With sufficient deficit spending private credit isn’t needed at all to sustain growth and employment, so the shift from private sector credit growth (falling M3) to 3% growth sustained by deficits of 10% of gdp is perfectly sustainable.

In fact, I’d prefer, for a given size govt, lower taxes rather than higher private sector credit growth. And a larger trade deficit means we can have taxes that much lower still. And cut out much the military expenditures for Afghanistan and cut taxes that much more, thanks! etc!

Unfortunately 3% growth doesn’t close the output gap, but that’s another (very ugly) story, but with the same answer. Agg demand is about a trillion a year short of potential right now, hence my proposal for a full payroll tax (FICA) holiday to restore private sector sales, output, and employment.

US money supply plunges at 1930s pace as Obama eyes fresh stimulus

By Ambrose Evans-Pritchard

May 26 (Telegraph) — The M3 money supply in the United States is contracting at an accelerating rate that now matches the average decline seen from 1929 to 1933, despite near zero interest rates and the biggest fiscal blitz in history.

The M3 figures – which include broad range of bank accounts and are tracked by British and European monetarists for warning signals about the direction of the US economy a year or so in advance – began shrinking last summer. The pace has since quickened.

The stock of money fell from $14.2 trillion to $13.9 trillion in the three months to April, amounting to an annual rate of contraction of 9.6pc. The assets of insitutional money market funds fell at a 37pc rate, the sharpest drop ever.

“It’s frightening,” said Professor Tim Congdon from International Monetary Research. “The plunge in M3 has no precedent since the Great Depression. The dominant reason for this is that regulators across the world are pressing banks to raise capital asset ratios and to shrink their risk assets. This is why the US is not recovering properly,” he said.

The US authorities have an entirely different explanation for the failure of stimulus measures to gain full traction. They are opting instead for yet further doses of Keynesian spending, despite warnings from the IMF that the gross public debt of the US will reach 97pc of GDP next year and 110pc by 2015.

Larry Summers, President Barack Obama’s top economic adviser, has asked Congress to “grit its teeth” and approve a fresh fiscal boost of $200bn to keep growth on track. “We are nearly 8m jobs short of normal employment. For millions of Americans the economic emergency grinds on,” he said.

David Rosenberg from Gluskin Sheff said the White House appears to have reversed course just weeks after Mr Obama vowed to rein in a budget deficit of $1.5 trillion (9.4pc of GDP) this year and set up a commission to target cuts. “You truly cannot make this stuff up. The US governnment is freaked out about the prospect of a double-dip,” he said.

The White House request is a tacit admission that the economy is already losing thrust and may stall later this year as stimulus from the original $800bn package starts to fade.

Recent data have been mixed. Durable goods orders jumped 2.9pc in April but house prices have been falling for several months and mortgage applications have dropped to a 13-year low. The ECRI leading index of US economic activity has been sliding continuously since its peak in October, suffering the steepest one-week drop ever recorded in mid-May.

Mr Summers acknowledged in a speech this week that the eurozone crisis had shone a spotlight on the dangers of spiralling public debt. He said deficit spending delays the day of reckoning and leaves the US at the mercy of foreign creditors. Ultimately, “failure begets failure” in fiscal policy as the logic of compound interest does its worst.

However, Mr Summers said it would be “pennywise and pound foolish” to skimp just as the kindling wood of recovery starts to catch fire. He said fiscal policy comes into its own at at time when the economy “faces a liquidity trap” and the Fed is constrained by zero interest rates.

Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown “Friedmanite” monetary stimulus.

“Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty,” he said.

Mr Congdon said the dominant voices in US policy-making – Nobel laureates Paul Krugman and Joe Stiglitz, as well as Mr Summers and Fed chair Ben Bernanke – are all Keynesians of different stripes who “despise traditional monetary theory and have a religious aversion to any mention of the quantity of money”. The great opus by Milton Friedman and Anna Schwartz – The Monetary History of the United States – has been left to gather dust.

Mr Bernanke no longer pays attention to the M3 data. The bank stopped publishing the data five years ago, deeming it too erratic to be of much use.

This may have been a serious error since double-digit growth of M3 during the US housing bubble gave clear warnings that the boom was out of control. The sudden slowdown in M3 in early to mid-2008 – just as the Fed talked of raising rates – gave a second warning that the economy was about to go into a nosedive.

Mr Bernanke built his academic reputation on the study of the credit mechanism. This model offers a radically different theory for how the financial system works. While so-called “creditism” has become the new orthodoxy in US central banking, it has not yet been tested over time and may yet prove to be a misadventure.

Paul Ashworth at Capital Economics said the decline in M3 is worrying and points to a growing risk of deflation. “Core inflation is already the lowest since 1966, so we don’t have much margin for error here. Deflation becomes a threat if it goes on long enough to become entrenched,” he said.

However, Mr Ashworth warned against a mechanical interpretation of money supply figures. “You could argue that M3 has been going down because people have been taking their money out of accounts to buy stocks, property and other assets,” he said.

Events may soon tell us whether this is benign or malign. It is certainly remarkable.

On Thu, May 27, 2010 at 12:04 PM, Marshall wrote:

Yes! For some odd reason there is a myth about the Great Depression that could not be more removed from the reality of the time. Most people believe the economy crashed between 1929 and 1932 and then remained depressed until the Second World War which finally mobilized the economy’s idle resources and brought about a full recovery. That’s complete bunk if you calculate the unemployment data correctly. Even leaving aside that fact, it is true that, once the Great Depression hit bottom in early 1933, it embarked on four years of economic expansion that constituted the biggest cyclical boom in U.S. economic history. For four years real GDP grew at a 12% rate and nominal GDP grew at a 14% rate. There was another shorter and shallower depression in 1937 CAUSED BY RENEWED FISCAL TIGHTENING. It was this second depression that has led to the misconception that the central bank was pushing on a string throughout all of the 1930s until the giant fiscal stimulus of the war time effort finally brought the economy up from depression. The financial dynamics of that huge economic recovery between 1933 and 1937 are extremely striking. Despite their insistence that changes in the stock of money were behind all the cyclical ups and downs in U.S. economic history, even Freidman and Schwartz in their “Monetary History of the United States” conceded that the money aggregates did not lead the U.S. economy out of the depression in 1932-1933. More striking, private credit seemingly had nothing to do with the take off of that economy. Industrial production off the 1932 low doubled by 1935. By contrast, bank credit to the private sector fell until the middle of 1935. Because of the collapse in nominal income during the depression, the U.S. private sector was more indebted than ever on the depression lows. Yet, somehow it took off and sustained its takeoff with no growth in private credit whatsoever. The 14% average annual increase in nominal GDP from early 1932 to 1935 resulted in huge private deleveraging because nominal income outran lagging private.

Fiscal policy is going to undergo a complete reversal as the $850 billion fiscal stimulus package wanes and the scheduled tax increases at the Federal level come into play early next year. It may be much worse if financially strapped state and local governments have to cut expenditures and raise taxes over the same time period – which is highly likely, especially as we get to the states’ budget year end which is mainly to June 30th. By then, if they haven’t got to their mandated balanced budgets, they’ll cut more staff off the payroll as that will temporarily get them to balance (from an accounting perspective). That will exacerbate the double dip, which is coming straight on schedule, as Randy predicted last year in his piece with Eric.

44 Responses

  1. Is this the same Tim Coodon that endorses thi site?

    “Mr Congdon said the Obama policy risks repeating the strategic errors of Japan, which pushed debt to dangerously high levels with one fiscal boost after another during its Lost Decade, instead of resorting to full-blown “Friedmanite” monetary stimulus.

    “Fiscal policy does not work. The US has just tried the biggest fiscal experiment in history and it has failed. What matters is the quantity of money and in extremis that can be increased easily by quantititave easing. If the Fed doesn’t act, a double-dip recession is a virtual certainty,” he said.”

    1. FWIW, here’s a more detailed quote on Congdon’s Friedmanite position vs. Bernanke’s “creditism”:

      Friedman’s position here was almost the exact opposite of Bernanke’s. He spent most of his career condemning economists who in his view placed too much emphasis on credit and so failed to understand how money affected asset prices and economic activity. For example, he had a decades-long tussle with James Tobin, a Nobel-prize winning American Keynesian, on precisely this subject. In another joint work, their 1982 volume on Monetary Trends in the United States and the United Kingdom, Friedman and Schwartz pooh-poohed Tobin’s focus on the monetisation of commercial lending, which Tobin saw as a vital first-round impact of bank credit on spending. Their rebuttal was that money was turned over many times a year. They wrote: ” … remember that the transactions velocity of money may well be 25 to 30 or more times a year, to judge from the turnover ofbank deposits. So the first-round effect covers at most a two-week period, whereas the money continues circulating indefinitely.”
      In short, Bernanke has different views from Friedman on both the merits of alternative money aggregates and the relative significance of credit and money.

  2. Falling M3 shows continued private sector deleveraging, which is needed before a recovery can begin based on healthier balance sheets. The public sector has to take up the slack and make space for this for this in order to prevent debt-deflation. Hardly a new concept. See Irving Fisher, “The Debt Deflation Theory of Depressions” (1933)


  3. More striking, private credit seemingly had nothing to do with the take off of that economy. Industrial production off the 1932 low doubled by 1935. By contrast, bank credit to the private sector fell until the middle of 1935.

    That”s interesting, I’d guess “bank credit” back then wasn’t including Reconstruction Finance Corporations loans. I was just reading how Volcker tried and failed to have the RFC brought back last year.

    Volcker, arguably the most revered Fed chairman in history… suggested that the ad hoc responses to Bear Stearns, Fannie Mae, and Freddie Mac, Lehman, American International Group, and soon the auto companies weren’t going to work. “We can’t keep doing this over a weekend,” he said. Volcker favored a new Reconstruction Finance Corporation, the Depression-era institution that made loans to companies… Larry Summers, the former treasury secretary under Bill Clinton who became Obama’s top economic adviser, wasn’t interested; he thought Volcker was yesterday’s news. Some of the Obama people thought it was Summers who seemed like a rerun.

    Some backfill on the RFC, which Hoover started but FDR expanded:
    Starting in 1933, Franklin Delano Roosevelt kept the agency, increased the funding, streamlined the bureaucracy, and used it to help restore business prosperity, especially in banking and railroads. He appointed Texas banker Jesse Jones as head, and Jones turned RFC into an empire with loans made in every state… The RFC also had a division that gave the states loans for emergency relief needs. In a case study of Mississippi, Vogt (1985) examined two areas of RFC funding: aid to banking, which helped many Mississippi banks survive the economic crisis, and work relief, which Roosevelt used to pump money into the state’s relief program by extending loans to businesses and local government projects…

    [During World War II,] President Roosevelt merged the RFC and the FDIC… The RFC established eight new corporations, and purchased an existing corporation. The eight RFC wartime subsidiaries are Metals Reserve Company, Rubber Reserve Company, Defense Plant Corporation, Defense Supplies Corporation, War Damage Corporation, U.S. Commercial Company, Rubber Development Corporation, Petroleum Reserve Corporation

  4. Not sure if this has been noted, but Brad Delong seems to be getting on board full fiscal policy, though he still needs to take a few more steps.

    “The Flight to Quality”

    After all,… a market tells us which things are valuable and thus gives us the signal to make more of them. … So those governments whose credit is still unshaken … should be creating a lot more of them. …
    How much should they do? As long as there is a clear global excess supply of goods and services – as long as unemployment remains highly elevated and inflation rates are falling – they are not doing enough. And the gap between what they should be doing and what they are doing grew markedly in May.


  5. Replacing M3 with monetary base constitutes a move towards full reserve banking, doesn’t it? Which is desirable in that M3 varies pro-cyclically, i.e. M3 promotes instability. Friedman favoured full reserve, though doubtless ff has its disadvantages.

    1. MMT argues that the money supply is endogenous and the monetary base is not significant because there is no money multiplier.

      As the money supply (and velocity) shrink, e.g., because of private sector deleveraging, then there will be deflation, unless the government intervenes with fiscal policy to shift the debt to its book and increase the circulation that is being cut off before it becomes critical. If this doesn’t happen, then debt deflation will set in, default will increase, and the danger becomes spiraling deflation and economic depression.

      That is why it is crazy to be recommending financial austerity before private sector delevering is ending.

  6. Warren,
    I accept the premise of MMT , that taxes don’t “fund” spending. So, the reason cutting military expenditures in Afghanistan would allow the USG to cut taxes, is because to do otherwise risks inflation?


    1. Patriot,

      Federal Spending creates money and can be inflationary when the economy is at full employment.
      Federal Taxation destroys money and can be deflationary when the economy is not full at employment.

      So cutting federal spending would not create an inflation risk in of itself. However, there are always two inflationary triggers apart from Federal spending/taxing, 1. high energy costs, 2. the Fed doing something dumb.

  7. More striking, private credit seemingly had nothing to do with the take off of that economy. Industrial production off the 1932 low doubled by 1935. By contrast, bank credit to the private sector fell until the middle of 1935.

    Private credit exploded from the low (which was in 1933, not 1932) to 1936 — just not bank credit. It was bonds and equities that funded industrial expansion then as they do now. Banks are irrelevant to industrial production. In the great depression era, as now, they focused on mortgages.

    1. RSJ,
      Are not bond purchases or stock purchases just asset swaps (cash for securities) and not credit expansion of the sort that such ‘loans create deposits’? Resp,

      1. They are not asset swaps, but the creation of new credit. I.e. the borrowing firm “creates” the liability out of pure hope and then sells it to the market. Then it deficit spends the funds.

        The deficit spending creates the flow of income necessary to buy the bond issue in the first place, in an overlapping firm model. Same process as loans create deposits, but without the safety net of a discount window or overdraft protection. On the other hand, this tends to happen with much lower leverage levels.

      2. To clarify, new issues are the creation of new credit, but secondary market transactions are asset swaps — I’m assuming that’s what you were talking about. The role of the secondary market is to make the assets liquid, and this is how they take on the characteristics of money.

        Basically anyone who can issue an IOU that can be readily sold for cash in the secondary market is expanding credit.

      3. RSJ:

        If a firm issues debt, it expands its balance sheet as it credits asset (cash) and credits liability (bond). Say household purchased that debt, they debit an asset (cash) and credit an asset (bond).

        So, the firm has a larger balance sheet, but the household has a balance sheet the same size.

        The quantity of deposits in the system though have not changed, as the firm cash credit precisely matches the household cash debit.

        By cash I am meaning bank deposit not actual paper of course.

        This is what Matt Franko means when he says it is asset swap. He seems correct to me — can you take us through t-tables to show how deposits increase when private credit is extended in this way?

      4. RSJ/Z, I think I see. Is it the establishment of the new liability that expands the issuers BS and hence the national BS. And then if the issuer held onto the funds for a while that adds to the non-govt sector deficit. (S-I) would be negative for the transaction as S would be 0 (no new net savings from the tansaction as long as the issuer held onto the funds), and I would be the proceeds of the bond issue. (?)

        I was focused on ‘money supply’ perhaps (oops!) wrt the loans create deposits. Resp,

      5. “He seems correct to me — can you take us through t-tables to show how deposits increase when private credit is extended in this way?how deposits increase when private credit is extended in this way?”

        Deposits don’t need to increase as a result of this. That’s orthogonal, unless you are defining “credit” to be solely deposits, in which case you need another word for equity, bonds, money market mutual funds, and commercial paper. As well as repos and other credit-market instruments I must have missed. 😛 It’s good to stick to standard usage, as all of these are considered to be “credit market instruments”, and an increase in any of these corresponds to an increase in “credit”.

        I think, if you want to only talk about deposits, then say “deposits”, or “bank credit”, if you prefer.

        Just as with bank loans, the supply of credit market issues expands and contracts as return prospects change, and as a result, the quantity of deficit spending increases and decreases, causing the quantity of cash-flow surpluses to increase and decrease (which helps or hurts the thirsts of savers for more and more and more financial assets :P)

        Any liquid IOU takes on the characteristics of money or “credit-money”, and the stock of these IOUs contribute to the stock of financial assets held by households. If the issuer of the credit market instrument is outside the household sector — say in the business sector, which would be typical for corporate bonds or equities, then an increase in these assets causes an increase in household net financial assets.

        “So, the firm has a larger balance sheet, but the household has a balance sheet the same size.”

        Yup. The borrower’s balance sheet is key. The borrower incurs a liability — to repay the loan, or to repay a bond — as well as an asset — a deposit, or money market fund, however he decides to park his short term assets while he goes about deficit spending.

        But the point is that the borrower does not hang onto his asset. The loan is used to buy a house or car, and the bond is sold to expand industrial production. So the borrower then turns around and spends the asset (technically, he sells it for cash, pays the cash to someone else, and that person buys some financial asset with the cash — maybe a deposit, maybe a money market fund, maybe a bond — who knows?).

        The bank borrower pays the homebuilder or the car maker, who in turn supplies wages and capital income to *someone* in the household sector, increasing that person’s financial assets. In the same way, the bond-seller turns around and invests in productive capacity by paying employees and parts suppliers, etc, and that ends up also increasing the wages and capital income of some households.

        In both cases, investment is self-funding, and the “savings” of the fortunate workers or capital owners whose financial assets increased as a result of the deficit spending ends up being the accounting record of borrowing — whether that borrowing takes the form of selling bonds or borrowing from a bank.

        As an aside, you can look at the various forms of credit market borrowing in table F.4 in Z.1. Hope that helps

      6. RSJ Very helpful thanks

        Ill take that from a national accounts perspective, non-govt sector deficit can be made larger by both bank lending and new debt securities issuance. Resp,

      7. RSJ, I agree with your very nice exposition except for your (perhaps inadvertent) lumping in equity with other financial assets. I do not consider equity to have money-like characteristics as bonds do. Equity is more tangible — it represents an ownership stake in something that creates goods and services. As such, it is not anybody’s liability (i.e. not an IOU), and it is more akin to title in real estate or some other form of property (e.g. a car).

      8. Well Matt,

        for the entire non-government sector, neither bank lending nor securities issuance will increase or decrease the deficit spending since these will all cancel out (in a closed economy).

        If you subdivide the non-government sector into households and businesses, then traditionally businesses deficit spend and households accumulate claims on them.

        Whether businesses deficit spend “too much” depends on how fast the sustainable growth rates are. You want businesses financial liabilities, which are mirror images of the capital stock, to grow at the same rate as that capital stock, and the capital stock will grow with the same rate as the profit rate.

        If this doesn’t happen, you get fluctuating yields and bubbles. But growing deficit spending on the part of businesses is not bad in and of itself — indeed, it must happen if the capital stock is to increase.

        If you subdivide even further, you get some households issuing liabilities (e.g. taking out mortgage loans or auto loans) while other households accumulate those assets. Again, there is nothing wrong with that unless here, too, the growth rate of the liability issuance exceeds the growth rate of the borrowers’ incomes, in which case here too you get asset bubbles.

        So a growing level of deficit spending between the business and household sector, as well as within the household sector, is required in order for an industrial economy to grow, but excess deficit spending, leading to excess financial assets, is where you get into problems.

        It’s at that time that the private sector turns to the government in order to supply it with the amount of deficit spending to which it has grown accustomed during the credit bubble.

      9. RSJ @ 4:45

        Right, and private sector deficit spending grows to excess in stages according to Hyman Minsky’s financial instability hypothesis — which is why government needs to exert vigilance and diligence in policing the system in order to prevent blowouts, instead of just waiting to clean up the mess afterward (as Alan Greenspan believed).

      10. RSJ/Tom/Beo,

        thanks for this discussion here. This one term of the Sectoral balances is a tough one to grasp ie non-govt surplus/deficit…I had a short chit-chat with Prof Mitchell at the Teach-in and he said it could not be measured, he had been at it for 20 years, so I took his word for it! But I think for the govt to have the ability to act proactively with fiscal it has to establish at least a proxy then of some sort.

        To look back at the crisis, in 2008, the current account stayed high at about 60B/mo with the commmodities so high in price; then you had the govt sector at least early in the year (and late 2007) running almost a balanced budget, so applying the identity would mean that you had to have strong non-govt deficits (I think credit creation?) or a violent adjustment would have to take place to maintain the identity…thats what seemed to have happened.

        You had Bear Stearns destruct in March and probably killed the non-govt deficit by shutting down credit issuance (bonds & loans) and forcing redemptions. Commodites stayed strong though and the current account stayed up at the 60B/mo area. So you had the perfect storm, high current account deficit, no non-govt deficit being created due to the shutdown of the credit markets post Bear Stearns, and then a govt sector that wanted to show ‘fiscal conservatism’ into the Nov. elections….system really made a violent adjustment back to balance by Sep/Oct 2008. You can look at the table F.1 of the feds latest z.1 that RSJ refered to and see how non-govt sector credit collapsed from 2007 into 2008 and 2009.

        So unless we can get better/more real time data on non-govt sector deficit (or a proxy) I guess we’re just going to have to throw more people out of a job so the unemployment rate can kick up before govt has any data to work with to justify a fiscal adjustment (workers screwed again).

        Intuitively, I equate ‘non-govt deficit’ with total non-govt net new loans and net new bonds issued. If you had near real time data on this in 2008 when it was collapsing, in light of the still high current account deficit, perhaps an extended/larger Bush tax rebate could have been proposed and most of this avoided. Resp,

      11. Matt, maybe I”m missing something, but I’ve always equated (or perhaps, confused) non-govt surplus/deficit with net private savings, that is, personal savings + undistributed corporate income. What Treval Powers called “alpha leakage”. The flow of funds “Flow Tables,” p. 15 gives you quarterly annualized net private savings (broken down by PS and UCI) as well as governmental savings (broken down by federal and state/local). Just for the sake of completeness you can also find current account balance at the bottom of p. 24.

        Anyway, federal governmental savings is -1363.1. Curiously, adding net private savings, +884.2 plus the inverse of both state/local governmental savings (-6.7 ) and the current account balance (-470.9) gets you…. +1361.8. Make of it what you will. :o)

        Seems to me in that in a perfect storm situation, its like Dylan says, you don’t need a weatherman to know which way the wind blows. If private sector credit freezes up, Tsy and the Fed should have the tools available to step in and plug the leak immediately before the boat starts sinking. In a perfect storm situation, when we’d want to firewall the engines, Tsy (or the President) should have the authority to temporarily drop FICA, or any other tax rate, to zero. The rest of the time, it’d be helpful to have a variable FICA rate tied to quarterly or monthly unemployment rates (ex. if U3 is multiplied by 10 and that percentage deducted from baseline FICA payments; a 7% unemployment, Tsy due only 30% of baseline FICA).

      12. Ramanan,

        Thanks for the reference. I did a very, very cursory check of the argument there, so maybe I didn’t get the gist of it. But I don’t think that a common share of stock is a liability in any real sense. Preferred stock, maybe, but not common. Although a corporation has a legal existence independent of its owners, it doesn’t make sense to say that it has a liability to its owners. Dividends represent a distribution of profits, not some sort of contractual service of a liability.

        Now, stock market wealth is important, just as real estate wealth is important. It is an electronic or paper representation of tangible (albeit volatile) wealth, and there are many banks that will lend money against it as collateral. So a rise in the stock market does faciliate horizontal expansion of private sector credit, but I don’t think it is a form of private sector credit itself.

        I understand if nobody wants to get into this discussion again here, so I’ll try to follow the thread on Bill’s blog.

      13. ESM,

        First, if stocks are financial assets, then those who issue stocks incur financial liabilities. That is indisputable.

        But more importantly, equity is a very real liability — equity really is *the* liability against which all other liabilities are discounted.

        The reason for this is that no one ever needs to sell a bond, but all firms have owners.

        All firms are created with an expectation of profits and growth. To you, those profits may just be a “residual” or “free bonus” item whose value is random, but to the owners of the firm, those profits are the reason for the firm to exist, and when they fail to materialize or when they are lower, in present value terms, than the profits of some other firm, the firm is re-organized and/or closed.

        Not necessarily if they miss a single quarter — there is flexibility, but you would be surprised at how little flexibility a firm has when it fails to meet its cost of equity. I once worked for a firm that would close a business unit if they failed to meet the cost of capital for two successive quarters. And it’s rare for a firm to dissapoint for more than 2 quarters without serious consequences and some form of liquidation. During the great depression, and during the current crisis, the SP 500 was paying more in dividends than it was earning — they were returning capital to investors as they struggled to defend their dividends.

        Even though equity is a long term liability, as soon as the shareholders believe that the long term prospects are less than the market return, management starts getting replaced, unprofitable units are closed or sold off, and the firm begins to restructure. Moreover, meeting shareholder profit requirements is what drives the firm’s investment and capital allocation decisions.

        So just because a firm is not *immediately* forced into bankruptcy should the anticipated dividend increase not materialize does not mean that equity is not a liability.

      14. I completely disagree. I think you’re confusing management with the corporation itself. And I don’t concede that stocks are financial assets in an MMT sense. For example, the value of a stock is independent of any currency. So how could a US stock be a dollar financial asset?

        In any case, by your logic, the title to my car is a liability of the car. It has to be at my beck and call and carry me from place to place. And if it ever doesn’t perform up to my expectations, I may decide to take it to a junkyard and sell it for scrap.

      15. In discussing credit markets, Doug Noland of Prudent Bear distinguishes between money and thing having “moneyness.” It’s a grey area.

  8. Matt Franko,

    Well from a national accounts perspective, wouldn’t also any reduction of private savings make the non-govt sector deficit larger?

    1. Yes Beowulf .. thats absolutely right. The private sector by itself cannot create net financial assets. It can shuffle around. One can imagine a pure credit economy with no government and its possible in theory. For example, the producers have a positive net worth because of real assets that they hold and the households can hold money and securities like corporate paper/bond/equity. Such a system would be highly unstable. It needs a government to complete an economy and stabilize the system.

      Even this crisis which is far from over, it needs a big government to come out of it. There is absolutely no other way. Why would producers issue equity or bonds if they don’t think they will find more consumers. Why will households spend more if the future is so uncertain ?

      1. Ramanan,

        If the private sector can’t create net financial assets by itself (a claim with which I agree), how can equities be considered a financial asset? In theory, equities can be bid higher with not even a single share trading. BP could be marked at 37 at the close on one day, and open at 45 the next with no money changing hands. What accounts for the rise in the value of BP shares? Whose increase in liability is that?

      2. ESM,

        Its actually confusing to think of equity as a liability. If the stock market rises, it doesn’t make a company poorer.

        There are many ways to account for liability increase in the example you mentioned. One is to just assume that the liabilities of BP increased. It doesn’t matter. Its just an internally consistent accounting fact/definition. Its helpful to track all stocks and flows in the economy that way.

        The point is that equities are liabilities in some sense. It is not binding for a company to pay dividend X in any quarter. However, at the marco level, it is beneficiary for producers to pay dividends.

        This brings one the question, since equities seem to create assets whereas, their liabilities are a bit vague, why can’t we have a system which is purely private and no government ?

        The answer is that such a setup will be unstable. Households’ propensities to consume/save fluctuate and so does their portfolio allocation decisions. An increase in desire to save may lead to a lower economic activity unless firms coincidentally increase their animal spirits and invest more. This may lead to a fall in stock prices, though not necessarily so because people are poor predictors of the future. So there are some possibilities including one in which households decide to spend less, producers decide to invest less (as in in fixed capital and through reduced inventories target) and the portfolio preferences of households leads to a decrease in desire to hold equities and in that case, the economy has just one way to go – down.

      3. BP’s.

        The answer lies in the ‘net’. Private can’t create ‘net’ only gross financial assets, which all have a corresponding financial liability somewhere within the private sector. Government issued assets have no corresponding liability within the private sector. So if BP shares go up from 37 to 45, those holding the shares have seen their assets increase while BP has seen its liabilities increase by the same amount. Net Private Increase = 0, Gross Private Increase = old BP share price x (37/45)

      4. And I suppose if the land value of my real estate goes up, then that means the liability of the earth has increased by the same amount?

        My point is that equities cannot be considered financial assets under MMT. A rise in BP’s stock price does not increase the liabilities of BP, either from the standpoint of common sense, or even accounting (which often does not track common sense — under standard accounting, even a short position in put options on its own stock does not count as a liability for the corporation).

      5. ESM:

        Land is real asset. It has no corresponding liability.

        Equity is financial asset. If you issue it, you have corresponding liability. A company would prefer to stay private, have founders own all equity, and not need to share profit with anyone else. Company only raises money through equity issuance if it needs to.

        If share changes price in secondary market, it is of no issue to company as it does not effect corporations equity at all. The only benefit is that if the company needed to use equity to raise additional capital, it would need to dilute itself less if it had high share price in secondary market.

      6. BP,

        Not necessary to consider land value going up as earth’s liabilities.

        It is difficult to have a description of macroeconomics without treating equities as assets. One loses track of flows in the economy. Plus people also consume when they have capital gains. I feel richer if my portfolio goes up in value etc. Not sure why you are thinking along those lines.

      7. Ramanan,

        I do think equities are assets — just not financial assets. I believe financial assets are those that have a corresponding liability. I consider equities to be assets like gold, real estate, capital stock, or intellectual property.

        People feel richer when the value of their houses goes up, and they spend more. Perhaps even more importantly, they can borrow more too. Same with equities, although to a lesser extent.

      8. ESM,

        I think I know some discomfort you are going through. Even I went through it when considering the economy as a whole. To confuse you further, the Federal Reserve’s Z.1 accounts sets equities values to zero in liabilities!

        The confusions can be gotten rid of if you give a list of good questions to yourself. A lot of times intuition and definitions are different. We define things so that it is convenient for us and sometimes it works against our intuition. Of course it is important to make sure that if we define 10 things, those 10 things are consistent with each other – i.e., there is self-consistency.

        For example I can define transaction deposits as money and time deposits as not money etc.

    1. Thanks for the links Oliver. I still have to get around to reading through the Bilbo one. It’s quite difficult to read a 3-month old comment stream for some reason :^).

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