Preface. I generally subscribe to the view that in free currencies, deficits are mostly self-funding, and ‘enormous’ deficits needn’t be accompanied by higher yields. Government builds a bridge, pays the bridgebuilder, who pays the grocer, who eventually either buys the Treasury or deposits in a bank whose reserves are fungible vs T-bills via the intermediating Fed. Government dissavings and private sector savings are equal and offsetting, as long as the Central Bank has a working spreadsheet and an interest rate target. Yields are just a function of duration needs of savers vs borrowers, but the AMOUNTS always match up. Likewise, I don’t believe that the creation of bank reserves is inflationary or hyper-inflationary; bank lending is capital – not reserve – constrained. Loan officers don’t check the vaults. There is always enough. I continue to marvel at the armies of deficit vigilantes who take aim at Treasuries and JGBs, armed with Gold Standard thinking or even the latest Reinhart/Rogoff, only to retreat 2-3 year later. It didn’t work shorting US Treasuries in 2009-2010 for the ‘money supply’ or ‘deficit spike,’ and that roadside is stacked with corpses. Even the Home Run deficit vigilante hitters who nailed Europe this year (and Europe is, for now, operating as a quasi-Gold standard and an entirely different set of risks) offset those gains with losses betting the other way on the US, UK, and Japan. It’s evident in the returns.

21 Responses

  1. Very awesome Warren.

    Can you expound on what he was trying to say by “Yields are just a function of duration needs of savers vs borrowers?”

    How does that align with the MMT view that govt rates follow or are set by the Fed?

    1. Today the gov sets the FF rate directly and attempts to influence long rates, but still let’s long rates fluctuate.

      So that term structure of rates reflects both anticipated future fed rate settings plus technicals

  2. A few weeks back I understood you to report that some countries had quit buying gold and that there might be a fall in gold prices because of the termination. Since then Jim Crammer has had several shows pushing gold. Do you think he has a basis for his optimism on gold? I can’t tell if he thinks the price will increase because he expects inflation or if he thinks the Euro will collapse, but I wonder if you stand by your opinion. By the way, I am not a gold bug and have never owned any; I just would just like to know your opinion.

  3. Re the central bank’s “interest rate target”, if the target is zero as per the Mosler “natural rate of interest is zero” theory, that’s OK with me. If it’s anything else, then I’ve got reservations because, 1, I see no reason for governments to borrow, and 2, I don’t think interest rate adjustments are as good a way of adjusting demand as adjusting government net spending (though I don’t mind interest rate adjustments being used in emergencies).

    1. @Ralph Musgrave,

      I’ve been thinking, and I would love to know if Warren agrees, that if the government wants to embark on a spending program (like building critical infrastructure or going to war, not a make work spending program to boost AD) and we are already at full employment, etc… then it has two choices, the carrot and the stick. Raising interest rates is like using the carrot because the private sector gets paid to save. Raising taxes is the stick; the government just takes away money to keep people from spending it.

      1. @briantheprogrammer,

        “Raising interest rates is like using the carrot because the private sector gets paid to save. Raising taxes is the stick” -> Funnily enough, I made the argument in this post that net spending was the carrot and interest rates was the stick, but that was in the scenario where policy makers are attempting to prevent deflation…

    2. @Ralph Musgrave,

      “I don’t think interest rate adjustments are as good a way of adjusting demand as adjusting government net spending” -> Why? Could you elaborate on that?

      (Was attempting to start the debate there but happy for it to happen here instead)

  4. @WARREN MOSLER,

    I read Ralph’s post and disagreed with just about everyone of his points, but would like to discuss the interest income channel argument in more details.

    Here’s my thinking on this:

    When the market expects the Fed to lower rates due to Economic slowdown and Treasury bond yields drop, it creates a massive surge in the NPV of net financial assets in the private sector. While the treasury does not mark its public debt to market, private sector agents now have the ability to resell these bonds into the market at a premium. To quantify this, if the public debt is $15tn with a duration of 8 years, and the curve shifts by 25bp in parallel, the private sector is now “wealthier” by $300bn.

    It will take years for that instantaneous NFA gain to be reversed via rolling matured Treasury Bonds. By then, we might be in the next business cycle, taxes can be lowered to reflect the lower interest expense, etc.

    So savers/China get instantly wealthier and now expect a much lower return on these assets going forward and should seek to sell them to spend/invest.

    Mechanically, there is of course no one to sell these things to since the Treasury isn’t buying them back and therefore selling would just transfer to someone else in the private sector. Luckily, the way the Fed implements these rate cuts is by expanding the base money supply via repo transactions. So while the private sector cannot sell the Treasury bonds, it can lend them to the Fed and get cash at a lower rate than it previously could.

    The lower real interest rate on cash in turn incentivizes those who hold any to spend/invest it, and those who don’t to borrow and spent/invest, thereby supporting aggregate demand.

    Looking forward to hearing thoughts on this approach.

    1. i seriously doubt tsy secs are held as alterntives to spending on consumption and/or real investment.

      the private sector can always borrow against its tsy secs.

      and, without going into how all the pieces add up, at the macro level, the economy is a net saver, so it net gets hurt by lower rates.

      1. @WARREN MOSLER,

        “i seriously doubt tsy secs are held as alterntives to spending on consumption and/or real investment.” -> what else could cash/treasuries they be held as an alternative to?

        “the private sector can always borrow against its tsy secs.” -> yes, but not at such a low rate. If the private sector had a fixed appetite for cash and truly didn’t care about the rate at which it can borrow against treasuries, then it would take a minuscule amount of increase in base money supply for rates to drop (high elasticity). Clearly, this is not the case..

        “[..] the economy is a net saver, so it net gets hurt by lower rates” -> Yes the economy is net long whatever bonds the treasury is short. Yield goes down, price goes up 🙂

      2. think of all the taxed advantaged reasons to spend income- pension plans, insurance and other corporate reserves and liquidity requirements, etc.
        and foreign desires to net export to the US. etc.

        you are back in a fixed fx ‘loanable funds’ world- please read ‘soft currency economics’ etc.

        think interest income earned.

  5. “Government dissavings and private sector savings are equal and offsetting, as long as the Central Bank has a working spreadsheet and an interest rate target. Yields are just a function of duration needs of savers vs borrowers, but the AMOUNTS always match up.”

    Correct me if I am wrong, but my understanding of MMT is that public sector deficits equal net private sector savings. Moreover, private sector savings can be broken down into domestic personal savings, business savings and foreign sector savings as reflected in the trade deficit. If so, can anyone recommend the best data sets from the national income accounts to illustrate this accounting identity relationship?

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