Dear Mr. Mosler:

If the US debt with China is merely numbers on a “Reserve Account” at the Federal Reserve Bank,

China’s funds are either in a reserve account or in a securities account at the fed.

could China close its account at the Federal Reserve

The dollars exist only as entries on the Fed’s computer, and actual cash, which is the same data written on a piece of paper

or move its account from the Federal Reserve Bank to the Central Bank of China?

The central bank of China has a reserve account and a securities account at the Fed dollars can’t be anywhere else.

It could loan the dollars to someone else and hold their liability. And that loan transaction debiting China’s fed account and crediting the borrower’s Fed account

And if it did, what would the mechanics of such a move be and what would be the consequence of such a move?

Don’t see any of interest.

I hear news reports that China would like to replace the dollar as the international currency. Would this be the same as “closing” its account at the Federal Reserve Bank?

No, I’m not sure what it would mean. I don’t use those words, and when I ask others who do they don’t know either.

Thank you for your anticipated response. David DePasquale

thanks for your interest!

81 Responses

  1. are you sure PBOC holds the dollars it purchases initially from Chinese exporters directly with the Fed?

    or does it use intermediary US clearing banks?

    1. I’ll take a stab at this.

      Does it matter? If the reserves are at intermediary US clearing banks, those banks probably have accounts at the Fed. That’s just the nature of the banking system.

      If I might guess, the goal of these questions boils down to what if the Chinese don’t keep their money in a place where it ends up purchasing US Treasury bonds. Well if you go with the most extreme example, the Chinese could withdraw their money from their accounts and physically hide the bills under their beds. Maybe they build a giant vault in Tibet and put packs of hundred dollars bills there.

      In that case the banking system would be short reserves, and interest rates would rise. In that case it’s the Federal Reserve’s obligation to lend reserves to the banking system at the Fed’s target interest rate, the same thing it’s been doing forever.

      The final result is that nothing happened except that the Chinese are not earning interest on their money, and we have received the goods or services they sold us, in exchange for paper they are burying in the ground.

      Or at least that’s my understanding of this.

      1. How do we account for the physical money in your pocket right now?

        When I go to the ATM and withdraw $60 and put it in my wallet, it obviously doesn’t result in the US government “defaulting.”

      2. I see. In that case I don’t know. But perhaps its something like the way the Federal Reserve ran it’s swap lines with the Central Banks in Europe and Latin America. Those central banks do seem to have direct connections.

    2. Foreign Exchange Reserves

      Chinese companies do business with US companies. They trade with each other commercially, and this results in some empty container space on the return trip to China and a trade deficit for the US. The Chinese government doesn’t want that surplus all to be returned to the Chinese economy because it would cause inflation, so it holds some of it instead as foreign exchange reserves at the Fed and then stores them at interest in Tsy’s. The Tsy’s can be converted to reserves at any time. In times gone by, those reserves would have been gold bars and they would have been stored in FRBNY’s subterranean vault. Now this is all done on spreadsheets. Actually it was then, too, and a manifest was sent to the gnomes in the vault who moved the bars from one country’s vault to another. I actually witnessed this one day in the ’60’s.

  2. Seems that China “replacing the dollar as reserve currency” simply means that China or someone else will need to run large trade deficits with the rest of the world. No other way for another country’s currency to do it.

  3. “China’s funds are either in a reserve account or in a securities account at the fed.”

    Why does the Fed keep track of securities? Since the Treasury issues Treasury securities shouldn’t the Treasury be keeping track of them?
    Could someone explain how does this work?

    “…could China…move its account from the Federal Reserve Bank to the Central Bank of China?”

    China could withdraw paper dollars (and coins perhaps 🙂 ) and ship it to China, effectively making their reserves into so called Eurodollars, correct?

      1. Thanks for the clarification Winslow R.

        So, could China, hypotetically, withdraw its reserves in cash, ship those reserves to China and close its account at the Fed?

      2. Don’t see why it couldn’t, though it would not collect interest so it doesn’t make a lot of sense.

  4. Hello,

    I am coming here from Bill Mitchell’s captivating blog where I tried to start a discussion on the operational structure of EMU but with little traction so far, so I’m giving it another shot here:

    1- Is the ECB the fiscal agent of the member states (via the NCBs)?
    2- If so, can the ECB, nonetheless, bounce a treasury check, say if the deficit does not comply with the Stability and Growth Pact (SGP) rules?

    If the answer is NO to 1/ or YES to 2-, I would understand that the EMU is financially constrained i.e. has to borrow funds from capital markets in order to net spend (*), resulting in
    a) crowding out in the bonds market
    b) A legitimate concern by them for the risk of default.

    Otherwise I don’t see that there is a risk of default, if one abides by MMT thinking. The SGP, in particular, is just a bunch of rules in an official document. Whether a particular member crosses some threshold, unless it triggers some operational change as in 2-, has nothing to do, per se, with its default risk.

    If neither of 1- or 2- is true, it begs the question of what underpins this previous post on this blog:

    “If all the national govts had started with zero debt when they formed the union, the markets never would have let them get beyond maybe 20% debt to GDP.”

    Thanks.

    (*) I do not confuse with selling debt to expunge an excess of reserves due to net spending in the first place in order to maintain a target interbank rate, as under the US system.

    1. B,
      This is interesting. I think as long as the Greek Govt Bonds maintain acceptable credit ratings and can be used as collateral at the ECB, you perhaps are on to something here.

      We need local guru JKH or the “JKH of Europe” on this one.

      Resp,

    2. This is something I’ve wondered, myself. U.S. states maintain accounts at commercial banks (with the lone exception of North Dakota, which actually has a state-owned bank…), and raise money by selling bonds to the public, which results in transfers of bank liabilities to their account. The different mechanics of the Federal treasury, as far as I can tell, come about because they deal directly with high-powered money through their account at the Fed. Thus, a Treasury check is a reserve add, while a California check is a mere bank transfer (and a California bond sale is a true “loan”, competing with other debtors in the loan market, as opposed to a Treasury bond sale, which is a reserve drain and in no sense a “loan”).

      If the EU member nations maintain accounts at the ECB, it seems to me that, absent ECB regulations, there is no functional reason that they can not operate just as the Fed/Treasury do. Indeed, this seems to be the crux of Warren’s proposal – the Trillion Euro “transfer” would merely be a marking down of members EU debt accounts, with no real external impact (except for the reduction in interest payments) on the larger EU monetary system.

      1. Jim,
        I think the “ECB” is just sort of an affiliation of the NCBs, I could be wrong. But this was from the settlement procedures of the FOREX swaps the US Fed did with the “ECB” last year: “On receipt of such collateral, the NCB will submit the corresponding US dollar payment instruction to the Federal Reserve Bank of New York (FRBNY) as soon as possible thereafter and ideally before 20:00 CET on the settlement
        date. On the maturity date, market counterparties are required to pay back US dollar funds to the accounts of NCBs at the FRBNY by 16:00 CET.”

        So the FRBNY’s relationship was with each of the NCBs actually, not a singular “ECB”. So if there was an “ECB” I would have thought the Fed would have just set up the swaps with just that one counterparty, and that party would have doled out the dollars.

      2. Jim,
        I got some time and looked into it last nite.

        Here is the Greek Central Bank Site….From the homepage:”Holds and manages the country’s official reserve assets, including the foreign exchange and gold reserves of the Bank of Greece and the government.
        Acts as treasurer and fiscal agent for the government.”

        they have a Greek Bond Primary Dealer set-up,
        here’s the list (many of the usual suspects!)

        so it looks like the NCB of Greece provides the reserves to buy the Govt Bonds, so as long as the Greek Govt Bonds are acceptable collateral, IMO the Greek Govt cannot default.

      3. i think it’s the ecb that services bank reserves region wide.

        the ncb’s simply have accounts at the ecb.

        it holds official reserves of Greece which are gold, etc. with any positive euro balances being held in the Bank of Greece account at the ECB

        If no one buys Greek debt their checks will bounce if they spend more than they tax.

        being able to repo the bonds is secondary

    3. Jim/B,
      One of the things I learned here (I think!) is that when the US treasury sells a bond, the Fed would provide the liquidity to the Dealer Bank if necessary (repo of Treasuries?).Now if the Fed were to say that Treasuries were no longer acceptable collateral (I know this is absurd but) then perhaps the auction would fail. So I sort of come back to the collateral issue with Greece, if the ECB says that the GGBs were not acceptable collateral, if they have a dealer system like we do, perhaps they could not get a dealer bank to step up (unless it was a greek bank in “cahoots” with the Greek govt or something).

      This is from Bloomberg recently: ….The rating was lowered by one level to BBB+ from A-, S&P said in a statement late yesterday. Fitch Ratings on Dec. 8 cut Greek debt to BBB+. Papandreou two days ago pledged “radical” measures to fix Greece’s budget. ……Further downgrades may cast doubt on the eligibility of Greek government debt as collateral in ECB operations. The ECB currently accepts bonds rated BBB- as collateral for loans after relaxing its rules in response to the financial crisis last year. At the end of 2010, it intends to revert to the old rules, under which A- is the minimum required rating. ”

      So it may come down to the ratings agencies (again!)…

      Resp,

    4. 1- Is the ECB the fiscal agent of the member states (via the NCBs)?

      YES, THE NATIONAL CB’S HAVE ACCOUNTS AT THE ECB, TO THE BEST OF MY KNOWLEDGE

      2- If so, can the ECB, nonetheless, bounce a treasury check, say if the deficit does not comply with the Stability and Growth Pact (SGP) rules?

      THE NATIONAL CB’S CAN’T RUN OVERDRAFTS IN THE ECB ACCOUNTS, TO THE BEST OF MY KNOWLEDGE. SO THE NATIONAL GOVTS HAVE TO BORROW FIRST, AND THEN SPEND, RENDERING THEM SUBJECT TO A LIQUIDITY CRISIS AND DEFAULT.

      If the answer is NO to 1/ or YES to 2-, I would understand that the EMU is financially constrained i.e. has to borrow funds from capital markets in order to net spend (*),
      TRUE FOR THE NATIONAL GOVS

      resulting in
      a) crowding out in the bonds market
      NO, THE EURO REMAINS A NON CONVERTIBLE CURRENCY, LOANS CREATE DEPOSITS, ETC. AND THERE ARE NO SUPPLY SIDE CONSTRAINTS/LOANABLE FUNDS CONSTRAINTS.

      b) A legitimate concern by them for the risk of default.
      YES AS THEIR CHECKS WILL BOUNCE IF THEIR ACCOUNTS DON’T HAVE SUFFIENT FUNDS.

      Otherwise I don’t see that there is a risk of default, if one abides by MMT thinking. The SGP, in particular, is just a bunch of rules in an official document. Whether a particular member crosses some threshold, unless it triggers some operational change as in 2-, has nothing to do, per se, with its default risk.

      If neither of 1- or 2- is true, it begs the question of what underpins this previous post on this blog:

      “If all the national govts had started with zero debt when they formed the union, the markets never would have let them get beyond maybe 20% debt to GDP.”
      TRUE. QUESTION?

    5. I’ve been trying to figure out how the ECB/NCB balance sheets work, but its slim pickings on information. Here’s something that says Euro reserves are held with the NCB’s:

      “Reserves must be held at the NCB in the country where the institution is located even if it is incorporated elsewhere, so a German branch of a French bank and a German branch of a US bank must both hold reserves with the Bundesbank. Reserve accounts may be used as settlement accounts, meaning banks will be able to draw on their reserves to make payments during the day.”

      http://www.bankofengland.co.uk/publications/practicalissues/eu9ch3.pdf

      (I’m wondering if there’s some sort of pass through arrangement whereby the NCB’s hold “contra” Euro reserves with the ECB.)

      FX reserves appear to be more centralized through the ECB though.

      1. sumner and rowe are like keystone cops in the comments trying to figure out which side of the balance sheet reserves are on

      2. JKH,

        This link is to a page at the Bank of Greece. At the bottom is a link to an excel file of the “Balance Sheet of the Bank of Greece”
        I got a password challenge in MS vista but it opened the excel file anyway.

        This is the “General Document”, Section 3 is Open Market Operations: “3.1.2 MAIN REFINANCING OPERATIONS
        The main refinancing operations are the most
        important open market operations conducted
        by the Eurosystem, playing a pivotal role
        in pursuing the aims of steering interest
        rates, managing the liquidity situation in the
        market and signalling the stance of
        monetary policy.
        The operational features of the main refi nancing
        operations can be summarised as follows:
        • they are liquidity-providing reverse
        operations;• they are executed regularly each week;1
        • they normally have a maturity of one week;2
        they are executed in a decentralised manner
        by the national central banks
        ;
        • they are executed through standard tenders
        (as specifi ed in Section 5.1);
        • all counterparties fulfi lling the general
        eligibility criteria (as specifi ed in Section 2.1)
        may submit bids for the main refi nancing
        operations; and
        marketable and non-marketable assets
        (as specifi ed in Chapter 6) are eligible as
        underlying assets
        for the main refi nancing
        operations.

        I have no direct experience with this but it reads like the “ECB” is just a bit more than the equivalent of having a “FRBNY” in every country and the ECB just rolls up the numbers …or something like that. Resp,

      3. Thanks, Matt.

        The Bank of Greece site actually looks quite well done in terms of information.

        I’m going to spend a bit of time on this at some stage. I’ve seen balance sheets now for the ECB, the consolidated Euro system, and the typical NB (e.g. Greece). The ECB balance looks quite different on the asset side from that of the typical central bank. Plus there are a lot of internal entries with the rest of the Euro system of NCB’s. It’s not that easy to see how the functionality breaks down as between centralized and decentralized. Or what the hypothetical entries might be for a trillion Euro helicopter drop. E.g. such a $ drop for the Fed ends up translating to a fiscal operation. Not sure quite how this looks when you do it through the ECB or the NCBs.

      4. I like the way they have banks ejaculate reserves over innocent passerbys. But my favorite remains Woolsley’s “non-monetary loans.”

        “Here’s your three pounds of goat meat. I’ll want it back next Saturday PLUS a chicken”

      5. I’ve got an idea of what he actually did in that post, which has absolutely nothing to do with the fallacy of composition or decomposition. The nature of the error is sort of interesting – another cautionary tale pointing to the value of some basic MMT knowledge. Maybe I’ll leave a note on it here in due course.

      6. Yes, JKH, very funny. And these are the “experts.”

        I read Rowe’s piece last night and thought the same thing. It’s a blend of absolute misinterpretation of MMT/horizontalism on cbs/banking (for instance, when did we ever say that the cost of acquiring liabilities didn’t matter? What does “it’s about price, not quantity” sound like it means to you?) and wasting too much time with an abstract and inapplicable model rather than just going out and looking.

      7. Scott,

        Yes. Given the amount of time some of us have spent there, I no longer appreciate that kind of misrepresentation on his part, and nor do you, if not more so I’m sure. It’s unprofessional.

        So apart from that I’ll try and leave a note here in the next couple of days on the fundamental error he made in the analysis he actually did.

  5. Matt, thanks for your interest.

    Jim, thanks for your insight. I follow you only up until this point:

    > “the Trillion Euro “transfer” would merely be a marking down of members EU debt accounts, with no real external impact (except for the reduction in interest payments) on the larger EU monetary system.”

    What is the need for this if

    > “there is no functional reason that they can not operate just as the Fed/Treasury do”?

    My current understanding of MMT is that if the government is not financially constrained, neither it, not the markets should worry about its level of debt.

  6. Matt,

    I now know what you know mean. If a bond looses its collateral status, the market will require a higher yield. Although I don’t minimize its implications, the answer is in my view is subordinated to that of a more fundamental question:

    i- Is ECB member states ‘like’ Fed US Treasury; whereby debt issuance is an optional monetary operation to soak up the creation of monetary base resulting from net spending, or
    ii- Each member state is like a US State i.e. it must borrow from the market in order to spend more than its tax receipts; an operation that does not create net financial assets?

  7. look at the national govs in the eurozone as in the same position as the US States.

    but without a federal gov that routinely runs a budget deficit to help ‘fund’ the states need for net financial assets (savings)

    1. Warren, thanks for your clarifications.

      You probably know that the no “overdraft facility” (of any kind) is effective (not just voted) since 1994 for the members of EMU, but also to some extent (it’s a bit murky) that this dates back to 1973 for some member states (as widely reported in some European blogs). One would think that problems would have kicked in earlier, no?

      ————- Application into French law of Institutional Arrangements at the EU level ———-

      Article L141-3
      (inserted by Order No. 2000-1223 of 14 December 2000, Official Journal of 16 December 2000)
      The Bank of France is prohibited from authorising overdrafts or granting any other type of credit to the Trésor public or to any other public body or undertaking. The direct acquisition of their debt instruments by the Bank of France is also prohibited.
      The agreements entered into between the Government and the Bank of France determine, when necessary, the terms of repayment of the advances granted to the Trésor public by the Bank of France prior to 1 January 1994.
      The provisions of the first paragraph do not apply to public credit institutions which enjoy the same treatment as private credit institutions in regard to the provision of liquid assets by the Bank of France.

      Source: 195.83.177.9/code/liste.phtml?lang=uk&c=25&r=707

      ————- Treaty on European Union ———-

      Official Journal C 191, 29 July 1992
      Article 21
      Operations with public entities
      21.1. In accordance with Article 104 of this Treaty, overdrafts or any other type of credit facility with the ECB or with the national central banks in favour of Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.

      21.2. The ECB and national central banks may act as fiscal agents for the entities referred to in Article 21.1.

      21.3. The provisions of this Article shall not apply to publicly-owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the ECB as private credit institutions.

      Source : eur-lex.europa.eu/en/treaties/dat/11992M/htm/11992M.html

      ————- What constitutes overdraft facility? ———-

      Council Regulation (EC) No 3603/93 of 13 December 1993 specifying definitions for the application of the prohibitions referred to in Articles 104 and 104b (1) of the Treaty

      HAS ADOPTED THIS REGULATION:

      Article 1

      1. For the purposes of Article 104 of the Treaty:

      (a) ‘overdraft facilities’ means any provision of funds to the public sector resulting or likely to result in a debit balance;

      (b) ‘other type of credit facility’ means:

      (i) any claim against the public sector existing at 1 January 1994, except for fixed-maturity claims acquired before that date;

      (ii) any financing of the public sector’s obligations vis-à-vis third parties;

      (iii) without prejudice to Article 104 (2) of the Treaty, any transaction with the public sector resulting or likely to result in a claim against that sector.

      2. The following shall not be regarded as ‘debt instruments’ within the meaning of Article 104 of the Treaty: securities acquired from the public sector to ensure the conversion into negotiable fixed-maturity securities under market conditions of:

      – fixed-maturity claims acquired before 1 January 1994 which are not negotiable or not under market conditions, provided that the maturity of the securities is not subsequent to that of the aforementioned claims;

      – the amount of the ‘ways and means’ facility maintained by the United Kingdom Government with the Bank of England until the date, if any, on which the United Kingdom moves to stage three of EMU.

      Article 2

      1. During stage two of EMU, purchases by the national central bank of one Member State of marketable debt instruments issued by the public sector of another Member State shall not be considered direct purchases within the meaning of Article 104 of the Treaty, provided that such purchases are conducted for the sole purpose of managing foreign exchange reserves.

      2. During stage three of EMU, the following purchases conducted for the sole purpose of managing foreign exchange reserves shall not be considered direct purchases within the meaning of Article 104 of the Treaty:

      – purchases by the national central bank of a Member State not participating in stage three of EMU, from the public sector of another Member State, of marketable debt instruments of the latter,

      – purchases by the European Central Bank or the national central bank of a Member State participating in stage three of EMU, from the public sector of a Member State not participating in stage three, of marketable debt instruments of the latter.

      Article 3

      For the purposes of this Regulation, ‘public sector’ means Community institutions or bodies, central governments, regional, local or other public authorities, other bodies governed by public law or public undertakings of Member States.

      ‘National central banks’ means the central banks of the Member States and the Luxembourg Monetary Institute.

      Article 4

      Intra-day credits by the European Central Bank or the national banks to the public sector shall not be considered as a credit facility within the meaning of Article 104 of the Treaty, provided that they remain limited to the day and that no extension is possible.

      Article 5

      Where the European Central Bank or the national central banks receive from the public sector, for collection, cheques issued by third parties and credit the public sector’s account before the drawee bank has been debited, this operation shall not be considered as a credit facility within the meaning of Article 104 of the Treaty if a fixed period of time corresponding to the normal period for the collection of cheques by the central bank of the Member State concerned has elapsed since receipt of the cheque, provided that any float which may arise is exceptional, is of a small amount and averages out in the short term.

      Article 6

      The holding by the European Central Bank or the national central banks of coins issued by the public sector and credited to the public sector shall not be regarded as a credit facility within the meaning of Article 104 of the Treaty where the amount of these assets remains at less than 10 % of the coins in circulation.

      Until 31 December 1996, this figure shall be 15 % for Germany.

      Article 7

      The financing by the European Central Bank or the national central banks of obligations falling upon the public sector vis-à-vis the International Monetary Fund or resulting from the implementation of the medium-term financial assistance facility set up by Regulation (EEC) No 1969/88 (4) shall not be regarded as a credit facility within the meaning of Article 104 of the Treaty.

      Article 8

      1. For the purposes of Articles 104 and 104b (1) of the Treaty, ‘public undertaking’ shall be defined as any undertaking over which the State or other regional or local authorities may directly or indirectly exercise a dominant influence by virtue of their ownership of it, their financial participation therein or the rules which govern it.

      A dominant influence on the part of the public authorities shall be presumed when these authorities, directly or indirectly in relation to an undertaking:

      (a) hold the major part of the undertaking’s subscribed capital;

      (b) control the majority of the votes attaching to shares issued by the undertaking; or

      (c) can appoint more than half of the members of the undertaking’s administrative, managerial or supervisory body.

      2. For the purposes of Articles 104 and 104b (1) of the Treaty, the European Central Bank and the national central banks do not form part of the public sector.

      Article 9

      This Regulation shall enter into force on 1 January 1994.

      This Regulation shall be binding in its entirety and directly applicable in all Member States.

      Done at Brussels, 13 December 1993.

      Source : eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=CELEX:31993R3603:EN:HTML

      ——— Application into French Law of the above ———–

      Le 1er janvier 1994, la loi n° 93-980 du 4 août 1993 relative au statut de la Banque de France interdit à celle-ci dans son article 3 d’autoriser des découverts ou d’accorder tout autre type de crédit au Trésor public ou à tout autre organisme ou entreprise publics, de même que l’acquisition de titres de leur dette. Les services bancaires (opérations de caisse, tenue de compte, placement des bons du Trésor, etc.) encore assurés par la Banque pour le compte du Trésor sont désormais rémunérés par l’État.

      ——— Antecedant ———–

      L’article 25 de la loi du 3 janvier 1973 : “Le trésor public ne peut être présentateur de ses propres effets à l’escompte de la Banque de France”, ce qui signifie que le trésor public ne pouvait plus, à partir de ce moment, présenter les garanties que lui, l’Etat ou les collectivités publiques auraient émis, à l’escompte de la Banque de France

      Source: legifrance.gouv.fr/jopdf/common/jo_pdf.jsp?numJO=0&dateJO=19730104&numTexte=&pageDebut=00165&pageFin=

      1. Hello,

        I’m following up with this issue that has been resolved completely from an empirical standpoint, IMHO. I hope I’m not sounding too much of pain in the neck for revisiting it, but it’s a for a good cause. Here’s a recap with updates:

        I asked (A): If the answer is NO to 1/ or YES to 2-, I would understand that the EMU is financially constrained i.e. has to borrow funds from capital markets in order to net spend (*),

        Warren replied:

        TRUE FOR THE NATIONAL GOVS

        I asked (B) : “If all the national govts had started with zero debt when they formed the union, the markets never would have let them get beyond maybe 20% debt to GDP.”

        Warren replied : TRUE. QUESTION?

        Update : Debt/GDP for Germany
        19.7% in 1950
        18.6% in 1970
        47.8% in 1993
        62.0% 2010

        I asked (C) : You probably know that the no “overdraft facility” (of any kind) is effective (not just voted) since 1994 for the members of EMU, but also to some extent (it’s a bit murky) that this dates back to 1973 for some member states. One would think that problems would have kicked in earlier, no?

        Update : At worst these countries were in a MMT regime from 1971 to 1973. At best, from 1971 to 1994. The debt/gdp figures don’t exactly agree with assertion (B). Did I get the facts wrong (all the relevant documents I could find are listed in the previous comment)? What else would I be missing then?

  8. Does China allow it’s citizens to leave the country ? If so, revive the old “See the U.S.A. in your Chevrolet” commercials and play them in China. Promote Chinese tourism in the United States. They could visit “Old Faithful” in Yellowstone,or see the the sites of San Francisco and Chicago,to name a few. Our hotels and restaurants,and cab drivers,etc,could use the business and China could use up some of those dollars they have…

    1. Winterspeak/Scott,

      Regarding the Rowe post:

      Suppose a bank has a shortfall of X in its required reserves. So it needs to attract additional reserves of X to meet its requirement. Nick says that this bank has a 100 per cent reserve requirement (for X) at the margin. Got that? Furthermore, he says Post Keynesians don’t understand this. Where would we be without this insight?

      To wit:

      “With a (say) 10% desired reserve ratio, the marginal cost to the banking system as a whole of a $100 expansion in deposits is the cost of needing an extra $10 in reserves. But for the individual bank, the marginal cost of creating a new $100 deposit is the cost of needing an extra $100 in reserves. At the margin, it is as if an individual bank has a 100% reserve ratio, regardless of the 10% (or 0% or whatever) desired reserve ratio.”

      This is a hopeless, ludicrous confusion of stock/flow analysis as it pertains to the subject of bank reserves. Banks need reserve stocks to meet statutory reserve requirements, whether that stock requirement is non-zero or zero. They need reserve flows to offset reserve flows in the reverse direction. Such offset matching is the essence of the reserve manager’s job as a response to normal asset liability flows, as well as the substance of the interbank settlement function. The effect of both asset and liability flows determines a net reserve result as an ongoing operational result. It is absurd to interpret the notion of “100 per cent reserve requirements” due to the (cumulative) settlement of asset outflows alone as a measure that is comparable to a stock reserve (ratio) requirement in any normal or meaningful way.

      So with this confused interpretation, Nick then believes he’s proven that “the supply of reserves matters”, and that the multiplier works, and that he’s uncovered the deep error of Post Keynesians, who according to him believe reserves “don’t matter”. Got that? This is powerful stuff indeed.

      Nick’s piece de resistance is the identification of a “fallacy of decomposition” trap that he announces Post Keynesians have fallen into. According to this high theory, the banking system as a whole (or the banking system imagined as a single bank) doesn’t need to attract reserves to match their loans. But individual banks do, based on Nick’s sleuth like discovery of reserve flows between banks. Got that? Post Keynesians missed the interbank flow aspect. They got the stocks, but missed the flows. But the Keystone cops have figured this out.

      What a joke.

      Rowe concludes his piece with a couple of absurd and useless caveats. The first is that nobody in the world (without Nick’s approval) is allowed to use the word “supply” unless they are referring to a supply function, as opposed to a particular value of that function. E.g. Mere use of the word “supply” in referring to the stock of $ 1 trillion in excess Fed reserves renders any related comment illegitimate. Got that? The second is an inane critique of the standard PK rejection of the money multiplier. He says, “The simple textbook model of the money multiplier is not a model of the supply of loans.” Well, nobody with at least half a brain directed toward balance sheet analysis insists that it is, exclusively. The fact that loans create deposits happens to be a material real world reference point from which to illustrate the error of the textbook multiplier concept. The issue is the absurdity of the error; not whether the generic example is exclusive. It is obvious to anybody with at least a minimum knowledge of banks that deposits can be created from other types of bank asset expansion (e.g. securities purchases), in addition to loans.

      Nick’s piece was prodded by David Beckworth’s post, where for example the meaning of the Fed’s $ 1 trillion in excess reserves was discussed in some detail. Nick’s post has nothing to do with that important topic, or much else in the real world.

      Now I don’t know why I’ve spent any time on this all.

      Ref:

      http://worthwhile.typepad.com/worthwhile_canadian_initi/2010/02/fallacies-of-composition-and-decomposition-the-supply-of-money-and-reserves.html

      http://macromarketmusings.blogspot.com/2010/02/feds-exit-strategy.html

      1. JKH, He’ll probably end up as the head of the Central Bank someday!

        On a more serious note, do you feel that this evenings Fed raising of the Discount Rate is less meaningful than at other times when there were not as much excess reserves in the system? Do you offer an opinion of what they are thinking by raising this rate? More “lip service” in a form of a rate increase?
        Resp,

      2. Matt,

        The timing surprised me some, but I haven’t been following it that closely. It certainly makes sense in terms of the sequence for the “exit strategy”. The normal orientation for the discount rate is that it be priced consistent with “moral suasion”. I.e. the nominal rate should not encourage use of the window, because the window is intended to be a last resort. This orientation was reversed during the crisis. The Fed wanted to encourage discount window use – or at least not discourage use, simply due to the normal stigma attached to window borrowing. So resetting the discount rate is very consistent with returning the system to normal functioning over some period of time. I think it’s meaningful even with excess reserves at their current level, because it’s indicative of a return to a more normal rate structure (including various spreads against the discount rate) over time. It may well be the case that discount window borrowing will end up being less with $ 1 trillion in excess reserves than with a normal counterfactual. But at the same time, the reserves are there because the system has gone through quite an upheaval, so the best idea is to phase in the return to normalcy gradually, in all respects.

        (Of course, the “moral suasion” factor is something that would be eliminated entirely in Mosler proposals, where the Fed would lend freely.)

      3. from FOMC minutes:

        ” discouraging depository institutions from relying on the discount window as a routine source of funds when other funding is generally available…. Participants generally agreed that such steps to return the Federal Reserve’s liquidity provision to a normal footing would be technical adjustments to reflect the notable diminution of the market strains that had made the creation of new liquidity facilities and expansion of existing facilities necessary and emphasized that such steps would not indicate a change in the Committee’s assessment of the appropriate stance of monetary policy or the proper time to begin moving to a less accommodative policy stance.”

      4. JKH:

        Some other things I noticed.

        1. The terminology is incredibly sloppy and crap. When I last looked, Rowe, Sumner, and Woosley were arguing over what base money was, and how it was multiplied into reserves or deposits or loans. And they are meant to be on the same side! Ogden’s Ogre is a dead giveaway here.

        2. All those pixels spilt on bank lending, and I don’t believe the word “capital” was mentioned once.

        3. Neither was “debt”. W. T. F.

        4. Part of me is sorry that no one answered David P’s question about a bank with more deposits by saying it had a lower cost of capital, and could benefit from that in a number of ways. The other part of me believes it would have made no difference.

        5. Sumner’s criticism that PKs don’t have a theory of prices is truly bizarre. When did simple supply and demand not become good enough?

      5. Winterspeak,

        All good points; I could have said a lot more as well. They make many allegations about what PKE says and doesn’t say. I suspect 99 per cent are wrong. The entire comment exchange indicates to me they’ve retrenched and gone backwards since that long discussion we had with them. There’s no hope they’re going to be motivated to learn something about the real world monetary system. I think the problem is about hubris ultimately. It really is analogous to Krugman’s idea of the Dark Age of Macroeconomics. The difference is that Krugman is talking about macro concepts that the Chicago school apparently never learned (you excluded?). MMT talks about macro banking architecture that only MMT has learned. Compare a Bill Mitchell post to this stuff. He has less jargon in 10 pages than you will find in a single sentence in Rowe. Notice how careful Mitchell is with the use of the English language? Compare that to this train wreck of bad syntax and worse logic. It’s downright childish. Yes, David is asking some reasonable questions. Too bad he won’t get much in return.

      6. I am a Chicago boy, but I never understood Chicago Macro. Now I know why, it makes no sense.

        Either way, my alma mater has taken a real pounding during this crises.

      1. OMG . . . saw the first 15 seconds and decided there was no way I was going to sit through 30 minutes! I doubt “interest rates and fiscal sustainability” comes up anywhere. And politically, he’s on the left (I think–???) and the others at Rowe and Co. are on the right. Not much wonder that our policy makers can’t do any better if the “experts” on both sides of the aisle are so lost (hubris is a good descriptor).

        All well said above, JKH. One small correction (???)–I thought that Rowe was suggesting that because an individual bank should expect withdrawals when it makes a loan, that’s why it essentially has 100% reserve requirement (to cover withdrawals). Maybe I misread your comments, but didn’t see that point there. Anyway, he’s wrong to critique PK on that for two reasons: (1) we always have noted that creating a loan creates a potential short position in reserves (and, of course, this is quite a bit different from saying the money multiplier is valid), (2) the details of liquidity management (which you’ve gone through quite well) and netted payment settlement.

        Winterspeak . . yes the critique about not having a theory of prices is weird, even though I wouldn’t necessarily agree with all PK stuff on prices. Haven’t seen any evidence he’s ever read PK; don’t know why he would from what I know about him.

        Good points from both of you on terminology. MMT is very picky about that, mostly out of necessity–can’t really do accounting correctly without it. If they were half as picky about accounting terminology as they are about how the word “supply” is used, they might have something.

      2. Scott .. Am in the 9th min of the video .. forget terminologies .. Thoma’s accounting is correct!

      3. I would actually say that Thoma made some progress there. I myself am not sure how to do the “real accounting”, but will give him the benefit of the doubt. His accounting with the nominals were correct. He acknowledges that the government is different from a household and that it can be in deficit forever.
        Actually reminded me of the topic brought up by JKH on Bill’s blog.

        Of course, “printing money” and “multiplier” etc and getting all sorts of causalities wrong were huge minuses but I guess he’s much better than Nick Rowe!

      4. Scott,

        “I thought that Rowe was suggesting that because an individual bank should expect withdrawals when it makes a loan, that’s why it essentially has 100% reserve requirement (to cover withdrawals).”

        Agree that what he said. I wasn’t clear in my analysis. Such an operational flow requirement is not relevant to the issue of trying to understand the relationship between a particular reserve stock requirement and bank asset expansion (i.e. “the multiplier”) – i.e. the PK understanding that there is no such relationship ex ante, versus the NC interpretation that there is. Such a differential flow requirement is irrelevant to the monetary interpretation of an average stock requirement of 10 per cent, or a stock requirement of zero per cent, or an excess stock supply of $ 1 trillion.

        I.e. the 100 per cent reserve requirement he refers to is a 100 per cent requirement for an inflow of settlement balances, relative to some prior outflow (e.g. a loan drawdown with an interbank clearing and net settlement outflow). The interpretation of such a micro operational flow requirement is quite independent of the macro interpretation of the macro rule for required reserve stock (e.g. zero per cent or 10 per cent) or the macro setting for excess reserves ($ 1 trillion). Put another way, PK’s and NC’s could have a debate about the relevance of 10 per cent reserves and “the multiplier”. We know where that goes. But there is no debate about whether a bank needs to source a reserve inflow to offset a reserve outflow, other things equal. Framing that sort of marginal flow requirement as a marginal 100 per cent ratio is completely irrelevant to the first debate.

        I think I’m not expressing this clearly. Make any sense?

      5. Gawd ! How did he arrive at a multiplier of 2 ?? I guess forgot M2 – M1, M3 – M1, …

        (Running commentary …)

      6. Scott,

        Yes the equations are as in IR&FS .. however, turn on the volume and you can see the Monetarist in him!

  9. Scott,

    I’ve just re-read your IR&FS and it seems more relevant than ever in light of all the talk about sovereign debt and fiscal sustainability, both here and in Europe. I strongly recommend that anyone on this blog invest the time to read and re-read it. Here is my question:

    In IR&FS you challenge (I think correctly) the Gokhale and Smetters calculation of “fiscal sustainability”, calling their study “questionable empirically”, and calling them out specifically for using the yield on 30yr Treasuries to measure the gap between interest rates and growth rates rather than the average yield of Treasury debt outstanding. In other words, they used the steep yield curve to make the numbers work in their favor.

    But it seems to me that the Gokhale and Smetters study can be attacked more forcefully on theoretical grounds. How do they explain the long-run gap between real interest rates and real GDP in the context of their own loanable funds, full employment equilibrium model? If that gap persists, then their equilibrium model seems flawed, if that gap doesn’t persist then there is no need to worry about fiscal sustainability in the first place, at least as it pertains to interest payments on the debt.

    What am I missing?

    1. Thanks, Knapp, for all that. If anyone wants the journal version of the paper, which is about 25% shorter (they wanted it still shorter than that, but I couldn’t do it) and a bit more tightly argued in places (though obviously missing some of the details included in the wp), I’m happy to email it (scott.fullwiler@gmail.com).

      Regarding your question, I don’t think you’re missing anything. I do make the criticism in your post’s 2nd paragraph specifically, but the broader purpose of the paper was to make the criticism in your last paragraph. Overall, sustainability as defined by the intertemporal constraint (Warren and MMT’ers have a different definition of fiscal sustainability, which I think is the far more appropriate one, obviously) comes down to the interest rate on the national debt, and for a sovereign currency issuer, this is a policy variable. The latter point is what economists who purport to understand that government’s can “print money” are missing, and it’s due to their reliance on analysis based upon loanable funds, money multiplier, etc.

      1. My last sentence got off track as I got a bit distracted here. My intent was to note that many economists claim to already understand that governments can “print money,” and thereby argue that MMT’s insights are trivial. But they are still usually operating with an incorrect understanding of the details of monetary operations, reserve accounting, etc., that are central to understanding how interest rates on the national debt are set for sovereign currency issuers.

      2. Yes,

        The distinctions are huge. A gigantic, earth-shattering result is that they don’t understand deficits are necessary. They are necessary for reserve currencies to run substantial deficits – that is if we like economic growth.

  10. Thanks Scott,

    I have a follow up comment on the distinction between deposits and Treasuries (p. 21 of IR&FS) where you say:

    “That the non-bank sector is holding Treasuries rather than deposits does not somehow constrain its spending…

    …[W]hether holding deposits or Treasuries, with greater wealth and net income flows the non-government sector might logically be more likely to spend than with the deficit while also appearing more creditworthy to banks, who themselves face no operational constraint on money creation.”

    My question gets back to discussions in the past about what exactly is so “high-powered” about HPM. It seems that according to your analysis, all net financial assets are equally- powered (via the wealth effect) and that the horizontal activity of the banks is a leveraging of that wealth, not just those that remain as reserves. Why not just drop the term HPM, and just use NFA, whatever their composition? If nothing else, it leaves you less vulnerable to attack by people who don’t understand that “leveraging HPM” is not an ex-post money multiplier.

    1. I agree in general, particularly regarding HPM vs. NFA. The MMT approach is to be concerned with NFA relative to “net saving desired” of the non-govt sector as the two variables driving aggregate demand (of course, there are a lot of moving parts for “net saving desired”). More or less HPM is mostly an asset swap that is related to monetary policy, not the qty of NFA.

      I wouldn’t characterize NFA necessarily via a wealth effect, though. My point–which I’ve realized lately I need to better clarify than I did there–is that the deficit leaves the non-govt sector with a new deposit for the recipient of the spending (or the individuals who have been taxed less in the event of a tax cut), whether or not a bond is sold. If a bond is sold to the non-bank pvt sector also, someone who was already intending to save now holds a Tsy instead of a deposit (or comparable). This latter transaction doesn’t somehow constrain the non-govt sector’s ability to spend or create loans or whatever, and it doesn’t somehow remove “funds available” for anyone else to use to spend or loan, though this is precisely what the loanable funds view suggests.

      1. Scott, the point that needs to be made clear is that there are two stocks/flows of “money,” the first being government money created by currency issuance and the second being bank or credit money created by bank lending (loans created deposits). (There is also the shadow banking system, but that is another story.) Confusion results since both are denominated in the same terms, so that they become indistinguishable. However, they retain their macro effects. Since everyone’s bank money is someone else’s loan, bank money nets to zero, and it not only doesn’t add to NFA but also creates an interest obligation in excess of the stock of bank money, necessitating further bank money creation to service. Government money has no corresponding liability in non-government so it increases non-government NFA. If there is a $4$ required offset of currency issuance with debt issuance, then this is just a transfer of currency issued by the government sitting in deposit accounts to Tsy’s, the transfer of one non-government asset for another. At the macro level this transpires in terms of normal flows in the economy, where some people are always seeking a risk-free parking place that pays interest, and others selling theirs to convert savings to deposits for use. It seems that almost no one gets this distinction and dual operation in the macro economy, but it is crucial. One problem is that it occurs at the macro level and most people aren’t familiar with this, so that people do no experience it and cannot visualize it because all money is denominated in the currency. What is needed are some metaphors, like comparing the transfer of reserves (deposit account) to Tsy’s (savings account) to switching one’s personal deposit account that earns no interest to a savings account or CD that does, showing how government debt issuance is not rally borrowing at all. The wealth effect is created mostly by leveraging bank money rather than currency issuance, too. Being based on borrowing at the horizontal level, the wealth effect can be chimerical, as people just learned when housing prices collapsed.

      2. What is needed are some metaphors, like comparing the transfer of reserves (deposit account) to Tsy’s (savings account) to switching one’s personal deposit account that earns no interest to a savings account or CD that does, showing how government debt issuance is not rally borrowing at all.

        I stated this too tersely. To clear any confusion, what it means is that when Tsy’s are bought/sold, the transactions transfer reserves in the interbank system between buyers and sellers’ banks, while in the commercial bank system, the sellers switch the NFA stored as Tsy’s to their deposit account, while buyers switch the NFA in their deposit accounts to storage in Tsy’s. Neither reserves nor NFA are increased or decreased by these transactions. These are just transfers.

  11. A complicating factor within the neoclassical paradigm is that there are many working definitions of what money is – from the ahistorical Walrasian numeraire to the market-institutionalism (“Metallism”) of Menger. So even though they all work within the loanable funds framework, I’m not sure many of them could explain why they do.

    I mean, what is Michael Woodruff’s definition of money? His models don’t even require the stuff.

    1. Some would say that’s a feature.

      And yes, when the models are explicitly designed to enable elimination of money, how can you expect them to understand it?

      Fundamentally, Monetarism believes that finance merely supports real economy, and so you should be able to remove money from the equation. And they build their models on that.

      Now here we have a purely nominal problem creating terrible real problems — and they are clinging to their old models. It is hopeless.

  12. Winterspeak,

    I see you’ve been having discussions over on the dark side.

    Nobody in these kinds of discussions used the phrase “capital constrained” before I introduced it, as far as I’m aware. It certainly wasn’t used for the particular meaning I intended. I think you know quite well my intended meaning, but more and more people are using it freely to describe whatever they want. In particular, the dark side has a habit of making up their own definitions in order to survive any discussion that relates to PK/Chartalism/MMT. So I thought a reminder was in order here. You know all this, but it may help you in your debates on the dark side.

    “Capital constrained” is a phrase I introduced in direct contradistinction to “reserve constrained”, as used by MMT, etc.

    The idea that banks are not reserve constrained in lending applies at both the systemic and the specific bank level. At the systemic level, it means that the central bank supplies any reserves required due to new deposit creation (which in turn results from new loans and other assets). The banking system does not start with a stockpile of reserves and expand balance sheets on that basis. The system is not constrained in lending by the necessity of a pre-supply of reserves. The central bank responds to any requirement after the fact of lending and balance sheet expansion. It is on this basis that the textbook multiplier is wrong. And the way the system actually works is all operational and accounting fact, as described by MMT, etc.

    At the individual bank level, banks compete for their required reserves from the total stock of reserves that the central bank provides. This becomes part of the daily clearing and settlement mechanism, which is essentially a mechanism to deal with reserve distribution. A bank that makes a loan with a reserve effect will always be able to source the required offset for that effect by looking around elsewhere in the system – e.g. additional deposits, interbank loans, etc. Assuming the bank is in decent financial health otherwise, the worst case may include access to the lender of last resort on a temporary basis. The discipline that IS important to the central bank in this regard is the use of the ex ante system excess it supplies to calibrate the pricing of the overnight rate according to individual bank competition for their required share of the reserve stock. (During the crisis, the central bank has created outsized excess reserves for entirely different reasons, necessitating the payment of interest on reserves for interest rate control purposes.)

    So that is the meaning of “reserve constraint”, or the absence of it, in my view.

    The meaning of “capital constraint” as I intended it exactly parallels the logic in the use of “reserve constraint” or the absence of it. I defined it this way in order to provide direct contrast between the constraint that was real – capital – and the constraint that was not real – reserves. Banks DO require a stock of excess capital before they can lend and take on new risk. The definition of excess capital in this regard is capital that has not yet been allocated to risk taking. This is all very much in synch with actual bank capital management and the regulatory framework for required capital and excess capital. E.g. Canadian banks are currently running very large excess capital positions (Tier I) relative to current requirements, because they are cautious about potential regulatory changes for required capital. That excess capital is normally available for new risk taking. In this special example, Canadian banks are even more constrained in lending than usual, due to capital considerations, because they are holding back excess capital as currently defined due to the contingency of a regulatory increase in required capital. At the systemic level, in the case of capital, there is no comparable analogy to the automatic provision of required reserves by the central bank. No public entity automatically provides the capital required to support risk in lending after lending has taken place. So this is the meaning of “capital constrained” as I intended.

    In other words, to understand the meaning of “capital constrained” in the way intended, you have to understand the meaning of “reserve constrained” in the way intended. This is impossible in the kinds of discussions you are having on the dark side. These people don’t work that way. They have no genuine interest in understanding the operational workings of the banking system. That is clear by now. They’ve had enough time to consider these things. Their interest is in promoting and spinning theory, with the objective of not letting operational realities and accounting get in the way of their theory. They have no interest in viewing their theory in the context of operational realities. They only want to reject operational facts where it threatens their theory. They are not capable of learning in this regard. That is why I haven’t left this note in that dark and sinister place where you have recently been.

    Instead, as is their usual tactic, they make up their own definitions. In particular, the idea of “capital constraint” as INTENDED has NOTHING to do with the ability of a bank to raise new capital. It has NOTHING to do with PE ratios and the cost of capital. As INTENDED, it is purely an observation on the operational importance of the EXISTING stock supply of capital as compared to the stock supply of reserves, and how those two stocks compare in the dynamics of balance sheet expansion.

    Now, it is quite possible for somebody else to start using the phrase “capital constraint” in a different way. But you CAN’T have a discussion with them on that basis. You have to specify the intended meaning in context. The context here is that capital stock constraints work on banks in a way in which reserve stock constraints don’t. From there, the pricing of (new) capital and reserves are quite separate issues and each distinct in its own way.

    This reminds me a bit of some recent dark side criticism about the use of the word “supply”. The difference is that I can distinguish between a function and one of its values. I’m sure those in the discussions you’ve returned to can’t distinguish between actual accounting, operations, stocks and flows on the one hand, and wild hand wavy economic theory on the other. If they could, they’d actually have a chance of improving on theories that are currently irrelevant to the functioning of the real world monetary system.

    1. JKH:

      I feel like an addict and I need help. Nick has pegged my weakness exactly.

      I do not believe I was misleading or incorrect in my use of the phrase “capital constrained”. It does have to do with the equity side on the balance sheet, yes, and it does provide a hard constraint on the ability for the bank to lend (and expand its balance sheet)?

      Maybe I was stepping down a slippery slope when I distinguished between a short term and a long term. In the short term, a bank has a fixed amount of capital. In the longer term, both an individual bank, and the banking system, can increase its capital, and thus its ability to extend loans. Net Financial assets (equity), of course, merely being the nominal element that the private sector can leverage on top of, with real assets also contributing to that base (you beat me up about that a while ago. I think I got the message).

      1. Wasn’t inferring you were incorrect at all. Just trying to provide you with additional technical support against an onslaught of irrational deception and trickery!

        You’re good to go. Just watch his infinite price level jab. It comes out of nowhere.

        Now get back in there, champ!

        🙂

      2. Re Rowe’s follow up post:

        “One important insight of this model is that the supply of reserves I determines desired reserves S, not the other way round. Deposits Y adjust to ensure that desired reserves S equals the supply of reserves I.”

        He’s got this backwards of course. It’s a completely arbitrary causality assumption on his part, with no logical justification. In the context of the mapping he’s created, the correct causality of banking system reserves is the opposite of that of “investment creates saving” in the income model. He’s merely constructed a false analogy of causality between the two models, due to the fact he doesn’t understand the causality of banking system reserves.

        However:

        “But this expansion of loans C and deposits Y can never happen, without an increase in the supply of reserves I… People who miss this important insight, who miss the distinction between desired reserves S and actual reserves I, end up with Say’s Law of Banking, which states that there can never be a general shortage of reserves I, so banks must always be at full employment… So the policy message is clear. The only way to get the total level of deposits Y to that required for full employment of banks is to increase the total supply of reserves I.”

        Ignoring the error relating to the first quote, and rejecting it because its arbitrary, you’ve got him on this. Everything in this last quote can apply to PKE.

        PKE observes that the central bank supplies the required reserves in this sense.

        What he calls “desired” is actually “required” in modern banking, due to additional loan and deposit creation and the central bank response of supplying what is required (with a regulatory time lag).

        As per my previous comments, this point has nothing to do with his erroneous attempt to apply the fallacy of composition.

        KO

      3. question from noted monetary economist:

        “Nick. I don’t get this. Say’s Law should apply to banks; there should never be any reason for banks to hold more than the desired amount of reserves. If their desired reserve ratio is 1/10, and total reserves are $5000, then total deposits should be $50,000. And this should always be true, as any unwanted reserves could immediately be exchanged for T-bills. What am I missing?”

        answer: the real world

      4. ” If their desired reserve ratio is 1/10, and total reserves are $5000, then total deposits should be $50,000. And this should always be true, as any unwanted reserves could immediately be exchanged for T-bills. What am I missing?”

        Exactly why bond sales are not like an “interest bearing account” at the Fed 🙂

  13. re:Nick Rowe’s post.

    I also made a post there but it was more concerned with the historical origins. I’d really appreciate if anyone has any feedback on what I wrote.

    I wrote a few draft replies to his latest post but haven’t felt the need to reply, partly because he has completely misunderstood what I’ve wrote, because I think it’s obvious that he hasn’t read any Post Keynesian material on the reasons for rejecting Say’s Law and because I think he reinterprets arguments back into his paradigm; completely distorting the argument and the distinction between the two paradigms.

    I’ve been taking a historical approach to understanding money, partly inspired by the works of Wray and Smithin and various anthropologists. I think this perspective is particularly important as it can potentially undermine the mainstream conception of money, barter and social relations.

    MDM

    1. I think he reinterprets arguments back into his paradigm; completely distorting the argument and the distinction between the two paradigms.

      MDM, I explained this to Nick once, but I guess he didn’t get it. People in general relate everything to their own frame of reference, which acts as a blinder to what is stated in terms of another frame. It’s a common epistemological problem and explains why so many people have a hard time getting the fundamentals of MMT.

      1. Agree, Tom. I expected that. What I didn’t expect, though, is that so many neoclassical and PK economists would have such an adverse reaction to accounting. I used to be under the impression that accounting–because it’s capitalism’s generally accepted method for “keeping score” (and even legally embedded)–would enable us to make our case in a language others would understand. Obviously, I was completely wrong.

      2. Underestimating the importance of accounting discipline constitutes a failure of imagination in mainstream economics.

        It’s a paradox of perception.

        Those that can’t see it don’t get it, and therefore think it unimportant.

      3. JKH:

        It’s more than that. There’s a snobbery built into it and ALSO bad models.

        Economists like to think they are working on the real economy, and that finance does not effect it. So they come up with models where money can drop out. I think Nick or Sumner or someone mentioned this as a flaw in PK.

        Still, Scott said PK economists don’t care about accounting and that surprises me. Maybe he’s thinking of Steve Keen?

      4. Aside from MMT, some stock-flow consistent modelers associated with Levy, and some horizontalists/circuitistes in Canada, I don’t know many among PK or any other heterodox school that focus much on grounding analysis in accounting. I’ve also been surprised that many Institutionalist economists (my original academic background in economics) don’t get it, either–they don’t think it’s “socially embedded” enough (sigh).

        As I said, it’s been a much tougher sell than I thought it would be. But I was biased early on as my own methodological approach (a sort of social science version of complex systems theory) led me to seek out operational details and rules/regulations/requirements that could be cited from primary sources–accounting was a natural fit there. For me, the question is always “how do you know that you know” the system works this way? And I quickly understood that accounting was fundamental for answering that question when you’re studying the monetary system (or most anything else where transactions in a capitalist system are concerned).

  14. Aha! Tracked you guys to your lair!

    Winterspeak: “Maybe I was stepping down a slippery slope when I distinguished between a short term and a long term. In the short term, a bank has a fixed amount of capital. In the longer term, both an individual bank, and the banking system, can increase its capital, and thus its ability to extend loans.”

    That’s a good and important slope to slide down! You are exactly right. The central bank can and does control the supply (curve/function) of reserves; it does not control the supply of capital (except perhaps, very indirectly). And that distinction is important if you want to understand how central banks control monetary policy. (Of course, this is not to say that all models of banking are aimed at understanding that question.)

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