Pragmatic Capitalism

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Would a “booming” recovery force the Treasury and Fed to compete with the private sector for credit?

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Today’s WSJ op-ed piece by Phil Gramm and Thomas r. Saving, title “The Economic Headwinds Obama Set in Motion” stated many things – confidently, of course – that made me scratch my head. I am sure they made some valid points, but in my opinion, the article is mostly a mess. After describing all sorts of terrible scenarios that might occur if our economy experiences a “full-blown” recovery, they end the piece saying that “failing to ignite a strong recovery in the private sector, or to reduce dramatically the growth of government during the ensuing recovery, will risk making the current Washington-induced stagnation a permanent part of American life.”

No arguments from me that our friends Washington DC share much of the blame for our muddle through “recovery”.

The article warns about federal borrowing costs rising to $4.4 trillion over the next decade “if interest costs simply returned to their post-war norms”. They go on to point out that during previous postwar recoveries, annual gross private domestic investment averaged 17.5% of GDP, and yearly Treasury borrowing went up on average by 1.6% of GDP. Then comes the projection that Treasury borrowing could “spiral to 6.6% of GDP in the fifth year of a recovery — and “federal borrowing would represent more than four times the competition for available credit than in did in previous postwar recoveries.” Next up, they say “a full-blown recovery and a return to normal interest rates would force the Fed to sell assets, increasing further the competition for available credit.”

It seems these experts think that any given time, there’s only so much available credit in our economy. Cullen, is that the “loanable funds” theory you’ve criticized in the past?

They mention that the “massive excess reserves have not expanded bank lending or the money supply because the Fed now pays interest on them – sterilizing excess reserves by in essence converting them into interest-bearing Fed securities.” Perhaps these “experts” don’t understand that banks don’t lend reserves – except to other banks. Also, I seem to recall reading something from Frances Copola explaining that the Fed is not paying interest on excess reserves to stop banks from lending.

They go on to describe the painful effects of the Fed unwinding excess reserves – and my understanding of how this may play out is not strong. What I do remember you pointing out is that the Fed could just sit on their Treasury securities let them all mature. I’m just not sure how – or even if we need to worry about those excess reserves will be reduced, or if they “should” be reduced under a robust growth scenario.

Sorry I don’t have a link to the online version of the article – there’s probably too much for me to justify this rant on your forum. They just keep coming back to “available credit” and why the Fed and Treasury might end up crowding out private investment.

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Posted by Steve W
Posted on 05/18/2017 11:45 AM
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That article sounds like a mess.

1) Yeah, they’re using loanable funds. This implies a fixed quantity of money in the economy that the govt then competes to borrow for. It’s totally wrong.

2) Banks don’t lend reserves to non-banks. These guys have no idea how banks work.

3) Interest on reserves doesn’t sterilize lending. It’s simply idiotic to say that earning 1% on a reserve would lead you to refuse a loan for 4% on a creditworthy loan. I mean, this fails banking 101 and logic 101.

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Cullen Roche Posted by Cullen Roche
Answered on 05/25/2017 1:08 AM
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    Thanks Cullen. Just this morning I took some time to try and learn more about the loanable funds theory and found a blog by Lars P. Syll. Interesting stuff. I also found the Frances Coppola article I was looking for (that explained the error of thinking that the Fed was paying IOER to motivate banks NOT to lend).

    I fired off a letter to the editor at the WSJ during my lunch hour. As they’ve published one of my letters fairly recently, I doubt we’ll see this one make it in.

    I continue to be astounded about how many so-called experts think that banks should be doing more lending given all those “excess” reserves.

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    Posted by Steve W
    Answered on 05/25/2017 3:16 PM
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