About the Coming Failed Bond Auction Romney Predicts….
In a recent piece Paul Krugman highlighted this quote from Mitt Romney (via Kevin Drum) in which he expressed his concern over an impending failed government bond auction. He said:
“Romney: Yeah, it’s interesting… the former head of Goldman Sachs, John Whitehead, was also the former head of the New York Federal Reserve. And I met with him, and he said as soon as the Fed stops buying all the debt that we’re issuing—which they’ve been doing, the Fed’s buying like three-quarters of the debt that America issues. He said, once that’s over, he said we’re going to have a failed Treasury auction, interest rates are going to have to go up. We’re living in this borrowed fantasy world, where the government keeps on borrowing money. You know, we borrow this extra trillion a year, we wonder who’s loaning us the trillion? The Chinese aren’t loaning us anymore. The Russians aren’t loaning it to us anymore. So who’s giving us the trillion? And the answer is we’re just making it up.”
This is particularly interesting to me because I was reading this monstrosity of a paper (issued by the Fed, Treasury and SEC) last night on the Government securities market that explains why Romney’s comments are deeply misleading:
“the Treasury believes that the government securities market, and hence the Treasury, have benefitted from the primary dealer system. The FRBNY has required that the primary dealers make markets in all maturity sectors of Treasury securities, and that each primary dealer’s share of customer trading volume must equal at least one percent of total secondary market volume. The FRBNY also expects primary dealers to demonstrate their continued commitment to the market for Treasury securities by bidding meaningfully in all Treasury auctions. If a dealer fails to bid meaningfully in an auction, the FRBNY typically contacts that dealer to remind it of its so-called “underwriting” responsibilities.
The Treasury believes that the existence of a group of dealers with a commitment to the government securities market has been of great benefit to the Treasury. The dealers’ underwriting responsibilities have served to “backstop” Treasury auctions, considerably reducing the risk of insufficient auction cover.”
Emphasis is mine. Now, some stuff has changed since this was written in 1992, but the basic gist is the same. The US government uses the banks to procure funds. They’re required to bid at auctions and maintain a reasonable market in government securities. This creates a backstop and a form of permanent demand for government bonds. This is why, if you study just about every government bond auction, you’ll notice that the auctions go off without a hitch and are routinely oversubscribed by the Primary Dealers by 2X. You could eliminate all the other bidders and it wouldn’t matter.*
So Romney’s concerns about failed government bond auctions are misleading and proves he doesn’t fully understand the institutional design of the monetary system. This form of misunderstanding leads to unnecessary and misguided fearmongering and inevitably misinformed policy decisions. So it’s absolutely crucial that people understand this. If you don’t I would recommend reading my paper on the monetary system and if you’re really hungry for knowledge read MR’s Contingent Institutional Approach.
*As I’ve mentioned before, the only environment in which the Dealers would likely break the rules and fail to bid is in a hyperinflation when it would become intolerably unprofitable for them to own US government securities. The Fed would likely buy on the primary market (as opposed to the secondary market as they do now) and you’d have a nice little case of currency collapse on your hands. But that’s an inflation constraint. Not a solvency constraint like having an inability to fund the government. BIG DIFFERENCE.
Cullen Roche
Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.
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Cullen, do you think anyone in the government understands all of this?
Hard to be optimistic. But obviously someone in Washington gets all of this….
And yet Whitehead, who was head of both the NY Fed and a primary dealer, is clueless. While Monetary Realism may be helpful for individuals to understand, I have to say there is zero hope that the political class figure it out in our lifetimes.
Cullen, If anyone should understand all of this it would be Chairman Bernanke correct?
He was recently addressing the Committee on the Budget, U.S. House of Representatives, Washington, D.C. February 2, 2012 He said “Even the prospect of unsustainable deficits has costs, including an increased possibility of a sudden fiscal crisis. As we have seen in a number of countries recently, interest rates can soar quickly if investors lose confidence in the ability of a government to manage its fiscal policy. Although historical experience and economic theory do not indicate the exact threshold at which the perceived risks associated with the U.S. public debt would increase markedly, we can be sure that, without corrective action, our fiscal trajectory will move the nation ever closer to that point.”
He seems to suggest that we would have failed auctions when he suggests that a “sudden fiscal crisis” would occur where interest rates “soar quickly.. if investors lose confidence in the ability of a government to manage its fiscal policy”
These “investors” would be bond investors. He points us to Europe as an illustration of how this would come about.
It would seem to me that bond investors loosing confidence and hence backing away from the treasury market is of utmost concern to the Chairman.
is there free lunch ? do you believe in no limits ??
His bottomline argument still stands…we cant live off QExxx for ever. I am all for taking advantage of US monetary system…but good grief, dont abuse it. Particularly without any meaningful regulations.
Chris whalen has a nice article over at dailybail on what i am talking about
http://dailybail.com/home/chris-whalen-on-qe3-the-core-problem-is-fraud.html
http://www.senseoncents.com/2012/09/chris-whalen-on-qe3-core-problem-is-fraud-recommended/
Of course there is a limit. The limit is inflation. But that’s very different than having a solvency constraint. And no, his bottom line argument does not stand. QE doesn’t cause inflation. He totally misinterprets the limits of the system we’ve designed.
he calls it solvency crash, you call it uncontrollable-inflationary-crash. They are not same words or dont even come close in meaning. But i believe they both point to same bottom-line – crash!
my point was that, either way, these Fed Backstopping, Fed QExxx policies – all of these without fixing the underlying fraud, regulatory problems – cant fix or get our economy back. As chris whalen points out in above article.
I dont agree with your claim that the Fed or the .gov doesn’t take advantage of US monetary system. They have been doing that since greenspan years. And Ben found out gazillion ways to further use it.
You cant possibly say that the Fed or .gov(with trillions in deficit, debt etc) DID NOT take advantage of MMT underlyings of US monetary solvency or system.
They are way near the limits (i know there is no inflation yet, but you could argue it is showing up in commodities, renewed risky rental home buyings, malinvestment, leveraged trading etc.etc.).
This is what romney is arguing (he uses solvency, but i think it doesn’t matter). The system reached abusive levels/limits.
I don’t endorse the state centric views of MMT so I think you’re confusing me with other people. See here. http://pragcap.com/understanding-modern-monetary-system
Cullen,
Isnt he also badly mistaken when he says;
“the Fed’s buying like three-quarters of the debt that America issues. He said, once that’s over, he said we’re going to have a failed Treasury auction,”
…suggesting that the fed is directly buying Treasuries and not buying them from the bond markets. I suppose one could call the primary dealers “the fed” but that wouldnt be consistent with MRs efforts to be technically correct.
Yes. 100% agreed Greg. The Dealers always on-sell their inventory. I don’t buy the notion that the Fed has to buy because there is a lack of demand. Long bonds wouldn’t be at record low yields if there was no demand outside of the Fed. In fact, if you study the auctions the PD’s aren’t even buying more of the allotments than they were before QE. So even if you wanted to say the PD’s were part of the fed then this thinking would still be wrong…..
You’ve made it clear that there is a limit, and it’s inflation. What I think many of us are struggling with is how the Fed/Treasury will ease back on the throttle. Goverment spending is perceived as being too high by many politicians. Same goes for the deficit. When it’s time to slow things down, will the Fed just need to raise rates? The politicians will continue their fights over what the Federal government should spend money on, and at what level(s). I know MR is descriptive, so I’m not asking for a political comment. I’m just trying to understand the mechanics, given the involvment of Congress and the White House in spending priorities and levels. Will the politicians impede appropriate actions of the Fed?
I think the key, Steve, is understanding the dynamics of inflation and our real constraint. The debt levels are just numbers on spreadsheets. There is no magical level at which we become screwed. As Japan has proven, an autonomous currency issuer can run extremely high levels of public debt without having inflation. So the kicker is understanding inflation and the govt should always be concerned about price stability and not solvency.
Thanks for the Chris Whalen links. I’m a big fan of his w/ regard to banking stuff… and I agree 100% with him regarding the fraud (and with his admiration for William K. Black). I don’t think, however, as Chris does, that fixing the fraud problem is all that’s required to get us out of this. I think the private debt levels have to fall down from their current 250% levels to something more like 100% of GDP. People are not going to start seriously spending again until they feel secure in their ability to pay down their debts. Just my opinion!
I also don’t agree with Whalen characterizing QE3 as “socialist Keynesiansim cooked up by Obama appointees at the Fed.” First off, Bernanke has overwhelming control of what the Fed does, and he is a Republican Bush appointee! He may have been re-appointed by Obama, but to say he’s an “Obama appointee” is somewhat misleading. Also, given that the right-wing school of “Market Monetarists” are pretty pleased (though not entirely) with QE3 because it takes a step in the direction of what they suggest ought to be done, I think they’d be a bit offended to read from Chris that it amounts to “socialist Keynesianism.” Especially in light of the fact that MMers view themselves as the true “free market” successors to Milton Friedman and his neo-classical neo-liberal Chicago School of thought.
Anyway, I posted links to each other’s pieces on Whalen and MM sites in an effort to stir up trouble (^:
This is where understanding a touch of MMT/MR is critical. Once you have the proper mental framework, the ‘low growth/high deficit’ aka Japanese style bond rally doesn’t seem bewildering, only inevitable.
Good work PragCap- you and others been all over this one
Does the Bank of Japan have a similar arrangement that would make a failed auction similarly unlikely?
I am not sure what they call it, but yes, they’ve spent the last 20 years developing a system that is very similar.
Cullen, I thought you may have had a comment about all this silliness over how China is going to launch a financial attack on Japan by selling bonds!
They could launch a financial attack by buying Yen and selling Dollars. It will drive up the value of Yen and make Japanese exports less competitive.
If I was Japan in this case I would print an equal amount of Yen and buy USD driving down the YEN and by happen chance lowering the USD.
Depreciating two currencies at once? Um, no, you depreciate one and appreciate the other. Supply and demand.
You’re missing the point that the Japanese government can create as much supply as they like.
I missed nothing. Print Yen, buy USD – Yen goes down, USD goes up.
Just like China has been doing the past 2 decades and Brazil is also now committed to.
I suspect they’re targeting the Euro, too. Just not being quite as loud-mouthed about it. (Or maybe the Eurozone doesn’t have enough economy bloggers looking into it.)
Then when Chinese stop buying all those yen, what will happen to their new and presumably massive yen holdings? The market will almost immediately devalue them of course. Meanwhile, by selling dollars, they appreciate their own currency, which is not what they want to do.
One could, I suppose, make the argument that huge Chinese losses from an ill-considered yen play would then ultimately put downward pressure on their own currency, but the reality is that the comments coming out of China about attacking Japan’s bond markets or currency valuation actually highlight the relative immaturity of some Chinese officials when it comes to understanding the difference between the possible versus the impossible, or even the downright nutty.
According to a report issued by Bank of America, by 2014 the Fed’s balance sheet will be greater than $5 trillion, or 30 percent of projected US GDP, and will comprise of 33 percent of the entire mortgage market and 65 percent of Treasuries with a maturity greater than 5 years.
The fed and the us gov are the same guy! Whether the debt is on the gov books as a treasury or on the Feds books as interest paying reserves doesn’t matter
They’re not “the same guy” even though the Fed’s liabilities are technically the govts. They’re very specific and different entities due to institutional design so blurring the lines between them is deceptive and confuses people about why these entities exist in the form they do. It’s important to understand the institutional structure. The Fed serves the banks primarily, not the govt (even though the fed is designed to partially serve public purpose). The entire Fed system is designed to preserve private competitive banking and create a buffer between the govt creating money and the private banks who create money. The Fed and Tsy have a symbiotic relationship in that they’re very close to one another, but make no mistake – the Fed has no choice but to to serve the banks. It’s practically a conflict of interest because the banks exist to serve private purpose and the govt exists to serve public purpose. But then you have the Fed who sits in the middle getting tugged by both sides. But since the Fed can only transact business through the banking system it ends up basically forced to serve the banks over the govt. That’s the only way monetary policy can really work after all – by ensuring a healthy banking system. And as we all know now, a healthy banking system doesn’t always mean public purpose is being served best….
Cullen what happens in a scenario say 8 years out – yes its theoretical but lets say we are stuck in a Japan like environment of low growth and the Fed’s mandate of fighting unemployment is facing the reality that the U.S. has fundamentally changed in the fact our multi nationals outsourced many jobs that are never coming back and automation continues to eat at others. Hence the U.S. is stuck at a natural 7-8%+ unemployment rate and hence the Fed will QE all that time. Again in theory. Let’s say annual deficits drop from $1.2T to say $700B a year or pick a number.
As these converge the Fed, by perpetual QE, will own much/most of the UST market, by most I say in 8 years a huge portion of the UST and also MBS as they continue to try to stoke the housing market (which by then I assume will have recovered but what else are they going to do).
So I ask you then, what can the Fed do next? In this scenario they will have vast majorities of UST and MBS on their balance sheets. How would they continue to QE short of asking the Congress to deficit spend in larger amounts (which of course they’d never do)
The Fed will still be buying on the secondary mkt. They don’t buy the deficit from the Tsy. The banks buy it and on-sell just as they always have done. This time they just happen to be on-selling to the Fed. If QE gets larger then they just end up buying more. But my guess is they’re near the end of their rope on this one. As you pointed out, this becomes a political problem at some point.
What happens to the UST and MBS bonds (that are now on the Fed’s books), when they mature? Does the principle vanish or does the cash paid out go back to the Treasury?
Cullen, excellent comment regarding the Fed stuck in the middle between Govt and the Banks, and ultimately serves the banks. The only counter-argument I can see is that Ben is ultimately at the mercy of the govt in the sense that he is hired and fired by them.
But the banks hire and fire the government.
The implicaion I was making here was that when the Fed buys Treasuries or MBS, the debt doesn’t magically go away, it just is transferred to another quasi Gov. entitity, the Fed, as reserves, which is still a liablity of the US Gov. at the end of the day.
Your distinction with the mechanics of the Fed vs. the US Gov. is well taken.
What’s more concerning to me is that Whitehead, the former head of the ny fed doesn’t get this. I would expect a politician to not understand
Good point!
It is beyond belief that a former head of the FRBNY does not understand how the monetary system works. He does not need to know how it works because he is an insider and will make money despite his ignorance.
Thanks anonymous for posting the Chris Whalen piece. He sees where the money ends up and it is going to people like ex members of FRBNY and their buddy bankers. Why would Whalen state so vigoursly that fraud is taking place if it were not so.
The quote in the piece of the where the hedge fund employees dance around like little children shouting QE3 is disturbing. They do not care what is happening as long as they know first and can take their piece and the bigger the better.
I totally understand Whalen’s position and agree the average investor now understands that the game is rigged.
Who is going to fix this if the ones in power don’t understand the system but get rewarded as if they do and well informed people like Whalen explain that the real reason for this policy is to save the banks and allow them to delever as the policy pushers look straight into the camera and assure us all it will create jobs and grow the economy.
Cullen,
I read recently a story on how a Beijing official hinted at a bond attack to produce a funding crisis in Japan unless they reverse course on nationalizing the disputed Senkaku/Diaoyu islands.
http://www.telegraph.co.uk/finance/china-business/9551727/Beijing-hints-at-bond-attack-on-Japan.html
This sounds more like political hot air, as China holds a sizeable holdings of Yen denominated assets and bonds, but if China was crazy enough to go through with this I’d think there could be a temporary spike in yields until the Japanese Central Bank begins a QE buying with their unlimited reserves for these bonds.
And in the unlikely event this bond attack become more serious and widespread than the outcome would be rejection of the YEN (which would be foolhardy for the Chinese holdings of Yen denominated assets) rather than a funding crisis that the China allude to.
Not that I expect anything to come of this but I wanted to check my “thinking” of this low probability scenario.
The Chinese can’t crash the JGB market. The threats of this had the market yawning in recent days. then the BOJ announced the QE measures and there you have it. Does China think they can defeat the BOJ? Yeah, good luck to them. They’re wasting their time with empty rhetoric like that.
Cullen,
Is the idea, for example, if the Chinese tried to inflate the Yen by selling dollars and buying Yen, the BOJ could continually flush the market with more Yen until the Chinese gave up?
Meaning, supposing they know what they’re doing, no sovereign government/central bank can bully another one, if that other one doesn’t want to be bullied?
The first comment on that article seems a sensible chap
Can you believe we drew to QPR? I’m still upset about it.
Yeh know what you mean, having a few QPR supporting friends rather have them beaten!
Shame about the result last night but Oscar looks a bit more than handy!
Repeated viewing of Oscar’s second has me convinced he is capable of witchcraft.
Sweet turn for that, one of the journos described it
“like stranding 2 people due to a wildcat tube strike”
could be a bargain at 25 mil
The thing that frightens me the most is that I’ve learned more about the monetary system and money from reading Cullen than I could have ever learned from going to a top 25 econ program, from government officials or from any investment firm.
Dude, why are you just writing a blog and not doing something more invovled?
It frightens me too.
My Brother, with all due respect, I think Cullen is doing something more involved by publishing his understanding of the way the monetary system functions for FREE. Not Only that, he offers a FREE Q&A section if any one on this PLANET has a question about how the monetary systems function FOR FREE!!!
I mean think about it. You can be the most destitute person in this country or planet for that matter.. and have the ability to access the internet and this sites publications for FREE.Man, That’s beautiful and shows that people like Cullen who could be demonized by certain groups as a greedy capitalist pig is in fact a decent person that is a benefit to society.
just My Thoughts…
” They’re required to bid at auctions and maintain a reasonable market in government securities. This creates a backstop and a form of permanent demand for government bonds.”
MR C, can you explain exactly HOW they are required? I mean. Does the FED look at their balance sheet and say BOA you have more than CITI so you have to take these bonds?
TIA…Thanks In Advance
Yes, if a PD does not make a substantial market in govt bonds they will get a warning from the FRBNY essentially “pick up your game or you’re out of the club”. This is a club all the banks want to be in so they don’t break the rules.
Man Oh man, does this fit into the Obama style of Chicago style strong arm politics.
Sorry for the Political Slant in my opinion.. I just can’t resist..
the system has been in place like this for a long long time.
Cowpoke, if you *really* want to understand Obama, this Vanity Fair piece is an essential read. “Obama’s Way”:
http://www.vanityfair.com/politics/2012/10/michael-lewis-profile-barack-obama
Seems to me the QE programs are designed to buy debt on the secondary market so the primary dealers can unload what they bought.
Maybe what Whitehead is saying is that if that ends the primary dealers won’t bid anymore.
The Dealers unload most of their inventory no matter what. The secondary market is so huge and liquid that it’s never really been an issue and shouldn’t be unless the value of the bonds was collapsing. And also, the Dealers are required to bid so that’s also not an issue outside of a currency collapse (which isn’t happening).
You framed your article to slam Romney–
Solvency crash or Currency Crash
Hard to have one without the other
Raise a cup to those Zimbabwe Billionairs
No offense but I believe you posted yesterday you were having a “Communication system” Crash
I think you have a bleed over–here
No, those readers with a political axe to grind will think I wrote this article to slam a particular candidate when the reality is that I used a prominent person to highlight a misunderstanding and teach an important lesson about the institutional design of the monetary system. I’ve slammed Obama plenty in recent months and when I do I always get accused of being biased for whatever reason when the reality is that the “slamming” is always accompanied by a lesson. You gotta break some eggs to make an omelette and unfortunately, I end up bad mouthing both sides of the aisle quite a bit in making the omelette (which you apparently don’t think is very tasty!).
I don’t mind you making your point–but you reduce it by naming names
Its the merit of your argument — right?
Here a video that explains
http://youtu.be/SwRFoxgEcHc
Actually, I strengthen the argument by showing that prominent people do not understand how this works. That exposes a specific flaw in the thinking that formulates policies and helps people understand why the current environment is the way it is. I don’t enjoy having to point out that some people in prominent places don’t understand this stuff, but in order to prove the points, we have to prove why some people’s understandings are wrong. It’s not personal or political for me. It’s about understanding the system.
John Whitehead is the author of the “Failed TR auction” statement
http://www.zerohedge.com/news/what-mitt-romney-also-said-glimpse-endgame
As noted above, long-term debt is moving onto the Fed’s balance sheet and this will accelerate as deficit spending rises.
So contrary to what you say, it apears that the secondary market simply can’t handle the amount of Treasury debt out there.
What evidence do you have of that? Tsy bond yields are at all-time lows. There’s zero evidence of low demand on the secondary market….
Well, it does seem that Treasury debt is gravitating is gravitating toward the Fed’s balance sheet. What do you make of that? And how much can they hold?
As for rates, yields are low because the Fed is buying up treasuries. That has also made it an attractive investment. (What I am missing, that seems obvious.) If the Fed was buying up Ford stock, wouldn’t we all be buying Ford stock and not even worrying about the fundamentals.
FYI, the Federal REserve has no limit on it’s reserve creating powers nor on how much it can buy with it’s reserves (ie, it can buy up all the bonds if need be)
and it can do it perpetually
In practial terms, it’s only ‘limited’ if inflation gets too high (ie, if production does NOT keep up with demand).. ie, there is NO bankruptcy or solvency contraint nor is it limited by capital contraints like regular banks(in making loans) in it’s reserve creating powers
and inflation wont’ get too high nor hyperinflation nor currency collapse UNLESS there is a production collapse.. ala Zombie Apocalypse, WW3, or expelling all the white people like in Zimbabwe’s 30%-57% production collapse in various sectors
or
90% production collapse from almost all industrial workers(coal, oil, steel, manufacturing, etc) going on strike for 8+ months due to invading French/Belgian troops confiscating almost all industrial production
If by long term debt you mean Mortgage Backed Securities, this has nothing whatsoever to do with Federal funding or spending. MBS are inside money created assets, not government issued, and they have nothing to do with deficit spending.
Auctions won’t fail but the government won’t like that demand is shrinking and therefore interest rates are rising.
Still singing that old song? You have zero credibility – you’ve been making the same call for months. Or is it years?
Agree. But I know higher rates are coming.
Foreigners have stopped adding to their T-bond holdings since september 2011. And that’s why the US government is forced to raise taxes per january 1st, 2013. (Fisacl cliff). You may believe the MR theory that the FED determines interest rates but the FED doesn’t, “Mr. Market” and “Mr. Margin” do.
And the FED buying T-bonds is only postponing the problem because the problem is too much outstanding debt and the solution is supposed to be “more debt” ?
Cullen, does it really matter who’s bidding the treasuries at the primary market when eventually they end up on the FED’s balance sheet? I mean, seriously, the banks are backstopping the auctions but the FED is backstopping the banks.
This is the most probable bad outcome of the forever high deficit spending: because it weakens the dollar, the americans will buy less and less from foreigners so all those with a lot of dollars will try to find a place for their dollars. The only one place is the US, so a lot of those dollars will come back home in a stampede. It’s going to be the end of the dollar as the world reserve currency. Trillions of unwanted petrodollars rushing back into the US economy will result in very high and persistent inflation.
1. If someone holds a lot of dollars it is probably because the US is a significant customer. Why would they want to reduce further their customer’s ability to pay by weakening the currency?
2. “americans will buy less and less from foreigners so all those with a lot of dollars will try to find a place for their dollars” the ‘so’ in this sentence doesn’t seem to follow. Why would reduced demand for exports to America change someone’s attitude towards the dollar.
3. If you are an exporting country, why would you want to strengthen your own currency by selling dollars and therefore make your own products less competitive?
4. It would take a major shift in sentiment towards the dollar for this to happen, which isn’t going to happen anytime soon. The dollar is the least bad currency out there at the moment.
5. Your use of the term ‘petrodollar’ suggests that you think that the fact that oil is priced in dollars, this increases demand for the currency (http://en.wikipedia.org/wiki/Petrodollar_warfare), it doesn’t.
You are essentially saying that because the world worked in a such way in the last 40 years, so it will in the future. But 40 years ago the US was the largest creditor and now it’s the largest debtor. The BRIC will have a hard time to change their economies from export driven to internal demand driven but this will happen because they don’t have any other possibility and they know it. So for me the role of the dollar as the world reserve currency will fade away. You don’t have to look at the current stock of the currency reserves which is the mere result of the past strenght of the country, but at the flows. If they are increasing the role of the dollar as the reserve currency is healthy otherwise, if the flows are diminishing that role is slowly fading. And one day, the owners of all those dollars will run for a place for that money: the US$ will go back home.
But this is GOOD for the average american citizen in the long term and not bad, this is the only one way to have a local healthy economy with much less imbalances. Michael Pettis wrote some great posts on this argument. The world does not need a reserve currency but a balanced economy. The losers will be the US big banks which are the pushers of the worldwide dollar based credit. They don’t want their credit back, otherwise they die.
Because I’m not ideologically biased (I hope so) this is what I mean when I write about the fact that the dollar standard is flawed:
http://ftalphaville.ft.com/blog/2010/11/22/411951/bernanke-hints-dollar-standard-is-flawed/
I don’t disagree that the Dollar as a reserve standard is a bad thing.
The problem is that it isn’t in the interests of the countries that hold all the dollar reserves to suddenly stop holding them.
If there were a sentiment shift towards the dollar, it would make US goods more competitive and fix the trade deficit, but I don’t understand why any country that is currently a net exporter would want to change the situation.
The dollars returning would have to be used to buy goods or services which would increase particular asset prices, but would not necessarily lead to an increase in prices in general.
Currently there is no alternative to the dollar that is viable. This situation will change, but I’m not going to suggest a date because it might take 50 years or more.
I don’t particularly care about what happens to the dollar as I don’t live in the US.
Hey, could you or someone explain point 5 further?
I always hear that argument about how oil priced in dollars creates more demand and if we lose having the dollar as what oil is priced in, then the US falls apart.
But Im not a econ person so thats confusing to me. Could you explain why its incorrect to assume that?
Oil producers price the oil in USD and want payment in USD.
So, an oil buyer needs to take whatever currency they have and go out on the FX market and say “I have X and want USD”. This equals more demand for USD and less demand for other currencies. Which always has predictable results in market economies.
Now, if the oil sellers went and converted it to their local currency, it would do the opposite and balance out. But why would they do that and decrease their own profits? So they don’t. They buy their yachts in USD. No problemo. Everyone accepts USD. Not everyone knows WHY they do, they just know “everyone does”, so they do too. And thus the USD becomes a self-appreciating reserve currency.
On a related note – did you know that Iraq started denominating their Oil in Euros in 2000? Guess what happened after the US save-the-world mission was done? Yep, back to denomination in USD. Now where did I put my tinfoil hat…
I have a question that I think is related to this post. How is what the Fed doing different from what the Reichsbank did during the Weimar Republic era. I am referring to the German central bank’s actions that culminated in the hyperinflation of 1922-1923. Whether you can muster the time or the energy to answer, thanks for a very informative blog.
To have hyperinflation, you need more demand than supply. This is not the case in any western country. It was definitely the case in Zimbabwe.
Weimar Germany was a very special case in that they needed to somehow buy 100 000 tonnes of gold on international markets – about two thirds of the world’s total gold supply. It did very predictable things to their exchange rate.
QE3 money isn’t used to buy things on the international markets. It doesn’t even reach the consumers where it could increase domestic demand. The usual transmission mechanism – increased house prices – isn’t transmitting at the moment since people are busy foreclosing.
Thanks for the clarification.
I guess I’m confused. At first it seems Cullen is saying there is no problem and then a little further down he says his guess is that they are near the end of their rope on this. Can someone explain why this is no problem if, on the other hand, they are reaching the practical limits of it?
I believe Cullen’s comment saying the Fed is at the end of the rope was in regards to QE.
If MMT is real and not merely a poor understanding of mathematics, as many have explained, the easy trade is to keep buying US treasuries as they will be able to be front run for the next 400 years as the monetary system is nothing more than a ponzi scheme with no real backing, other than the belief that the citizen collective will continue to pay taxes in said paper. Why would you waste your time actually working when you can be a banker and get in on the free money, which is nothing more than time. Instead of toiling in the fields or factories all day, you can just buy treasuries and sell them to the fed……all day long in a continuos loop.
It’s funny how just a little bit of knowledge of history shows that every time bankers get between the populace and the money supply, the sound money system is destroyed, and thus the will to produce. Every time they come up with a new understanding of the system and give it a name. This time it is MMT, but it is really just a snow job, the same snow job being repeated throughout history.
While MMT is nothing more than an explanation of the current system, which everyone understands, it is nothing more than that. It is not a roadmap or a solution to the problems we see our monetary system has created. So, focusing on MMT is nothing more than a waste of time. How many of you have made any money from this magic trick? If money is time, then how many of you are net positive on time from this magic trick? Has your understanding of the flawed system garnered you investment knowledge and thus lowered your retirement age and bought you more time?
Again, the only conclusion of MMT is that if in fact this the game that defines the system now and in the future, the only play is to buy the only thing that the system needs, and that is treasuries, from here to infinity. The end result of any MMT defined system is zero interest rates and perpetual recycling of currency in a giant feedback loop.
Since the power to tax is the only driver of demand, spare me the desire for ipads bought on credit argument, this will run its course until it destroys all productive capacity and the citizens choose not to pay taxes. In the end, paying taxes is merely a choice. The majority sets the government in the long run.
The reason fed governors speak as if they don’t have a clue, is not because they dont have a clue, but because if they did tell you the truth, the system would in itself increase the speed of its breakdown and they would have to go back to work.
Here is a tip: 30% in Gold and silver
30% in UST
40% in cash to buy the bottom of the deflationary collapse ahead
All of the understanding of the monetary system will not help you one bit in reality, because MMT proves that there is no value in the monetary system as it is constructed today.
John,
I haven’t been an MMT advocate for almost a year now. We created Monetary Realism because of the vast disagreements. If you’re not familiar with the differences you might want to review this:
http://pragcap.com/mmt-critique
In PRACTICAL terms of how bonds, stocks, QE, go up or down due to policy, MR & MMT (I see both as related sister schools since MR developed from MMT) arrive at the same conclusions on how to invest & effects on economy
ie, in investment advice, both are the same w/ same conclusions on effects of QE, deficit spending, etc(they just differ on the origin of ‘state theory of money’ & ‘private theory of money’) ..most people care about practical effects & investing, not theory of state vs. private… just bottom-line
in that respect of bottom-line results, MR & MMT are identical & most accurate in describing & predicting how stock market, bonds, deficit spending, QE, etc results & effects are
The worse predictors are Austrian, Monetarist, Mises, Ayn Rand, economic-libertarian type models & theories
I do not derive my investment decisions from MMT or really any macro theory. All of my investment strategies preceded my understanding of MMT or MR by years. Macro theory provides a framework or a starting point to better understand certain dynamics, but I think it is extremely dangerous to go around claiming that MMT or any macro theory will generate alpha. Investing is MUCH more specific than that. Macro is just a starting point. It is not an investment strategy on its own. A strategy must be boiled down into very specific risk managed and properly constructed approaches. This goes well beyond just understanding that the USA isn’t going bankrupt or rates aren’t going to rise. That barely scratches the surface. And no, no one is “getting rich” from MMT. Warren got rich using strategies that have little to do with the macro theories around MMT. And as far as I know, no one has ever gotten rich trading some MMT approach.
And I don’t at all consider MR and MMT “sister schools”. MMT is a state centric view of the world. MR is not. There are some post-keynesian similarities, but they start and end at totally different places. These are very different perspectives of the world. I’d appreciate it if MMTers just stopped coming here claiming MMT and MR are basically the same thing. They are not. If you’re still confused by all this I would suggest you read this. http://pragcap.com/mmt-critique
How many of us have made money? Those who understood the monetary system realized early that the Fed’s reflationary efforts, such as QE, would fail. Many of them have been very successful in fading the reflation trade. I hope you bought long Treasury bonds when yields rose above 3% temporarily last week following the FOMC announcement. I also hope you avoided Europe like the plague, or perhaps went short, as many of those who understood their monetary system did.
MMT/MR has helped many people make tons of money
Warren Mosler was middle-class but has made hundreds of millions to billions betting that gov bonds from countries that issue their own currency can’t/won’t go bankrupt (according to NY magazine & himself, he made about $500 million to $1+ BILLION dollars & bought his own bank –he’s modestly says he’s worth less than 1/4 of Ross Perot (Perot has $4.1 Billion)
MIke Norman himself made tons as well as others & myself in my social circle & others at PragCap who believe/follow MMT/MR made thousands to milions of dollars in our investments (ie, betting that US bonds would go up, stocks going up, dollar going up while Bill Gross/Schiff/Peterson & other debt-hawks LOST MILLIONs to BILLIONs on their funds betting against US bonds)
Eh, money schmoney. Money is worth exactly what we as a collective believe that it is worth. It’s that simple.
If you think that gold is hard value I propose that you try to eat it.
If people see gold not buying them food because of destroyed supplies, gold becomes pretty useless too. The guy with the storehouse full of SPAM becomes the new king and maybe the new currency becomes paper slips worth 1,5 and 10 cans of SPAM.
The real world is primary. Money is secondary.
Cullen, could you do a follow up post on the mechanics of this for the PD’s? I’m thinking that the PD’s buy the treasuries via balance sheet expansion, then seek reserves from the Fed at the end of the period, if necessary. Is that how the chain is connected?
Also wondering how that chain connects in Europe too, given recent developments. If the ECB is committed to unlimited bond purchases, and the private banks in Europe are over-leveraged with private assets, it would seem they should now be buying as much of the Government debt as they can get their hands on, knowing that the Governments are backstopped? Wouldn’t that improve their capital position, or am I misunderstanding bank capital?
+1
As Dave I would also like to here your thoughts on this. Here my suggestion what’s going on – but don’t know if that’s accurate:
Not sure PD’s need to hold reserves for TSY holding. I suggest PDs offload the purchases to clients to a large extent. If they can not because there is no demand – that’s when we could see a problem, even though the auction didn’t fail. Because then PDs need to hold the TSY on balance sheet and have to finance it eg. via repos.
Cullen, what do you think?
Whilst I don’t think the US is likely to get a failed auction without the primary dealers being in significant difficulty I think there might be some specifics about the rules and who buys US debt to be concerning. Take the following rule for example
Each primary dealer’s share of customer trading volume must equal at least one percent of total secondary market volume.
That is fine but there is an assumption that all bonds are available on the secondary market and I am not sure that the intra governmental holdings which make up 35% of the take up of bonds are. Those depend somewhat on the social security and medicare trust funds and there are indications that going forward their take up may not continue at the rate it has. That might shift more volume to the auction, while I don’t think it will result in a failed auction it might well have an impact on the yield curve since primary dealers need to sell the bonds on. I guess I am not sure and worry that the unique nature of the US’s debt structure may be storing up problems for the future.
This link gives some break downs on who owns government bonds these days. Curiously the numbers don’t seem to tally up with many of the percentages and numbers some have claimed in the comments.
http://www.bondvigilantes.com/blog/2012/08/17/who-owns-government-bonds-these-days/
You all know where the Romney quote came from, right?
http://www.motherjones.com/politics/2012/09/secret-video-romney-private-fundraiser
I watched the whole thing, and was going to ask for CR’s take on on that exact comment.
And it’s not as if Romney was pandering to a bunch of poor uneducated idiots…those folks all paid more than the median HH YEARLY income for the pleasure of one meal and piddling access to the candidate.
CR, Thank you so much for helping train my bullshit sniffer…
I did appreciate the video for it’s gloves off attitude and opinions, some of which have merit, but most nonetheless are better off left unsaid by a potential POTUS and LOTFW.
I can help you with that one: pure, unadulterated bullshit.
Of the 10 states with the highest amount of federal tax payers (roughly 70%), almost all vote democrat.
Of the 10 states with the lowest amount of federal tax payers (roughly 60%), most are republican.
http://taxfoundation.org/article/nonpayers-state-2010
Math no worky, Myth Romney wrong again. Nothing new to see here, carry on.
Crap that’s not the quote you meant. Sorry for the irrelevance.
Can we have a comment plugin with an edit button, please? :S
Hey, that’s a pretty decent study. Go deeper than the charts.
I love the term “fiscal illusion”…