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.
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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.”
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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
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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
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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
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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.
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3. Where does money come from?
MMT: The government just credits accounts
Modern money comes from “nowhere.”
— Bill Mitchell
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Conventional Wisdom: Money comes from the government printing currency and making it legal tender.
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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
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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
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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
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Conventional Wisdom: Quantitative Easing is “money printing”
James Grant, editor of Grant’s Interest Rate Observer, says Quantitative Easing Is Just Money Printing
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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.
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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
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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
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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
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With the debt ceiling extended, the risk of an catastrophic automatic pro cyclical Treasury response, as previously discussed, has been removed.
What’s left is the muddling through with modest topline growth scenario we’ve had all year.
With a 9% budget deficit humming along, much like a year ago when markets began to discount a double dip recession, I see little chance of a serious collapse in aggregate demand from current levels.
It still looks to me like a Japan like lingering soft spot and L shaped ‘recovery’ with the Fed struggling to meet either of its mandates will keep this Fed ‘low for long’, and that the term structure of rates is moving towards that scenario.
With the end of QE, relative supply shifts back to the curve inside of 10 years, which should work to flatten the long end vs the 7-10 year maturities. And the reversal of positions related to hedging debt ceiling risks that drove accounts to sell or get short the long end work to that same end as well.
The first half of this year demonstrated that corporate sales and earnings can grow at reasonable rates with modest GDP growth. That is, equities can do reasonably well in a slow growth, high unemployment environment.
However, a new realization has finally dawned on investors and the mainstream media. They now seem to realize that government spending cuts reduce growth, with no clarity on how that might translate into higher future private sector growth. That puts the macroeconomic picture in a bind. The believe we need deficit reduction to ward off a looming financial crisis where we somehow turn into Greece, but at the same time now realize that austerity means a weaker economy, at least for as far into the future as markets can discount. This has cast a general malaise that’s been most recently causing stocks and interest rates to fall.
With crude oil and product prices leveling off, presumably because of not so strong world demand, the outlook for inflation (as generally defined) has moderated, as confirmed by recent indicators. As Chairman Bernanke has stated, commodity prices don’t need to actually fall for inflation to come down, they only need to level off, providing they aren’t entirely passed through to the other components of inflation. And with wages and unit labor costs, the largest component of costs, flat to falling, it looks like the the higher commodity costs have been limited to a relative value shift. Yes, standards of living and real terms of trade have been reduced, but it doesn’t look like there’s been any actual inflation, as defined by a continuous increase in the price level.
However, the market seem to have forgotten that the US has been supplying crude oil from its strategic petroleum reserves, which will soon run its course, and I’ve yet to see indications that Lybia will be back on line anytime soon to replace that lost supply. So it is possible crude prices could run back up in September and inflation resume. For the other commodities, however, the longer term supply cycle could be turning, where supply catches up to demand, and prices fall towards marginal costs of production. But that’s a hard call to make, until after it happens.
With the debt ceiling risks now behind us, the systemic risk in the euro zone is now back in the headlines. Unlike the US, where the Treasury is back to being counter cyclical (unemployment payments can rise should jobs be lost and tax revenues fall), the euro zone governments remain largely pro cyclical, as market forces demand deficits be cut in exchange for funding, even as economies weaken. This means a slowdown to that results in negative growth and rising unemployment can accelerate downward, at least until the ECB writes the check to fund counter cyclical deficit spending.
China had a relatively slow first half, and the early indicators for the second half are mixed. Manufacturing indicators looked weak, while the service sector seemed ok. But it’s both too early to tell and the numbers can’t be trusted, so the possibility of a hard landing remains.
Japan is recovering some from the earthquake, but not as quickly as expected, and there has yet to be a fiscal response large enough to move that needle. And with global excess capacity taking up some of the fall off in production, Japan will be hard pressed to get it back.
Falling crude prices and weak global demand softening other commodity prices, looks dollar friendly to me. And, technically, my guess is that first QE and then the debt ceiling threats drove portfolios out of the dollar and left the world short dollars, which is also now a positive for the dollar.
The lingering question is how US aggregate demand can be this weak with the Federal deficit running at about 9% of GDP. That is, what are the demand leakages that the deficit has only partially offset. We have the usual pension fund contributions, and corporate reserves are up with retained earnings/cash reserves up. Additionally, we aren’t getting the usual private sector borrowing to spend on housing/cars as might be expected this far into a recovery, even though the federal deficit spending has restored savings of dollar financial assets and debt to income ratio to levels that have supported vigorous private sector credit expansions in past cycles.
Or have they? Looking back at past cycles it seems the support from private sector credit expansions that ‘shouldn’t have happened’ has been overlooked, raising the question of whether what we have now is the norm in the absence of an ‘unsustainable bubble.’ For example, would output and employment have recovered in the last cycle without the expansion phase of sub prime fiasco? What would the late 1990’s have looked like without the funding of the impossible business plans of the .com and y2k credit expansion? And I credit much of the magic of the Reagan years to the expansion phase of what became the S and L debacle, and it was the emerging market lending boom that drove the prior decade. And note that Japan has not repeated the mistake of allowing the type of credit boom they had in the 1980’s, accounting for the last two decades of no growth, and, conversely, China’s boom has been almost entirely driven by loans from state owned banks with no concern about repayment.
So my point is, maybe, at least over the last few decades, we’ve always needed larger budget deficits than imagined to sustain full employment via something other than an unsustainable private sector credit boom? And with today’s politics, the odds of pursuing a higher deficit are about as remote as a meaningful private sector credit boom.
So muddling through seems here to stay for a while.
With the debt ceiling extended the risk of an catastrophic automatic pro cyclical Treasury response, as previously discussed, has been removed.
What’s left is the muddling through with modest topline growth scenario we’ve had all year.
With a 9% budget deficit humming along, much like a year ago when markets began to discount a double dip recession, I see little chance of a serious collapse in aggregate demand from current levels.
It still looks to me like a Japan like lingering soft spot and L shaped ‘recovery’ with the Fed struggling to meet either of its mandates will keep this Fed ‘low for long’, and that the term structure of rates is moving towards that scenario.
With the end of QE, relative supply shifts back to the curve inside of 10 years, which should work to flatten the long end vs the 7-10 year maturities. And the reversal of positions related to hedging debt ceiling risks that drove accounts to sell or get short the long end work to that same end as well.
The first half of this year demonstrated that corporate sales and earnings can grow at reasonable rates with modest GDP growth. That is, equities can do reasonably well in a slow growth, high unemployment environment.
However, a new realization has finally dawned on investors and the mainstream media. They now seem to realize that government spending cuts reduce growth, with no clarity on how that might translate into higher future private sector growth. That puts the macroeconomic picture in a bind. The believe we need deficit reduction to ward off a looming financial crisis where we somehow turn into Greece, but at the same time now realize that austerity means a weaker economy, at least for as far into the future as markets can discount. This has cast a general malaise that’s been most recently causing stocks and interest rates to fall.
With crude oil and product prices leveling off, presumably because of not so strong world demand, the outlook for inflation (as generally defined) has moderated, as confirmed by recent indicators. As Chairman Bernanke has stated, commodity prices don’t need to actually fall for inflation to come down, they only need to level off, providing they aren’t entirely passed through to the other components of inflation. And with wages and unit labor costs, the largest component of costs, flat to falling, it looks like the the higher commodity costs have been limited to a relative value shift. Yes, standards of living and real terms of trade have been reduced, but it doesn’t look like there’s been any actual inflation, as defined by a continuous increase in the price level.
However, the market seem to have forgotten that the US has been supplying crude oil from its strategic petroleum reserves, which will soon run its course, and I’ve yet to see indications that Lybia will be back on line anytime soon to replace that lost supply. So it is possible crude prices could run back up in September, and inflation resume. For the other commodities, however, the longer term supply cycle could be turning, where supply catches up to demand, and prices fall towards marginal costs of production. But that’s a hard call to make, until after it happens.
With the debt ceiling risks now behind us, the systemic risk in the euro zone is now back in the headlines. Unlike the US, where the Treasury is back to being counter cyclical (unemployment payments can rise should jobs be lost and tax revenues fall), the euro zone governments remain largely pro cyclical, as market forces demand deficits be cut in exchange for funding, even as economies weaken. This means a slowdown to that results in negative growth and rising unemployment can accelerate downward, at least until the ECB writes the check to fund counter cyclical deficit spending.
China had a relatively slow first half, and the early indicators for the second half are mixed. Manufacturing indicators looked weak, while the service sector seemed ok. But it’s both too early to tell and the numbers can’t be trusted, so the possibility of a hard landing remains.
Japan is recovering some from the earthquake, but not as quickly as expected, and there has yet to be a fiscal response large enough to move that needle. And with global excess capacity taking up some of the fall off in production, Japan will be hard pressed to get it back.
Falling crude prices and weak global demand softening other commodity prices, looks dollar friendly to me. And, technically, my guess is that first qe and then the debt ceiling threats drove portfolios out of the dollar and left the world short dollars, which is also now a positive for the dollar.
The lingering question is how US aggregate demand can be this weak with the Federal deficit running at about 9% of GDP. That is, what are the demand leakages that the deficit has only partially offset. We have the usual pension fund contributions, and corporate reserves are up with retained earnings/cash reserves up. Additionally, we aren’t getting the usual private sector borrowing to spend on housing/cars as might be expected this far into a recovery, even though the federal deficit spending has restored savings of dollar financial assets and debt to income ratio to levels that have supported vigorous private sector credit expansions in past cycles.
Or have they? Looking back at past cycles it seems the support from private sector credit expansions that ‘shouldn’t have happened’ has been overlooked, raising the question of whether what we have now is the norm in the absence of an ‘unsustainable bubble.’ For example, would output and employment have recovered in the last cycle without the expansion phase of sub prime fiasco? What would the late 1990’s have looked like without the funding of the impossible business plans of the .com and y2k credit expansion? And I credit much of the magic of the Reagan years to the expansion phase of what became the S and L debacle, and it was the emerging market lending boom that drove the prior decade. And note that Japan has not repeated the mistake of allowing the type of credit boom they had in the 1980’s, accounting for the last two decades of no growth, and, conversely, China’s boom has been almost entirely driven by loans from state owned banks with no concern about repayment.
So my point is, maybe, at least over the last few decades, we’ve always needed larger budget deficits than imagined to sustain full employment via something other than an unsustainable private sector credit boom? And with today’s politics, the odds of pursuing a higher deficit are about as remote as a meaningful private sector credit boom.
So muddling through seems here to stay for a while.
Imagine a card game, where every entity in the economy is one of the players,
and you, Congress, are the scorekeeper.
The message here is the difference between being the scorekeeper and being a player.
The problem is, you are acting like one of the players when, in fact, you are the scorekeeper.
And you support your mistake with false analogies that presume you are one of the players,
when, in fact, you are the scorekeeper for the dollar.
That correct analogy is between scorekeepers in card games and your role as scorekeeper for the US dollar.
As scorekeeper in a card game, you keep track of how many points everyone has.
You award points to players with winning hands.
You subtract points from players with losing hands.
So as the scorekeeper, let me ask you:
How many points do you have?
Can the scorekeeper run out of points?
When you award points to players with winning hands,
where do those points come from?
When the scorekeeper subtracts points from players with losing hands,
does he have more points?
Do you understand the difference between being the scorekeeper and being the players?
You are the scorekeep for the US dollar.
You spend by marking up numbers in bank accounts at your Fed,
just like your Fed Chairman Bernanke has testified before you.
When you tax, the Fed marks numbers down in bank accounts.
Yes, the Fed accounts for what it does, but doesn’t actually get anything,
Just like the scorekeeper of a card game doesn’t get any points himself
when he subtracts points from the players.
When Congress spends more than it taxes,
it’s just like the scorekeeper of the card game awarding more points to the players’ scores than he subtracts from their scores.
What happens to the players total score when that happens?
It goes up by exactly that amount.
To the point.
What happens to dollar savings in the economy when Congress spends more than it taxes?
It goes up by exactly that amount.
To the penny.
The score keeper in a the card game keeps track of everyone’s score.
The players’ scores are accounted for by the scorekeeper.
The score keeper keeps the books.
Likewise, the Fed accounts for what it does.
The Fed keeps accounts for all the dollars all its member banks and participating governments hold in their accounts at the Fed.
That’s what accounts are- record keeping entries.
So when China sells us goods and services and gets paid in dollars,
the Fed- the scorekeeper for the dollar-
marks up (credits) the number in their reserve account at the Fed.
And when China buys US Treasury securities,
the Fed marks down (debits) the number in their reserve account.
And markes up (credits) the number in China’s securities account at the Fed.
That is what ‘government borrowing’ and ‘government debt’ is-
the shifting of dollars from reserve accounts to securities accounts at the Fed.
Yes, there are some $14 trillion in securities accounts at the Fed.
This represents the dollars the economy has left after the Fed added to our accounts when the Treasury spent, and subtracted from our accounts when the IRS taxed.
And it also happens to be the economy’s total net savings of dollars.
And paying back the debt is the reverse. It happens this way:
The Fed, the scorekeeper, shifts dollars from securities accounts to reserve accounts
Again, all on it’s own books.
This done for billions of dollars every month.
There are no grandchildren involved.
The Fed, the scorekeeper, can’t ‘run out of money’ as you’ve all presumed
The Fed, the scorekeeper, spends by marking up numbers in accounts with its computer.
This operation has nothing to with either
‘debt management’ which oversees the shifting of dollars between reserve accounts and securities accounts,
or the internal revenue service which oversees the subtraction of balances from bank reserve accounts.
And so yes, your deficits of recent years have added that many dollars to global dollar income and savings, to the penny.
Just ask anyone at the CBO.
It is no coincidence that savings goes up every time the deficit goes up-
It’s the same dollars that you deficit spend that necessarily become our dollar savings.
To the penny.
A word about Greece.
Greece is not the scorekeeper for the euro,
any more than the US states are scorekeepers for the dollar.
The European Central Bank is the scorekeeper for the euro.
Greece and the other euro member nations,
like the US states,
are players,
and players can run out of points and default,
and look to the scorekeeper for a bailout.
What does this mean?
There is no financial crisis for the US Government, the scorekeeper for the US dollar.
It can’t run out of dollars, and it is not dependent on taxing or borrowing to be able to spend.
That sky is not falling.
Ever.
Let me conclude that the risk of under taxing and/or overspending is inflation, not insolvency.
And monetary inflation comes from trying to buy more than there is for sale,
which drives up prices.
But, as they say, to get out of a hole first you have to stop digging.
(I don’t think you, or anyone else, believes acceptable price stability requires 16% unemployment?)
Someday there may be excess demand from people with dollars to spend for labor, housing, and all the other goods and services that are desperately looking for buyers with dollars to spend.
But today excess capacity rules.
And an informed Congress
That recognizes it’s role of scorekeeper,
And recognizes the desperate shortage of consumer dollars for business to compete for,
Would be debating a compromise combination of tax cuts and spending increases.
Instead,
presuming itself to be a player rather than scorekeeper,
Congress continues to act as if we could become the next Greece,
as it continues to repress the economy and turn us into the next Japan.
***comments welcome, feel free to repost, etc.
