|Excess reserves as a result of Quantitative Easing, which changed Treasuries back into the reserves from which they sprang.|
Wednesday, August 24, 2011
It has been over week since Rick Perry in one of his first idiotic statements as a Presidential candidate suggested the Fed Chairman Bernanke was treasonous. Part of his statement was
“Printing more money to play politics at this particular time in history is almost treasonous in my opinion.”
His apparent dislike of playing politics, which is his game, and giving it an historic perspective made it sound positively profound for a few milliseconds until he threw in treason, which carries the death penalty.
The mainstream media had a field day with his lack of Presidential perspective. But, none questioned the truth of the Fed printing money. That’s where we come in.
Clearly, Gov. Perry was referring to the Fed’s purchase of Treasuries in what has been called Quantitative Easing. QE is not “printing money,” a term used by conservatives to conjure up the specter of uncontrolled inflation. Actually, QE was ineffective as students of modern money expected.
QE and Gov. Perry’s remarks were based on an outdated understanding of old monetary theory that says bank lending is constrained by bank reserves. You may have heard of the old multiplier effect that says: If banks must hold in reserves 10% of their customer deposits, then when one deposits $100 dollars in the bank, the bank can loan out $90, when that is deposited in a bank that bank can lend $81, and the next bank 0.9 x 81= 72.9, and so on. After some more math, we conclude that the multiplier is 10. So, a total of $1000 can be loaned by the banking system.
With modern money banks are not constrained by reserves but only by their capital and the availability of creditworthy customers. So, what does this have to do with QE? Well, QE raised the level of excess reserves in the vain hope that it would encourage lending.
Previously, (here and here) we have discussed how excess reserves are converted into national debt (Treasury bonds) as the Fed tries to maintain its target interest rate and banks try to minimize their excess reserves.
Remember, Treasuries are just interest-earning savings accounts at the Fed. They don’t even come with a gold embossed piece of parchment, they are just numbers on a spreadsheet. Said Treasuries arose from the Fed selling them to drain excess reserves from the banking system. Under QE, buying the Treasuries back returns them to being excess reserves in various bank checking accounts. It is just like someone converting a Certificate of Deposit at a bank back into a checking account. The net balance of one’s wealth is unchanged except for the interest earned.
The consequence of this action is that excess reserves are no longer maintained at zero balance. The excess reserve are now large and the overnight bank rate is driven to about zero. The Fed has recently announced that it will keep that rate at zero for a couple of years. The chart below shows this increase in excess reserves graphically.
That $1,600 billion is not new money. It is old money converted back to checking accounts.
What does this mean to you? You won’t be getting any interest on your bank savings accounts for a couple of years, because the banks can get money from the Fed at 0.25% or less. It also means that banks don’t have to charge as much on loans. So, car and house loans will carry less interest.
Another consequence is that those Treasuries are earning no interest out in the private sector. At say 4% interest that $1,600 billion would have earned $64 billion which is now lost to the private sector. That should be a gain for the deficit hawks.
Tuesday, August 16, 2011
In an attempt to understand the national debt better, I thought it might be worth stepping back a bit and ask, what is money? To illustrate, we might try a bit of drama.
My former friend Fred, a really big guy, bought a thing from me for $10.
In payment he gave a $10 IOU. I was perplexed
Dan: Fred, how about some real money?
Fred: Dan, ole buddy, you know I’m good for it.
Dan: Well, OK. (Reluctantly)
Days later I go to Fred.
Dan: Fred, ole buddy, I came to collect my money.
Fred: Right now the best I can do is give you 10 $1 IOUs.
Dan: What? How about some real money? (Somewhat pissed)
Fred: That’s it.
Days later Fred comes to me.
Fred: Dan, give me back 5 of those $1 IOUs, or I’ll beat the crap out of you.
Dan: What the hell for?
Fred: It’s a friendship tax.
Dan: 50% is a lot
Fred: Yep. (Raises clenched fist)
Dan: Well OK, I’ll give back 5 of your IOUs, to satisfy my tax liability.
We wouldn’t accept this kind of behavior very long in our private lives, but that is just what our government does. It purchases goods and services from us and pays us with IOUs (Federal Reserve Notes). Then it turns around and taxes some of those IOUs back. What’s left we get to save.
This drama, OK bad skit, reminds us that the government creates money first and then takes back in taxes money it has already spent. The issuer of currency must always spend before it can either tax or borrow dollars. In either case, it is getting back dollars it has already spent.
Money has been debt for centuries, if not millennia. Any lord, king, or government that can enforce taxes can have money that will circulate based on credit and debt. Money is a claim on the taxing authority and moves around as people go about their trading.
During the 19th century in the African British colonies, the Brits offered coins of the realm to the natives for them to work in the fields. The natives had no use for British coins and wouldn’t work for them. So, the Brits levied a hut tax payable only in British coin. Soon the workers were willing to work for the Brits and those who didn’t work directly for the Brits sold their goods and services to the workers in order to obtain the now precious coins. That’s all it takes.
It’s so astoundingly simple, it boggles the mind.
Wednesday, August 3, 2011
Yesterday morning I heard Secretary Geithner on Good Morning America while I was waking up a bit late. What he said made me stop and groan. He was explaining how reduction of the deficit was good, because it would provide room for private business to grow.
That is an old, outdated gold standard concept. Maybe his new employer (He will soon be leaving the Administration.) made him say it. In any event, it is weird to hear the Secretary of the Treasury make such a statement in these times.
Under the gold standard government and the private sector competed for a limited quantity of money. Government spending drove up interest rates and crowded out business investment. It is difficult for an economy to grow under a gold standard or other fiscally constrained paradigm, e.g., the eurozone.
Good grief, with 25 million underemployed and production capacity at 76%, this country has plenty of room for the private sector to grow. The reason it is not growing is because there is a lack of aggregate demand rather than crowding out.
When there is full employment and full utilization of productive capacity, government acquisition of available resources may interfere with the private sector. Right now, with the capitulation to the Tea Party, we can only pray that we might someday reach a competitive situation between government and private sectors.
At that point we might be looking at possible inflation. That is when aggregate demand is greater than our productive capacity can supply. That would look pretty good at present. Either too much deficit spending by the government or to much debt in the private sector can bring financial trouble. Given the explosion of the housing bubble, the private sector has had enough borrowing until people reduce their debt. Consequently, spending by the government is all we have for increasing aggregate demand. That isn’t going to happen for about a decade according to the dastardly debt deal just done.
Austerity works for households not for government. Households must live within their means; governments must live up to the nation’s means.
We are five years into our lost decade just like Japan suffered through after its big real estate crash. And, we will be fortunate to recover in a decade. Explain that to your grandkids when they notice that their lives are less abundant than yours.
Tuesday, August 2, 2011
On the eve of the Debt Ceiling vote in the House of Representatives, I submitted the following Letter to the Editor of the Albuquerque Journal. It is a short recap of my post here on July 22. As a friend told me, "Few people will understand or believe it, but you have to keep trying." So, here goes...
"Few people concerned about the national debt know what it is. Certainly, nobody in Washington, DC seems to know or the discussions would be much more intelligent and beneficial to the nation.
The national debt is not like a loan one gets from a bank to buy a house or car. Such a loan has to be paid back in a certain time or default with some consequences.
Treasury securities (Notes, Bonds, and Bills) are savings accounts at the Federal Reserve Bank (Fed). Those saving accounts are owned by entities, including people, mostly in the non-government sector. So, why not call the national debt clock a savings clock?
Commercial banks have checking accounts at the Fed. These are called reserve accounts and are maintained at a level to promptly clear checks written on each of the many banks in the banking system. These checking accounts earn very little interest, so banks like to keep their reserve accounts at a minimum. To accomplish this, banks loan to one another in the overnight funds market. Those banks with excess reserves can loan to those with too little. The Fed tries to set the loan rate for these transactions.
Deficit spending by the government tends to increase reserves as recipients of government checks deposit them and draw upon their deposits. When the banking system as a whole has excess reserves, no amount of interbank trading will reduce them. The forces of supply and demand will drive the interbank lending rate down.
To decrease the level of excess reserves in the banking system the Fed sells Treasuries to the banks. That is, they transfer funds from bank checking accounts to savings accounts. When the Treasuries mature, the funds plus interest are transferred back to the checking (reserve) accounts. There would be no need to sell Treasuries, if the Fed just paid interest on the reserves.
There are two points to realize about these operations. They are accomplished within the US banking system not the international bond market, and there are no grandchildren involved.
We are having an unnecessary crisis over an anachronism in our government accounting system."