Roubini again
Posted by WARREN MOSLER on August 24th, 2009
Just in case you thought he knew how the monetary system works.
The nonsense about the penalty for deficit spending being anything but possible inflation makes him part of the problem:
“There are risks associated with exit strategies from the massive monetary and fiscal easing,†Roubini wrote. “Policy makers are damned if they do and damned if they don’t.â€
Government and central bank officials may undermine the recovery and tip their economies back into “stagdeflation†if they raise taxes, cut spending
Yes, that would reduce demand and is a deflationary bias.
and mop up excess liquidity in their systems to reduce fiscal deficits,
Huh???
Roubini says. He defines “stagdeflation†as recession and deflation.
Market Vigilantes
Those who maintain large budget deficits will be punished by bond market vigilantes, as inflationary expectations and yields on long-term government bonds rise and borrowing costs climb sharply, he wrote. That will in turn lead to stagflation, Roubini said.
Mainstream economics is a disgrace
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August 24th, 2009 at 12:32 pm
Krugman’s at it again, too – this time trying to calm people’s fears about the deficit:
http://krugman.blogs.nytimes.com/2009/08/23/how-big-is-9-trillion/
As usual, he says that a growing deficit is “bad” without defining exactly what’s “bad” about it. It’s just something that “everyone knows”.
I’ve recently been reading a great book (http://www.amazon.com/What-Hath-God-Wrought-Transformation/dp/0195078942) about the Jacksonian era, when Jackson decided that the national debt was an intolerable burden on futer generations and paid it off entirly – and caused a depression that lasted almost ten years. The fact that virtually nothing has been learned in 170 years proves that “economic science” is an oxymoron…
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Curious Reply:
August 24th, 2009 at 3:20 pm
Government paying off debt is just an exchange of financial assets (I’m guessing coins for debt certificates in those days).
How does it cause a depression?
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Jim Baird Reply:
August 24th, 2009 at 3:41 pm
Government paying off debt drains financial assets from the private sector. Here’s the logic:
Private sector starts with (say) $1000 cash plus $1000 treasury securities. Total wealth: $2000.
Government collects $100 from private sector.
Government pays creditors $100 with money collected, retires debt.
Private sector now has $1000 cash, but only $900 securities. Total wealth: $1900.
Note that you can have a short-term boom in pure private sector assets while this is going one, since the reduction in total financial assets causes private sector assets such as stocks and bonds to get bid up past their intrinsic value (as happened in the late 20s and late 90s surplus years) but since this leads to one part of the private sector devoting ever more of it’s cash flow to another part, it eventuially comes crashing down.
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Warren Mosler Reply:
August 24th, 2009 at 7:09 pm
right, but depends on how you ‘pay it off’
if you just let maturing bonds result in excess reserves there’s no effect.
Jim Baird Reply:
August 24th, 2009 at 8:43 pm
True, but I was thinking in terms of a gold-standard regime a la Jackson, where there is a difference between “cash” and “debt”.
Matt Franko Reply:
August 24th, 2009 at 10:46 pm
Jim/Warren sort of related:
I was thinking; that net new Treasury issuance this year is running at about $1.5T (will go up a bit more), while the Fed will purchase $300B Treasuries, $1.25T MBS and $200B Agency bonds by the next few months ($1.75T total).
I now count Agency MBS and Agency bonds as Govt Securities, and as of the 1Q data it doesnt look like any signiicant amount af new mortage debt will be created. So the Govt sector will buy back in mortgage securities about the same amount of Treasuries issued..So to me its like the Govt will net not issue any debt this year.
So we have the Fed paying interest on reserves and not issuing debt…
Warren is it time for you to declare victory? Am I mis-interpreting Govt actions?, Resp
jcmccutcheon Reply:
August 25th, 2009 at 10:32 am
Jim, aren’t the ‘creditors’ the private sector? So wouldn’t the total private sector cash be $1100 ?
Jim Baird Reply:
August 25th, 2009 at 10:43 am
Yes, but the government is just taking money from some in the private sector through taxes and paying others via debt repayment. The total would remain $1000.
Curious Reply:
August 25th, 2009 at 1:10 pm
Thanks Jim. That makes sense.
Are taxes the only way the government can get the money to retire the debt? How did they create the money in the first place (in a fixed system)?
“…this leads to one part of the private sector devoting ever more of it’s cash flow to another part, it eventuially comes crashing down.”
The cash is unchanged, there are only fewer assets (as you explained above). Why doesn’t the price stabilize at this new higher level, why does it have to crash?
warren mosler Reply:
August 25th, 2009 at 2:59 pm
Jim Baird Reply:
August 24th, 2009 at 3:41 pm
Government paying off debt drains financial assets from the private sector. Here’s the logic:
Private sector starts with (say) $1000 cash plus $1000 treasury securities. Total wealth: $2000.
OK, THAT WOULD HAVE COME FROM 2,000 IN PRIOR DEFICIT SPENDING
Government collects $100 from private sector.
A TAX
Government pays creditors $100 with money collected, retires debt.
OK, A BUDGET SURPLUS OF $100
Private sector now has $1000 cash, but only $900 securities. Total wealth: $1900.
YES, A SURPLUS REDUCES NET FINANCIAL ASSETS BY THAT MUCH
Note that you can have a short-term boom in pure private sector assets while this is going one, since the reduction in total financial assets causes private sector assets such as stocks and bonds to get bid up past their intrinsic value (as happened in the late 20s and late 90s surplus years) but since this leads to one part of the private sector devoting ever more of it’s cash flow to another part, it eventuially comes crashing down.
THE OTHER THING THAT CAN BE DONE TO ‘PAY OFF THE DEBT’ AS DEFINED IS THAT GOVT CAN BUY $100 OF THE OUTSTANDING SECURITIES AND PAY FOR THAT BY CREDITING THE SELLER’S ACCOUNT. THIS RESULTS IN $1,100 IN CASH AND $900 IN SECURITIES. NET FINANCIAL ASSETS REMAIN THE SAME. IF THE CASH DOESN’T ‘COUNT’ AS DEBT THEN THE DEBT HAS BEEN REDUCED.
August 24th, 2009 at 12:35 pm
i think you have to be open-minded about the context in which people/analysts operate when they talk about deficit risks. yes, there is a near complete misunderstanding of loans to deposits and keynesian policies in general. and that in itself is the ‘risk’, and not the deficit itself. look around at the deficit ignorance displayed at some of these town hall meetings, both by the questioners and the elected reps that are moderating them. the real risk is that this ignorance becomes policy, right? whether roubini himself was implying such is debatable, but others like richard koo have correctly pointed out that the great error in japan was running too small a deficit, despite the howls of almost all that their debt/gdp ratio was unsustainable (in a land of savers, no less!).
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August 24th, 2009 at 12:38 pm
so when talking about whether a deficit is ‘sustainable’ we should be mindful of whether it’s sustainable in an economic context (yes), or in a political context (not so clear).
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warren mosler Reply:
August 24th, 2009 at 2:17 pm
yes, and the likes of roubini make it unsustainable politically, making them ‘part of the problem.’
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August 24th, 2009 at 2:39 pm
right. it’s my impression that many in both the current and past tsys actually understand this. summers in particular has spoken in this context in the past. but it’s political dynamite because it’s hard for voters to grasp and they rebel against what they don’t understand. most (not all) of their elected reps are no better unfortunately, and they play to this sentiment and ignorance. thus, the political risk of deficits. what truly baffles is how what’s rapidly becoming a country of savers is somehow still convinced that low rates are good for them. if we really want to protect savers/consumers why not start with a reasonable return on simple deposits? a steep curve is good for wall street; a flat curve is good for main street.
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August 24th, 2009 at 2:47 pm
I’d rather have a tax cut then an interest rate hike
:)
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Ed Rombach Reply:
August 30th, 2009 at 5:01 pm
I agree. However, Supply Siders would say that tax cuts and higher interest rates would be the right policy mix, as Robert Bartley argued in “The Seven Fat Years”.
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August 24th, 2009 at 2:50 pm
sure, but the delta on that is around .001 :-D
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Warren Mosler Reply:
August 24th, 2009 at 7:10 pm
meaning even taxes can be cut that much more to offset the lower demand from lower interest rates?
excellent!
hit me harder!
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August 24th, 2009 at 3:29 pm
Yields on long term bonds are an expression of market participants’ expectations of future inflation.
Whether the market is correct or not is a separate issue, right?
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Warren Mosler Reply:
August 24th, 2009 at 7:11 pm
I’d say long term expectations of future fed funds rate decisions by the Fed. and don’t forget to throw in a few technicals- pension funds that rules on durations, convexity issues, tsy supply decisions by govt, etc.
and yes, whether right or wrong is a separate issue
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August 26th, 2009 at 1:56 am
Thanks Warren, so we end up with either
a) $1000 cash and $900 debt
or
b) $1100 cash and $900 debt
In both cases the ratio of cash to debt increased. So prices of debt/assets should go up. How does it cause a depression?
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August 26th, 2009 at 7:39 am
the price of the tsy secs will gravitate to indifference levels vs cash.
what causes a depression is reducing private sector net financial assets and ‘take home pay’ by taxation (or other means) to less than levels desired/necessary for the propensity to consume to support output and employment.
in other words, if the deficit is too small to satisfy ‘savings desires’ total spending falls short of full employment levels
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Curious Reply:
August 26th, 2009 at 1:25 pm
Thanks.
How different is deficit spending in a gold standard system compared to flexible system?
Does deficit spending under gold standard mean that government buys gold from the private sector? Or do they just risk default and “print new money”?
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August 26th, 2009 at 6:00 pm
under a gold standard if the govt prints new convertible currency and spends it they risk conversion and loss of gold reserves.
so they borrow first, and then spend the borrowed funds, so they don’t have to worry about losing their gold until the bonds mature.
therefore markets determine interest rates based on the risk of not getting your gold back if you lend your convertible currency.
see ‘exchange rate policy and full employment’
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Ed Rombach Reply:
August 30th, 2009 at 5:34 pm
Warren – In Sep 1981, Alan Greenspan wrote a WSJ Op Ed, “Can the U.S. Return to Gold?”. In this Op Ed Greenspan made the case for gold indexed bonds that would give the bond holder the option to recieve interest payments and redeem principal in either dollars or an equivalent weight of gold. If the investor owns an option to receive interest and principal in dollars or gold, the cost of those options would reflect in a lower yield. In the private sector, the now defunct Sunshine Mining company issued silver indexed bonds in 1980 at a rate of 8% or 9%, which was about half the yield on U.S. treasury paper at the time.
Back in 1996, before the the government started running a chronic surplus, I priced up a such a theoretical gold indexed 2yr note and discovered that the internal rate of return was fairly close to what 2yr TIPS were yielding at the time. Some time later I tried to do the same excercise in JPY and found that the internal rate of return was about 4-5% negative, which left me somewhat confused.
A few months ago economist Judy Shelton repeated Greenspan’s 1981 call for gold indexed bonds in another WSJ Op Ed, which prompted me to repeat the exercise again in dollars. Using COMEX gold options and a little interpolation, I estimated that given current pricing in gold options a 2yr gold indexed treasury note would have an internal rate of return in the neighborhood of negative -5.67%.
From a different perspective, the time value of the embedded gold options would have to be less than a quarter of current levels for a 2yr gold indexed note to provide the same yield as 2yr TIPs. Alternatively, the yield on the nominal 2yr note would have to rise to 9.15% for a 2yr gold indexed note to offer the same yield as 2yr TIPs.
I’m still not sure what to make of this, but it seems to support the argument that current fiscal/monetary policy is leading us along a similar path as Japan in the wake of the bursting of their real estate asset bubble. Any thoughts?
However,
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August 30th, 2009 at 8:26 pm
If you conclude aggregate demand is low and the output gap high I agree!
The US issuing gold indexed bonds is like getting short gold. Seems pointless to me with regards to public purpose?
Sorry, but I may be missing the point of your calculations.
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