Round two. Constructive comments as well!
Mosler: The wrong standard
Reader Note: This is the second entry from Warren Mosler in a debate with Jim Rickards about how to fix the economy. More on the authors here. This is a response to Rickards first piece. Mosler’s first piece is here.
by Warren Mosler
Jim’s recommendations are “sound money, lower taxes, and light regulation.”
We do agree on lower taxes. My proposals include a full payroll tax holiday to support demand. And while Jim suggests a return to Glass-Steagall, my banking proposals are even more narrow and dramatically reduce the need for regulation. I also support price stability.
We also agree that the Monetarist concept of “velocity” is flawed, but our reasons differ. Jim’s derive from the long-dead gold standard where velocity is a calculation of how many times the given amount of money (gold) is used to buy and sell goods and services. Today, however, monetary expansion has nothing to do with money supply like it used to under the gold standard. The reason banks aren’t lending isn’t because they don’t have money to lend. Lending is constrained only by bank capital and the creditworthiness of willing borrowers, not by gold or any other concept of bank reserves. That’s why quantitative easing – i.e. the Fed printing money to buy securities – has no effect on bank lending.
Interest rate cuts transfer income from savers to banks, reducing overall spending. So while interest on savings dropped from over 5% to near 0%, borrower’s rates fell little if any. The wide yield spread means banks’ profit margins widened.
New Keynesian thought is also flawed, because it too presumes gold standard constraints. Today government never actually has nor doesn’t have dollars, and spends, taxes, and borrows simply by changing numbers in bank accounts at the Fed.
When it comes to the dollar, the US government is the scorekeeper. Unlike the gold standard days, the government can’t run out of money. Nor is it dependent on China to fund spending.
Under the old gold standard, taxes and borrowing did fund spending. Today taxes function only to regulate aggregate demand and to control prices. The federal deficit is merely the difference between the numbers changed upward when the government spends, and the numbers changed downward when it taxes. Taxes therefore function to regulate aggregate demand, not to raise revenue, per se. Tax cuts increase our spending power, tax hikes lower it. This is indisputable operational fact, not theory or philosophy.
Jim’s general warning is that too much spending or monetary stimulus might lead us to cross a “critical threshold where diverse actors reject dollars in a cascading collapse.” But this only applies to fixed exchange rate regimes such as the gold standard, where a weak currency results in gold outflows.
Today the dollar is a non-convertible currency. The exchange rate continually adjusts, always representing indifference levels with no gain or loss of gold reserves. I would note too that the U.S. is actively seeking to weaken the dollar vis-à-vis the Chinese yuan. Would Jim want the reverse?
Jim’s arguments are as good as gold. However, we are not on a gold standard, so they don’t apply. Today’s monetary arrangements call for my solutions to restore output, employment, and price stability.
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It’s happening.
And the MA Massacre is showing that people running as independents can win state-wide elections. Voters are of a mind to throw out the Establishment of both parties that are coddling crony capitalism for campaign cash. Of course, it remains to be seen how independent Brown will actually be, but that is the campaign image he projected, and I doubt the overwhelmingly liberal voters of MA will reelect him if he doesn’t deliver on this independent image.
Warren is their any limit to how much debt the united states can issue. I realize we can just create debt and no one has to buy it. But if the markets see massive monetization then no one will have confidence in holding the dollar. Investors around the world will freak , its all a confidence game. What am i missing. Their have to be some risks for us in a floating exchange world if we just issue debt and run up say a 3 trillion dollar deficit.
Not confidence, but taxing authority.
Note this post for a while back:
you are addressing a room full of people.
you tell them taxes turn litter into money.
you try to sell your business cards to the group for $5 each.
probably no takers.
you offer your cards to anyone who stays to help clean up the room
no takers.
you then point to the man at the door with the 9mm who’s the tax collector, and no one leaves without 10 of your business cards.
you then repeat the questions.
If the value of $ comes from taxes only, shouldn’t there be a deflationary spike every April, as demand for dollars, to settle tax liabilities, increases?
Hi Curious,
Cant speak for the US (though I would imagine it is almost similar). Taxes are paid all the time, not just in one month. Here in India, taxes are paid every quarter. For employees, the employer deducts taxes at source every month and pays it every 3 months – even every month in some cases. Sales tax are paid monthly, though I could be wrong on this one. People “file for returns” in one particular month of a year – they don’t pay all the tax for a year at one shot. They either ask for a refund, in case they have paid more or give a cheque if they have paid less.
Taxes are not the only driver of aggregate demand – government spending adds to aggregate demand. The Treasury and the Fed have reasonable forecasts about taxes and spending and try to figure out the timing of spending.
Check this http://bilbo.economicoutlook.net/blog/?p=4402 and the BoJ document Bill talks of, in his blog.
right, and it’s also the ongoing tax liability as much as the actual payment
Hi Warren,
Nice article, but I’m confused about the comment, “The wide yield curve means banks’ profit margins widened.” Perhaps I am misinterpreting something, but isn’t this at odds with many other posts here arguing that banks don’t make their profits via duration mismatches in their assets and liabilities ?
Warren, or anyone else, it would be great if you could point to me to some arguments on how much profit a bank could make off of some static yield curve through acceptable gap risk. What are acceptable duration mismatches for different durations, and are they a fixed percentage of assets?
I think I understand most of you fiat currency arguments, and have found great earlier sources (like Innes) through your site and it’s connections. But I think I’m missing your gap risk argument.
it was a typo, should be wide yield spread.
sorry!!!!!!!!!!!!!!!! emailing reuters now
fixed, thanks!
just checked and the text i sent to rolfe at reuters had ‘yield spread’ in it and he changed it to ‘yield curve’ without informing me. he also changed the rest of the wording some.
never thought to even check for that.
Great! Glad I was able to catch a bad edit.
I certainly understand how ‘yield spreads’ make it easy for banks to prosper. 🙂
But, I’m still not sure I understand the constraint of gap risk, and why banks don’t make at least some profits from duration mismatches. From here and other places, I understand that there are constraints on the duration mismatches a bank can have – but I don’t know where to go to find the quantitative bounds in order to get some idea of how much a bank could make purely from term structure. Any help – pointers to sources, I do read a lot – would be greatly appreciated. I’m surrounded by folks who think it’s obvious that this is how banks make money – mostly professional traders.
Thank you!