Winterspeak wonderland & miraculous Mencius

I’ve been flabbergasted by just how good Winterspeak has been lately. I don’t agree with all of his conclusions, but the perspective he’s developing is quite beautiful, and very useful. I’m going to highlight a few of the bits I really like, and add a bit of spin.

I want to start with a related insight from the excellent Mencius Moldbug. Apologies to Mencius if this isn’t the best reference, but the point is very clearly stated, in a comment at Brad Setser’s:

Money is the bubble that doesn’t need to pop. As long as there is demand for indirect exchange, at least one asset will be stockpiled by hoarders, hence experience demand that is not a consequence of any direct utility, hence be overvalued. As long as the storage cost for this asset is zero and the supply in existence is fixed, you have a perfect Nash equilibrium – using any other asset as a medium of indirect exchange provides no advantage, and runs the risk of buying into a bubble which will subsequently pop as punters revert back to the stable standard.

This idea stands in stark contrast to the view recently offered by John Cochrane:

The value of government debt, including money, is equal to the present value of the primary surpluses that the government will run in order to pay off the debt. Nominal debt is stock in the government, a claim to its taxing power.

I think Mencius’ view is more accurate. [1]

The next insight I will attribute jointly to Mencius and Winterspeak (while quoting neither): When a government implicitly or explicitly guarantees deposits and other bank debt, it is useful and in some ways more accurate to describe the arrangement as loans by individuals to the government and then separate loans by the government to banks. If bank loans sour, it is the government who is out the money. Bank creditors do not discipline banks, or select banks based on their investing acumen. The connection between the deposit base of a bank and that institution’s ability to lend is formal and vestigal, and is disappearing as reserve requirements become an ever less binding constraint on bank lending. (I’m pretty sure I’ve read both Winterspeak and Mencius make this point, but I can’t find great quotes. Here’s an example from Winterspeak.)

This idea foreshadows the new Winterspeakian synthesis that has me suddenly awestruck. Winterspeak presents a view of the monetary/finacial system in which the government is ultimately the hub. As above, when we “save” without explicitly investing, we don’t lend to banks which then lend to businesses. We lend to the state — we hold instruments that are ultimately claims against the state — while the government organizes the distribution of loans, implicitly via how it structures bank lending or explicitly by various forms of directed credit. But the government’s role is deeper than that. Here’s Winterspeak’s counterintuitive, but obvious-once-you-think-about-it view of taxation:

Everyone agrees, more or less, that the Federal Government has the power to print money. That’s what fiat money means by definition. Since the Federal Government can print it’s own money, in whatever quantity it chooses, have you ever wondered why it taxes at all? In fact, if you chose to mail in your 2009 taxes in crisp Federal Reserve Notes, the Government would take that paper money and shred it.

The Federal Government does not need taxes in order to spend. At the Federal level, because the Fed is a currency issuer, the sole purpose of taxes is to extinguish money, reduce aggregate supply, and therefore limit inflation to a tolerable level.

But if the government destroys money, it also creates it:

The Government creates money and transfers it to the private sector by spending. The private sector transfers the money amongst itself (spending, investment) and puts the rest in the bank. If the private sector wants to put more money in the bank, that money can either come at the expense of transactions, or it can come from the Government simply running a larger deficit, and thus creating additional money for the private sector. So long as the private sector uses this money to save, it’s creation is not inflationary and will not show up in the CPI. Inflation is caused by too many dollars chasing too few goods, and dollars under the mattress are not chasing anything.

There’s an elegance to this perspective that comes with what is of course oversimplification. Winterspeak invites us to consider the government, the central bank, and the private banking system as a consolidated entity. Money taxed, lent to the government or deposited in a bank is money destroyed (at least temporarily). Money spent by the government, or borrowed from a bank is money created. Questions of control are not addressed — we don’t know whether it is Congress, the Fed chair, or private bankers who most influence this public-private hybrid at the core of the monetary system. But thinking about money this way cuts through a lot of confusion.

Let’s combine all this with the Moldbugian insight that money is the bubble that needn’t break, that its value is due to the stability of a Nash equilibrium — as long as everyone wants it, it is rational for everyone to want it. The government/banking system, then, has the incredible power of creating what everyone wants or destroying it, as it sees fit via spending and taxation, but also via lending and borrowing. However, there may be constraints on its ability to use that power, for institutional and political reasons, but most profoundly because of the dynamics and potential fragility of Nash equilibria. We’ll come back to this.

Both John Cochrane and Paul Krugman would agree that the current crisis, at least in part, is a phenomenon related to an unusual increase in people’s desire to hold money. Moldbug’s Nash equilibrium is on overdrive somehow: all everyone wants is what everyone wants, claims against the government that the government can create or destroy at will. To understand the implications of this phenomenon, we have to add a bit more substance to the meaning of “savings” and “investment”. We’ll follow Winterspeak’s treatment first, which is remarkably insightful, although I don’t entirely agree. (I hope W— will for give me for lifting such a large chunk of his post, but I’d not do it justice in paraphrase.) Winterspeak:

The Issue

Essentially, Cochrane and Fama both assert that savings = investment (+ capital account), and so say that any Government stimulus will crowd out private investment. Here’s the derivation (by identity) to get you S = I

Y = C + I + G

National savings can be thought of as the amount of remaining money that is not consumed, or spent by government. In a simple model of a closed economy, anything that is not spent is assumed to be invested:

NationalSavings = Y – C – G = I

If you think that banks make (investment) loans based on their deposits, then it’s reasonable to assume that all money not spent (ie. saved) is invested. But banks do not take deposits and loan them out. In fact, banks make loans first and then those loans become deposits. Remember — loans create deposits, deposits do not “enable” loans.

Loans create deposits

Banks, by way of their Federal charter, can expand both sides of their balance sheet at will, subject to capital requirements. This money is created ex-nihilo, but always nets out to zero in the private sector, as each (private) asset that a bank creates must be matched by a (private) liability. Government can create money outside of the system, but banks always need to net out and balance the balance sheet.

People believe that fractional reserve banking, in some weird way, has banks taking deposits, multiplying it (through what seems like a strange and fraudulent process), and then making a larger quantity of loans. In fact, banks make whatever loans they think make sense from a credit perspective, and then borrow the money they need from the interbank market to meet their reserve requirements. If the banking sector as a whole is net short of deposits, it can borrow the extra money it needs from the Fed. If you think this is a weird and pointless regulation you are correct. Canada, for example, has no reserve requirements and yet seems to have a banking sector. The quantity banks can loan out is constrained by capital requirements and credit assessments.

Facts on the ground

If a description of how banks actually work doesn’t shatter your belief that savings = investment, consider Reality. From about 2000-2006, American savings went negative, yet banks loaned out huge amounts of money (made huge investments). In fact, they came up with all kinds of clever ways to skirt capital requirements so they could make even more investments. If savings = investments, and savings fall, how can investments rise? By the same token, from 2006 to now, the private sector has actually delevered, saved, but banks aren’t making any loans (investments). What’s up with that?

More Facts on the ground

Anyone who thought they were saving by putting money in the S&P500 has had a rude wakeup call. They were not saving, they were investing, and now 40% of that money is gone. I don’t think they will confuse saving with investing in the near future.

So, what is savings?

A better way to think of savings is to think of it as what’s left after taxes, consumption, and investment.

Y = C + I + G

Net Private Savings = Y – C – I – T = G – T

Austrians will howl that it is unreasonable to define savings as a residual, there should be a term S for active savings, but people have to save in currency, and in a fiat, floating fx, non-convertible world, currency is not a store of value. Fiat currency trades bankruptcy risk for inflation risk, and fiat currency is all that’s sitting in bank accounts. So the Austrians are right, there should be some way to actively save, but they are wrong, because fiat currency in a bank is not it.

You split out savings from investment and you get Net Private Savings = Government spending – Taxes, also known as the deficit. So, the Government runs a deficit (spends more than it taxes) in order for the private sector to have the extra money it needs, after consumption, investment, and paying those taxes, to net save. This idea totally blew my mind when I first encountered it, but it actually makes total sense.

So, if you acknowledge that savings does not equal investment, then you see that Government deficit enables private savings. This is the OPPOSITE of all the Chicago guys who argue that the Government deficit REDUCES national savings. Government is a currency issuer, why does it need to save? Does a bowling alley need to hoard the points it awards for strikes and spares? Everyone acknowledges that the Fed can print money, but few people actually think about what that means.

There is so much meat in this. First, a quibble. Winterspeak is disingenuous when he suggests that the disconnect between the miniscule savings rate and the maxicule investment rate argues against the traditional closed-economy identity S = I. The US very much was not a closed economy. The US was importing capital at a breathtaking rate to fund its investment boom, and globally the traditional S = I identity always held. In Bernanke-speak, a Chinese and Middle Eastern savings glut funded an American investment boom. That Americans saved less than they invested hardly mattered, as long as foreigners were willing to lend.

Winterspeak has not really disproved anything here. He has just derived a different definition of savings. The reason this is important is because we talk about savings, economists and real Americans alike slip between the two definitions unconsciously, which badly muddles things. On the one hand, we talk about the savings rate, which most certainly includes investment: If you were contributing to your 401-K or buying farm machinery, you were doing your part to keep the US savings rate above zero. But on the other hand, when we say that during this crisis, Americans’ shift to savings is proving disruptive of aggregate demand, what we are talking about sudden desire to hold claims on money rather than to invest in real capital. Let’s disentagle these two phenomena. Keeping with a closed economy, we’ll define:

Investment = Y – G – C (Traditional savings)
ΔClaimsOnGovt = Y – C – I – T = G – T (Gov’t deficit = Winterspeakian savings)

Actually, this is my party, and I hate how private expenditures are conventionally disaggregated into investment and consumption, while government expenditures are just “G”. So, let PC be private consumption, PI be private investment, GC be government consumption, and GI be government investment. Then:

Investment = Y – GC – PC = GI + PI (Traditional savings)
ΔClaimsOnGovt = Y – PC – PI – T = GC + GI – T (Gov’t deficit = Winterspeakian savings)

So here’s a bit of insight: We can increase Winterspeakian savings in three ways: by increasing government consumption, increasing government investment, or reducing taxes. But note that an increase in Winterspeakian savings only results in traditional savings (current new investment) if the government purchases investment goods. I don’t wish to take a side on the stimulus debate now, but I do want to point out that when people use the normatively charged word “savings” to imply investment, a tax reduction that enables purchases of bonds doesn’t cut it. A tax reduction increases claims against the government without increasing aggregate investment. Individuals imagine they have saved, but collectively, we have only reorganized claims surrounding the consumption and investing we were already doing. (Arguably a tax reduction could saturate the demand for government claims and lead to more real private investment. But that’s a dynamic scoring kind of story.)

Fundamentally, Winterspeakian savings is about restructuring our collective balance sheet in a way that leaves individuals with more claims on government. If the private sector reduces investment and the government increases investment to take up the slack, the ultimate result is the government controlling more real capital, and individuals holding claims on the government. In other words, what the private sector is doing right now is using financial markets to demand more socialism. Individuals no longer want to hold direct claims on private enterprise. They wish to hold claims on government, which implies the government must own and direct the productive activity that will enable it to make good on all those claims.

Regular readers may have noticed that I love telling ironic capitalists-are-socialists kind of stories. But I don’t think a shift towards public ownership of the means of production is a good thing. A consumption-centered stimulus or tax cut would keep the government out of the business of investing while enabling people to hold more money, but that would lead to reduced future production despite an increase in “risk free” claims against government. Today’s “savings” would be a losing investment, in real terms. That is, if we satisy the public’s demand for an increase in government claims, but do not invest the proceeds well, we should expect a great inflation. Hopefully, we are capable of identifying sufficiently productive infrastructure and public goods investments that the government can earn a real return without interfering in the traditional private sphere. But in the intermediate term, there will be no substitute for increasing PI. We need to persuade individuals to undertake investments whose risk they hold and bear if we want to have a capitalist economy. We need a private financial system.

But did we ever have one? If you buy the Moldbug/Winterspeakian view of banking, we did not to the extent that individuals used the banking system to intermediate investment. Instead, the government effectively created incentives for bankers to invest in good projects by letting them keep the proceeds when they chose well, while punishing them a bit but then eating their losses if they chose poorly. We could reproduce that system more directly by having the government invest in private equity funds. Is that what we want?

We really need to think clearly about what we used to have, what was good and what was broken about it, and what we want going forward. How much should investment risk be socialized, to encourage entrepreneurship, vs how much should be borne privately, to encourage discrimination? Would it be possible to build the right mix transparently, rather than to rely on hidden guarantees and subsidies as we have until now? (It may be that subterfuge is prerequisite to an effective financial system in a political world. But I don’t like to believe that.) To the degree that the investors will actually bear investment risk, can we define instruments that they can productively invest in? As index investors have learned, bearing risk without discriminating between good and bad is a prescription for disaster, eventually.

This has gotten terribly long, and terribly rambling, but I do want to come back to one idea. Early on, I described a Winterspeak/Moldbug synthesis in which the government comes off as incredibly powerful. Government money is what everybody wants because everybody wants it. The government destroys money through taxation and borrowing, and creates it by spending and lending, and can do so at will. A very large fraction of “private” lending is in the influence of government, by how it organizes the pseudoprivate banking system as well as via direct market interventions. With so much power, what are the government’s constraints? Why can’t it get an outcome that it wants, presumably a good economy with a bit of corruption on the side? Let’s put aside the institutional stuff. (For example, governments usually have to pretend private banks are private; their ability to direct the loans they guarantee is limited; in fact, a bankers-control-government-expenditure story is historically more compelling than government-controls-bank-expenditure). Right now, the government can pretty much do what it wants with the banking system, can expand the quantity of risk-free claims to meet demand at will, can lend to whomever it pleases. Why can’t it fix the country?

Cassandra had a brilliant post not long ago called “an idea crunch“. Read it if you haven’t. Ultimately, a financial system has to find productive projects for the private parties to invest in. The government can invest directly, can delegate investment to the best and the brightest, can saturate the public’s demand for money until private parties try to find other means of storing wealth. But it’s what real human beings do with real resources that ultimately matters. Our financial system didn’t fail because it was overlevered. It failed because it was uncreative: It could not conjure up worthwhile things to do with the capital it was asked to invest, and instead of owning up to that, it pretended that poor projects were good. Financial markets are ultimately information systems. The only way out of this is to discover worthwhile things to do, or more importantly, to develop better means of generating a diverse menu of worthwhile things to do going forward. Right now, the government is being asked to do what the semi-private financial system could not: generate a positive real return on trillions of dollars of undifferentiated future claims. The stakes are very high — that Moldbugian monetary Nash equilibrium can be a bitch. Money is the bubble that need not pop, but that’s no guarantee that it won’t. Anything that’s desirable only because everybody desires it is just a single major failure away from being yesterday’s darling. If unthinkable banking system failures can occur, so can unthinkable failures of the monetary system.


[1] I think Cochrane’s essay has been too roughly treated in the blogosphere, and I don’t wish to pile on. A fair reading of the piece makes it clear that Cochrane is not making the elementary errors that an excerpt from the beginning might suggest. I quote Cochrane’s essay here with some affection. I think his view of money is wrong, but like nearly all of economics it is better read as a form of organized hope that the world might be rendered coherent than as a reliable description of the world as it is.

 
 

110 Responses to “Winterspeak wonderland & miraculous Mencius”

  1. Nemo writes:


    the sole purpose of taxes is to extinguish money

    …and to redistribute wealth, of course.

    More to the point, your description seems to treat the central bank as part of the government. Could you justify this treatment a bit, especially since they claim to be “independent”? Specifically: How and why would the description change if we used a gold standard? Or if we had no central bank of our own and used some other country’s currency? I am trying to understand what it is (exactly) about the relationship between the central bank and the Federal government that makes it meaningful to treat them as a single entity.

  2. pwm writes:

    Nice mind opening post. Do you have any formal publications on the way?

  3. Nemo — I hope it’s clear that I’m quoting Winterspeak there.

    Your question is at the heart of what’s interesting. For some purposes, it’s clearly meaningful to consolidate the central bank and the treasury (and arguably the banking system). For example, obligations and losses of the central bank are ultimately borne in one fashion or another by taxpayers. (Even if they are monetized, they represent an opportunity cost — if the central bank losses were private losses, that is if the central bank hadn’t assumed the credit risk that lost, it could have monetized with the same noninflationary effect, and the funds would have gone to taxpayers rather than the party whose risk the CB bore.)

    For other purposes, it’s obviously meaningful to distinguish between the “core” government, the central bank, and private banks. The consolidated view isn’t the “truth”, but I’m finding it to be a useful perspective (and this post is really a way of thanking Winterspeak for that and spreading it around).

  4. pwm — Maybe someday, maybe not… we shall see. Certainly nothing too soon. Again, thank winterspeak and moldbug for openings of the mind.

  5. Harald Korneliussen writes:

    “Right now, the government is being asked to do what the semi-private financial system could not: generate a positive real return on trillions of dollars of undifferentiated future claims.”

    But isn’t it reasonable to think that they can? Doesn’t education, infrastructure improvement and similar things generate a positive real return?

  6. glory writes:

    “For the system of economic science the main importance of this theory lies in the fact that, if distribution can be described by means of the social marginal utilities of the factors of production, it is not necessary, for that purpose, to enter into a theory of prices. The theory of distribution follows, in this case, directly from the law of social value.” —Joseph Schumpeter, On the Concept of Social Value, 1909

    re: the idea crunch

    i would say it’s not lack of productive investments per se, just that many of them might be considered _public goods_ — non-rival, non-excludable — that the market (or ‘financial system’) does not provision for very well*…

    i think perhaps the most challenging task of our times is how to account for non-local, high externality activities such that the negative ones are properly discouraged while positive ones incentivised, an essential part i believe for building your ‘real’ fianncial system**…

    but how to evaluate the ‘returns’ on public investment for prioritisation? is it possible to objectively consider the competing claims of, say, a park, school and hospital? just because social utility curves aren’t amenable to measurement does not mean they do not exist; it’s just, sim city-like, so much guesswork and political patronage***…

    —-

    *Profits and charity: How to be bold – “To mount a campaign to convert 6 billion people to love—which is essentially the role of charity—takes a lot of money… Raise the capital to promote the idea by offering a return on investment, hire the best people to manage the effort, and run the advertising to spread the word. You beat capitalism at its own game”

    **the record for private provisioning of public goods i would say is decidedly mixed; file under government outsourcing, altho i have high hopes for kremer-like gov’t held contests and x-prizes that, as delong and summers have written, have “all the advantages of market competition, natural monopoly, and public provision” cf. Speculative Microeconomics for Tomorrow’s Economy wrt coasian inversion of gov’t functions

    ***i suspect that a transparent reputational (complementary) currency system might help in providing some rigour to the process, but i can see how one might be skeptical of ‘popularity points’ or a glorified system of ‘gold star’ awards for social entrepreneurship — it’s tacky, but it works for children! and like community modding, for instance, is fairly highly evolved on the internet :P

  7. reason writes:


    “Our financial system didn’t fail because it was overlevered. It failed because it was uncreative…”

    Isn’t this distinction drawn too boldly.

    My own view is that, surely, it became overlevered because that was the only way it new to generate sufficiently high rates of return, and excessive debt creation let it be fooled by what was effectively a ponzie scheme (what Steve Keen calls “Ponzie finance”.) This was enabled both by the Fed AND by neo-mecantilists. And the lack of paying investment projects was largely a result of mispriced currencies (holding down rich country wages and so spending power – before consumer credit that is) not just the lack of capturable social value that glory talks about.

    But your emphasis on clearly distinguishing between the real world and the financial world is refreshing.

  8. JKH writes:

    SRW –

    Yes, the consolidated view of the government and its central bank is very useful and informative.

    A stepped up version of this integration is the view that government is a long term extension of its short term central bank. This positions the CB as the operational center of a closed system that enables Moldbug’s “bubble that doesn’t need to pop”. This closed system also captures the home currency’s global reach. E.g. the Fed’s dollar currency swaps appear on its balance sheet both as “other assets” and as reserve liabilities resulting from the return trip within the global banking system.

    The government is an extension of its central bank as follows:

    G injects funds into the banking system when it spends. This results in a potential overdraft at its CB deposit account. Such an overdraft would also increase bank reserves at the CB; but the government covers its position by taxation and deficit financing. It drains bank reserves in doing so. This is an extension of central bank sterilization. Central banks are constrained by monetary policy objectives that in turn guide the tactical setting for bank reserves. Both G and CB are guided by policy that controls the level of bank reserves.

    By similar extension, the creation of government debt is a variation on the creation of money by its central bank. The consolidated liability structure is a continuum from the most liquid (CB reserves and currency) to the least liquid (long term G bonds).

    Viewed this way, government expenditures are a form of monetary easing; taxation and deficit financing are a form of tightening. These activities are parallel to normally defined central bank operations.

    Central banks normally create their liquid liabilities (reserves and currencies) by monetizing something. Typically, in a fiat system, it is a government liability – e.g. government bonds. So the CB is monetizing the deficit when it creates money. Recently, central banks are monetizing private sector liabilities instead, crowding out normal financing for deficits. I.e., the Fed has pushed government financing from the bank to the market by funding private credit rather than government debt.

    (The famous “helicopter drop” of currency is another form of deficit financing, without using the internal transfer mechanism of a government bond. The currency when dropped is simultaneously the instrument of CB financing and a medium of payment for the recipient. No asset monetization is required, because the CB liability monetizes itself.)

    The central bank is the hub for more than the government. It plays the same role for the commercial banks. Central banks and their commercial bank members all create money in roughly the same way by creating credit or purchasing financial assets. New loans create new money for the system and for individual banks. In the case of existing loans, banks compete to maintain their required share of system money in order to fund their own positions. This is the usual interpretation. But what is true of the life of money is not true of its conception.

    This causality flip applies in a similar way to international current account deficits. The US current account deficit when created is not financed by foreign capital inflows. It finances these flows. Foreigners obtain their capital surpluses from the deficit. These surpluses revert immediately as funding for the US banking system, because the global dollar banking system is a closed one.

    A few random observations on Winterspeak quotes:

    “Private sector transfers the money amongst itself (spending, investment) and puts the rest in the bank.”

    - All money created by banks ends up in banks unless it is destroyed by the unwinding of bank credit or other bank assets, or converted to other bank liabilities. Whether the money is “saved” or “invested” by purchasing other types of real or financial assets has no effect on the mortality of money.

    “If the banking sector as a whole is net short of deposits, it can borrow the extra money it needs from the Fed.”

    - The banking system as a whole can’t be net short deposit liabilities. It can only be short reserve assets as is determined by central bank supply of same. (Or maybe that’s what W. means.)

    “So long as the private sector uses this money to save, its creation is not inflationary and will not show up in the CPI. Inflation is caused by too many dollars chasing too few goods, and dollars under the mattress are not chasing anything.”

    - Money disappears by putting credit creation or asset intermediation into reverse; or by converting bank MZM liabilities to bank term liabilities. Otherwise, the outstanding stock of money continues to influence inflation according to its velocity of repeated use. A good deal of the blogosphere criticism of the Cochrane paper, rightly or wrongly, has to do with the recognition of the velocity factor as instrumental to the effect of the stock of money on anything. Those who ignore velocity are implicitly confusing the stock and flow of money.

    I agree with the Winterspeak point on the macro causation from loans to money, as well as the uselessness and error of the so-called “money multiplier” idea that was once taught in textbooks. It’s too bad many Austrians apparently still hang their hats (unnecessarily) on criticizing this non-existent monetary technology.

    The Winterspeak derivation of net saving is quite interesting, although I wouldn’t associate it with any revolution in the interpretation of national accounts identifies. In a defined closed system, you can pick just about any point as a definitional anchor, and then spin the usual identities around it. E.g., for a closed economy, simply write:

    I + G = S + T

    G – T = S – I

    Public deficit = “Winterspeakian net saving” or WNS

    More generally in gross terms, a government bond is a liability for government and an asset for non-government. In the consolidated view, the government is acting as a financial intermediary, with the economy’s real investment lying somewhere beneath the entire financial veil. The government’s role in supplying a source of saving to the private sector is not unlike the banking system’s role in supplying a source of saving to that subset of the private sector defined as depositors. The banking system is intermediating savers with dissavers. There often is no underlying investment (credit card expenditures), or at least none that generates cash flow (owner occupied houses). It’s even more contentious as to how to interpret the other side of government intermediation. The bottom line in both cases is that financial intermediation as a set of assets and liabilities is still quite dissociated from underlying real investment. Investment and finance are still two separate activities. Winterspeakian net saving is disassociated from real economic investment, but no more so than bank deposits.

    You can’t have one foot in the national accounts definitions of saving and investment, and one foot out, and expect to construct a consistent paradigm. You’re either in or out. Winterspeak is in, effectively. Rearranging identities is not rocket science, and carving out sub-sections and redefining terms is not a problem. The problem of acknowledging more properly the investment content of government expenditure remains, but that’s separable, as you have done, SRW, with interesting insights.

    A more conventional and international case of something similar to the WNS relationship is that the rest of the world is providing “surplus saving” to the United States because ROW saves more than it invests (S – I > 0.) This of course corresponds to the funding for the US current account deficit. This resembles WNS according to the side of the equation that represents “surplus savings” = S – I. Unfortunately, this parti
    cular application of WNS is not quite pure in that it ruins the theme that connects government to the private sector in the closed national model. But we can globalize Winterspeak by globalizing each component. Then the sum of all budget deficits globally would equal the excess of global private saving over global investment. This redefines global S parallel to the national WNS case.

  9. winterspeak writes:

    Steve: First, thank you for the post, and in particular, access to your commenters. I don’t allow comments on my site, and the quality of your commenters are excellent.

    JKH: Thank you for your long and thoughtful post. I’ll need to read it 5 times to understand it all, as I find the mechanics of banking confusing and counter intuitive.

    That said, I 100% agree that my “Net Private Savings” derivation is no revolution. It is certainly not original to me. What I like is that it draws a straight line between the Federal deficit and private savings. Most everybody thinks “the Government should run a smaller deficit”. Most everybody believes that “people should save more” (although some may want that day postponed). Hardly anyone realizes that those two goals are diametrically opposed to one another. That is pertinent today.

    The nexus between the Government (particularly the Treasury and OCC), Fed, and commercial banking is almost certainly are you describe. I just need to understand it better!

    I’m not sure that the Treasury issuing debt is a form of monetary tightening (as taxation clearly is. Taxes reduce aggregate demand in a straightforward way). Doesn’t Government debt just change the term structure of the money they have outstanding? A 30 year bond is essentially the same as a 3 month note, except one has a term of 30 years and the other a term of 0.25 years. How does this tighten (reduce aggregate demand)?

    You are 100% correct when you say that there is no connection between the above and real investment. Y = I + G + C tells you nothing about how to run an economy long term.

    “Winterspeakian net saving is disassociated from real economic investment, but no more so than bank deposits.” Exactly.

    One final point about currency, which gets to your comment re: the global picture. Moldbug’s Nash equilibrium is the mechanism wherein an economy standardizes on a single currency to solve the coordination problem, but fiat currency as a first mover that seeds the whole process: a sovereign entity with the power to enforce taxation. You accept the first Government coin because it will keep the Government from throwing you in jail when it demands that same coin back in taxes. Nash equilibrium spreads this throughout the economy, and the strength of the local sovereign’s ability to tax also determines whether the economy runs on a single currency, or is like all third world countries and runs on a mix.

    In this light, I think it is backwards to think that the “rest of the world funds the US current account deficit”. I think it’s more accurate to say that the US runs a current account deficit to produce the dollars that the rest of the world wants to save. China gives us real goods for the pleasure of our shiny paper baubles. In real terms, imports are a benefit, exports are a cost. (There are sophisticated arguments against this position, which I am sympathetic to, but at a first level the above is correct). The US Govt can print its own money and has no need to borrow dollars from anyone, and no need to have anyone “finance” their deficit. Currency issuers play a different role than currency users.

    Finally, credit where credit is due. Warren Mosler started me down this road, and while I find him difficult to understand, it’s worth spending time on this site (Mosler Economics).

  10. Benign Brodwicz writes:

    A few observations:

    1. The monetary unit bubble has been popping since 1913; you younger guys are just used to a little fizz recently, but just wait…. You want to hold dollars?

    2. Yes, we are overleveraged. As a nation we’ve been living beyond our means. As I used to tell my students, “Make the adjustment.” Persistent bloated trade deficits are meaningful. See James Fallows’ great interview with a PRC state lender. He pretty much tells it like it is. h/t Calculated Risk.

    3. What we are seeing is near total regulatory capture of the banking industry by the New York City plutocracy; see “The Big Banks vs. America”; h/t Naked Capitalism. We live in a political economy.

    There are public goods that need producing, and this is a good time to produce ‘em. It would be nice to keep the graft and corruption quotient down to <5%. But there will be lags in stimulation.

    It’s great that President Obama is trying to back-door national health insurance by making Medicaid available to the unemployed. I also favor a poverty-level dole, money that is guaranteed to be spent. The numbers being thrown around represent continued panic. The economy is going through a structural adjustment that will take years as it reverts to C ~ 65% of GDP so continued labor market slack is to be expected. I’d rather see a meaningful permanent negative income tax than hundreds more billions thrown to Government “contractors.”

    For $180 billion, we could give 12 million unemployed people $15,000. See what I mean?

    The big question is whether the United States of America coheres, or fragments, as the “nation state is dead–multinational corporations rule” camp have it. President Obama faces the greatest challenge to holding the Union together since Lincoln, and seems to know it.

  11. Paul Fraser writes:

    RBC Bank President Gordon Nixon – Salary $11.73 Million

    $100,000 – MISTAKE (FISHERMEN’S LOAN)

    I’m a commercial fisherman fighting the Royal Bank of Canada (RBC Bank) over a $100,000 loan mistake. I lost my home, fishing vessel and equipment. Help me fight this corporate bully by closing your RBC Bank account.

    There was no monthly interest payment date or amount of interest payable per month on my loan agreement. Date of first installment payment (Principal + interest) is approximately 1 year from the signing of my contract.

    Demand loan agreements signed by other fishermen around the same time disclosed monthly interest payment dates and interest amounts payable per month.The lending policy for fishermen did change at RBC from one payment (principal + interest) per year for fishing loans to principal paid yearly with interest paid monthly. This lending practice was in place when I approached RBC.

    Only problem is the loans officer was a replacement who wasn’t familiar with these type of loans. She never informed me verbally or in writing about this new criteria.

    Phone or e-mail:

    RBC President, Gordon Nixon, Toronto (416)974-6415

    RBC Vice President, Sales, Anne Lockie, Toronto (416)974-6821

    RBC President, Atlantic Provinces, Greg Grice (902)421-8112 mail to:greg.grice@rbc.com

    RBC Manager, Cape Breton/Eastern Nova Scotia, Jerry Rankin (902)567-8600

    RBC Vice President, Atlantic Provinces, Brian Conway (902)491-4302 mail to:brian.conway@rbc.com

    RBC Vice President, Halifax Region, Tammy Holland (902)421-8112 mail to:tammy.holland@rbc.com

    RBC Senior Manager, Media &Public Relations, Beja Rodeck (416)974-5506 mail to:beja.rodeck@rbc.com

    RBC Ombudsman, Wendy Knight, Toronto, Ontario 1-800-769-2542 mail to:ombudsman@rbc.com

    Ombudsman for Banking Services &Investments, JoAnne Olafson, Toronto, 1-888-451-4519 mail to:ombudsman@obsi.ca

    http://www.pfraser.blogspot.com

    http://www.corporatebully.ca

    http://www.youtube.com/CORPORATEBULLY

    http://www.p2pnet.net/story/17877

    “Fighting the Royal Bank of Canada (RBC Bank) one customer at a time”

  12. winterspeak writes:

    Benign Brodwicz:

    There don’t have to be any lags in stimulation. If the Federal Government began picking up both sides of the payroll (FICA) tax, you’d see plenty of stimulating starting… tomorrow.

    This would also help “make the adjustment” but at a much lower cost of private sector unemployment. Households could delever, and we would still maintain aggregate demand.

    The fact that this simple idea has gained no traction in the media, or by Paul Krugman, certainly suggests some kind of capture. The economy is not the only political animal in this zoo.

  13. JKH writes:

    Winterspeak,

    Thanks for your response and comments.

    The point on monetary tightening relates to a view of the government operationally as an extension of its central bank. Central banks typically tighten monetary policy by selling bills or bonds, which has the effect of withdrawing both reserves and deposit liabilities from the banking system. The CB can also retire currency, which reduces the amount available to the public.

    The government has a similar marginal effect on the monetary system when it sells bills or bonds or collects taxes and transfers the funds to its central bank deposit account. Optical differences do exist, of course. There is typically no specific financial or real asset that offsets the government’s issuance of debt. And no liability claim is issued when the government collects taxes.

    You referred to two points that relate to government activity – the effect of taxes compared to debt, and the effect of debt term structure.

    In addressing the first point on taxes, I think it’s useful to ask a broader question – what would the equity account of the combined G/CB institution/bank look like?

    There are a number of reasons why this question might be useful:

    1. The answer may provide some insight as to the monetary effect of taxation.

    2. Some people point to central bank solvency as an important issue. This suggests that solvency of a consolidated institution may be an interesting idea as well.

    3. The completion of the balance sheet through the idea of an equity account invites a more differentiated view of its real economy investment content, as per SRW’s emphasis.

    4. Other pieces of the puzzle may start to fit in. E.g. is Ricardian equivalence equivalent to the existence of a G/CB tax asset?

    I won’t attempt to fully answer the equity question or complete the balance sheet now; but here are some tentative responses:

    1. Taxation can be viewed as equivalent to the purchase of equity in the G/CB. Government expenditures can be viewed as the equivalent of a buyback of that equity in return for public sector goods and services. When governments collect taxes (again, operationally), the monetary effect is equivalent to the issuance of this equity, which has the effect of draining bank deposit liabilities and reserves, just as in the case of selling a bill or bond. This constitutes monetary tightening. I think this addresses the first point – the monetary effect of taxes compared to debt.

    2. Because central banks typically fund government deficits, and because in doing so their assets are typically government liabilities, central bank solvency only makes sense as a concept within the broader solvency framework for an integrated G/CB institution. The true economic solvency of this institution could be captured as accurately as possible in such an equity account.

    3. Solvency analysis should take into account the identification and value of the government’s real economic investment.

    4. Ricardian equivalence may be equivalent to a G/CB tax asset. If so, this may or may not amount to a balance sheet plug item, displacing a more conventional interpretation of balance sheet insolvency.

    Your second point related to the interpretation of debt term structure in the context of monetary policy.

    First, define money as any bank liability of zero maturity – central bank reserves, currency, and commercial bank demand deposits.

    I would then define monetary “tightening” as a change in which the consolidated institution G/CB converts money of zero maturity to another financial asset whose duration is greater than zero or whose credit quality is worse than money. Examples:

    a) Central banks tighten when they sell bills or bonds and withdraw money of both types (bank deposit liabilities and reserves) from the banking system.

    b) Governments tighten when they sell bills or bonds and withdraw money of both types (bank deposit liabilities and reserves) from the banking system.

    c) Governments tighten when they tax and withdraw money of both types (bank deposit liabilities and reserves) from the banking system. In doing so, they effectively convert money to G/CB equity as conceptualized above.

    d) Central banks or governments tighten when they sell longer term bonds and buy shorter term bills. The reason is that liquidity and interest rate risk typically correlate with bond duration. The longer the maturity, the greater the price risk in a given market, usually. This interpretation is also consistent with the notion that the conceptual equity issued by government through taxation is a more severe form of tightening due to the typically longer duration of equity as opposed to debt. I think this addresses your second point.

    e) Central banks or governments tighten when they sell lower credit financial assets, combined with a reversing operation in which they buy government bills and bonds. This may be envisaged as the type of future monetary tightening that will be required to reverse the corresponding easing that has been initiated by the Fed in this credit crisis. Willem Buiter has referred to this type of easing as “qualitative easing” and Bernanke has referred to it as “credit easing”.

    f) Governments tighten when they issue the conceptual equity associated with taxation, as described above. This interpretation is also consistent with the notion that the conceptual equity issued by government through taxation is a more severe tightening exercise due, not only to the typically longer duration of equity as opposed to debt, as noted above, but due to the greater risk in general of equity risk in comparison to credit risk.

    Finally, I certainly agree with your assessment “I think it is backwards to think that the “rest of the world funds the US current account deficit”, and was attempting to suggest something close to this in the paragraph starting: “This causality flip applies in a similar way to international current account deficits.” Perhaps I should have emphasized this point more, because I agree with you that it is important.

    Moreover, I would analogize the US net international investment position (a net liability) to the total reserve liability that a central bank supplies to its banking system. In this case, the USA (the national entity) plays the role of a central bank (not the Fed), and the NIIP is the level of reserves supplied by Bank USA to its member banks, China, GCC, etc. The dynamic of a recurring current account deficit and a growing NIIP is akin to Bank USA steadily increasing the supply of reserves to the rest of the world “system”, ROW.

    Appendix – the case of monetary easing by government expenditure:

    The government by spending and disbursing a cheque into the banking system has the same operational potential to create money as its central bank. Considered as an isolated transaction, this would increase the broadly defined money supply and bank reserves along with it. The effect is the same as when a central bank buys treasury bills from the market. Both types of transactions – G expenditure or CB asset purchase – will increase bank deposit liabilities and bank reserve accounts. This represents a dual monetary stimulus. The first is that it increases the money supply available to the private sector. The second is that it increases reserves available to the banking system. In normal times, absent a liquidity trap, this will increase the potential for the private sector to spend through the circulation of existing deposits balances. And it will increase the potential for the banking system to increase lending in order to deploy excess reserves. And even in a liquidity trap, the marginal effect, if not materially effective, will still be at least directionally consistent with this normal response.

    (apologies for the length of this com
    ment)

  14. Benign Brodwicz writes:

    Winter –

    Agreed, but a payroll tax cut only helps the employed.

    I suggested a progressive, revenue-neutral payroll tax tilt (raise the ceiling, cut on lower incomes) that also fell upon deaf ears.

    The problem is that the economists are too invested in their own theories and questionable Government-generated numbers to see the human problem. They’re all listening to some scribbler from fifty years ago. And to paraphrase what Mr. Natural once said about Flaky Funt, you know they’ll blow it.

    I do favor the big G-Investment projects–infrastructure, health and education–and hope that they’ll be administered cleanly.

    But the human need is immediate, and it’s amazing how unresponsive the politicians can be to those at the bottom. They had to debate extending our chintzy unemployment benefits, for crying out loud.

    But I also expect the “massive coordinated policy response” currently being mounted to lead to the Bretton Woods super-nova, as the floating rate currency system blasts off into hyper-inflationary instability that will be very conducive to resource-grabs and war. And just a little policy restraint might mitigate that risk.

  15. winterspeak writes:

    JKH: A long response indeed! I’m still only on reading number 4 of your previous response, so I now have a lot of homework to do.

    One quick clarifying question:

    You ask “what would the equity account of the combined G/CB institution/bank look like?”

    Interestingly, Mencius has also put forward a theory of money as equity.

    I’m not sure what you mean by equity. Do you mean as if it were a balance sheet entry, the way a corporation has a remained bucket for “equity” on the liabilities side?

    While I am a firm believer that the balance sheet approach is the right way to look at money within the private sector (including private sector banks) I think it is the wrong way to look at endogenous money creation (which the Government can, and must do, as the sole supplier of specie).

    I don’t think paying taxes is anything like purchasing an equity share. Most tax payers would agree. You pay your taxes, you get a receipt, and you stay out of jail. You have no residual claim on anything thanks to your tax payment. If you paid your taxes in cash, the IRS should shred the paper bills. Government can print money, and therefore has no need for yours.

    When the Government spends money, that money is newly created. When it taxes, the money is uncreated. The difference is the deficit (G-T). Since the private (non-Government) sector wants to net save, the Government needs to run a net deficit (G-T). (I don’t like to refer to this as “net owe” because Government is a currency issuer, and therefore is not subject to the same rules as us poor currency users.)

    One last point, and then I need to read and think about both of your posts in more detail. I think it is utterly meaningless to talk about sovereign, CB, or G default on its debts if its debts are in its own currency, and its currency is a floating-fx, non convertible currency. The terms “solvency” and “default” are meaningless, because by switching to a floating fx, non-convertible currency the sovereign has exchanged default risk for inflation risk.

    Arnold Kling and Martin Wolf argue that inflation risk is the same as default risk, but they are wrong. If you can show me a CDS with “inflation” in its default clause though, I will change my mind.

  16. JKH writes:

    Winterspeak,

    I’m aware roughly of Mencius’ equity interpretation, but haven’t fully thought it through. It’s very different at the entry point from what I’m suggesting. I think it’s probably quite different finally because he interprets central bank money as equity (I think). I’m not doing that. I’m interpreting taxation as a contribution to a consolidated CB/G equity account, but only one contribution to it, as follows:

    Yes, I’m looking at an equity account in the sense of a corporate balance sheet. But I’ve qualified it very quickly with the caveat that while taxation is equivalent to equity issuance, expenditure and the goods and services it delivers is equivalent to an equity buy back. The process of creation and destruction is continuous in this sense, but the accounting concept of residual equity, positive or negative, still has integrity. Due to the continuous creative destruction process of taxation and expenditure (equity issuance and buyback), it’s reconcilable on a cumulative basis with “You pay your taxes, you get a receipt, and you stay out of jail. You have no residual claim on anything thanks to your tax payment. If you paid your taxes in cash, the IRS should shred the paper bills. Government can print money, and therefore has no need for yours.”

    A consideration for you:

    Accounting is not the enemy. All of economics and finance and its measurement is constrained by the logic of double entry bookkeeping. That may seem unseemly on the surface. But it is true; as true as the natural numbers. Just look at the phenomenal blogosphere debates that are going on right now among the top economists regarding the role of national accounts identities in the interpretation of Keynesian economics and related fiscal or monetary action. This debate is not occurring because the idea of accounting isn’t important.

    The key is to leverage the constraint in thinking fully through the economics.

    (And I am NOT an accountant.)

    I’m not finished – more to go re your latest.

  17. Winterspeak — Interfluidity‘s commenters are indeed excellent. I hope you understand that I charge for access. (But please don’t mention this to them.)

    I’m going to have to refrain from participating at length in comments now, but I want to respond to…

    Most everybody thinks “the Government should run a smaller deficit”. Most everybody believes that “people should save more” (although some may want that day postponed). Hardly anyone realizes that those two goals are diametrically opposed to one another. That is pertinent today.

    It’s not inconsistent to suggest that people should save more under the traditional, S = I, definition but to want the gov’t deficit to decrease. Not to slur your namesake, but if I had to attach a normative valence to the behavior I’ve termed “Winterspeakian saving” — that is, accumulating debt claims against the government — it would be BAD. Saving by investing, pushing ones own wealth into the future and bearing the risk of failing to do so, creates incentives to do a competent job and internalizes the cost of failing to do so. Saving by accumulating claims against the government is really delegating to the government or the economic-system-at-large the task of pushing wealth forward, and creates incentives to use the political system to externalize the cost of failure by having the government tax to make savers whole. I think we should generally actively discourage the accumulation of risk-free claims on money, not laud it as “saving”.

    JKH — I love your consolidated balance sheet picture, and the taxation-is-equity idea offers immediate and useful food for thought in comparing and contrasting taxes paid to more traditional forms of equity. (Some of the forms of nontraditional equity financing I like to think about resemble taxation, in terms of repeated repayment and redemption rather than perpetual securities, although repayment in my schemes is voluntary rather than compulsory. A deeper difference between normal equity and taxation is that with equity ones entitlement to benefits is directly proportional to contributions, while with taxation, contribution levels and benefit receipts are decouples, except inasmuch as the highly taxed are differentially better at manipulating the political system. (That’s probably broadly true, but there are “donut holes”, demographics that are relatively higher taxed but receive relatively fewer benefits.) Also the primacy of debt to equity is an interesting question here: were the government to face a serious financial crisis, it would probably print to finance government services, effectively forcing a cramdown on debtholders while continuing to make payouts to equityholders. Anyway, very nice food for thought, and I like the style of analysis in exactly the same way that I like Winterspeak’s.

    reason — yeah, the point was overstated. leverage obviously has quite a bit to do with our meltdown, and even if the financial system had identified wealth generating projects, with sufficiently high leverage, mark-to-market volatility could produce a meltdown. (that’s kind of what the bankers are telling is is happening when they claim that they’re cool if we look at “hold-to-maturity” values.)

    in a world without mark-to-market or liquidity constraints, financial institutions could survive at any level of leverage as long as the set of projects they fund is ultimately good. my point was that even in that kind of world, they would be insolvent, because the funded obviously poor projects and used mathematical smokescreens to persuade themselves and others that it didn’t matter. under the most favorable regulation regime imaginable, our banks are insolvent because they were uncreative. but we don’t (and shouldn’t) offer them a regulatory regime quite so favorable. i’m perfectly happy to nationalize Citibank even if its projects do turn out to be “hold-to-maturity” money good, just like my broker is entitled to liquidate my account if I violate margin, despite my ultimately correct demurral that my bets would turn good if she lets me hold out. We give banks extraordinarily much slack on “liquidity” issues that might really be solvency issues, but that slack should have limits, and banks should fear to tread close to those limits. so, in the world as it is and as it should be, leverage does matter, quite a bit. i shouldn’t have put it that way.

  18. JKH writes:

    Winterspeak,

    I haven’t thought through the default issue yet.

    The rest looks fine.

    In total, apart from our difference on whether to conceptualize the equity piece, I haven’t intentionally disagreed with your view of things (so far at least).

  19. winterspeak writes:

    Benign Brodwicz:

    “Agreed, but a payroll tax cut only helps the employed.”

    …which makes up 93% of workplace participants, right now. That’s not chopped liver! And if they start spending that extra money, you see aggregate demand pick up, and that will increase employment.

    Remember, a payroll tax holiday also makes workers 7% cheaper to businesses!

    There is a huge amount of stimulus in a payroll tax holiday, and it can be started instantly.

    “I suggested a progressive, revenue-neutral payroll tax tilt (raise the ceiling, cut on lower incomes) that also fell upon deaf ears.”

    Good. Revenue neutral makes it non-stimulative. Deficit has to go up.

  20. SW:

    Winterspeak or Newspeak? Warning, I agree with about 95% of everything MM says. That said, posing inflation as an alternative to taxation is not news. I read specifically this in 1958! 1958? Yes, in something we got in school for a nickel in those days, “My Weekly Reader” (MWR). MWR said South American countries did this as a matter of government policy. What’s the big deal here? Now for my version of “Carthago delenda est”: Got gold? Get more! Got bonds? You fool!

  21. winterspeak writes:

    JKH: I am a friend of accounting! If I hesitate to use a balance sheet approach to think about a combined CB/G entity it is not because I don’t think balance sheets are wrong, it’s because it is not obvious to me what a balance sheet of a currency issuer should look like.

    It would be a 100% equity financed entity, because even though it carries debt, so long as the debt is denominated in its own currency it can always print enough new currency to meet its obligations, and need never default. (Of course, it may choose not to pay at any time, but that is a choice, and not an act of Physics. It’s good to be King.)

    I struggle with how to handle G and T because remember, it must always run a deficit (G>T) so the private sector can be a net saver and still maintain aggregate demand. I don’t know how to capture this dynamic in a balance sheet, and would appreciate any ideas you have. I can run it on a ledger like t-table, where you just add up spending and subtract taxes and what you have left (the deficit) is money out there in the private sector. Given that private savings are an asset, they have to exist as a liability on the Government balance sheet, and that liability corresponds to the difference between money out (G) and money in (T). But exactly how this should be organized, I do not know.

    However, I think I understand your point on how CB purchases of Treasury instruments impact money supply. Your point is that short term money can count as reserves, but that long term money cannot, so if the term of Government liabilities moves from short term to long term it essentially drains CB reserves and so acts as a restriction on bank lending. Did I get this right?

    However, and this may just be me, but doesn’t this strike you as being odd? The Fed targets the Federal Funds rate and conducts open market operations (as you describe) to try to have banks actually make overnight loans to one another close to the Fed described target rate. But if the banking system is net short of reserves, it just borrows through the discount window at the discount rate. So, on the one hand, the Govt has a price target in mind (interest rate) and manipulates quantity ($) to try and hit that price target. On the other hand, if the system is net short, it can simply borrow whatever quantity it wants ($) at a price (%) set by the CB! If the CB wanted, it could set, by diktat, the entire yeild curve (% at each term) and then let the market pick the quantity of debt it wants at that price. Certainly the Fed can try to manipulate the yeild curve all along its length, and I beleive it is going to begin conducting open market operations at longer terms soon.

    But I digress. I don’t know how heavily the discount window is used in real life, or how much of a limit reserve requirements actually place on bank lending. Given recent events, my feeling is they have very little practical significance, and are a residue left over from the Gold standard era. Europe has far lower reserve requirements than the US and I don’t see their banks being more risk loving. Canada has no reserve requirements at all, and their banking system is comparable to the US’s. Capital requirements can serve to constrain bank lending in lieu (or as a complement) to reserve requirements.

    SRW: I’m not going to take a strong position on the virtue of saving, but come one! The private sector wants to net save. It will always want to net save! The unit it will use to net save is a fiat currency — so good luck to them — but it’s still going to want to do it! Taking away opportunities to save and you’re not going to see more investment, they’re just going to take it out of investment and consumption. The Federal deficit enables private savings, it does not crowd them out. The traditional S = I defition just ain’t true. Putting money under my mattress, which is certainly strong form savings, does not contribute in any way to I. And having your money in a checking account at a bank is, as JKH put it, “disassociated from real economic investment, but no more so than bank deposits.”

    Bank deposits simply do not drive I. The Govt cannot make banks lend (q), they can only set the price (%). Banks lend when they think they can get paid back, plus a little extra, not when their deposits are particularly engorged.

    “if I had to attach a normative valence to the behavior I’ve termed “Winterspeakian saving” — that is, accumulating debt claims against the government — it would be BAD.”

    Hah! Well, I’m not going to claim it’s good, but perhaps we could agree that it’s neutral? The private sector just wants to do some of this. It doesn’t hurt anyone. It doesn’t limit real investment. To the extent that it enables greater G and lower T it gives the Government greater latitude to do stuff, which could be good or bad depending on what you think of the Government. Just print some money and let people stick it under their mattress so they feel good, big whoop. It won’t even show up in CPI.

    “Saving by investing, pushing ones own wealth into the future and bearing the risk of failing to do so, creates incentives to do a competent job and internalizes the cost of failing to do so.”

    This happens too. Both happen. But money under the mattress emboldens people to take (calculated) investment risks. Taking away the safety net will certainly focus the high-wire performer, but is that really what we want? It’s certainly unneccessary.

    “Saving by accumulating claims against the government is really delegating to the government or the economic-system-at-large the task of pushing wealth forward, and creates incentives to use the political system to externalize the cost of failure by having the government tax to make savers whole.”

    We disagree here. A dollar bill is a point, it’s not a claim against anything. This is my reservation with the equity model — it isn’t that I don’t think a balance sheet is the right construct to manage financial assets and liabilities — of course it is, but to a currency issuer the concept of “asset” and “liability” means something very different than it means to us poor slobs, currency users all. In a fiat world, you need to really embrace that currency is not any kind of store of value at all. It’s just a point, like a frequent flier mile. Savers won’t be made whole, they’ll be diluted.

    Do you think that American Airlines is concerned about everyone who has stored up its frequent flier miles deciding to redeem them at once? Do you think that they will have to take frequent flier miles away from some people so they can give them to other people? No. If they need extra frequent flier miles, they will just issue more. If they need fewer frequent flier miles, they will just increase the trade in cost for their tickets, or expire miles at a faster rate. But AA has an infinite well of these miles, there is no residual claim associated with them, not even a sliver of one!

    Independent Accountant: Inflation *is* an alternative to taxation. Inflation is caused by too many dollars chasing too few goods. Taxation reduces the number of dollars available to chase goods. This was true in 1958, 1858, 1758, etc. We seem to have forgotten it in 2008.

  22. Winterspeak — I am really not supposed to be participating in the comments. And I was not supposed to be writing last night. You have ruined me with your thoughtful words, I tell you!

    Anyway, I can’t resist, so here goes.

    1) There’s a terrible epiphany one gets when one really takes the identity S=I seriously. I recommend it, if not for its economic wisdom, then as a form of intellectual blow, an econopharmaceutical mindf*k. Suppose it is true that S=I. Suppose also that government bonds and dollar bills are in fact claims against the government, in the same manner as corporate debt and equity might be. I know you don’t like this view, but work with us here. Then holding dollar in the mattress is like holding corporate stock, and is “investment” in exactly the same way. Sure, you never transferred any capital directly to the government. But you got that dollar bill from someone who got it from someone who did provide a real good or service to the enterprise known as government. (We’ll stick with direct government claims. If we want to include bank deposits, things will get more temporally complicated, and we’ll have to consolidate the government and the banking system to define the enterprise on which we hold claims, but the logic won’t be fundamentally broken.)

    Anyway, I put a dollar in the mattress. Why do I do this? For the same reason I hold a (non-dividend-paying) stock certificate — I expect that the dollar will someday be redeemable for future goods and services in an amount that represents a reasonable tradeoff viz the present goods and services I am forgoing, given my rough timetable of expected consumption and a risk/return analysis re other assets I might hold to push wealth forward. From a saver’s perspective, there is no fundamental difference between holding stock and holding money. It’s just that, rightly or wrongly, many savers have been persuaded that money or default-free claims on money offer a return that better matches their risk preferences than alternative instruments.

    Ah, you say. Capital invested in stock, at least in some indirect fashion, relates to some real investment. How does indirectly funding the government’s farm subsidies contribute to actual I?

    Here is the key to the S=I identity, which does from its perspective always hold true. NO ONE EVER SAID THAT ALL INVESTMENT IS GOOD INVESTMENT. Everytime the government issues a dollar, someone purchases that dollar with real goods or services in hopes of getting real goods or services back in the future. For the purposes of the S=I equality, running up vacations on a credit card is actually I, because the person who funds that Cancun blowout expects that putting you on the hook will motivate you to produce real future labor that will recoup the “capital outlay” of margaritas and massages, and then some. The quality that distinguishes C from I isn’t anything inherent in the activity or good being purchased. It is the spender’s expectation, reasonable or not, that the expenditure will by some means or magic cause future performance by the party funded that will justify the present outlay. When I accept a government dollar to mop the floors of the Pentagon, and then hold that in my portfolio rather than buying some MBS, I am making an investment decision. This must be true, if we accept as an axiom that S=I. The public’s greater or lesser desire for money, for Winterspeakian savings, generates a demand curve that determines the ease with which the government can marshall resources towards its purposes, exactly in the way that the level of people’s enthusiasm for IBM stock can make it easy or hard for IBM to acquire firms or build new factories.

    (If you think that this discussion would imply that C=I, you are missing something. Not every acceptance of a dollar is an investment in Americorp. Swapping a dollar for a hamburger is a transfer in the secondary market, the terms of which may ultimately affect the price, in real terms, of future government capital-raisings, but does not directly serve as investment. Buying a hamburger is still consumption, unless somebody else pays for it, and you promise to pay them back, in which case it is precisely investment.)

    It is worthwhile, I think, both to take seriously the idea that S=I, and to mock it.

    2) In theory, holding claims against the government, however unenforceable, is no different from holding claims against a firm. In practice, “Winterspeakian savings” is usually the result of an investment non-decision. That is, people hold money as a default, when they have not chosen some more specific claim on future wealth. People “want” to save in this sense because they “want” to have a reliable claim on future wealth without having actually to participate in the process of ensuring that the wealth they will want will actually be there. They de facto delegate that task to the government. I will agree with you that it is true, as a social fact, that money savings helps to enable risk-taking because people believe that money is nearly riskless, that the worst case scenario on say a goverment money market fund is a return that matches but fails to much outpace inflation. Because people believe that money claims have a very truncated lower tail, a money-heavy portfolio enables rich-averse individuals to mix much riskier projects or claim into their portfolio at a tolerable perceived overall risk. But here’s the rub — I don’t think the government, whose ease-of-funding is related to demand for money, actually does a very good job of ensuring that real wealth will be around to make good on its claims. So claims on money are often misdirected investment. Holders of money are really relying on holders of more conspicuously risky claims to make good decisions that result in future prosperity. When the economy does grow, the government can deliver goods or services against its claims, either Ponzi like by getting someone else to accept them, or by taxing — indirectly forcing someone to deliver goods that can be used to redeem your claim. Now claims against the government are unenforceable, just like IBM stock certificates. But the government has every interest in upholding the Moldbugian equilibrium, and sustaining the illusion of value it confers to “points”. In reasonably good times, the government succeeds easily. But in poor times, the government will still struggle to keep its stock valuable. Nothing is more important to a government that ensuring that no alternative becomes the focus of the monetary Nash equilibrium. Money is the means by which government keeps its ultimate basis in a supremacy of physical force hidden. It is the lubricant by which state coercion is rendered indirect, civilized, and legitimate. Therefore, when an economy fails under circumstances where the government cannot easily borrow, the government will not solely resort to printing to redeem its obligations. It will do that, but it will also increase taxation, balancing its fear of losing the currency against political and sociological constraints on its ability to tax.

    A bit of money saving might be a good thing. As long as the private sector’s portfolio in aggregate is mostly productively invested, money saving, like limited liability and cheap bank financing, can be viewed as a behavioral trick that encourages useful risk-taking. (I might prefer more transparent risk-pooling schemes, but “risk free assets” have the advantage of history.)

    But money saving substitutes for directed investment, while providing no information to entrepreneurs about future consumption plans. As government claims occupy a greater fraction of investment (in the S=I sense above), the quality of the aggregate portfolio is likely to suffer. Again, I don’t want to say that the right quantity of claims on government that should be held is zero — at the moment I’m “Galbraithian” in the sense Kling is using the term, I think we’ve underdone public good investing and the government has a range of extremely productive projec
    ts it could invest in. (That doesn’t mean I’m enthused about the increased demand for government claims, only that I would be if I thought government would offer those claims selectively in exchange for the public goods I favor.) But over all, I think a surfeit of money saving is damaging, both by virtue of the better investments foregone and by virtue of the increase in the tax burden that will accompany a resort to inflation. I think that for the most part we’d all be better served if government were equity rather than debt funded in JKH’s sense — that is if government funded itself almost entirely from present taxes and people’s savings took the form of directed investment.

    American Airlines may well dilute its points, but that would cost it in PR terms and in the credibility of its future loyalty programs. I’m with IA in thinking that the US government will be pretty soon be forced to dilute its points as well, but those points are much more central to the USG than frequent flier miles are to AA, and the USG will fight much harder than AA to prevent people from giving up in disgust on its loyalty program.

    Enough, then. It’s nearly 4:30. Must you always be so thoughtprovoking?

  23. reason writes:

    Steve

    thanks for your answer, but I think you missed an important point. Maybe, given the current misallignment of currency prices there are not any marginal domestic investments that make sense. Of course, the banks could decide to invest outside the US and maybe I have to think more carefully about they don’t do that (currency risk is one obvious problem, but that is hedgable).

  24. locrian writes:

    Sorry to noobify this discussion, but what’s the difference between a reserve requirement and a capital requirement? The post says Canada has no reserve requirement but has a capital requirement.

    Thanks!

  25. JKH writes:

    Winterspeak,

    As a preliminary point of terminology, I think it is important to distinguish between an equity security or equity financial claim, and equity per se. Suppose a given household owns a house and has some money in the bank. The total value of these assets is $ 300,000. It owes no money. Then we say that the net worth or equity value of the household is $ 300,000. This has nothing to do with whether the economic unit in question has issued equity securities or an equity claim to somebody else. It hasn’t. The applicable use of the term is also evident in the idea of “mortgage equity withdrawal”, in which households borrow to spend, thereby depleting or “withdrawing” their household equity. The reduction in household equity value comes about as a matter of debt issuance, not equity issuance. And all of this has nothing to do, of course, with whether the household owns equity securities or equity claims as assets. This is fairly important, in that the totality of US household net worth or equity as calculated by the Federal Reserve is currently about $ 50 trillion. Only a tiny portion of this if any of it at all would be evident in the form of some sort of equity claim issued by households.

    That said, the essential characteristic of equity when used in this sense of net worth is the characteristic most associated with common stock, and not for example with preferred stock; i.e., the essential characteristic is that equity must completely capture the measure of residual value, after netting liabilities from assets. This distinction is particularly important, I think, in dealing with the issue of whether currency should be viewed as equity, which I’ll address below.

    So on to the problem at hand.

    The effect of taxes flowing into a government revenue account is to increase the G equity position at that point in time (assuming the existence of an equity concept, as I am doing). This is because the immediate effect of taxes collected is an increase in the government’s bank account, which is an asset, without a corresponding increase in liabilities. An increase in net assets is an increase in equity.

    A good analogy, I think, is that corporate retained earnings (not paid out in dividends) increase the corporate equity account. Households also effectively incorporate the concept of retained earnings (cumulative savings) in their own balance sheets. Taxation can be viewed by extension as a diversion of private sector retained earnings to the government. Therefore, it is a transfer of equity.

    What the government does with that equity injection is another thing. It may spend it or invest it. Spending eliminates it as far as the government is concerned. Investing preserves it.

    Government debt is different. The effect of debt proceeds flowing into government coffers is neutral on its equity position at that point in time. This is because the debt liability is immediately offset by a bank deposit asset.

    What the government does from there with those debt proceeds is another thing. It may spend it or invest it. Spending it results in a net negative equity contribution. This is because the government has a liability but no asset. Investing it is neutral for the equity position. This is because there is a match between asset and liability.

    The net negative equity case just identified is what typically corresponds to deficit financing.

    Therefore, to the degree that government borrows and spends, it drives its equity position increasingly negative. To the degree that accumulated central bank liabilities represent an additional source for such borrowing, the natural balance sheet position for GCB is one of accumulated negative equity.

    Negative equity, when all is properly and consistently measured (including investment), is the necessary offset to a GCB balance sheet that has a natural net liability (i.e. reserves, currency, debt) profile. (Proper measurement recognizes SRW’s point that expenditure and investment warrant truly accurate classification.)

    Negative equity effectively appears on the left hand side of the balance sheet. The interpretation is that it represents, not an equity claim or equity security asset, but a notional receivable in the form of the future equity capital injection that would be required to bring the balance sheet back to the point of a zero equity position.

    In summary, the appearance of government debt on the G balance sheet, when combined with a bank deposit asset, makes a neutral equity contribution, before considering further balance sheet activity. Subsequent investment will preserve the neutral equity contribution. Subsequent expenditure will result in a net negative equity contribution equal to the debt liability.

    The appearance of tax proceeds on the G balance sheet in the form of a bank deposit asset makes a positive equity contribution, before considering further balance sheet activity. Subsequent investment will preserve the positive equity contribution. Subsequent expenditure will result in a net neutral equity contribution, since neither asset nor liability has been left behind.

    Thus, my previous comment stands:

    “Taxation can be viewed as equivalent to the purchase of equity in the GCB. Government expenditures can be viewed as the equivalent of a buyback of that equity in return for public sector goods and services.”

    Both sentences are important, I think, in interpreting how taxation contributes to GCB equity.

    Again, the examples above infer the existence of a conceptual G or GCB equity account that changes due to various types of fiscal and monetary transactions. They show that taxation can supply an operational surplus that increases G equity. When spent, the equity change is flat. And when expenditures are financed by debt, the equity change is negative. Since G and GCB are typically in a cumulative net deficit position, this corresponds to a negative equity position. This can be represented as a balance sheet where equity appears on the left hand side as an offset to debt.

    One of SRW’s recent themes has been the appropriate classification of government expenditures as between true expenditures and true investments. Such a reclassification would allow for the insertion of any such investment identified in the left hand side of the GCB balance sheet. This would increase GCB equity.

    “Ricardian equivalence” suggests the possibility that the assumed existence of a tax asset might also increase GCB equity (i.e. make it less negative).

    Finally, I noted the importance of the residual characteristic of equity in dealing with the issue of whether currency should be viewed as equity. Some view CB money liabilities as equity. I would say they are not equity, at least not in the sense I’ve delineated GCB equity here.

    In fact, the issuance of reserve liabilities and currency constitutes a negative equity contribution for a central bank and a positive equity contribution for the holders of those assets. But the equity contribution in the case of the holders is not due to the equity characteristic of their asset. It is due to the fact that its value (as a non-equity financial asset) makes a positive contribution to their household equity position. These are two distinct ideas, as noted in the earlier preamble.

    Some argue that the potential for a central bank to dilute the float of its money issuance means that its money has an equity characteristic. This is not so, for several reasons. First, the capacity for a central bank to dilute its float of money issuance is not unique. Commercial banks can do exactly the same thing with their deposit liabilities by expanding credit. Such dilution does not indicate that bank deposits are equity.

    Moreover, some might further argue that central bank monetary dilution is unique because it effectively funds government expenditures. The second part is t
    rue. But it doesn’t mean that CB monetary dilution has some unique equity characteristic. The entire purpose here is to demonstrate that the GCB has an equity position, which may well be driven negative or positive or sideways due to a number of factors, including monetary dilution, other forms of debt financing, taxation, expenditure, and investment.

    CB monetary dilution is indeed a partial driver of negative GCB equity. But the dilution doesn’t make it equity. Dilution only contributes to equity, along with debt, taxes, expenditures, and investments.

    If one wants to persist with this view of monetary liabilities as equity, it would be more conceivable to me to interpret them as some sort of perpetual preferred equity that pays zero interest. This sort of classification would exclude the sort of residual equity value that I’ve attempted to capture in the concept of equity as used here, and on that basis wouldn’t necessarily be inconsistent with it. But I would still tend personally to resist this sort of classification. It seems natural to identify the CB component of GCB as the operational interface for the consolidated GCB institution, and the G component as the strategic driver. I don’t like viewing the operational and liquidity interface for the entire mechanism as financed by the equivalent of preferred equity. And given the fact that it isn’t in the nature of the residual equity value that I’ve described, it doesn’t really matter.

    In summary, there is a residual element to the idea of GCB equity that is not captured in the currency itself. Therefore, CB money narrowly defined or GCB liabilities broadly defined are not equity in this sense.

    Regarding your specific comment: “So long as the debt is denominated in its own currency it can always print enough new currency to meet its obligations, and need never default”

    This is true. But it doesn’t mean that currency is equity. It only means that the CB or GCB has the capacity to drive itself ever further into a negative equity or insolvency position by issuing currency (along with reserves, bills, and debt).

    (I’ll address your points on Fed operations separately.)

  26. winterspeak writes:

    STEVE: Well, here we are in the muck. Let’s sally forth, but I am going to try to be more concise.

    We are in agreement that, if you embrace S=I, you can simply reclassify malinvestment as consumption. You thought you were making a good investment, you were wrong, the money is gone, so you reclassify as C. This is true even in the WPS model, btw. It has a C and an I.

    We are also 100% in agreement that “The public’s greater or lesser desire for money …determines the ease with which the government can marshall resources towards its purposes” assuming you mean the degree to which the Government can spend without generating inflation. If there is a lot of demand out there for “Winterspeakian” savings, then the Government can run higher deficits without triggering inflation. Certainly the US is a beneficiary of this as we have foreigners who also want to put dollars under their mattress.

    Is this why you don’t like private savings? They enable greater Government spending and Government makes bad spending decisions?

    “Money is the means by which government keeps its ultimate basis in a supremacy of physical force hidden.” Nothing hidden about it! Try not paying your taxes on April 15th. btw. the IRS does not accept ringgit. I think the converse is more accurate though — the government’s monopoly on physical force enables it to maintain demand for its currency (or token of exchange).

    “cannot easily borrow, the government will not solely resort to printing to redeem its obligations. It will do that, but it will also increase taxation, balancing its fear of losing the currency against political and sociological constraints on its ability to tax.”

    We disagree here. *All* government spending is with newly printed money. Whenever the Government spends, it injects money into the banking system. When it taxes, it uncreates that money. When it borrows, it changes the term structure of the money available, plus the interest rate. The change in term structure can drain reserves, which tightens to the extent that reserves constrain bank lending (which I don’t think they do, much). Certainly open market operations can change interest rates, but then the Govt can do this by diktat also as it does at the discount window.

    The US could stop issueing Treasury securities and it would still function just fine. It does not have to “finance” its deficit.

    If the Government increases the deficit above and beyond WPS, you’d see inflation.

    “I think that for the most part we’d all be better served if government were equity rather than debt funded in JKH’s sense — that is if government funded itself almost entirely from present taxes and people’s savings took the form of directed investment.”

    What you’re saying here is that you would outlaw private savings in the home currency. The consequence of this would be that people would save in some other unit. In prisons, that unit is cans of sardines I believe. In third world countries, where people don’t *want* to save in the local currency it’s dollars, or gold. You certainly would not see any increase in directed investment. You seem to believe that the Government needs to be fundED in some way. It does not, it is a currency issuer, which means it is The FundER.

    JKH: I’m still struggling with a balance sheet for a combined G/CB entity. What would you put in the cash entry on the assets side? Infinity?

    I’m beginning to think that Government really should simply account on a cash basis. So, cash flow statement is meaningful, still struggling with balance sheet construct.

  27. winterspeak writes:

    JKH: I posted before your latest, so let me digest (5 times). you may have answered my question already.

  28. JKH writes:

    Winterspeak/SRM (consolidated),

    On the S = I issue:

    S = I in conventional macro, closed, net terms.

    S does not = I in gross micro or macro terms.

    This is because S admits negative values, while I does not admit negative values.

    If I borrow to buy a hamburger, I have incurred negative savings.

    (My balance sheet changes by a corresponding amount of negative equity.)

    The people who sold me the hamburger, or their economic equivalent, have incurred positive savings.

    This must be the case, because they have income from selling the hamburger that they can’t use to buy it, because I bought it. So they must save their income.

    If macro net saving is S = I, then gross micro/macro saving equals S + JKH’s hamburger finance provision.

    If I were the government, my hamburger purchase would be G, and the provision of my hamburger finance would amount to Winterspeakian net saving.

    Here ends my short comment.

    P.S. Winterspeak – infinity is a good cash position, but not a sound balance sheet entry.

  29. JKH writes:

    locrian,

    The terminology is confusing.

    Reserve requirements refer to the amount that banks are required to keep as either vault cash or deposits with the central bank, as protection against immediate demands for funds from clients.

    Capital requirements refer to the amount that banks are required to keep in the form of common or preferred equity, as protection against losses in their income statement.

    Reserve requirements protect against liquidity risk; capital requirements protect against solvency risk.

    That’s a rough translation. Quadrillions of words have been spilled comparing the two otherwise.

  30. JKH writes:

    Reserve requirements in Canada are zero mostly because the banks are sufficiently well regulated that they can be checked for internal liquidity management policies that are far more comprehensive than statutory reserve requirements. Also, technological advances in funds transfer have allowed banks to operate at very thin levels of cash balances at the central bank. Most precautionary liquidity is held in treasury bills and other liquid assets, again under the umbrella of fairly comprehensive internal policies.

  31. winterspeak writes:

    locrian:

    JKH is right-on. Except reserve requirements are meant to protect against liquidity risk (bank run) but they do not, for obvious reasons. FDIC does that, since the Fed has no default risk.

  32. MethodMan writes:

    All in all very interesting.

    Do we not find it amazing the this money thing is still open for debate, all the way down to its core purpose? As if civilization was still trying to figure how to make bread every 100 years.

    What is missing in the discussion here is that more than anything, taxes are what gives fiat its “value” and thereby underpin its existence. Thou must payest taxes in dollars, or go to jail. Money serves a political purpose that transcends all the formulae here.

    Taxes create a demand for fiat. Remove them, and be ready for a big surprise.

  33. winterspeak writes:

    JKH: OK, let’s run with the balance sheet for a combined G/CB entity.

    Assets:

    - Cash and Cash Equivalents

    - Net Receivables (Taxes)

    - Inventory (National Parks, etc.)

    - Other assets (GM, MBS, etc.)

    Liabilities:

    - Long term debt (Treasuries lent out)

    - Accounts Payable (Entitlements, Payroll)

    - Other liabilities (misc)

    - Equity (residual after assets – liabilities)

    You’re saying that, in the construct above, if you increase taxes, equity goes up. If Govt pays money to build a bridge, then liabilities go up (long term debt, and/or account payable), assets may go down (cash) and equity may or may not decrease depending on whether the bridge remains G/CB property of whether it is gifted to some other entity (such as a State or a City).

    Good so far?

    Suppose I, as the Govt, load on accounts payable by doubling everyone’s SS and Medicare payment? I don’t raise taxes. Now my equity is negative as liabilities > assets.

    This negative equity position has no impact on my ability, as the Govt, to issue checks to SS and Medicare recipients that will not bounce when they cash them. Govt checks never bounce. Now, this action may cause inflation, but no default.

    You say “infinity is a good cash position, but not a sound balance sheet entry.” I agree, but infinity is the accurate number to put in the balance sheet entry for cash in the assets column of a G/CB entity. Its unsoundness may have more to do with fitting a balance sheet structure onto a currency issuer than any deviation from reality.

    That said, maybe you know some way to square the circle I’ve posited above.

    Also, and please forgive me, but I find it very difficult to follow your arguments. Can we stick to the simply model I have at the top of this post? I am not an accountant either, nor do I work in finance or banking.

    —–On your S=I comment

    You use the term “I” for income. In the identity, I is “investment”. “S” = “I” means “savings” = “investment”. That’s what you meant, yes?

    “If I were the government, my hamburger purchase would be G, and the provision of my hamburger finance would amount to Winterspeakian net saving.”

    That is correct, but it’s funny to call “hamburger finance” winterspeakian net savings because, as the Government, I would not have to “finance” this deficit by borrowing from anyone. It would just live as a whole in my balance sheet and equal, exactly, the savings of the hamburger vendor.

    When people use the word “finance” it suggests they are borrowing from someone. Government does not have to borrow. I can do the transaction, run the deficit, and not borrow a thing if I was the Government. By deficit precisely equals net private savings. No one has issued any debt.

  34. winterspeak writes:

    MethodMan: The taxes point is not missing, just buried in words.

  35. JKH writes:

    Winterspeak,

    We’re reasonably close on the balance sheet.

    I agree negative equity for the government doesn’t preclude more spending – I didn’t mean to suggest it did.

    Sorry, but I don’t know what you mean by putting in an infinity cash position.

    Not sure what circle you’re looking to square. The infinity issue? Can you elaborate?

    One area of apparent disagreement – the government can write cheques and potentially go overdraft at the central bank, but it won’t go overdraft in practice. It will borrow to cover. It must borrow. You will never see a government overdraft position on the Bank of Canada balance sheet. This is a fact.

    I don’t use ‘I’ for income. I use it for investment.

    And yes the government does have to borrow to cover the hamburger expenditure. The whole in the balance sheet is not on the borrowing side – it’s on the asset side. The hole is equivalent to negative equity.

  36. JKH writes:

    Assets = Liabilities + Equity

    If Liabilities > Assets,

    then:

    Equity < 0

    And Equity appears on the left hand side of the balance sheet – the reverse from what it should be in a solvent organization

  37. MethodMan writes:

    winterspeak: yes indeed. I have read your ideas about a payroll-driven stimulus, and it certainly would have the added affect of reducing busisness payroll taxes and thereby reducing unemployment (a bit).

    Although it could be initially highly effective, it would be not be pretty to have individual taxes fluctuate down and especially back up to meet monetary policy. Even the grant of one “tax holiday” once discovered will become a regular, expected demand. In otherwords, now we potentially make the very existence payroll taxes political again, beyond the usual debate of up or down a few percent.

    Further, business will be keen to what labor is netting in discretionary income. If they see the government just gave their employees a 50% reduction in taxes, bet your bottom dollar they will grab a slice of that pie with immediate wage reductions. Pull one lever, another one shifts. Now what do you do? Freeze wages?

    I get the strong feeling all this is largely academic, however.

  38. JKH writes:

    I think your “infinity cash” should instead be negative equity.

  39. JKH writes:

    Winterspeak,

    I said:

    “One area of apparent disagreement – the government can write cheques and potentially go overdraft at the central bank, but it won’t go overdraft in practice. It will borrow to cover. It must borrow. You will never see a government overdraft position on the Bank of Canada balance sheet. This is a fact.”

    I should have qualified this – the only variation being when the CB purchases the debt and prints money. Otherwise the debt is floated in the market.

    But G can’t run a deficit without borrowing. What it can do is spend in anticipation that the funds provided to the system will ensure the availability of funds to cover its overdraft. But that’s not the same idea.

  40. winterspeak writes:

    JKH: Glad we are close on the balance sheet! And OK, let’s drop cash = infinite for now.

    Remaining issues to focus on — which I think are tightly defined now:

    1) Govt can operate with negative equity, fine. This entry appears on the left hand of the balance sheet “the reverse from what it should be in a solvent organization”. OK. But so what? The Govt is not and cannot be insolvent so long as its liabilities are denominated in its own currency. The CB/G can always print $s to meet its $ denominated liabilities. It may inflate, but it need never default.

    Given this fact, why is “equity” a useful concept here. What does it represent?

    2) I think these two are related: “the government can write cheques and potentially go overdraft at the central bank, but it won’t go overdraft in practice. It will borrow to cover.”

    and

    “And yes the government does have to borrow to cover the hamburger expenditure. The whole in the balance sheet is not on the borrowing side – it’s on the asset side. The hole is equivalent to negative equity.”

    OK. You say the Government has to borrow to cover so it does not go into overdraft. Who does it have to borrow from? Suppose no one lends?

    My position is that the Govt does need to borrow from anyone. It can just change entries in electronic bank records and credit the vendor. Or it can issue a check, which the vendor submits to the CB for clearance, and it clears. There may create negative equity, but who cares? To the extent that negative equity *is* Federal debt (the sum of deficits) then negative equity is, in fact, a requirement so the private sector has the money it needs to net save. I’m not there yet with how to interpret negative equity, but I do content that the Govt does not have to borrow in order to spend, or to “finance” its deficit. It just spends, endogenously creating money. It could do this even if the Govt stopped issuing any bonds.

  41. JKH writes:

    Winterspeak,

    This might help:

    Equity is on the left hand side, under assets, when its negative.

    $ 1 in additional taxes, before spending, will increase equity, meaning make it less negative in this case. That part of the balance sheet (i.e. a reduction of $ 1 of negative equity, which is under assets) will be replaced by $ 1 of cash in the government’s bank account, before spending.

    etc.

  42. winterspeak writes:

    MethodMan: “Although it could be initially highly effective, it would be not be pretty to have individual taxes fluctuate down and especially back up to meet monetary policy. Even the grant of one “tax holiday” once discovered will become a regular, expected demand. In otherwords, now we potentially make the very existence payroll taxes political again, beyond the usual debate of up or down a few percent.”

    The debate around taxes is extremely ugly and 100% political. We’ve seen rates bounce up and down like yoyos. Spending though, is forever.

    I see no reason why a payroll tax holiday should not be demanded whenever there is a dramatic fall in aggregate demand! It is the very best medicine.

    “Further, business will be keen to what labor is netting in discretionary income. If they see the government just gave their employees a 50% reduction in taxes, bet your bottom dollar they will grab a slice of that pie with immediate wage reductions.”

    Businesses are cutting wages now, and their profits are falling. Improving corporate profitability is not an insane way to get hiring to return. I’m not going to get into a debate about how corporations rip off their employees.

    “I get the strong feeling all this is largely academic, however.”

    Totally true. We’ll get our fiscal stimulus the hard way, through unemployment. Obama/Krugman/NYTimes picked permanently higher G, and tough luck if you’re on the dole.

  43. winterspeak writes:

    JKH: I think we’re cross posting:

    “I should have qualified this – the only variation being when the CB purchases the debt and prints money. Otherwise the debt is floated in the market.”

    OK, so a combined G/CB would simply… print the money. (G issues debt, CB buys it and print money. Combine G and CB and you have… printing money). Yes?

    “But G can’t run a deficit without borrowing. What it can do is spend in anticipation that the funds provided to the system will ensure the availability of funds to cover its overdraft. But that’s not the same idea.”

    Help me understand the difference in a combined G/CB entity. G writes a check, knowing that it’s account in the Fed cannot cover it. Check is submitted for clearing, G’s account threatens to go into overdraft. No worries — CB provides funds for G’s account and the check clears. So long as the CB will always clear G’s checks, why does it need to borrow? Who does G borrow from? If G borrows from the CB, in a combined G/CB entity, it isn’t borrowing.

  44. JKH writes:

    Winterspeak, your 5:29

    “The CB/G can always print $s to meet its $ denominated liabilities. It may inflate, but it need never default.”

    Both true at least in theory, but that doesn’t mean it isn’t insolvent.

    Equity is a useful concept because it measures the condition of the government with respect to the issues we’re talking about. Somebody watching the government might have something to say about such a condition, if extreme, in terms of fiscal and monetary policy going forward.

    “Suppose no one lends?”

    That typically doesn’t happen. If it does, then it can go overdraft. But it’s not the normal occurrence or normal practice. And if it ever did happen, it’s totally equivalent to the central bank monetizing debt. That’s what an overdraft is – a daylight or overnight extension of credit directly from a deposit facility.

    “I do contend that the Govt does not have to borrow in order to spend, or to “finance” its deficit. It just spends, endogenously creating money. It could do this even if the Govt stopped issuing any bonds”

    That sounds like Mosler. And it’s correct, provided that the government and the central bank are comfortable with an overdraft position. But it doesn’t happen. They don’t permit it to happen. So it’s academic.

    Mosler goes overboard with this. His observation is that there’s no real operational constraint that precludes it from happening in theory. But it’s a trivial observation in terms of the operation of the banking system. And it’s not that important, because it doesn’t happen. The government and the central bank conduct their operations in a more regular way, which includes covering daylight overdraft positions with market financing as necessary.

  45. MethodMan writes:

    Nor I about employers ripping off employees, nontheless your problem remains of getting more money into the employees’ hands as a stimulus. If you massively reduce their payroll taxes in an attempt to boost their net income, employers (well, non-union at least) can and will erase most of it in an instant simply by reducing wages. It simply doesn’t matter if we characterize that as unfair.

  46. JKH writes:

    Winterspeak,

    Your 5:41

    No. The combined entity doesn’t automatically print the money.

    It has the choice of taking it from the market or running it through the CB (i.e. printing).

    “Help me understand … etc. ” :

    G writes check to household H.

    H deposits in commercial bank C.

    C clears against CB.

    Reserves increase.

    GCB doesn’t want to bank reserves to increase because that would disrupt monetary policy.

    G “tightens” as I described earlier by issuing treasury bills.

    Firm F buys bills.

    F pays for bills by debiting its account in commercial bank C.

    CB clears against C for F’s payment for bills.

    CB credits G account while debiting C’s reserve account.

    Bank reserves go down and are restored to original level.

    G overdraft now covered due to bill issuance.

    Monetary policy is back under control.

    This is all because G has played by the rules in terms of covering its overdraft position with CB.

    I.e., G has not followed through on the operational, theoretical POSSIBILITY of not borrowing as suggested by Warren Mosler – because that would totally disrupt monetary policy.

  47. JKH writes:

    Winterspeak,

    I’m out for a few hours.

    Can resume later this evening or tomorrow if interested.

  48. winterspeak writes:

    JKH 6:13pm

    I’m not ignoring you! Just that life is intervening. Also, I spent time on your posts, so forgive the slow response.

    Mosler takes an extreme position on this, or you can view it as a logical position based on fully embracing the “token” nature of fiat money. He’s certainly mad, but I don’t know if he’s wrong.

    Operationally some of his ideas are non-starters, and he’s very bad at anything that has long term capital stock accumulation consequences, but I think on straight nominal transformations he is right.

    Anyway, let me digest, and we will continue (or I may simply say I agree with everything you’ve written!)

  49. winterspeak writes:

    JKH: OK, I think we’re in (almost) agreement.

    When the Government spends it has a choice: it can “sterilize” that purchase with a bond issue or it can just carry the hole as an overdraft.

    In practice, it issues the bond, but there is no law of physics preventing the overdraft.

    I say the Government never needs to default, they can always inflate, and you say that this may be technically true but the entity may still be insolvent. My definition of “insolvent” is “cannot pay its debts with available cash” and this can *never* be true for a sovereign serving debts with fiat.

    What’s your definition of “insolvent”? If it’s just “negative equity”, then why does it matter if it has no operational impact?

    We agree on the construct of “equity” but I still struggle to relate it to anything useful. Japan’s debt is more than double its GDP, I think the US stands at 50%, and there is no inflation nightmare in Japan. Clearly, private savings matters!

    What does this “equity” entry reflect in the real world? Is it outstanding Government debt?

    Your description of monetary mechanics is very clear — thank you! And yes, G covered its overdraft position with CB to maintain monetary policy. But we are clearly in a position now where conventional monetary policy is hard to apply. I believe the Fed now pays interest on reserves, to lower the FFR. Don’t you wonder why there is an overnight interbank lending market at all? Why not just use the discount window plus capital controls? Or just capital controls and drop reserve requirements altogether? It can be done, we have the technology.

    My point in all of this was that, the Government must run a deficit so the private sector can save. This deficit can be financed or not, and I 100% agree that not financing it would reflect a dramatic deviation from past monetary policy. It would reflect a less dramatic deviation from current monetary policy, which is decidedly funky.

    Whether this deficit (financed or not) triggers inflation depends on how much of it flows into private savings (bank accounts — low velocity) or private consumption and investment (transaction — high velocity). Yes, it all lives in bank accounts, but some of it is chasing goods and services, and some of it is not. If money isn’t transacting, it isn’t counted in GDP or CPI, nor does it finance bank loans. Lots of low velocity money can let the Government run very large deficits without having any impact on inflation.

    Are we agreed on the above?

    Looking forward to your answers re: “solvency” and “equity”. In your own time, of course.

  50. JIMB writes:

    Winterspeak: Seems there is a huge mistake in equating “savings” with accumulation of currency. First currency is accumulated by selling some service or good, and hence it is not simply a dollar transaction … The government does not create the goods that are sold by the private sector in the efforts of the private sector to accumulate the currency. Second, the private sector does not “save” by accumulating currency either, currency is a system of temporary exchange ** only **. The private sector saves shifting spending from consumption to capital goods which enable future production. Since ability to produce valuable goods is the only REAL form of savings, I submit that all this verbiage is really falling for modern financial doublespeak.

    The Fed is the world’s largest market maker ensuring a continuous market for government bonds. That is their only purpose in the eyes of the U.S. government. The banking system creates loans which create deposits which makes the demand for public debt. What you have seen right now is the forcible creation of a domestic market for U.S. treasuries by incurring a huge boom, then bust. My feeling is the Fed being able to pay interest on reserves is of huge, huge importance. It means they are issuing their own debt and have effectively divorced themselves from solvency of the U.S. government. Elite finance is taking over now.

    Banks are very much constrained by reserves as they have to supply them to depositors on redemption demand and not all their balance sheet is redeemable for reserves. So if a bank (WAMU) takes losses that drain it’s capital, depositors know that the capital might be the only extent of deposit redeemability, and uninsured depositors (corporations) pull their deposits immediately. This forces the bank to sell any good assets it has to redeem deposits, which it must redeem ** in reserves ** and that in turn shuts down the organization.

    Clearly we are talking about the real world here, in which banks cannot willy nilly get reserves any time they want for junk loans they issue, else all bad debt could be exchanged for cash, and the amount of spendable deposits would go to the moon. (Just look how bad the real estate market boomed when the top banks know they get a bailout…). Reserves DO constrain the system.

    Some technical observations: Taxes are frequently price inflationary because fewer transactions are profitable at the same interest rate when taxes go up, so the Fed tends to have to drain reserves.

    Government solvency is a key variable that has been ignored in this string. If the government is insolvent there is only ** one ** way it can finance itself (without forcibly restructuring), and that by printing money. I’m not sure what is meant by the government can’t default … yes it can … when the market rejects the currency and the bonds the only way the government can remain is to default … This happens routinely to other governments who are not as sound as the U.S. government (as bad as the U.S. is) and their currency is demonetized by the market.

    Capital gains in particular prevent using alternate currencies the market would likely devise as the transaction costs kill the usefulness. Capital gains tax must be higher than inflation (round trip) which is why the self-serving cry by officials is for “speculators” to be soaked during inflations. However, eliminating capital gains tax also increases transactions, so that tends to revalue a currency and leave a relief outlet preserving confidence the government will hold the currency sound.

    Shift to savings does not cause “deflation”, it is a choice by individuals not to borrow and banks not to lend because of the economic situation. What all this confused lingo means (when you parse it down) is that “we banking elite know we are going to get into trouble and we don’t like the fact that we cannot continue lending and people stop borrowing, so we invent concepts like ** saving causing economic problems ** so the government forces people to borrow and spend by stepping in and doing it for them”. Note the reverse of causality. Collapse of economies these days is caused by bad policy, not by “saving”.

    Since deposits are lent into existence and since bank liabilities are in essentials U.S. government liabilities, the access to purchasing power (not just to reserves) ends when the U.S. government is cash flow insolvent (cannot finance except to sell bonds to the central bank). Then there is a run on banks (as the government may constrain redemptions to “slow inflation” and at the same time continue it’s spending … it’s happened before). Complete breakdown.

    Lastly, money is a unique good fundamentally different from stocks. Stocks are claim to assets but not universally accepted as a medium of exchange. Money is the ultimate form of legal settlement: only reserves (cash and deposits at the Fed) qualify. However, it could be considered stock in “aggregate production”, which is how people look at it … but never stock in “the U.S. government” because the government is ultimately subservient to the market … the grasshoppers need the ants, the ants don’t need the grasshoppers.

    Any comments?

  51. JKH writes:

    Winterspeak,

    I think we’re closer.

    There are two commonly used definitions of insolvency. One is cash flow insolvency. The other is balance sheet insolvency. You’re referring to the first; me the second.

    The second matters because it’s frequently a catalyst for the first. More precisely, fears of balance sheet insolvency (negative equity), that may be based on very imperfect information and rumour, can lead to a bank run. The balance sheet, because it provides insight into the long term, is often the progenitor of these worries. Then the operational bunching of cash flow obligations can lead to the run.

    I quite agree that high debt to GDP ratios have proven to be sustainable in some cases. I also think that the current capacity for US government debt expansion is underestimated for this reason, in a comparative sense. And there is no doubt that such a capacity translates to the same capacity within your equation of deficit financing and excess private saving. It’s just a matter of how much borrowing and saving can one jam into each side of the Winterspeakian identity. To suggest that capacity is unlimited is dubious. That would be equivalent to suggesting the expansion of debt/GDP ratios is unlimited.

    The equity entry is a construct that as far as I know doesn’t exist in the real world in the sense that governments and their central banks don’t attempt to calculate or publish such calculations. The construct would be as simple as assets minus liabilities for the consolidated entity except, as you know, there has been considerable debate in the sphere as to whether central bank issued money should be categorized as a liability. I have no problem with the liability classification. Therefore, negative equity simply reflects the fact that, in this sense, liabilities exceed assets. The construction itself is informative, because it requires some facility in the manipulation of the various assets and liabilities of a central bank, challenging enough in itself, and their relationship to the government balance sheet. The notion that central bank liabilities normally act as a source of deficit financing is fundamental of course. Formal consolidation is not required to understand this, but it clarifies the nature of the relationship somewhat. The other thing it makes graphic is that the central bank balance sheet is pretty much a negative equity position on its own, apart from the degree to which it may have external assets (such as the Fed now has). Here the reason for interest becomes a little more pragmatic relative to recent sphere discussions. Willem Buiter has spilled copious amounts of ink on the subject of central bank insolvency and the requirement for government recapitalization in that event. My view is that this subject is not particularly relevant if kept outside of the context of government solvency, or combined solvency. What good is it debating central bank solvency if the parent government is insolvent according to the same type of measure? (His measure certainly involves at least an equivalent concept to negative equity.). If you were to think that the idea of equity is not a particularly interesting or useful idea for the consolidated entity, then you should think a fortiori that Buiter’s investigations are a waste of time. Another reason why the construction is useful is to highlight SRW’s theme of properly identifying government investment. Correctly classified investment may change the equity position. Therefore, to the extent these things are interesting, why not attempt to measure equity or at least be familiar with the idea? The concept certainly connects to the idea of debt/GDP ratios, in terms of measuring official sector debt exposure. It just expands the domain of interest to central bank liabilities and to the beneficial effect of any external assets held by the consolidated entity.

    But I’m not here to defend the use of the thing. I’m mostly interested in its construction (as interested as I am in the construction of debt/GDP ratios), and the various insights offered by that.

    Now I’ll make some comments on Fed operations, to which you referred here and earlier.

    First, the reason it is essential to have an overnight interbank lending market is that it enables the necessary operational function of clearing of surplus funds held by banks at the Federal Reserve. Why is it necessary that banks hold funds at the Fed? Well it is necessary that they hold funds somewhere. This is because of the following equation:

    Fed deposits + other assets = liabilities + equity

    Banks need a “place” like the Fed to sort out their net positions each day as reflected in the first term (or conversely the other three) of this equation. Any change in the first term is the inverse of the sum of changes in the other three, reflecting all changes in outstanding assets, liabilities and equity due to normal banking activity. Such a “place” is essential in allowing banks to go about their business and account for daily fluctuations in their other assets and liabilities, as well as occasional cash induced changes in their book equity. If this “place” of sorting out the effect of such changes is not the Fed, where? I’m sure there are answers in terms of offered alternatives, including those from the Austrians, but let’s assume that the Fed accepts this role for the time being.

    These positions resulting from balance sheet changes can be positive or negative for individual banks on an intra-day and end-of-day basis. Banks need to be able to trade these positions with each order in order to end up with a minimal Fed balance at the end of the day, because ending up with a significantly positive or negative balance is only evidence that they’re failing to balance their normal business flows with the private sector, which is something they should be successful at. Those that end up negative at the end of the day must borrow from the Fed. But they try to end up flat to positive, as a demonstration that they can run their businesses and balance their books by ultimately taking in any required funding from the private sector.

    So the Fed offers this funds clearing facility for asset-liability balancing.

    But it uses this facility for its own purposes as well. Because it is the monopoly provider of the pot of funds available for banks to clear, it is the price setter for those funds. And because it is the price setter, and because it controls the size of the pot, it can set the price where it wants (apart from marginal pricing inefficiency due to short term operational frictions). So the Fed effectively controls the fed funds rate, and therefore can set a target for it.

    The fact is that the fed funds rate is the normal anchor for monetary policy. All of the stuff relating to easing and tightening is just marginal activity in support of setting the price. This all assumes the Fed is operating in the normal zone of interest rates, comfortably above the zero bound.

    This normality is currently not the case. The Fed has run out of room on conventional monetary policy via Fed funds easing. So it has moved on to quantitative easing (expansion of excess bank reserves) and qualitative or credit easing (shifting from government to private sector assets).

    One of the reasons the Fed wanted to implement payment of interest on bank reserves is that it facilitates quantitative easing when interest rates are above the zero bound. This is because the rate of interest paid on reserves sets a notional floor for the funds rate and the Fed no longer has to worry for the same reason about tightening up on excess reserves for the purpose of controlling the funds rate. Excess reserves are the primary conduit for quantitative easing. The Fed has removed the major constraint their introduction might otherwise introduce for monetary policy, which is the unintended consequence of easing up on the policy rate. Ironically, at the same time the Fed
    was concerned about implementing the payment of interest on reserves, it was well advanced toward its ultimate destination of the zero bound for the funds rate, at which time the floor becomes the zero bound and the payment of interest on reserves becomes moot. (It’s just amazing how efficiently the Fed responded with this change and a host of other operational changes in a financial environment of such turmoil.) There was an issue regarding the effective control the Fed had over the funds rate following its implementation of interest payments on bank reserves, as it was heading toward the zero bound for rates. This however was due to some operational complications which will probably not be an issue for the future.

    The overnight market is essential to the process by which the private sector clears its obligations each day. It couldn’t be replaced simply by discount window borrowing because this would imply a one-way ticket toward an unlimited increase in the size of bank balance sheets. If banks didn’t clear surpluses with each other, and funded their deficits exclusively from the Fed, the result will be a bloated horror monster in terms of the gross size of the system balance sheet.

    Paying interest on reserves should certainly simplify the process by which the Fed controls the overnight interest rate range, particularly down the road when we get back to positive policy rates. And it allows them much more flexibility in terms of quantitative reserve adjustments, for whatever reason, that don’t necessarily relate directly to the issue of the funds rate per se.

    Required reserves are pretty much eliminated already. The fact that the requirement is even positive is mathematically irrelevant. The locus of rate control depends not on the required level of reserves, but on the differential between actual reserves and required reserves. The Fed could run a zero requirement and control the rate using the actual differential against that requirement. You’ve already noted that Canada has been operating without reserve requirements for years.

    I’ve had only a brief look at Mosler’s stuff. One thing I immediately liked was his clear understanding of the fundamental deception that’s involved in the textbook story of “fractional reserve banking”. He knows the conventional wisdom on this is exactly backwards. It’s the first time I’ve seen this thought elsewhere, as it was a conclusion I came to years ago. He has some extensions of the same idea as it applies to current account deficits, which I agree with as well. I think your idea of Winterspeakian net savings is another one that he refers to one way or another. All of these ideas have to do with understanding the points at which the financial system is subject to macro closure, and where macro relationships are inverse to micro.

    Returning to your original theme, you say:

    “My point in all of this was that, the Government must run a deficit so the private sector can save. This deficit can be financed or not, and I 100% agree that not financing it would reflect a dramatic deviation from past monetary policy. It would reflect a less dramatic deviation from current monetary policy, which is decidedly funky. Whether this deficit (financed or not) triggers inflation depends on how much of it flows into private savings (bank accounts — low velocity) or private consumption and investment (transaction — high velocity). Yes, it all lives in bank accounts, but some of it is chasing goods and services, and some of it is not. If money isn’t transacting, it isn’t counted in GDP or CPI, nor does it finance bank loans. Lots of low velocity money can let the Government run very large deficits without having any impact on inflation.”

    We’re on the cusp of broad agreement throughout here.

    There is no question that the government must run a deficit in order for the private sector to save in the sense you’ve defined it (emphasis on the last six words).

    You’ve defined private sector saving in the sense of excess saving. This is an identity, in the following sense:

    S + T = I + G

    S – I = G – T

    So the government must run a deficit to satisfy the private sector’s desire for excess saving, defined as S – I.

    This is certainly a way in which the private sector can satisfy its demand for excess saving and for government assets.

    I just think we need to be a little careful in saying that the government does not need to borrow to spend. I’m not sure that’s the best expression of the symbiotic relationship between private saving and government borrowing that you want to convey.

    I agree generally with what you’ve said about bank account money, velocity, and inflation.

  52. winterspeak writes:

    JKH: Another excellent response, thank you. As per the usual, it will take me five readings to digest it all, but I can comment on the solvency note you open with. I will return to the Federal reserve in a later comment.

    OK, so when you talk about “insolvency” you do mean “negative equity” after all. You say that this is important in that it can trigger the more traditional definition of insolvency, which is cash flow insolvency. Fine.

    My point is that currency issuers can *never* be cashflow insolvent so long as their liabilities are denominated in the currency they can issue, float freely against other currencies, and are non-convertible (so not on a gold standard). They can *always* inflate to meet their payments, in the same way American Airlines can always create enough frequent flier miles to meet any call on AA frequent flier miles, or a bowling alley can “create” enough points to award to successful bowlers, no matter how many world champions happen to show up one Wednesday night.

    The currency issuer may choose not to make a payment, but this choice is available to them even if they have positive equity. You can always choose to default. But, if you are a currency issuer you never *have* to default, the way current users — the rest of us — do.

    Willem Buiter writing on this subject, as well as Martin Wolfs, and a whole host of others, is simply wrong because they do not distinguish between a currency issuer and a currency user. This is certainly true to the extent that a CB is, in fact, a combined G/CB entity.

    This is not to say that a G/CB inflating its way out of debt payments is painless. It will probably result in extremely high CPI increases, will very negatively impact trade deficits (in that they may become surpluses) and the terms of trade will certainly move decidedly against them. For must-have commodity imports, like oil, it will be a very painful and dramatically lower the real wealth of the country. BUT they will not have defaulted, or be insolvent in the cash flow sense. And if you can never be insolvent in the cash flow sense, why does it matter if you are insolvent in the equity sense?

    A final point re: solvency, which segues into my thoughts on your federal reserve operations (which I will post on after more thinking).

    If the equity entity is, in some way, the sum of period Federal deficits (and I’m not at all sure it is) then I will go so far as to say that equity *MUST* be negative, and trying to make it less negative, or worse, positive, is a disaster for the economy of the country. But I am not there yet as I don’t know how to think of this entry.

  53. Flaneur writes:

    A naive question: is this an academic discussion, or is there some practical application of this Mosler “paradigm” to our political economy?

    How practical is a “paradigm” that proscribes counter-cyclical application of fiscal policy? ( It’s one thing to require Congress to defecit spend to balance a rising savings preference; its quite another to expect Congress to cut spending/raise taxes when that savings preference wains. Ain’t gonna happen.)

    How are the practical limitations of fiscal policy are accomodated into this paradigm? Tangentially, isn’t this paradigm dependent on reserve currency status (the ability to issue debt in our own currency)? Wouldn’t loss of that status–a shift in the savings preference to another currency–render the paradigm self-limiting at best, inflationary at worst?

  54. winterspeak writes:

    FLANEUR: This is an academic discussion in that none of us have any influence in policy spheres.

    The most practical application of the “paradigm” is that, when consumers delever, that money will either come from aggregate demand or from the Federal deficit. If you want to maintain AD, then you must increase the Federal deficit. It turns the deficit from an evil that should be shrunk, or at least balanced, into a counterweight that needs to balance the private demand for savings, else you see the economy spill into inflation (if G-T is too high) or deflation (if G-T is too low). In this sense, it makes fiscal policy equivalent to monetary policy by showing how Government spending impacts money supply.

    This has immediate and dramatic practical implications.

    I agree that the mechanisms for fiscal policy now are lousy, but this is at least in part that no one understands how Federal deficits must equal the private demand for savings. The US didn’t always have an independent CB either for managing interest rates.

    The paradigm still holds if an economy moves to a mixed currency (as many countries already are). It just means lower demand to save your currency. If you don’t run smaller deficits, then yes, this will trigger CPI.

  55. JIMB writes:

    Winterspeak – The demand for savings is for the existence of real goods and not for “currency”.

    Look at it this way. The gov has been printing tons of tickets and now people get to the stadium and they don’t have a seat. If there’s high leverage based on the existence of seats, it’s a collapse of the ticket pyramid…

    The ponzi scheme (borrowing from your future income means I can sell out of my borrowing from my future) is in the process of collapse.

    It’s too bad to see so many people fooled by money illusion, which this most certainly is.

  56. JKH writes:

    Winterspeak,

    Your fundamental point above makes sense.

    Again, however, I would view it as an operational point. It reflects the fact that there is no operational constraint to central bank monetization of government debt (including the monetization of compound interest). There is a strategic constraint which we know as monetary policy.

    “And if you can never be insolvent in the cash flow sense, why does it matter if you are insolvent in the equity sense?”

    It matters because the process of precluding cash flow insolvency through monetization is inflationary, and potentially hyper-inflationary, when pursued to the limit of aggression. To the degree that the measure of equity insolvency (or balance sheet insolvency, as it’s sometimes called) indicates the cumulative extent of a central bank’s “evasive action” in monetizing its cash flow obligations, it is a useful warning signal. It’s an in-depth gut-check of a developing problem for inflation and currency depreciation. For this purpose, the problem is not the existence of insolvency per se, but the degree of insolvency.

    That said, I realize that fiat monetization is standard practice in the context of controlled growth of the central bank balance sheet. To one of your points, it is inevitable that the CB makes a negative equity contribution when considered on its own, if it is financing G through the purchase of G debt. Interestingly, and very ironically, recent Fed purchases of private sector debt are “diluting” its rate of negative equity contribution to the consolidated entity, because its marginal asset additions are now external rather than internal. These assets, notwithstanding Armageddon projections for their eventual values, still make positive gross contributions to equity in comparison to the internal purchase of government debt.

    It is also more usual than not, it seems, that the G entity on its own functions as a negative equity entity. The question is to what degree is this advisable. (This reminds me that a friend of mine once pursued a PHD investigating the idea of an optimal level of government debt, which he certainly thought wasn’t zero. (He didn’t finish it)).

    I suspect as well that none of our fiscal or monetary authorities would really appreciate advertisements of their organizations as insolvent entities. I think that’s why I started out sticking mostly to the term “negative equity”, as an expression of remote empathy.

    (I’ve always thought that the equity or balance sheet interpretation in using the term “insolvency” was more the standard than the cash flow one. Doesn’t really matter, provided we know what we’re talking about.)

    By the way, I don’t consider myself to be writing anything in defence of Mosler or his “paradigm.” That isn’t to take anything away from his rare and brilliant comprehension of operational wiring in the macro banking system. But I don’t know enough about the policy prescriptions he infers to make a judgement about them one way or the other. So my responses to you here really have nothing to do with Mosler. And while I noted that your basic point on private savings seems as if it might be connected to his view, I have no idea to what extent this is the case. That’s your turf.

    Addendum:

    My earlier reference to “the textbook story of fractional reserve banking” should have referred instead to “the textbook story of the money multiplier”.

  57. JKH,

    Fascinating discussion, though it is making my brain hurt! I agree with you about the usefulness of a consolidated public sector balance sheet, but not that taxation represents an equity purchase. I would say that taxes are more like a charge for government services, and that public sector equity is simply a gift of citizenship. Some people – eg those born handicapped – never pay a penny in tax but live their entire lives on the dividends paid by their equity inheritance. You are, however, right to say that the ultimate source of shareholders’ funds is taxation, in the same way that a business grows shareholder’s funds from revenue.

    On another point, I would also question your rejection of the textbook multiplier idea. I agree that money creation may be initiated by banks lending, but it seems to me that banks do so in the knowledge that, even if only for prudential reasons (as opposed to a reserve requirement), they will have to hold a certain amount of additional central bank liabilities to cover typical withdrawals, even if only as till money. The multiplier is therefore determined by the bank’s cost of obtaining the additional central bank money it requires to support the new deposits. If the central bank makes it cheaper to obtain central bank money, the banks will expand lending and draw base money up to the point that it is no longer profitable to do so, hence a multiplier-like channel from base to deposit money. No?

  58. winterspeak writes:

    JKH: OK, I’m ready to continue.

    —“That would be equivalent to suggesting the expansion of debt/GDP ratios is unlimited.”

    It has a limit that’s set by the sovereign’s ability to tax. Remember, the point of taxation is not to enable the sovereign to spend, but to create demand for the currency in the first place. A sovereign with no ability to tax is not really a sovereign at all, and we would expect to see that currency vanish. Any debt denominated in that currency would go to 0. debt/GDP would go to 0.

    If you had a weak sovereign who could tax, but people had not desire to save any more in that currency than they had to to meet the tax, and converted to something else as soon as they could, would not be able to run a deficit or carry much debt.

    Y = G + I + C

    would collapse to

    Y = G

    as I and C would be in some other unit of specie. SRW hopes that eliminating WPS would lead to greater (and smarter) I but he will be disappointed. This experiment has been done and the result is cans of tuna stashed under the mattress.

    Moreover, G could only be as high as T so as to not trigger inflation. G=T. G-T=NPS=0. Although, at this point, inflation may be the least of their worries.

    debt/GDP would equal 0/G. T = G. Any increase in G would trigger inflation, devaluing the currency further.

    —Equity

    I’ve been thinking further about the equity construct. Standard financial articulation goes income statement => retained earnings => equity, and straight G/CB cash (which is easiest to understand) is clearly negative, and I struggle to come up with an income statement based on a negative CF statement that is also anything other than negative. This means retained earnings by decrease (become negative) which would argue strongly for equity to be negative.

    This is not to say that equity MUST be equal to, or even proportional to, total outstanding Government debt, but it does suggest that i) equity must be negative, and ii) the question is whether the negative equity is sufficiently large to balance the demand for NPS without triggering inflation or deflation.

    Again, I struggle with the notion of a consolidated balance sheet for a currency issuer. Entitlement spending will increase in the future. G will increase then too. G can tax more, or run a higher deficit to meet those liabilities. Whether G runs on overdraft at the CB or issues debt does not matter in the sense than G’s SS checks will not bounce. There is a *very real* question about how much that SS check will buy the recipient (inflation) but whether that check will be written, and whether it will clear is not in question.

    I think the above example highlights how “future generations will pay for our consumption today” just is not true. The populace today will get to consume what it produces today. Fiscal and monetary changes re-distribute who gets what, but this distribution is *inter-temporal*. The only *intra-temporal* transfer has to do with capital stocks, and that does not so much shift consumption as reduce future productivity.

    —Federal reserve operations

    Again, thank you for your patience and clarity in this section.

    I understand why we need a Fed. I understand why we want to know whether banks are able to raise funding successfully from the private sector.

    I still don’t understand why we need banks to trade reserves with one another, or why the Fed should set short term interest rate through open market operations targeting the FFR.

    I understand your point about the discount window providing a (potentially) unlimited ability for the banks to increase their balance sheets, but couldn’t we control that with capital requirements? We could also set the discount rate high, and it would be a hurdle banks would need to clear when they lend. Banks would also be constrained by credit worthiness of borrowers. Ideally that should be their primary concern — they should be focused on competing to make loans that they think will be paid back.

    —Mosler

    Yes. What SRW is called “winterspeakian” net savings, Mosler and L. Randall Wray calls Net private savings. I wish we could simply use that term, as the idea is certainly not original to me. Mosler and Wray seem as able to move beyond their own circle of acolytes as the Austrians, so I’m simply trying to help translate between the various camps. They all have some good ideas.

    —Does the Govt need to borrow in order to spend?

    “I just think we need to be a little careful in saying that the government does not need to borrow to spend. I’m not sure that’s the best expression of the symbiotic relationship between private saving and government borrowing that you want to convey.”

    This is the part I’m having most trouble with. I’m very confident that it’s possible. I’m pretty sure that it’s been done. I also acknowledge that it isn’t how things are usually done, but I’m not sure to what degree there are critical operational reasons to do this, and to what degree it’s just legacy. There are many things rattling around in the US financial system that make no sense, and seem to have been forged in some ragged compromise between tired gold bugs and weary fiatists. FRB is one example, FDIC tapping out at $100K is (was) another, no FDIC on MM funds is a third, MM funds at all! is a fourth, etc.

    It is routine to see CB open market operations at the short end of the yield curve, and we have seen, and are seeing now, CB open market operations at the long end of the yield curve designed explicitly to manage rates. It is a short move from manipulating Q to set P, to just setting P(%) directly and letting Q fall where it may. This severs the tie between CB debt issuance and overdraft at the CB on G’s account. I’m sure it feels as momentous to us as first FDR, and then Nixon moving us off the Gold Standard seemed in the 30s, and then the 70s.

  59. winterspeak writes:

    JKH:

    — “It matters because the process of precluding cash flow insolvency through monetization is inflationary, and potentially hyper-inflationary, when pursued to the limit of aggression.”

    *Absolutely*. And I would say that that limit is determined by the local population’s desire to hold that currency in savings. A local population that trades out of the local specie as fast as possible has an extremely limited ability to monetize without triggering hyperinflation. A local population that wants to hold lots of specie enables a large degree of monetization without triggering inflation. This local population can change its mind too, so the same amount of monetization can trigger or not trigger inflation depending on what demand for NPS was at the time.

    “it is a useful warning signal. It’s an in-depth gut-check of a developing problem for inflation and currency depreciation. For this purpose, the problem is not the existence of insolvency per se, but the degree of insolvency.”

    Maybe, but only if you think about this in the context of people’s desire to save.

    Look at right now for example. Many smart people thought that the dramatic increase in the Fed’s balance sheet would trigger inflation. Certainly it would have had it happened 5 years ago. But demand for WPS in dollars is so high, we have an extra $T in Fed reserves, open swap lines with foreign central banks, and still we see deflation.

    This is why I don’t like the term “solvent” or “negative equity”. Yes, they are correct as defined, but I don’t think they give us the right intuition.

    Certainly, those short the $ used those words a lot over the past 12 months and they’ve been spanked. They did not bank on the greater demand for the specie which made the massive Fed BS expansion *insufficient* to avoid deflation.

    — (I’ve always thought that the equity or balance sheet interpretation in using the term “insolvency” was more the standard than the cash flow one. Doesn’t really matter, provided we know what we’re talking about.)

    I’ve had the same issue, and usually they walk hand in hand so it does not matter. But for the Government, or General M otors (which I guess now is part of the Government) the distinction breaks down. When a country has a floating fx, non-convertible currency it swaps default risk for inflation risk.

    RebelEconomist: I know this was directly at JKH, so maybe consider this a test for me?

    Taxes are best thought of as a way to generate and maintain demand for currency, which Government spending then creates. It is not a fee for service, and could be levied with nothing given in exchange and simple punishment for non-compliance.

    “public sector equity is simply a gift of citizenship.”

    Sorry, I had to laugh at this, because it’s negative! Maybe that *is* the gift of citizenship, a gift that keeps on giving ; )

    “You are, however, right to say that the ultimate source of shareholders’ funds is taxation, in the same way that a business grows shareholder’s funds from revenue.”

    Nope. The ultimate source of $ is the Govt. Taxation destroys/uncreates money (or if you prefer JKHs term, flows money into this negative equity blob that then spits it out again). Government spends to give us the money we need to pay taxes, buy stuff, and save. It taxes to reduce aggregate demand and control inflation. And redistribute wealth, of course.

    “If the central bank makes it cheaper to obtain central bank money, the banks will expand lending and draw base money up to the point that it is no longer profitable to do so, hence a multiplier-like channel from base to deposit money. No?”

    No. Banks make loans they think will be paid back, and in making those loans create deposits at other banks. They are not constrained by reserve requirements, as they can always borrow the reserves they need through the interbank market, or at the Fed discount window.

  60. Winterspeak,

    There were taxes long before fiat currency existed. Fortunately, we have moved on since kings taxed mainly for their own consumption. Because the relationship between payment and service is loose, society collectively agrees that taxation is legally enforced.

    It is hard to say what the value of citizens’ equity is, because, unlike certain benefits, future taxes are not contracted. However, since citizens can avoid negative equity by emigrating, I suggest that mass emigration would be a sign that citizens’ equity is seen as negative (eg Zimbabwe).

    Of course a bank expects to be repaid when it lends, but it will factor in some probability of default into its costs, along with the cost of obtaining more base money before it makes a loan. I am not saying that the multiplier is a hard constraint.

  61. JKH writes:

    Winterspeak,

    Your 4:43:

    Taxation creates demand for the currency.

    Demand for the currency (and by the transitive property, taxation) allows the sovereign to do the following:

    a) issue the currency via the CB

    b) finance expenditure via monetization

    c) finance expenditure via taxation

    Income statement:

    Revenue T

    Expense G

    Retained Earnings T – G (positive or negative)

    “Whether G runs on overdraft at the CB or issues debt does not matter in the sense than G’s SS checks will not bounce.”

    Winterspeak – please come in from the cold, and join me on this! It does matter. Overdrafts are equivalent to CB credit. CB credit is monetized. Money is only one liability class in the liability mix of GCB. Money (i.e. money of zero maturity) has a different inflation implication than a 10 year bond. The fact that G checks don’t bounce is an operational issue. The non-operational question is what monetary policy will a responsible GCB follow? Will it monetize by default, or will it issue debt as part of a responsible liability diversification program, thereby sterilizing the irresponsible counterfactual of monetization by default?

    Banks must be able to trade reserves with each other. If there is no facility for surplus banks to sell their surplus positions, then deficit banks must borrow from the fed every day. Therefore, every daily deficit position becomes a permanent increase in the size of the banking system. It’s simply a non-operational, dysfunctional architecture for a payments system. Capital constraints would have no effect on this, because capital constraints don’t preclude a built-in daily liquidity dysfunction such as this.

    “I’m very confident that it’s possible.”

    It’s only possible via CB overdraft, which I’ve addressed above.

  62. JKH writes:

    Rebel,

    Textbook:

    Bank deposit expansion is a function of the level of reserves.

    JKH:

    The central bank automatically (for the system as a whole) supplies the level of reserves required by statute according to the level of deposits.

    (The CB may supply a negative excess reserve setting occasionally when in tightening mode, but that’s a minor detail.)

    I like to differentiate between central bank deposits and vault cash when talking about this kind of reserve. Banks manage their vault cash like inventory. Any inventory model would prescribe some sort of optimal quantity as a function of the size of the deposit and customer base, etc. But I don’t think this is a big deal in terms of the multiplier issue.

  63. JKH writes:

    Winterspeak,

    “flows money into this negative equity blob that then spits it out again”

    Love it!

    I look forward to seeing this language, when I read Geitner’s first annual report on the operations of the consolidated Treasury/Fed, including negative equity highlights.

  64. JKH writes:

    Rebel,

    Have you had a chance to look at any of Buiter’s work on central bank solvency? If so, any thoughts on its validity?

  65. winterspeak writes:

    JKH 6.30pm: Add “winterspeak” to the JKH explanation.

    JKH 6.12pm:

    —“Overdrafts are equivalent to CB credit. CB credit is monetized. The non-operational question is what monetary policy will a responsible GCB follow?”

    I’m trying to come in from the cold here — honest!

    Is your point that CB will not monetize because it’s _irresponsible_ to do so (even though it technically can)?

    And I presume you’re arguing that the reason it’s irresponsible is because CB monetizing is inflationary, while a simple sterilization through a debt issue is not (or, at least, less so).

    Is that right?

    Is CB monetizing debt equally inflationary if demand for NPS is rapidly increasing?

    Suppose NPS demand is flat, but the GCB decides to monetize debt, and control inflation through fiscally reducing AD (lower G, higher T). Would that be responsible?

    You know my answers here. I want to see if we’re on the same page.

    — Fed operations

    I see your point about there needing to be a mechanism to for banks to sell surplus positions. OK, I am won over.

  66. JKH writes:

    Winterspeak 6:50

    Is your point that CB will not monetize because it’s irresponsible to do so (even though it technically can)?

    YES!

    And I presume you’re arguing that the reason it’s irresponsible is because CB monetizing is inflationary, while a simple sterilization through a debt issue is not (or, at least, less so).

    YES!

    Is CB monetizing debt equally inflationary if demand for NPS is rapidly increasing?

    TRICKY!

    I’m not entirely comfortable yet with the motivation for NPS demand. I see the identity of NPS with the deficit, but I’m not sure about translating that identity to NPS demand per se. The mechanism to satisfy this presumed demand is fiscal policy. Note that there is also a monetary policy mechanism that doesn’t involve monetization of the deficit. That is what the Fed is doing now. Quantitative easing is intermediating private sector credit to private sector bank deposits. Bank deposits aren’t public debt, but they’re close to it. Quantitative easing is a balance sheet transaction that probably has little or no effect on current saving or the propensity for current saving. It’s transforming existing assets that represent the result of prior saving. I find it easier to see tangible evidence of demand there than in the case of NPS for some reason. I’m not sure why. NPS demand is a flow or income (including current saving) demand, while the Fed’s quantitative easing is a stock or balance sheet demand.

    “Suppose NPS demand is flat, but the GCB decides to monetize debt, and control inflation through fiscally reducing AD (lower G, higher T). Would that be responsible?”

    This seems like an unwieldy combination, particularly given that I’m having difficulty with the motivation for NPS demand. Fiscal tightening wouldn’t be responsible in today’s environment, but I’m not sure that’s the question.

  67. JKH writes:

    Winterspeak,

    I’m out for the evening.

    Pleased to resume tomorrow, as you like.

  68. JKH,

    Yes, I did read Buiter’s cepr paper “Can central banks go broke” and some of its references a year or so ago. I think we have moved on from that now though, in that central banks and governments are cooperating increasingly closely so that the solvency of the consolidated public sector becomes the key issue.

    Let’s abstract from the issue of what form of base money banks hold (currency and current account balances at the central bank are exchangeable on demand anyway). For some reason, be it regulatory or prudential (inventory management), a bank needs to hold a certain percentage of its demand deposits in base money. This has a cost depending on the short term interest rate. If the central bank conducted monetary policy by fixing the supply of base money, then the causation would run clearly from base money to deposits, because when the central bank supplied more base money, the cost of expanding deposits would fall (because the base money requirement is cheaper) so deposits would be expanded. But money supply and the short term interest rate are just two sides of the same coin. It looks like reserves follow deposits because the central bank sets interest rates not base money supply, but remember that the interest rate was set, through an economic model, so that the amount of money supplied is consistent with price stability.

  69. winterspeak writes:

    JKH: Relatives are flying into town, but I’m learning a lot and enjoying the discussion, so let’s keep going if you’re up for it. We’re both allowed a leisurely weekend though.

    OK, so we’re agreed that CB monetization, while possible, is irresponsible because it’s inflationary and sterilization through debt is so easy.

    We might part ways on whether the potential for inflation matters in an environment which is strongly deflationary, both because of reduced velocity, and capital writedowns. We may part ways even further on whether *not* monetizing in this environment is irresponsible, but I’m not going to push it.

    —Motivation for NPS demand

    I was surprised to see that you had a question about this, as it’s the most intuitive part of the construct for me.

    I interpret the identity as saying that the private sector spends some money on consumption with other private sector actors (high velocity, shows up as C, is a net wash in terms of size of money supply), the private sector invests some money with other private sector actors (high velocity, shows up as I, is a net wash in terms of size of money supply–and yes I know separating C and I can be hard), pays some taxes to the Government (T, reduces aggregate demand, shrinks money supply). The residual after all of this is NPS, and it’s the money that sits under the mattress, or in checking accounts.

    Since this money is not transacting it does not show up in Y, and it is effectively taken out of the money supply in the sense that (by definition) it is not available for I or C. This is shown most clearly in that an increase in NPS does not increase CPI, and you would expect increases in money supply to do so.

    The motivation for people to save more (or, if you prefer, spend and invest less) I think is straightforward. They may see fewer good investment opportunities, they may want “insurance” in case of a job loss, they may postpone purchases of things like houses because they see better prices in the future, etc. Similarly, business may decide to build a warchest instead of expand forseeing declines in AD.

    Fiscal policy is the mechanism to address this if you *want to keep AD constant*. If you’re OK with letting AD fall, people can save by just transacting less. Because of built in stabalizers (tax collection falls with unemployment, spending increases, deficits rise) you end up getting the “right” fiscal policy anyway to support AD, but it’s at the cost of employment.

    And yes, there are monetary mechanisms to deal with this also, but they act very indirectly, and right now I believe are counterproductive. Consumers want to save more and don’t want to take out additional loans. A low FFR, even if that did translate into lower borrowing costs for consumers (which it is not doing right now) does not help them delever, which is entirely the point. Moreover, it takes out interest income, which reduces AD. This is why I think helping the banking sector is useless to the economy at large because banks are pro-cyclical, and they will fix themselves once households are done delevering, have the (higher) level of NPS they demand, and are ready to spend and invest again. The goal of fiscal should be getting here as fast as possible.

    (I will also add that the line between fiscal and monetary blurs. How would you classify paying interest on reserves at the Fed?)

    I also agree that QE is essentially disintermediating the intermediation that the banking sector usually does. Fed’s stepping in where banks will not, most obviously in the mortgage sector where they are the only game in town. It is having a clear impact on that sector, transactions, particularly refis would be much lower if they did not, but fundamentally it is not satisfying the current demand for NPS nor is it lowering that demand. Why should it? It isn’t helping households delever.

    We’ve spent some time looking at a G/CB balance sheet, so maybe we should look at a HH balance sheet. Right now, many have negative equity, or are levered too high for comfort (certainly in a deflationary environment which is increasing the real cost of their debt). They want to manage their income statement to increase their equity, which means increasing cash on hand/retiring debt. The easiest, least distortive entry to hit on that balance sheet is the payroll tax liability. Paul Krugman/Obama/NYTimes sees households taking that money and delevering as being a “waste” which is why they oppose tax cuts. They do not see that HHs simply want to return to the traditional level of leverage on their balance sheets, and are not interested in accelerating that process.

    Higher G is a very roundabout way to accelerate HH delevering, so roundabout that it actually does not work at all. NPS will increase by unemployment driving the natural stabilizers of unemployment benefits and lower taxes.

    RebelEconomist: “so that the amount of money supplied is consistent with price stability.”

    Or not, right? I’m sure deflation of 3% was not what the Fed could call “price stability.”

    Velocity is critically important when thinking about how the size of the monetary base impacts prices. As V slows down (NPS increases) AD falls through fewer transactions, lower prices, or both. This is true even if M is constant. If V slows down a lot, you can increase M pretty dramatically and still not see it hit CPI.

    People believe that savings (NPS) drives investment because money in a bank is leant out. This is simply wrong, deposits do not create loans, loans create deposits. This, I believe, is the point JKH was making by “central bank automatically (for the system as a whole) supplies the level of reserves required”.

    Once you see that deposits do not drive loans (investment/consumption), but instead essentially take money out of supply (or simply lower velocity) you understand how the Fed taking on debt is a solution to an over-indebted private sector.

    And if you’re really bold you see why the Fed *must* run persistent deficits so the private sector has the money it needs to save. You will also see why the coming entitlement Tsunami is highly stimulative. Hang onto your hats.

    And if you are completely off your rocker, you believe that any “equity” residual on a Government’s balance sheet must be negative, with the only question being about its size. You also believe that the concept of “central bank insolvency” is wrong, because inflation does not equal default.

  70. Wow. I’m going to try to be more concise than usual, but I’ll probably fail.

    Rebel — “central banks and governments are cooperating increasingly closely so that the solvency of the consolidated public sector becomes the key issue.”

    I think that’s a brilliant, often overlooked point. We are finding (and it wasn’t clear before the crisis) that we have a semi-global monetary system managed by collaborating central banks. Not all countries are included — bye Iceland! — but the entity referred to here as “GCB” is clearly something more complicated than the US Treasury and Fed. While we’re consolidating entities as thought experiments, it might be worth consolidating several central banks and governments together, and consider their options and combined balance sheet. Imagine a confederation of states that each issued and taxed different currencies, but that are interchangeable at rates determined (or at least constrained) by a common, rather unruly, and not necessarily elected parliament. The parliamentarians’ loyalties are divided between their domestic constituencies and the umbrella organization which confers upon them a certain authority and status. (The parliamentarians reconcile any conflict with the belief that continued smooth functioning of the umbrella organization is essential to their domestic constitiences, despite its unpopularity.) This is not “world government” — the confederation is too loose and the parliamentarians to fractious for that to be accurate — but it is not independence or ordinary economic interdependence through trade. It is something else. But it does have a balance sheet, per the discussion above, and must manage currency issuance and taxation, both in level and distribution, in a manner that avoids various breakdowns.

  71. Benign Brodwicz writes:

    The problem is distributional, which no one talks about, preferring algebra. Why has our distribution become so much more unequal, including the current obscene disparities? Because we let it.

    What we’re seeing is the plutocracy in action, taking what it wants, bending the rules willy nilly, and fogging many minds with pseudo-science, just like the investment bankers and rating agencies did.

    If we had a society that adhered to a standard of fairness (FD: I believe there’s a hard-wired preference for a certain degree of which that we’ve left far behind) we wouldn’t be in this mess.

    Many people are living lawfully, and a plutocratic minority is taking advantage of them, and that can only go on so long.

    Will America fracture or cohere? Time will tell.

  72. Winterspeak — I want to defend my honor a bit against tuna cans. I don’t think the stock of “Winterspeakian savings” should be forced to zero. I agree that this would have adverse, tuna-canly consequences. So long as we have a single asset payments system, the stock of “WPS” must at least be sufficient to accommodate transactional balances. When the stock is much larger than that, though, I think it is corrosive of aggregate investment quality. As a policy matter, I’m not opposed to accommodating the sudden demand for WPS, but that demand is itself a pathology we ought to have strived to avoid. (Avoiding that would have required preventing the dollar-denominated leverage that the household sector has now taken on.) Enabling HH deleveraging by increasing the stock of WPS transfers a liability from the household sector to the “GCB”. As you point out, a USD liability has different meaning for the GCB than for households, and operationally the GCB can extinguish any burden just by maturity-transforming the stock of WPS to zero. But as JKH emphasizes, and I think he’s persuaded you, the GCB faces important constraints: there are things that it can do that would gravely harm other important state objectives.

    I’m very opposed to eliding the distinction between “Winterspeakian savings” and more general savings, regardless of Mosler’s definitions. To the degree that “savings” is viewed as a social good, it ought to be the kind of savings that is likely to translate to useful current investment. Ideally, when households have healthy balance sheets, government should be cautious about expanding WPS unless it has available high value projects in which to invest. Those who wish to “save” default-free claims on currency should have to accept low or potentially negative real returns. When the government expands WPS without investing in high value projects and at the same time commits to price stability, it is vulnerable to being forced to tax (or reneg on the price stability commitment) if there is a shift from long-term to short maturity WPS and savers become spenders. GCB has to manage the stock of WPS strategically to avoid bad outcomes. Forcing the government to borrow, when the government lacks investment opportunities but the private sector has them, is forcing “malinvestment”, and socializing its cost. If no one has investment opportunities, consumption will have to rise, and better it be private consumption privately paid for by whoever is most willing to consume than a government rent transfer.

    Savings, Winterspeakian or otherwise, is normatively good when it’s attached to useful investment. Otherwise, it’s either rent-transfer or a means of often traumatically dispersing the costs of private consumption. (I’ll concede a role for vary cautious consumption smoothing schemes, where the risk of nonrepayment is close to zero.)

  73. Re infinity, it’s worth noting that the state’s ability to produce infinite cash does not invalidate a balance sheet analysis. You just have to redenominate the balance sheet in something other than the print-at-will currency. In theory, there is a maximum wealth associated with the time series of real goods or services a seignorage maximizing central bank could purchase by printing. Printing more quickly than the seignorage maximizing rate leads to a lower value (to the sovereign, hopefully evaluated via some “wise” social utility function) of wealth acquired, net of any redemptions that may be forced. So you could write a balance sheet, treating the cash printed as some kind of preferred equity and the value of the maximal seignorage purchase as an asset that balances it. In this way, the power to print does generate positive equity for the sovereign, but not an infinite quantity.

  74. winterspeak writes:

    SRW: Prepare to defend your honor!

    — Central bank coordination

    When you see how velocity and NPS links monetary policy and fiscal policy, it’s obvious to see the connections between G and CB. There is no distinction between fiscal and monetary policy at the edges. It’s best to think of them as a combined entity.

    If you want to see the international dollar denominated hegemony in action, just trace out the unsecured swap lines the Fed opened a few months ago. It’s basically a pipe of dollars sent to foreigners. If Congress understood what was happening, they would split a gut. Also, it’s not surprise that the swap to the EU was unlimited, but Mexico was capped at $30B (or so). There’s your global conspiracy in black and white.

    — Cans of fish

    While I’m sure you do not want to reduce people to hoarding cans of durable, but unpalatable fish, that would be the consequence of running a zero deficit.

    The stock on NPS should not support transactions, it should support hoarding above and beyond transactions. Transactions are a wash in the private sector, you need extra money if people want to hoard more (or less money if people want to hoard less).

    I’ve switched from “saving” to “hoarding” to remove any moral value that the term “saving” has. I come to praise savings, not to bury etc. etc.

    JKH has convinced me on interbank lending, but monetizing CB debt remains… tricky. This may be the 21st Century’s equivalent to coming off the gold standard. And that worked out just fine, didn’t it?

    The NPS identity separates savings that is a social good by calling that investment (“I”). You also have consumption (“C”). NPS is pure hoarding, and it does no good but it also does not harm. I’m fine with NPS being low or slightly negative return, but I do warn you that if the returns get too low they may exit to try to achieve yield elsewhere. We’ve seen where that leads to.

    In some ways, SRW, and you only just made the think of this, the stability and safety of NPS may improve the yield of I (and reduce unintended C). If you’re secure in your store of wealth, then investment needs to be actually worthwhile and thought out, instead of just a desperate attempt to keep your head above water.

    GCB definitely has to manage the WPS stock — or rather, it has to manage its deficit so that equals WPS stock. Think of the required target WPS stock to be the budget constraint that binds G, and forces it to prioritize. Also note that good investments, resulting in more productive capital stock, increases the real amount of G available.

    NPS is *always* disconnected from investment. Let’s just call it hoarding. This disconnection is also why increases in the deficit, if they meet demand for NPS, don’t crowd out private investment (pace Fama). It’s also why they support AD (pace Krugman).

    — Balance sheet

    I still struggle with this. Maybe it is right to denominate the GCB balance sheet in something other than their local specie, but the whole job of the GCB is to manage this responsibly!

  75. Winterspeak — I’m afraid I have no honor to defend.

    I don’t disagree very much.

    Re balance sheet: If somewhere I gave the impression that I did not think consolidating G and CB to be useful, and even for some purposes (a la Rebel E) G and CB of multiple countries, then I misspoke. It’s also sometimes useful to consider them separately, but that’s conventional and hides a lot of insight. I’m very much with you on thinking consolidated.

    Re Cans of fish: Again we’re converging. As soon as you surrender the Mom and Apple Pie word “savings” and replace it with the gently negatively connoted “hoarding”, I’m glad to move aside. As a policy matter, I think gov’t clams at a transactional level is an ideal (e.g. money as means of exchange and store of value), and perhaps even one step too far, since I think government spending that is investment can be funded as investment without much trouble as long as they are valued cautiously. I don’t advocate never accomodating “hoarding”, just discouraging it, by for example letting the price of government claims rise so that returns are near zero. As you say, to a first approximation someone wanting and the government generating claims looks neither helpful or harmful. A deeper analysis looks at the dynamics, and I stand by my story above, gov’t claims that offer real returns while reducing future wealth are actively harmful. But I’ll also acknowledge your point, that the availability of gov’t claims serves as a form of risk management that may promote useful activity and help people forego foolish risks. However, like any insurance or risk management scheme it must be well managed, or pooled risk becomes shared catastrophe. If everyone sheds risk and no one finds good projects, then the insurance company goes bust one way or another, and the sense of safety turns out to have been false and dangerous. Also, foolish risks in search of yield would not have led us to where we are had the risks not been perceived as and (ex post) actually guaranteed by the state. The trouble wasn’t foolish risk-taking per se, but “safe investing” that was actually foolish risk-taking in disguise. So I’ll concede the sometimes usefulness of letting people shed risk in order to enable useful activity, and that money claims have sometimes managed to serve the purpose, but argue that money claims have been abused in this role so frequently (every banking crisis) that we would be better off finding other ways of insuring lower-tail risk (such as traditional safety nets, or better yet a not-means-tested flat transfers amounting to a modest income).

    Anyway, I hope I have thoroughly dishonored myself, without too much besmirching you (unless you enjoy a good besmirching, that is).

  76. Benign — Good point. Distributional issues and the algebra are not unrelated. An increase in the demand for cash or claims against the government (money savings, hoarding, whatever) is not exogenous. It arises when people without consumption needs or investment ideas have a lot of wealth, while those who would prefer to consume or invest than to hold money claims lack wealth. Tax and transfer schemes can reduce the aggregate desire for money. The algebra of the capital letters takes distribution for granted, but the numbers behind those capital letters change if the distribution of wealth and income changes.

  77. JKH writes:

    Rebel,

    “central banks and governments are cooperating increasingly closely so that the solvency of the consolidated public sector becomes the key issue.”

    I presumed you meant central banks and their own governments, which is what I was trying to write about for 2 days.

    Did you actually mean to refer to solvency of the globally consolidated public sector?

    I.e. the sum of all national GCB’s?

    The solvency of all that?

    I suppose if you did, it makes it all the more worthwhile to figure it out at the national level also.

    It’s a brilliant point either way. You can’t lose.

  78. JKH writes:

    Winterspeak,

    I think we want to take a weekend break, but let me just record this first:

    “We might part ways on whether the potential for inflation matters in an environment which is strongly deflationary, both because of reduced velocity, and capital writedowns. We may part ways even further on whether *not* monetizing in this environment is irresponsible, but I’m not going to push it.”

    Don’t misunderstand me here. I’ve been writing mostly in generic rather than current environment terms, and mostly in monetary policy terms, not paying a whole lot of attention to fiscal policy yet (and certainly not all of that in global terms). I don’t see us disagreeing on this at all. And what you’ve written broadly makes sense. Sorry to waste your time thinking I need a basic lesson in fiscal policy (or, silly me, maybe I do).

    In terms of fiscal policy, and in the current environment, I can certainly see your case for NPS demand. One way to think about it is that fiscal policy stimulus is a response to the paradox of thrift, and issuing government debt is a parallel response to thrift itself in the form of heightened NPS demand. So I see NPS in the normal cyclical context of countercyclical fiscal policy and its natural response to NPS. NPS is now high because people are backing off in economic terms, wanting to save rather than spend. So I think we’re in synch there. Correct me if I’m wrong on that.

    I didn’t completely follow your discussion on C, I, T, and money, but I don’t think it matters, if we’re agreed on the above interpretation. What we know for sure is that G has the potential to create money but T plus (G – T) in bonds reverses that. But I think we’re now in synch on the NPS intuition in any event.

    P.S. I suspect you would agree that algebra, along with accounting, is not the enemy.

  79. No, I meant the public sector within each country. Actually, I have wondered why the Fed needs to swap at all with the likes of Japan, Korea, the ECB etc. I am sure these countries have more than enough dollar reserves to sell US securities or pledge them as collateral to raise dollars, rather than using their own currency. It is interesting that reserves are supposed to be kept liquid for use, and yet when a need arises, every non-US government prefers to raise extra dollars by borrowing them against their own currency (on swap) from the Fed.

  80. JKH writes:

    Rebel,

    Thanks for clarifying.

    SRW’s interpretation is a challenging call to the national analysis, but I think we need to work up to the mountain peak in steps.

    By the way, I saw your comment at Buiter’s latest. This was very ironic. As mentioned earlier, I’d only taken the time to work my way through your PRAT analysis about a week ago. It’s something you must have spent a reasonable amount of time on, and you’ve had it out there for quite a while. I don’t recall seeing exactly the same idea anywhere else. I actually thought of you right away when I read the seventh paragraph of Buiter’s article two days ago. If I were in your position, I’d be fairly miffed as well at the lack of attribution. Oh well, drive on.

  81. winterspeak writes:

    JKH: I’m on weekend break, but still very much interested in continuing.

    Thank you all for your patience, good humor, and wisdom.

  82. Thanks for your support, JKH. Actually, I am beginning to form an idea that the privileged position of a limited number of established opinion formers (like Willem Buiter) is one reason for the mess we have got in. The media tends to consult the people they already know and (in the UK at least) it is common for directors to sit on several company boards. One result is that some useful ideas go unheard, and another is that the privileged are in such demand that they are unable to consider issues in enough detail and with sufficient rigour. Hopefully the blogosphere can provide a more democratic outlet, providing that people do not overwhelm it with verbose, sloppy and unselective contributions. The writing on Interfluidity tends to be good, so it is worth reading.

  83. JIMB writes:

    Steve – I don’t get the usefulness of the paradigm — just what does this add to our understanding of investments, banking, policy, and their effects? What are the limits to policy? Where do we get into trouble? The real hard hitting stuff seems to be missing … Wish I could have explored that here a few times with Winterspeak.

  84. Steve Roth writes:

    Your concluding paragraph is much in keeping with James Livingston’s ideas re: the Great Depression and now.

    Pre-crash scenario:

    Wages declined as a percentage of GDP. Aggregate demand dried up. (Maintained temporarily by borrowing/leverage.)

    Profits increased by the same measure. But because of insufficient demand, there were not enough truly productive investments available. We all know the rest.

    (My) Solution:

    European-level progressive taxation, redistribution, and social programs to maintain aggregate demand and keep the log rolling.

    Haven’t seen any global meltdowns coming from that quarter, and life is really good over there.

    Major bonus: that social platform/springboard means you can adopt far more draconian (and efficient) trade and labor practices without the Dickensian effects.

  85. Incidentally, was just catching up on my reading o’er at Brad Setser’s, and it occurs to me there’s a pretty obvious connection between “global imbalances” and the Winterspeakian savings debate.

    One way to think about what happened this decade is that China, sometimes Japan, and the petrostates dramatically increased their desire to Winterspeak-save US dollars. In my view, it was a (big) mistake that we accommodated this in part by expanding the government deficit. But in Bernanke’s original “global savings glut” speech, he made the point outright that growing the US deficit served an important purpose in helping to balance supply and demand.

    The growth in Winterspeakian savings by foreign central banks is a good example of why I think the practice of holding unallocated “safe” instruments is hazardous and should be discouraged. If we consolidate the government and “core banking sector”, and consider AAA+ securities reputationally attached to core banks, we can view the entire credit boom as the result of accommodating a worldwide expansion in the desire for such instruments. (Mortgage-derived securities are obviously allocated, but from buyers’ perspective AAA+ structures were deemed substitutable, investors were not expressing an opinion on the US housing market by purchasing mortgage derived AAA structures.) If you buy this (admittedly a bit stretched) view of what went down, you can see exactly the downside of Winterspeakian public savings I’ve been carping about: the “investor” community poured into unallocated savings, which meant that the funds were supplied without investor discipline, which meant that much of the money flowed to poor projects and consumption-masquerading-as-investment, which has now implied that the government/core-banking-system may be forced to extract transfers from those who didn’t participate in the savings orgy or permit inflation in order to make good on quasigovernment claims that resulted from accomodating the desire for unallocated savings.

    (I know that so far it’s been deflationary, and monetized transfers that are not inflationary are not exactly transfers. But they are transfers from an opportunity cost perspective — a Federal bailout of AIG that didn’t provoke inflation suggests that there may have been other ways the same money might have been printed and used without provoking inflation. Moreover, the transfers thus far have been less than inflationary thus far because they have been issued in far-from-cash instruments, i.e. in contingent liabilities. Should a substantial fraction of the $8T+ of commitments and contingent liabilities be turned to cash, I think the choice between taxation and inflation will become quite obvious. (Financial markets are already, suddenly catching whiffs of inflation, check out what’s happened to treasury spreads and gold over the lats two weeks.)

    Anyway, I know that the analogy is imperfect, but broadly I think the trouble with Winterspeakian savings is precisely the trouble with global imbalances. Savers expect to redeem their savings with a certain nominal return, while the parties they fund fail to endow future wealth well enough to grow real output much faster than the nominal return promised, which means that the public (or public/banking) sector is likely to either to inflate or to transfer wealth from workers and information-worker investors to “savers” who frankly deserve their losses.

  86. JIMB — I think the framework Winterspeak has evolved is useful for getting past the details of fiscal and monetary policy, and understand in broad outline what we can expect given the overall shape of government response. For investors, it bears directly on the inflation/deflation debate, and is important in thinking about the tradeoffs we can expect between say taxation and inflation.

  87. BTW, I think an interesting question in all this is hysteresis &mdash: We know a government (GCB-banking system) can expand claims issuance to accomodate an increase in Winterspeakian savings, but contraction of that demand may be a bitch. In a way, so far we’ve had it easy, because a contraction in appetite for implicitly guaranteed “savings” assets has been matched by an increase in the appetite for explicitly guaranteed claims on currency. We had a great expansion in global USD savings. In the crisis, we’ve not as much seen a change of demand in quantity as a shift in composition within the broad category of quasipublic money claims, which we should be able to accomodate by expanding the deficit.

    But if there is a downward shift in demand for quasipublic money claims overall, the mechanics of accomodating that might be much more nettlesome.

    G-T=Y-C-I-T doesn’t look like it discriminates between the signs of changes, but in reality governments prefer to expand deficits than to reduce them.

  88. Ravi writes:

    The reason I disagree with Winterspeak on a payroll-tax holiday is that I think “government solvency” concerns matter. I agree that, formally speaking, the US Government effectively can’t (or won’t) default on its debt, nominally speaking. But when this crisis is over (whenever that is), the debt overhang could easily be large enough that an “inflation default” is inevitable. And since that is a likely possibility, policy today has to consider more than the immediate crisis – it has to consider the situation when the crisis is resolved. And when the crisis is resolved, the US and the US government (and the world in general) will be better off if the US economy is as large and productive as possible. I think there’s general consensus on that.

    Where I think there isn’t consensus is what policy will achieve the best possible economy when the crisis is over. I think there are plenty of productive, high-return projects for the government to invest in (infrastructure, education, public goods, etc.). I also think that we’ve learned that directly funding current US consumption (the way that overseas demand did and the way a payroll-tax holiday would) *isn’t* a terribly productive project. Given those opinions, I think that large government spending is the preferred form of stimulus, even if it isn’t ideally timed and even given the significant governmental and political inefficiencies we have to deal with. I think basing our response to this crisis purely on tax cuts is just more-of-the-same. We’d still be funding our lifestyle based on unsustainable debt without any plan to fix the situation. The only difference is that it would be public rather than private debt picking up the tab – so the mechanism of default would look different. The reality of default (and the negative effects associated with it) wouldn’t really change.

  89. Lord writes:

    Yes, people want to deleverage, but I am not sure enabling them to do so is not encouraging panic and further deleveraging. Transferring debt from people to the government can be done but it weakens the ability to control inflation, and it consumes borrowing capacity that may be better spent stimulating the economy. Considering the distributional aspects of tax cuts, I would rank them from worst to best, income tax rates, payroll taxes, rebates, to SRW flat checks to everyone. Last year’s rebates were not that stimulative and going from fixed to flat would be even less so as even more would be saved (used to deleverage). The reason for spending is an attempt to increase V by insuring it is spent (at least once). Now we could use tax cuts, but they would likely have to be significantly larger for the same impact. There are a lot of hazards though. How many jobs of which type will be created? Will the result be useful and by how much? How quickly can it be done? My preferred deleveraging is default which will leave the government with it one way or another combined with moderate inflation to pay it off.

  90. Greg writes:

    This is the best piece I’ve read in a while. Now I’ll have to read it a few more times to really comprehend it, but my initial thoughts are that given this interesting view of taxation and government deficits it seems we need to go as big as possible with the stimulus package, not in an effort to return to some previous circa 2005 state, but to really give private savings a real smorgasboard of things to choose from. We obviously need new things to do with our money and the only institution with the ability to go as big as they want is the “gubmint”. It seems you (or Winterspeak more accurately) are suggesting the bigger the feds go the more the private savings increase, so lets go real big.

  91. winterspeak writes:

    I do not know if this thread is over — it may be! — but let me add a few responses. Depending on interest after that, I’m happy to give others the final word.

    RebelEconomist: I love PRAT

    SRW: I think we can both continue with our heads held high. I’m fine with “hoarding” instead of “saving” if that helps you distinguish NPS from real investment (which it is not). You may also want to call it “low animal spirits” to quantify a very real phenomenon.

    Also, your global imbalance point is exactly correct. The US is blessed with NPS demand for dollars from *abroad*. As I mentioned before, people think the Chinese are “financing” the US deficit. They are exactly wrong, the US is *funding* the Chinese demand for NPS. Suckers. Your position that the US is getting the worst of that deal is incorrect (although concerns about oil are very real. High energy costs will materially worsen the terms of trade for the US).

    I continue to advocate for savings and investment to be split. Bad investment decisions do not mean that savings are bad, or should be discouraged. I also don’t think “savers” are getting bailed out at all. If you’re a net saver, you want to return to the time of the ten cent hamburger. Yet ZIRP has taken away all your interest income, and every Government on earth is moving heaven and earth to keep CPI from falling and sustaining AD. The opp cost savers have bourn is massive. (This means I agree with your CPI analysis of AIG et al btw.)

    If you’re talking about corporate bondholders, then yes, they are getting bailed out, but buying CP is not saving — certainly not in a WPS sense. WPS is limited to owning Government instruments, or FDIC accounts (which I think are exactly equivalent to Government instruments, JKH may think otherwise).

    Finally, yes, demand for NPS can decrease as well as increase. If it decreases, the deficit must come down. In inflexibility of fiscal policy (compared to monetary policy) is a major problem, and I see that being what is screwing the economy now, and will continue to screw it in the future. Payroll tax holiday is the most flexible fiscal measure I know, which is why I promote it.

    JKH: I think we will simply have to part ways over whether “insolvency” is meaningful for a sovereign. I see it as being obviously true that a sovereign can always meet any debt obligation so long as it is in their specie, and they have a non-convertible, floating fx currency.

    I’m sure you agree that the above is technically true, but have real operational and consequential concerns. I hear those concerns, but believe that they are in the final analysis, immaterial. I simply reject “inflation” as being a synonym for “default”, so I don’t think we can make any headway here.

    This extends into my discomfort with the balance sheet analysis that you presented (but not to balance sheet analysis in general!) The concept of “equity” you describe gets the intuitions all wrong for me. Equity should be positive, and the more positive, the better. But GCB equity *must* be negative, the question being — is it negative enough? So mechanically we are in agreement, but overall I think this muddles the issue as it gets the intuitions I think are most important (government deficit funds private savings) backwards.

    I agree that it’s useful to have gut checks, but I think a better gut check it: how does US debt compare to the desire to hoard $? That would lead us to the right conclusion in Japan, the right conclusion in the US for 2008, and is a good guide through 2009 and beyond. Those short $ have been spanked because they did not factor in NPS.

    Finally, I must also reject the concept of paying taxes as being “buying equity” in the sovereign. Ironically, I think the balance sheet frame is the right one here. Taxes represent a liability on the HH balance sheet, and a receivable asset on the GCB balance sheet. When taxes are paid, the liability cancels, the receivable cancels, the deposit liability at the bank is decreased, and the private balance sheet shrinks overall. There is a straightforward interpretation of this: extinguishing money (or “uncreating money”) which is exactly how to think of any asset/liability pairing being fulfilled. Taxes “uncreate” money.

    I don’t mean to be all negative, I’ve learned a great deal from our dialogue and I think, overall, we agree on more than we disagree! Perhaps in this final note I’m just highlighting areas of continued disagreement (which is fine), and I want to apologize for the confrontational tone. Overall I hear more harmony than discord.

    One final point to ponder: The usual reason the GCB issues debt is to drain excess reserves from the Federal Reserve and thus enable a positive (non zero) overnight FFR. If the GCB monetizes debt and lets G carry an overdraft, excess reserves remain in the system and you have no bid, so a zero FFR.

    In a situation where the FFR *pays interest on reserves* in order to *create a zero bid*, does letting G carry an overdraft *increase* inflationary pressure further? You already have that zero FFR anchor acting across the yield curve…

  92. JIMB writes:

    Steve – We end up right back where we started. Higher taxes relative to spending means lower bond sales and vice versa so that AD is maintained steady, else under deficit spending rates go to zero and inflation soars. The theory predicts a budget constraint just as “solid” as the (presumably) incorrect theory of taxing to obtain revenue.

    But even that is counterfactual. Raising taxes impedes production and given government spending remains roughly the same, that is excess AD (not deficiency of AD) … the data seem counter to the theory.

    In my view, the whole point of economics is trade in goods / services, not a cycle of exchanging money. But anyway, perhaps it will show it’s usefulness some other time.

  93. curt writes:

    I like the discussions so far. There seems to be a good understanding of money=debt. Both from the way the G/CB creates money, and also from how the commerical banks create money. There seems to be an understanding that from one agent to have savings, another agent must be a borrower. Borrowing creates savings. Or to put it more clearly, borrowing creates claims on another agent’s production. Savings, and all other forms of financial wealth, are simply different versions of claims on another agent’s production. Fiat currency is the same. A G/CB prints fiat currency, which the agents under the G/CB’s dominion accept for the sole reason that the G/CB’s monopoly on violence ensures that the taxes can only be paid to the G/CB with the same fiat currency. An agent has a self preservation reason to hold some ‘savings’ of the G/CB. For those agents outside of the G/CB’s dominion, there is no reason to hold the G/CB’s fiat currency, except if it can be considered as claim on the future production of the population of those who operate under the dominion of the G/CB. For the G/CB to incentivise external agents to hold fiat currency, the G/CB must ensure that the claims on future production that it creates by printing fiat currency are do not become too many on the static future production. That is, think of currency as an unsecured claim that can be devalued (quasi-default) if too many claims are created on a fixed amount of future production. This is all that inflation is.

    So, the next question is..what makes future production valuable or not. Well, it’s only valuable if other agents are willing to sacrifice their own future production in exchange for it. That is, are other agents willing to borrow to buy your production? If so, then economic growth is possible under the debt=money system. There must be someone somewhere who is borrowing to support the whole system. And for that borrower to pay off her debts, she must be able to find yet another borrower to keep the process rolling. Debt=money systems absolutely require an ever expanding debt bubble. The trouble is that a infinite system like this does not work well in a fininte real world. There is a limit to how much debt can be created as there is a limit to population. And more importantly, there is a limit to how much future production agents are willing to sacrifice (become debt slaves). That limit at it’s logical extreme is that agents have finite lifespans. However, the limit is reached much sooner as agents tend to balance debt-slavery against material well being.

  94. JKH writes:

    Winterspeak,

    Thanks for the discussion. It was very worthwhile and enjoyable from my perspective.

    GCB negative equity is an analytical construct that I was careful not to push too hard as the precise equivalent of “insolvency”. As far as that’s concerned, I pointed out there are two different definitions or modes of insolvency, only one of which is focused on balance sheet condition.

    I’m convinced that the idea of GCB equity is a rational concept at the level of flows. Canada has run sizeable budget surpluses for years. Growth in the Bank of Canada monetary base subtracted only marginally from this. The government sector as a whole saved. That’s a positive equity contribution by any definition. The extension of this flow result to a stock or balance sheet representation is analytically trivial.

    Sometimes it’s instructive to lean on an unpopular or awkward analytical idea to see what pushback it generates. With this one, I’m by no means convinced that it’s absolutely the right way to look at things at the macro level. But I didn’t see the arguments that would convince me otherwise. I’m still looking for them. In a world where fresh and saltwater economists are embroiled in debating what seem to be the very rudiments of economy theory, I feel quite at ease in pushing the concept of the balance sheet.

    The world has changed with the payment of interest on Fed reserves.

    SRW – thanks once more for hosting a great blog, with immensely thought provoking posts.

  95. winterspeak writes:

    JKH: Hear hear re: freshwater and saltwater economists!

    Very interesting point about Canada — I did not know that. I’m now intrigued and will look into it further.

    Thank you for a great discussion. Glad to hear that you also think the Fed paying interest on reserves is a big a deal.

    SRW: You are a gracious host.

  96. Aw, shucks. Thanks all for the incredible conversation.

  97. wizard1073 writes:

    I have been following this with great interest, being a small businessman and an amateur economist. I want to make one correction to your balance sheet construct:

    Seigniorage is an additional revenue when currency is printed. When government debt is sold and the currency is afterward destroyed (ostensibly to prevent inflation), seigniorage is an expense. In this way, there is no need for the currency issuer (the government) to have an infinite cash position on the balance sheet.

    What I am not certain of, however, is how the government should account for net seigniorage. It is in fact the gross amount of that government’s currency in the world.

  98. Jonathan writes:

    Money is not in “fixed supply.” This is all great and grand theorizing, including some nice abuse of game theory, but if the government really wants to inflate, they can inflate. Maybe you should look at history, instead of breathlessly applauding bloggers’ homespun economic theories.

  99. baduin writes:

    I think that the discussion would benefit from one important distinction.

    There are actually TWO different equations about Savings and Investment.

    One equation describes money, the second real economy.

    The important point is that the majority of textbook economic equations describe the real economy, not money!

    Moreover, the equations applying to money can be very different depending on the KIND of money. Pure gold currency with fixed amount of gold follows very different rules from bank-based economy, with most of the “money” originating as debt.

    In other words, Savings=Investments applies ONLY to real economy, NOT to money economy. In real economy, according to textbook terms, “Investments” are the totality of goods which are not consumed. Obviously, the amount of investments is the same thing as savings.

    In real economy, but using this time nontechnical terms, “investments” are goods which are set aside in order to produce other goods in future (eg machines, factories). “Hoarding” are goods which are not consumed, but will be consumed in the future (unsold cars). Those two, very different categories, make up technical “investments”.

    But the classical equation does not apply to money economy. It is very much possible to “save” money without investing it. If you keep your money under mattress, you save it, but you do not invest it. Of course, in the real economy the (real, not money) savings DO equal investments. For example, with fiat money, the fact that citizens tend to keep money under the mattress can be used by the government to issue extra money without causing inflation, and to either invest, or consume the equivalent amount of real goods.

    With the gold backed currency the money economy will be different – and even here we have two different variant, depending whether we have fraction-reserve banking or eg no banking or full-reserve banking. The simplest case will be that the increased amount of savings causes fall in demand, and the increased amount of unsold goods – which technically count as “investment”. Or, if the entepreneurs foresee the increased future demand, they can use the increased supply of labor and decrease present demand for consumption goods to increase real investments. Of course, we want the second situation, not the first.

    This shows that for any situation we need two different equations: one for real economy, the second for money economy.

    The attempts to solve problems with one equation using eg “inflation-adjusted dollars” which should describe both aspects of the economy WILL NOT work. For one thing, it is impossible to “adjust” dollars for inflation in any mathematically consistent way. Even if one manages to do it – approximately, of course – the resulting equations will not describe money economy (which uses not-adjusted dollars) nor real economy (the real goods change value in quite different ways than “inflation adjusted” dollars).

    This separation has an additional benefit: it makes clear the difference between ends and means. The “money economy” is the “steering” part. It has no value per itself, it exists only to direct “real economy”. It is a free-market equivalent of the Soviet Gosplan, hopefully better designed.

    The key part is “traction”. Money economy normally can direct real economy, but in certain situations, when the trust in money fails, it loses its influence. You can still pull levers, but the strings are mixed or broken, and there is little or no response. That linking elements between money and real economy is trust.

    Finally, the money economy when it malfunctions can destroy real economy, but it never can rapidly improve real economy. The present economic problems are caused by insufficient production of goods in real economy. This, together with earlier excesses, caused the collapse in the money economy.

    At present, even the best possible reform of money economy, which will gain the full trust of the population, cannot rapidly improve things – the underlying real problems won’t allow it. Any improvement will require “supply-side” reforms in the real economy. On the other hand, of course, the failure of the money economy will lead to the stoppage in the real economy.

  100. wh writes:

    winterspeak:

    I think you’ll make faster-and-deeper progress if you adopt the following program.

    Firstly: buy a book or three on graph theory, a book or three on operations research, and a book of three on social network analysis. Read them until you understand them well enough to apply their intellectual tools.

    Secondly: spend some time playing around with models of a zero-sum monetary economy as a network; each node has a private hoard of money (which can never go negative), and nodes can send other nodes money over “links” (the edges in your network).

    For realism you’ll want the patterns of monetary flows across this network to resemble the patterns of monetary flows in real-world economies, but you don’t need anything more than that — you’re modeling the mechanics of a zero-sum monetary economy, and for the moment you’re setting aside the problems of how the monetary economy couples to the “real economy”.

    If you’ve done this realistically enough you’ll almost immediately see the problems inherent to a zero-sum monetary system with no countervailing forces: the system will lock up, or the system will operate indefinitely but the volume of circulation will dwindle to zero, or nodes will drain to zero internal money hoard.

    Once you’ve gotten this far, many of the “schools” of economics can be seen as either attempts to fix this tendency-towards-lockup (Keynesian tax-and-spend), or as attempts to explain why this lockup cannot happen due to how the monetary system couples with the real economy (Austrians in particular).

    Thirdly: having a realistic model of a zero-sum monetary system’s mechanics, you can proceed with your analysis of the “consolidated public sector” in the following fashion: add a single node (call it Z) that has the unique ability to create money, destroy money, and coerce payment.

    Z has lots of tunable parameters — under what circumstances does it create money? to whom does it distribute the money? how much? under what circumstances does it destroy money? from where? from whom does it coerce payment? using what rule? what is done with the coerced payments? — and the influence of Z on the network’s dynamics will depend heavily on how those parameters are set.

    The model I’ve suggested you build is a little too simplistic to fully capture the nuances of any real-world economy, but it’ll let you get a feel for the dynamics; the dynamics are a little complicated, but the relationship between Z’s and parameters and the rest-of-the-network’s dynamics aren’t much more complicated than something like simcity or simearth.

    The motivation behind doing this as an exercise in applied graph theory and operations research is this:

    - working in this framework, you can always recover the system aggregates (S and I and so on) with which to do algebra, so you “lose” no information

    - but, working in this framework, you can very easily build up an understanding of how the microstructure of the economy dictates distribution, and thus you can talk about distribution, too, without resorting to handwaving

  101. baduin writes:

    wh:

    Various historical economies operated on gold as money without banks and never met your problem. It seems that your model fails to resemble reality.

    Remember that models do not prove anything, they can at mostsuggest the correct solutions. It is the duty of the modeller to show how his model is applicable or why the results are different from reality.

    Back to the drawing board.

  102. RueTheDay writes:

    Sorry to come late to this party, but what is being described here is essentially Chartalism as formulated by G.F. Knapp in his 1924 book, The State Theory of Money.

  103. wh writes:

    baduin:

    The model only models a simplified monetary economy, and it’s a toy model (amongst other things: no ability to take on debt, no ability to enter into contracts, and no provision for adjusting the flows in response to eg supply-and-demand or changes in the structure of the underlying real economy).

    It’s a snapshot of the dynamics of a monetary economy (dME/dt, as it were), and is only helpful because of its simplicity.

    You’re also arguably incorrect about the historical experience, I can point you to many places where this model — as crude as it is — elucidates the underlying dynamics nicely.

    One of the simplest historical examples is Shay’s Rebellion.

    Put three nodes on the board: a node for consolidated farmers (“F”), a node for consolidated distributors (“D”), and a node for consolidated merchants (“M”).

    Next add the following links: F gets money (T_df) from distributors (in exchange for selling crops), and D gets money (T_fd) from F (F buying non-farm products from D). Likewise, M gets money from D (T_dm) (D buys goods to sell to F) and M sends money to D (T_md) in exchange for food.

    Already as modeled above we can expect problems:

    - F (the farmers) hope to see monetary profit, which requires T_df > T_fd

    - D (the distributors) hope to see monetary profit, which requires T_fd + T_md > T_df + T_dm

    - M (the merchants) hope to see monetary profit, which requires T_dm > T_md

    If we force everyone above to use the same accounting schedule, it’s impossible for F, D, and M to show simultaneous profit (assuming a fixed money supply); you can have a perpetual cycle of breaking even.

    Now, Shay’s Rebellion happens in 1787, and the economic activity whose monetary flows are sketched above had been going on since before the revolution.

    Why did Shay’s Rebellion happen in 1787, and not sooner?

    Simple: before the period leading up to Shay’s Rebellion, F, D, and M had relied on an informal credit system; if farmer John and trader Joe did regular business, they’d keep informal tabs of what each party owed the other and only settle up / withdraw “real money” when there was a specific reason to do so.

    That’s all it takes to step outside of the framework I sketched, and that’s the historical norm — within trust networks a constant extension of credit, and using hard money only when necessary (eg: when doing trade with a party outside of a given trust network).

    What leads to Shay’s Rebellion is M’s overseas customers begin to demand payment in specie (actual gold and silver).

    Due to superior market power / access to coercive force / your choice of euphemism, M is able to force D to start settling up in specie, and D is able to force F to settle in specie; that’s the pecking order.

    So, M enforces T_dm (sales to distributors) > T_md (payments to distributors) (it enforces this by paying less back out).

    D enforces T_fd + T_md > T_df + T_dm. Since we know that T_md < T_dm, this reduces to enforcing T_fd > T_df + delta.

    F gets the short end of the stick: it lacks “power” to fight against D, and it has no one to try and siphon species from, and so: F’s net change in species holding = (T_df – delta – T_fd) < 0.

    This drain can only go on for some finite interval — F only had so much hard currency to begin with, and F is growing crops, not gold nuggets, so F gets tapped out pretty quickly.

    Boom! Shay’s Rebellion (which actually happens when merchants-and-their-agents start seizing farmer’s properties to sell for specie to send overseas, but the mechanics leading up to it are correct).

    What happened here? Two things:

    - firstly, all three nodes were forced to settle up in hard currency (which, for the purposes of our historical example, could be considered as effectively in finite supply). The forced-settlement in hard currency is what made the situation blow up so quickly, because the forced-settlement made the facts on the ground more closely resemble the toy model I sketched; before the forced-settlement, trade was conducted with running tabs and informal credit lines, whose dynamics are quite different — and more sustainable — than the dynamics in the toy model.

    - secondly, one node was taking a profit, and was positioned in such a way as to be able to push the cost of that product “down the pecking order” a bit. In the case of Shay’s Rebellion the profit was shipped over seas — effectively burned or vaporized — but the short-term dynamic wouldn’t have been any different if, scrooge mcduck like, the merchants had just locked it all away in basement vaults. (Note: if the money collected had been stuck in a vault then eventually it would’ve been spent or invested or something, but that’s outside the scope of the model and it’s not what happened in this specific example).

    Obviously the F-D-M model of Shay’s Rebellion is horribly simplified, but if you take the time to read some histories you’ll find nothing has been materially misrepresented in my summary.

    Which leads me to the moral of my story and the end of my response:

    Of course my model above is unrealistic. It is, however, “true” in the a priori sense (but more rigorously so than anything the Austrians have): it’s just a specialized version of the theory of zero-sum games when you have a finite total quantity of “points”, let players keep their winnings between rounds, and have the same people keep winning; you escape that dynamic by:

    - playing another game (which is the norm historically)

    - or having different players win in each round (which the Austrians argue arises naturally from the coupling of the real and monetary economies, and which seems to happen fairly often in reality)

    And finally, I’d suggest looking more closely at your economic history.

    Firstly, you’ll find that its only very recently that much of the economy wasn’t “monetized” for all but a handful of transactions — the trend towards a “monetized” economy is really just a *fad* of the last few centuries in western europe, and before that you have to go to the Roman empire to find anything comparable in the west.

    Long-range transactions were usually settled in “gold money” or silver or whatever, as were transactions between parties with little trust for each other. Outside of major trading cities and the like, though, most economic activity wasn’t really coordinated through money and prices: plenty of peasants would go their whole lives never even *seeing* more than a handful of coins, and settling most affairs (even taxes, sometimes) with some mix of informal credit (ala rolling “tabs”) and barter (N% of their crop).

    The gold-as-money system worked fine for what it was used for, but outside of major cities — eg: trade hubs — and sovereigns, it was rarely used for coordinating much actual production.

  104. wh writes:

    Oh I forgot the moral.

    Here’s the moral:

    I don’t necessarily believe my toy model is all that helpful for understanding real-world economic activity; there are certainly points in history where it’s a useful lens — eg Shay’s Rebellion — but for most of history most of economic activity has not been coordinated using anything like the “zero sum monetary economy” I sketched.

    However, the real-world “monetary economy” CAN be studied as:

    - a monetary economy consisting of a network with a “zero sum monetary system” (a la my suggestion, this is everyone BUT the consolidated public sector)

    - a node with the power to create/destroy/coerce money flows (winterspeak’s consolidated public sector)

    This is a fact: the monetary economy can be decomposed into those two parts.

    If you want to understand the mechanics of the combined system, here’s how you do it:

    step one: study the mechanics of the zero-sum side, get a feel for how various topologies and assumptions about node behavior change outcomes

    step two: study how the mechanics of the combined system change depending on how you connect the magic node (Z) to the system and how you configure (Z) to behave

    step three: add in your-choice-of-model of the “real economy” and “your-choice-of-coupling” of the “real” and “monetary” economies, see how things change

    The austrians go step three, step one, step three again, step two; if you’re just focusing on better-understanding monetary mechanics and the range of possible system designs, you won’t lose much by leaving step three for last.

  105. baduin writes:

    “If we force everyone above to use the same accounting schedule, it’s impossible for F, D, and M to show simultaneous profit (assuming a fixed money supply); you can have a perpetual cycle of breaking even.”

    To be more precise: you can have a profit in the accounting sense, but you must spend it. The amount of capital in economy cannot increase.

    Cumulatively, there can be no profit understood as the increase in the amount of capital – in the monetary terms. We start with the assumption of fixed money supply and we come to the conclusion of the stable amount of money. This isn’t actually a surprise, and I fail to see a need for a model.

    As for Shay’s rebellion, the situation was rather simple:

    http://en.wikipedia.org/wiki/Shays%27_Rebellion

    “The financial situation boiled down to this: European war investors among others demanded payment in gold and silver; there was not enough gold and silver in the states, including Massachusetts, to pay the debts; and through the state, wealthy urban businessmen were trying to squeeze whatever assets they could get out of rural smallholders. Since the smallholders did not have the gold that the creditors demanded, everything they had was confiscated, including their homes.

    At a meeting convened by aggrieved commoners, a farmer, Plough Jogger, encapsulated the situation:

    “I have been greatly abused, have been obliged to do more than my part in the war; been loaded with class rates, town rates, province rates, Continental rates and all rates…been pulled and hauled by sheriffs, constables and collectors, and had my cattle sold for less than they were worth…The great men are going to get all we have and I think it is time for us to rise and put a stop to it, and have no more courts, nor sheriffs, nor collectors nor lawyers.”

    I do not see any explanatory benefit in your model which could add anything to our understanding of that situation. Especially as your model has no taxes, which were the source of the problem.

    Yes, if the state forces all to pay taxes in gold, but does not spend the gold, the amount of gold in the system will decrease. There will be a great deflation. Those with debts will be crushed, since their debts will effectively double or triple. You can build a pretty model to explain this, but I fail to see the need.

    Anyway, no state ever tried any setup of that kind in long term, for a simple reason – you get a rebellion each time you try. Why do you think Bernanke is printing money like mad? You do not need models to understood the effects of deflation on debts.

    And your idea of dispensing with “real economy” to study monetary system is suicidal. When you got fiat money, its value depends on one thing – the amount of trust people have in it. If you leave out the real economy, you leave out the only important part.

  106. wh writes:

    maduin: well, we’ll have to agree to disagree.

    As to whether states would be dumb enough to do this? Well, maybe not states-qua-states, but “consolidated public sectors” a la winterspeak? If you accept the Austrian theory of the business cycle — credit expansion followed by credit contraction — and accept the existence of a winterspeak-style “consolidated public sector”, what do you think happened in the great depression? What do you think is arguably happening now? For someone who’s not a part of the consolidated public sector — a currency user, as it were — what’s the difference between “gold money” and “fiat money”? The “poor old currency user” can no more increase the gold supply than they can go xerox paper money…

    Let’s leave that aside for a moment.

    We agree economic activity splits into a “real economy” and a “money economy”.

    I think we ultimately agree that the real economy is causally first, and that the dynamics of the real economy ultimately establish the nature of the coupling between the two systems (the real economy is in the driver’s seat, of course).

    We have a first point of disagreement in what we think we know of economic history. You think “gold — or other precious metals — as money worked, without encountering the problems I say it should”. I don’t disagree, but you’ll find that the use of money — in general — for anything like the nigh-universal coordination of economic activity like we have today is a modern phenomena.

    When you roll back the clock and look outside of cities, you find most transactions were barter, or on kind of rolling “balance” — possibly denominated in gold or possibly influenced by the current prices various goods fetch at market, in gold — but actual gold (or money) changing hands represents a minority of transactions recently.

    So the conclusions you can draw from history as the effectiveness of a hard currency are somewhat limited: it worked for the uses it was put to, but it didn’t work so well that even a majority of transactions saw its use as being worth the hassle (compared to barter, or just keeping a running tab).

    And we have a second point of disagreement vis-a-vis the utility of studying

    abstractions, this may be more fundamental.

    The monetary economy can be viewed as a network; this is just semantics.

    The monetary economy can be split into a set of actors that can create money and a set of actors that can’t; this is also semantics. (It could also be split into actors with positive net worth and zero or below net worth, or people with blond hair and everyone else…all semantics).

    The advantage of splitting it into the network that can create money and the network that can’t is that one half of that network — the part that is zero sum — has mechanics that are easy to understand.

    Understanding the total behavior of the network, then, is a matter of understanding the ways the other part of it — that part that creates money and destroys money — can be connected to the first network, how it can be configured to behave, and how the combined system behaves.

    You can do all this sure — does it get you anything? Who can say? Maybe it’s just nonsense abstractions and a jerk on the internet blowing smoke rings, right?

    It’s possible, as you seem to think, that the real economy is so powerfully coupled to the monetary economy that any information you glean by working through these models — if indeed there’s any at all — is confined to such a short period of time it’s practically useless, and not worth the time; you might, maybe, get a snapshot (dME/dt, as it were), but the changes in the real economy happen quickly enough — and change the behavior in the monetary economy quickly enough — that you can learn nothing from those snapshots.

    It’s also possible, though, that working in this way — building a realistic model in steps, starting from the easiest-to-understand component, then the next-easiest, then the hardest — results in a qualitative improvement in the depth of your understanding. It’s also possible that although the structure of flows in the monetary economy do change with time, they actually tend to change very slowly (most of the time), and even when they change rapidly they only rarely change in ways that substantially change the system-level dynamics (for example, a law firm switching from one paper supplier to another doesn’t have much systemic impact; moving to a paperless office might, thought).

    Hence the suggestion to winterspeak: you can go from a loose declaration like “winterspeaking net private savings = net cumulative deficits” to much more interesting statements when you switch from an aggregate view to a network dynamics view; if you go that route it’s easier to get lost, hence the suggestion for splitting into the zero-sum and non-zero sum components.

    Everything I’ve put in since then has been trying to convince you, and I suspect that’s not happening, so I’m done here with you — I might be right, you might be right, but I doubt either of us is going to convince the other. Hopefully sooner or later I’ll have a more rigorous argument to point people at, instead of trying to summarize in blog posts; these things take a long time to work through.

  107. baduin writes:

    I do not disagree with you – I do not think I opposed any of your conclusions.

    On the other hand, such simplified models do not seem to improve our understanding of the problem. Perhaps more detailed models will do that? This remains to be seen.

    But there is one factor which cannot be eliminated from any model which is to resemble the reality. In very short term, you can treat the “real economy” as fixed. The month-to-month variations in the real production are usually small enough that they can be treated as constant, independent from money economy. This of course is not true in longer term or in some moments where the trend breaks.

    But one factor is volatile enough to impact the money economy even in the short term: the perception of the future performance of the real economy. If the real economy is perceived to be poised to massively grow, even a very great infusion of credit or money will be absorbed. On the other hand, when that perception gets revised downward, the credit economy breaks down.

    Because people are really not interested in money, but in real things. When they think that increase in production will balance the increase in the amount of money, they are willing to lend. When they see that they will receive much less things for their money, they increase credit rates.

    Manipulations of money economy can create an illusion of rapid grow in the real economy. When that illusion fails, the money economy suffers. This is especially deadly for the system in which money is generated as credit. In other systems, eg classical fiat money, such failure of trust would cause increased inflation.

    Because in the credit-money system the money is not issued by any single node, but by banks in cooperation with all other economic actors (borrowers), failure of trust can lead to rapid decrease in the amount of money in the system. This of course makes paying off existing debts even more difficult, which leads to bank failures, which decreases the amount of money etc; this vicious circle goes on until all excess debt is eliminated from the system.

    This would be even beneficial, but that amounts of bankrupcies damages the real economy. All present manipulations by government are supposedly meant to prevent the disturbance in money economy from affecting the real economy.

    As you see, the whole problem is exactly at the connection between real and money economy. If you abstract the real economy, your model will be useless in understanding exactly that kind of crisis which is happening even now.

    The fact that in economic acitvity people want things, not money per se, shows why your original three actor model does not describe an practical economy. Your model would better describe three people playing poker. They do engange in a game, and the only goal in gaining money. Not surprisingly, quite often one of them ends with all the money.

    But the economy is not a zero-sum game, and people want ultimately things. If I hoard all gold I receive I will finally die from hunger. That is why hoarding of gold in an economy is not enough to keep it all out of the circulation.

    On the other hand, your model shows interesting conclusions for such things as the trade with China. China was historically interested only in gold and silver, but not in any product of the West. It was also big enough to absorb any amount of noble metals. Even during the Roman Empire there were complaints that the luxury trade for silks etc is sucking out the gold from the economic system.

  108. baduin writes:

    I do not disagree with you – I do not think I opposed any of your conclusions.

    On the other hand, such simplified models do not seem to improve our understanding of the problem. Perhaps more detailed models will do that? This remains to be seen.

    But there is one factor which cannot be eliminated from any model which is to resemble the reality. In very short term, you can treat the “real economy” as fixed. The month-to-month variations in the real production are usually small enough that they can be treated as constant, independent from money economy. This of course is not true in longer term or in some moments where the trend breaks.

    But one factor is volatile enough to impact the money economy even in the short term: the perception of the future performance of the real economy. If the real economy is perceived to be poised to massively grow, even a very great infusion of credit or money will be absorbed. On the other hand, when that perception gets revised downward, the credit economy breaks down.

    Because people are really not interested in money, but in real things. When they think that increase in production will balance the increase in the amount of money, they are willing to lend. When they see that they will receive much less things for their money, they increase credit rates.

    Manipulations of money economy can create an illusion of rapid grow in the real economy. When that illusion fails, the money economy suffers. This is especially deadly for the system in which money is generated as credit. In other systems, eg classical fiat money, such failure of trust would cause increased inflation.

    Because in the credit-money system the money is not issued by any single node, but by banks in cooperation with all other economic actors (borrowers), failure of trust can lead to rapid decrease in the amount of money in the system. This of course makes paying off existing debts even more difficult, which leads to bank failures, which decreases the amount of money etc; this vicious circle goes on until all excess debt is eliminated from the system.

    This would be even beneficial, but that amounts of bankrupcies damages the real economy. All present manipulations by government are supposedly meant to prevent the disturbance in money economy from affecting the real economy.

    As you see, the whole problem is exactly at the connection between real and money economy. If you abstract the real economy, your model will be useless in understanding exactly that kind of crisis which is happening even now.

    The fact that in economic acitvity people want things, not money per se, shows why your original three actor model does not describe an practical economy. Your model would better describe three people playing poker. They do engange in a game, and the only goal in gaining money. Not surprisingly, quite often one of them ends with all the money.

    But the economy is not a zero-sum game, and people want ultimately things. If I hoard all gold I receive I will finally die from hunger. That is why hoarding of gold in an economy is not enough to keep it all out of the circulation.

    On the other hand, your model shows interesting conclusions for such things as the trade with China. China was historically interested only in gold and silver, but not in any product of the West. It was also big enough to absorb any amount of noble metals. Even during the Roman Empire there were complaints that the luxury trade for silks etc is sucking out the gold from the economic system.

  109. baduin writes:

    I do not disagree with you – I do not think I opposed any of your conclusions.

    On the other hand, such simplified models do not seem to improve our understanding of the problem. Perhaps more detailed models will do that? This remains to be seen.

    But there is one factor which cannot be eliminated from any model which is to resemble the reality. In very short term, you can treat the “real economy” as fixed. The month-to-month variations in the real production are usually small enough that they can be treated as constant, independent from money economy. This of course is not true in longer term or in some moments where the trend breaks.

    But one factor is volatile enough to impact the money economy even in the short term: the perception of the future performance of the real economy. If the real economy is perceived to be poised to massively grow, even a very great infusion of credit or money will be absorbed. On the other hand, when that perception gets revised downward, the credit economy breaks down.

    Because people are really not interested in money, but in real things. When they think that increase in production will balance the increase in the amount of money, they are willing to lend. When they see that they will receive much less things for their money, they increase credit rates.

    Manipulations of money economy can create an illusion of rapid grow in the real economy. When that illusion fails, the money economy suffers. This is especially deadly for the system in which money is generated as credit. In other systems, eg classical fiat money, such failure of trust would cause increased inflation.

    Because in the credit-money system the money is not issued by any single node, but by banks in cooperation with all other economic actors (borrowers), failure of trust can lead to rapid decrease in the amount of money in the system. This of course makes paying off existing debts even more difficult, which leads to bank failures, which decreases the amount of money etc; this vicious circle goes on until all excess debt is eliminated from the system.

    This would be even beneficial, but that amounts of bankrupcies damages the real economy. All present manipulations by government are supposedly meant to prevent the disturbance in money economy from affecting the real economy.

    As you see, the whole problem is exactly at the connection between real and money economy. If you abstract the real economy, your model will be useless in understanding exactly that kind of crisis which is happening even now.

    The fact that in economic acitvity people want things, not money per se, shows why your original three actor model does not describe an practical economy. Your model would better describe three people playing poker. They do engange in a game, and the only goal in gaining money. Not surprisingly, quite often one of them ends with all the money.

    But the economy is not a zero-sum game, and people want ultimately things. If I hoard all gold I receive I will finally die from hunger. That is why hoarding of gold in an economy is not enough to keep it all out of the circulation.

    On the other hand, your model shows interesting conclusions for such things as the trade with China. China was historically interested only in gold and silver, but not in any product of the West. It was also big enough to absorb any amount of noble metals. Even during the Roman Empire there were complaints that the luxury trade for silks etc is sucking out the gold from the economic system.

  110. chaingangcharlie writes:

    Just wanted to say thanks to all you good people for providing a discussion that kept me rubbing my chin in almost painful thought way too long into the night.

    Having payed you with praise, I now balance the books by using my (now) earned right to hand over my 2 pence worth :

    I liked the ‘modelling’ posts towards the end there. In fact, I’m a bit surprised to find that there aren’t generally agreed pre-existing ( software ) models already around that at least are generally agreed to capture *something* of the way our incomprehensible economies work.

    Seems to me that , without such models, the only way to find out if (say) pulling monetary lever M will have the desired effect on the economy is to … pull monetary lever M. In other words, admit that the actual real world economy is it’s own simplest possible model. If that actually IS the case , I respectfully suggest we need to design a monetary system that actually is ‘modellable’, otherwise, we are like a bunch of baboons playing around with an H Bomb trying to find out how it works by real world experiment.

    The CB ? banking system we have seems (?) to be a kind of ad hoc contraption thrown together over centuries for a million different immediate reasons and the most striking thing about it – as is too too obvious from reading econ. blogs – is that *nobody seems to have any real idea how it all works * in anything but the broadest handwavingly approximate fashion.

    I mean – for eg – before you go out &spend 800 billion dollars, it might be nice to have some idea of the likely effect …

    I guess that’s more than enough from me.

    Keep up the good work, now.