Here’s part 2 of the Q&A. I hope it’s helpful.
Tom Brown says:
What’s going on here?:
OK, seriously though, what do you make of this?
CR: Looks like an old Lone Ranger cartoon about hard work. Don’t ask me to explain the message entirely because I have no idea.
I am not so certain about that. The implication seems to be that QE is a direct transmission mechanism for controlling the rate of inflation. I find the evidence supporting this idea to be spurious at best. But Market Monetarists have extreme faith in the power of the Central Bank to be precise in controlling inflation. I just don’t think it’s that simple primarily because the legal constraints on the Central Bank don’t allow it the flexibility that’s probably necessary to achieve its goals.
Since net exports for the world must be zero, by construction, then the level of world trade has no impact on nominal GDP or nominal incomes for the world. Yet I believe a higher level of trade is a benefit because it increases real GDP because of movement of resources to the lower cost and/or more efficient producers of goods and services. It would seem, then, that this result of higher GDP must importantly be a consequence of higher productivity, not necessarily higher employment. In your opinion, do your think a higher level of world trade has any impact on employment?
CR: I think this is a hugely important driver of emerging market employment at present. We’re essentially witnessing a massive global arbitrage take place where cheap labor is performing the tasks that were once performed by more expensive domestic labor. As a result producers are able to create more output at a lower cost to their domestic consumers. And yes, the domestic labor force competes by becoming more productive, not by becoming less expensive. All of this would presumably increase aggregate demand which would be beneficial to aggregate employment. But I guess it depends on the specifics to be honest.
J John says:
Why is gas at the highest level and it hasn’t affected our economy at all?
CR: If gas prices rise by $1 because a nuke hits an important oil producer that supply shock is presumably temporary. So you would get more revenue going to fewer producers, which hurts certain economies and benefits others. The USA is a big importer of foreign oil, but I think the natural gas export boom and surge in US oil production has actually resulted in a less foreign dependent environment which means that less of the revenues are flowing outside of the US economy. So the changing dynamics of our dependence on foreign oil has meant that rising oil prices aren’t necessarily hurting the domestic economy in the same manner that they once did.
How much does $100 of QE typically increase the money supply? From what I gather much of the treasury purchases eventually sold to the Fed are funded by deposits, which should be regarded as money.
David Tepper has been bullish on the US stock market as “the money has to end up somewhere” and he “wants to figure out what people will do with the money. A lower budget deficit plays a part of that reasoning.
A Fed blog post said that QE does increase the money supply but the relation is not 1-1 between new reserves and m0, but much less than 1.
CR: It depends on the specifics, but let’s just take QE with a non-bank. In this case $100 of QE increases deposits by $100 and reduces the private sector supply of T-bonds or MBS by $100. As a whole the private sector doesn’t gave more financial assets, but it does have more deposits than it did before. But it also has fewer bonds. The money doesn’t “go somewhere”. Instead, the private sector has fewer bonds and will presumably force a scramble for more interest bearing assets. This MIGHT increase asset prices and reduce interest rates, but doesn’t have to. Think of it like a stock buyback. A firm can reduce the quantity of its shares outstanding, but it can’t necessarily make those shares more valuable simply by reducing the quantity. Presumably, the firm must also create sustained value by boosting its output. Stock buybacks, like QE, are a cheap trick to try to boost prices. Whether it can be sustained is dependent on factors other than mere quantity.
1. I remember reading sometime ago in Peter Bernstein’s Primer on Money, Banking and Gold that commercial banks create money and control the money supply simply by being part of a closed system. That is to say, a system in which money cannot be deposited outside the commercial banking system will guarantee that there exists more money than in fact exists. Are the modern money arguments anything more than this simple empirical fact?
2. It’s probably a misunderstanding on my part, but there seems to be an inconsistent argument within the modern money community around who in fact creates and controls the money supply. The MMT group claim all money is government money, and so government can if it chooses control the creation of money. Then we have people like Richard Werner and the group Positive Money who claim that government has effectively ceded control of the money supply to commercial banks, leaving them essentially powerless (97% of the money supply is created by commercial banks). Both arguments seem correct! How do you see it? If government can control the money supply, why was monetarism such an abject failure?
3. I’ve heard people like Warren Mosler and Randall Wray argue that the great recession need not have happened. Had governments simply initiated aggressive tax cuts, ensuring people had enough income to pay their mortgages and keep up consumer demand, things need not have turned out the way they did. Their argument seems weak. It seems to me that that would only have delayed the day of reckoning because the levels of private debt had become unsustainable. That is, a debt that cannot be repaid will not be repaid. Do you think tax cuts could have done anything more than delay an inevitable debt collapse?
4. Superficially, it made sense to save the banking sector. A banking collapse would have made the Great Depression look like a picnic. Now, leaving aside the political control exerted by finance on politics, was there an *economic* reason not to simply protect the public via government guarantee (deposit insurance), and at the same time initiate insolvency measures against the big Wall Street firms (chapter eleven is usually rather efficient), wipe out bond holders, and after reorganising the collapsed banks once again privatise the banking sector?
5. Modern money claims that sovereign debt in a currency controlled by your own central bank and treasury should not be considered debt in the usual way. That sounds about right. But is there a limit? Are there any *non-inflationary* circumstances where a so-called sovereign “debt” can be too big? For argument’s sake, is there anything economically wrong with US sovereign debt totalling $1000 trillion or even $1 trillion trillion as long as it is not inflationary? Every now and then, though, I have heard economists associated with modern money – Michael Hudson is prominent here – who claim that US foreign debt cannot be repaid! Is there a subtle argument that I’m missing?
CR: 1. It depends on how you define “money”. I use a “scale of moneyness” in my work that takes financial assets and ranks them along this scale. The thing that serves as the most useful medium of exchange has the highest level of moneyness. In our case, that happens to be bank deposits. So yes, banks create most of the money in a modern system. I don’t think there’s anything necessarily “modern” about this. It’s just a fact of banking. Banks control the payment system we all use for most of our transactions and we engage in that system by obtaining deposits.
2. I agree more with the Richard Werner argument than the MMT argument. MMT constructs a hierarchy of money to depict an economy in which state money is the real money. Bank issued money is just a claim on state money. I think this is backwards. I think the current system puts banks in control and has the government creating money that simply facilitates bank money. In other words, when you obtain cash or coin it’s because you’re using a bank account. When you settle an interbank payment in CB issued reserves, the CB is simply processing a payment on behalf of banks. This whole system is constructed around the banks, not around the state. MMT and most neoclassicals construct their argument so that the state controls the “real” money. The only real difference between “money” in MMT and “money” in Monetarism is that MMT includes T-bonds. In fact, both schools are basically quantity theoretic schools. MMT just thinks you should use fiscal policy and T-bond issuance to control the economy while Monetarism thinks you should use high powered money. Both schools are wrong because these just aren’t very precise ways to control the real money supply in any substantive way that actually drives aggregate demand.
3. I am not familiar with their position on this and I don’t want to put words in their mouths. But I do think that that consumer credit bust was inevitable. It wasn’t a matter of if, but when. The dominoes were in place and the government could have softened the collapse, but I don’t believe the theory that the government could have completely stopped it. Interestingly, Market Monetarists make the same claim you say the MMT people do.
4. I was actually in favor of wiping out a few of the big banks with a government guarantee on deposits. It probably would have led to a sharper decline, but I have little doubt that that would have also meant a sharper recovery. Instead, we have too bigger to fail now which in my opinion makes the system even more fragile.
5. The argument is misleading. Debt, in the aggregate, doesn’t get “repaid”. In a modern financial system the liabilities will always presumably increase in a healthy environment. That doesn’t mean we shouldn’t call them “debts”. The government, like any other entity, issues financial assets that will be held by other parties at a certain value. The government has a certain exorbitant privilege, but that doesn’t mean it is immune to the reality that it must issue financial assets that other parties actually want to hold. MMT often implies that any sovereign issuer of currency can find willing holdings of its financial assets which just isn’t true in any meaningful sense. And yes, if you issue more of the financial asset than people want to hold at current prices then the value will presumably decline in real terms.
Boxers or briefs?
CR: It’s warm in San Diego. Boxers bunch up in the heat. So I wear briefs or boxer briefs. Or a bathing suit if I am having a good day.
Very Serious Sam says:
So, about the soccer world cup finals – how high will Germany win against Argentina?
CR: I am late here. I thought Germany would win by more. Glad it didn’t go to PKs. The Penalty Kicks annoy me and I thought Germany deserved to win the whole thing anyhow.
Given the current level of interest rates globally and the unconventional central bank operations implemented since 2008, do you think the current monetary system has failed?
Do you think central banks try to create stability by smoothing out the business cycle only to create more instability (Minksy’s financial instability) because market participants end up taking more risk (due to moral hazard)?
Do you think the current monetary system leads to greater inequality? If so, do you also agree with PKEs that inequality will lead to lower aggregate demand and thus a low growth future?
PKEs also point to rising levels of private sector debt and talk about secular stagnation. Is this caused by our current financial and monetary system and is this sustainable?
Is a gold standard really that bad when many point to the post WW2 Bretton Woods era as one of the most prosperous time periods? and do you think that under a gold standard we would see less inequality?
Paul Krugman wrote a book called “End this Depression Now!”. If Cullen Roche wrote a book with the same title, what would be the key recommendations for the US economy and the Japanese economy today?
If you were forced to give advice, what would be the optimal asset allocation of a long-term investment portfolio for a 25 year old and how would this differ for a 55 year old GIVEN the current environment of historically high equity and bond prices?
CR: The monetary system is a construct of the human mind. It doesn’t exist in any “real” sense. And like most things we just imagine out of thin air, it is highly imperfect. Has it failed? No. But it does fail us at times as a result of being the direct creation of imperfect thoughts.
I think that Central Banks, as clearinghouses, do more good than bad. But yes, I do think they can exacerbate trends by tinkering with things they might otherwise be better off not tinkering with.
I think capitalism is designed to lead to greater inequality. It’s not the monetary system. It’s just the natural monopolistic state of a capitalist economy. If we never intervened I have no doubt that a few capitalists would buy up the whole system over time.
The gold standard creates natural constraints that I think are unnatural in a world with a financial asset based monetary system. It is an imperfect blend of a financial and non-financial asset based world. I don’t think both can co-exist without creating bigger problems.
I don’t think we’re in a depression, but I wouldn’t mind seeing substantial tax cuts, more infrastructure spending, some non-financial deregulation and a more export friendly policy initiative.
I’d have to see the specific portfolio and client. I will never provide general portfolio asset allocations as it would be highly imprudent for me to do so. Sorry.
would you ever consider buying leveraged inverse 3x efts of the SnP500/Russell 2000/Dow Jones. Is that a good hedge against a 2008 like drop in the stock markets? Will they really pay out 6-9% a day if the market drops 2-3% daily?
CR: It really depends on your experience, but leverage is almost always a very dangerous tool for anyone who isn’t a very sophisticated investor. I personally don’t find much use in leverage and don’t know too many people who handle it very well so no I wouldn’t recommend toying with those instruments. They are generally very dangerous.
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CR: I have issued all the readers a full refund for their monthly membership fees. Keep an eye out for your $0 check in the mail.
What are your thoughts about mainstream DSGE models?
CR: A model is only as good as its ability to tell us about the actual financial world. The problem with most of the economists who use a DSGE model is that they don’t use a realistic framework of the monetary system to begin with so the model ends up being useless.
Great admirer of the site and the author. Several times you have mentioned QE is not printing money, but many intelligent people and the mass of people don’t believe this to be the case. My question is this…if its not printing money then where or how does the FED get the money to buy these treasuries/MBS from the banks?
And if its not printing money, and Japan is doing the same thing….why do most people expect inflation in Japan(Kyle bass, Mauldin, you?). So is Japan different, after all they are doing QE just like we are?
Also….the FED wants 2% inflation, why not just skip the banks all together and lend to the treasury, thus monetizing the debt?
CR: My point on QE is very specific. The Fed “prints” a reserve into the private sector, but also unprints a bond. So it’s a wash in terms of financial assets. There are other side effects of this, but the idea of “money printing” often implies that the Fed is just shooting dollar bills out the front door. That’s not the case.
I don’t actually expect sustained high inflation in Japan for the same reasons I don’t think QE will create sustained inflation in the USA.
A more effective strategy for creating inflation would be buying bags of dirt from anyone and everyone for $1,000 bucks a pop. Of course, that would be crazy, but it would sure create inflation.
What Happens to the US Dollar value if Russia and China are able to convince the rest of the world to ditch US currency for OIL AND Chinese goods purchases?
(figured I would toss ya a soft ball for the illiterate (Illmontaryfuncting process) press folks to have somthing to publish on thier blogs/sites)
CR: The foreign demand for the US dollar is not really a function of contractual obligations. It is a result of the fact that the USA creates a huge amount of output which results in huge global exchange flows which leads to high demand for dollars. We are OPECs #1 customer. You don’t just tell your #1 customer that you’re going to stop accepting their currency unless you want to reduce your revenues substantially.
Assuming that it does not end up with tangible inflationary impact (let’s just say for now that is a given), does it really “matter” in practice that Central Banks are losing money on their QE investments? What is the harm and who gets hurt?
CR: The Fed has actually made an extraordinary amount of money on QE. Something like $500B or so over the last 5 years. If the Fed were to begin losing money on its current holdings it would simply hold them to maturity of receive Congressional relief. After all, who is going to tell the Fed that they’re bankrupt. Bankruptcy is a legal definition applied to entities who can’t operate and there’s no such thing as the Fed not being able to operate unless Congress and the voters determine that it is inoperable.
will your romance novel include a female serial killer prostitute who kills men with lethal drugs injections?
CR: No. It’s about a man who kills people with boring Q&A’s about economics, QE, investing and money.
Are you going to answer all these questions ?
CR: Of course. Answer them well – eh, maybe. 🙂
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.