REPEAT AFTER ME: THE USA DOES NOT HAVE A ‘GREECE PROBLEM’

By Marshall Auerback


To paraphrase Shakespeare, things are indeed rotten in the State of Denmark (and Germany, France, Italy, Greece, Spain, Portugal, and almost everywhere else in the euro zone). An entire continent appears determined to commit collective hara kiri (link), whilst the rest of the world is encouraged to draw precisely the wrong kinds of lessons from Europe’s self-imposed economic meltdown. So-called respectable policy makers continue to legitimize the continent’s fully-fledged embrace of austerity on the allegedly respectable grounds of “fiscal sustainability”.

The latest to pronounce on this matter is the Governor of the Bank of England, Mervyn King. This is a particularly sad, as the BOE – the Old Lady of Threadneedle Street – has actually played a uniquely constructive role amongst central banks in the area of financial services reform proposals. King, and his associate, Andrew Haldane, Executive Director for Financial Stability at the Bank of England, have been outspoken critics of “too big to fail” banks (link), and the asymmetric nature of banker compensation (“heads I win, tails the taxpayer loses”). This stands in marked contrast to America’s feckless triumvirate of Tim Geithner, Lawrence Summers, and Ben Bernanke, none of whom appears to have encountered a banker’s bonus that they didn’t like.

But when it comes to matters of “fiscal sustainability” King sounds no better than a court jester (or, at the very least, a member of President Obama’s National Commission on Fiscal Responsibility and Reform). In an interview with The Telegraph (link), the Bank of England Governor suggests that the US and UK – both sovereign issuers of their own currency – must deal with the challenges posed by their own fiscal deficits, lest a Greece scenario be far behind:

“It is absolutely vital, absolutely vital, for governments to get on top of this problem. We cannot afford to allow concerns about sovereign debt to spread into a wider crisis dealing with sovereign debt. Dealing with a banking crisis was bad enough. This would be worse.”

“A wider crisis dealing with sovereign debt”? Anybody’s internal BS detector ought to be flashing red when a policy maker makes sweeping statements like this. The Bank of England Governor substantially undermines his own credibility by failing to make 3 key distinctions:

1. There is a fundamental difference between debt held by the government and debt held in the non-government sector. All debt is not created equal. Private debt has to be serviced using the currency that the state issues.
2. Likewise, deficit critics, such as King, obfuscate reality when they fail to highlight the differences between the monetary arrangements of sovereign and non-sovereign nations, the latter facing a constraint comparable to private debt.
3. Related to point 2, there is a fundamental difference between public debt held in the currency of the sovereign government holding the debt and public debt held in a foreign currency. A government can never go insolvent in its own currency. If it is insolvent as a consequence of holdings of foreign debt then it should default and renegotiate the debt in its own currency. In those cases, the debtor has the power not the creditor.

Functionally, the euro dilemma is somewhat akin to the Latin American dilemma, such as countries like Argentina regularly experienced. The nations of the European Monetary Union have given up their monetary sovereignty by giving up their national currencies, and adopting a supranational one. By divorcing fiscal and monetary authorities, they have relinquished their public sector’s capacity to provide high levels of employment and output. Non-sovereign countries are limited in their ability to spend by taxation and bond revenues and this applies perfectly well to Greece, Portugal and even countries like Germany and France. Deficit spending in effect requires borrowing in a “foreign currency”, according to the dictates of private markets and the nation states are externally constrained.

King implicitly recognizes this fact, as he acknowledges the central design flaw at the heart of the European Monetary Union – “within the Euro Area it’s become very clear that there is a need for a fiscal union to make the Monetary Union work.”

This is undoubtedly correct: To eliminate this structural problem, the countries of the EMU must either leave the euro zone, or establish a supranational fiscal entity which can fulfill the role of a sovereign government to deficit spend and fill a declining private sector output gap. Otherwise, the euro zone nations remain trapped – forced to forgo spending to repay debt and service their interest payments via a market based system of finance.

But King then inexplicably extrapolates the problems of the euro zone which stem from this uniquely Euro design flaw and exploits it to support a neo-liberal philosophy fundamentally antithetical to fiscal freedom and full employment.

The Bank of England Governor – and others of his ilk – are misguided and disingenuous when they seek to draw broader conclusions from this uniquely euro zone related crisis. Think about Japan – they have had years of deflationary environments with rising public debt obligations and relatively large deficits to GDP. Have they defaulted? Have they even once struggled to pay the interest and settlement on maturity? Of course not, even when they experienced debt downgrades from the major ratings agencies throughout the 1990s.

Retaining the current bifurcated monetary/fiscal structure of the euro zone does leave the individual countries within the EMU in the death throes of debt deflation, barring a relaxation of the self-imposed fiscal constraints, or a substantial fall in the value of the euro (which will facilitate growth via the export sector, at the cost of significantly damaging America’s own export sector). This week’s €750bn rescue package will buy time, but will not address the insolvency at the core of the problem, and may well exacerbate it, given that the funding is predicated on the maintenance of a harsh austerity regime.

José Luis Rodríguez Zapatero, Spain’s Socialist prime minister, angered his trade union allies but cheered financial markets on Wednesday when he announced a surprise 5 per cent cut in civil service pay to accelerate cuts to the budget deficit.

The austerity drive – echoing moves by Ireland and Greece – followed intense pressure from Spain’s European neighbors, the International Monetary Fund on the spurious grounds that such cuts would establish “credibility” with the markets. Well, that wasn’t exactly a winning formula for success when tried before in East Asia during the 1997/98 financial crisis, and it is unlikely to be so again this time.

Indeed, in the current context, the European authorities are simply trying to localize the income deflation in the “PIIGS” through strong orchestrated IMF-style fiscal austerity, while seeking to prevent a strong downward spiral of the euro. But the contradiction in this policy is that a deflation in the “PIIGS” will simply spread to the other members of the euro zone with an effect essentially analogous to that of a competitive devaluation internationally.

The European Union is the largest economic bloc in the world right now. This is why it is so critical that Europeans get out of the EMU straightjacket and allow government deficit spending to do its job. Anything else will entail a deflationary trap, no matter how the euro zone’s policy makers initially try to localize the deflation. And the deflation is almost certain to spread outward, if sovereign states such as the US or UK absorb the wrong lessons from Greece, as Mr., King and his fellow deficit-phobes in the US are aggressively advocating.

There are two direct contagion vectors off the fiscal retrenchment being imposed on the periphery countries of the euro zone.

First, to the banking systems of the periphery and the core nations, as private loan defaults spread on domestic private income deflation induced by the fiscal retrenchment. Second, to the core nations that export to the PIIGS and run export led growth strategies. So 30-40% of Germany’s exports go to Greece, Italy, Ireland, Portugal and Spain directly, another 30% to the rest of Europe.

These are far from trivial feedback loops, and of course, the third contagion vector is to rest of world growth as domestic private income deflation combined with a maxi euro devaluation means exporters to the euro zone, and competitors with euro zone firms in global tradable product markets, are going to see top line revenue growth dry up before year end.

Let’s repeat this for the 100th time: the US government, the Japanese Government, or the UK government, amongst others, do NOT face a Greek style constraint – they can just credit bank accounts for interest and repayment in the same fashion as if they were buying some helmets for the military or some pencils for a government school. True, individual American states do face a fiscal crisis (much like the EMU nations) as users of the dollar, which is why some 48 out of 50 now face fiscal crises (a problem that could easily be alleviated were the US Federal Government to undertake a comprehensive system of revenue sharing on a per capita basis with the various individual states). But, if any “lesson” is to be learned from Greece, Ireland, or any other euro zone nation, it is not the one that Mr. King is seeking to impart. Rather, it is the futility of imposing arbitrary limits on fiscal policy devoid of economic context. Unfortunately, few are recognizing the latter point. The prevailing “lesson” being drawn from the Greek experience, therefore, will almost certainly lead the US, and the UK, to the same miserable economic outcome along with higher deficits in the process. As they say in Europe, “Finanzkapital uber alles”.

593 Responses

  1. my presentation is not confused

    govt spending is not operationally constrained by revenues

    any constraints on spending are self imposed.

    self imposed constraints include the no overdraft rule and debt ceiling rules

    these serve no economic or financial purpose beyond introducing the possibility of financial disruption

    monetize means ‘turn into money’ so buying securities is monetizing only if the security purchased was not already considered ‘money’

    monetizing financial assets has no further economic consequences beyond the ramifications of lowering interest rates for the securities purchased.

    for the cb, it’s about price, not quantity.

    except for the latest round of fed swap lines which are invitations to fiscal transfers

    what’s the problem, mates? isn’t that how it is?

    1. “govt spending is not operationally constrained by revenues”

      That’s the one I would change.

      My concern:

      It doesn’t seem consistent to me with:

      “any constraints on spending are self imposed”

      Because:

      I interpret a self imposed constraint as an operational constraint

      But I’m not sure right now what to suggest as my alternative

      1. I can see how “operationally” might seem confusing. MMT’ers often say instead that a monetarily sovereign government that issues a nonconvertible floating rate (fiat) currency is not financially constrained. The only constraints are real (e.g., inflation), or self-imposed (by statue or regulation).

      2. the gov is not constrained at the level of actual monetary operations.

        operationally spending is by pushing buttons or handing out pieces of paper or other tokens.

        ‘financial’ may have implications beyond ‘operational’

      3. I would suggest development of an internally consistent formal taxonomy for operational constraints, financial constraints, self imposed constraints, and real constraints. If already done, I assume somebody’s done a blog post or paper on it. If not, MMT’ers may be underestimating its importance to the coherence of MMT. This might help also with US/EZ/gold comparisons of late.

      4. So it sounds like the overdraft prohibition is a financial constraint, and not an operational constraint.

        Notwithstanding the fact that the Fed prohibits what is generally considered to be an operating line of credit (overdraft) for the government.

        I’d describe it as a self-imposed operational constraint.

        I’d say the government is constrained in that case.

        And it sounds like inflation is a “real constraint” rather than an “self-imposed” one, notwithstanding the fact that policy makers are responsible for setting the inflation boundary they’re comfortable with.

        I don’t think there are operational or financial constraints that aren’t self-imposed – including voluntary participation in the EZ.

      5. Anon: I think that when the MMT’ers say that the government is not financially constrained they are referring to the fundamental distinction between a convertible fixed rate system and a nonconvertible flexible rate system.

        Warren’s definition adds another layer, it seems.

        So, yes, MMT’ers need to specify the technical meaning of key terms. They may be generally understood by specialists, I don’t know, but certainly non-specialists are going take them in their accustomed sense or provide their own interpretation. Then confusion and misunderstanding is bound to result.

        This is another reason I suggest a central repository of this kind of stuff that is easily accessible and permanently available. One aspect of that is a Wikipedia entry for the overview and a web site for a comprehensive resource base, with links to references.

      6. Tom,

        I had exactly the same thought re your repository idea when I raised this.

        I absolutely guarantee you there is no generally accepted dictionary for this stuff.

        To put it as bluntly as I would dare here, it’s MMT constraint-speak, as well as some other words.

        The followers of MMT who’ve been struggling to communicate on the EZ issues in particular deserve better if they are the followers they believe themselves to be.

    2. Warren Mosler: “what’s the problem, mates? isn’t that how it is?”

      One possible problem is that people do not care about operational constraints. People may not be operationally constrained from deliberately running each other down with their automobiles. (Remember the video of the woman repeatedly running over her husband’s body in the motel traffic circle?) But they have lots of voluntary constraints. (There are also legal constraints, but they are imposed by others.)

      So to say that the gov’t is not operationally constrained from something is likely to get a response of So What?

      1. Let’s say that people are operationally constrained from flying their cars – the cars do not OPERATE that way. They can CHOOSE to run over people, or may do accidentally. “Voluntary constraint” is an oxymoron (kind of like “self-regulation”).

        To say that Greece can choose to leave the EU and is thereby not operationally constrained is missing the point. Yes, people can go buy airplanes if they want to fly, but then they aren’t driving cars anymore, and besides they need to learn how to fly. Greece is operationally constrained because to remove the constraint is a very significant change within Greece and throughout Europe (regardless of whether you believe they should or should not do so).

      2. How about voluntary (political) “restraint” instead of “constraint?

  2. Anon: “No. The government first borrows, and then spends under the existing monetary system. That’s a fact.”

    What is a fact is a borrowing/spending cycle. What comes first, morning or evening? Christian calendars say morning, Jewish calendars say evening.

    Gov’t spending depends upon previous gov’t borrowing, and gov’t borrowing depends upon previous gov’t spending.

    1. assume a given time period t:

      government deficit is 50 for period t

      5 is the starting level for the treasury account at the central bank

      Assume best cash flow case otherwise where all taxes T collected in period t are credited on day 1

      Assume government spends before it borrows

      It eventually spends T + 50

      At which point it has an overdraft of (45)

      Unless it borrows before it spends

      QED

      1. What this is actually about is whether government needs to borrow from nongovernment to spend or whether the government spends without borrowing from nongovernment. This is the logical priority that is important. How the temporal priority occurs if government does not borrow from nongovernment to spend is irrelevant to the logical priority, since in the latter case government is “borrowing” from itself, which is just an accounting fiction. Because it is a fiction and not a financial necessity, any imposition on it is voluntary and can be changed without affecting the nonconvertible floating rate (fiat) system. Under a convertible fixed rate system, borrowing from nongovernment is a financial necessity, unless the government obtains an increase in the numeraire of convertibility.

      2. OK, now. That’s a different discussion.

        And I agree it’s the priority.

        It’s the overdraft question, effectively (spending without borrowing).

        What you left out was what we’ve been debating regarding the existing system, which is how the temporal order occurs if the government DOES borrow from non-government – and that fact matters if you’re interesting in understanding the existing system, and it’s borrowing before spending, as I have outlined above.

        There is no temporal priority issue if there is no borrowing. In this case, since there is none, it can’t be relevant.

        But again this is conflation of the possible with the actual – that’s not the system we have, which features what I would describe as a self-imposed operational constraint (overdraft prohibition).

      3. Anon,

        The fact that overdraft is not allowed doesn’t mean that governments cannot run higher deficits. If governments were really “constrained” in some sense of the word, it will show up somewhere. In the US, it does not. The public debt has risen rapidly and the US Treasury and the Fed can still manage to keep the interest rates/yields low.

        One can also look at it another way using the “blur argument”. The private sector may not really know if the Treasury is running an overdraft or not and indeed it behaves that way. Institutions participating in auctions do not really know these facts. In fact the private sector unanimously thinks that the US can “print money”. Even if they don’t think like that, the particpants in auctions “feel” the need to bid because there is a demand. There are many particpants in the auction and each has its own investment goals. Foreign central banks, for example have more funds in their accounts at the Fed because a higher deficits in previous periods increases the demand for imports and the foreign central banks purchase foreign reserves from exporters (indirectly).

        The investors also know that the Fed has a bazooka in its pockets – that it can purchase US treasuries from the secondary markets.

        The overdraft constraint is more a cash management hassle for the US Treasury.

      4. MMT’er assert, as I understand it, that the US government does not borrow from nongovernment. It only seems that way, since Tsy’s are sold at auction, seemingly competing for funds in nongovernment. However, The funds are provided by the deficit spending that is identical to the debt issuance, so it’s a wash at the macro level, just a shift in composition from the initial spending (demand deposits) into Ty’s (negotiable term instruments).

        There could be a temporality issue if auctions fail and the US government cannot place its bonds. MMT’ers discount that as a hypothetical possibility that has an extremely low probability of ever actually occurring. MMT’ers further presume if it did, the government could just remove the offset requirement by vote of Congress., just like they roll up the ceiling when the limit is reached.

        But for all practical purposes, the temporality issue is irrelevant because the government is just shifting currency issued into debt issued at a modest interest premium.

        This operation is not a financial requirement of “borrowing,” because it not the case that the borrowed funds are spent. That is to say, MMT treats the debt issuance as monetary operation for draining excess reserves and storing them as Tsy’s by shifting the composition of assets held by nongovernment with the incentive to earn some interest. The government is willing to pay a fee in the form of interest for this convenience.

      5. Ramanan: “The overdraft constraint is more a cash management hassle for the US Treasury.”

        Well stated.

        A monetarily sovereign government with a fiat currency has a lot of wiggle room and work-arounds, and if required, it can alter self-imposed constraints. “Emergency powers” covers a lot, for example. In addition, there are no penalties for transgressing the rules, and voters are very unlikely to hold anyone accountable for such things at the ballot box. However, if the government follows the rules rigidly and stiffs the voters by creating economic havoc, voters will definitely hold politicians accountable

      6. “The fact that overdraft is not allowed doesn’t mean that governments cannot run higher deficits.”

        you’ve missed the point

        I’ve said repeatedly the constraint is against deficits with overdraft; not higher deficits

        the issue of the overdraft constraint is not higher deficits – its deficits with money instead of bonds – that’s what the overdraft constraint is there for and that’s why it’s bonds before spending

        and now somebody’s going to chime in and say money instead of bonds is irrelevant, which is also not the point – the point is to know the facts

      7. “The overdraft constraint is more a cash management hassle for the US Treasury”

        it’s not a cash management hassle

        it’s cash management

        it’s a constraint to fund with bonds rather than spend into an overdraft and an open ended credit line

      8. Anon: “and now somebody’s going to chime in and say money instead of bonds is irrelevant, which is also not the point – the point is to know the facts”

        “it’s a constraint to fund with bonds rather than spend into an overdraft and an open ended credit line ”

        Yes, it is irrelevant since it is just a matter of appearance financially and not a financial constraint in a fiat system where government “borrows” its own funding. It is an operational constraint, however, imposed by Congress, since it involves different monetary operations than “overdrafts.” But “borrowing” and “overdraft” have a very different meaning in nonconvertible floating rate system where only government is involved. Essentially, these are fictions since it is just the left hand passing funds to the right. This can be done in front or behind one’s back, but essentially the “passing” is the same, the left giving to the right.

      9. This discussion has been useful for sharpening our definitions and tightening up our language, but the operational constraints we are quibbling about does not have real world consequences.

        I believe that even if the US doubled, tripled or quadrupled its budget deficit next year, there would still not be a hiccup in any auction that the Treasury would hold. Does anybody dispute this?

        The same cannot be said for any Eurozone country. There are simple ways in which the Eurozone could rewrite its rules, so that a EZ country would have this freedom (e.g. ECB provides non-recourse lending on all EZ-govt debt), but cultural and political differences preclude such unifying rules.

        The main difference between the EZ and the US is this: the US govt can tax people in New York and California in order to subsidize people in Iowa or Florida, and nobody complains; but the Germans and French will not allow the EZ to tax them in order to pay for Greeks to retire at age 50.

      10. ESM

        it has implications for whether the US government finances by bonds or central bank credit line; that’s relevant as a matter of fact

        it has no implications for the ability of the US to finance its desired deficit per se – unless Congress chooses to default (which it won’t)

        it has no implications for the ability or inability of EZ countries to finance their deficits per se – if neither the market will take their bonds (at a decent price or at all) or nor will the ECB finance them through overdraft or credit line – because the individual countries have lost their ability to open ended deficit spend in either way, either because of imposed limits on the size of individual fiscal deficits or imposed prohibitions on central bank backup

      11. Ok Anon – Minor misunderstanding 🙂

        I continue to see your points otherwise 🙂

      12. ESM Reply:
May 24th, 2010 at 2:09 pm

        “I believe that even if the US doubled, tripled or quadrupled its budget deficit next year, there would still not be a hiccup in any auction that the Treasury would hold. Does anybody dispute this?”

        I read Ramanan warning of Bond vigilantes in the US. Let’s not confuse small probability and small effect. They are usually inversely related. MMT proponents allegedly equate small with zero, as I gather from this thread.

        “The same cannot be said for any Eurozone country. There are simple ways in which the Eurozone could rewrite its rules, so that a EZ country would have this freedom (e.g. ECB provides non-recourse lending on all EZ-govt debt)”

        Glad to hear it from someone else.

        “but cultural and political differences preclude such unifying rules.”

        Yes, America is the unavowed state controlled economy, not Europe.

        “The main difference between the EZ and the US is this: the US govt can tax people in New York and California in order to subsidize people in Iowa or Florida, and nobody complains; but the Germans and French will not allow the EZ to tax them in order to pay for Greeks to retire at age 50.”

        That 50 years of age estimate is underestimated by 3 years and even then it is a hoax that the media has not bothered to double check :

        “The socialist government said it wanted to increase the average retirement age from 61 to 63 by 2015.”

        http://news.bbc.co.uk/2/hi/europe/8506142.stm

        There exists transfers, mostly as a result of the common agricultural policy and to help East-European newcomers.

        More importantly, Germany could be asked to increase its deficit to reduce its CA surplus, and lift up the rest of the EZ economy. Meanwhile, they would have to change the rules, as you say, so that solvency becomes a credible claim. Although, here, you might argue, we’re committing an innocent fraud, as trade deficits don’t matter.

      13. Bx12.

        I didn’t warn of of bond vigilantes. I basically meant to say that markets may go crazy and I don’t rule that out and that Ben Bernanke is ready with a bazooka in his pocket and knows how to handle – perhaps with a simple announcement.

      14. Bx12 — remember, trade deficits don’t matter when you have a floating exchange rate. They do matter in the case of intra-EZ accounting because the exchange rate is fixed. So, yes, getting the Germans to reduce its CA surplus with Greece would help, but how are you going to do that if you can’t lower costs/prices in Greece versus Germany?

        I exaggerated the average retirement age in Greece, although my understanding is that in certain hazardous jobs (which includes hairdresser because of the exposure to dangerous chemicals), the retirement age can be as low as 50 year. In any case, the retirement age in Germany is 67, so quite a bit higher than in Greece, even after so-called austerity measures have been implemented.

      15. “Ramanan Reply:
May 24th, 2010 at 3:54 pm
        Bx12.
        I didn’t warn of of bond vigilantes. I basically meant to say that markets may go crazy and I don’t rule that out and that Ben Bernanke is ready with a bazooka in his pocket and knows how to handle – perhaps with a simple announcement.”

        Yes you did, literary, here

        “Ramanan Reply:
May 23rd, 2010 at 12:08 pm”

        And I don’t see a contradiction with what I reported : the bazooka is for a small probability consequential event.

        “ESM Reply:
May 24th, 2010 at 4:24 pm
        Bx12 — remember, trade deficits don’t matter when you have a floating exchange rate. They do matter in the case of intra-EZ accounting because the exchange rate is fixed. ”

        Well said.

        “So, yes, getting the Germans to reduce its CA surplus with Greece would help”

        Then why not start with that instead of opting out of Euro to who wants to listen.

        “but how are you going to do that if you can’t lower costs/prices in Greece versus Germany?”

        It is the Germans who lowered their costs in 2000 (see below), which increased their CA surplus, and allowed them to limit their deficits growth.

        Increasing demand via deficits will put pressure on prices. The increased income, induce them to travel to Greece, say. Is this line the usual line of reasoning?

        In 2008, in 2000, the Germans were over-exposed to subprimes, Tech/Telecoms, respectively, relative to the rest of Europe, and went into increased saving to pay back their debts. They have a responsibility.

  3. Curious: “Once the system is set up (I assume that means the Treasury having money in its account) you can always frame it so that you can claim either (spending first or borrowing first, because money is fungible).

    “But answering the question “how did the gov’t get the very first dollar to spend” clarifies, that it is really borrowing that must precede spending and not the other way around.”

    Where did the dollars come from that the gov’t borrowed? How did they get into the hands of the lenders?

      1. It is not irrelevant to Curious. Nor to others who believe that the gov’t is at the mercy of others to fund its spending. The gov’t is not at the mercy of others and that is a very important point, given current fears.

    1. Min: “Where did the dollars come from that the gov’t borrowed? How did they get into the hands of the lenders?”

      The lenders borrowed them from the Fed.

      1. Such arguments are dangerous, for it implies the buyers of Treasuries are indebted to the Fed forever, which certainly is not the case.

  4. BTW,

    I can’t believe there is anybody else on this blog that doesn’t hate Greenspan.

    But suspend disbelief on this point:

    What AG said once is that modern fiat systems replicate gold standard system objectives

    Regardless of how effective one or the other is, or how credible he is, the meaning of that is clear in my view:

    it is that independent central banks and their governments have a self-imposed operational constraint that forces the “customer” of the central bank, the government treasury, to borrow by bonds instead of open end deficit spending into a credit line with the central bank. The treasury in the current system is a deposit customer of the central bank – not a credit customer.

    One MMT proposal is “no bonds”.

    This proposal effectively amalgamates the treasury and the CB, eliminates the deposit customer relationship on consolidation, fully consolidates an open ended credit line for the government (with itself now), and basically turns the government into a bank for itself – it deficit spends into money and reserve/deposit creation

    1. Now you being unfair to the MMTers. They have always said that governments and politicians behave as if they are in gold standard.

      1. wasn’t intending on being unfair

        I thought they said a lot of the constraints were irrelevant because they were gold standard like

        implying that the governments and politicians didn’t know what they were doing

        I certainly get the vibe that MMT believes these guys don’t know what they’re doing – hard to believe they (these guys) are smart enough to understand that the existing system is designed to replicate the gold standard, to a degree

        that’s a little different, isn’t it?

      2. I don’t know how to answer that. Whatever the explanation is – it’s a complex behavioural one. The central bankers and Treasury officials may say one thing in speeches and articles and behave differently in action. They wanna win elections so they relax the fiscal policy. They want to satify lobbies and they tighten – Predator State as James Galbraith says.

        Alan Greenspan also said once that there is nothing preventing governments to spend without limits. I don’t have the exact quote at the moment.

        Not related to this directly – the “rules of the game” never applied in the Gold-Standard era! The specie-flow or the Mundell-Fleming doctrine didn’t apply.

        Assume that there are two nations in a gold-standard setup and they have sufficient gold. The different sectors of the two economies will behave exactly the way it behaves in the modern setup. Both countries can do well and chose their fiscal and monetary policies (assuming imperfect capital flows).

        Now comes the part where a nation is running out of gold. In that scenario, the governments would tighten both fiscal and monetary policies. However policies are exogenous but debt ratios endogenous. The behaviour of govt/CB when there is a loss of gold reserves is different from what happens in the present world. Now, I would imagine that they in fact had overdrafts in the gold-standard era and most countries still have overdrafts.

        So basically I am saying – mainstream economists didnt know how it operated in the gold standard, don’t know how it operates now and don’t really know the difference.

        What mainstream guys don’t understand is that deficits and public debt are endogenous – outside the control of governments. However, they treat the citizens with a Scourge of Monetarism.

      3. “The behaviour of govt/CB when there is a loss of gold reserves is different from what happens in the present world.”

        Is it? Choose your poison.

        Gold flows out and the authorities tighten.

        Suppose the CB is wedded to CPI.

        CPI increases and the authorities tighten.

        The gold standard is actually a price rule. The gold flow indicates there’s pricing pressure one way or another.

        It’s actually the flow of gold that is critical to the official response – because that indicates pricing pressures similar to CPI. The stock of gold behind those flows is immaterial – i.e. the gold ratio is immaterial to the signal provided by the gold flow. Much like the stock of bank reserves in today’s system is immaterial, at a different level.

      4. Here it is – Government cheques don’t bounces + Greenspan + Billy Blog

        http://bilbo.economicoutlook.net/blog_archive/blog_entry.cfm?ID=68

        Mar-05-2005

        Government cheques do not bounce!

        In testimony to the US House of Representatives Budget Committee on Wednesday, the Federal Reserve Chairman Alan Greenspan confirmed the obvious in an answer to Wisonscin Republican Paul Ryan (who is a social security fund privatisation zealot). While the full transcript is not yet available he is what transpired:

        RYAN: do you believe that personal retirement accounts can help us achieve solvency for the system and make those future retiree benefits more secure?

        GREENSPAN: Well, I wouldn’t say that the pay-as-you-go benefits are insecure, in the sense that there’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody. The question is, how do you set up a system which assures that the real assets are created which those benefits are employed to purchase.

        Thanks Alan, government cheques do not bounce!

        Blog entry posted by bill.

      5. price = price of gold

        an outflow of gold indicates upward price pressure on gold, which is offset by central bank selling at that price

        upward price pressure on gold corresponds to upward price pressure on CPI

        both require policy tightening

        “there’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody”

        right, by Congress doing away with the overdraft constraint – if you don’t define bonds as money, that’s the only way of doing it, and that’s what he meant

        but it’s still a constraint on normal operations until that day when Congress does away with it – no contradiction there

        it DOESN’T mean that’s how it works now; it can’t work that way now – there’s an overdraft constraint and the deficit is bond financed – and it was no different under Greenspan

        Greenspan is talking about a CONTINGENCY for changing the rules

        MMT SEEMS to present it as normal course, as in Bill Blog note (correct me if you perceive it differently) – it’s not

      6. based on previous info, it seems there was only one recorded example of an inadvertent overdraft

        so the further point is that the whole check bouncing meme is moot so far – because the cash management prowess of treasury and the effectiveness of bond financing are sufficiently strong that even the technical possibility of a bounced check only occurred once in the past

        if it comes up in the future, sure; they can change the rules

        none of this changes the discipline of bond financing that is now in place and which is the actual operation of the system

      7. I suppose the problem with the EZ countries is that they don’t have their own central banks and they don’t have their own Greenspans to be able to make such a statement

      8. Anon:

        I think you answer your own point. The discipline of bond financing does not come from the rule, as it will be bent or broken if need be, it comes from the mental paradigm that the players (and rule writers) are operating in (which means they will never test the rule).

        This is both much stronger, and much weaker than any operational constraint. RSJ made this point very well in an earlier discussion.

        The US is a MMT/fiat system being run as if it were a gold standard, by people who don’t really understand the difference. Formal and informal rules, at the extreme, are in contradiction with one another.

      9. of course the discipline comes from the rule; its the law

        its only broken by error or incapacity – not by intention; that’s the effect of a law

        there is no “mental paradigm”, whatever that is

      10. Anon,

        There are some assumptions you are making about the Gold Standard. The price of gold was fixed diplomatically. Imagine there are two countries. The price of gold in one and the exchange rate fixes the price in the other country.

        There is no relation of the price of gold and the price of actual products. The argument for a relation relies on Monetarism and the money-multiplier hypotheses. And monetarism implicitly assumes full employment.

        If one country exports to another country, there is no price pressure. The increase in income increases employment.

        Btw, whats the defining bond as money in your recent comment all about ?

      11. Ramanan,

        “There is no relation of the price of gold and the price of actual products. The argument for a relation relies on Monetarism and the money-multiplier hypotheses. And monetarism implicitly assumes full employment.”

        I didn’t say there was. I said there was a correspondence – I suggested central bankers who adopted the gold standard did it in an attempt to control inflation; they effectively attempt to do the same thing today in large part using the CPI as the inflation measure; I didn’t say or imply I believed in monetarism.

        “If one country exports to another country, there is no price pressure. The increase in income increases employment.”

        I didn’t say otherwise. I said gold flows reflected pricing pressure on gold (pricing pressure inherent in net supply/demand forces from non government.)

        Re “the defining bonds as money” comment, i.e.:

        “there’s nothing to prevent the federal government from creating as much money as it wants and paying it to somebody”

        “right, by Congress doing away with the overdraft constraint – if you don’t define bonds as money, that’s the only way of doing it, and that’s what he meant”

        That’s Greenspan’s alleged comment in the first line.

        It’s not true unless you open up the gates to allow the government to write cheques but not borrow – i.e. go overdraft or use a central bank credit line – otherwise the government per se does not create money, only the central bank does

        Somebody else in the comments wanted to define (include) bonds as money; in any case, if you define/include bonds as money, the government is printing money all the time

        Maybe it’s the define = include that confused you

      12. The Government IS printing minting all the time, just on metal and not paper. The US Mint, (an agency within Tsy), creates money with every coin it stamps, which the Fed buys at face value, contra federal reserve notes, which it buys at the paper and printing costs). And don’t get me started about platinum coins (see my comment above). :o)

    2. From what I’ve understood, MMT argues from the position that fiat currency is both a theoretically consistent construct as well as a concrete system which was imposed in most modern economies because of the obvious flaws of what preceded it. It has some inherent systemic risks (e.g. inflation) and limitations (all real) but also offers many possibilities that other systems don’t or at least weren’t designed to (e.g. the indefinite credit line / pushing buttons). From this theoretical vantage point, MMT ventures out to dissect the history, meaning and merits of all institutions and regulations that are in place (>reality) some of which certain MMTers posit stand in the way of the system unfolding its full potential. Most of the latter can be placed in the categories ‘gold standard remnant’ or ‘political necessity’. By studying the inherent ‘physics’ shall I say of the pure, theoretical system, MMT boldly concludes that many of these constraints can be either done without or at least ignored (in theory) / worked around (in practise). There is some dissent about who is aware of this and who isn’t.

      Think of fiat as the aeroplane that aeronautical engineers have proven can fly safely wherever the pilots tell it to but that the general public, and with it politics, have yet to trust. So to keep it from crashing, we keep it chained to the ground and watch it fly around in circles. The EU engineers have an even safer system in which they staple the wings to the runway and then cheer about its apparent stability. What you’re saying, or at least what it sounds like to someone who has been successfully indoctrinated by the MMT scientists, is that the chains are part of the original design.

    3. “I can’t believe there is anybody else on this blog that doesn’t hate Greenspan.”

      Greenspan was not the one pulling the strings and making the big bucks. He’s closer to the clueless middle-manager that gets great pleasure out of the small perks afforded to him while more ruthless men steer the ship, and others do the actual work.

      It’s hard to hate someone who is in way over his head and just along for the ride.

      Also, he is a bit cuddly.

  5. Here is a summary of Anon’s points/issues/concerns according to me.

    (rt Anon ?)

    ————–

    In the present system, the US Treasury releases auction calendar which has the date and its forecasts of how much issuance will happen in those dates. The Treasury also has constraints of not going overdraft on its account at the Federal Reserve. So it also has to work on efficient cash management. The Treasury has forecasts of tax payments and outlays – pure government expenditures and coupon payments. In addition, it has the hassle of rolling over expiring securities.

    Now, assuming that bid to cover ratios are in the comfortable ranges, is there a limit on spending? What is the mechanism to make sure that the bid to cover ratios stay in the same range? If the government spending increases by 20%, will the bid to cover ratios remain the same? If they fall, how much do they fall? Does anyone actually think that they will rise?

    True, government deficits increase the private sector net worth by the same amount. But does the private sector bid all the dollars created in future auctions? That doesn’t seem so right because the private sector consumes as well. The private sector invests in other securities as well. Production firms need to finance their production. They raise money in the corporate credit market. They issue equities as well.

    If the Fed increases reserves, does anyone think that it will change the bid-to-cover ratios?

    In the recent years, the US federal deficit increased but the investors also bought Treasuries a lot. One can’t depend on a flight to quality forever.

    If someone argues that the overdraft rules don’t matter, is it still possible for the US government to spend without the Fed monetizing the debt? How long can primary dealers agree to finance their auction purchases by financing it with repos with the Fed ?

    ————

    Now these are complicated questions. However insightful answers exist and one has to look at the economy as a whole and consider each sector’s income, wealth, expenditures, financing etc – a point I have been trying to make.

    Now one can give some partial answers but I am sure central banking operations won’t satisfy Anon, because he/she seems very good at it.

    1. Ramanan,

      You should have discerned that my theme is larger than what you’ve attributed there.

      But on that specific issue, I’ve done two listings in previous comments:

      May 24th, 2010 at 10:57 am

      assume a given time period t:

      government deficit is 50 for period t

      5 is the starting level for the treasury account at the central bank

      Assume best cash flow case otherwise where all taxes T collected in period t are credited on day 1

      Assume government spends before it borrows

      It eventually spends T + 50

      At which point it has an overdraft of (45)

      Unless it borrows before it spends

      QED

      AND

      May 22nd, 2010 at 9:25 pm

      Here’s the operational sequence in the current system:

      – Government borrows

      – Non government deposits and reserves are debited

      – Treasury general account is credited

      – Central bank injects required system reserves via system repo

      – Government spends from treasury general account

      – Non government deposits and reserves are credited

      – Treasury general account is debited

      – Central bank withdraws excess system reserves via system reverse repo

      Now, regarding your comment:

      All market players generally strive for “efficient cash management”. That’s what the $ 5 billion is about in the case of Treasury.

      I’m not sure why you invoke bid to cover. You seem to be getting into the area of debt limits or the market’s capacity to absorb debt in general, which is of no concern to me in the case of the US government, and I’ve said so many times. The idea that deficit spending creates income and saving and net financial assets equivalent to the deficit is indisputable and I’ve said so specifically. The required deficit flow is fully matched by an increase in net financial assets, and I’ve said so. The stock capacity of the economy to absorb government debt will adjust accordingly. That the incremental flow requires bond financing is a constraint – but it doesn’t mean that constraint will prevent successful bond financing, and I’ve said so many times.

      My thinking on the bond issuance operations is partly outlined above – in the two excerpts.

      Here’s additional:

      Dealers do not generally finance 100 per cent of every auction on their own books. They do not do so by Fed repo, or any other way. The general situation is that dealers find end buyers before hand for Treasury bond issues. So the idea that central bank repo financing of treasury auctions is the norm for the bulk of bonds issue is simply not on.

      The norm is that end buyers buy the bonds via dealers.

      Treasury is constrained by the overdraft rule to sell such bonds to cover deficits ex ante, as outlined in my excerpt above. This is because bond financing is done in bulk, and in excess of average cash levels held by treasury. So it is logically sequenced ex ante relative to corresponding deficit spending.

      The idea that dealers are there to finance otherwise failed auctions first of all needs to be heavily qualified, and second is irrelevant to the base case for existing monetary operations. The base case is that the normal behaviour of the treasury is to issue bonds according to the overdraft constraint. The idea that either dealers or Congress are there to provide ultimate backstop in case the “natural” demand for bonds fails does not change the base case operation. Treasury must sell bonds according to the constraint – unless it makes an inadvertent cash forecasting error, or until is simply can’t float bonds successfully in the market. MMT should describe it this way rather than meld the contingency case seamlessly into the base case, as it seems to do in my impression.

      Ramanan, it seem to me you’re venturing into some interesting thinking about economics that relates to the capacity of non government to absorb government deficits and/or government debt. That’s fine, but it’s beside the point here. For the umpteenth time, I have no problem at the core with MMT thinking on that question. The size of government deficits and debt is not the question here. It’s the operational nature of the overdraft/bond constraint, the nature of “contingency plans” to deal with that constraint if it is breached, and the relationship between normal operations and contingency operations.

      “If someone argues that the overdraft rules don’t matter, is it still possible for the US government to spend without the Fed monetizing the debt? How long can primary dealers agree to finance their auction purchases by financing it with repos with the Fed ?”

      I don’t know what “doesn’t matter” means, but if the overdraft rule is eliminated as a rule, only then is it possible for Treasury to willfully not issue bonds and instead willfully “monetize” the debt.

      Primary dealers generally finance their auction purchases with the Fed under their own volition, bearing in mind the brand and economic value of primary dealership and the functional role they are expected to play in distributing bonds in general. They will NOT finance bonds indefinitely and in an open ended unlimited fashion due to an Armageddon case of chronic failed customer demand – unless the Fed fully guarantees them against interest rate risk on the bonds. I doubt that sort of guarantee has ever happened.

      More generally:

      Governments have a self-imposed constraint (according to MMT) of issuing bonds, even though they’re not operationally constrained (again according to MMT) and/or they’re not financially constrained (again according to MMT). A meaning can be derived from this cluster of constraints with some hacking and rearrangement of language and logic. This part of MMT really isn’t theory; it’s scenario analysis. And it should be straightforward for people who understand monetary operations. We should be able to construct a language and logical framework that is an unambiguous description of standard versus contingent monetary operations in the present system, and differentiate it as necessary from any type of MMT structural proposal (such as permanent no bonds).

      1. Anon,

        Your sequence is wrong. There must be either an overdraft or a repo by the Fed so that Tsy sec’s can be purchased in the first place, unless the reserve balances were already circulating (and in that case, how did they get there?). Treasuries only settle at auction via Fedwire.

      2. “So the idea that central bank repo financing of treasury auctions is the norm for the bulk of bonds issue is simply not on.”

        Nobody in MMT said that. What we’ve said is that Tsy securities settle at auction via Fedwire, which requires either prior reserve balances or an overdraft for EVERY SINGLE purchase.

      3. The sequence is not wrong.

        The first four steps are all on auction settlement day.

        The Fed won’t decide on its net injection until all other settlement information is compiled – so that it knows in full what it’s netting against.

      4. “Nobody in MMT said that.”

        Sorry for misleading.

        It’s a general counter to an exaggerated case that I sense has been brought in discussion at times

        Not attributable to any MMT professional -apologies

      5. Yes, but that’s not what I’m referring to. The actual settlement of a Tsy purchase requires reserve balances . . . if it occurs before the repo then there’s an overdraft. You haven’t stated where the rbs are coming from. It’s like discussing how someone buys a candy bar but continuously neglecting to explain how they happen to have or otherwise obtain the funds to make the purchase.

      6. OK, don’t worry about my 8:38. You did say reserves are debited. SORRY! (The eyes are the first things to go, I hear!). I’m in agreement, though I have to re-check the sequence in my research, because the Fed does repos around 9am (earlier? It’s been a while since I looked), and I don’t recall if all those things happen after/before. Assuming that checks, I’m in agreement with the sequence.

      7. the treasury settlement is locked in at the day’s open

        the Fed injects required reserves during day, after it compiles all necessary information, which includes more than just the auction settlement info

        the treasury settlement puts the SYSTEM intra-day short at the beginning of the day

        it doesn’t necessarily put SPECIFIC buyers – bank or non-bank – short

        but even if SPECIFIC BANK buyers are short at the beginning of the day, they seek to cover their positions during the day by sourcing their required share of available and adequate system reserves that the Fed injects that day

      8. By placing “govt borrows” before the “reserves are debited,” are you referring to the fact that the auction is prior to the auction settlement? Otherwise, the ACT of “borrowing” and the act of crediting the Tsy’s account would seem to be simultaneous.

      9. We’re posting at the same time . . . should just email to avoid missing each other’s points!

        8:48 comment sounds good to me. Ignore my 8:51.

      10. “By placing “govt borrows” before the “reserves are debited,” are you referring to the fact that the auction is prior to the auction settlement? Otherwise, the ACT of “borrowing” and the act of crediting the Tsy’s account would seem to be simultaneous.”

        who’s on first with our comment timing here!

        I didn’t give that much thought and don’t think it matters too much.

        The trade date obviously precedes settlement date

        The settlement day timing is the same as the first 4 items in the list, but as I noted above, on an intra-day basis, it is the first logical thing to be locked in as the Fed’s system settlement information to be looking at that day in order to determine their net reserve injection

    2. I’m still failing to see how MMT disputes any of the facts there, though I would have a different answer regarding bid to cover. And spending already DID increase by roughly 20% from 2008 to 2009, while the deficit went from below 2% of GDP to about 10%. Bid to covers are higher now and have been for some time, if anything. Those are also facts. And you can say, “sure, but will it continue?” but there’s no analysis backing up the implied view behind the question (and if there is, I’d like to see it). (And, regardless, MMT argues that, at worst, in the GENERAL case, the interest on the national debt CAN BE a policy variable. In the case of a SPECIFIC nation, the govt/cb can choose not to do this via self-imposed constraints.)

      MMT says that, in the GENERAL case (not applying to any particular country), a govt that issues its own currency and allow the fx value of that currency to be flexibly set in fx markets does not have an operational constraint on its ability to deficit spend. In a SPECIFIC case, a govt can choose to put constraints upon itself at the policy level that prohibit this from actually occurring.

      I honestly can’t see how there can be any other interpretation of Warren’s comments at #51, and it’s the same thing we’ve been saying for years.

  6. Ramanan,
    Your post here re-focuses my attention on the key role the Primary Dealers play in the current process. Ive posted the Section of the Fed Res Act that says the Treasury may elect to use the Fed Res System as the govts Fiscal Agent. And if you look at it that makes alot of sense as it fits right in with the banking system and is efficient, etc…but the PD network they have established is a key intermediary because the Fed (it’s in a bankers blood) wants Treasury to maintain a positive balance, so be it. It is very easy to accomplish if your Dealers are working in your direct interest only.

    The Treasury and Fed (both here and Greece imo) have lost control of their Primary Dealers. They need a “re-boot” here. Start all over again. Fire them all, they have proven themselves unworthy of this lucrative govt business. Even if they have to capitalize them themselves (PDCF: thats like your real estate agent calls you early Sunday am to ask to borrow your car because he lost his playing poker the night before and now has no car to take a buyer out to show your property later that day), they need to get firms involved in this that understand that they are just a “utility” type of business that is there to provide a very mundane, reliable service of govt securities brokerage in support of Treasury and CB operations, no glamour, no golf tournament sposnsorships, no Madison Ave commercials, expense accounts, bazillion dollar bonuses, etc.

    Tight spreads, large volume…it is a sweet set-up for a lean and mean operation to make a ton of money, with little to no risk. All computer based. Only the Wall St “gang that couldnt shoot straight” could screw up this virtual money mill like they have.

    If they had PDs that were truly on board with the program, alot of the currently perceived “problems” would go away.
    Resp,

  7. Anon,

    I just wanted to bring out a few things for discussion and that’s why I brought out primary dealers. As you said, the PDs just buy it for their customers keeping their demand in mind.

    Yes I actually wanted to venture into the capacity of the non-government sector to absorb the debt and to go into a discussion that they have absolutely no problems absorbing the debt in case of the US. In fact I am 200% sure that it is important to discuss when doing the comparison between the US and the EZ. That’s how the discussion started! I couldn’t convince Bx12 about this but will continue to try.

    In fact (attn: @Scott May 25th, 2010 at 8:21 am)

    the present system is almost equivalent to a system where the government has an account at commercial banks. There is one rule needed to define this equivalent system – when banks purchase government debt, their assets and liabilities increase and there is no change in reserves. In such cases, questions/comments such as “where do the reserves come from to purchase govt debt” cant be asked.

    Yes I know that the numbers changed from 2007-2009. What I wished to point out is that the US still managed to sell the debt without going overdraft not because of reserve effects but because there was an increase in demand as well. Reserve dynamics alone cannot explain it because banks hold very little government bonds.

    1. “There is one rule needed to define this equivalent system – when banks purchase government debt, their assets and liabilities increase and there is no change in reserves. In such cases, questions/comments such as “where do the reserves come from to purchase govt debt” cant be asked.”

      Not exactly. Tsy’s still settle at auction only with reserve balances, so even though if you take before/after pictures of balance sheets, no reserve balances were added, the actual process does require them. An alternative is to allow banks holding TTL account balances to replace these balances with Tsy’s, but in this case the TTL is evidence of a previous deficit. Apologies if I am missing something in your argument.

      1. Scott,

        I agree in general about money having being created by previous deficits etc.

        What I am saying is that there can be a setup where the Treasury just runs from a bank account – it doesn’t require that the settlement happen in HPM. Taxes are transfered to the TTL account and proceeds from bond issues also lead to increases in government’s deposits. The accounting identities still hold, but it makes Anon’s points and his complaints clearer.

      2. I misspoke at 10:27am when I said:

        “An alternative is to allow banks holding TTL account balances to replace these balances with Tsy’s, but in this case the TTL is evidence of a previous deficit. Apologies if I am missing something in your argument.”

        Meant to say that “An alternative is to allow banks holding TTL account balances to ADD TO these Tsy balances,” which is essentially what you are saying, too.

      3. yeah, I wasn’t following that

        also, I tend to view these things using non-bank transactions as the default as opposed to bank transactions

        my perception, rightly or wrongly, is that many tend to use bank transactions as the default

        it’s more than a subtle difference of course

        particularly in the case of the government, which is a bank customer (both commercial band central) in the current system

        but morphs into its own bank in a consolidation system

    2. “There is one rule needed to define this equivalent system – when banks purchase government debt, their assets and liabilities increase and there is no change in reserves. In such cases, questions/comments such as “where do the reserves come from to purchase govt debt” cant be asked.”

      In such a system, the central bank is not involved in the clearing/settlement process.

      Reserve balances are required to make settlement, but no differently than is the case for any other commercial transaction in the existing system. The buyer’s bank’s reserve account is debited, and the government’s banks’ reserve accounts at the commercial banks are credited. This results in a redistribution of existing reserves in the system, but unlike now doesn’t change the level of reserves in the system.

      The government in such an arrangement is not paid in reserves; it is paid in “clearinghouse funds” (an old expression I think), payment that must be mirrored by reserve fund payments for the banks involved.

      Technically, the government is not paid in reserve funds now for settlement. Reserve funds are debited for the paying banks, but the funds that are credited to the government’s central bank account are not technically bank reserve funds.

      1. slight qualification to my:

        “In such a system, the central bank is not involved in the clearing/settlement process.”

        the central bank/clearinghouse must still track the macro netting of settlements and payments of reserves among banks, but not the specific payment to the government, at least not any more so than any other individual transactions

      2. Yes my effort was to just highlight the case where banks purchase the Treasury securities at the auction. In that case, the bank gets the securities and increases the government’s deposits. In case, the government has an account at a different bank, the reserves shuffle, but the deposits in the banking system still increases.

        However, as is the case in the US, banks’ holding of Treasury securities is tiny compared to other balance sheet items and size.

      3. “However, as is the case in the US, banks’ holding of Treasury securities is tiny compared to other balance sheet items and size.”

        it’s also tiny compared to the total float of treasuries, and it’s tiny compared to both of those measures for European banks, which is interesting and now very dangerous

  8. Back to the issue of the order of spending and borrowing, notwithstanding the question of its relevance and the fatigue associated with the general discussion, I suppose I could bend slightly on the substance of it in the following sense:

    My argument has been that the government must issue new debt prior to exhausting the deficit spending to which that debt corresponds. Otherwise, it will go into overdraft at the central bank. And I stick by that.

    The only reason for this fact and observation is that government bond issues are “lumpy”. The typical bond issue is larger than the government’s typical average operating balance at the central bank. The lumpiness of the bond issue pretty well forces it to stockpile cash temporarily before corresponding deficit spending occurs in a less lumpy fashion.

    That bond issue “lumpiness” spills over into an effect on bank reserves, which the central bank must offset at settlement.

    The central bank typically takes in market bonds on repo in order to replenish these reserves. These bonds are typically not the new bonds issued, at least not in their entirety. Dealers don’t typically take down the entire issue, and end buyers have no reason to immediately and collectively enter the repo market through their dealers with all of their new bonds.

    Nevertheless, the total effect is to calibrate the net increase in the total amount of bonds not ultimately financed by the central bank.

    The central bank then gradually reverses its system repo position as the government spends its new cash into the system.

    When you view the entire stock of bonds held outside of central bank financing in this way, the matching of deficit spending with outstanding bond growth is closer to matched and continuous, and the order is closer to simultaneous.

    That’s net market bond growth though, measured in this particular way. That growth doesn’t match new bonds issued for the reasons explained. It doesn’t change the fact that the government has to get those new bonds out into the system before it can deficit spend the corresponding amount.

      1. No it doesn’t.

        Those programs are offered to TT&L depositaries only.

        No effect on the level of system bank reserves – only on reserve distribution.

      2. Right. These are balances already on hand at the Tsy that are reinvested at TTL’s (it IS the TTL investment). The point is to limit how much work the Fed has to do, so these are offsetting operations in terms of the effect on the Fed’s balance sheet.

      3. or maybe it depends which account the auctioned funds are coming out of

        doesn’t matter; the Fed has to respond to it along with everything else

    1. Anon, I don’t think that the MMT’ers have said anything different from this, and it is pretty general knowledge that vertical money as the currency of issue in contrast to endogenous credit money is created through bond issuance rather than the Treasury issuing coins. Under the present system, those are the options.

      But I still think that the MMT claim that government spends before it borrows as a logical priority in fiat system is true. What this means is that government does not need a source of funding outside of its power to issue currency and in the $-4-$ offset currently required in the US, the government funds its own spending (currency issuance) through debt issuance. This is an operational constraint and not a financial constraint, in that the government can either issue currency through using bonds and the CB, or “greenbacks” and coins by the Treasury, without financial limit under a fiat system (as Greenspan admitted). Since bonds are term repositories for reserves, there is effectively no difference between issuing bonds or “greenbacks,” other than the interest and the hassle involved with cash flow management.

      The is very different from a gold standard, since the government doesn’t have a philosopher’s stone that creates gold. In such as system the government cannot issue currency in the same way that it can under a fiat regime, because there is a financial constraint that is also a “real” constraint, i.e., physical gold in the vault.

      When MMT says that spending logically precedes borrowing, what is meant is that currency issuance funds debt issuance at the macro level. No one ever claimed that this happens at the micro level or in terms of Fed operations, to my mind.

      If Tsy’s are to be purchased, then the wherewithal must be available. That must come from something other than Tsy’s, if there is not to be an infinite regress. Moreover, it is obvious that the process doesn’t involve exchanging Tsy’s for Tsy’s. That is the logical priority, and it is important because a lot of people think that the somewhere is endogenous money, so that the government is competing in the economy for funding, when it is actually providing its own funding exogenously.

      Perhaps I don’t fully understand the MMT position, but that’s what I’ve gleaned from reading about it.

      1. Modern Money Mechanics by the Chicago Fed (no longer in publication)
        http://upload.wikimedia.org/wikipedia/commons/4/4a/Modern_Money_Mechanics.pdf

        Page 35 says this

        The amount of Treasury currency outstanding currently
        increases only through issuance of new coin. The Treasury ships new coin to the Federal Reserve Banks for credit to Treasury deposits there. These deposits will be drawn down again, however, as the Treasury makes expenditures. Checks issued against these deposits are paid out to the public. As individuals deposit these checks in banks, reserves increase

      2. I’ve never focused on the coins.

        How does that work?

        The coins are a Treasury liability?

        They’re part of the monetary base but not a Fed liability?

      3. Me too …

        When the Treasury creates currency called Treasury currency, not necessarily coins, it will be added to its liabilities and the Fed’s assets. The Fed in turn increases the Treasury General Account by that amount, if MMM is to be believed!

      4. Nice find, Ramanan. The Constitution gives the government the power to “coin money.” There is no reason that government could not be financed this way, which was the initial intent apparently.

        But Fed/Treasury ops are not the issue. The deficit is created by Congress and it is Congress that has created the constraint that deficits be offset $-4-$ by debt. So I don’t see any way that government agencies can circumvent this through operations since the budget is a matter of record, and anyone can check on the offset.

      5. So Tom, they really can print money as they say!

        However, it doesn’t mean that its the right way. The need for currency is demand led. So if the Treasury starts spending like that, holders will give it to the banks (who will increase deposits to compensate) and banks will hand it over to the Fed (which will increase reserves to compensate) and the Fed may keep it or give it back to the Treasury.

      6. ever see the Seinfeld episode where Kramer tried to pay with coin to have his shirt dried in a pizza oven?

      7. Provided further, That the [US Mint Public Enterprise] Fund may retain receipts from the Federal Reserve System from the sale of circulating coins at face value for deposit into the Fund (retention of receipts is for the circulating operations and programs)… Provided further, That at such times as the Secretary of the Treasury determines appropriate, but not less than annually, any amount in the Fund that is determined to be in excess of the amount required by the Fund shall be transferred to the Treasury for deposit as miscellaneous receipts
        31 US 5136

      8. Beo,

        Saw your other comment as well – the one with the link to the Cornell page.

        What does this mean in English 🙂

        Btw, any provision for intraday printing ? Like what if the Treasury is running $3b in the Treasury General Account and some urgent unexpected payment needs to be made intraday .. can the printing happen intraday ?

      9. As far as “printing money” goes, when the current rule requires a 4-4-$ debt offset, how much of a difference is there between printing greenbacks or minting coins and printing Tsy’s to issue currency, other than the interest Treasury pays on the term instruments that adds to the deficit? Operationally, debt issuance must precede currency issuance to offset it. This gives the erroneous impression that borrowing finances spending when what is actually the case is that Treasury is “printing” securities instead of bills or coin to fund itself.

        We already knew that the government can print as much as it wants, since Greenspan told us so :). The debt offset rule coupled with the debt limit is put in place politically supposedly to control “runaway spending” by mimicking a convertible fixed rate regime — and bringing in the bond vigilantes to boot, not mention the rating agencies.

      10. MMM also says that

        The amount of Treasury currency outstanding currently increases only through issuance of new coin. The Treasury ships new coin to the Federal Reserve Banks for credit to Treasury deposits there. These deposits will be drawn down again, however, as the Treasury makes expenditures. Checks issued against these deposits are paid out
        to the public. As individuals deposit these checks in banks,
        reserves increase.

        Btw, the public debt limit is meaningless.

        http://www.treasurydirect.gov/govt/resources/faq/faq_publicdebt.htm#LimitDifferences says:

        What’s the difference between the Public Debt Outstanding and the Public Debt Subject to Limit?

        The Public Debt Outstanding represents the face amount or principal amount of marketable and non-marketable securities currently outstanding. The Public Debt Subject to Limit is the maximum amount of money the Government is allowed to borrow without receiving additional authority from Congress. Furthermore, the Public Debt Subject to Limit is the Public Debt Outstanding adjusted for Unamortized Discount on Treasury Bills and Zero Coupon Treasury Bonds, Miscellaneous debt (very old debt), Debt held by the Federal Financing Bank and Guaranteed Debt.

        The Treasury can hand out Treasury coins to the Federal Reserve. This increases the Treasury’s liabilities not the public debt. It also increases the Fed’s assets and liabilities. Cheques written by the Treasury decreases the Fed’s liabilities to the Treasury and increases the liabilities to the banks. Cheques written do not increase the Treasury’s “public debt”, and hence the debt limit doesn’t have any meaning if carried out this way.

        This way the no overdraft rule is not needed to be abolished.

      11. You know what’s funny is, as a lawyer, the economic terms and equations you guys throw around often lose me, I forget that most folks think (thank God!) like lawyers.

        Coins and bank notes don’t become legal tender until they leave Tsy (both the Bureau of Engraving and the US Mint are part of the Treasury Department). For very small runs, there’s no technical challenge for the Mint to stamp coins on a “just in time basis” or just stockpile a set for when the Secretary asks for it.

        The Cornell link for 31 US 5112(k) is where Congress screwed up with their platinum coin act 10 years ago (there are some other anomalies in the code, but I’ll keep those under my hat in case some diligent Treasury official comes across this and lobbies Congress to fix the platinum law). With every other kind of coin (from small change to 1 oz. gold pieces), Congress has established a face value by statute and/or fixed its metal composition or total number of coins. WIth platinum coins, Congress was a bit slack and inadvertently delegated its full seignorage power to the Secretary of Treasury (I didn’t find any code sections that put limits on this, if anyone finds one, do let me know). The Secretary is given full discretion as to “specifications, designs, varieties, quantities, denominations, and inscriptions”.

        So, to provide an example– President Mosler could direct Secretary of the Treaury Wray to pay off the national debt by lunch. The Secretary has had minted, say (he has full discretion as to specs an variety) a dozen 1 oz. platinum coins. The metal cost is currently around $2000 an ounce, however if the denomination is set by Secretary Wray at $1 trillion, he could hand-deliver the 12 coins to the Federal Reserve Building (or I suppose to a bank holding a TTL account). The Fed would pay face value and credit the US Mint Enterprise Fund for $12 trillion. The Fund would then deduct its costs (basically the $24,000 in platinum). After that, the Secretary could sweep the $11.99999976 Trillion remainder into General Revenue (where per, the US Code, its treated as a miscellaneous receipt, like receiving a check from a taxpayer). Since all US Mint coins are legal tender at face value, the FRS must accept them. If the Board of Governors refuses to obey the law, that’s certainly “cause” under the Federal Reserve Act for the President to fire them. So the coins will be clear. Maybe the President will change his mind and decide not to pay off the federal debt. After all, just threatening to do so will make those future contracts he had CIA Director Norman establish via covert offshore accounts will net Tsy trillions). Doesn’t matter really since a US Government willing to use its sovereign currency to benefit the American people instead of the bond market has a lot of options.

        And when SEC Chairman Auerback meets the President and Secretary for lunch, he’ll have no clue of all the excitement he missed. :o)

      12. ” The metal cost is currently around $2000 an ounce, however if the denomination is set by Secretary Wray at $1 trillion, he could hand-deliver the 12 coins to the Federal Reserve Building (or I suppose to a bank holding a TTL account). The Fed would pay face value and credit the US Mint Enterprise Fund for $12 trillion.”

        How? If something is legal tender, it can be used to pay all debts — fine. What is the 12 Trillion dollar debt that Treasury owes the Fed, for which the platinum coin is being offered as payment?

        Banks are not required to accept deposits, are they?

        On the other hand, the treasury could mail those coins to households that hold treasury bonds.

      13. Well I think Matt Franko citing the “fiscal agent” code section (12 USC 461) above is relevant. The Mint Enterprise Fund certainly qualifies as “any part thereof” of the Government, and “shall act as fiscal agents” should mean, if nothing else, accepting the Government’s deposits of legal tender when required to by the Secretary of Treasury.

        The hammer is the President could threaten to fire the BOG for cause if they don’t. Do I imagine any President having the platinum balls to do any of this? Nahhh. However, it was only because House Banking Chairman Wright Patman was making noises about a Tsy takeover in the 1960’s that the BOG started to “voluntarily” refund the Fed’s net income to Tsy. If you want the moon, you start out by asking for the Sun. :o)

        Beyond that, I think we’d agree that Tsy shouldn’t pay back the public debt even if it had the necessary funds in its account (the funds should be sent out to the public as tax rebates) . There’s no good reason to ever pay back the debt unless the goal is a Milton Friedman-style 100% reserve banking syste). My goal with that rather extreme example is to demonstrate the scope of Tsy’s powers, not to make policy recommendations. More realistically (assuming a presidential candidate won after campaigning on the issue) would be that once Congress has passed a budget and the deficit number was established, Tsy would use its seignorage power to fund the deficit. Of course, if the economy is already at maximum employment, Congress should be funding the budget with taxes not deficit spending.

      14. Beo,

        Doesn’t matter if the debt is paid back or questions like that.

        The need for currency is demand led. If the Treasury pays in Treasury currency or coins, the holder will give it to a bank and get compensated in deposits, the bank will give it to the Fed and get compensated in reserves and the Fed may keep it or give it back to the Treasury.

    1. “Marshall’s latest” has become “Marshall’s longest”, without Marshall.

      LOL, that’s hilarious! Just like Godot never shows up in “Waiting for Godot”.

  9. Tom 1:19

    deficit spending creates non government income, saving, and net financial assets

    that’s a national accounts flow identity, MMT transformation version

    operationally, the government borrows before it spends

    that’s not a national accounts flow identity; it’s a flow of funds characterization

    both are true and consistent with each other

    I believe in both

    with respect, you are using the first to fend off challenges on the second

    it’s not necessary

    the first is strategic, the second is operational

    the strategic representation is the most important for policy

    I believe that and have never said otherwise

    the operational representation is a matter of operational fact

    I think the operational facts should be clear in the development of MMT’s full operational perspective

    my entire emphasis in “Marshall’s longest” has been to prod for clarification of this operational perspective

    I’ve barely touched on the strategic

    the current operational framing for MMT seems to be to default from operational precision around the current system to strategic summary

    it’s not necessary

    clarity in operational explanation is entirely consistent with the strategic sequence

    What do YOU think, Marshall?

    1. I think that the confusion arises from the terminology that (deficit) spending “precedes” (offset) borrowing. The term precedes is unclear because it could mean either logically or temporally. The MMT position is precedes “logically,” as Scott stated. This has to be true if the offset requirement is voluntary and could be removed. There is no such financial constraint on a fiat system other than one that is imposed internally.

      Of course, under the “no overdrafts” rule deficit spending must be preceded temporally by debt issuance. I don’t think that was ever the issue as far as the MMT’ers are concerned, since they understand reserve banking very well.

      To my mind, the issue is how to state MMT principles concisely and precisely. Since I am not an expert in this, I try to use the same words that the MMT’ers use to avoid making an inadvertent mistake. I try to understand the words as best I can, but I have a limited amount of time to study things like reserve banking in any detail. Moreover, most of the people with whom I deal would just be confused by such an explanation. I’m looking for something that ordinary people can grasp that overcomes the overly simplistic or outright bogus stuff they are being fed, both by the so-called experts, the inflationistas, and the conspiracy theorists.

      What I am thinking now is that it may be simpler and less confusing to say that the Treasury’s debt issuance does not fund deficit spending, as it may appear. Rather, deficit spending funds debt issuance (at the macro level). I have found that is what the explanation comes down to in the end anyway, if someone pursues it.

      As far as most people are concerned, deficit spending involves either borrowing or printing. They think, or have been trained to think, that printing leads to inflation and borrowing must be paid back by raising taxes. These are the bogus notions that have to be countered if the US and world is to avoid the impending move toward austerity. It is also necessary is the US and world are to b able to break the shackles of the mind that prevent using the potential of the fiat system to achieve full employment and price stability, if the MMT assertion is correct.

      BTW, someone needs to write a simple yet correct presentation on reserve banking, along with the basics of reserve accounting, or provide a reference to something that already exists that I haven’t been able to find. It would also be helpful to lay out the differences among the various CB’s for comparison.

      1. I agree the thing needs to be simplified for mass consumption. You are right on that.

        But the technical groundwork on which that simplification is based should be as good as possible.

        IMO, the operational flow of funds exhibits temporal precedence of borrowing over spending as I described above at 1:36. This is a relationship that is defined as an ordering within a given temporal period, which is the period of the defined deficit and an equivalent amount of borrowing.

        Temporal simultaneity is exhibited in the national accounts derived relationship that deficit spending creates income, saving, and net financial assets. “Temporal simultaneity” reflects the fact that this is an income statement type of measure where a defined temporal period is in play, but the measurement captures the full summary result at the finish relative to the start, without regard to operational order in between.

        I emphasize that the flow of funds relationship is completely different from the national accounts relationship.

        I don’t know what “logically precedes” means; I don’t use that phrase.

      2. ” X is logically prior to Y” implies that Y is dependent on X. That is, X is a necessary condition for Y — “Y only if X.”

        Bond issuance is dependent on deficit spending, not vice versa, This is illustrated by the fact that no-bonds is an option. It was also demonstrated when Australian financiers strongly lobbied for continued debt issuance during periods in which the government was in surplus. But the rule is no deficit, no bond issuance.

        Logical priority is formal, e.g., the terms is usually employed in math. Logical priority does not require temporal priority, which would be stated, “Y occurs only if X occurs before it in time sequence.”

        This is obviously confusing to those who do not regularly distinguish these uses, so it is better to avoid the claiming that spending comes before borrowing. Instead, maybe it is clearer to say that in a convertible fixed rate system, government borrowing finances deficit spending, while in a nonconvertible floating rate regime deficit spending finances “borrowing,” i.e., debt issuance saves current currency issuance through deficit expenditure as nongovernment net financial assets (at the macro level).

        Of course, then it is a problem explaining to many people what “at the macro level” means, since they are well aware that people do not take their SS funds and buy Tsy’s.

      3. “Bond issuance is dependent on deficit spending, not vice versa”

        So in that sense you say deficit spending in the current fiat system is logically prior to bond issuance. That’s your definition.

        That’s true whether the system is fixed or floating. You don’t issue bonds in a fixed rate system if you have a balanced budget.

        I don’t see how it’s a relevant definition.

        I must be missing the point.

    2. “my entire emphasis in “Marshall’s longest” has been to prod for clarification of this operational perspective”

      I think the clarification was available many days ago. Looking back over this, Warren’s comment appears to have given you the answer but been misinterpreted. In #21, you asked:

      “What prevents US government checks from bouncing if it doesn’t have sufficient funds in its account at the Fed?”

      In response, Warren wrote:

      “the fed can let the balance in the tsy account go negative with a nod from congress, which is the entity doing the spending. in otherwords, congress clears its own checks”

      Min then asked, “Warren, can you provide a reference to the legislation that allows that?”

      Warren’s point was that the “nod” from Congress WOULD BE the legislation—it doesn’t yet exist. In other words, we have a self-imposed constraint.

      As I wrote above earlier today:

      MMT says that, in the GENERAL case (not applying to any particular country), a govt that issues its own currency and allow the fx value of that currency to be flexibly set in fx markets does not have an operational constraint on its ability to deficit spend. In a SPECIFIC case, a govt can choose to put constraints upon itself at the policy level that prohibit this from actually occurring.

      That’s always been our approach.

      1. That may be your interpretation of my objective here, but it certainly isn’t mine.

        That was an isolated rhetorical question to get some discussion grounding. I’ve acknowledged that sort of answer many times in these comments in many other ways. It’s the least of my questions.

      2. OK. Can you direct me to one that gets at any continuing concerns? Like RSJ, given the sheer volume, it’s a bit tough to figure out where everything has been here and where it currently stands. Thanks.

  10. Actually the FED does not buy banknotes from Treasury but borrows them against collateral (you guessed it! it gives treasuries as collateral) and on top of that FED covers printing costs.

    1. Yes, Fed pays Tsy for the printing cost of Federal Reserve Notes (so a $1 bill costs the Fed the same as a $100 bill). The Fed pays Tsy face value for coins, so a dollar coin costs the Fed 100 times as much as a penny. So my question is– From the Fed’s standpoint, what is the operational difference between crediting Tsy with $10 billion from bond sales versus $10 billion in coins?

  11. I can’t keep up with the endless loop between Anon and Everyone else.

    All the points have been made, and yet no one sees the irony:

    If the government can spend by simply adjusting computer accounts, then why can’t Warren do the same and give us Avatars? Is that an operational constraint or a self-imposed constraint? Or is it an “irrelevant” constraint?

  12. from Jan 2009 Asia Times article
    It’s intriguing to note what Federal Reserve chairman Ben Bernanke, then Princeton University economics professor, said about seigniorage. He wrote in his Macroeconomics textbook, co-authored with Andrew Abel, that the government can print money when it cannot (or does not want to) finance all of its spending by taxes or borrowing from the public. In the extreme case, imagine a government wants to spend $10 billion (say, on submarines) but has no ability to tax or borrow from the public. One option is for the government to print $10 billion worth of currency and use this currency to pay for the submarines… Bernanke and Abel continue: “Governments that want to finance their deficits through seigniorage do not simply print money but use an indirect procedure. First, the Treasury authorizes government borrowing equal to the amount of the budget deficit, and a correspondent quantity of new government bonds are printed and sold. However, the new government bonds are not sold to the public. Instead, the Treasury asks (or requires) the central bank to purchase the $10 billion in new bonds. The central bank pays for its purchase of new bonds by printing $10 billion in new currency, which it gives to the Treasury in exchange for the bonds.”
    http://www.atimes.com/atimes/Japan/KA23Dh01.html

    Economically, the direct Fed loan route works fine especially since interest flows back to Tsy. But even this interest-free debt counts in the statutory debt limit and every congressional vote for a debt ceiling hike puts more political pressure to raises taxes and cut spending. If instead of new bonds, Tsy deposited $10 billion (ex Mint costs) in coinage, the Navy would get its submarines without Tsy adding one dollar to the public debt (and yes, larger denomination coins would be needed to make this practical).

    1. Excellent find Beo!

      Said almost similar stuff myself in #59.

      However Bernanke is not that accurate. The Treasury would send a coin to the Fed which can have any denomination as per your findings. The Fed would then increase the Treasuy’s TGA account. If the government needs $10b,

      Treasury Assets+ = $10b (TGA account)
      Treasury Liabilties+ = $10b (Treasury Currency)

      Fed Assets+= $10b (Treasury Currency)
      Fed Liabilities+ = $10b (TGA account)

      The Treasury can then write a check without holding an auction and violating any law on public debt limits and/or overdrafts.

      1. Well the GOP is gung go to put Reagan’s name or face on everything. :o)

        What’s funny about this discussion is Coast to Coast AM (late night talk show that finds an endless stream of “experts” on UFOs, ghosts, Bigfoot, etc. ) had a conspiracy theory author on the other night who sounded surprisingly sane. His book is about how currency is based on government debt but it could be more easily issued by the government debt-free, like President Lincoln did with his US Note “Greenbacks”. Of course, he then lost me at the part tying it into astrology, zero point energy and alchemy– and not in the metaphorical sense. :o)
        http://www.global-information-network-society.com/the-banking-monopoly-babylon-banksters-by-joseph-p-farrell.html

      2. Beowulf, the debt-currency debate is usually confused, sine many people commenting on it don’t understand the basics.

        It boils down to whether the government should “print” term instruments or currency to fund its deficits under a fiat system. Of course, there is a strong lobby to print interest-bearing negotiable instruments since that benefits the folks that deal in these things. The problem is that it is unnecessary operationally and represents a transfer of purchasing power to the elite needlessly and for no good reason other than private benefit. Interest on the national debt constitutes a significant portion of the budget, and it subsidizes private interests for no substantial public purpose that I can determine.

  13. there is an important distinction between willingness to pay and ability to pay

    willingness to pay is always an issue

    for the US govt, Japan, Uk, etc. ability to pay is not an issue.

    For the euro zone nat govs, US states, corps, etc. ability to pay is an issue.

    1. I disagree.

      In the US, ability to pay (ultimately) depends on the willingness of Congress to allow treasury overdraft at the Fed, or the equivalent of that.

      The Fed is not generally willing to do that, but can be overruled by Congress.

      In the EZ, ability to pay depends on the willingness of ECB to allow national treasury overdrafts at the ECB.

      The EZ is not generally willing to do that, but can be overruled by Euro constitutional change.

      Ability and willingness are not the defining issue.

      The issue is the degree of difficulty that defines the political constraint.

    2. While Warren’s input

      “there is an important distinction between willingness to pay and ability to pay”

      is certainly useful in shaping the debate, would he care to qualify gov spending by the Eurozone as

      – functionally (as for a corporation) or politically constrained? Equivalently,
      – a vertical or a horizontal transaction? Equivalently,
      – deficit spending adds or not to nominal savings of financial assets.

      as I’m still seeing wasteful speculation over these matters.

      1. Let us say you are a Spanish and that the Spanish government allows some retail participation in the auction. Your non-competitive bid is successful and you are alloted all the €1000 bid by you. “The Banco de España acts as a treasurer and financial agent for public debt” The Banco de España instructs your bank to reduce your deposits by €1000 and reduces your bank’s account at the Banco de España by €1000 and replenishes the government account at the Banco de España by €1000 and hands you Spanish government bonds worth €1000 in a dematerialized format. Later in the week, the spanish government needs to send a cheque worth €1000 to a school in Spain. Assuming it happens without the use of paper, the Banco de España reduces the government balances at the Banco de España and increases the school’s bank’s account at the at the Banco de España by €1000 and instructs the bank to increase the school’s account by €1000.

        Deficit spending has thus created a networth increase by €1000.

        Now comes the complicated part in the banking operation. The banks in the Euro Zone and indebted to their NCBs. In the points above, I assumed that the institutional setup of the Euro Zone is like that of the US. However there is a difference. So some redoing is required.

        In the second step when the government spent, the Spanish bank’s reserves do not increase since the setup is an overdraft economy. Rather Spanish banks go into less indebtedness to the Banco de España. Collateral worth €1000 + haircut is returned to the Spanish bank. Similarly in the first step, the Spanish bank’s account at the Banco de España doesn’t decrease. Its indebtedness to the Banco de España increases. The Spanish bank needs to provide collateral worth €1000 + haircut at the end of the day if no other transactions happen.

        In spite of this complication, the deficit spending still increases the private sector’s saving.

      2. To be clear, when you say “overdraft economy”, that doesn’t mean government overdraft. There’s potential for confusion there.

        It’s commercial bank borrowing from the ECB, effectively.

        Are you sure the system is net “overdraft” in your sense? It’s certainly gross “overdraft”, but some banks are net long reserves as well.

      3. Yes!! How on earth did I forget to add the part that it doesn’t mean government overdraft 🙂

        Yes it is true that it is net overdraft.

        Here is the balance sheet of the Eurosystem before the crisis. The crisis adds all sorts of complications!

        http://www.ecb.int/press/pr/wfs/2006/html/fs061228.en.html

        There item 5 in assets is the typical ECB way of writing the complicated item “Claims on banks”

        In fact the ECB calls the refinancing operations “open market” but the sense is very different from that of the US. Fine tuning happens by moving government deposits in and out of the banking system – though in some rare cases, they may have to purchase or sell government debt or do repos/reverse (like the Federal Reserve)

      4. “There item 5 in assets is the typical ECB way of writing the complicated item “Claims on banks” ”

        I meant to say that its the typical way of the ECB of complicating things – although in this case its more transparent.

      5. thanks!

        so the net was 264

        that’s weird

        why did the banks need net 264 in “normal times”?

        I think maybe its forced somehow by the fact that the system needed 628 in bank notes but the ECB couldn’t buy government debt to “fund” the required note issuance

      6. I see 441 + 10.

        I think thats the way the system is.

        Yes, its true that it makes it difficult for the NCBs to purchase government debt. However, it was the case even before the Euro Zone was formed. Almost all the Euro Zone countries had the same setup. In fact the Anglo-Saxon institution setup is an exception rather than the rule.

      7. no

        – there’s 177 in reserves on the liability side

        – and it’s not that it makes it difficult for the NCB’s to purchase government debt

        it’s that the prohibition on the purchase of government debt combined with the requirement to issue currency on demand and in sufficient size forces them to “monetize” something else on the asset side – which in this case is lending to banks net

      8. to elaborate on my 2:11

        the typical currency transaction for the typical CB is that the commercial bank “buys” newly issued currency in exchange for a reserve debit; the CB replenishes system reserves by purchasing government debt; so the balance sheet increases over time by debt on the asset side and currency on the liability side

        in the case of the EZ, looks to me like commercial banks “buy” newly issued currency in exchange for reserves borrowed from the ECB

        could be wrong, but I’d like to know the explanation for the big net on that balance sheet otherwise

      9. Thats a good point Anon about the explanation. Yes the central bank buys government bonds over time as currency needs in nominal terms increases over time. In the Euro Zone, even before the Euro Zone was formed, the change in the balance sheet would occur automatically – banks become more indebted to the central bank.

        But I think it has always been like that even before the EZ was formed, when the countries had their own sovereign central banks and Treasuries. The item “claims on banks” was always huge. It probably had to do with the historic setups and Treasuries having accounts at banks instead of the central bank.

        In fact the overdraft financial system is a rule rather than an exception. The Europeans may be surprised why there isnt a big net in the US central bank balance sheet.

      10. are you saying the national central banks never bought bonds to fund currency expansion in Europe?

        interesting

        and are you saying the national governments never had accounts at their central banks?

        and are you saying the national governments don’t have accounts at their central banks now?

        that’s more than interesting

        are you quite sure on the last two points above, especially?

      11. Anon,

        I am saying that they generally do it that way. In fact, I will phrase it differently. Since currency is a demand-led phenomenon, its banks who get the currency from the central bank and the central bank is fully accomodative. Banks will get more cash depending on how much their customers demand and will never refuse.

        Here is the balance sheet of the Deutsche Bundesbank
        http://www.bundesbank.de/download/volkswirtschaft/jahresberichte/1996gb_bbk_en.pdf

        It seems that “claims on banks” is a major item.

        I wouldn’t say that governments don’t have an account at the central bank. It is certainly not the case now. http://www.ecb.int/mopo/liq/html/treas.en.html explains that governments do have an account at their home NCBs. In fact its a tool to fine tune – just move the government deposits in and out of the banking system – and you have the control of interest rates.

        In the pre-EZ setup, not sure. Its possible but the sectoral balances still hold.

      12. The balance sheet in the annual report of 1996 – a few years before joining the Euro Zone.

        “I am saying that they generally do it that way.”

        I meant – the item “claims on banks” increases rather than “government securities” when more currency is needed.

      13. Marc Lavoie wrote about the “claims on banks” quite a bit. He called these operating procedures “overdraft systems” and the US/Canada/UK were referred to as “asset-based systems.” The point Marc and I started to emphasize was that both systems were essentially the same in character (just not always in magnitude), as US/Canada/UK systems do repos (i.e,. loans or “claims”) with banks or at least dealers that are far, far larger than the qty of rbs outstanding (in the US, I think under pre-Lehman procedures, the were around $100B). Unfortunately, the textbook view of the US/Canada/UK was that the open market operations (asset-based operations) created the reserve balances to fund loans, when in reality, again, those operations were not different in character from those of the overdraft systems–the overdraft systems are the general case, in other words. I discussed this a bit in my paper linked to above (it’s in principle 8 or 9), and I think I’ve cited some of Marc’s relevant work there.

      14. thanks

        don’t have time just this minute to look at those papers, but a quick question before I do:

        my observation was that in the US for example, the normal state of the Fed balance sheet is that currency issuance is offset by acquiring Treasuries for the asset side – this is the core position of the central bank balance sheet – the other stuff is NORMALLY reserve related noise, etc., although since the crisis the reserves have increased by $ 1 trillion plus in order to accommodate all sorts of abnormal asset expansion

        for the EZ balance sheet, the normal state seem to be currency issuance, like the Fed, but the offset is not acquisition of government debt

        my further point, earlier on, is that this basically FORCES the ECB to doing some else on the asset side, because the demand for currency is effectively exogenous

        and its interesting to me in that interpretation is that the ECB tool chosen in responding to that is to supply lending to the banks that exceeds system deposits/reserves with the ECB

        does that interpretation make sense?

        if so, without looking at those papers yet, do those papers pick up on that?

        and given that the ECB can’t purchase debt, does it have any other choice in managing it’s balance sheet than doing it the way it does?

        if not, can you correct me on it?

        rush comment – sorry if I’ve overlooked something fundamental here

        thanks

      15. My understanding was that the ECB was using repos as an offset of currency, rather than the outright purchases of govt securities. Perhaps someone can correct me if I’m wrong (repos can of course be loans to banks, essentially).

        For the US, pre-Lehman case, see, for example, Chart 10 here, where repos total are more than reserve balances, but, yes, most of currency is offset by outright purchases. http://www.newyorkfed.org/markets/omo/omo2006.pdf

        I do have to correct myself, though, as it appears the repos are far less than the $100B, and actually just around $25-$35B (checked that with data on the Fed’s site). That’s still more than reserve balances, but less than I was saying above. That $100B figure was in my head, and I remember the source, so I’ll have to double check why I thought that.

        Repos/loans can be greater than rbs. Repos/loans create RBs, but the RBs are drained when a bank desires currency, and the repos/loans stay on the balance sheet. Only a portion of repos/loans are rolled over at any one time, so it’s not a problem to have repos/loans > rbs.

  14. Congress is the entity that decides how much to spend. Congress sets the rules the fed and tsy and alters them at will to do its bidding.
    That is, the same people who vote to spend also vote to tell the fed and tsy what to do.

    in the ez, the national govts decide how much to spend. But if they don’t have sufficient funds in their bank accounts their checks will bounce, unless other people vote to clear them.

    Just like the US States, where it’s not the same people doing the spending that control the people who run the books at the CB.

    1. I agree with the US and EZ characterizations because they’re factual, and I haven’t said anything that contradicts that.

      I’m more sceptical of the States/EZ member analogy in substance.

      With regard to the first, the operational capability for overdraft is the same in both cases. The substance of the no overdraft constraint is the same. The way in which the constraint is broken is generically the same – by political force.

      The difference is that breaking the constraint requires national willingness for the US and supranational willingness for the EZ. The degree of political difficulty is higher for the EZ.

      It’s a self-imposed constraint for both, and in the case of the EZ because nations are voluntary members of the EZ.

      On the issue of the States/EZ member comparison, my reason for some discomfort there is that the States operate through commercial banking connections. The EZ members operate through a supranational central bank. I’ll leave that for now. It requires more exploration on my part.

      My difference of opinion is not on substance. It’s on language. We’re saying the same thing, with different logic in the connections within such language as operations, constraints, capability, and willingness.

      My larger point expressed throughout is that the language of MMT requires more robust connections. That’s just my personal view. No doubt you and the others are comfortable with it. I’m not sure about your larger target audience. I think it’s a problem, but that’s just my opinion. I stand to be voted down on that.

      So maybe the important thing is that I agree on the substance of the facts and the analysis as you state them. I just have a problem with the MMT generic language and logic template when it comes to classifying these things. It’s important to me. The only reasons it might be relevant for you and others is if there is an associated communication issue in getting the MMT message out. Just sayin’.

      What say others?

      1. I think you have touched on a matter of importance, Anon. As it nay field, technical terms need to be define operationally, and those definitions have to be adhered to if there is to be clarity and precision.

        This is a reason I have suggested a central repository containing references that can be cited for assertions. A FAQ could contain the definitions of key terminology.

        A lot of material was generated on this blog entry alone, but much of it is just going to get lost in cyberspace. There are many other threads like this on this blog alone and many more elsewhere, some buried in unlikely places that would be relatively impossible to find if someone else didn’t point them out. Usually those pointers are in blog posts or comments that also soon get lost in the cyber-maze of information.

        The problem is that in writing blogs or posting comments the scope of limited by the space. Many blogs, like HuffPo, only allow 250 words for comments. Moreover, only MMT pro’s can answer many questions in the detail that is required if the issue is pursued.

        Only one level MMT is a simple description of how a fiat system functions, but different countries have various operational rules that are significant to a correct understanding of what is gong on there and what the actual possibilities are under those rules.

        MMT is also a developed macro theory that underpins a lot of the more simple assertions. I envision a repository that “tags” those references and organizes them so that they can be called up easily. This is a project that the MMT pro’s aren’t going to get around to themselves, since their expertise is better occupied elsewhere. So we need an unfunded task force to do this, if it going to get done.

        As I’ve suggested before, a Wikipedia article, necessarily at least overseen by MMT pro’s, would be the chief portal for many people initially interested in MMT aka Neo-Chartalism/Chartalism. They could be referred to the MMT info site from there.

      2. excellent

        “clarity and precision” is essentially my point

        words matter, particularly when building a theory around them

        they can also change the way you view the logical construction of the theory, even if you end up in the same place

        that said, there may be slightly different views within the MMT professional group as to what the logical construction is and what the words mean; that could be a challenge in itself – for my part, I would build the logical edifice somewhat differently, as I’ve noted

        but a glossary with an internally consistent structure would be the practical goal out of this, in conjunction with your bigger idea of a central repository

      3. Agreed.

        I’ve tried to do this with CB operations in my own research, such as here (http://www.cfeps.org/ss2008/ss08r/fulwiller/Fullwiler%20Modern%20CB%20Operations.pdf) and did an even more institutionally detailed chapter (starting on p. 123) for my book here (http://books.google.com/books?id=sgfUgRoFDPEC&printsec=frontcover&dq=scott+fullwiler&hl=en&ei=Pkz9S_34AYq2NrOP0d4H&sa=X&oi=book_result&ct=result&resnum=1&ved=0CCUQ6AEwAA#v=onepage&q&f=false)

        I’ve had plans for several years to do the same thing for Tsy operations, but this discussion has caused me to regret I hadn’t yet done this even more than I already did.

      4. Tom,
        Do you think a service like this would cover it?

        http://www.godaddy.com/Hosting/Legacy.aspx?ci=9009#details

        I perhaps could “donate” 2 years worth of the Deluxe Service ($6.29/mo.) if you think this is all it would take hosting wise…if its mostly just text files with a few diagrams, etc..I think it would suffice.

        I’d nominate you to be one of several administrators 😉
        Resp,

      5. Anon: “that said, there may be slightly different views within the MMT professional group as to what the logical construction is and what the words mean; that could be a challenge in itself – for my part, I would build the logical edifice somewhat differently, as I’ve noted”

        I think it is important to show these differences. MMT is not monolithic; rather, it is a project under construction. There is a lot to come, but there is also a very solid background already, which builds on a solid foundation that needs to be elucidated along with MMT as a contemporary school.

        I do think that there will be Nobels coming out of this, and it is a shame that Wynne Godley was not more profusely honored before his demise for his immense contribution to economic understanding even thought he was not a “professional economist,” as he lamented. It’s lucky he wasn’t, but rather worked hands on to get his training. We are gong to be hearing a lot more about Abba Lerner, too. MMT is indeed standing on the shoulders of giants. Not coincidentally, Lerner worked for ten years before beginning his study of economics at the London School.

        Additionally, as a policy tool, it can be used differently, and various MMT’ers have different ideas on this, too, since as an economic theory, MMT reveals various options and their consequences. Then, it becomes a political matter, and everyone is entitle to their view — but it should be reality-based, not myth-based.

      6. Matt, thanks for the offer, but Bill has already offered some space on his server to get the ball rolling. As I have said previously, we need an experienced web hand who can take care of the development and design, and then some content people to gather and organize the info. We also need a couple of MMT pro’s who are willing to be advisors.

        I will happily volunteer as a content person. But my web skills are too limited to develop/design the kind of site that is needed, and it will be simpler and easier in the long run to get it right from the outset, if a competent web person is available. If not, we can make do with a preliminary site until someone comes along.

      7. “I’ve tried to do this with CB operations in my own research”

        for one thing, that paper looks like must reading

        yes, too bad you didn’t get around to it for treasury operations

        although the issue is more than just a description of operations, which is factual

        it is the characterization of capability – such as “not constrained”, “operationally constrained”, “financially constrained”, etc. etc. – and the precise, consistent definition of those kinds of phrases, which are very commonly employed in MMT, and the precise, consistent attribution of that capability (or lack of it) to actual operations versus potential operations and the link between the two

      8. Tom,

        good that you acknowledge there are differences

        and maybe there are suggestions from outside that are different again, like here

      9. Yes, there has been al lot of discussion on other blogs, especially billy blog, as well as Warren’s, which often bring up differences in viewpoint over both substance and application.

        BTW, there is not necessarily a uniform technical definition accepted by all parties to a discussion. Different parties are free to define their own terms as long they are operational, and there is no monopoly on the use of a term. So differences can arise. The same author doesn’t always stick to his definition either. This is true of all fields, and MMT is no exception.

      10. Thanks, Anon. Regarding taxonomy/characterization, the issues you mention are embedded in the methodological approach used in the book. If interested, you can see some of it at work in my chapter beginning with the section that discusses “normative systems analysis.”

    2. The rewriting of the rules governing the ECB would require the executive branch of the EU, the Commision, to propose such a law, and for the Parliamant (lower house) and the Euroconcil (upper house) to vote for it. That’s just how a democracy operates. MPs are elected by direct suffrage and represent the largest number of citizens bound by common treaties (not yet a constitution).

      In actuality, a treaty such as the SGP is only as binding as the influential members of the EZ/EU want it to be. The ECB has already breached the no purchase of gov bonds rule, for example.

      While central governments are independent within the constraints they signed on, the formation of economic policy in the EZ is the result of a consensus (or not) between various actors, most notably those of the Eurogroup, in consultation with the ECB. Peer pressure, in other words, plays a big role.

      The Eurogroup is a meeting of finance ministers who preside over the control of the EZ. As such it represents the people. It does not necessarily seek approval from the parliament, as the matters it decides upon are the prerogative of central governments. Decisions can therefore be made and executed fairly rapidly, in principle. It is under the impetus of this group, for example, that a EUR110 billion Greek rescue package was decided, together with the approval of the European Council, for any other country in need of it.

      This somewhat informal way of doing business is likely to be overhauled as a result of the ongoing turmoil. There are calls for fiscal coordination, an IMF-like structure within EZ etc.

      Until then, there is no justification for pointing to its lack of legitimacy simply because it does not equate the near ritualistic US style consultative relationship between congress and the executive branch, and its presumed cozy arrangements with the Fed.

      Should the Germans get sick of Merkel’s puritanism, that would be reflected in a new government, so that the frogs and the PIGS would have their way in shaping policy. There’s only so much resistance the ECB can offer if it is isolated.

      Conversely, deficits hawks could have their day in the US congress.

      It’s all about politics to me and I don’t see where “checks will bounces” delineates the US vs EZ.

      1. “It’s all about politics to me and I don’t see where “checks will bounces” delineates the US vs EZ.”

        Under a fiat system, there is no inherent financial constraint and operational constraints are ultimately political. So it’s a matter of who blinks first. It fairly similar between the US and EZ. It’s not whether the dollar or euro will default, but whether the elite will let Greece or California bounce its checks.

        The situation in the US and Europe is actually quite similar in this respect: In the US the prosperous coastal states support the more rural southern and western states economically, and in Europe it is the prosperous countries, especially Germany, that support the peripheral states. At least, that is the perception. So there is an internal tug-of-war politically.

      2. This has been an interesting discussion (over 530 comments at this point), but there is only so much to be gained by trying to make the English language we employ to describe MMT as rigorous as mathematics. The argument about what it means to be “constrained” is becoming a little Clintonesque. Every currency and debt issuer and user is constrained to some extent, but none are 100% constrained. I could, for example, borrow $10B if only Bill Gates recognized what a good credit I am.

        The analogy we make between the EZ countries and the US states is not precise for several reasons, but it is close enough, and it is illuminating.

        Any of the US states can run out of money to pay its debts because of a failed bond auction. The same is true for any of the EZ countries. It is a real possibility, and not just a theoretical possibility at the level of 0.1% per year.

        Likewise, any of the US states or EZ countries can be bailed out through the collective action of others acting as a higher governmental authority.

        I suppose even the US government could be bailed out by the IMF or through collective action of the BRICs, but the likelihood of a failed Treasury auction is so remote as to be a waste of time to contemplate.

        That is the key difference. The US default probability is teensy-weensy and is not even positively correlated with the size of the public debt.

        And not only is the probability of default material (and always has been) for each of the EZ countries, I submit that you will see an EZ country default eventually, and that it will happen before a US state defaults.

      3. No need for the IMF to bail out the US. The IMF is there because the US has kept it in business.

        The US can bailout itself by this:

        The Secretary may continue to mint and issue coins in accordance with the specifications contained in paragraphs (7), (8), (9), and (10) of subsection (a) and paragraph (1)(A) of this subsection at the same time the Secretary in minting and issuing other bullion and proof gold coins under this subsection in accordance with such program procedures and coin specifications, designs, varieties, quantities, denominations, and inscriptions as the Secretary, in the
        Secretary’s discretion, may prescribe from time to time.

        Beowulf pointed this out.

        Page 284 here

        http://frwebgate.access.gpo.gov/cgi-bin/usc.cgi?ACTION=RETRIEVE&FILE=$$xa$$busc31.wais&start=2282115&SIZE=93048&TYPE=PDF

        No change in law required. The Fed could purchase the coin of any denomination from the Treasury and this would prevent the TGA from going overdraft. The national debt limit law need not be changed as well because Treasury coins and federal reserve liabilities are not counted in the national debt.

      4. you’re right about Clintonesque, a point I’ve already made in the comments

        which is why it’s important to determine an unambiguous definition of words and phrases that MMT tends to “sloganize”

        as opposed to winging the definitions and applications when something like the EZ crisis comes along

        BTW I remain completely uncomfortable with the gold standard “anti-analogy”, for reasons of operational detail relating to the gold standard

        and you’re absolutely right about the importance of probability, and the avoidance of ambiguous claims to certitude

      5. Yes I agree with you on the gold standard. In fact, I think it is important to understand the gold standard to understand fiat currency international economics.

      6. “The analogy we make between the EZ countries and the US states is not precise for several reasons, but it is close enough, and it is illuminating.”

        I’ll accept that as an ironic statement 😉

        The question of EZ would have been resolved more quickly, I think, had someone taken a stance from the beginning as to whether net deficit spending by EZ government creates net financial assets, G-T = S – I, as most would recognize that as the heart of MMT.

        But the net financial assets are just the counterpart of the assumption that government are not revenue constrained… So looking at one for an explanation to the other does not help.

      7. and more to the point, a failed tsy action process can be addressed and the funds spent in any case by the same people (congress) who are doing the spenidng.

        not true with the states or the euro zone member nations.

      8. “That is the key difference. The US default probability is teensy-weensy and is not even positively correlated with the size of the public debt.”

        “And not only is the probability of default material (and always has been) for each of the EZ countries, I submit that you will see an EZ country default eventually, and that it will happen before a US state defaults.”

        That, and Warren’s points here are the key points:

        “a failed tsy action process can be addressed and the funds spent in any case by the same people (congress) who are doing the spenidng. not true with the states or the euro zone member nations.”

        And these are precisely the points (a) that are at the core of MMT, and (2) it appears aren’t allowed to be spoken or investigated further in this thread. Now who’s being Orwellian?

      9. It’s clear to me that Congress has the say in a federal system over whether the US or any state in the US will default since there is no financial constraint in a fiat system and the operational constraints here are politically imposed. That is to say, certain operational avenues are voluntarily closed and that can be opened in the same way.

        I am still not clear on how this works in the EZ, even after all the go-around. Could someone summarize this simply, so I could explain it someone else who doesn’t know a lot about government finance, with some confidence I have it right? Thanks in advance.

  15. Scott, maybe if you tell them MMT is Mosler Monetary Theory it might help
    😉

    Tom, the treaty prohibits the ECB from writing checks directly to the member nations

    1. Thanks, Warren, that is a simple and clear way to put it. The treaty restriction seems to be similar to a constitutional impediment in the US — a very big deal. It could be changed, but ….

      The difference in the US is that Congress has imposed voluntary restraints like the debt offset rule, the debt ceiling, and the no overdrafts rule, and it can remove them.

      1. So let me recap,

        Net Financial Assets is no longer the heart of MMT, as anon daringly suggested, and for a while got away with, but it’s a matter of degree in probability of default.

        And it does not matter that the US and the EZ have exactly the same rules, because they are legislated by congress and the EU parliament, respectively, and moreover in form of a treaty in the second case, even if it was breached on two counts, essentially because the Eurogroup decided it (16 finance ministers, only two of which run the show), namely the SGP and Purchase of sovereign bonds, only leaving no overdraft as yet to be overruled.

        It’s all good to me, although I would suggest adding an M to MMT, for Moving, yielding MMMT. 😉

      2. “But the net financial assets are just the counterpart of the assumption that government are not revenue constrained”

        That’s just simply false. No MMT’er has ever said that.

        And I have no idea what you mean by “NFA is no longer the heart of MMT.” Was it the heart? If so, how? I just thought it was an accounting identity. Silly me . . . I just publish on this, so I probably don’t know. Regardless, has there been anything proven one way or the other about NFA? Again, it’s an accounting identity. We never said anything more or less than that. What’s been “agreed upon” besides that?

        I can’t believe that after 530+ comments only 2 people–Bx12 and Anon–appear to have a clue what Bx12 and Anon seem to find wrong with MMT. I’ve heard enough regulars here wonder out loud what the issues we are discussing here actually are to believe I’m not completely exaggerating there.

      3. The way I understand what MMT’ers have been saying is that by definition in a fiat system the monetary sovereign can issue currency at will without limit; that’s what “fiat” (Latin for “Let it be”) means. This implies that a monetary sovereign under a fiat system is neither financially constrained (since issuance is at its discretion) nor operationally constrained (since it can put in place any operational constructs it chooses). Different countries have different operational constructs. For example, the FRS has public and private aspects, while the BOE is an indepdendent governmental agency (nationalized in 1946).

        While a monetary sovereign is not financially or operationally constrained under a fiat system, it can impose voluntary (political) restraints on monetary (Treasury and CB) operations. It can even restrain itself voluntarily, e.g., through setting a ceiling on the national debt to restrain deficit spending.

        Monetary sovereigns such as the US have chosen to put restraints on monetary operations, as well as themselves, through, for example, a deficit offset rule, a debt ceiling, and a no-overdrafts rule in the US, although practically speaking the government often makes space as circumstances require, as the US has done.

        OK?

      4. “I can’t believe that after 530+ comments only 2 people–Bx12 and Anon–appear to have a clue what Bx12 and Anon seem to find wrong with MMT. I’ve heard enough regulars here wonder out loud what the issues we are discussing here actually are to believe I’m not completely exaggerating there.”

        I’m pretty consistent and persistent in my investigation of the matters I seek an interest in, so I doubt that it just came off the top of my hat. You might want to do a word search for “heart”.

        Am I giving MMT too much credit in trying to clarify some aspects, you’re saying?

      5. “But the net financial assets are just the counterpart of the assumption that government are not revenue constrained”
        That’s just simply false. No MMT’er has ever said that.

        As I understand it, MMT uses “net financial assets” to describe the relationship between introduction and withdrawal of financial assets into nongovernment through issuance and taxation without creating a corresponding liability in nongovernment that would net to zero. Financial assets that government adds to nongovernment through its spending (issuance) are only withdrawn through taxation. G minus T has three possibilities: 1) zero (balanced budget), in which case NFA is neither increased nor decreased, 2) G is greater than T (deficit), in which case NFA is increased, and 3) G is less than T (surplus), in which case NFA is decreased.

        Conversely, credit money (loans create deposits) is endogenous to nongovernment and necessarily nets to zero, since all financial assets created by lending (deposits) are offset by corresponding liabilities to a creditor (loans), so that extinguishing a loan is extinguished extinguishes a corresponding amount of credit money (deposit). Net = 0

        This is the basis for the vertical-horizontal distinction in MMT, as well as exogenous and endogenous money creation.

        The way I understand the difference between a convertible systems and nonconvertible one is that the former is financially constrained and the latter is not. For example, a government on a gold standard can only issue currency up to the fixe rate of convertibility, and it creates nongovernment net financial assets up to its financial constraint. Such a government is operationally constrained in that if it desires to deficit spend in excess of its financial constraint imposed by convertibility, it, it then must borrow from nongovernment. When this happens, then government competes for loanable funds and crowding out ensues.

        On the other hand, a government issuing a nonconvertible floating rate currency never needs either to tax in order to fund itself or borrow in order to finance itself, because it issues its own currency without financial constraint. It is neither financially constrained by convertibility, nor is it revenue constrained operationally. However, politically, such a government can impose whatever voluntary constraints on itself it chooses, for as long as it chooses, and it can change such restraints IAW its rules for doing to.

        OK?

      6. BX12, I can’t figure out what the problem is either. I could be that I’m just not getting it, but when Scott says he isn’t either, then I think you need to make clearer what you are saying. I am interested and really trying to figure this out. I don’t think that anyone is putting you down but after 500 comments here and a few at bill’s place, some fatigue is probably settling it.

  16. Me: “But the net financial assets are just the counterpart of the assumption that government are not revenue constrained”

    TH: “As I understand it, MMT uses “net financial assets” to describe the relationship between introduction and withdrawal of financial assets into nongovernment through issuance and taxation without creating a corresponding liability in nongovernment that would net to zero.”

    My remark is construed exactly from this kind of remark. Sure, NFA is an accounting item, but it is granted special status by assuming the government’s liability has evaporated. Why else would we say that the gov is not revenue constrained? I still don’t know.

    Now, since you read my entries at billy earlier today, you and Scott will have seen that I’ve already moved beyond this :

    A private bank can create money by fiat (moving numbers up in a computer). This does not distinguish it from the CB. Is it, instead, that the funds to pay taxes and buy government securities come from government spending?

    I wonder, instead if this is simply not a feature inherent to all economic activity : acquisition of inputs necessarily precede the generation of output, and banks provide the necessary bridge between these two cash flows. To live until their next paycheck people use their credit card.

    I have argued this in more detail here (the first set of accounting statements is not all that relevant)

    http://bilbo.economicoutlook.net/blog/?p=9956&cpage=1#comment-6653

    and I reproduce it partially here:


    As Ramanan has said (he is going to deny it?), the Tsy ALSO keeps accounts at private banks. So how about this?

    Step 1: Tsy borrows

    Treasury
    ——————————
    A : + Deposit at Citi
    L: + Borrowings

    Citi
    ——————————
    A : + Tsy IOU
    L : + Tsy deposit

    Step 2: Tsy spends

    Treasury
    ——————————
    A : – Deposit
    L: – Net worth

    Citi
    ——————————
    A: unchanged
    L : – Treasury deposit + Client deposit

    Step 3: Tsy taxes

    Treasury
    ——————————
    A : + Deposits (Taxes)
    L: + Net worth

    Citi
    ——————————
    A: unchanged
    L : – Client deposit + Treasury deposit

    Step 4: Tsy repays bond

    Treasury
    ——————————
    A : – Deposits
    L: – Borrowings

    Citi
    ——————————
    A: – Tsy IOU
    L : – Treasury deposit

    Again, and again, and again, there is nothing special about spending first and collecting taxes later.

    On your first day on the job, assuming you are broke, you have to borrow from someone until the next paycheck to sustain yourself. That is inherent to economic activity : inputs come before outputs. And that’s why the banking system exists, to bridge the two.

    I’m told (see above) that gov spending is different, because it purchases finished product. In other words they buy outputs, not inputs. I don’t see how this is relevant. The state does not have the money (yet) so it borrows, until taxes come due.

    Employees of a company are paid at the end of the month, but what if they manufacture toys that are only sold around X-mas? In this case, employees need to borrow on the first of each mont to sustain themselves until the next paycheck. The manufacturer must keep borrowing each month to pay the employees. Comes X-mas, sales start flowing in, and it can finally pay back its debt towards the bank.

    Replace employees by civil servants, the manufacturer by the government, X-mas by April 15th, sales from goods by taxes, and you can understand there is nothing special about the gov having to spend before collecting taxes.

    Finally, while I’m thankful for the comments that have coalesced around my questions, I do not recognize myself as the source of fatigue, at least not in substance, honestly.

  17. A private bank can create money by fiat (moving numbers up in a computer)

    The bank cannot issue currency. It can extend loans denominated in the currency. To get currency demanded at its windows, it has to exchange reserves for currency. The bank cannot create reserves, only the Fed can do this. Moreover, if the bank wants to create deposits denominated in the currency as the unit of account through extending loans against its capital (and assuming the associated risk), it has to have reserves to clear as these deposits are drawn down. It cannot create these reserves. Ergo, banks cannot create fiat money denominated in the currency. Creation of the currency of issue assumes the capacity to create reserves, which all but the CB lack.

    Because the CB (a government agency in the US, UK, etc,) can create reserves and its reserve creation is not financially constrained under a fiat system, the government can create all the currency it chooses operationally, although it can establish voluntary restraints politically. However, the CB does not issue currency into nongovernment other than in exchange for reserves. The Treasury does this through disbursements IAW congressional appropriation. Similarly, taxation is at the sole discretion of Congress, which establishes fiscal policy.

    The fact is that the Treasury “borrows” reserves from the Fed by issuing Treasuries. This is obviously a fiction since both are agencies of the government, carrying out the directives of Congress, who has constitutional authority over the government purse. These transaction just balance the respective books at the two agencies. The reserves that the Treasury uses to clear its deposits just get transferred (at the macro level) into Tsy’s when they are sold by the Fed. What the government spends is saved as Tsy’s as aggregate deposits are reduced accordingly. There is no actual borrowing from the private sector, no competition for loanable funds, and no crowding out.

  18. Moreover, if the bank wants to create deposits denominated in the currency as the unit of account through extending loans against its capital (and assuming the associated risk), it has to have reserves to clear as these deposits are drawn down.

    NOT EXACTLY. IF THE BANK DOESN’T HAVE RESERVES, IT WILL BE OVERDRAWN AT ITS FED ACCOUNT, AND AN OVERDRAFT IS A LOAN FROM THE FED. AND THE FED CAN’T STOP CHECKS FROM CLEARING AS THEY ARE OFTEN DRAWN ON INSURED DEPOSITS. SO INSURED DEPOSITS MEANS THE FED HAS TO ALLOW OVERDRAFTS

    It cannot create these reserves. Ergo, banks cannot create fiat money denominated in the currency. Creation of the currency of issue assumes the capacity to create reserves, which all but the CB lack.

    BANK LOANS ‘CREATE’ BANK DEPOSITS WHICH ARE BANK LIABILITIES.

    HOWEVER, BANKS ARE ‘DESIGNATED AGENTS’ OF GOVT WHICH ALLOWS BANK DEPOSITS TO BE ACCEPTABLE FOR TAX PAYMENT.

    I ALWAYS CONSIDER TODAY’S BANKS AS PUBLIC SECTOR ENTITIES THAT ARE ALSO PUBLIC PRIVATE PARTNERSHIPS, PRESUMABLY FOR FURTHER PUBLIC PURPOSE.

    1. Right. Banks can make loans but they cannot make reserves — they have to obtain them, the Fed being lender of last resort (discount window) at the price (interest rate) it sets. Therefore, US banks must have access to the FRS, and this entails a charter from the government, as well as following the standards and rules set by the government. Thus, banks are not purely private enterprises, but public-private partnerships.

      The Fed controls the price of money through interest rate, but not the quantity of money (there is no money multiplier). Endogenous money supply is controlled by the banks through making loans against capital, which create deposits denominated in the currency of issue. Hence, a bank is financially accountable for the money (deposits) it creates through loans, and it does participate in money creation (which, I think, is the point that BX12 was making).

      My point in response to BX12 was that banks make loans but not reserves. They have to obtain reserves, at a cost to them and under conditions set by the government (CB is a government agency) that are beyond their control. Therefore, it is not correct to say that bank “create” fiat money, for they do not do so through decree, which is what “fiat” means. They have to follow a procedure that is under government control that involves participation of the government in banking, to the point of resolution if standards are not met.

      This is important to understand because judging from things I have read elsewhere some people think that banks do create reserves by themselves instead of obtaining them, hence, banks are essentially purely private enterprises independent of the CB and government. Often, the same people think that the Fed is privately owned and operated. This is not the case under the present system despite the widespread myths.

      Once the facts are recognized, then it is clear that banks are public-private institutions that exist not only for making a profit as a reasonable return on investment for performing a service useful to society, but they are also institutions chartered for the purpose of serving public purpose as well, unlike most other private enterprise that exist solely for the benefit of the owners/investors. Therefore, it is arguable that banking activities that serve no useful public purpose should be separated from those that do, e.g., through Glass-Steagall type regulation.

      As Scott observes, there is a hierarchical relationship involving government and the banking sector that cannot be ignored. MMT points out that this hierarchical relationship involves the vertical-horizontal and exogenous-endogenous distinctions that affect modern monetary theory in a fundamental way.

    2. Public-private partnerships typically end up benefitting a private purpose, any public benefits are likely to be purely accidental. :o)

      In the course of this thread (doing some Title 31 research along the way), I’ve become a fan of Congress funding the deficit by use of its Art I, Sect. 8 coinage power. As mentioned above, Congress has already granted Tsy authority to mint coins in the quantity and denomination of the Secretary’s discretion. Curiously, the proposed (and quite insane) Balanced Budget Amendment wouldn’t impact at all use of the coinage power to provide as much federal spending as economic conditions warrant (or Warrent as they say in the Mosler Monetary Theory literature. :o) ). The Amendment’s restrictions apply to borrowed funds and “internal revenue”, not seigniorage revenue.

      “Section 1. Total outlays for any fiscal year shall not exceed total receipts for that fiscal year, unless two-thirds…shall provide… by a rollcall vote.
      Section 2. The limit on the debt of the United States held by the public shall not be increased, unless two-third…shall provide.. by a rollcall vote
      Section 4. A bill to increase the internal revenue shall require for final adoption in each House the concurrence of two-thirds.. by rollcall vote.
      Section 7. Total receipts shall include all receipts of the United States Government except those derived from borrowing. Total outlays shall include all outlays of the United States Government except for those for repayment of debt principal.”
      http://www.opencongress.org/bill/110-sj24/text

      1. He he … yes even I have become interested in the usage of coins. The government can run surpluses by the usage of coins 🙂 However sectoral balances approach holds that the sum of income less expenditures of all sectors combined must sum to zero, so it will show up somewhere – I guess as a Fed deficit.

      2. Oops not sure of my comment. However they themselves made accounting errors. COINS AND CURRENCY How the Costs and Earnings Associated with Producing Coins and Currency Are Budgeted and Accounted For – http://www.gao.gov/new.items/d04283.pdf

        Whats internal revenue ?

        Yep the public debt limit need not be raised because neither coins nor Fed’s liabilities is counted in public debt.

      3. Internal revenue is what’s collected via domestic taxation (as opposed to customs duties on imports). A more expressive term is used by British equivalent of the IRS– Inland Revenue.

  19. That’s an interesting GAO report, thanks for posting.
    Because it is not considered a receipt, seigniorage is not counted, or scored by the Congressional Budget Office or the Office of Management and Budget, for purposes of determining the budgetary effects of legislation. (fn, p. 12)

    1. Beowulf’s Law: “There is no self-imposed constraint so idiotic that a sufficiently large minting of coins cannot deal with it.”

  20. Ha ha! Beowulf’s Law™
    Maybe strike the words “self-constrained”, enough coins will get you past most other constraints too. :o)

    Perhaps there’s an economic reason use of the coining power is ill-advised, I’m simply looking at the political landscape. If you can think of another way to both boost aggregate demand and jump on “the no more public debt” bandwagon, let me know.

    In fact, I see an “End the Fed” activist beat me to the punch… last July he asked people to exchange their paper money for dollar coins so Tsy can capture the seigniorage.
    http://endthefedusa.ning.com/forum/topics/independence-from-the-fed-day

  21. I have a question about the trillion $ coin idea. Since the vast majority of the public (not to mention the politicians and policy makers) are convinced that the debt and deficit in and of itself is a problem why is the trillion $ coin/debt ceiling “solution” not to have treasury use this trillion to buy back a trillion $ of the federal debt? wouldn’t that lower the overall debt and thus eliminate the need (at least for now) to raise the debt ceiling? In addition, wouldn’t it lower the interest payments on the debt which, again according to the pols and policy makers, is eating up an ever greater chunk of the federal budget and is thus why we “are broke” and don’t have the money for social programs, infrastructure rebuilding etc? So, i guess i’m asking why not use this power to pay down the debt instead of trying to convince people that the debt doesn’t matter which strikes me as a harder sell? And, for those that want to push for increased gov’t spending (on things like infrastrucure, “green” energy etc) wouldn’t it make it easier to make the case and sell it to the public if we were able to say, to use an extreme example, that if we paid off the entire debt tomorrow that we would save nearly 1/2 a trillion a year in intereest payments that could then be used for other spending needs?

    1. @Dkonstruction,

      Using the proceeds of the coin to buy back debt would actually end up enriching bondholders and bond traders more than leaving the proceeds as reserves. What you’re suggesting leads to a lot of transactions costs – buying back Treasury debt and then issuing more Treasury debt. Why cross the bid/ask spread twice for $1T of bonds?

      Also, any interest savings from issuing coins instead of debt is mostly illusory. Treasuries trade to a yield equal to the expected interest paid on reserves averaged over time, plus maybe a small risk premium. The Treasury/Fed would only save the small amount due to the risk premium, and in any case, it doesn’t really matter in the grand scheme. It’s more important that the government not waste real resources by spending on stupid things.

  22. ESM, thanks so much for your response. I am still trying to wrap my head around the MMT ideas (and economics more generally). So, i may come back to you and this blog with a follow-up after i’ve had time to digest and think on your response (at work now and so can’t devote to much time/mental energy. For now though, how does this relate to those that argue that a larger and larger piece of the federal budget is going to pay the interest payments on the debt and so is not available for more productive (whatever one thinks those are) spending? I guess i am still unclear as to why/how if the treasury is minting a coin (of whatever denomination/value) that is not issued as debt and upon which interest payments need to be made, how the “interest savings” are “illusory.” Again, thanks so much for your response. this seems like a great site where some serious and much needed discussions are taking place

    1. @Dkonstruction,

      Government payment of interest is a form of transfer payment. It involves simply shifting dollars from one reserve account to another. It may be unfair in that some people receive dollars and other people don’t, but it is not wasteful (or useful) in and of itself since it does not induce or force real resources to be allocated to any specific purpose.

      I’m not saying I would be happy if the government just randomly transferred hundreds of billions of dollars to people other than myself, but it doesn’t waste resources in the aggregate, at least to a first order approximation (there may be second order negative effects in terms of malinvestment, disincentives to work, etc, or even positive effects, for the people who receive those transfer payments).

      As for interest costs on the coin, those exist because the Fed pays interest on reserves. The coin creates $1T more reserves for the Fed to pay interest on. Currently, the rate that the Fed pays is lower than longer term bonds, but actually higher than the yield on T-bills (even out to 1yr maturity). So the government’s interest cost would actually go up versus the alternative scenario of raising the debt ceiling by $1T and issuing that many T-bills.

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