Here’s a response to the first question from last week’s Q&A. I feel like it’s worthy of its own post because it’s important. The question was:
“How do you respond to someone who is constantly claiming that inflation and therefore interest rates are bound to shoot up with “all of the money the government is printing?”‘
That’s easy. Here is how that conversation will usually go:
Hyperinflationist: “Can you believe how reckless our government is printing all this money every year?”
You: “Well, technically, the government doesn’t ‘print’ most of the money we use. Most of the ‘money’ we use is created by banks and is created when banks issue loans which create deposits. These deposits make up the majority of the money we all use to transact. Banks are the biggest ‘money printers’.”
Hyperinflationist: “Yeah, but can you believe the high government deficits we’re running and all that new money that gets printed when the government spends?”
You: “The government isn’t printing new money when they run a budget deficit. They’re actually ‘printing’ a government bond that is used to raise ‘money’. This results in the redistribution of existing money and the issuance of a new government bond. The amount of ‘money’ in the system doesn’t change, but the quantity of assets is increased.”
Hyperinflationist: “Oh yeah, but Quantitative Easing has been crazy money printing. Have you seen the size of the Fed’s balance sheet? Just wait until those dollars all get out of the banking system and cause crazy high inflation!”
You: “Well, that’s not exactly right. The Fed has created reserve balances through QE’s asset purchases which resulted in the increase in outstanding reserves in the private sector, but the reduction of another asset in the private sector. This isn’t asset printing. It’s asset swapping. Of course, if it’s done in conjunction with a large deficit then that could be called “money printing” and might cause high inflation, but QE alone is just asset swapping cash for bonds.
And more importantly, these reserves are used by banks INSIDE the banking system. That money doesn’t “get out” of the banking system in any meaningful sense. Remember cash is transformed from deposits so even if customers withdraw cash then this doesn’t mean there is necessarily “more money” in the system. It just means the type of money has been exchanged.
Hyperinflationist: “Well, what about when the banks start using all those reserves to multiply the money supply through new loans? Won’t that cause crazy high inflation? ”
You: “That textbook story is cute and all, but it’s not really how banks operate. Banks make loans and find reserves later if they must. They aren’t reserve constrained. The money multiplier is a myth.”
That should help you out. Good luck. It’s an uphill argument every time!
Related:
- Stop with the “Money Printing” Madness
- Pragmatic Capitalism: What Every Investor Needs to Know About Money and Finance
- The Biggest Myths in Economics
- Understanding the Modern Monetary System
- Hyperinflation: It’s More Than a Monetary Phenomenon
- The Bank of England Debunks the Money Multiplier
Buy Cullen Roche’s New Book Pragmatic Capitalism – What Every Investor Needs to Know about Money and Finance
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.
Frederick
Nice post. Too bad your thinking isn’t catching on. The Fed seems to getting all worked up about inflation again.
Cullen Roche
I don’t think the fed is really that worried about inflation. They’re just talking it up in case they need to be positioned for a change in policy. Hedging their bets….
Frederick
I’m not as certain about that as you seem to be. I think the Fed could make the same mistake the ECB made in 2011 and raise rates as a cautionary measure.
Cullen Roche
I’m not THAT certain about it. I just don’t think the FOMC Minutes were as hawkish as some made them out to be.
connie hawkins
i’d say, yup, the federal reserve has created a bubble economy, and the next one will probably be a doozy.
connie hawkins
qe is absolutely money printing. the fed creates money out of thin air, to buy assets reserves in the private sector. the fed creates artificial demand which drives these assets values higher. assets in the private sector are therefore increased.
Cullen Roche
It’s not really a question of whether the Fed is creating “money” or not. Of course they are. It’s a question of whether their actions are inflationary. I say it depends on the environment and what exactly they do. Most of QE2 and QE3, etc have not been very inflationary because they’re just swapping assets around.
connie hawkins
when the fed buy bonds it creates demand which drives the prices of bonds up. therefore asset values are increased. inflation is not an issue since the velocity of money is nil. its simply finding its way into the stock market.
Cullen Roche
That assumes all else is equal. I can guarantee you that bond yields wouldn’t be low if inflation were higher. QE3 for instance, had no mechanism by which to create higher inflation. The wealth effect is weak at best. Yes, I agree that QE is keeping assets higher than they otherwise would be, but I think the programs have had diminishing returns over the years….
Sean McCalgan
If QE is an asset swap, how is it that the S&P500 and other ‘risk’ assets have rallied so profoundly since the 2009 crash? Are you saying that QE has been misunderstood by the broader markets to be much more than it is and generate widespread euphoria? Also, where is the money coming from that is feeding this asset price rally if the QE equation is net neutral?
me
So when there’s a Treasury Auction where does the money to buy the bonds come from? The primary dealer bank borrows from the Fed window to get the money to buy the bonds?
Cullen Roche
Here’s how a SOMA desk trader once explained it to me:
“The primary way dealers finance their bond purchases is in the repo market. So here is one scenario. Funds are wired from the dealer’s account at its clearing bank to Treasury on issuance day. During the day, the clearing bank provides intraday credit to the dealer, so the dealer is borrowing from the bank. That same day, the dealer enters into a repo, pledging the newly acquired Treasury as collateral. The other side of the repo is likely to be a money market mutual fund or other money market investor. Therefore, by the end of the day, and for the overnight period, the money market investor is effectively funding the dealer’s position. Of course, there are a variety of ways in which positions can be funded, but the repo market is the key one.”
Cullen Roche
It depends. I would argue that QE1 had a huge impact on asset prices as it helped create a floor for the markets during a period when volatility was extremely high. Since then there’s been a diminishing impact.
The key driver of stocks in recent years has been corporate profits, not QE:
me
This is why I love this site, comments are amazing.
So how does that work in aggregate after it’s all settled? Since the Treasury only takes dollars and there were X amount of dollars before the auction in total. Now there’s X + the auctioned amount. Does someone in the chain have to borrow from the Fed at some point?
Cullen Roche
The Treasury is just a user of the reserve system like a bank is. So its balances settle in the reserve system in the Fed’s account. But remember, the reserve system is just a settlement system that smooths the payment process. The reason the Treasury uses the Fed system is to make the Treasury’s payment processing more efficient. So yes, the funds have to settle through the Fed, but don’t confuse that for being self funding. The money comes from elsewhere, settles through the Fed system and is ultimately settled in another bank account. It’s a flow of funds through the reserve system just like any interbank payment is.
me
To make sure I’ve got this right, there’s really no functional difference when compaired to any normal corperate bond sale. And the bond itself is the asset to balance the new money to pay for it.
Cullen Roche
Right. The settlement operation is different, but deficit spending is the same thing as a corporate bond issuance in essence. There are some differences in the impact on the economy (obviously), but the operation is essentially the same.
John Daschbach
I think the theory which postulates that QE should have no impact on interest rates is the Modigliani-Miller theorem (price is the expected discounted value of future cash flows). One of the stronger arguments that QE has not (artificially) lowered long yields is that the US long yields are ca. 1% higher than EU long yields. To first order, using the relative inflation levels and projections in the two domains, supports the view that the market sets interest rates and QE in the US has not artificially altered the market set rates.
Willy1964
I would respond as follows:
– Inflation doesn’t drive interest rates. If that was the case then US interest rates would have doubled from 2001 up to mid 2008. Then interest rates would have crashed in the 2nd half of 2008. And they didn’t do that.
– The inflation that occurred in the stock & bond market since 2009 was the result of QE/”money printing”.
John Daschbach
What? Inflation went from ca. 1.8% in 2001 to ca. 2.1% in 2008 using a double exponential weighted 1st derivative. Why would anyone think that this small change would double interest rates? Long yield changes post 2008 have been roughly as expected. If you showed the data on inflation and yields to 1000 scientists without any reference that it was economic data, at least 900 would find it all quite normal and find zero evidence for an impact of QE (from the data they would not postulate anything outside of the natural correlation of y1 (yields) with y2 (inflation) ).
me
Makes sense now, thanks a lot. Feels like I just learned something important or maybe unlearned something.
Cullen Roche
I hear ya. The first time I ever thought of it like that (from the perspective of corporate bonds) I was like – “well, that should have been obvious all along”. But for some reason most people think of govt debt in a totally different way. At least I did…
Old Dog
Thank you Cullen. I am sending a link to this article to a number of good friends who seriously need to read this. Can you get someone to put this on a full page in the NYT?
Simon
Cullen, I am interested to learn why you believe QE has kept asset prices higher. The prices of French and German bonds are “higher” (yields are lower) than on 10yr UST’s and they have not been subjected to QE. “Everyone” says the S&P500 is higher because of QE/”money printing” yet since almost all of the QE “money” has ended up in reserves, I have not heard a satisfactory explanation of the transmission mechanism for the “printed money” to end up in equities. You seem more knowledable than 99% of us on this and I’d love to hear your views. Cheers.
Willy1964
Precisely.
But A LOT OF inflationistas look at e.g. oilprices and say “High Inflation ==> Riising interest rates” like it happened in the 1970s.
Auburn Parks
The TSY is the monopoly issuer of T-securities
The Fed is the monopoly issuer of Reserves
The only way to “buy” T-securities is with reserves
The only logical result of these facts are that the Govt is necessarily self funding. Its the only entity that can “fund” its liabilities with its own liabilities.
Cullen Roche
AP,
It’s patently absurd to argue that the govt is self funnding. It’s a concept that is totally void of value. An entity that can’t convince other entity’s to hold its liabilities at a stable value is effectively insolvent. The fact that govt’s don’t go to bankruptcy court doesn’t change this.
You guys overemphasize the solvency point to the degree that you sound like you don’t understand basic points here. Study any Latin American hyperinflation and you’ll see that these entities can’t find holders of their liabilities at a stable value. The fact that they don’t go to bankruptcy court doesn’t mean a damn thing. “Bankruptcy” is just a legal definition for someone who can’t find someone to hold their liabilities. When a household can’t find a lender they default b/c that’s how the laws are constructed. When a govt can’t find a lender it inflates the currency as there’s no one to take them to court or they just change the rules of the game. The fact that a central bank can fund the govt is entirely meaningless in this context. This is a point that should be obvious even to the most brain dead “monetization” screaming fool….And the exorbitant privilege of some countries like the USA and other developed economies doesn’t extend to all other countries.
It’s important because you misunderstand where the value of money comes from. You think it comes from the power of a govt to tax when the reality is that the power to tax comes from having private output WORTHY of being taxed in the first place. Men with guns don’t make a currency worthy. Men with private production lines do. Get this wrong and you’ll misunderstand the entire economy.
MMT has this whole story backwards. Sorry, but you’re just wrong and repeating it here every few weeks only makes your position look inflexible and dogmatic.
Auburn Parks
I agree with a lot of what you wrote, especially wrt what gives any nation’s currency its relative value. Taxes aren’t the only thing for sure. what you can buy with it is also important.
I have no idea what hyperinflation has to do with any of this.
Nothing changes the inexorable fact that its a logical and accounting impossibility for the private sector to fund the Govt. You would never say that Google needs to tax and borrow its own shares before they can issue them.
No matter what your personal ideology is, the Govt issues its own liabilities. And it “pays” for one type of its liabilities with another type of its own liabilities. Its the only entity that can do that.
Cullen Roche
So what? I issue my own liabilities also. I can walk into any bank in the country and convince them to hold my liabilities and they’ll give me money. And when I can’t repay the value of my liabilities will go to zero and the bank will sue me to recoup some of that value. The point is that in order to spend money you have to be able to convince someone to hold your liabilities. The govt is not immune to this reality. The govt must convince others to hold its liabilities. Granted, the govt is a unique entity because it can tax and sell the risk free instrument, but that doesn’t mean it doesn’t have to “fund” its liabilities. It sure as hell does. After all, a govt that can’t convince anyone to hold its liabilities is just printing up worthless notes. You can claim they haven’t technically run of money, but so what? For all practical purposes, the govt does run out of money that people actually want to use.
You guys are right to focus on inflation. But you should focus PRIMARILY on inflation. All of this talk about “self funding” is meaningless. So, you’re telling me that an entity with a printing press and the ability to tax, can’t “run out of money”. Well, that is obvious to anyone who thinks through the basic facts here. Repeating this everywhere every 10 minutes on the internet makes you guys sound like you don’t understand what you’re talking about.
And no, I don’t think most MMTers would agree that the private production line is more important than the power of the printing press. Actually, once they talk to me they’d likely realize it’s an obvious fact. But then they have to change their whole story because the Warren Mosler “business cards” or “men with guns” story becomes a moot point.
The bottom line is, we all have to convince other people to hold our liabilities if we want to spend money. Governments have unique powers in this regard, but that does not mean they cannot run out of the power to spend money or that they don’t have to find willing holders of their liabilities. We’re all endogenous money creators. It’s just that some of us have much lower credibility than others. If you want to claim governments don’t go “bankrupt” because they don’t go to bankruptcy court then fine. But it’s a pointless distinction in any realistic sense. Governments have high credibility, but MMT makes it sound like they’re totally immune to any funding problem of any type…No, once a govt can’t find willing holders of its liabilities it just changes the rules of the game and alters the way they “fund” themselves. So what? That doesn’t mean they haven’t run out of people who want to hold their liabilities. It just means they’ve determined the rules so that they can’t be held accountable for running out of people who want to hold their liabilities….
Auburn Parks
“So what? I issue my own liabilities also. I can walk into any bank in the country and convince them to hold my liabilities and they’ll give me money.”
But you can’t pay off your liability (bank loan in your example) with your own liabilities. you can only pay off your liabilities with your assets, just like everyone else. Like I said, nobody can pay off their liabilities with their own liabilities except for the Currency sovereign. Its just accounting and if you don’t get the accounting right, you can’t get the economics right.
“The point is that in order to spend money you have to be able to convince someone to hold your liabilities”
yep, and taxes do that.
“All of this talk about “self funding” is meaningless. So, you’re telling me that an entity with a printing press and the ability to tax, can’t “run out of money”.”
You’re totally right. Everyone knows that the Govt can’t run out of money. Except for every elected republican and just about every single democrat, the president, etc etc etc. And even once people accept the ‘obvious’ as you put it, they think that there is some great difference between issuing T-securities and so-called “printing money” or not issuing T-securities. As QE has shown, there is no real difference wrt to inflation between issuing securities or not. Eccles understood this just fine in the last paragraph on page 2:
https://fraser.stlouisfed.org/docs/historical/house/1947hr_directpurchgov.pdf
It won’t let me copy and paste the paragraph for some reason.
I want the private sector to do well, but it can’t without enough aggregate demand. So I just want the Govt to add enough demand to satisfy the needs of businesses and consumers. Its not asking that much.
Cullen Roche
Governments don’t “pay off their debts” any more so than the aggregate private sector does. Your point is a fallacy of composition.
Taxes don’t convince people to hold money. No one in the world says “gosh, I need to make some money so I can pay some taxes”. Output drives money. People say “gosh I need to make some money so I can feed myself”. Taxes are just a way for govt’s to generate revenue from output. You have the order of importance exactly backwards here.
I know what you guys want. You want the govt to steer the economy. You think the economy can’t operate functionally without a huge budget deficit. And when the deficit shrinks you all scream about how it just has to end badly. Well, you’ve all been screaming like rabid bears for the last 3 years as the deficit has declined and the economy just keeps getting better and the bears just keep getting more and more wrong. So what’s wrong with your model? Why has every bearish MMTer been so wrong about the economy as the deficit has declined? Did it ever occur to you that maybe the model is wrong? That maybe all of this obsessing over a govt centric perspective of the world is just wrong and puts the cart before the horse?
Cullen Roche
Also, there are lots of Conservatives who understand that an entity with a printing press can’t run out of money. Either way, it changes NOTHING. Once you convince the entire world that an entity with a printing press can’t run out of money they’ll say that the govt can’t spend efficiently. They’ll say “well, duh, that’s exactly the problem! The govt spends too much!”. They don’t care about solvency in any realistic sense. They just use that to spread an agenda. What they are really saying is that the govt can’t spend efficiently. Whether that leads to insolvency or inflation is a moot point in their eyes. So all this talk about how govts can’t go bankrupt is fun for a little bit, but overemphasizing it is a waste of breath.
Auburn Parks
“Governments don’t “pay off their debts” any more so than the aggregate private sector does. Your point is a fallacy of composition.”
That is a complete misunderstanding of what I’m saying.
All currency users must use their assets to pay off their liabilities (Micro not macro).
The currency issuer pays off its liabilities with its other liabilities.
No conjecture. No opinions. Its just how the accounting works.
And yes, taxes drive money. That also is not an opinion. hundreds of examples, with the Euro being the biggest of them.
“You want the govt to steer the economy.”
We are the Govt, so yes, I think society should steer its own economy.
“You think the economy can’t operate functionally without a huge budget deficit.”
Oh it can, with enormous increases in the money supply coming from private debt issuance or from exporting, or from a more equitable disttribution of the income. But since those things aren’t happening, I don’t think its unreasonable for wanting businesses to have customers with enough money to buy their products. And if that demand cant come from the 3 aforementioned methods, then yes, we should have the Govt provide that additional demand.
The economy is not good, regardless of what the stock market says, so you entire paragraph about how the economy is doing just fine with the current level of demand is just plain factually wrong.
Auburn Parks
“Either way, it changes NOTHING”
It changes EVERYTHING
“Once you convince the entire world that an entity with a printing press can’t run out of money they’ll say that the govt can’t spend efficiently.”
yeah, because tax cuts or simply sending everyone checks every month is so inefficient.
” So all this talk about how govts can’t go bankrupt is fun for a little bit, but overemphasizing it is a waste of breath.”
Well, when the masses understand that and a politician says that we have to cut SS because the trust fund is going broke, then he can be laughed out of office. Until then, you pretending that the Govt doesn’t issue the currency and that it doesn’t necessarily fund itself is simply a waste of breath
Cullen Roche
Let’s look at some facts:
NGDP has averaged 3.8% since 2010. That could certainly be better, but unless up is the new “down” then you’re obviously wrong about the state of the economy. The problem is that you guys are permabears who won’t be satisfied with the economy until all of your policy agenda has been implemented. Which will never happen. I’ve read the MMT economists for years. They’re always bearish. It’s a tired old political act. You sound like the Austrians always complaining about the “fiat money” system’s coming collapse. Except in your case it’s not enough fiat money system….Same trick, different set of people screaming.
The govt does not spend its own assets. It also does not pay off debts with its own assets. If you want to misconstrue the role of the reserve system in the settlement process there then have at it. But you’re just misleading people about how things actually work. The govt doesn’t spend deposits. And the govt doesn’t pay back bonds by issuing reserves. In fact, no one in the private sector wants reserves or could use reserves. The govt pays people in bank deposits which are liabilities of private banks. So unless you’re consolidating the banking system into the govt then you’re wrong. Factually wrong.
“We” are not the govt. We live in a representative republic. The majority do not rule. “We” do not rule. “We” get to place votes on people who make decisions on our behalf. And if they vote against the majority (as they often do) then that’s that. We don’t live in a society where everyone gets to divy everything up equally. You seem to think the USA is a pure democracy or worse, that it’s socialist. You don’t even seem to understand the design of our government and you certainly don’t understand the design of our monetary system as it relates to the real world. That’s why MMT keeps getting things wrong in recent years. And speaking of Europe – you all said Europe would collapse because there was no currency issuer. But in your misunderstandings you failed to understand that the ECB is a currency issuer. Yet you don’t point this out in the USA because it would contradict many of your views. It’s just politics. That’s all MMT really is. It’s politics masquerading as economics.
Cullen Roche
No, the point is that once the narrative changes people will say Social Security is going to cause high inflation in the coming years rather than saying it will cause insolvency. Same basic point delivered in a different context.
You’re wasting your breath telling people that the US government can print its way out of every mess. That’s true in some cases, but very very wrong in many other cases. Warren Mosler’s claim that there’s no tax cut or spending increase that can’t fix an economic problem is factually wrong. Just study any Latin American hyperinflation to prove it wrong. Printing money doesn’t fix every problem in the world and it’s shocking that smart people think this way….
Auburn Parks
“NGDP has averaged 3.8% since 2010. That could certainly be better, but unless up is the new “up” is “down” then you’re obviously wrong about the state of the economy.”
And that might true if NGDP were the end all be all of economic measurements. But its not.
“The problem is that you guys are permabears who won’t be satisfied with the economy until all of your policy agenda has been implemented.”
Nope, I would be satisfied with full employment and rising real wages.
“The govt does not spend its own assets.”
Duh, it spends its own liabilities
“It also does not pay off debts with its own assets.”
I’m glad you agree with what I’ve been saying. THis is totally different than everyone else who can only pay off their liabilities with their assets.
” But you’re just misleading people about how things actually work.”
That would be you actually.
“The govt pays people in bank deposits which are liabilities of private banks.”
Thats just factually wrong. It pays banks by crediting reserve accounts which in turn leads to banks crediting deposit accounts.
“”We” are not the govt. We live in a representative republic. The majority do not rule. “We” do not rule. “We” get to place votes on people who make decisions on our behalf.”
We The People would disagree with you.
“You seem to think the USA is a pure democracy or worse, that it’s socialist.”
If you were honest about what “socialism” means you would understand that every nation partakes in some socialism. SS medicare, roads, bridges, research, etc.
“That’s why MMT keeps getting things wrong in recent years.”
” you all said Europe would collapse because there was no currency issuer.”
I think 11% unemployment and getting worse is bad. Spain, Greece =have unemployment rates worse than the great depression, I think thats pretty bad, but you must not.
“That’s all MMT really is. It’s politics masquerading as economics.”
Thats what MR is
Auburn Parks
“No, the point is that once the narrative changes people will say Social Security is going to cause high inflation in the coming years rather than saying it will cause insolvency.”
Wouldn’t it be nice if that was the argument we were having as a society. Its not.
“You’re wasting your breath telling people that the US government can print its way out of every mess”
capitalism runs on sales, and the govt can easily and at no cost to the public it serves create demand. This is not that complicated.
“Warren Mosler’s claim that there’s no tax cut or spending increase that can’t fix an economic problem is factually wrong.”
You can’t know that as its never been tried.
“Printing money doesn’t fix every problem in the world and it’s shocking that smart people think this way….”
Thats an awesomely dishonest strawman. Please provide one quote where anyone says that. You can’t youre wrong.
Cullen Roche
So what’s your alternative and superior measure of economic growth? Your opinion?
This is very simple. Saying that the govt “spends” bank deposits is like saying that a transfer from Bank A to Bank B in the interbank market is the equivalent of the Fed “spending” deposits into my account. No, there is a flow of funds. Bank B does not issue the liabilities upon transfer until it has received credits in its Fed account from the Bank A settlement. Same thing happens when the govt taxes and sells bonds. You just skip the steps there and misconstrue it to make your narrative sound true. But anyone who understands this can see that you’re cutting corners to make a false narrative appear consistent. It’s amateurish accounting.
Anyhow, there’s no point arguing with you. You are wedded to this ideology that has been proven wrong on many things in the last 4 years. If you want to keep being wrong then have at it. I am not the one who has to live with all these dire predictions that never keep coming true….
Cullen Roche
This is why your entire theory is wrong:
“Capitalism runs on sales, and the govt can easily and at no cost to the public it serves create demand. This is not that complicated.”
“No cost”? How can you make such a general and extreme claim? This statement is true SOME TIMES. It is not an absolute ironclad law of economics and it’s astoundingly naive to believe so. If “capitalism” (whatever that means to you) could simply run on governments printing money then every Latin American country would be unfathomably successful. The fact is, your extremist thinking is dangerous and leads people to think that money can solve all of our problems. That’s pretty naive if you ask me.
It’s truly amazing to me that you can, in one sentence, declare that the govt can solve all problems “at no cost” by spending money and then, just a few paragraphs later, claim I constructed a “strawman” by saying you didn’t say something that you literally JUST said….Are you bi-polar?
gbgasser
Hey Cullen
I have a question and I don’t mean to be a smart ass. In your discussion with Auburn you made the claim that the US govt has to get its liabilities accepted just like everyone else. So it seems to me you are suggesting that there is no one, no entity at all, that can just create money (I know that is a nebulous term) from nothing. Presumably that would include CBs too.
If you disagree and suggest that CBs are special and can create money form nothing, where is it that they get these powers?
BTW my new handle on disqus is gbgasser but I am Greg form the old system
Geoff
Cullen, you do an excellent job poking holes in MMT, and clarifying the MR position at the same time. I’ve said before that I think you are at your best when you take on MMT. In a way, this is sort of unfortunate because I don’t think MMT is really the enemy. Their rhetoric can indeed be extreme at times but that strikes me more as sound bites designed to counteract the hard money Austrians and Libertarians. Their understanding of the monetary system is reasonably sound, albeit it too hierarchical and govt centric! Personally, I’d like to see a larger deficit at this time so I count MMTers as allies.
At least for now. 🙂
gbgasser
I guess what Im getting at is that trying to say that the govt must get its liabilities accepted just like everyone else is beside the point really. Isn’t the real crux of all this monetary talk simply “Who has the highest chance of getting their liabilities accepted?” I think the answer to that is the govt, which includes the CB and Treasury.
Of course you can come up with scare scenarios where the US govt has no takers and can’t buy anything, but short of the Zero Hedge crowd no one thinks its likely. In fact Id say that its way more unlikely than abolishing the CB. I hear lots of people wanting to “End the Fed”. Ive seen no one call for an end to the treasury or an end to the US dollar. I know people who think the end of the dollar is near but they do not wish for it
blonderealist
Cullen, I understand what you mean when you say the money multiplier is a myth — as it relates to money in reserve accounts.
Isn’t there another money multiplier notion out there? I’m thinking of the what I believe is some version of the Keynesian notion that when the federal government spends a dollar that it multiplies throughout the economy. In the political debate about cutting or raising spending for food stamps, I heard/read a number of comments from “experts” that confidently stated that every dollar spent on food stamps helped the economy by more than one dollar. This thinking seems to be common among politicians advocating government spending on many programs. Unless those “government” dollars result in private sector credit expansion, I’m not sure how those dollars would multiply.
Cullen Roche
Hi Greg,
My point is that we are all endogenous money creators. But we all have different levels of credibility. When I run out of people who will accept my liabilities I have lost credibility. When the govt runs out of people who will accept their liabilities the currency inflates because they generally just print more of it. We all need other entities to accept our liabilities so the idea that printing money precedes acceptance is silly.
Now, the govt has an extremely high level of credibility because they can tax the entire output of the private sector. But this does not mean they have an infallible credibility just because they can create money. The govt doesn’t default on itself or “run out of money”, but we shouldn’t take this to mean that printing money is some infallible power. The fact that govt’s don’t generally default doesn’t mean that they can’t run out of credibility. I guess that’s the main point. We can all run out of credit even if we can’t all run out of money.
I hope that helps.
Cullen Roche
That’s the weird thing. I would consider most of them allies as well. But they sure don’t act like it. I don’t visit MMT websites, but they are constantly coming here aggressively attacking my ideas. It’s like – do you even realize who your closest allies are? Why would you attack someone like me who is more likely to sympathize with you than disagree? But this is their MO. They attack anyone and everyone who isn’t 100% in paradigm with them. It’s self defeating. They turn everyone into an enemy by acting like this.
Cullen Roche
Hi BR, Yes. That is a different “multiplier”. The fiscal multiplier is just how much a certain policy change impacts GDP.
LVG
The banking example debunks his thinking. Anyone who understands reserve accounting can see that in today’s environment with so many excess reserves the Central Bank does not create money when the government spends. The amount of reserves aren’t even shifting as there are plenty to meet reserve requirements as need. It’s surprising that the MMT people don’t see how simply their model can be disproven.
John Daschbach
I won’t speak for Cullen, but the data that EU long yields are ca. 1% lower than US yields is a strong argument that if QE has caused price distortion it’s lower prices (higher yields) not the other way around. The huge drop in yields at the end of QEII seems pretty solid data to support this. People in the bond market seem predominantly exist between those who think of selling a bond in QE is a pure asset swap (no price impact) to those who think having and active Fed will be slightly inflationary and hence yields go up a bit during QE.
The reserves issue is mostly just a result of accounting. There can be a long chain of transactions, but when a private party sells a bond to the Fed the net result is that they now have a bank deposit in exchange for a liquid financial asset (the bond). However, the bank now has a new liability, the deposit, without a standard offsetting asset (e.g. a loan, a T-bill, …) I think of it as the bank has to offset the liability (the private deposit) with an asset (a reserve deposit).
Cullen’s view that if you want to think that the Fed is printing money when it engages in QE then you have to also argue that is unprinting a bond is correct. A US Tsy is a completely liquid financial asset. Essentially you can exchange a Tsy for many other liquid assets most of (24x7x265). Every month the US Tsy market transacts ca. 1 yr of GDP, almost 10x higher than the MZM transacts. Liquidity is the normalized flux, and US Tsy are second only to US dollars in currency exchanges in terms of liquidity.
The “printed money” only ends up in equities if there is data and logic to support that QE has lowered yields. The data shows that it has increased yields. The printing money argument then has to be that QE has raised yields (vs. non-QE, it’s a fact you can’t dispute) but that yields would be far higher without QE. The press never seems to ask the question “If you owned a Tsy bond and you thought that QE was artificially raising prices, why would you sell before the end?” So when QE has ended (especially QEII and now with QEIII nearing the end) you have to see lower prices (higher yields) if the Fed is distorting the market to lower yields. What we have seen, every time, is exactly the opposite. Long yields crashed right after the end of QEII, and they have been falling now as the Fed reduces QEIII.
tealeaves
I think the “inflationists” are coming up with more elegant arguments. That is, I came across this doozy which is incredibly disempowering as an investor
“High inflation will come. It is just a question of when.”
An almost “religious” statement like this would keep you out of the bond market for the entire QE program. In fact, taken fully it would keep you overweighted in commodities/REITs/TIPs and other inflation related assets.
Certainly, an uptick in inflation will come at some point. High inflation is another matter as it depends on the choices, actions and health of central banks, governments, economy corporations and individuals.
Matt
Could you say that there are two extreme sides in this discussion:
– on the one extreme, the viewpoint that the (US) government is completely bankrupt, being 17T in debt, China owns half the country, a debt we all have to pay back at some point, etc
– on the other extreme side, the (MMT) viewpoint that the government is totally self funded, can “print” its way out of every recession, etc
But the truth would be somewhere in the middle? In some ways the government can always fund itself (in some way using its CB), but there are real limitations, being trust and inflation?
This remains a difficult issue, since there seem to be so many subtleties in the middle. If someone comes here are says the US government is totally bankrupt, you will reject that. If someone else comes here and says it can print whatever money it needs, you will also reject that viewpoint.
Cullen Roche
Yes, I think that’s pretty accurate. I have come to believe that MMT is at least somewhat extremist in a lot of its views. MMT tends to be outright socialists, leftists and extreme leftists.
The point I was trying to make here is that no one is immune to the reality that we need someone else to accept our liabilities. The fact that a govt doesn’t go bankrupt doesn’t mean it’s immune to that. So the idea of “self funding” is actually irrelevant if you understand basic economics. All you need to understand is that the US govt can tax and print high quality bonds. That means its inability to find people in the private sector to hold its liabilities, is extremely low. But it can happen! The fact that the CB can then finance those liabilities doesn’t mean this point doesn’t matter.
Whether we want to call that a “solvency” constraint or an inflation constraint is irrelevant. Every entity in the economy has a balance sheet constraint meaning that they all need to find someone willing to hold their liabiilties. And once you can’t find someone to hold your liabilities you start to have big problems.
As a side note, this is one reason why stocks often perform well in a hyperinflation. When the government’s money is deteriorating people will often flock to the liabilities of corporations (stock) because they think that the underlying output will still be valuable in real terms when the hyperinflation is done. This is one more reason why I think it’s important to understand that the value of money doesn’t come from entities with guns and legal stature – it comes from entities with powerful production lines.
Frederick
Auburn,
Cullen’s point is very simple. Every entity in the monetary system needs someone else to be a willing holder of their liabilities at a stable value. The fact that the government can have its central bank buy up all its debt does not mean that the private sector wants to hold their liabilities. And that’s the only thing that matters here. Is the private sector a willing holder of government liabilities at a stable value? If the answer is no then the government is effectively bankrupt even though they won’t go to court.
No one in the economy can “run out of money”. They run out of people who want to hold their liabilities. The fact that a government doesn’t go through bankruptcy proceedings doesn’t mean they are above the rules of basic accounting. No entity is above the rules of accounting. And when the rules dictate that your liabilities aren’t worth holding then you’re bankrupt regardless of what a court says.
Cullen Roche
This guy Auburn is not interested in understanding the facts. He’s only interested in one thing:
Promoting MMT and its political agenda.
That’s all. I’ve seen him on a dozen other sites lashing out at people, calling them names and just promoting MMT. He’s not open-minded to any alternative views at all and his comments are consistently abrasive and rude. He should be ignored in the future.
Matt
Thanks Cullen for your reply. I think I understand what you mean. But it’s still a very difficult concept to grasp. Reading your articles here through the years it seems as though you switch a bit between emphasizing one side or the other.
(could be me misunderstanding things)
Like here you explain why it’s not possible for the USA to go bankrupt
https://pragcap.com/why-the-usa-isnt-going-bankrupt
https://pragcap.com/not-technically-bankrupt-but-economically-bankrupt
while in the response above you say the “probability is extremely low”. That seems like a big/important difference to me. What seems “extremely unlikely” to you, might seem “quite likely” for someone else (say a politician trying to push lowering government spending).
Cullen Roche
Hi Matt,
I think the key to understanding that “extremely low” probability is understanding that the US economy would have to devolve substantially to a point where its autonomy is reduced. So, its economy would have to shrink, the USD would have to become less important, its dependence on foreign countries would have to increase, etc. In this case, the USA could devolve to a third world sort of status in which case there would be very real solvency problems in potential scenarios.
At present, the USA is so powerful in so many different ways that its autonomy level is extremely high. So this affords it the ability to issue its liabilities knowing there will almost always be high demand.
That’s just referring to technical “solvency” though. Remember, “bankruptcy” is just a legal definition synonymous with someone who has run out of people who want to hold their liabilities. None of this means that demand for USDs can’t decline and result in high inflation relative to other goods and services. In this scenario the US govt is issuing an instrument that sees reduced demand even if it doesn’t technically go bankrupt. They’re very similar things though. When you can’t get someone to hold your liabilities you’re bankrupt even if the courts don’t declare it so. Degrees of autonomy at the sovereign level help to understand how this concept applies to a govt.
Does that make sense? I know I don’t always explain it in that level of detailed thinking….
Cullen Roche
I should add – the reason I think this matters is because it has to do with where the “value” of money comes from. MMTers often claim that the demand for money comes from the sovereign forcing us to pay taxes. Mosler uses an example where a man hands out business cards in a room, demands that people use them and then points a gun at them when they don’t want to use them. This is not why people have demand for money. The demand for money can collapse whether taxes and men with guns are present. In fact, taxes and men with guns don’t really have much to do with the demand story at all. It’s almost entirely about how people view “money” relative to goods and services. If the liabilities you issue are deemed as worthless relative to goods and services then no one will want to hold them.
A govt is not immune to issuing so many of its liabilities that people don’t want to hold them. Call it inflation. Call it insolvency. But it’s the same basic concept – once people lose demand for your liabilities you’ve lost credibility. And I don’t care how many guns you shove down people’s throats, if money can’t buy goods and services, then your guns are worthless also. The ability to print your own currency in an autonomous state might help you avoid insolvency, but it doesn’t mean that printing money is always the solution to every problem. Yet MMTers claim there is no financial crisis too big that a larger deficit can’t fix. That’s just wrong. Yes, there are times when a larger deficit can help, but there are environments where a larger deficit could just make things worse. And this flaw in the thinking stems from the above misunderstandings.
Matt
Hi Cullen,
Yes that does make sense. As the largest economy in the world, the reserve currency, the most powerful country, etc, it would take a massive change before people really started to doubt the value of the US dollar (and not wanting to buy government bonds anymore).
So if I understand correctly:
– there is a fundamental difference between countries issuing their own currency and those that don’t (EU countries for example, or previous gold based currencies)
– there’s is also some kind of continuum of “solvency risk” (in practical, real terms, not the technical way) for different countries issuing their own currency. The US as the biggest and strongest has the lowest risk. Some tiny country with a bad economy and bad political situation for example, has a very high risk, even if it can technically not go bankrupt because it issues its own currency.
Is that about right?
As always, really appreciate your explanations.
Matt
Sorry didn’t see your second reply before my own.
Yes, makes total sense!
I can see how there is some small value in the claim that taxes in a certain currency make it more likely that people want to hold/use that currency. But that would not be the only reason, let alone the biggest. First comes the fact that everybody in your own country is already using that currency and the fact that that currency is stable. Having to pay your taxes in that currency is an added benefit.
Cullen Roche
Yes. The USA can’t and won’t go bankrupt in the bond markets because it can always fund its spending. So bond traders don’t have to worry about the USA not being able to pay. Greece can’t even create their own currency so it’s a totally different situation. They can literally run out of money.
But that doesn’t mean that issuing money is some sort of panacea. The bond markets could reject bonds in the case of a high inflation. This doesn’t mean they’re worried about your ability to pay. It means they’re worried about the currency inflating and being left holding an asset denominated in something worthless. Ie, people don’t want to hold the government’s liabilities. The govt hasn’t “run out of money”. But they have run out of people who want to hold their liabilities.
Not sure if you’ve read my book, but I describe this at the sovereign level as degrees of autonomy. The USA is a very unique country so it’s a little misleading to always refer to the USA or other developed countries (which is an unfortunate mistake I often make). We have to keep in mind that there are many emerging market economies who are dependent on the kindness of strangers which makes their solvency situation much more tenuous. Here’s the image I use in the book:
I hope that all makes sense.
Matt
Makes sense. Is getting more clear by the day 🙂
And yes (of course) I got your book but just last week so haven’t gotten far yet. Will soon 🙂