A rampaging mutant macroeconomic theory called Modern Monetary Theory, or MMT for short, is kicking keisters and smacking down conventional wisdom in economic circles these days. This is because an energized group of MMT economists, bloggers, and their loyal foot soldiers, lead by economists Warren Mosler, Bill Michell, and L. Randall Wray are swarming on the internet. New MMT disciples are hatching out everywhere. They are like a school of fresh-faced paramedics surrounding a gasping heart attack victim. They seek to present their economic worldview as the definitive first aid for understanding and dealing with the critical issues of growth, unemployment, inflation, budget deficits, and national debt.
MMT is a reformulated blend of some older macroeconomic theories called Chartalism and Functional finance. But, it also adds a fresh dose of monetary accounting for intellectual muscle mass. Chartalism is a school of economic thought that was developed between 1901 and 1905 by German economist Georg F. Knapp with important contributions (1913-1914) from Alfred Mitchell-Innes. Functional finance is an extension of Chartalism, which was developed by economist Abba Lerner in the 1940’s.
However, Chartalism and Functional finance did not directly spawn this new mutant monetary theory. Rather, Modern Monetary Theory had a hot, steamy, Rummy induced, immaculate conception as its creator, Warren Mosler, has stated:
The origin of MMT is ‘Soft Currency Economics‘ [1993] at www.moslereconomics.com which I wrote after spending an hour in the steam room with Don Rumsfeld at the Racquet Club in Chicago, who sent me to Art Laffer, who assigned Mark McNary to work with me to write it. The story is in ‘The 7 Deadly Innocent Frauds of Economic Policy’ [pg 98].
I had never read or even heard of Lerner, Knapp, Inness, Chartalism, and only knew Keynes by reading his quotes published by others. I ‘created’ what became know as ‘MMT’ entirely independently of prior economic thought. It came from my direct experience in actual monetary operations, much of which is also described in the book.
The main takeaways are simply that with the $US and our current monetary arrangements, federal taxes function to regulate demand, and federal borrowing functions to support interest rates, with neither functioning to raise revenue per se. In other words, operationally, federal spending is not revenue constrained. All constraints are necessarily self imposed and political. And everyone in Fed operations knows it.
The name Modern Monetary Theory was reportedly coined (pun unintended) by Australian economist Bill Mitchell. Mitchell has an MMT blog that gives tough weekly tests in order to make sure that the faithful are paying attention and learning their MMT ABC’s. MMT is not easy to fully comprehend unless you spend some time studying it.
MMT is a broad combination of fiscal, monetary and accounting principles that describe an economy with a floating rate fiat currency administered by a sovereign government. The foundation of MMT is its recognition of the importance of the government’s power to tax, thereby creating a demand for its money, and its monopoly power to print money. MMT’s full potential and its massive monetary fire power were not locked and loaded until President Nixon took the U.S. off the gold standard on August 15, 1971.
There is really not that much “theory” in Modern Monetary Theory. MMT is more concerned with explaining the operational realities of modern fiat money. It is the financial X’s and O’s, the ledger or playbook, of how a sovereign government’s fiscal policies and financial relationships drive an economy. It clarifies the options and outcomes that policy makers face when they are running a tax-driven money monopoly. Proponents of MMT say that its greatest strength is that it is apolitical.
The lifeblood of MMT doctrine is a government’s fiscal policy (taxing and spending). Taxes are only needed to regulate consumer demand and control inflation, not for revenue. A sovereign government that issues its own floating rate fiat currency is not revenue constrained. In other words, taxes are not needed to fund the government. This point is graphically described by Warren Mosler as follows:
what happens if you were to go to your local IRS office to pay [your taxes] with actual cash? First, you would hand over your pile of currency to the person on duty as payment. Next, he’d count it, give you a receipt and, hopefully, a thank you for helping to pay for social security, interest on the national debt, and the Iraq war. Then, after you, the tax payer, left the room he’d take that hard-earned cash you just forked over and throw it in a shredder.
Yes, it gets thrown it away [sic]. Destroyed!
— The 7 Deadly Frauds of Economic Policy, page 14, Warren Mosler
Gadzooks!
The delinking of tax revenue from the budget is a critical element that allows MMT to go off the “balanced budget” reservation. In a fiat money world, a sovereign government’s budget should never be confused with a household budget, or a state budget. Households and U.S. states must live within their means and their budgets must ultimately be balanced. A sovereign government with its own fiat money can never go broke. There is no solvency risk and the United States, for example, will never run out of money. The monopoly power to print money makes all the difference, as long as it is used wisely.
MMT also asserts that the federal government should net spend, again usually in deficit, to the point where it meets the aggregate savings desire of its population. This is because government budget deficits add to savings. This is a straightforward accounting identity in MMT, not a theory. Warren Mosler put it this way:
So here’s how it really works, and it could not be simpler: Any $U.S. government deficit exactly EQUALS the total net increase in the holdings ($U.S. financial assets) of the rest of us – businesses and households, residents and non-residents – what is called the “non-government” sector. In other words, government deficits equal increased “monetary savings” for the rest of us, to the penny. Simply put, government deficits ADD to our savings (to the penny).
— The 7 Deadly Frauds of Economic Policy, page 42, Warren Mosler
Therefore, Treasury bonds, bills and notes are not needed to support fiscal policy (pay for government). The U.S. government bond market is just a relic of the pre-1971 gold standard days. Treasury securities are primarily used by the Fed to regulate interest rates. Mosler simply calls U.S. Treasury securities a “savings account” at the Federal Reserve.
In the U.S., MMTers see the contentious issue of a mounting national debt and continuing budget deficits as a pseudo-problem, or an “accounting mirage.” The quaint notion of the need for a balanced budget is another ancient relic from the old gold standard days, when the supply of money was actually limited. In fact, under MMT, running a federal budget surplus is usually a bad thing and will often lead to a recession.
Under MMT the real problems for a government to address are ensuring growth, reducing unemployment, and controlling inflation. Bill Mitchell noted that, “Full employment and price stability is at the heart of MMT.” A Job Guarantee (JG) model, which is central to MMT, is a key policy tool to help control both inflation and unemployment. Therefore, given the right level of government spending and taxes, combined with a Job Guarantee program; MMTers state emphatically that a nation can achieve full employment along with price stability.
As some background to understand Modern Monetary Theory it is helpful to know a little about its predecessors: Chartalism and Functional Finance.
German economist and statistician Georg Friedrich Knapp published The State Theory of Money in 1905. It was translated into English in 1924. He proposed that we think of money as tokens of the state, and wrote:
Money is a creature of law. A theory of money must therefore deal with legal history… Perhaps the Latin word “Charta” can bear the sense of ticket or token, and we can form a new but intelligible adjective — “Chartal.” Our means of payment have this token, or Chartal form. Among civilized peoples in our day, payments can only be made with pay-tickets or Chartal pieces.
Alfred Mitchell-Innes only published two articles in the The Banking Law Journal. However, MMT economist L. Randall Wray called them the “best pair of articles on the nature of money written in the twentieth century”. The first, What is Money?, was published in May 1913, and the follow-up, Credit Theory of Money, in December 1914. Mitchell-Innes was published eight years after Knapp’s book, but there is no indication that he was familiar with the German’s work. In the 1913 article Mitchell-Innes wrote:
One of the popular fallacies in connection with commerce is that in modern days a money-saving device has been introduced called credit and that, before this device was known, all, purchases were paid for in cash, in other words in coins. A careful investigation shows that the precise reverse is true…
Credit is the purchasing power so often mentioned in economic works as being one of the principal attributes of money, and, as I shall try to show, credit and credit alone is money. Credit and not gold or silver is the one property which all men seek, the acquisition of which is the aim and object of all commerce…
There is no question but that credit is far older than cash.
L. Randall Wray, in his 1998 book, Understanding Modern Money,
was the first to link the state money approach of Knapp with the credit money approach of Mitchell-Innes. Modern money is a state token that represents a debt or IOU. The book is an introduction to MMT.
L. Randal Wray is a Professor of Economics at the University of Missouri-Kansas City, Research Director with the Center for Full Employment and Price Stability and Senior Research Scholar at The Levy Economics Institute. These institutions are hotbeds of MMT research. Wray also writes for the MMT blog, New Economic Perspectives.
Finally, to finish the historical tour, here is how Abba Lerner’s Functional finance is described by Professor Wray:
Functional Finance rejects completely the traditional doctrines of ‘sound finance’ and the principle of trying to balance the budget over a solar year or any other arbitrary period. In their place it prescribes: first, the adjustment of total spending (by everybody in the economy, including the government) in order to eliminate both unemployment and inflation, using government spending when total spending is too low and taxation when total spending is too high.
Given its mixed history it is not surprising that MMT has been given different labels. Some economists refer to MMT as a “post-Keynesian” economic theory. L. Randall Wray has used the term “neo-Chartalist”. Warren Mosler stated, “MMT might be more accurately called pre Keynesian.” Given that Georg Knapp’s work was cited by John Maynard Keynes, the use of “pre-Keynesian” does seem more appropriate than “post-Keynesian”.
But under any category, MMT has been considered fringe or heterodox economics by most mainstream economists. It therefore has been relegated to the equivalent of the economic minor leagues, somewhere below triple-A level. However, that perception is changing.
MMT is slowly seeping into the public policy debate. These days Warren Mosler and others with an MMT viewpoint are frequently being interviewed on business news channels. MMT articles are being published. Recently, Steve Liesman, CNBC’s senior economics reporter, used a Warren Mosler quote to make a point. Liesman said: “As Warren Mosler has said: ‘Because we think we may be the next Greece, we are turning ourselves into the next Japan’.”
MMT is not easy to for many people, including trained economists, to understand. This is probably because of its heavy reliance on accounting principles (debts and credits). Some critics consider MMT nothing more than a twisted Ponzi scheme that is simply “printing prosperity.” Calling MMT a “printing prosperity” scheme, by the way, is the quickest way to send MMTers into spasms of outrage. MMT does not “print prosperty” according to its proponents. The MMT counter argument is:
it [is] a perverse injustice that, in online discussions, MMT sympathizers are frequently reproached for imagining that “we can print prosperity” when in fact it is us who constantly stress as a fundamental point that the only true constraints are resource based, not financial or monetary in nature. We are the ones insisting that if we have the resources, we can put them to use. It is the neoclassical orthodoxy and others who try to make out that we can’t use resources, even if they are available, because of some magical, mysterious monetary or financial constraint. Just who is it that believes in magic here?
Emotions run hot in the current economic environment, especially on the internet. In some cases the energetic online promoting of MMT has turned into passive aggressive hectoring, hazing, name calling, badgering, and belittling. So be warned, if you write some economic analysis online that disagrees with MMT doctrine you might find yourself attacked and stung by a swarm of MMTers. If you are an economic “expert” and you do not understand monetary basics you may also get mounted on an MMT wall of shame.
A heavyweight Keynesian economist, like Nobel Prize winner Paul Krugman, has felt the sting of MMT. But the quantity and quality of his criticism of MMT, so far, has been featherweight. He could not land a solid glove on the contender, Kid MMT. Krugman only proved that he does not understand MMT, so his criticism was weak (see MMT comments) and his follow-up even weaker. MMT economist James Galbraith did a succinct breakdown of Krugman’s major errors.
Another school of economics feeling the heat from MMT are the Austrians. Austrian economist Robert Murphy recently wrote an article critical of MMT, calling it an “Upside-Down World“. MMTers lined up to disassemble and refute Murphy’s essay. Cullen Roach at the Pragmatic Capitalist blog shot back this broadside::
we now live in a purely fiat world and not the gold standard model in which Mises and many of the great Austrian economists generated their finest work. Therein lies the weakness of the Austrian model. It is based on a monetary system that is no longer applicable to modern fiat monetary systems such as the one that the USA exists in.
Does MMT really offer a path to prosperty? Or did the ancient Roman, Marcus Cicero (106 BC – 43 BC), have it right when he said: “Endless money forms the sinews of war.”? The debate will only intensify. If you value those green, money-thing, government IOU tokens in your wallet then it pays to learn what all the commotion is about.
*********
Because of MMT’s growing popularity it might be helpful to present a quick start guide so beginners can get up to speed and understand some of its fundamental elements. As a starting point here are some basics of Modern Monetary Theory (MMT) compared to some other principles of money and economics that might be considered conventional wisdom or old school wisdom.
1. What is money?
Modern Monetary Theory: Money is a debt or IOU of the state
[The] history of money makes several important points. First, the monetary system did not start with some commodities used as media of exchange, evolving progressively toward precious metals, coins, paper money, and finally credits on books and computers. Credit came first and coins, late comers in the list of monetary instruments, are never pure assets but are always debt instruments — IOUs that happen to be stamped on metal…
Monetary instruments are never commodities, rather they are always debts, IOUs, denominated in the socially recognized unit of account. Some of these monetary instruments circulate as “money things” among third parties, but even “money things” are always debts — whether they happen to take a physical form such as a gold coin or green paper note.
— Money: An Alternate Story by Eric Tymoigne and L. Randall Wray
“money is a creature of law”, and, because the state is “guardian of the law”, money is a creature of the state. As Keynes stated:
“the Age of Chartalist or State Money was reached when the State claimed the right to declare what thing should answer as money to the current money-of-account… (Keynes 1930)…
— Chartalism, Stage of Banking, and Liquidity Preference by Eric Tymoigne
John Maynard Keynes in his 1930, Treatise on Money, also stated: “Today all civilized money is, beyond the possibility of dispute, chartalist.”
——
Old School Wisdom:
Money is essentially a device for carrying on business transactions, a mere satellite of commodities, a servant of the processes in the world of goods.
— Joseph Schumpeter, Schumpeter on money, banking and finance… by A. Festre and E. Nasica
Conventional Wisdom:
Money is any object or record, that is generally accepted as payment for goods and services and repayment of debts in a given country or socio-economic context.
— Wikipedia
*********
2. Why is money needed?
MMT: Money is needed in order to pay taxes
Money is created by government spending (or by bank loans, which create deposits) Taxes serve to make us want that money – we need it in order to pay taxes.
— The 7 Deadly Frauds of Economic Policy, Warren Mosler
The inordinate focus of [other] economists on coins (and especially on government-issued coins), market exchange and precious metals, then appears to be misplaced. The key is debt, and specifically, the ability of the state to impose a tax debt on its subjects; once it has done this, it can choose the form in which subjects can ‘pay’ the tax. While governments could in theory require payment in the form of all the goods and services it requires, this would be quite cumbersome. Thus it becomes instead a debtor to obtain what it requires, and issues a token (hazelwood tally or coin) to indicated the amount of its indebtedness; it then accepts its own token in payment to retire tax liabilities. Certainly its tokens can also be used as a medium of exchange (and means of debt settlement among private individuals), but this derives from its ability to impose taxes and its willingness to accept its tokens, and indeed is necessitated by imposition of the tax (if on has a tax liability but is not a creditor of the Crown, one must offer things for sale to obtain the Crown’s tokens).
— Money: An Alternate Story by Eric Tymoigne and L. Randall Wray
Money, in [the Chartalist] view, derives from obligations (fines, fees, tribute, taxes) imposed by authority; this authority then “spends” by issuing physical representations of its own debts (tallies, notes) demanded by those who are obligated to pay “taxes” to the authority. Once one is indebted to the crown, one must obtain the means of payment accepted by the crown. One can go directly to the crown, offering goods or services to obtain the crown’s tallies—or one can turn to others who have obtained the crown’s tallies, by engaging in “market activity” or by becoming indebted to them. Indeed, “market activity” follows (and follows from) imposition of obligations to pay fees, fines, and taxes in money form.
— A Chartalist Critique of John Locke’s Theory of Property, Accumulation and Money… by Bell, Henry, and Wray
——
Conventional Wisdom:
Money is needed as a medium of exchange, a unit of account, and a store of value.
Old School Wisdom:
Money is needed because it could “excite the industry of mankind.”
— Thomas Hume, Hume, Money and Civilization… by C. George Caffettzis
——
Old School Tony Montoya, aka Scarface, Wisdom: money is needed for doing business, settling debts, and emergency situations…
Hector the Toad: So, you got the money?
Tony Montana: Yep. You got the stuff?
Hector the Toad: Sure I have the stuff. I don’t have it with me here right now. I have it close by.
Tony Montana: Oh… well I don’t have the money either. I have it close by too.
Hector the Toad: Where? Down in your car?
Tony Montana: [lying] Uh… no. Not in the car.
Hector the Toad: No?
Tony Montana: What about you? Where do you keep your stuff?
Hector the Toad: Not far.
Tony Montana: I ain’t getting the money unless I see the stuff first.
Hector the Toad: No, no. First the money, then the stuff.
Tony Montana: [after a long tense pause] Okay. You want me to come in, and we start over again?
Hector the Toad: [changing the subject] Where are you from, Tony?
Tony Montana: [getting angry and supicious] What the f**k difference does that make on where I’m from?
Hector the Toad: Cona, Tony. I’m just asking just so I know who I’m doing business with.
Tony Montana: Well, you can know about me when you stop f**king around and start doing business with me, Hector!
[…]
Hector the Toad: You want to give me the cash, or do I kill your brother first, before I kill you?
Tony Montana: Why don’t you try sticking your head up your ass? See if it fits.
[…]
Frank Lopez: [pleading] Please Tony, don’t kill me. Please, give me one more chance. I give you $10 million. $10 million! All of it, you can have the whole $10 million. I give you $10 million. I give you all $10 million just to let me go. Come on, Tony, $10 million. It’s in a vault in Spain, we get on a plane and it’s all yours. That’s $10 million just to spare me.
— dialog from Scarface, the movie
Note: The comment about the $10 million stashed in a Spanish vault highlights a small chink in MMT’s armor. If the taxing power of the sovereign state is sabotaged, or there is widespread tax evasion, then MMT falls apart.
*********
3. Where does money come from?
MMT: The government just credits accounts
Modern money comes from “nowhere.”
— Bill Mitchell
——
Conventional Wisdom: Money comes from the government printing currency and making it legal tender.
*********
4. Government Spending: any limits?
MMT: government spending is not constrained.
a sovereign government can always spend what it wants. The Japanese government, with the highest debt ratio by far (190 per cent or so) has exactly the same capacity to spend as the Australian government which has a public debt ratio around 18 per cent (last time I looked). Both have an unlimited financial capacity to spend.
That is not the same thing as saying they should spend in an unlimited fashion. Clearly they should run deficits sufficient to close the non-government spending gap. That should be the only fiscal rule they obey.
— Bill Mitchell
——
Conventional Wisdom: government spending should be constrained
One option to ensure that we begin to get our fiscal house in order is a balanced budget amendment to the Constitution. I have no doubt that my Republican colleagues will overwhelmingly support this common sense measure and I urge Democrats to as well in order to get our fiscal house in order.
— House Majority Leader Eric Cantor (R-VA), June 23th, 2010
*********
5. What is Quantitative Easing?
MMT: It is an asset swap. It is not “printing money” and it is not a very good anti-recession strategy.
Quantitative easing merely involves the central bank buying bonds (or other bank assets) in exchange for deposits made by the central bank in the commercial banking system – that is, crediting their reserve accounts… So quantitative easing is really just an accounting adjustment in the various accounts to reflect the asset exchange. The commercial banks get a new deposit (central bank funds) and they reduce their holdings of the asset they sell…
Invoking the “evil-sounding” printing money terminology to describe this practice is thus very misleading – and probably deliberately so. All transactions between the Government sector (Treasury and Central Bank) and the non-government sector involve the creation and destruction of net financial assets denominated in the currency of issue. Typically, when the Government buys something from the Non-government sector they just credit a bank account somewhere – that is, numbers denoting the size of the transaction appear electronically in the banking system.
It is inappropriate to call this process – “printing money”. Commentators who use this nomenclature do so because they know it sounds bad! The orthodox (neo-liberal) economics approach uses the “printing money” term as equivalent to “inflationary expansion”. If they understood how the modern monetary system actually worked they would never be so crass…
So I don’t think quantitative easing is a sensible anti-recession strategy. The fact that governments are using it now just reflects the neo-liberal bias towards monetary policy over fiscal policy…
— Bill Mitchell
——
Conventional Wisdom: Quantitative Easing is “money printing”
James Grant, editor of Grant’s Interest Rate Observer, says Quantitative Easing Is Just Money Printing
*********
6. What is the view on personal debt?
MMT: personal debt is not dangerous
Americans today have too much personal debt. False. Private debt adds money to our economy. Though bankruptcies have increased lately, that is due more to the liberalization of bankruptcy laws, rather than to economics. Despite rising debt and bankruptcies, our economy has continued to grow. The evidence is that high private debt has had no negative effect on our economy as a whole, though it can be a problem for any individual.
— Free Money: Plan for Prosperity ©2005 (pg 154), by Rodger Malcolm Mitchell
Note: Rodger Mitchell is an MMT extremist. He calls his brand of MMT, “Monetary Sovereignty“. Not all of his views may be in sync with mainstream MMT doctrine.
——
Conventional Wisdom: too much debt is dangerous
The core of our economic problem is, instead, the debt — mainly mortgage debt — that households ran up during the bubble years of the last decade. Now that the bubble has burst, that debt is acting as a persistent drag on the economy, preventing any real recovery in employment.
— Paul Krugman, NY Times
Old School Wisdom: debt is always dangerous
“Neither a borrower, nor a lender be”
— Polonius speaking in Hamlet, by William Shakespeare
*********
7. What is the view on foreign trade?
MMT: Exporters please just take some more fiat money and everyone will be fat and happy!
Think of all those cars Japan sold to us for under $2,000 years ago. They’ve been holding those dollars in their savings accounts at the Fed (they own U.S. Treasury securities), and if they now would want to spend those dollars, they would probably have to pay in excess of $20,000 per car to buy cars from us. What can they do about the higher prices? Call the manager and complain? They’ve traded millions of perfectly good cars to us in exchange for credit balances on the Fed’s books that can buy only what we allow them to buy…
We are not dependent on China to buy our securities or in any way fund our spending. Here’s what’s really going on: Domestic credit creation is funding foreign savings…
Assume you live in the U.S. and decide to buy a car made in China. You go to a U.S. bank, get accepted for a loan and spend the funds on the car. You exchanged the borrowed funds for the car, the Chinese car company has a deposit in the bank and the bank has a loan to you and a deposit belonging to the Chinese car company on their books. First, all parties are “happy.” You would rather have the car than the funds, or you would not have bought it, so you are happy. The Chinese car company would rather have the funds than the car, or they would not have sold it, so they are happy. The bank wants loans and deposits, or it wouldn’t have made the loan, so it’s happy.
There is no “imbalance.” Everyone is sitting fat and happy…
— Warren Mosler, The 7 Deadly Frauds of Economic Policy
——
Old School Wisdom: Trade arrangements will break down if a currency is debased
“Sorry paleface, Chief say your wampum is no good. We want steel knives and fire-water for our beaver pelts.” — American Indian reaction after Dutch colonists debase wampum in the 1600’s
*********
>
> (email exchange)
>
> On Thu, Jul 14, 2011 at 9:55 AM, wrote:
>
> I see Bernanke is speaking your language now…
>
Yes, a bit, but but as corrected below:
“DUFFY: We had talked about the QE2 with Dr. Paul. When — when you buy assets, where does that money come from?
BERNANKE: We create reserves in the banking system which are just held with the Fed. It does not go out into the public.
Not exactly, as all govt spending is done by adding reserves to member bank reserve accounts. Reserve accounts are held by member banks as assets, and so these balances are as much ‘out into the public’ as any.
What doesn’t change is net financial assets, as QE debits securities accounts at the Fed and credits reserve accounts.
But yes, spending is in no case operationally constrained by revenues.
DUFFY: Does it come from tax dollars, though, to buy those assets?
BERNANKE: It does not.
Operationally he is correct, and in this case, to the extent QE does not add to aggregate demand, he is further correct. In fact, to the extent that QE removes interest income from the economy, it actually acts as a tax on the economy, and not as a govt expenditure.
However, and ironically, I submit he believes that QE adds to aggregate demand, and therefore ‘uses up’ some of the aggregate demand created by taxation, and therefore, in that sense, it would be taxpayer dollars that he’s spending.
DUFFY: Are you basically printing money to buy those assets?
BERNANKE: We’re not printing money. We’re creating reserves in the banking system.
Technically correct in that he’s not printing pieces of paper.
But he is adding net balances to private sector accounts, which, functionally, is what is creating new dollars which is generally referred to as ‘printing money’
All govt spending can be thought of as printing dollars, taxing unprinting dollars, and borrowing shifting dollars from reserve accounts to securities accounts.
DUFFY: In your testimony — I only have 20 seconds left — you talked about a potential additional stimulus. Can you assure us today that there is going to be no QE3? Or is that something that you’re considering?
BERNANKE: I think we have to keep all the options on the table. We don’t know where the economy is going to go. And if we get to a point where we’re like, you know, the economy — recovery is faltering and — and we’re looking at inflation dropping down toward zero or something, you know, where inflation issues are not relevant, then, you know, we have to look at all the options.
DUFFY: And QE3 is one of those?
BERNANKE: Yes.
Very hesitant, as it still looks to me like there’s an tacit understanding with China that there won’t be any more QE, as per China’s statement earlier today.
PAUL: I hate to interrupt, but my time is about up. I would like to suggest that you say it’s not spending money. Well, it’s money out of thin air. You put it into the market. You hold assets and assets aren’t — you know, they are diminishing in value when you buy up bad assets.
But very quickly, if you could answer another question because I’m curious about this. You know, the price of gold today is $1,580. The dollar during these last three years was devalued almost 50 percent. When you wake up in the morning, do you care about the price of gold?
BERNANKE: Well, I pay attention to the price of gold, but I think it reflects a lot of things. It reflects global uncertainties. I think people are — the reason people hold gold is as a protection against what we call “tail risk” — really, really bad outcomes. And to the extent that the last few years have made people more worried about the potential of a major crisis, then they have gold as a protection.
PAUL: Do you think gold is money?
BERNANKE: No. It’s not money.
(CROSSTALK)
PAUL: Even if it has been money for 6,000 years, somebody reversed that and eliminated that economic law?
BERNANKE: Well, you know, it’s an asset. I mean, it’s the same — would you say Treasury bills are money? I don’t think they’re money either, but they’re a financial asset.
Right answer would have been gold used to be demanded/accepted as payment of taxes, which caused it to circulate as money.
Today the US dollar is what’s demanded for payment of US taxes, so it circulates as money.
In fact, if you try to spend a gold coin today, in most parts of the world you have to accept a discount to spot market prices to get anyone to take it.
PAUL: Well, why do — why do central banks hold it?
BERNANKE: Well, it’s a form of reserves.
Yes, much like govt land, the strategic petroleum reserve, etc.
PAUL: Why don’t they hold diamonds?
Some probably do.
BERNANKE: Well, it’s tradition, long-term tradition.
PAUL: Well, some people still think it’s money.”
“CLAY: Has the Federal Reserve examined what may happen on another level on August 3rd if we do not lift the debt ceiling?
BERNANKE: Yes, we’ve — of course, we’ve looked at it and thought about making preparations and so on. The arithmetic is very simple. The revenue that we get in from taxes is both irregular and much less than the current rate of spending. That’s what it means to have a deficit.
So immediately, there would have to be something on the order of a 40 percent cut in outgo. The assumption is that as long as possible the Treasury would want to try to make payments on the principal and interest of the government debt because failure to do that would certainly throw the financial system into enormous disarray and have major impacts on the global economy.
So this is a matter of arithmetic. Fairly soon after that date, there would have to be significant cuts in Social Security, Medicare, military pay or some combination of those in order to avoid borrowing more money.
If in fact we ended up defaulting on the debt, or even if we didn’t, I think, you know, it’s possible that simply defaulting on our obligations to our citizens might be enough to create a downgrade in credit ratings and higher interest rates for us, which would be counterproductive, of course, since it makes the deficit worse.
But clearly, if we went so far as to default on the debt, it would be a major crisis because the Treasury security is viewed as the safest and most liquid security in the world. It’s the foundation for most of our financial — for much of our financial system. And the notion that it would become suddenly unreliable and illiquid would throw shock waves through the entire global financial system.
And higher interest rates would also impact the individual American consumer. Is that correct?
BERNANKE: Absolutely. The Treasury rates are the benchmark for mortgage rates, car loan rates and all other types of consumer rates.”
“BERNANKE: A second problem is the housing market. Clearly, that’s an area that should get some more attention because that’s been one of the major reasons why the economy has grown so slowly. And I think many of your colleagues would agree that the tax code needs a look to try to improve its efficiency and to promote economic growth as well.”
While housing isn’t growing as in the past, housing or anything else is only a source of drag if it’s shrinking.
It’s not that case that if housing were never to grow we could not be at levels of aggregate demand high enough to sustain full employment levels of sales and output.
We’d just be doing other things than in past cycles.
G. MILLER: Well, the problem I had with the Fannie-Freddie hybrid concept was the taxpayers were at risk and private sector made all the profits.
BERNANKE: That’s right.
That’s the same with banking in general with today’s insured deposits, a necessary condition for banking. Taxpayers are protected by regulation of assets. The liability side is not the place for market discipline, as has been learned the hard way over the course of history.
G. MILLER: That — that’s unacceptable. What do you see the barriers to private capital entering mortgage lending (inaudible) market for home loans would be?
BERNANKE: Well, currently, there’s not much private capital because of concerns about the housing market, concerns about still high default rates. I suspect, though, that, you know, when the housing market begins to show signs of life, that there will be expanded interest.
I think another reason — and go back what Mr. Hensarling was saying — is that the regulatory structure under which securitization, et cetera, will be taking place has not been tied down yet. So there’s a lot of things that have to happen. But I don’t see any reason why the private sector can’t play a big role in the housing market securitization, et cetera, going forward.”
As above, bank lending is still a public/private partnership, presumably operating for public purpose.
See my Proposals for the Banking System, Treasury, Fed, and FDIC (draft)
And there’s no reason securitization has to play any role. Housing starts peaked in 1972 at 2.6 million units with a population of only 200 million, with only simple savings and loans staffed by officers earning very reasonable salaries and no securitization.
“CARSON: However, banks are still not lending to the public and vital small businesses. How, sir, do you plan on, firstly, encouraging banks to lend to our nation’s small businesses and the American public in general?
And, secondly, as you know, more banks have indeed tightened their lending standards than have eased them. Does the Fed plan to keep interest rates low for an extended period of time. Are the Fed’s actions meaningless unless banks are willing to lend?
CARSON: And, lastly, what are your thoughts on requiring a 20 percent down for a payment? And do you believe that this will impact homeowners significantly or — or not at all?
BERNANKE: Well, banks — first of all, they have stopped tightening their lending standards, according to our surveys, and have begun to ease them, particularly for commercial and industrial loans and some other types of loans.
Small-business lending is still constrained, both because of bank reluctance but also because of lack of demand because they don’t have customers or inventories to finance or because they’re in weakened financial condition, which means they’re harder to qualify for the loan.
Right, sales drive most everything, including employment
“PETERS: Do you see some parallels between what happened in the late ’30s?
BERNANKE: Well, it’s true that most historians ascribe the ’37- ’38 recession to premature tightening of both fiscal and monetary policy, so that part is correct.
Also, Social Security was initiated, and accounted for ‘off budget’, and, with benefit payments initially near 0, the fica taxes far outstripped the benefits adding a sudden negative fiscal shock.
The accountants realized their mistake and Social Security was put on budget where it remains and belongs.
I think every episode is different. We have to look, you know, at what’s going on in the economy today. I think with 9.2 percent unemployment, the economy still requires a good deal of support. The Federal Reserve is doing what we can to provide monetary policy accommodation.
But as we go forward, we’re going to obviously want to make sure that as we support the recovery that we also keep an eye on inflation, make sure that stays well controlled.
