the accounting entries.
At the central bank level, negative equity would suggest the required present value of future seigniorage, a la Buiter. But this is a subset of the consolidated entity.
BTW, this notion of equity I use here has nothing (necessarily) to do with stock or equity as a financial claim. E.g. household net worth is the same as household equity, but households don’t issue stock from their own balance sheets.
Taxation is revenue or income to the government, so it represents government saving and equity accumulation at the margin. Government spending represents negative saving and negative equity accumulation at the margin. Since cumulative spending typically exceeds cumulative taxation, governments are typically in a negative equity position.
Government spending self-monetizes to its own funding source. It is “funded†at least temporarily by the money it creates – an increase in broad money at the commercial bank level and an increase in reserves at the CB level. This mechanism is essentially the same as for the central bank in the case of asset acquisition.
The technical accounting at the instant of expenditure includes a G overdraft at the CB level, representing a draw of “funds†by G on CB. This entry is effectively a negative liability (i.e. a negative deposit) for CB. Implicitly, this negative deposit is equivalent to a CB asset, representing a loan from CB to G. Excess reserves created by the expenditure itself are then seen to “fund†that loan. I think this is the “ground zero†representation that illustrates how the government doesn’t really “need†taxes or bond issuance to “fund†its expenditures.
On a consolidated GCB basis, this internal loan disappears, and the excess reserves are offset instead by negative equity as an asset (alternatively as a negative item on the right hand side of the balance sheet).
This consolidated negative equity position reflects the fact that the government has spent money without any offsetting revenue or income.
GCB can crystallize the “internal loan†by issuing G bonds to CB. This leaves both reserves and broad money unsterilized, but formally extinguishes the “internal loan†or G overdraft with CB.
Alternatively, G can sell bonds to the private sector, which sterilizes both the reserves and the broad money effect while reversing the G overdraft with CB (excess reserves are extinguished in order to cover the overdraft).
Finally, G can tax the private sector, which again sterilizes both reserves and the broad money effect while reversing the G overdraft with CB.
These last two options are both sterilizing ones – debt sterilization and equity sterilization respectively in my suggested parlance. But they have different implications for the GCB equity position.
Both sterilization options remove both the reserve and broad money effects of government expenditure.
But equity (tax) sterilization also reverses the negative equity impact of government expenditure, while debt sterilization leaves the negative equity impact of government expenditure in place.
So the two sterilization options have the same effect on money, but different effects on equity. The different equity effects are manifested also in the type of paper ultimately held by the private sector – e.g. a bond, representing a preservation of private sector saving (i.e. positive equity) and government dissaving (i.e. negative equity), or a tax receipt, representing a transfer of saving (equity) from the private sector to the government sector.
Insofar as Canada is concerned, I’m embarrassed to admit I follow the Fed more closely than the Bank of Canada (O Canada!). But I believe the standard mechanism is a zero reserve requirement with a modest amount of excess reserves in place to lubricate the system operationally. I believe the Bank pays interest at the lower bound of its stated interest rate range to manage a floor on the overnight rate. Even though the reserve requirement is zero, the Bank still charges a penalty on overdrafts in some measured way, in order to enforce policy tightening. That’s it roughly, I think.
I think it’s important to be clear on language on this. The reserve requirement is zero. That’s not the same as saying there is no reserve requirement. There must be a reserve requirement in order to enforce a tightening environment properly. It doesn’t matter whether the reserve requirement is positive, zero, or negative. What is critical is the ability of the central bank to charge a penalty rate for shortfalls against the requirement in order to combat any potential system resistance when it’s in tightening mode. It’s the existence of an enforcement differential that is critical for central bank tightening control – i.e. the differential rather than the chosen level of required reserves per se.
There’s really no reason why the Fed couldn’t move to a zero reserve requirement. It would certainly serve to eliminate a lot of the incorrect and counterproductive opining and whining (emanating especially from the blogosphere) on the meaning of reserves. This change in itself would be an extremely productive contribution to the general understanding of the US financial system. It would be a fine case study for the application value of differential calculus. And it would help cleanse the blogosphere of some of its more beastly interpretations of bank reserves – like a mass intellectual enema.
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winterspeak Reply:
July 18th, 2009 at 1:22 pm
JKH: A lot of detail — it will take me time (and t-tables) to digest.
I am in full agreement that the US should change its reserve requirement to zero. It should stop issuing bonds too. Although, given how resistant commentators (prominent and obscure alike) have been to 18 months of evidence, I am pessimistic that yet another dose of reality will have any impact.
Mosler and the PKs have gained no traction throughout this crises, but Scott Sumner is now on required reading lists. There was a recent exchange I had with Bill Woosley, whose thinking is inline with Sumner’s, and he demonstrated ignorance of real vs nominal, double entry book keeping, fractional reserve banking, what a “sector” is, and more in just a few lines. Not promising.
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July 18th, 2009 at 11:59 am
small point, but let me suggest the word ‘sterilization’ in the above contexts is counter productive.
It’s an old gold standard term from the days when outstanding convertible currency could result in gold outflows. By selling securities to ‘sterilize’ those balances they were no longer ‘active agents’ that threatened the gold supply.
With non convertible currency/floating fx this concept has no application in that regard.
So while if today the govt sold secs yes, reserve balances at the fed go down, but they weren’t some how more ‘active’ than the securities now held by buyer of those securities in any meaningful way. They are just alternative fiancial assets.
by using the old gold standard terms there is the implication something has been ‘deactivated’ when ‘sterilized’
make sense?
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JKH Reply:
July 18th, 2009 at 12:26 pm
Makes sense based on your more expert knowledge of the history. I was under the impression that central bankers still use the term in the basic case of FX intervention at least. I’ve extended that somewhat. Hopefully in my case this is just an awkward or inappropriate consistency, rather than a foolish consistency! I’ll try to avoid the term when commenting further here.
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warren mosler Reply:
July 18th, 2009 at 7:35 pm
Yes, they use it, and use it out of context and not knowing what they are talking about!
And so do a lot of other at the highest levels.
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July 18th, 2009 at 2:10 pm
If you are china and hold US bonds, which “sterilization” would you prefer and try to make happen? Which one is better for US workers?
“But equity (tax) sterilization also reverses the negative equity impact of government expenditure, while debt sterilization leaves the negative equity impact of government expenditure in place.”
So the two sterilization options have the same effect on money, but different effects on equity.
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JKH Reply:
July 18th, 2009 at 2:47 pm
I’ll avoid the s-word, but as far as I know Chinese government expenditure isn’t a big issue in that example. It’s an example of a central bank (China’s) financial asset expansion that creates domestic money as a liability. PBOC risks the danger of running up RMB bank reserves and broad money supply as a result of purchasing mass quantities of dollars. I believe PBOC issues RMB interest paying bills (i.e. debt) to absorb the RMB, which is the kind of thing we’re talking about. This has no effect on “equity distribution†within China.
In my terms above, the US is accumulating negative equity (dissaving) via its current account deficit and China is accumulating positive equity (saving). The US is not really in a position to affect the form of the related liability though, other than that it is dollars.
I wouldn’t touch the policy question on the US current account deficit, or the Chinese current account surplus. The conventional recommendation seems to be that China should have allowed the RMB to appreciate.
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SENATOR Al Franken Reply:
July 19th, 2009 at 1:13 am
“The US is not really in a position to affect the form of the related liability though, other than that it is dollars.”
Wouldn’t it be better for the citizens of the USA if the US WAS in a position to affect the form of the related liability? More options are always better no?
As to the RMB value. I don’t understand, I thought currency traders and the currency “market” could reward or punish various currencies beyond what any government wishes for it’s currency. Why aren’t the currency traders from Soros on down out getting all kinds of short futures on the US dollar and long futures on the yuan? Perhaps MARKETS that reward and punish various currencies are the wrong way to run our global financial system. It sure seems to tie up a lot of time by a lot of people.
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JKH Reply:
July 19th, 2009 at 1:51 am
Might be better for China if the US were to issue RMB denominated liabilities.
RMB is not a freely convertible currency.
July 18th, 2009 at 7:43 pm
Under gold standard related thinking, spending can be tax financed, debt financed, or money financed, if I recall correctly. And it mattered back then.
If you simply deficit spent by printing gold certificates, the risk was they could be converted at the CB and the govt run out of gold.
If you taxed and then spent, that risk isn’t there.
If you borrow and spend, the risk of gold loss is delayed to when the securities matured.
With floating fx and non convertible currency that’s all moot.
Deficit spending without selling secs results in the balances spent sitting in some member bank’s reserve account.
If tsy secs are offered the holder of the reserve balances can exchange them for tsy secs. It’s just an exchange of one financial asset for another, done voluntarily at market prices, so in theory there is no change of value for either party.
Under different ‘M’s’ reserves might be ‘money’ and tsy bill not. Whatever. Those are academic definitions with no further purpose or economic ramifications beyond the resulting interest rates.
So it doesn’t matter for all practical purposes if the Fed offers secs as alternatives to the excess reserve balances currently on its books. Financial assets in the non govt sectors remain unchanged.
It does matter if the Tsy increases taxes and takes them away. Non govt financial assets are reduced.
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JKH Reply:
July 19th, 2009 at 8:25 am
There’s a connection I’m not fully getting here. I think I understand the operation of the current system fairly well, but am not too familiar with the gold standard system.
I presume under the gold standard that the (relatively) finite supply of gold acts as a discipline on the central bank in the sense that too much money printing risks a run on conversion into gold with consequent paper depreciation.
What I don’t understand is why that in itself would prevent the same operational process whereby government expenditure generates private sector saving, as you describe for the existing system.
Is there something in the architecture of the central bank that prevents the same banking operations from happening under a gold standard? The only difference I see is the discipline of a finite supply of gold versus the self-imposed discipline of a central banker when he promises to raise interest rates if inflation threatens. This seems to me to be a question of degree (tight versus loose discipline) and effectiveness in monetary discipline. In that sense, I can see the gold standard being a more constrained system.
But I don’t see the mechanical difference in the actual banking operations under a gold standard. Why would anything you’ve written in the main post necessarily change at an operational level? Wouldn’t the operational details of spending, taxing, borrowing and creating bank reserves be the same?
You’ve written that if you tax and spend or borrow and spend under the gold standard, the risk of a gold run is avoided. I can see that. But is it necessary at the operational level? If you do the same thing under the current system, the risk of an embarrassing government overdraft or a bad bond issue is avoided. The operational consequence of this is moot as you point out, but doesn’t it reflect a similar sentiment about the risk to the value of the currency? Just as the gold standard central bank would be threatened under a gold run, wouldn’t today’s central bank be threatened (at the margin) by failed bond auctions and a depreciating currency, and forced to at least consider monetary tightening?
That said, it’s starting to become clearer how the gold standard is a cleaner discipline in terms of forcing its own causality. But I see it as a question of degree, and not precluding the reverse causality at the operational level. Nor is the gold standard causality necessarily outlawed in today’s regime, although there’s much less discipline pointing it in that direction.
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July 19th, 2009 at 11:42 am
Hi,
Good questions. Best to read the talk I gave in Australia way back called ‘exchange rate policy and full employment’ on this website and also at http://www.mosler.org.
With a gold standard the way it works is there are always/necessarily real/continuous supply side constraints on ‘money’ so even the tsy is constrained when it goes to borrow. it must sell secs in order to spend ‘safely’ (without risk of default/devaluation if it spends by ‘printing money’ and doesn’t ‘borrow that money back’).
therefore, the tsy ‘competes’ for funding when it deficit spends and is part of the process that puts upward pressure on interest rates when it attempts to borrow. it’s not unusual to see rates soar past 200% in fixed rate currencies about to blow up.
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July 23rd, 2009 at 3:24 pm
JKH: This thread is dead I’m sure, but I wanted to add that I understand what you are saying operationally about Fed/Treasury interactions. G runs an overdraft at the CB, where the CB essentially loans money to G. The reserves created by the expenditure “fund†that loan. To me, this is entirely analogous to how private bank lending works, where banks make loans, and thus create the reserves to “fund” the loans, ie. the bank increases both sides of its balance sheet at once, it does not draw down a cash reserve and increase a receivable (and thus change the composition of its assets, but not the size of it’s balance sheets). Bank loans create bank deposits, not the other way around. Same deal with the central bank.
Good gold standard discussion. Lots of digest. Also takes me back to the question of whether, in a fiat realm, the Gov needs to run chronic deficits.
The question boiled down to: in an economy with technological innovation, do you need an ever increasing quantity of (private sector net) savings? I think the answer is yes, as innovation requires investment, and savings is the “accounting” that enables the investment to happen. So, if investment increases, savings must increase. I’m not sure if that’s the case if investment is constant, though.
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Devin Finbarr Reply:
July 24th, 2009 at 9:34 pm
You are confusing the nominal and the real. A growing industrial economy requires constantly increasing quantity (and/or quality) of capital goods. But those capital goods are not funded out of government deficits. Creation of capital goods can be funded in many different ways – unaccounted for sweat equity, consumption (aka a pickup truck used to start a landscaping company), operating revenues (ex. Google’s servers), private investment (bond funded factories), or government deficits (highways).
Government deficits only increase the paper wealth of the private sector, not the real wealth. Deficits can help preserve real wealth in the special case of a recession. A recession happens when a bubble bursts wiping out private balance sheets. Private actors cut spending, lowering aggregate demand. The spending cuts are concentrated in the long term durables sector, thus causing unemployment and an increase in idle resources (which is a decrease in real wealth). A government deficit can restore private balance sheets, prevent the fall in aggregate demand, and prevent the unemployment and fall in production.
But in normal times, government deficits are only beneficial if the money is spent in a beneficial way. In a recession government deficits are counter-deflationary which is good. In normal times, deficits are inflationary which is bad. Deficits are a tax on savers and result in resources being spent on the governments’ typically wasteful activities.
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Hoover Printing Presses Reply:
July 24th, 2009 at 10:16 pm
“A government deficit can restore private balance sheets, prevent the fall in aggregate demand, and prevent the unemployment and fall in production.”
Wow, what a magic silver bullet. What an easy fix to something that has some many devilish details. I am sorry Wizard oF Oz, I do not agree that pulling on the government deficit lever is going to get all of dorothy’s friends to play ball in ways you want or expect. It may make the tin man do something different than the cowardly lion, and the witch always has her own ideas too. If only the REAL world could be fixed by such a simple thing, you people living in fantasy land with the wizard of oz are always interesting though, rational behavior perhaps may not follow your academic models relating to emotional bags of conflicting logic – others known as human beings.
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warren mosler Reply:
July 26th, 2009 at 1:59 pm
“A government deficit can restore private balance sheets, prevent the fall in aggregate demand, and prevent the unemployment and fall in production.â€
THIS IS NECESSARILY THE CASE AT THE MACRO LEVEL WITH CURRENT INSTITUTIONAL ARRANGEMENTS.
FOR JUST ONE EXAMPLE, THE GOVT. CAN ALWAYS OFFER A PAID JOB TO ANYONE WILLING AND ABLE TO WORK. BY DEFINITION THAT IMMEDIATELY ENDS UNEMPLOYMENT.
THAT IS NOT TO SAY IT SOLVES ANY OTHER PROBLEM, AND IT MAY EVEN CREATE A FEW NEW ONES. BUT IT DOES END UNEMPLOYMENT AS DEFINED.
winterspeak Reply:
July 26th, 2009 at 2:10 am
FINBARR: I’m not confusing real and nominal. The savings/investment identity only makes sense when looking at real output that is produced in a period, but not consumed in that period. Real output *is* period income.
Not sure where you got capital goods being funded out of Federal deficits. I said exactly the opposite. Real output is left unconsumed. That is real investment (capital deepening and inventory, can be good or bad). You see that recorded as savings (nominal).
In normal times, private sector still wants to add to its net savings, so the Government needs to keep running deficits. (This is contentious. I think it’s true though). Not sure where your point about spending comes in — Govt will spend whether it runs deficits or surpluses! The spending should always be worthwhile!
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Devin Finbarr Reply:
July 26th, 2009 at 1:04 pm
Winterspeak-
Are you saying that the private sector wants:
a) to increase its total real stocks of capital goods and inventory
or
b) increase its nominal net savings (nominal savings is probably best defined as the ratio of paper wealth to expenditures)
Mike S Reply:
July 26th, 2009 at 7:44 pm
I am not sure the efficacy of the spending is as important as the relative level of spending. I would contend that getting the money into the economy though poor choices is superior to not spending because once the money is in circulation, it will normalize credit consumption and leverage in the economy. Overleveraged economies set off asset bubbles and subsequent crashes.
winterspeak Reply:
July 26th, 2009 at 11:57 pm
Devin:
a) yes
b) yes (although I would define nominal savings as income minus all expenditures)
Look — in real terms, and economy’s real income in a period is everything it produces. If it does not consume everything it produces, then what is not consumed either exists as inventory or capital (of any kind). This is “investment”. It can be good or bad: cars piling up in Long Beach are investment (inventory), but we don’t think it’s good.
This unused real output is recorded as (nominal) savings. But “nominal” does not mean “not real” or “unimportant”. Someone has to supply nominal savings too — and that someone is the Fed Govt, who does it by running a deficit!
Thus the absurdity of the current situation. The US private sector is taking a *real* hit because the US Government is unwilling to supply the *nominal* savings even though it could do so tomorrow at zero cost to itself, and massive benefit to everyone else!
winterspeak Reply:
July 27th, 2009 at 12:14 am
Mike S: I agree. In practice though, spending (even bad spending) is simply too slow. Better to use tax cuts as Warrens suggests which are both 1) fast, and 2) allocate intelligently.
One can have full employment at many different levels of output.
July 23rd, 2009 at 4:06 pm
WS –
But remember, “net” savings is savings desires in excess of investment desires. I would guess (just a hunch – do any of our resident economists know of any work on the subject?) that as we have moved from the industrial to the post-industrial age, business has become less capital intensive, just as the desire (and ability) on the part of individuals to save for retirement has grown. (Workers who get bare subsistence wages and don’t expect to live to retirement age aren’t likely to save much). This alone would tend to require an increase in government deficits; in the case of the U.S., the “extra” savings demand of the foreign sector demands more.
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Mike S Reply:
July 26th, 2009 at 7:21 pm
Good points Jim.
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July 23rd, 2009 at 5:42 pm
JIM: I know what net savings is. Nevertheless, in a time period, savings must equal investment (but the causality runs investment -> savings).
Also, investment does not restrict itself to industrial capital stock. I have no idea whether a post-industrial economy requires more or less investment than an industrial economy. Remember, US industrial output has (generally) been rising since 1950, even though that’s about the time the US began “de-industrializing”. Workers were replaced with machines, and other industries grew larger, faster. I’d guess that there might have been more industrial investment as machines replaced people, and industrial jobs shrank.
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Dissenting Comments Encouraged Reply:
July 23rd, 2009 at 8:03 pm
Mish recently had an article talking about how many of the machines/factory robots in asia were sitting idle in what looked like a robot graveyard. Even the machines are suffering massive unemployment, they just don’t complain like us humans ;)
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Dissenting Comments Encouraged Reply:
July 23rd, 2009 at 8:06 pm
Also over at slashdot.org they had 2 recent interesting articles on the front page. 1 about 300 million in IT data center spending in washington state that is being challenged because MSFT and AMZN want cloud computing to take hold so no need for a local data center anymore. A 2cnd article talking about all these IT people at various companies and government entities that are about to be unemployed because cloud computing makes them irrelevant, productivity is making many humans useless for this world.
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zanon Reply:
July 23rd, 2009 at 11:01 pm
Mish is stuck on a gold centered paradigm. I’ve stopped reading him.
As for productivity, it is true that it can give you positive GDP and rising employment, but the US isn’t at 10% unemployment because it’s too productive! LOL!
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Dissenting Comments Encouraged Reply:
July 24th, 2009 at 6:55 am
Zanon I must have lots more time than all you guys. I read practically every finance/econ blog I can find. I agree with you on Mish being stuck on many issues and not able to broaden his horizons, in fact I used to pick on him pretty badly 10 years ago before he got famous. Still there are lots of blogs where you can combine lots of their anecdotal info and get a good big picture I think. I don’t see how I benefit myself by ignoring certain blogs over others when I have time for them all. I guess the people that don’t have time to absorb all the info, never gonna have the total picture. Spock once said, infinite diversity, infinite combinations IDIC.
warren mosler Reply:
July 26th, 2009 at 1:54 pm
As for productivity, it is true that it can give you positive GDP and rising employment, but the US isn’t at 10% unemployment because it’s too productive! LOL!
NEVER. THERE IS ALWAYS MORE TO BE DONE THAN PEOPLE TO DO IT, MAINLY IN THE ‘SERVICE SECTOR.’
UNEMPLOYMENT IN OUR MONETARY SYSTEM IS NECESSARILY REPRESENTATIVE OF A SHORTFALL OF AGG DEMAND.
July 24th, 2009 at 7:00 am
PS how you ever going to ever understand the enemy or the ignorant masses you are trying to help if you ignore content from them and thier virtual leaders? Isolating yourself up in the ivory tower is great until the marauding hoards topple it over.
PPS Mish first many years of real work was working in grocery store in the meat cutter section and then manager of the grocery store before moving on to IT work, I guess his mind evolved to work with hard physical limits in all his mental concepts.
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winterspeak Reply:
July 27th, 2009 at 12:12 am
I understand them — I used to be one of them.
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July 27th, 2009 at 10:31 am
Winterspeak . . .you wrote several days ago . . “I’d love to know how Canada manages non-zero interest rates as it has no reserve requirements. How does the central bank of canada set rates?”
Didn’t see it before . . . still interested?
There are several countries w/o RR, actually. But in Canada’s case, they do several things. First, the BOC sets a bid/ask corridor 0.25% + and – the target rate, effectively keeping the overnight rate in that range. Second, the BOC and Treasury can with absolute precision offset any net changes to the BOC’s balance sheet by the end of the business day, as with Treasury Tax and Loan accounts in the US. That leaves only banks with surpluses or deficits, all of which perfectly offset. So, the third thing the BOC does is after the close of business, there is a special period in which banks with surpluses can lend to banks with deficits (which they are happy to do, since not lending will leave them earning a return on their balances at 0.25% less), leaving all banks with 0 net positions, and the overnight rate almost exactly at the target every day.
In the US, we don’t have points 2 and 3 (and didn’t use to have point 1), so the RR keeps the demand for RBs substantially more elastic on most days, and so the Fed can usually (under normal circumstances . . . not now, obviusly) hit the target or close to it even without 2 and 3.
That’s the general approach everywhere . . . use RR to flatten the demand for RBs a bit, or otherwise get more precise with some combination of narrowing the spread of the corridor, controlling net changes to the balance sheet, and enabling banks to offset surplus/deficit positions by the end of the day. Some, like the ECB, use RR and a corridor, which enables it to reduce open market operations to about once a week.
You probably already knew some/most of this.
Best,
Scott
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winterspeak Reply:
July 27th, 2009 at 11:17 am
Scott:
That’s helpful detail. JKH said (elsewhere on this site) that the BOC sets RRs at *zero*, so it’s not that there is no RR, it’s that it is at zero. Once you have a target, you can conduct open market operations to hit that target.
Did not know the details — thanks for enlightening me!
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Scott Fullwiler Reply:
July 27th, 2009 at 12:16 pm
Right . . . rrr=0%
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July 3rd, 2010 at 6:01 am
Investment does not restrict itself to industrial capital stock. I have no idea whether a post-industrial economy requires more or less investment than an industrial economy. Remember, US industrial output has (generally) been rising since 1950, even though that’s about the time the US began “de-industrializing”. Workers were replaced with machines, and other industries grew larger, faster. I’d guess that there might have been more industrial investment as machines replaced people, and industrial jobs shrank.
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