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Treasury Auctions

Hi Cullen,

According to MMT, the Fed effectively finances all Treasury borrowing by injecting reserves into the system and having the Primary Dealers use those reserves to buy USTs. New money is created and this is spent by the Treasury into the economy, raising incomes and NGDP.

Recently I read an interesting critique of MMT that said that this narrative doesn't go to it's logical conclusion, which is that the Primary Dealers immediately want to/required to sell the Treasuries off to Private Investors in the capital markets. Private Investors use their own, already existing, privately created money to buy the Treasuries. The existence of such investors is a pre-requisite for this whole thing to work. As "old" money is used to buy the Treasuries, in the end the monetary base doesn't really increase and NGDP also doesn't really increase through such bond financed spending.

(https://medium.com/@hpublius/does-mmt-describe-the-operational-realities-of-our-monetary-system-93f05657e106)

What is your view of this critique? Is it really true that without the existence of private investors wanting to buy Treasuries from the PDs, this way of financing the Treasury wouldn't actually work? On the flip side, do you think MMT's narrative also has issues- for e.g., they probably believe that the Fed can always buy up all the Treasuries in the secondary market through the PDs and that they don't really need Private Investors.

What is your view? I find this to be such a fundamental topic, especially for developing countries which don't have well developed capital markets with a lot of wealthy investors just waiting to invest into Govt bonds. If that were the case, no wonder these countries are poor. On the other hand, if things worked the way MMT describe and having private investors is not a pre-requisite, then developing countries could get all the financing they need from their central bank to invest into productivity enhancing areas such as schools, health care, green jobs, energy independence etc. (Ofcourse I'm not advocating that they just give away the money to people for doing nothing).

Thank you for sharing your views which I always greatly respect and value.

 

Hi @fnm500,

I think MMT plays a bit of dirty pool with their description. Publius’s post isn’t making the most salient points, but he gets most of it right. Here’s what MMT actually says:

When the Govt taxes us they do this by transferring central bank reserves to the Tsy, who has an account at the Fed. So, reserves leave the banking system and get credited to the Tsy’s account. If you consolidate the govt into one sector with the CB and TSY consolidated then the govt holds its own liabilities. Ie, it must therefore destroy that liability and create it when it spends just like a bank loan that creates money and destroys it when the bank obtains that liability back.

So the MMT people would argue that the govt’s spending is “self funding” in the sense that it just expands its balance sheet from thin air when it wants to spend. It doesn’t have to get money or rely on bond sales to issue money. This is true in a very narrow sense. But as Publius notes, the govt still relies on non-govt demand for their money. After all, when inflation rises it is a direct sign that the demand for money is falling. And if the govt’s demand for money is falling then they likely need to raise rates to increase demand for money. So it’s all a bit circular in my mind. You can’t say that the govt doesn’t “fund” its spending when it most definitely relies on the non-govt to fund its spending by having demand for that money.

As for the specific operational details, it’s just flat misleading to argue that taxes destroy money and govt spending creates money. Taxes are paid in deposits, existing money, and transfer those deposits to another person the govt spends. The fact that this settles in reserves does not matter one bit. Nothing is created or destroyed there. The money is only transferred. When the govt runs a deficit it does indeed create something new and when it runs a surplus that would destroy something. But taxes in and of themselves do not destroy anything. And MMT’s depiction if this is a rather misleading depiction of the reason reserves even exist in the first place (because we have a  private deposit system).

In the end, a lot of the MMT narrative is just word games. Yes, the govt has an inflation constraint. And yes, the govt can’t run out fo money, but it can very much run out of demand for its money which is functionally a default. So I don’t know how much these MMT narratives really add to our understanding of things here.

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

Thank You Cullen, I understand your points about funding and demand for money a lot better now. So yes, even if the Fed were to monetize all Govt debt and Private Investors were not involved, it could still lead to inflation i.e. lack of demand for Govt money.

But in the US, interest rates are just going lower and lower and auctions are overbid. And in poor countries, with such high unemployment, do you think increasing inflation is realistic?

Thanks again for everything. I learn a lot from this website and your posts on Twitter as well 🙂

Hi @fnm500.

This gets to the real heart of the matter - what causes inflation? The answer is a lot more complex than most people seem to think. It's obviously not just the money supply as many theories assumed. It's not just govt spending. And honestly, I don't think anyone really knows what exactly causes it. Clearly, in a world of low inflation and high govt debt it's obvious that MMT has been validated in some sense and mainstream econ has been invalidated. But MMT goes too far here and has no empirically supported theory of inflation. So the fact that so many people were wrong about govt debt and inflation does not mean that MMT is necessarily right that govt spending won't potentially cause high inflation. Or worse, MMT has no valid way of controlling inflation once it gets out of control. And that's the bigger worry. Not only do they not know what causes inflation, but if we implement all the things they want (Job Guarantee, Green New Deal, etc) then how will they control inflation? They have no empirically supported proof of having a way to contain it.

So again, while some mainstream econ ideas have been invalidated by the current low inflation I think it's an overreaction to then conclude that MMT is right when we really have no proof of whether MMT would manage a high inflation well or not.

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

MMT argues that the government can create its own demand for its money. This assumes that there is always excess capacity in the economy and that the government knows how to put it to work in a manner that won't create inflation.

This strikes me as a remarkably naive faith in government.