Thursday, July 28, 2011

The President is teaching bad economics

President Obama’s speech Monday evening took the starch out of me. It was terrible to hear him deliver the conservative line and not even as ewell as they do. 
Everyone should know a little about economics and that’s all I claim to know, a few basics. In an earlier blog I tried to explain many ways in which private finances differed from those of the government. We all know that government can “print” money and households can’t. This difference has huge ramifications when we stop to think about it.
Perhaps the biggest difference is that households and firms try to make a profit. They save to accumulate wealth over time. Even state governments try to build a contingency fund for bad times. 
The federal government does not attempt to profit and has no way to save. It doesn’t need to because it can “print” all the money it needs. If it were to save, where would it put it? We don’t want government holding large amounts of stock in private firms. Hell, then Congress would try to run them. 
With a few moments thought, it should be obvious that government and private budgeting must be different.
Yet, our ill-advised President centers speeches around phrases like “the government must tighten its belt just like households do.” He must be getting his advice from Paul Ryan who says similar things with more conviction. President Obama is certainly not listening to his former economic advisor Larry Summers, who recently and belatedly wrote that the country needs a WPA project similar to FDR’s in the 1930s.
Early in his speech Monday, the President recited the following nonsense.
“Now, every family knows that a little credit card debt is manageable. But if we stay on the current path, our growing debt could cost us jobs and do serious damage to the economy. More of our tax dollars will go toward paying off the interest on our loans. Businesses will be less likely to open up shop and hire workers in a country that can’t balance its books. Interest rates could climb for everyone who borrows money – the homeowner with a mortgage, the student with a college loan, the corner store that wants to expand. And we won’t have enough money to make job-creating investments in things like education and infrastructure, or pay for vital programs like Medicare and Medicaid.”
He began with the government is like a household nonsense.
Then there is no way to save tax money. Government spending and taxation are separate functions. Government doesn’t need taxes to spend.
Our study of sector balances (here or here) has shown that a government that balances its budget in the face of private sector net saving (not spending) and foreign trade deficits will cause businesses to close as money is drained from the private sector and demand sags.
Obama is teaching the prevailing view of the day, which is out of date - to be kind.
To be less kind, this debt crisis is fabricated to induce enough panic that the polity will accept anything as a solution. Such a solution would be different from anything that would be concluded after public debate. Michael Hudson takes the less kind position. 

Spooky Debt to China

We tend to be spooked by the amount of our debt held by China. It makes good late-night comedy and cartoons abound. 
"Chinese President Hu Jintao was hinting that China may not loan the U.S. any more money. President Obama is now talking to him about a reverse mortgage." –Jay Leno

"The President of China is in Washington. It's a bit like when you're into your bookie for more than you can afford, and he stops by the house to say hello." –Jimmy Kimmel
We seem sure that China finances our profligate spending and resulting trade deficit. Nothing could be farther from the truth. Our spending shows up in our own loan balances.

The myth is that foreign investment funds our trade deficit. To be sure, we typically have imported more than we export for the last four decades.
Suppose we want to buy a Japanese car, many of us have done that. First we go to a bank and get a loan on reasonable terms, we draw on that loan to pay for the car and drive happily away. There is more happiness all around. The bank is happy to have the loan as an asset, and the car company is glad to have the money in trade for the car. 
Big deals work the same way. Walmart gets a boatload of Chinese stuff that it buys with a loan and the intent of making a profit when it sells the stuff to us. In neither case is there any foreign capital involved; there is just our private credit.
However the foreign country, Japan, China, or another trading partner has some dollars after the trade and can buy with those dollars any dollar denominated assets or convert to another currency. If they choose to buy safe US Treasury assets and we wish to sell them, it can be done. It is a matter of making a transfer from their checking (reserve) account at the Fed to a time deposit.
Our credit has funded their desire to acquire US dollar assets. Yes, it is that simple.

Friday, July 22, 2011

Circumvent the Debt Limit Crisis

Why don’t we just retire the debt? We don’t need it, and it causes endless concern. We just borrow or own money back from ourselves and the Treasuries further enrich the rich, as they end up owning most of them.
Recently I posted an idea from Rep Ron Paul as a way to get rid of debt now held by the Fed as a result of Quantitative Easing. A better idea has surfaced that involves coin seigniorage. That is the profit made on the cost of a coin relative to its face value. 
In short it goes like this. The US Mint is authorized to mint coins in any denomination, oh say $2 trillion, which is a huge profit. The Treasury then sweeps the profit from the Mint’s account at the Fed into its own General Account. With these funds it buys back Treasury bonds which reduces its General Account balance and increases bank reserve balances at the fed. It is essentially Quantitative Easing through the Treasury. It would be legal, feasible, and require no new legislation.
Of course, it won’t be done. People’s minds will recoil from the simplicity of it. If it were to happen the President could give the following speech copied from here.
My Fellow Americans:
1) Until now we’ve been borrowing the money the Government created back from the private sector, in order to cover our deficit spending, so the national debt has been steadily growing.
2) That’s silly! According to the Constitution, this Government, of the people, by the people, and for the people, is the ultimate source of all US money. So why should we ever borrow US money back and pay interest on it, since we can create it any time by the authority of the Constitution and Congress?
3) Congress has also imposed a debt ceiling, which, as you know, we've now reached, so we can’t borrow back our own money, anyway. 
4) So, on my order, and in accordance with legislation passed by Congress in 1996, and with the US Code, the US Mint has issued $30 Trillion in a single platinum coin, and deposited it at the NY Fed. It’s legal tender, so the Fed credited the PEF with about $30 Trillion in USD credits using its unlimited authority from Congress to create US Dollars.
5) This is not inflationary because the Fed will put our coin into its vault, and keep it there permanently out of circulation, and we will use the $30 T in USD credits only to pay back debt and to spend what Congress has already approved, which is only a fraction of these credits and far from the amount needed to cause inflation.
6) My action ends the debt ceiling crisis, because we have no further need to borrow our own money back in the markets, so we don’t need the tea party or other Republicans, or even my fellow Democrats to agree to raise the debt ceiling.
7) Now the Treasury, has plenty of money, much more than we need, in fact, to pay for all appropriations Congress has already approved for 2011, and, again, we won’t have to borrow our own money back.
8) So we will pay all Government debts which will come due in 2011. Treasury securities and all other debts included. We will also pay back all debts held by other agencies of Government and the Federal Reserve. When we do this we will lower the national debt by about $7.5 T, reducing the “debt burden” by about half this year, and creating an actual Social Security trust fund with 2.6 T in cash reserves in it; and again, to do this we don’t have to borrow our own money back, and we will also reduce our interest costs on the outstanding national debt.
9) None of the $30 T in new credits created by our actions is “money” in the economy until the Treasury spends it. For now it is just capability to spend awaiting the appropriations of Congress to mandate deficit spending, should it need to compensate for the reduction in demand, probably close to 10% of GDP right now, caused by your own desire to save (which we want to do our best to facilitate), and your desire to import goods from foreign nations.
10) We have created $30 Trillion in new credits even though we needed only a fraction of that to cover anticipated deficit spending and debt repayment until 2021. The reason for this, is that I wanted to have enough capability created in the Treasury account, so that the national debt could be completely paid off (except for a small amount in very long-term Treasury debt still not mature by 2021), and all projected Federal deficits covered over the next 10 years.
11) Of course we can always make new coins if our projections turn out to be wrong; but I thought it would be best to ensure that all $14.3 T of the “debt burden” can be completely eliminated from our political concerns; and also to provide enough funds in our spending account at the Fed so that it would be very clear to Congress and all newly elected Representatives and Senators, that even though they, according to the Constitution, continue to control the purse strings, the national purse is very, very full, and that we will be able to afford whatever deficit spending for the public purpose, including for full employment and Medicare for All, that Congress, in its wisdom, chooses to appropriate now and before the election of 2012.
Good night, my fellow Americans and Sweet dreams! Rest well knowing that our beloved country won't be defaulting on any of its debts, and that I've prevented this without going over the legal debt ceiling, by providing money for spending mandated appropriations, in compliance with the laws authorizing coin seigniorage, while supporting the Constitution's prohibition against our Government ever defaulting on its debts. I hope that in the future everyone will obey the 14th Amendment's prohibition against questioning the validity of Federal Government debts, and think twice before they indulge themselves in such loose talk. America will always pay its debts in US Dollars according to the terms of the contracts it has concluded, and in line with the pension payments and other obligations that it owes. Neither you nor the rest of the world need ever doubt that again!
Further discussion of this approach is found here.

National Debt: What Is It?

Ignorance at the top of our government is appalling. Much time has been wasted by the President and Congress in political posturing around the debt ceiling rather than in meaningful discussion at a time when the economy is in a crisis that no one seems to understand.
In his testimony before the Commission on Deficit Reduction, Prof James K Galbraith made the following comments on June 30, 2010:
“The effect of government check-writing is to create a deposit in the banking system. This is a "free reserve." Banks of course prefer to earn interest on their reserves. Thus they demand a US Treasury bond, which pays more interest without incurring any form of credit or default risk. (This is like moving a deposit from a checking to a savings account.) The Treasury can meet that demand, or not, at its option -- it can permit, or not permit, the stock of US Treasury bonds in circulation to increase.

So long as U.S. banks are required to accept U.S. government checks -- which is to say so long as the Republic exists -- then the government can
and does spend without borrowing, if it chooses to do so. And if it chooses to issue Treasuries to meet the demand, it can do that as well. There is never a shortfall of demand for Treasury bonds; Treasury auctions do not fail.”

His full testimony is an exemplary piece of profound brevity. The essence of how money works in the modern era, since 1971 when the USA went off the gold standard, are contained in the two quoted paragraphs.
As the monopoly issuer of currency, the government can create money, at will, by purchasing goods and services from the private sector. Payments for these purchases result in bank account deposits that, in turn, increase reserve balances at the Fed. Federal taxation removes reserves as bank accounts are debited, which effectively destroys money. Government deficit spending is defined as spending in excess of taxation and results in net assets in the private sector exactly in the amount of the deficit.
So far, we have spoken of spending and taxation resulting in a deficit for the government and increased assets for the private sector. So, where does this debt thing come in? It has to do with those reserves - not foreign bond markets.
Those reserves must be adjusted daily to make sure checks written on one bank and cashed at another will be paid (cleared) promptly. Bank loans also create deposits and reserve requirements. The Fed Funds Rate is the interest rate that banks must pay to acquire required reserves in the overnight market. The Fed adjusts its target funds rate to inflate or deflate the private sector appetite for creating money through bank loans. 
An excess of reserves would drive down the Fed Funds Rate, so the Fed sells Treasury bonds to get rid of excess reserves that accumulate as a result of deficit spending. This is just a matter of moving money from a demand checking account to an interest bearing savings account. Banks are eager to put reserves safely in Treasuries rather than hold low-yield reserve accounts.
But, the Fed has another option. It could just pay its target Fed Funds Rate on the reserve balances to the respective banks. This would eliminate the the overnight funds market, let reserves accumulate, and forego the sale of Treasuries.
Hopefully, this clarifies Prof Galbraith’s statement above. Contrary to popular wisdom, the US or any other country with a sovereign, non-convertible, floating rate currency is not affected by the global bond markets.  The US can meet any debt obligation denominated in its own currency and does not borrow to fund its deficit, it borrows to maintain its target rate in the reserve funds market.
So, we need pay no heed to S&P or Moody’s bond ratings. The Fed sets our borrowing rates. 
The national debt is a optional artifact of the national accounting scheme, which has not changed since we went off the gold standard. Always a nuisance, the debt ceiling, a gold-standard hold over, has become a menace.
Related Reading:

Sunday, July 3, 2011

Quantitative Easing Might be Good for Something

In the past, I have mentioned that when the Government sells Treasuries it is affecting only the level of reserves in the banking system and providing a subsidy for the rich rather than financing the deficit. QE1 and QE2 consisted of the Fed buying back Treasuries from the Banks in the hope of stimulating borrowing a low rates. It didn’t work.
Yesterday, Ron Paul, whom we all know well, stumbled on to a good idea here. Perhaps it was tongue in cheek when he suggested just abolishing the debt held by the Fed. The  $79 billion paid to the Fed in interest is just returned to the Treasury anyway.
Dean Baker picked up on this idea here and sized it up this way,
“Unlike the debt held by Social Security, the debt held by the Fed is not tied to any specific obligations. The bonds held by the Fed are assets of the Fed. It has no obligations that it must use these assets to meet. There is no one who loses their retirement income if the Fed doesn’t have its bonds. In fact, there is no direct loss of income to anyone associated with the Fed’s destruction of its bonds. This means that if Congress told the Fed to burn the bonds, it would in effect just be destroying a liability that the government had to itself, but it would still reduce the debt subject to the debt ceiling by $1.6 trillion. This would buy the country considerable breathing room before the debt ceiling had to be raised again. President Obama and the Republican congressional leadership could have close to two years to talk about potential spending cuts or tax increases. Maybe they could even talk a little about jobs.”
As Baker explains, this would leave the Fed with excess reserves in the banking system, which would keep the Fed funds rate at 0% where it is destined to stay for some time in any event. Later on the Fed would have to look to other means to hit its target funds rate.
The idea, which is admittedly tarnished by its source, is actually too good to be put into effect by the clowns of Congress. However, even discussion of it would, perhaps, make people think more realistically about our the national debt and Fed bank reserves.