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Debunking MMT

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Cullen, I found an interesting MMT blog which discusses the operational reality of the Fed to prove their currency sovereignty claim (govt spends first, then taxes).

Link: http://heteconomist.com/exercising-currency-sovereignty-under-self-imposed-constraints/

The author starts with simple points of logic, yet in a sense I think this is quite intriguing.

As a simple matter of logic, a currency-issuing government that imposes a tax denominated in its own money cannot receive tax payments until it has first issued that money. Likewise, it cannot borrow its money from the non-government without first having issued money. A currency-issuing government creates money when it spends or lends. Tax payments and purchases of government debt result in the destruction of money. This makes clear, as a matter of first principles, that government spending or lending must occur before tax payments or government borrowing can take place.

According to above paragraph, before you can pay tax, you need to receive the money which is spent by the govt prior to tax payment. After all, in order to pay the tax, reserve balances (which are the base money) are required to commit the transaction.

Now, MMT is aware of the limitation imposed by the US law which prohibits the Treasury to over-draft its account at the Fed and directly sell its bonds to the Fed. So, the author argues that in order to cope with these limitations, he claims prior to selling the govt bonds, the Fed lends the reserves to primary dealers so that they have money/liquidity to purchase the bonds from govt. If it is assumed to be true, then I would agree with MMT notions because when the Fed is lending, it means that the govt through the fed as its agent, spend the money into existence at the first place.

To debunk whether MMT claims are correct or not, I would like to ask the question.

Is the Fed allowed by law to lend the reserves to primary dealers for purchasing bonds ? (which is then cleared by finding reserves loan in interbank market).

The MMT people get this wrong. There’s absolutely no need for the govt to spend before taxing. For instance, most people pay their taxes with bank deposits. Bank deposits are created independent of government spending. So, as long as banks create money taxes can be paid.

The MMT people respond to this by saying that taxes settle in reserves. But the only reason reserves even exist is because there is a private credit system. Further, saying that reserves precede taxes is the logical equivalent of saying that reserve issuance IS govt spending. As a matter of logic, this makes no logical sense.

The MMT people really make a mess out of the reserve system. They pretend to be experts about reserve accounting, but their entire paradigm is a bunch of basic mistakes that misconstrue what the reserve system is, why it exists and how it works.

There’s plenty of good stuff in MMT, but this stuff about the govt not needing funding is nonsense. It’s just wrong in a very basic manner.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Cullen, I do understand that reserves do exist because of the underlying of private credit money. However, I would like to get clarification first in regards with my first question.

Is is true that the fed is allowed to lend the reserves to primary dealers for purchasing bonds ?

I need this answer as I would ask further question which will solve this chicken and egg problem, whether reserve precedes deposits, or vice versa.

Banks can borrow from the Fed if they need liquidity or if they need to meet a required reserve regulation, but banks don't need to borrow from the Fed to purchase bonds. Most of the financing of bonds is done in the reverse repo market.

In any case, I've had that debate with the MMT people and it misses the point. The existing operational constraints have NOTHING to do with whether the USA "funds" its spending. Whether there are "self imposed constraints" (as the MMT people claim) has nothing to do with anything regarding the funding of the govt. The fact is, the govt funds its spending by having willing counterparties. When the govt has willing counterparties they have funding. The real price of that funding is what matters most for the govt. So, for instance, when inflation is rising or spiraling out of control what you're seeing is a repricing of govt money. This is a de-facto decline in the demand for money from willing counterparties. Ie, it costs the govt more to fund its spending.

That's it. It's that simple. MMT quite simply misconstrues this to mean that a printing press means you are "self funding". It's extremely misleading.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

The existing operational constraints have NOTHING to do with whether the USA "funds" its spending. Whether there are "self imposed constraints" (as the MMT people claim) has nothing to do with anything regarding the funding of the govt.

So, it is clear from your statement that although the fed can purchase the bonds directly from the govt, it doesn't eliminate the core concept of funding whereby in this case the govt still needs funding from the fed, right ?

Now, I want to ensure the concept is applicable for all kinds of situation. Let me ask hypothetical question. Let say in the operational realities, the fed imposes private banks to take reserves loan to purchase the bonds, does your concept of funding (having counterparty) still hold true for that case ? Or, within that circumstance, would it be shifted to "self-funding" ? Please say your argument.

I would argue that we would have "self-funding" system. It is true because the constraint is not determined by counterparty anymore. Instead, it is determined by asset issuer itself.

Yes, the govt always needs “funding”. Ie, it always needs demand for its money from willing counterparties. We only have funding when we have willing counterparties who want to hold our assets. This is as true for a govt printing a cash bill as it is for me looking to create a loan agreement with a bank.

Importantly, having a Central Bank buy your bonds does not mean you necessarily have viable “funding”. After all, this is what happens during most hyperinflations. The key variable to pay attention to is the inflation. That’s where the decline in demand shows up. The govt cannot force this demand on the private sector. Therefore, the monetary system is never “self funding”.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Alright, I got your point. The funding concept still remains the same. What differentiates is that whether it would be "viable" or "not viable" funding. Viable funding would lead to healthy economy, while the other one would lead to disaster (hyperinflation, etc). As simple as that.

I think you still haven't answered my another half question. Let me repeat below.

Let say in the operational realities, the fed imposes private banks to take reserves loan to purchase the bonds, does your concept of funding (having counterparty) still hold true for that case ? Or, within that circumstance, would it be shifted to "self-funding" ? Please say your argument.

I would argue that we would have "self-funding" system. It is true because the constraint is not determined by counterparty anymore. Instead, it is determined by asset issuer itself.

The bold wording here is impose. More specifically, the counterparty will always need to accept the liabilities from the fed. Do you still argue that govt imposition here would not lead to "self-funding" ? I know this is imaginary situation. But I think the what-if approach will help us better in constructing the right way of thinking .

It only matters in nominal terms. I’ve explained before that Primary Dealers in the USA are required to bid at t-bond auctions. So the auctions can’t fail. But this is in nominal terms. There’s nothing to stop everyone else from re-pricing govt money lower and lower relative to everything else. This would occur in a hyperinflation or high inflation and it’s indicative of a decline in funding.

Think of it like a stock where the govt imposes a law that the govt has to buy Bank of America stock over time when they issue more of it. The stock won’t go to $0 because there will always be a bid for it, but that doesn’t mean its price can’t drop in real terms vs everything else. Same basic thing here. You still need “funding”, the question is what is the cost of that funding. In the case of a rising inflation the govt’s cost of funding is rising.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

I am not sure why people have trouble with the idea that the government has to fund its spending. If the government spends $100 in 2019 to fund its deficit and then inflation rises by 100% then it costs the government 2X to fund its deficit. This isn't a free lunch just because you have a printing press. The government's real cost of funding itself doubled.

MMT people completely contradict themselves when they say inflation constrains government spending, but funding doesn't. They're the same damn thing for a government!

In MMT logic of  government deficit spending,  government deficits are self-financing and deficits push rates down, thus, cause no high inflation concerns and no constraints on government deficit spending.

In operational realities,  there is no such a thing called "self-financing" or "self-funding" and less-funded deficits may push rates Up not Down, thus reflect hyperinflation or high inflation and constrain government deficit spending.

In NIPA data realities, government deficit spending can cause high inflation if it is mal-investment or over-investment spending.  Inflation rate can be viewed as "more spending growth than produced product growth". In notation, %P= %NGDP - %RGDP.   Spending is not product production itself.  Three kinds of spending measures are needed for calculating quantities of real produced products:

(1) pre-production spending such as investment I, etc.
(2) post-production spending such as consumption C, etc.,  and
(3) price level P

Thus, higher pre- /post- production spending does not necessarily guarantee higher quantities of real produced products. This missing gap is the price level P if  lower quantities of real products are produced. For example, deficit spending will push price level P up and create high inflation if  it is mal-investment or over-investment spending and not good for real goods production.

 

 

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