Ask Cullen

* To see the old archive of the original “Ask Cullen” page please see here.  

Since the Q&A’s are so popular I figured I’d add a permanent page on the navigation bar so readers can ask questions any time they want.  Feel free to ask anything about anything.  And if it’s a great question I’ll make it a post.  Please bear in mind that I don’t know everything about everything so reader help in answering questions is encouraged, but please only answer if you’re “in the MR paradigm”!  Also, it might take me days to respond some times depending on my time constraints and availability.  And remember, this is all about education so if you think I have something wrong then let’s push the discussion in the right direction towards a better answer.   I don’t give specific investment advice at the website so please avoid specific investment questions.  Lastly, as always, let’s keep it cordial.  This is all in the pursuit of better understanding so let’s be constructive even in our criticism.  Thanks as always.

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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  • Tom Brown

    Cullen, I’m happy I saved links to my favorite threads in “Ask Cullen” because it’s not clear how to get back to them (there’s no “Previous Comments” button here any longer).

    I had a very halting ongoing discussion going w/ Romeo Fayette.. if we wants to continue it I hope he can figure out how to get back there.

    My old links seem to work, but the old “Ask Cullen” comments are no longer contiguous with these I guess, correct?

  • Mark Caplan

    The website Peak Prosperity, in the article “QE for Dummies,” has a graph of the Fed’s balance sheet that shows that QE effectively ended in June, 2011. Since then, the Fed’s balance sheet hasn’t materially changed despite all the chatter to the contrary. Interestingly, gold peaked and the dollar bottomed around the same date. Would you care to comment?

    Here’s the graph of the Fed’s balance sheet showing little change since June, 2011:
    http://media.peakprosperity.com/images/Fed-Balance-Sheet.jpg

  • Victor

    hi Cullen:
    could you please help to explain the impact of China’s approach to converting $US dollars to US Treasuries. Do they then issue an equivalent amount in yuan into their economy. Does this contribute to inflation there? What would happen if they were to reverse this? What would happen to the domestic economy if anythng?
    thanks.

  • http://www.orcamgroup.com Cullen Roche

    Tom, you’ll find the links to the old page at the top of the front of this page. Hope that helps you track everything down.

  • Tom Brown

    Ah… missed the fine print. Thanks.

  • JimG

    Cullen,

    What, if anything, is the relationship among or between any of these components: the federal debt, the US national private debt, the US money supply, Fed treasuries purchases, and QE1, QE2, QE3? If that’s too broad a question, then may I ask what is the impact of Fed bond purchases on the money supply? Thanks.

  • whatisgoingon

    Do you care to weigh in on the great rotation debate?

  • Tom Brown

    Cullen, when a neoclassical is talking about a supply or demand curve with “stock of X” on the x-axis and Y on the y-axis and he states:

    “perfectly elastic with respect to Y” or “perfectly inelastic with respect to Y” are they saying in the former case “draw a horizontal line at some value of Y” and in the latter case “draw a vertical line at some specific stock of X?”

    Is it the word “perfectly” which gives these curves their straight vertical or horizontal character? What would be an example of an “imperfectly elastic wrt Y” curve or a “imperfectly inelastic wrt Y” curve?

  • Christian

    Hi Cullen, first I want to thank you for a very educating and interesting webpage. I wonder whether you have some ideas regarding the connection between velocity of money and pricing multiples such as the Price/book (and maybe the P/E). My thesis is that increased velocity should lead to higher multiples. Looking at the historcial P/B-data on S&P500 and the US velocity (calculated as nominal GDP/M2) this seems to fit. I would be very thankful if you have some thoughts regarding this.

    Kind regards!

  • Garibian2

    am not an economics guy . Most of what i have gleaned on the topic comes from your site so I am holding you personally responsible if this is grossly incorrect :-)
    “money” has its various attributes and definitions but how it is used here is mainly as a medium of exchange characterized by “What is acceptable in the checkout at Wallmart”. There are other money like entities (financial instruments) that exist and can be exchanged for “money” that get counted in various definitions of money supply (M1, M2,M3 ETC). What has happened in the global financial crisis is a gross expansion of the “M” to what I will call “M huge 2007″that includes collateral debt obligations and other instruments of mass distruction, along with other debt instruments and Shadow banking that resulted in an obscene Fire economy which imploded and resulted in a” Balance sheet recession” .This exposed the structurally weak real economy which was and still is dependent on Consumer consumption and debt.
    The Banks and to a very limited extent the general public had to be bailed out temporarily to prevent a major collapse. Some people feel the system should have be let go to wherever it should fall and let the market forces of “Destructive Capitalism” do their work with a brand new stronger economy (based on ???) rising from the ashes. What was used instead,derived from the theory of Sectoral Balances ,socialized the Debt through Government spending and continues as a prop. To date there has ben little real structural change in the real economy and little real effort to change the private entities. This pisses people off.
    According to your equation what is needed is real expansion in the “Real Economy” with attention to “productive investment” however we may define it. Then government debt can be reduced.
    With this in mind my question for you is “What really are the two sides of the Balance Sheet in the balance sheet recession?” . On one side will be my “M huge 2007″ which will now be “M reasonable 2013″. Does this regress to the mean of 100 years of progressive growth from which it departed in a parabolic move in the 80′s 90′s and 00′s?. What is on the other side of the ledger?

  • Steve W

    Cullen,

    I thought today’s WSJ opinion piece by George Melloan, “The Fed’s Asset-Inflation Machine”, was interesting. I’m just not sure some of George’s points are on the right track, or at least not presented in the right context. I don’t question his view that the Fed is trying to inflate risk asset values (equities, residential real estate) and keep bond prices up. I also think his point about Greenspan keeping rates too low for too long is valid — although he leaves out any mention of the Clinton budget surplus. I think he left out some of the dots that would help connect the chain of events properly (from an MR perspective). He then goes on to say that “…Obama and Mr. Bernanke worsened the effects of the 2008 crash by adopting Keynesian antirecession measures….that had failed before, most dramatically in the 1970s. Stanford economist…John Taylor recently argued persuasively on these pages that stimulus measures had retared rather than speeded recovery.”

    From an MR perspective, what’s wrong with such a view? Am I right in saying that the Keynesian “multiplier effect” is a myth, but that’s not the point, because in the current BSR we need federal (deficit) spending just to try to fill the gap? (I’ll try to find Mr. Taylor’s piece.)

    Later in the article there is this: “a credit expansion in the United States of close to $10 trillion — in relation to nominal GDP growth of barely $2 trillion over the last four years since 2000 — definitely represents more than the usual dose of inflationary credit excess. This is really hyperinflation in terms of credit creation.”

    Let’s set aside the proper definition of hyperinflation for now. I get how Fed policy and the budget surplus helped fuel excessive credit expansion in the private sector. What I’m trying to reconcile in the article is the suggestion that the Fed’s policy of (essentially) zero rates, along with the Fed’s vast bond portfolio being vulnerable to a major drop in value are adding up to a ticking time bomb similar to what led to the 2008 crisis.

    He states that the “wealth illusion of asset inflation if seductive, which is why central banks in charge of a fiat currency and subject to no external disciplines so often drift in that direction.”

    I don’t have much faith in Congress showing much discipline, but we can hope for a little better actions from the Fed. Is the Fed running out of bullets (without help from Congress)? Is it realistic to think that the Fed will be able to implement the proper changes when the private sector is stronger (and credit expansion resumes at a healthy pace)? If not, then perhaps George Melloan’s concerns are valid, even if he’s missing some key parts of how our monetary system works and why deficit spending doesn’t always lead to damaging inflation (or certainly not true hyperinflation).

    If you have time to read the article, I’d love to know your thoughts.

  • Jonathon McKitrick

    If the Fed can strong-arm the interest rate, what are the interest rate increases that some of the inflation hawks are talking about? Do they not believe the Fed set and keep rates low? Or is there another rate that the Fed cannot control they are referring to?

  • Tom Brown

    Nevermind! I think I figured it out from a wiki article.

  • Tom Brown

    Cullen, can a CB always control increase the inflation rate? Suppose they wanted to move us from where we are now to 4% on their own, do you foresee any problem with that?

  • Tom Brown

    remove “control” from above.

  • Steve W

    Cullen,

    I searched the WSJ site for John Taylor’s article that supposedly “argued persuasively on these pages that stimulus measures had retared rather than speeded recovery.” (as George Melloan said in his 2-7 WSJ op-ed piece), but I don’t think I found the right article. His 1-29-2013 article “Fed Policy is a Drag on The Economy” is mostly about the Fed’s current zero interest rate policy and bond/MBS purchases. One section in that article did catch my attention. Regarding those purchases, he states “When the economy begins to heat up, the Fed will have to sell the assets it has been purchasing to prevent inflation…..If its asset sales are too slow, the bank reserves used to finance the original asset purchases pour out of the banks and into the economy. But if the asset sales are too fast or abrupt, they will drive bond prices down and interest rates up too much, causing a recession.”

    If I understand (what you’ve written before) correctly, banks don’t lend reserves, so I’m not sure how those reserves Mr. Taylor refers to will “pour out of the banks and into the economy.”

  • Tom Brown

    That John Taylor article caught the attention of David Glasner and Scott Sumner too in recent posts. I got into a long discussion on both sites regarding just how reserves can leave the banking system. Please defer to Cullen for the correct answers!, but I’ll point out a couple of things. Individual banks can lend reserves to each other, and they can use the reserves to invest with, pay salaries with, pay dividends with, or pay expenses with, but on aggregate, they do not leave the consolidated banks’ balance sheet in any of these ways (except when they invest in Treasuries from a Treasury auction or when they buy assets from the Fed), and they are NOT loaned out to non-bank customers (except if the customer withdraws the loan as paper bills and coins). I think the only way reserves can leave the banking system are as follows:

    1. Withdrawn from deposits as paper bills and coins by private entities.

    2. Taxes paid (by anyone!) to the Federal Government or in Treasury bond auctions.

    3. Fed OMOs (specifically OMSs).

    However excess reserves can be converted to required reserves on aggregate (on the consolidated banks’ balance sheet) by increasing the net dollar amount of outstanding loans to private non-banks. Only a about 10% of the aggregate net loan principal increase is converted in this way, however. So perhaps that’s what Taylor is talking about. Some MMers argue that my number 1. above is also significant.

  • Tom Brown

    I won’t attempt to answer for Cullen here, but I’ll just point out a couple of things you may find interesting. I think the Taylor article he’s referring to is the one you point out below, “John Taylor: Fed Policy Is a Drag on the Economy.” He quotes Taylor as saying “stimulus” right? I think he means “monetary stimulus” not “fiscal stimulus.” I think Keynesians believe in both. The “multiplier effect” that he labels as Keynesian is also something monetarists talk about with regard to monetary policy/stimulus. That’s a key part of the Market Monetarist theory. I can also tell you that both Sumner and Glasner (both MMers) were unhappy with Taylor’s article. Glasner wondered whether John is now the first “Post-Modern Monetary Theorist” in the title of his response (he doesn’t intend that as a compliment). Sumner simply seemed annoyed to have to ask “Does John Taylor want easier money or tighter money?” (which was the title of Sumner’s piece, BTW). Of course Sumner thinks we need easier money now, while he seems annoyed that Taylor seems to question that.

    I’d be interested to know Cullen’s thoughts as well after having seen the reaction from the MM camp.

  • http://www.orcamgroup.com Cullen Roche

    Technically, the Fed was simply letting assets mature and then QEing them so there was little impact for a while there. That’s all changed in recent months as evidenced by the spike here:

    http://research.stlouisfed.org/fred2/series/WRESBAL/

    We should see that chart go much higher in the coming months.

  • http://www.orcamgroup.com Cullen Roche

    China obtains USD in the course of foreign trade and exchanges those USD’s for Yuan in the domestic economy. China’s central bank then has dollar reserve balances that it uses for various purposes including t-bond purchases.

  • http://www.orcamgroup.com Cullen Roche

    Lots of moving parts there. The general effect on the money supply depends. If a bank sells bonds to the Fed then there is a simple swap of reserves (outside money) for bonds. If a non-bank sells then there’s an extra step where the non-bank increases deposits (inside money) and the bank then sells on the bond to the Fed. In the end the result is no increase in net financial assets in either case and I argue that inflation is primarily the result of future expected income relative to desired savings. QE doesn’t change any parts of that equation so while it changes different parts of the money supply in different ways there’s a simple reason why it isn’t inflationary (though it can cause portfolio rebalancing and asset price inflation).

  • Tom Brown

    Cullen, you write:

    “I argue that inflation is primarily the result of future expected income relative to desired savings.”

    Could you elaborate on that a bit? I don’t understand.

    Some have claimed that “No CB that has tried to increase inflation has ever failed.” Do you agree? If this is true, how do they do it then? Do they start buying up non-financial assets (real-estate, groceries, etc.)?

    Was increased inflation one of the goals of QE, or where they simultaneously trying to keep inflation at target levels? If you ran the Fed and wanted to increase inflation, what would you do?

  • http://www.fanbrowser.com/ Cowpoke

    Tom, is there a govt mandate that banks HAVE to buy fed assets?
    I keep reading all this about the FED reversing course and selling assets to tame inflation, but what if their is no mkt for their assets?

    Primary Dealers are required to participate at treasury auctions, but there is nothing by law that says they have to purchase FED assets. That I am aware of anyways.

    Thoughts?

  • Tom Brown

    You’ve got me there cowpoke! This wiki article states that it’s the primary dealers that are active in this market.

    http://en.wikipedia.org/wiki/Open_market_operation

    Also check out how “required” is used here:

    http://www.newyorkfed.org/education/pdf/2012/Hilton_monetary_policy_implementation.pdf

    That last one makes it sound like a treasury auction, don’t you think?

  • auresdemulo

    I don’t think that MMR or MMT imply hyperinflation will result. Keep in mind the saying, “There is a time for everything”. Deficit spending which effectively creates new money and issues it will not be done all the time. Only if the government endlessly deficit spends will that happen, and it won’t if the government has knowledgeable economists advising it, and the politicians understand it do what is necessary..

    In MMT and MMR you deficit spend when you have recessions and depressions. Somewhere in your economy you have had a severe leakage of money out of circulation. It could go out with a surplus budget produced by higher tax revenues than spending.
    It could be produced by the nation having a bad trade deficit, with more money going out from buying imports and less coming back in by selling exports. You could have
    citizens who are obsessive savers, putting away excessive amounts of money in savings accounts, under the mattress and buried in the backyard. Or after borrowers have run up huge debts on their credit cards they stop buying and start paying down their debt.
    And these cases represent outflows from circulation that leaves less money chasing goods and services, producing recessions and depressions. So you want to deficit spend to put new money into circulation. When you have inflation you can fight it by raising taxes, cutting government spending (especially deficit spending), having the Fed sell bonds to banks to drain their reserves, encourage buying imports, raise interest rates, encourage savings. Each of these cause outflows from circulation.

  • http://www.orcamgroup.com Cullen Roche

    Deficit spending does not create new money. It redistributes existing money and adds NFA as bonds. Taxes do not destroy bank liabilities. And govt spending does not create bank liabilities. The process of taxation and spending redistributes existing bank money. If you are going to spread the MMT ideas here and confuse them with MR then please stop commenting in this section. Thanks.

  • http://www.orcamgroup.com Cullen Roche

    I’ll write something next week on this. It seems to be a hot topic.

  • http://www.orcamgroup.com Cullen Roche

    Hi Christian,

    I’ve never thought about that to be honest with you. Your assumption seems to make some logical sense. But I would be careful implying correlation = causation. It’s perfectly reasonable to assume that money velocity could increase, prices can rise and book value can rise at a faster rate which would reduce the P/B during a time of high velocity. Or, a more recent example might be 2009 when velocity was declining and earnings expanded quite sharply.

    Not sure if this will help, but a quick google search turned up this:

    http://www.bostonfinancialmanagement.com/publications/2009-April-The-Velocity-of-Money.pdf

  • http://www.orcamgroup.com Cullen Roche

    The BSR is all about understanding what happened to pvt sector balance sheets following the debt collapse. Pvt actors had taken on huge amounts of debt (mostly mortgage debt) and when the asset base from which these debts were based, imploded, the incomes to service these debts went up in air. That results in defaults and a positive feedback loop that is extremely negative for the entire economy. So, the BSR is about understanding how asset values and liabilities are directly connected in the game to service outstanding debts.

  • http://www.orcamgroup.com Cullen Roche

    Haven’t read the Taylor article, but I did read the Melloan article, which I found rather good even if it’s not 100% in paradigm.

    I like that he focuses on credit creation. As you guys know, MR is primarily about credit creation and how private banks create most of the money that chases goods, services and even assets. I think Melloan makes an important point and it’s one that Richard Werner often makes – there’s a disaggregation of credit that is increasingly occurring in the US economy whereby money is created for unproductive means as opposed to productive means. This is one of my big beefs with QE. It rewards the creation of money for speculative purposes (like buying stocks) as opposed to rewarding the creation of money for productive purposes (like R&D). That’s why I really dislike the chase of this “wealth effect” and portfolio rebalancing in QE. It just wreaks of bubble creation and rewarding bad behavior.

    I’ll have a read at the Taylor article now.

  • http://www.orcamgroup.com Cullen Roche

    Okay, Taylor is 100% out of paradigm. Not only is he talking about how reserves “pour out of the banks and into the economy”, but he seems to think that the current Fed policies are having a negative impact on growth. I wouldn’t go that far. I think the Fed’s policies are having marginal positive impacts in different ways, but I worry that the risks created by the Fed’s policies outweigh the rewards. Ie, the potential for bubblenomics to resurface will just end up creating more disequilibrium at a later date. That’s disruptive in the long-run even if it’s stimulative in the near-term.

  • http://www.orcamgroup.com Cullen Roche

    JM,

    Not sure what you’re referring to exactly. The Fed sets the OVERNIGHT rate based on economic expectations. It has a monopoly on reserves so it can always set this rate. While the Fed controls the overnight rate, it doesn’t control the economy which is what really drives the rate.

  • Johnny Evers

    You know, I don’t think that’s entirely accurate.
    When housing values fell, the leveraged loans on those mortgages fell in value, creating a huge margin call for the holders of those loans.
    As a result, the banks lost the capacity to make new loans, thus crashing the economy.
    The response to this has been to inflate those assets (either by the Fed buying them directly, or lowering interest rates to drive housing up.)
    While it’s true that the consumer was also in trouble, the economy didn’t crash because Joe in Boca Raton defaulted. For Joe, defaulting was a positive event.

  • http://www.orcamgroup.com Cullen Roche

    The loans were leveraged by Joe’s income on his mortgage. When he stopped paying it caused a domino effect….

  • Johnny Evers

    No, that’s not really what happened.
    Had Joe’s mortgage not been leveraged, there wouldn’t have been a financial crisis.
    Remember, the financial crisis was triggered when the price of Joe’s home fell, even when most Joes were still paying the mortgage. When the value of the loan fell, the banks seized up.
    In a normal economy, when housing dips, it hurts some people (speculators mostly) but helps others.
    But in a highly-leveraged economy, a lot of artificially created wealth disappeared and the banks couldn’t lend to healthy actors.
    It’s important to recognize the guilty party here, both because of fairness, and because if we don’t we are just trying to re-create a failed system.

  • http://www.orcamgroup.com Cullen Roche

    You’re rephrasing my original comment (which you said was wrong). The banks went belly up because their assets were no longer worth what they originally estimated and because the cash flows to feed their asset base was deficient. I’ve said all of this a million times here. Why did that happen? Because banks were greedy in making loans and consumers were greedy in wanting McMansions. Anyone who blames only the banks in this process has a very biased view of what happened….

  • JK

    Cullen,

    I’m a confused in a chicken-or-the-egg sort of way. Can you comment on the choronological transmission of events…

    1) Bank’s balance sheets begin to get in trouble because people who were given loans they could not afford started missing payments
    2) This led to a slowing down of the housing bubble, then a flattening, then a decline…. in the value of housing and property (mid-2000s)
    3) The flattening and then decline of housing and propery prices in the mid-2000s put enormous stress in the financial system
    4) ???
    5) With housing prices falling, consumers shift more of their income toward deleveraging, and less to consumption
    6) The drop in spending through the economy causes businesses to lay off workers, resulting in high unemployment…

    Maybe you would write up a post describing the the dominoes and how each dominoe affected the next one, with interesting and essential choke-points like e.g. when housing prices turned south, the freak out in Fall 2008 when the shit it the fan, etc.

    I think there’s a lot of confusion of “how it all happened” in chronological sense.

  • Johnny Evers

    No, that’s dead wrong.
    It wasn’t a mortgage issue. It was a case of the mortgages being securitized, and then the banks making incredible leveraged plays on those mortages.
    It only took a few ‘Joes’ defaulting on their mortgages for the asset values to crater. In a functioning banking system, that wouldn’t have been an issue. Some specific lenders would have failed, and mortage bond holders would have taken a loss.
    But in the system you apologize for, it caused a crash.

  • Johnny Evers

    JK: The banks got themselves in a position in which even a 5 to 10 percent slump in their mortgage securities caused massive losses in their loan portfolios.
    That seized up the credit markets.
    That led to the collapse in business lending.
    That led to layoffs.
    It’s vitally important to understand that a few homeowners getting into trouble didn’t blow up Lehman Brothers.

  • Tom Brown

    I personally wouldn’t assign blame 50/50 though. I’d blame the banks a bit more. There were some cases of “predatory lending” where homeowners, some of which had already paid off their mortgages, were convinced to take home equity loans on terrible terms, weren’t there? Yes the borrowers share some responsibility even there… but the banks were behaving very badly in those cases. Like snake-oil salesmen or TV preachers trying to get the elderly to buy a ticket to heaven (my friend’s mother sent a TV preacher a big chunk of her savings… $40k). It’s my impression that in some cases the mortgage brokers were just a hair away from being out and out con men.

  • Tom Brown

    Plus it seems that in general there’s an asymmetry of financial sophistication: Who’s supposed to be the financial expert in these deals? Joe the 7-11 employee who’s convinced that he’ll be OK taking a negative equity 40 year ARM to buy a condo, or the institution lending him the money? Normally we expect the financial institution to be the grown up in these circumstances, but the industry was filled with “perverse incentives” as George Akerlof wrote about the S&L crisis or the used car “Lemon Market,” wherein the “bad actors drove the honest dealers from the market.” So I think a good question is, what happened to the grown ups in these financial arrangements? I think Joe might think “Well the bank thinks I’m a good risk, so it must be OK.” I’m not letting Joe off the hook for being a dunce, but I’m going to assign more blame to the bank in that case.

    Plus where were the regulators when these perverse market conditions caught hold? They share a good chunk of blame too.

  • JK

    “That seized up the credit markets.
    That led to the collapse in business lending.”

    This is what I’m after… the chronology of it all.

  • Steve W

    Thanks, Cullen. I think more of this MR stuff is actually sinking in to my brain!

    I’d say my biggest challenge on the broad MR topic relates to the growth of federal debt, future obligations (Medicare, Social Security), and whether it’s all “sustainable”. We understand that there’s no solvency constraint, but should we be concerned about inflation? I recently re-read your paper on Hyperinflation, so I understand that “it’s more than just a monetary phenomenon”. I’m not looking for some magic debt-to-GDP ratio. We’ve all noted Japan’s massive amount of debt, yet still no currency or hyperinflation disasters. I don’t want to confuse MMT with MR on this, so if you can point me in the right direction, I’d be most appreciative.

  • Tom Brown

    Final point: I really see the problem as more top down than the reverse. I have the impression that once it was discovered that Germany (and other countries) seemed to have an insatiable appetite for zero risk (AAA) MBSs, that this led in turn to lending standards being lowered, ratings standards being lowered, regulatory standards being lowered, and appraisal standards being lowered.

    Sure there are plenty of examples of greedy McMansion buyers who should have known better, or property flippers that should have known better, but I think there were an awful lot of Joe the 7-11 employee types who say prices for homes rising all around them and figured… “Gee… I’d better see what I can get now or I’ll be priced out forever!” They were probably worried about being perpetual renters in an ever rising rental market. They weren’t shooting for McMansions, but a small condo perhaps… one where they could barely afford the association dues, let alone the full mortgage once it kicked in. They go to their real-estate agent who puts them in the biggest place he can based on the every dropping standards of the mortgage broker. Somewhere up the chain S&P is stamping Joes mortgage AAA and it’s getting sold to Germans, so who cares! Lower those standards… there’s nothing to lose and everything to gain. If we have to rely on the financial sophistication of Joe and his high powered 8th grade education to save us from our next financial crisis… we ALL need to be very very worried!

  • Tom Brown

    BTW, I don’t have the stats to back me up on any of my assertions. My perspective is based on personal experience and from watching “Frontline” documentaries (they have a BUNCH of good ones on this crisis by the way… probably close to 10 now… with a new one out asking why nobody went to jail).

    But in my personal experience I can remember the frustration of getting outbid for houses time and again in 1997 (when I dropped out of the race) and again in 1999 (when I got back in). I eventually bought from my boss in a private deal, so I didn’t have to compete. And then three years later I was in the role of the “greedy property flipper” although I was thinking more long term and actually didn’t flip any properties… I just hung onto them. And a husband/wife team of real-estate agents who were my friends played their role… I recall clearly piling in their van w/ young couples looking to buy super modest condos… who could just barely be able to pay the association dues… and looking at properties. I recall my friends sending me in to their guy at Countrywide (of all places!)… and him telling me “We’re not used to doing full doc loans like in your case.” The place reeked of snake oil! I remember those 40 year, 5% down, no-doc, negative equity ARMS! (I didn’t take one, but I asked my friends how their clients could afford to buy ANYTHING at all). The median price of homes in my neighborhood hit $1M about 2003. Median! A lot of young engineers (I worked at Raytheon at the time) were wondering if they’d ever be able to get a place or if they’d be priced out forever. Yes it had bubble written all over it… but where were the financial sophisticates? Where were the regulators? Instead Greenspan was out there telling people to treat their homes like ATMs. I can remember one property appraiser who refused to go up to the price of my offer on a place… my real-estate agents and the broker were furious with him, but little did I know he was trying to do me a favor! He was definitely in the minority in this giant food chain of greed and craziness! I don’t blame those young couples (I assume they must have defaulted eventually… on their one BR condo)… I blame everyone else.

  • http://www.orcamgroup.com Cullen Roche

    Dead wrong? What in the world are you talking about? Without the mortgages there is no securitization. If you continue commenting in this manner in this section I will ban you from commenting here. I can deal with your repetitive argumentative commentary in the regular comments, but it’s just muddling the space here. Stop it please.

  • http://www.orcamgroup.com Cullen Roche

    The mortgages enabled Wall Street. Again, stop muddling the facts.

  • http://www.orcamgroup.com Cullen Roche

    I wouldn’t say 50/50 either, but to assess no blame on the homeowners is outrageous.

  • Tom Brown

    Granted the homeowners/speculators/flippers deserve some blame. But it depends on the circumstances. In my personal experience I witnessed some cases where an unsophisticated buyer just wanted to get something… anything a all (e.g. 1 BR condo)… to live in… not to flip,… probably because they were worried they’d be priced out forever and didn’t want to pay ever increasing rents the rest of their lives. A kind/wise/honest lender/real-estate-agent/appraiser in an unperverted market would have told them to wait… that the bubble would blow over eventually and not to panic and then would have denied their loan application. But that’s not at ALL what happened! In those cases I assign blame more like 10/90 to the people who were supposed to be “good with money.” And that goes for the real-estate agents right up the chain of regulators and ratings agencies to the very top. In the end those borrowers probably defaulted and ruined their credit… while most of the rest of the chain suffered nothing, and just lined their pockets.

  • http://www.orcamgroup.com Cullen Roche

    Let’s be honest. Mortgage brokers are sales people. If you go to buy a home and you assume anything otherwise then you’re incredibly naive. Like assuming that a car salesman is out to sell you the best car and not the car that earns the dealer the highest profit. Banks are in business to make a profit for themselves BEFORE ALL ELSE. They aren’t there to save the world and help you understand every line of every contract you are responsible for understanding. They assume you’ve done enough due diligence and understanding of the process to make a decision ON YOUR OWN. YOU have to sign the dotted line. NOT the mortgage broker. I agree that many of these people took advantage of others maliciously, but I just don’t agree with this view that Wall Street is somehow America’s best friend and that they’re responsible for letting us all down. Once you understand that you’ll not only be smarter, but better informed and more prudent in the future. But most people don’t want that. They want to push the responsibility out on other people so they can point the finger later….That’s part of the problem here….I am trying to help people understand all of this, but some people just don’t want to. They want to believe this la-la land story where Wall Street is everyone’s best friend and banks serve public purpose. Wake up people. That’s a load of garbage and anyone selling you that stuff is full of it. The guy selling you a car doesn’t give a rats ass whether you like the car. He just wants to sell you a car. Welcome to financial capitalism. Enjoy your stay.

  • http://www.orcamgroup.com Cullen Roche

    The really simple story is this:

    1. Housing boom takes off. Greed all over the place from homeowner who want in on the action to banks who want to make more profit.
    2. Banks make loans to huge amounts of low credit borrowers and repackage them as AAA securities.
    3. Housing trends become unsustainable, asset prices begin to decline.
    4. Asset price decline no longer justifies AAA rating on underlying securities.
    5. Credit freeze ensues as mass defaults occur.
    6. Positive feedback loop takes hold and a minor BSR turns into a full blown credit crisis as Wall Street’s leveraged balance sheet implode and lending/credit markets die.
    7. Rinse, wash, repeat?

  • JK

    What was the primary cause of the uptick in unemployment? JohnnyEvers suggests businesses lost access to credit in the process (and this seems to go along with the point by point you just offered), and that causes layoffs, i.e. businesses lost access to the amount of credit they needed to sustain their costs. The general story I’ve heard along the lines of the BSR is that overleveraged households, once home prices collapsed, switched toward more deleveraging and less consumption, which signaled to business (via less sales) to cut costs, and employees are one of the first to go.

    Maybe it was a combination of both, but each are a very different explanation for the rise in unemployment. The first suggests that the banking system freezing up directly caused the lay offs, the second suggests that a contraction in aggregate demand directly caused the layoffs.

    Any thoughts on this?

  • Tom Brown

    I agree that all those up the chain were just trying to make a buck too. But I still can’t shake the impression I have that something went terribly wrong. It’s not just the that bank should be kind/wise/whatever, its that their SELF INTEREST should align with treating people honestly and not selling mortgages they shouldn’t. There should be consequences (financial or criminal) to their irresponsible behavior. I think banks cashed in on there stolid reputations as brick and mortar, button-up, institutions of conservative financial level-headedness to make a quick buck, and they suffered no consequences in the guaranteed ensuing meltdown. If they engage in dishonest or reckless behavior there should be a price to pay eventually. It doesn’t seem there was a price though… except for those at the bottom, and *some* of those left holding the toxic waste.

    Why didn’t self interest seem to work to keep things under control? Back in 1999 when I got “pre-qualified” it was clear I had to impress them with my creditworthiness: they wanted to see documents, they wanted 20% down, they wanted paystubs …. it was like… well what’s it’s like now! Just to refinance recently I had to jump through a lot of hoops. It made sense that people extending me LARGE amounts of credit (relative to my income) would be highly interested in making sure I was a good risk. It seemed like it was in their self-interest!

    What happened between 1999 and 2002/2003 when all that went out the window? Why was it suddenly in the lenders’ interests to make as many crap mortgages as possible and move them out the door ASAP?

    It’s as if banks suddenly transformed from respectable pillars of the community, keeping a lid on financial over-exuberance (again, ultimately for their own self interest), into wild drunken ponzi schemes overnight. It’s no wonder that it caught many of us off-guard.

  • http://www.orcamgroup.com Cullen Roche

    As usual, businesses fire people when their sales and margins get squeezed. Sales peaked in Oct 2007 as the unrate troughed. Lending didn’t actually peak until after that. So there were a lot of moving parts there, but I presume businesses pull in the reins when they saw their sales start to decline as a result of consumers who were becoming fearful about their personal balance sheets. But I wouldn’t definitively say that the two events weren’t related or occurring at nearly the exact same time. In fact, I am surprised that lending didn’t turn down at the same time as sales. So I don’t have a clear cut answer here. Sorry.

  • Tom Brown

    Cullen, how would you respond to David Beckworth in this very short (old) article wherein he describes how he stopped believing in the BSR and instead believes a different story now:

    http://macromarketmusings.blogspot.com/2011/01/do-we-really-have-balance-sheet.html

    Is he just being confused by the false neo-classical “loanable funds” model? That’s what it sounds like to me.

  • Tom Brown

    Along those lines, I pointed out to Nick Rowe recently an example where x buys a house from y, but nobody had money on their BSs in the 1st place, so how was the bank acting as an intermediary between savers and spenders? He pointed out that y could have accepted an IOU from x directly, and thus the bank WAS acting as an intermediary. I complained that while that was true, it fails to recognize that in the IOU case, y would be receiving all the interest payments (which are considerable) as well as slowly getting the principal back, whereas if the bank is an “intermediary” then y gets all the principal (and 0 interest) immediately and perhaps uses it at that time in his spending plans… while the bank is the one that collects the interest… and the principal component of x’s payments only work to shrink the bank’s BS. The reason I bring this up is in relation to Beckworth’s article above. No I’m not really sure where I’m going with this line of thought, but it seems like Beckworth is glossing over this fact.

  • Steve W

    This whole thread about the real estate bubble and financial crisis is excellent (except for some of the muddling). As to apportioning blame, I feel compelled to include Congress. Barney Frank and his friends seemed to think that everybody should own a home. Banks were told they were not doing enough loans to lower income borrowers. Pleas to reform Fannie and Freddie were largely ignored. Amazingly, all sorts of people (in government, in banking, on Wall Street) actually were saying that the USA had never experienced a uniform, across-the-nation significant decline in residential real estate values. I don’t think it really matters if that’s even true. If they’d just looked at the ugly correction in southern California in the late 80s — which took more than ten years to recover, they should have realized the risks were much higher than advertised.

    The rating agencies were blessing pools of crap with AAA ratings. Banks were greedy. Developers and builders were greedy. Realtors, mortgage brokers piled on too. As Cullen has pointed out a few times in this thread, consumers were greedy too. If not greedy, they were unrealistic. A good friend of mine lives in California. She thought she’s was missing out on an opportunity — and pretty much hit just right. By that I mean she bought at the peak, did a simultaneous first and second mortage, and bought too much house. She had a good job, but the payments (interest only mortgages — of course!) were a stretch. She did get a roommate to help. With no equity and very little emergency savings, she was in trouble very quickly when she lost her job.

    I remember people saying “you can never go wrong with real estate”. Really? Never? Naive statements like that are not the banks fault. I’m a financial advisor (stock broker, if you like) and some of my clients were liquidating their portfolios to buy houses. I don’t mean investors with $2 million putting half of that in real estate. That was happening, but more troubling were the people with a few hundred thousand (or less) in their accounts putting it ALL in real estate — because they just knew “it was different this time” and that “they couldn’t lose on real estate”. Much of the conversation then reminded me of the tech stock frenzy in the months just before it blew up. Capitalism isn’t pretty sometimes. People are stupid sometimes. Congress is stupid most of the time (just kidding).

  • Tom Brown

    A lot of good points here all around. I never really understood the Barney Frank connection though. I realize that even going back to the Carter days there was an attempt to do something about “red lining” which IMHO was a terrible injustice. Again, IMHO there was an attempt by the political interests of those in the financial sector to figure out a narrative that blamed Carter, Clinton and the democrats in congress for the whole mess. I do blame Clinton especially with the 1999 and 2000 bills getting rid of Glass-Steagall and deregulating derivatives, but I don’t lay this all to rest in Barney Frank’s hands… the Dems took over the House in 2007 (the vote was in 2006)… that wasn’t a lot of time to destroy everything… I think the market peaked in my area in 2006 (A guy on my bock bought a 1400 sq ft house built in 1963 for $948k that year… while some of the original residents were still there that had paid $20!). He’s still in the house, but I think he hit it at the very peak. I can’t blame Barney for that!

    OK, but what do I know. I haven’t followed all the evidence against Barney, so maybe you’re right… maybe he did do some damage… I’m just thinking of the Limbaugh/Hannity/etc argument that came out right after: Isn’t it terrible what Freddie/Fannie/Barney/Dodd/Clinton/Carter did? That just really made me laugh. I agree with a lot of that, but It’s a very selective examination of the evidence. I think a lot of that goes back to the congressional commission set up to look into what happened. As I recall they ended up issuing three separate reports: one for the liberals, one for the conservatives (a minority by one member) and one for one guy who had to issue his own completely separate report. If you read that thing (I skimmed it) it’s his (super) minority explanation that became the talking points in all of right wing media. It laid the blame solely on the Dems and their “good intentions.” It completely exonerated the banks.

  • Tom Brown

    Sorry: $20k not $20! Ha!

  • http://www.orcamgroup.com Cullen Roche

    None of the MMers understand banking. For instance, DW says banks receive some money balance when loand are paid, but this ignores the fact that banks dont lend out money they have. Loans create deposits and repayment of loans destroys deposits. Banks earn a profit by charging interest so if borrowers dont repay loans the banks dont get paid. There’s a very fundament misunderstanding of banking across MM and its a huge hoke in their work.

  • Johnny Evers

    I’m making a point that you are not addressing.
    It was the securitized mortgages falling in values that led to a liquidity crisis among banks that were leveraged to the hilt owning those things. True or not?
    Without the MBS, and without the leverage, the system doesn’t crash? True?
    There’s a flaw in your logic that ‘without the mortgages there is no securitization.’ The latter does not necessarily follow the former.
    My other point is that when the homeowner fails, he suffers a loss, but it’s usually constrained to him.
    But when the bank failed, because of their own reckless actions, we all suffered.
    So how can we blame the homeowner?

  • http://www.orcamgroup.com Cullen Roche

    I agree entirely Steve. There’s plenty of blame to go around. Odds are, if someone is trying to blame one party only then they’re just playing politics….

  • Tom Brown

    Here’s what I’m talking about: Peter J. Wallison’s one man dissenting report at the bottom:

    http://fcic.law.stanford.edu/report/conclusions

    Read that or skim it, and then go on youtube and watch Hannity from that time period cover the talking points from this report verbatim. It’s pretty striking.

  • http://www.orcamgroup.com Cullen Roche

    Johnny, I’ve discussed the securitization problem a trillion times here. Its central to the BSR. As usual, you dont read everything before you comment. And now you’re veering the convo off course to whatever is Johnnys gripe of the day.

    It takes two to tango. If you find no blame in the homeowner enabling the banks then fine, but banks dont make loans and leverage themselves up unless a customer enables them to do so.

  • Tom Brown

    Cullen, you write “None of the MMers understand banking.” … regarding Sumner and Beckworth here I’m inclined to agree, but I think some have a glimmer… or more than a glimmer. Glasner and Rowe, for example, seem to understand quite well that “loans create deposits” and that the money multiplier is hogwash (at leas Glasner does on this latter point). They will also admit that the “stock” of bank-money is “demand determined” at least in the short term.

    Call me a fool for trying I guess, but I’m very much interested in seeing how different camps view each other. I think at least some of the MMers do understand and might even agree with the basic MR framework. For instance, I got into a long discussion with a guy going by “dtoh” on Sumner’s site, whom Sumner seems to agree with on pretty much everything, and yet I tried to pin him down and see where he went off the rails (that is dtoh) MR paradigm wise, but I really couldn’t. Perhaps you could have, but I did my best.

    In case you’re really bored, my long interchange w/ “dtoh” starts here:

    http://www.themoneyillusion.com/?p=19141#comment-225110

    I thought Mr. dtoh did a much better job of explaining MM than any of the rest of them BTW. Sumner even admitted that perhaps dtoh’s way of looking at things (which doesn’t require what I called “Physical Cash Mysticism” or a hot potato effect) is perhaps “more marketable.”

  • Johnny Evers

    I’m not trying to get myself run off here, I’m really just trying to understand …
    How do you blame the homeowner for what the banks did with the mortgage? When my home fell in value, and I kept making the payments, why is it my fault that the banks somehow figured to lose big-time money on that deal?
    You’ve written that the bank wants to make money first and foremost — well, when they lose money because of their own misjudgement, isn’t that entirely their fault?
    I mean, if you buy Apple stock at 700, lever yourself to the hilt, and then lose big-time when the stock falls, do you blame Apple, or do you look in the mirror?

  • Tom Brown

    **Warning: smart ass comment to follow**: Ponzi schemes also require require two to tango. Sure it’s partly the chumps at the bottom to blame for participating, but the scheme relies on finding a never ending supply of said chumps. Some of the “middle layer” chumps (property flipper) are perhaps more to blame since they could probably see what was happening, but decided to continue anyway. OK, sure perhaps that’s an unfair comparison if the banks didn’t actually engage in illegal activity, but for the most part we’ll never know since the statute of limitations has run out on most of the potentially indictable crimes so it’ll never get brought before a jury. After the S&L crisis, this was not the case and a lot of juries sent bankers to prison for fraud. What’s the essential difference between the S&L crisis and 2008? IMHO it’s a matter of scale, and the gov was just too worried they’d destabilize the situation more by going after some of these guys.

    Am I arguing that banks are evil? No! Am I saying it’s all their fault? No! But if there are no consequences for such key players in what happened, what’s to prevent this from happening again? Perhaps the answer is, like you suggest, it’d be incredibly naive at this point to trust any bankers to do anything but go for short term gains… (I would think Goldman Sachs clients have got to be thinking that in light of some of the recent stories that have come out about what they think of their “muppet” customers) … the implication to me being that we should view them (bankers/banks) with maximum skepticism and think of them as no better than shifty, double-talking used car salesmen. Wow though… that’s so cynical!… I think it’d be better for all of us if they could reclaim their reputation as entities, which acting in THEIR OWN SELF INTEREST, were naturally long-view oriented and conservative. Who act, again in their own self interest, as the wary gatekeepers of credit. If we need some more laws and tough regulators and maybe to bust up TBTF banks to get us there, then that sounds good to me!

    Fining the banks a few hundred million doesn’t seem like a big consequence since the shareholders just end up paying those fines. And corporate governance (as John Bogle points out again and again) is in such a bad state, that again, the board’s of directors ultimately DON’T dish out any consequences for these fines to management.
    **Smart Ass Comment Mode Off**

  • http://www.fanbrowser.com/ Cowpoke

    “Let’s be honest.”?? Yes, Let’s REALLY Be Honest, The Legalize Speak in our Litigious society is outa control.
    Just look at all the disclaimers labeled everywhere for fear of law suits.
    To simply say that someone should be responsible for understanding what they are signing or buying is not taking into account the difficulty OR time in actually understanding all the Legalize rhetoric that the multi billion dollar Legal Industry has put in place to distort and confuse the common folks.

  • http://www.fanbrowser.com/ Cowpoke

    Thanks for that Link Tom, I wonder if a REPO of some sort is mandated?

  • http://www.fanbrowser.com/ Cowpoke

    Cullen,
    You switched to Samsung a while back and did a write up. If you have time, would you be so kind as to post some new experiences and opinions using the Samsung?
    Thanks

  • http://www.orcamgroup.com Cullen Roche

    Who do you think buys all those securitized products from Wall Street? You’re acting as though Wall Street’s main customer isn’t the American consumer. All these people who complain about big bad banks are enablers. They have bank accounts, brokerage accounts, love ATMs, trade stocks, have a mortgage, etc….show me someone who hates banks and I’ll show you a bank customer.

  • hangemhi

    Samsung what? The phone? I’ve got the Galaxy S3 and not particularly happy. All reviews seem to be of the hardware – yes, all great. But the experience – the software – has really ludicrous failures. For example, the screen is large, but the apps don’t make use of it. I’m in my late 40′s and I now need reading glasses for very small print – I mean very small still as my eyes aren’t bad enough to wear glasses for most things. Well, the apps and widgets text is so small I can’t tell what it is unless I recognize the icon. That’s the least of it. In both email and websites if you want to make text larger it does not adjust to fit the text to the screen so you have to scroll back and forth over and over again to read. Then there’s the auto spell – if you type too fast it thinks you’re finished with the word and starts creating a new word. Then if you delete to get back to where the word left off it doesn’t recognize that you’re re-starting the word, so it starts suggesting new words – like “wo” and then going back to write “rds” for words – it thinks you’re writing a word starting with rds. In sum, I’m really disappointed with the Galaxy S3 and am unlikely to buy any other Samsung product (my last Android was an HTC Thunderbolt and was a far better experience).

  • Tom Brown

    “show me someone who hates banks and I’ll show you a bank customer.”

    Nope. Credit Union actually.

    …Ha! No, I’m kidding! Good point!

  • Tom Brown

    … however, weren’t a lot of the customers of those securitized MBSs Europeans rather than Americans? Germans in particular. You know how *those people* are! Ha! ;)

    Actually one account I heard about this is that the Germans actually responsible for buying a lot of this stuff were fairly low level types who really didn’t make much money off the deal. They were fired of course (so they suffered some consequences!). Any truth to that? I think I read it in that book called “Boomerang” by the guy that wrote “Moneyball.”

  • http://www.orcamgroup.com Cullen Roche

    HH, one of the best things about the SG3 is the open source platform of the Android system. Try changing fonts under settings, font size and downloading something like SwiftKey keyboard. That will solve a lot of your problems. Odds are, if you don’t like it the app store has an alternative for you. Most of the default stuff on the phone is not optimized to everyone. I changed a huge amount of stuff on my phone before I loved it.

  • http://www.orcamgroup.com Cullen Roche

    Also just got a Nexus 7. It’s rendered my ipad useless…

  • http://www.fanbrowser.com/ Cowpoke

    Cullen, what do you mean by ” It’s rendered “by” ipad useless? Do you mean My instead of By? and if so, Why?
    If you have time can you please do a write up on your Blog about this?
    You see, it is Tax Time and after visiting the Tax lady for our family Business we are going to have to Spend More Profits this year on Technology or else pay it to Uncle sam. So any Opinions/Reports on Samsung Galaxies VS Ipads are greatly appreciated from a business perspective.

  • http://www.fanbrowser.com/ Cowpoke

    Yes, hangemhi The Phone and other Tablet products. I just did Taxes and because of profit have lost a lot of capital to Govt. Won’t happen this year. I need to ramp up spending in tech needs otherwise I will just give to Govt. So should I spend on Samsung or Apple?

  • Tom Brown

    I started to read Wallison’s report again. It’s not as crazy sounding or partisan as I made it out to be (he blames both the Bush and Clinton admins), but so far I still disagree with two of his major findings:

    “This dissenting statement argues that the U.S. government’s housing policies
    were the major contributor to the financial crisis of 2008.”

    and

    “Deregulation, lack of
    regulation, predatory lending or the other factors that were cited in the report of the
    FCIC’s majority were not determinative factors.”

    Minority opinions for sure, but probably worth more than a skim through if you’re really interested in this stuff.

  • Andrew P

    A new ZH article shows that all the QEternity cash has ended up as deposits in US subsidiaries of EU banks.

    http://www.zerohedge.com/news/2013-02-09/feds-bailout-europe-continues-record-237-billion-injected-foreign-banks-past-month

    Is this a stealth bailout of Europe? Is this propping up the EURUSD price as the article claims?

  • Tom Brown

    Here’s what Wallison had to say about predatory lending:

    “This [predatory lending] undoubtedly occurred, but it also appears that many
    people who received high risk loans were predatory borrowers, or engaged in
    mortgage fraud, because they took advantage of low mortgage underwriting
    standards to benefit from mortgages they knew they could not pay unless rising
    housing prices enabled them to sell or refinance.”

    … so he’s saying it may have been “predatory borrowers” just as much as “predatory lenders” … well I guess it does “take two to tango.” Ha!

  • jt26

    As in bankruptcy law, I’d say the onus (blame) is ALWAYS on the lender (except student loans).

  • auresdemulo

    Cullen,
    I’m sorry if I seemed to be trying to steal your thunder. The fact is that as a novice with MMT and MMR I’ve needed a place where there were “authorities” on MMT and MMR to test my ideas with. That I mentioned MMT was because I thought I was responding to MMT questions. I have to tell you that I learned more about what I regarded as MMT from your essay on MMR, especially the sector balances, than from some of the other writers on MMT. And it would help me, if you think I am not correct factually in some of the things I assert if you would point out and explain specifically what those are. And I think others would get something from that. After all your responses are very clearly marked and distinguishable from mine and the others. So, no body should think that my answers are authoritative, however much my academic training has led me to write in an authoritative manner. Actually, until someone points out the contrary to what I assert and has good evidence and explanations to back it up, I continue to believe on the best of my knowledge that I am right. Anyway, sorry again. It’s your blog.
    That said, I do have a couple of things to ask you.
    (1) On sector balances. (G – T) + (S – I) + (X – M) = 0. For others here
    G = government spending
    T = tax revenues collected
    S = private savings
    I = private investment from savings
    X = inflow of money from exports
    M = outflow of money from imports
    What about private bank lending L and loan redemption R?
    I once saw a remark by someone on the web that many people were not consuming because they were paying down their debts, either mortgage debt, credit card debt or college loan debt. And right now this was contributing to how slow the economy was recovering from this recession. Of course deficit spending could be increased to the point where it cancelled out the effect of paying back of loans and then began to
    positively increase the money supply in circulation if put into the hands of workers who would start buying goods and services and stimulating businesses to expand and hire more workers. So, could we write by extension
    (G – T) + (S – I) + (X – M) + (L – R) = 0 ?

    (2) Second point: Have you ever seen the book by the now deceased ecologist Howard Odum “Environment, Power and Society”, which was published by Wiley in 1971 (a key year for MMT and MMR). Odum discovered that thermodynamics could be used to analyze the ecology of biological environments. He used flow diagrams very much like Steve Keen does, but he was describing the flows of energy from exogenous high concentration sources like the sunlight to low endogenous “sinks”. But for us here, his chapter on “Power and Economics” is most relevant:
    “Money is a special currency evolved to allow the production of one person to be rewarded by a feedback loop from some other part of society. Some authors have compared money to energy, but the two are not the same and they flow in opposite directions. We receive food from the grocery store by passing money in the opposite direction to the grocer. We receive money when we put energy into work that makes an energetic contribution to the function of at least one other unit. The money system keeps its members contributing useful work for the network and money provides a means for organizing energy flows. Money circulates whereas energy flows are unidirectional. (Odum, 1971, p. 174). In terms of MMR, he is dealing with a physical, thermodynamic system, and he sees even our money based economies as physical thermodynamic systems. It takes energy to move money around, but in feedback loops. Interesting concept. I think Odum is going to be rediscovered any day now. Once the Steve Keens see that their flow diagrams correspond in many ways to thermodynamic flow diagrams for the same phenomena but flowing in the opposite directions in feedback loops, we’ll see how to ground economics on physical reality.

  • Jonathon McKitrick

    Then how do the overnight rate and the market rate affect the rate on the face of the bonds that are auctioned by the Fed, which supposedly affect the ability of the government to service its debt?

  • Tom Brown

    For anybody who followed the recent debate in this section over the weekend regarding apportioning blame between banks and borrowers for the financial crisis, I found the following (somewhat dated now) interview with John Bogle, retired founder of the Vanguard Group of mutual funds and inventor of the low-cost index mutual fund, to be interesting:

    http://www.youtube.com/watch?v=mA62qqiYZWU

    What John talks about here is not directly related to the debate (he doesn’t discuss the housing bubble or lending practices — the crisis may not have even taken place yet at the time of the interview), but in a more general sense I found it to be very interesting.

    His comments touch on both sides of the debate and support both positions to some extent. On the one hand his description of the role of Wall Street echos Cullen’s comments about not being naive. On the other hand, he has witnessed (over the last 50+ years he’s been in the business… I think he said he started out in 1951 or so) that business ethical standards have declined tremendously.

    John is not some radical bomb-throwing, bank and corporation hating anti-capitalist loudmouth. In my view he’s a super conservative financial services insider, primarily focused on providing low-cost investment options to the public (Vanguard, which is owned by the mutual funds it manages — which I believe is a a unique arrangement in the industry — is famous for its emphasis on offering low cost index funds).

    He covers a lot of ground in this interview, and apparently there’s a book he’s written that goes into more detail (published in 2005). But let me try to summarize a few of the major points he covers

    1. Ethical standards in the financial services industry are much lower than they used to be.

    2. Corporate governance is in a terrible state of affairs. Completely unlike in the past, the owners today are mostly passive (mutual fund clients and beneficiaries of pension funds for the most part), boards of directors have conflicts of interest and are not doing their jobs, and management has grown tremendously more powerful, and is using that power to enrich themselves at the expense of shareholders.

    3. The “fiduciary mindset” has been greatly diminished. What he means by “fiduciary mindset” is the sense of responsibility to look out for the clients’ interests in the financial services world. For example, this is what’s missing from the boards of directors I mention in 3. above. This is also true in the “bizarre” relationship between mutual fund management companies and the funds they manage. He gives the example that management companies charge their (on average) 1.5% fee not matter their size, however economies of scale are at play, and thus the actual cost per share of a $1T fund is much less than a $10M fund, making the 1.5% fee difficult to justify if the “fiduciary mindset” were really at play.

    4. The difference between the real state of businesses (the “business market”) and the expectations market. His point here is that management has found that improving the business market is difficult, but managing the expectations market is a whole lot easier. For example, by doing something as simple as bumping up the expected rate of return on the employees’ pension fund from 7% to 9%, a company’s future earnings could be improved from being -$400M to +$1.2B, and this in a year when the value of the pension fund dropped by a huge amount! (His example here is Verizon in 2001).

    5. Management is compensated based on the expectations market more than anything else, and they can effectively take HUGE compensation based on questionable assessments. As long as they “meet expectations” every quarter they get their bonus and stock options (which they cash in immediately… often they’re just issued a “difference” check between what they would have paid for the stock and the value the company puts up to buy it back)… even though those numbers are often revised downwards later. Management does not have to pay the price for these later revisions. The amount that pours into management stock options is immense, and ends up, because of accounting and legal tricks, diluting the shares of the common stockholders tremendously.

    6. Legislatures are easily (and super cheaply!) co-opted by the financial industry. Buying influence in congress is one of the best returns on investment the industry has, and that’s why some of these rules favoring management over the interests of the shareholders have persisted.

    7. Investors have been replaced by speculators for the most part. The average time a mutual fund holds a stock has declined to about a year. He calls them “stock renters” rather than “stock owners” and their concern for corporate governance has declined as a result.

    The way I’ve paraphrased his points here comes off sounding a lot more er.. like a bomb-thrower than he does… I purposely tried to tone it down to match his calm tone, but I still came off a little strong.

    … he covers many more points, and like I say the interview is somewhat dated, but I found it too be well worth listening to. A more hyperbolic interpretation of these same topics would surely have come from a Michael Hudson or a Bill Black, but in some ways hearing a calm, level headed, analysis of the sad state of affairs from someone like Mr. Bogle is even more sick-making.

    Enjoy!

  • Johnny Evers

    Exactly to jt26 and tombrown.
    WHen I am lending you money, and then leveraging that loan in a MBS, the onus is on me to do my due diligence and get it right. It’s too rich to see bankers blaming borrowers or credit agencies or Barney Frank for their losses, especially after we bailed out the bankers and not the borrowers.

  • Tom Brown

    and by “ethical standards” he emphasized that he didn’t mean “ethics.” He literally meant that the bar has been lowered for what you need to do for it to be considered “ethical.”

    Also, fast forwarding till today, John has 62 years experience in the industry!

  • Tom Brown

    Is anybody else having problems with an “Unresponsive script” message box popping up every few minutes?

    I’ve seen this on two different machines and two different networks now.

  • SMOB

    What does the Fed do with the income it makes each year, if it is distributed, then to whom? Who (actual person) if any at the ‘end’ get actual Dollars from those profits?

  • http://www.orcamgroup.com Cullen Roche

    The Fed remits all profits at year-end to the US Treasury, ie, the US taxpayer.

  • auresdemulo

    I think you are misreading what I say. My intention was that when the Treasury had to cover Congress’ deficit, it issued securities. These were sold to the banks at public auction. Banks got securities and Treasury got its money. Then banks put the securities back up for sale at auction and the Fed bought them with newly created money (out of thin air), which also redeemed the debt of the U.S. to the banks. The money the banks got equaled the money the Treasury got. Money being fungible you might say that Treasury has the new money. But as a result of the deficit spending needs of Congress new money gets injected in the economy if the Fed buys the securities from the banks, which it inevitably will do.
    That is what is meant by saying “effectively creates new money and issues it” which I thought most MMR’s and MMTers would understand: there is a causal chain that runs from deficit spending through Treasury to banks to the Fed creating corresponding new money and putting it into the economy. (I didn’t say that deficit spending directly created new money. I know that; I thought you’d understand my meaning. But the effect is to end up with equivalent amounts of new money injected into the economy.) I’m sorry if I don’t know the distinctions you are making between MMT and MMR. Please explain how these apply to my comments here. Are you denying that it happens the way I say here? Even learning that would be important to me. That’s why I want to participate here. (That was a question).

  • auresdemulo

    Tom, I’m currently reading Ives Smith’s book “ECONed”. She documents numerous cases of greedy, unethical behavior in the financial sector. She connects traditional economists and their emphasis on ‘free markets’ and “equilibrium” as contributing to the breakdown of ethics in capitalist financial markets.

  • auresdemulo

    Cullen, what constitutes the profits the Fed remits? Is it just the interest on the securities? Is it any and all money it received from the Treasury paying off securities with taxpayer money? The Fed gets 6% of the interest on each security it buys as a transaction fee to support Fed operations and avoid depending on appropriations from Congress.

    If the Fed were to get the whole value of a security plus interest from tax payers that it buys with money created out of thin air, that indeed would be an enormous profit. And who at the Fed would get to keep all that money? But if it pays it all back to the Treasury, then all it gets to keep is its transaction fee and maybe even less than that if operations are even more efficient. So which is it?
    As you know, I don’t think the Fed can claim the value of the security as its own. It would be like a bank clerk claiming to be paid the value of a security it has bought from a bank customer, for the bank, with bank money.

  • JP Ziller

    Cullen — Do you think there’s anything clearly wrong with John Hussman’s ongoing historical-data-based reasons (repeated in every weekly column) for his bearishness? If you feel he’s off-target, how so?

  • auresdemulo

    Johnny, you need to emphasize that the securities were based on slicing and dicing the mortgages into little pieces and combining them into the MBS’s. A few AAA mortgage pieces were combined with a lot of subprime crap just to average-out their values and then sold by the bank. You are right, if a bunch of those subprime mortgages went bad, the whole security could be made worthless. The bankers thought that collecting them from different parts of the country, they would be independent and could figure the risk. But starting out with a few of those mortgages going bad, they started a cascade that rippled through the economy, making the whole lot go bad. Furthermore, as Ellen Brown, a lawyer points out, the bankers’ eagerness to sell these securities did not take into account that you had to transfer the whole mortgage to a new owner, and this needed to be registered properly, otherwise the diced securities were not in the mortgage contract. It frequently ended up that no one owned the mortgage and “homeowners” could challenge the foreclosures because the banks gave up ownership of the title when they sold the mortgages, but the owners of the securities didn’t have clear title either because, what piece does a security holder own in a home, and no clear title was properly transferred and recorded. A lot of this was ineptness by the bankers who had an erroneous grasp of the true risk of those sliced and diced securities; and of the law of mortgage transfers. Some bankers even may not have had a malicious intent at all, but it was a form of fraud in any case. The govt. of Iceland bought a whole bunch of those MBS’s and went bankrupt. And the salesmen were so knowledgeable and honest appearing. (They may not have known themselves what dynamite they were selling). So, we need to analyze these things in detail.

  • auresdemulo

    Sometimes it is the serial and combined ignorance of a lot of people who create these messes. You don’t have to attribute malicious greed to everyone. The housing industry, the banks, were dealing with products they had little experience with and further a lack of proper mathematical analyses of the true risks, and were just trusting that the wonks knew what they were creating. And in many cases, they didn’t.
    But the banks would be held responsible for the failure of the MB securities and have to pay them back. That left them with lots of toxic assets, and the banks couldn’t borrow from other banks, who were also in the same boat because no one trusted the other banks to be able to pay them back.

  • Joe in Accounting

    Cullen,

    Are you familiar with any of Anat Admati’s work? She has a new book coming out regarding bank reform in two weeks. I found this slide deck from a recent lecture she gave with a plug for her book at the end. Wondering if you had any thoughts on her description of “what’s wrong with banking” and her solutions.

    http://www.gsb.stanford.edu/sites/default/files/research/documents/Copenhagen-rev.pdf

  • Steve W

    Hi Cullen,

    In today’s WSJ, Timothy Beardson states in his opinion piece “Don’t Count on China to Bail Out the U.S.” that “the largest buyer of new U.S. Treasurys during the past three years has been…the U.S. Federal Reserve. In fiscal year 2011, for example, the Fed bought more than three-fourths of all new Treasury debt.”

    It appears that Mr. Beardson is suggesting that the Fed is funding U.S. Government spending. He also believes that while China is “going to contineu buying up U.S. Treasurys”….Beijing will not likely finance America’s mounting deficits and debt.”

    He seems to be very much out of paradigm. (He should read your “The Fed is not Monetizing the Debt” piece.)If you have time, read the article. He goes on to discuss potential problems with China’s currency, debt to GDP ratios, tax revenues, and off-balance-sheet liabilities that all may impact the amount of U.S. Treasurys that China will continue to rollover and/or buy.

    I don’t think we should be thinking in terms of what country is going to “bail us out”. Please share your thoughts. Thanks!

  • http://www.orcamgroup.com Cullen Roche

    In theory, yes, because a central bank is just a bank. It can create money from thin air. So, if central banks were used like normal banks they could issue money at 0% and create money from thin air for people in what would essentially be central bank deficit spending.

  • http://www.orcamgroup.com Cullen Roche

    Love my Nexus so much I just bought a second one. I think the switch dilemma is simple. Are you an Apple user or are you a google user? If you’re a google user then I think the Android products create a seamless user experience. The apple products can’t do it the same way because they’re not integrated with google. I use google everything so it just makes sense for me.

  • http://www.orcamgroup.com Cullen Roche

    So, all those European banks are selling govt bonds for cash and now they’re suddenly better off? I’d love to know how this simple swap of risk free assets for risk free assets makes them so much better off. I surely can’t figure it out….

  • Tom Brown

    So specifically, what steps would the Fed take, different than what they are doing now, to move us to 4% inflation? You mention dropping the interest rate to 0%, in our current situation the interest rate is controlled by setting IOER, no? So they’d drop it from 0.25% to 0%. JKH points out to Morgan Warstler in the comments to his piece yesterday that w/ ~$1.5T in ER out there, this will lead to maybe $2.5B in losses for the banks (assuming they make that much on IOER after taxes):

    http://monetaryrealism.com/krugman-on-says-law/#comment-15559

    He argues this is hardly any incentive for the banks to go crazy making loans (and thus converting a small percentage of the dollar amount of those loans from ER to RR), since the industry brings in upwards of $100B a year in profits. He mentioned some other reactions the banks are more likely to have, but none of them sounded like they’d cause inflation.

    Or are you saying that somehow the Fed skips the banks and loans directly to non-banks at 0%?

    It doesn’t sound like you’re talking about the MM idea of the Fed directly buying “non-traditional” assets (which clearly would cause inflation, but which MMers say will remain a threat and not an action), are you?

    And it doesn’t sound like you’re talking about OMOs or QE type operations… are you?

    I could see the gov deficit spending to accomplish this…. but we’re talking only about actions that the gov might take.

  • Tom Brown

    Sorry, that last line should read “only about actions that the Fed might take.”

  • Jonathon McKitrick

    Does the yield on Treasury bonds at auctions even matter?

  • http://www.orcamgroup.com Cullen Roche

    Yeah, the Fed could just make loans to people at 0% and circumvent the banking system entirely. Right now, the Fed lends to banks who then lend to you and I based on various factors. A govt that had not care in the world for lending prudently could literally just print money from its central bank and “lend” it to people at 0%. It would be like putting a money tree out in front of the White House and inviting people to pluck from it. I think that would get inflation going. :-)

  • Tom Brown

    Surely it would! … however, does the Fed really have to go that far to move us from where we are now to 4% inflation? Is this where the MMer’s might have a point: that inflation of 4% could be accomplished by threats of “non-traditional” asset purchases (perhaps backed up by a few actual non-traditional asset purchases)? Or do you consider that threat idea to be largely a fiction, and the Fed would really need to carry out the threat?

    What’s a more ridiculous idea? The Fed operating a 0% money tree for the public, or the Fed buying groceries to raise the CPI? I don’t really know.

  • http://www.orcamgroup.com Cullen Roche

    I just don’t see how the threat idea works. What’s the fundamental transmission mechanism? None of them can explain it properly. People don’t just spend more because the Fed says things. Hell, most people don’t even know the Fed exists. Maybe you understand the transmission mech better than I do???

  • Tom Brown

    No, I don’t understand it! So let’s cross that off the list. The question remains: Which is more fanciful, the 0% money tree or the Fed buying groceries?

    Or is the answer the Fed realistically wouldn’t undertake raising inflation all on its own? Is that a job better suited to deficit spending, or tax policy (i.e. reducing taxes) … I guess I’m assuming here that at least the Fed and the gov would be working as a team on this problem (the problem of raising inflation) which also may not be a realistic assumption.

  • LVG

    The Fed buying groceries is money printing. It’s the same as lending money to people at 0%. It will never happen of course so the whole discussion is stupid. Sumner doesn’t get the difference between buying bonds (which is a swap of private assets) and injecting new purchasing power into the economy through loans or money printing.

  • Tom Brown

    LVG, I won’t argue with you about Sumner and MM, but I’m not sure my original question is so silly: What if the gov/Fed, for whatever reason, determined that they’d like to move us from where we are now to a higher inflation rate. What’s the most likely way they’d accomplish that? I believe Krugman (not an MMer) has suggested in the not so distant past that a higher inflation target would be a good idea for present circumstances (the ZLB).

    Under normal circumstances (ER ~= 0), they could adjust interest rates, correct? But what do they do now?

  • http://www.orcamgroup.com Cullen Roche

    Well, Krugman would say print money. Of course, he thinks deficit spending is pure money printing, but whatever. The MMers say the Fed should tell us all fairytales about what their real powers are. Frankly, I don’t see how that works. Money creation in our monetary system is ultimately about creating new credit. If the Fed can’t do that then it’s got a problem. The govt can influence this by making private balance sheets healthier (through deficit spending), but it also can’t directly cause money creation without a design change in the system.

    So, welcome to our BSR predicament. It’s a credit based world that revolves around private banking. All these models designed around what the govt can do are backwards. They’re looking at the problem through the wrong end and ultimately misdiagnosing it. MMT comes the closest to getting all of this, but even their model is ultimately govt centric.

  • Tom Brown

    Cullen, thanks for you reply. So this is not so trivial after all then, in your opinion? Sumner is fond of stating that “no CB in history has every tried and failed to raise the inflation rate” … to make it sound like it’d be a cinch, but not so much eh? At least in present circumstances?

  • http://www.orcamgroup.com Cullen Roche

    Sumner’s world would require changes. For the Fed to buy groceries as he suggests means the Fed must be allowed to do fiscal policy. But again, I don’t see that very many of the MM guys understand the differences here mainly because banking is not even in their model.

  • Anonymous

    Just for the record, it was me that brought up the groceries!… Sumner left the progression as

    T-bills
    agency debt
    MBS
    corporate bonds
    the Earth
    and “non-traditional assets” in general
    :)

  • Tom Brown

    “Anonymous” being me. Wonder why this thing blanks out my info sometimes. It never used to do that.

  • Tom Brown

    Oh… and BTW, Sumner claims anything the Fed buys is “Monetary policy.” His reasoning is that the gov doesn’t go into debt when the Fed spends. That’s his dividing line. He gets lots of pushback on that from his commenters. “Shining Raven” comes to mind as one that seems driven to distraction by that definition.

  • http://www.orcamgroup.com Cullen Roche

    The govt doesn’t technically have to go into debt to spend either. We just choose to. So Sumner’s counterfactual where the fed can just buy anything is the same counterfactual as the govt spending without going into debt. Again, this is all covered in JKH’s Contingent Institutional Approach. If Sumner actually understood half of what MR does he’d see how his Fed program is really just deficit spending in a counterfactual world.

  • Igor Zuev

    What credit spread indicators are you following?

  • johnw

    Dear Cullen, When the treasury engages in an open market operation and a buyer happens to be a bank, does the bank swap reserves for T bonds or does it create a deposit ex nihilo for this purpose? or can it do either?

  • Tom Brown

    Cullen, what in your opinion constitutes the “macro” economy? Does the number of people involved matter, or just the fact it’s viewed from the point of view of aggregates?

    In other words, is considering an economy of two people on an island, with no interaction with the outside word, a study of a “macros economy” as long as the focus is on aggregates?

  • CharlesD

    While I am not Cullen’s, in my opinion, Hussman’s principle bearish anchor is that profit margins are at record levels. If profit margins were to return to “normal”, as they always have, profits would be 40% lower and stocks would be very “expensive”. The reason for the high profit margins are the high government deficits (which create corporate revenues with no addition to corporate costs – (see Cullen’s discussion of Kalecki, etc in his material)
    Even Hussman himself has belatedly recognized this fact but now he notes that deficits are abnormally high and should decline to “normal” levels as well. His problem going forward is that the other major determinant of profits in net private domestic investment – which has been at it lowest level (as a % of GDP) since WW2.
    Investment (which included housing) is and will likely be improving
    , offsetting much of the drag on profits from lower deficits. That
    is, profit margins may fall somewhat, but they are likely to stay
    well above average for many years. So for his bearish forecast to
    work out, multiples must fall. But with interest rates relatively
    low and economic growth likely to stay at least positive, this may
    not happen. In a nutshell, this is his problem.

  • CharlesD

    Cullen a question on currency “issuers” vs. “users”. As you have explained, we the people, corporations and state and local governments
    are currency “users” and therefore can not create net new financial
    assets, as can the Federal government. However, when, for example,
    a State or Local government issues a bond, the transaction appears on
    the surface to be very similar to a US Treasury sale. That is, the
    private sector is debited the payment for the bonds but the private
    sector also ultimately receives the credit from the spending of the proceeds of the bond issue (for roads, schools, whatever). And the private sector has a new asset – the bonds. So the private sector
    gains short-term. The offsetting longer-term debit is the debt incurred by the government.
    So while these State and Local and Federal transactions look similar, State and Local governments are “currency users” unlike the Federal government. So the question is where does the difference lie?
    Thinking it through, I think the answer is that when the bonds are
    redeemed, the Federal government does this with money created “ex-nihilo”. This redemption basically is just a swap which converts to cash the bonds which were already created “ex-nihilo” as the normal consequence of deficit spending. In contrast, the State and Local government can only pay off a bond with taxpayer revenues or additional borrowings.
    From your standpoint, is this understanding of the essential difference correct? Thanks much.

  • Tom Brown

    Hi johnw. I don’t know the definitive answer, but what’s depicted here (if correct) might answer your question:

    http://econviz.org/macroeconomic-balance-sheet-visualizer/

    The last two items in the “Choose Operation” selector pull down list (both involving “TT&L” accounts) in the lower left hand corner (and described in the accompanying notes underneath) show that BOTH happen! Econviz shows it as a two step process, the 1st being very similar to a bank making a loan to Treasury, except that instead of holding a loan document as an asset as a result on their balance sheet, the bank holds the Treasury bond. So that part looks “ex-nihilo” since they didn’t necessarily have to have reserves on hand to “purchase” the T-bill in the 1st place. The just create a TT&L account for Treasury ex nihilo in the amount of the purchase price of the T-bill.

    The 2nd TT&L operation on econviz is very reminiscent of a bank transferring a deposit in the private non-bank world. When Treasury request that their TT&L funds be transferred to Treasury’s Fed account, the bank needs to come up with those reserves to transfer. The end result of both steps though is as if the bank just purchased the T-bill directly with reserves.

  • Tom Brown

    Hey Cullen, looks like I’m free of those annoying script errors today!

  • http://www.orcamgroup.com Cullen Roche

    Au,

    The Fed’s profits are mostly the interest they earn on the securities they own. And yes, it amounts to a large amount of income.

  • http://www.orcamgroup.com Cullen Roche

    Hussman takes much more of a long-term value approach whereas my only long-term model essentially comes down to “stay bearish long enough and you’re fighting extremely powerful progressive human trends”. Ie, a permabear approach is fighting the tide of human progress, which to me, is very silly. So, you have to be more tactical in your approach to risk management. That means I take a shorter view on things with regards to how I position my portfolio for negative disruptions in the markets.

    I don’t pretend to be able to forecast out more than about a quarter in advance and I think many investors make the mistake of building a portfolio around the idea that they can predict where markets will be in 1 year, 3 years, etc. Hussman has, in my opinion, succumbed to fighting very positive trends for too long so he’s suffered from what I discuss in the first paragraph.

  • http://www.orcamgroup.com Cullen Roche

    I am not familiar with her work. I’ll look into it though. Thanks!

  • http://www.orcamgroup.com Cullen Roche

    Right. Well, the key here is understanding how the US banks can essentially fund the US govt all on their own. If you study the auction data each week you’ll notice that the domestic banks tender enough to take down all of the auctions on their own. You could eliminate all the foreign buyers and it wouldn’t matter. We don’t need China to buy the bonds. We don’t need the Fed to buy the bonds. And yes, when QE2 ended the banks were able to digest auction results no differently than they were during QE so the idea that the Fed is funding the govt is wrong in my opinion.

  • http://www.orcamgroup.com Cullen Roche

    Probably not as much as the press makes it out to sound. The price of govt bonds is set in the market every minute of every day. The auction price is essentially some deviation from the market price to some varying degree.

  • http://www.orcamgroup.com Cullen Roche

    The only one I look at with great regularity is the Merrill Lynch US High Yield Master II Option-Adjusted Spread.

  • http://www.orcamgroup.com Cullen Roche

    The study of macro is the economy in its aggregate. It is the 30,000 foot view. And yes, if that world only involves 2 people on an island then you can still view it from 30,000 feet.

  • http://www.orcamgroup.com Cullen Roche

    Great news Tom. Sorry about that.

  • Tom Brown

    Ha! .. I glossed over the “open market operation” in johnw’s comment and assumed he meant a Treasury auction at which a bank buys a T-bill.

  • Tom Brown

    Has anybody ever taught chimps to use money? Are they capable of it?… I could imagine that they might be able to decipher the numbers on paper bills , and then use them to operate a vending machine for example. After all, they’ve got the same “digits” we have to make their digital, base 10 calculations, right?

    If so, it seems like a good place to perform an economic experiment with a captive group in a necessarily “primitive” closed economy. Let’s put some of these economic theories to the test!

  • Tom Brown

    I think this answers my question:

    http://www.pri.kyoto-u.ac.jp/ai/intra_data/MatsuzawaT/The_use_of_tokens_as_rewards_and_tools_by_chimpanzees.pdf

    The part I find worrisome is:

    “So, although we know that chimpanzees can work for exchangeable
    tokens, an empirical question remains to be
    answered: can chimpanzees perform an intellectually costly
    task reinforced by tokens?”

    I think this paper answers this question in the affirmative, which means I now have more competition for my job! :)

  • auresdemulo

    Cullen,
    Several weeks ago you said this in a post: “The Fed doesn’t create Federal Reserve Notes. The US Treasury does. The US govt allows the Fed to issue the notes to its member banks.”
    My concern is with the word “create”. Chairman Bernanke has said that the money the Fed spends comes from digital strokes on a keyboard. That is a nice way of saying “create out of thin air”. I heard an interview on PBS around 2010 of several young bankers in a room at the Fed doing quantitative easing. They were buying toxic assets with money they created out of thin air by entering the money required to buy them in their spreadsheets. “Created out of thin air” was their term.

    Then I’ve heard others say that the Fed creates money and issues it.

    So, in what way does the Treasury “create Federal Reserve Notes”?

    Then there is this in the U.S. Code:
    12 U.S.C. § 411 : US Code – Section 411: Issuance to reserve banks; nature of obligation; redemption
    Search 12 U.S.C. § 411 : US Code – Section 411: Issuance to reserve banks; nature of obligation; redemption

    Federal reserve notes, to be issued at the discretion of the
    Board of Governors of the Federal Reserve System for the purpose of
    making advances to Federal reserve banks through the Federal
    reserve agents as hereinafter set forth and for no other purpose,
    are authorized. The said notes shall be obligations of the United
    States and shall be receivable by all national and member banks and
    Federal reserve banks and for all taxes, customs, and other public
    dues. They shall be redeemed in lawful money on demand at the
    Treasury Department of the United States, in the city of
    Washington, District of Columbia, or at any Federal Reserve bank.

    No mention here of getting notes from the Treasury.

    2 U.S.C. § 414 : US Code – Section 414: Authority of Board of Governors respecting issuance of notes; interest; lien
    Search by Keyword or Citation

    The Board of Governors of the Federal Reserve System shall have
    the right, acting through the Federal Reserve agent, to grant in
    whole or in part, or to reject entirely the application of any
    Federal Reserve bank for Federal Reserve notes; but to the extent
    that such application may be granted the Board of Governors of the
    Federal Reserve System shall, through its local Federal Reserve
    agent, supply Federal Reserve notes to the banks so applying, and
    such bank shall be charged with the amount of the notes issued to
    it and shall pay such rate of interest as may be established by the
    Board of Governors of the Federal Reserve system on only that
    amount of such notes which equals the total amount of its
    outstanding Federal Reserve notes less the amount of gold
    certificates held by the Federal Reserve agent as collateral
    security. Federal Reserve notes issued to any such bank shall, upon
    delivery, together with such notes of such Federal Reserve bank as
    may be issued under subchapter XIII (!1) of this chapter upon
    security of United States 2 per centum Government bonds, become a
    first and paramount lien on all the assets of such bank.

    I haven’t discovered everything that may be in the code about the
    Fed and its Notes. So, I don’t know if this is the last word.

  • Johnny Evers

    Where is this federally created money? Is this money what we call reserves? Can this money reach the private sector? Can it be used to retire debt?

  • CharlesD

    Cullen, thank you. If I may express your words with my words: Because a state, when issuing a bond, has an “inside” liability, it can only be paid off with taxes or additional borrowings. In contrast, the Federal government redeems bonds “ex-nihilo” or, as you put it, “by typing numbers into an account”. This Federal redemption is just an asset swap because the Treasury bonds were already created “ex-nihilo” as the normal consequence of deficit spending. Thanks to your response I think I “got it”. But I want to make sure I understood you correctly. Is my interpretation basically correct? Thanks.

  • johnw

    I did Tom, and apologise for the confusion. my question,as corrected, is therefore repeated.

    Thanks, however for your replies.

  • Tom Brown

    johnw / Cullen,

    I still haven’t figured out how the “recent comments” links work. It seems the comments listed in the box are a function of which page I’m on (e.g. pragcap.com, ask-cullen, any of the articles, etc.).

    I was trying to find johnw’s comment that showed up in the recent comments box I see when I’m in “Ask Cullen” that starts like this:

    “I did Tom, and apologise for the confusion. my question,as corrected, is th ”

    but I can’t find it! Clicking on it doesn’t get me there. It doesn’t seem to be present on previous “Ask Cullen” pages either. Anybody know how this thing works?

  • Tom Brown

    After posting this, it works now. Problem (but not the mystery) solved for now.

  • CharlesD

    Hi Cullen when I explain MR concepts (thanks to you) to my acquaintances, they generally get it – if they are open-minded – so you are having an impact – one by one. One question they ask, however, I can not adequately address. I explain that the “National Debt” is really just a private sector saving account, representing securities which were created as a normal consequence of past deficit spending. So, for example, if hypothetically no more debt were added, when these existing securities mature the government would simply credit the Treasury holder’s “checking accounts”. No tax money nor additional borrowings would be necessary. And, as you have explained, no additional financial assets would be created. The private sector gains the cash but loses the bonds. The question I can’t answer is ”
    if no taxes or additional borrowings were used to make this “credit”
    (my understanding is that it would be ex-nihilo) then in the “real world” of government accounting, what is the government debiting for
    this payment of cash for the maturing Treasury securities? That is, if
    they are not debiting tax revenues or additional borrowings, what do
    the government accountant’s debit for this ex-nihilo payment?
    Thank you much for any insights which would help me and others. .

  • Anthony Henson

    Hi Cullen,
    I wanted to thank you for the link to James Montier piece on hyperinflation. I really enoyed Mr. Montier’s opinion about what creates hyperinflation. I had a question: when Mr. Montier says that the money supply is endogenous, and interest rates are exogenous, what is he saying? This may be a stupid question, but I’m really trying to understand Mr. Montier’s argument.

  • http://www.fanbrowser.com/ Cowpoke

    Cullen, here is a Federal Reserve Response to my question on Excess Reserves.. I am Speechless.. No wonder people have no trust in these institutions. Heck how more simple could I have asked the question?

    Dear Mr. Cowpoke:

    Thank you for your recent correspondence to the Federal Reserve Board in which you asked “Can a Bank loan out to the public in the form of “CASH”, “EXCESS” reserves that it has on it’s account with the FED?”

    Unfortunately, we do not have enough information at this time to assist you. Please use the “Contact Us” form to provide more detail regarding your question, and we will be better able to help.

    Sincerely,

    LOD
    Board Staff

    Original Email Content:

    Following is the original e-mail received:

    First Name: Cowpoke
    Last Name:
    E-Mail:
    Profession:
    Organization:
    StreetAddress1:
    StreetAddress2:
    City:
    State: **
    Country: US
    Postal Code:
    Referring URL: https://www.google.com/

    E-mail Content:

    Can a Bank loan out to the public in the form of “CASH”, “EXCESS” reserves that it has on it’s account with the FED?
    Thanks

  • Knives Knelson

    Hey Cullen! I came across this interesting article from stone McCarthy that the Fed will have to raise their Discount Rate to 4.5% by December 2013 to remain profitable. Anyways does the Fed have to be profitable? Is that an actual constraint? I would love your thoughts on the piece:

    http://www.zerohedge.com/news/2013-02-19/feds-d-rate-45-dec-31-2013-and-dropping-fast

  • Steve W

    Mosler’s site quoted part of this story (and included a link to the whole article, of course). I thought it was interesting, and perhaps helpful in understanding a little more about the relationship between the Fed and the Treasury:

    http://blogs.reuters.com/macroscope/2013/02/20/the-fallacy-of-fed-profits-and-losses/

  • Steve W

    That’s funny — sort of. Did you really use your “cowpoke” name on your inquiry? Maybe that confused them.

  • brazzo

    Cullen,

    What is the Book about macroeconomics you would recomend a trader to read in order to better understand it and have a solid ground to growth knowleadge in the subject??

    I would really apreciate your comments on it so thanks you vm.

    Julio

  • http://www.orcamgroup.com Cullen Roche

    Hi Brazzo,

    I get this question a lot. Frankly, there isn’t one. To me, macro is starting with the correct world view. That means starting from a foundational understanding of the machine or the system at its highest level. From there, you have to work down through the components of the machine to its various micro pieces. You should end up with one or a few finely communicated ideas about how to attack that system from the perspective of allocating and protecting your savings.

    A book like that doesn’t exist as far as I know. Maybe if I ever have the time I’ll try to write one….

  • Tom Brown

    And remember to make sure it has a provocative title so you get invited on Oprah!

  • http://www.orcamgroup.com Cullen Roche

    Tom,

    I actually derive much of my thinking on money from the fact that apes definitely use forms of money. Once you understand that apes use money you can begin to better formulate how money evolved into a modern form. In ape societies, money is a promise. It’s a non-spoken tool of exchange. This for that. I scratch your back, you have sex with me. That sort of thing. As we evolved, unspoken bonds became written bonds. You owe someone something in essence. That’s what money is all about. It’s interesting how money has evolved from an unspoken bond, to a physical bond to an electronic bond.

    http://www.telegraph.co.uk/science/science-news/3933343/Orangutans-learn-to-trade-favours-at-a-price.html

    http://www.nature.com/news/2008/080611/full/news.2008.882.html

    http://www.time.com/time/magazine/article/0,9171,934239,00.html

  • http://www.orcamgroup.com Cullen Roche

    All cash comes from the US Treasury and is held by Fed banks for distribution as needed by members.

    http://www.ny.frb.org/aboutthefed/fedpoint/fed01.html

  • http://www.orcamgroup.com Cullen Roche

    Charles, bonds are a net financial asset. You can think of the govt conjuring them out of thin air in the same way that a corporation would issue one. Where does a stock or bond note “come from”. It comes from thin air. That’s essentially what a govt bond is. If the govt were to retire all the debt they would conjure cash out of thin air to repay all the debts.

  • http://www.orcamgroup.com Cullen Roche

    Not sure of the exact quote, but he is probably referring to the idea that the Fed sets interest rates. I am not sure I agree 100%. The way I view interest rates on govt securities is that they set rates based on their view of the economy. And traders front-run the Fed by trying to guess what the economy will do and how the fed will respond.

    Most interest rates are endogenous though. The Fed rate is exogenous because the Fed can always set it, but banks set most other rates based largely on your creditworthiness. For instance, your credit card rate has almost nothing to do with what the govt does.

  • http://www.orcamgroup.com Cullen Roche

    No, the Fed doesn’t have to be profitable. Besides, who is worried about the Fed not being profitable when it’s generating $100B in profits per year from its portfolio!

  • http://www.orcamgroup.com Cullen Roche

    Right. Fed losses would get passed onto the Treasury. Just like the gains currently get passed onto the Treasury.

  • CharlesD

    Hi Cullen thank you. I think it should be clear I understand that the
    Treasury securities are created “out of thin air” and can be retired in the same way by reversing the original transaction, as you indicate.
    I was simply asking what the government accountants would debit for this retirement – since they would be recording the transaction.
    Maybe I am wrong, but I don’t think the analogy to a corporate bond is
    entirely applicable. That is, when the corporate bond is retired at
    maturity, the corporation would debit the “cash” on the asset side of its balance sheet and eliminate the debt on the liability side.
    When retiring government bonds, the government would similarly eliminate the debt on the liability side. But since the cash used
    to retire the debt is “ex-nihilo”(unlike the corporation) it is still not clear to me what the government actually debits for the cash they paid out. I assume the government doesn’t have an “ex nihilo account”
    to debit but I don’t know. If my question is a poor one I appreciate your patience. That is, I understand what is happening in the
    real world. I’m just asking what the guys in the government with
    their “green eye shades” debit to record the payment of the cash (since tax money or additional borrowings would not be used in this
    hypothetical retirement). Thanks again for any thoughts.

  • AYC

    Hi Cullen,

    I have a couple questions about endogenous money.

    1)When banks make loans and borrow the funding, do they borrow the full amount of the loan, or just enough to cover the reserve requirement?

    2)Don’t capital requirements for banks work effectively the way reserve requirements are supposed to work by the exogenous money crowd? Is there a difference in this presumed money multiplier effect beyond the fact that capital requirements are lower than reserve requirements?

  • http://www.orcamgroup.com Cullen Roche

    Hi AYC,

    The term “funding” can be very confusing for people who don’t understand banking so it’s easier in my opinion to just think of banks as companies that run a huge payment system. That payment system is profitable for them as long as their liabilities are less expensive than their assets. They issue money into this system by ensuring that they can generate a profit. In other words, banks aren’t constrained by how many deposits they have or how many reserves they have. These are just various forms of liabilities that serve a purpose in helping them settle payments and keep their balance sheets balanced. So yes, think of capital as their main constraint. So their capital constrains lending, but their reserve or deposit balances don’t necessarily.

    When a bank makes a loan it will find reserves after the fact if needed. Most of the time this just means meeting the reserve requirement or meeting their payment needs. And of course, they can always go to the Fed for this so it’s not really an issue with regards to making new loans.

  • Tom Brown

    I just now noticed this. Thanks, those look like some great articles.

  • AYC

    Thank you for your prompt response. If banks only borrow enough to cover their reserve or payment requirements, doesn’t that mean they could be creating more money than is necessary? That is, are they creating money ex nihilo when there is existing money available that could be borrowed instead? This would make an endogenous money world more radically different from a “loanable funds”/ exogenous money world than I had initially thought.

  • Tom Brown

    Think about it this way AYC. Say there were no reserve requirements. Bank A makes a loan to x for $100. x transfers the deposit to Bank B. Say A didn’t have any reserves…, then the Fed would cover the overdraft and credit B with $100 of reserves. A needs to repay the Fed by the end of the day, so it borrows $100 in reserves from any bank. Say it borrows from B. So by the end of the day no reserves are left in the banking system. A has a loan to x for $100 as an asset on its balance sheet (BS) and reserve borrowings of $100 from B as a liability. B has a loan of $100 of reserves to A as an asset and a deposit of $100 for x as a liability. The Fed’s balance sheet is clear. Add in reserve requirements: Now at the end of the day The Fed has $10 (10%) in reserve lending to A on its BS and B has $10 of reserves as an asset on its BS as well as a loan to A for $90 in reserves. A has a $90 liability to B and a $10 liability to the Fed. So w/ reserve requirements the Fed had to create some “permanent” reserves in the amount of $10 (or whatever the reserve requirements are).

    So even w/o reserve requirements A ends up borrowing the full amount of the loan in reserves (from B), even though those reserves cease to exist by the end of the day. The borrowing stays on A’s BS. Make sense? Now with reserve requirements, A owes $90 to B and $10 to the Fed. I’m assuming here we started off with clean balance sheets all around. If, however, the banks (in general) had a bunch of excess reserves already, then A wouldn’t need to borrow from the Fed at all.

  • http://www.orcamgroup.com Cullen Roche

    Banks only lend what they can to creditworthy customers. The problem today is not a lack of “supply” of loans, but a lack of creditworthy demand.

  • Tom Brown

    AYC, I’ve typed something similar so many times, I’ve decided to go ahead and show it graphically w/ balance sheets:

    http://brown-blog-5.blogspot.com/2013/02/banking-example-1.html

    I found this kind of thing tremendously helpful when learning how all this worked. I don’t know if you will, but perhaps!

  • Tom Brown

    AYC, and here’s the case with reserves:

    http://brown-blog-5.blogspot.com/2013/02/banking-example-2.html

  • Tom Brown

    Sorry, with “required reserves.”

  • CharlesD

    Hi Cullen. Very helpful note today on “Will Fed lose boatload of money, etc). Thanks! I’m repeating a post from above (you may not see it I think I shouldn’t post on older messages). This is in response
    to your response (above-thank you) to my question on the operational aspects of retiring a Treasury bond:
    I do understand that a Treasury security is retired with money created “out of thin air”. In effect, it is just a reversal of the original transaction which created the Treasury security, as you have explained. I am simply asking what the government accountants would debit for this transaction – since they would presumably be recording this transaction. Maybe I am wrong, but I don’t think your analogy to a corporate bond is entirely applicable. When a corporation retires a bonds, they lose the liability (the bond) and they also debit an asset (the existing cash paid for the bonds). When the government retires a bond, they similarly lose the liability (the bond). But when the ex-nihilo cash is used to retire the government bond, it is not clear to me what the government is actually debiting for the cash they pay out. I assume the government doesn’t have an “ex-nihilo” account to debit, but I don’t know. If my question is a poor one, I appreciate your patience. But, as I noted previously, when I explain MR, I have been asked about this operational detail and I don’t have an answer – even though I know the cash is ex-nihilo. That is, I understand what is happening in the real world. I’m just asking what the people doing the government accounting (with the green eyeshades) debit for this cash payment – since tax money or additional borrowings would not be used for this hypothetical retirement. Thanks again for any thoughts.

  • Knives Knelson

    Thanks Steve!

  • Victor

    hi Cullen:
    do you have an opinion on the debt situation in China
    http://online.wsj.com/article/SB10001424127887324338604578325962705788582.html?mod=WSJ_Opinion_LEADTop
    based on the thesis net govt debt = net non-govt saving
    is there a problem?
    and is so , coudl the govt just nationalize the debt ie do a reset of sorts?
    thanks,
    Victor

  • Keith Patton

    Dear Cullen,

    I have been getting into a debate with a number of market participants regarding QE and money printing. I have forwarded your Understanding the US Monetary System ” to support the argument

    This is the response I have received back and I would appreciate any assistance in responding

    “In the US the FED buying treasuries is not “money printing” its merely
    an asset swap between a bank and the FED ( reserve balance swapped
    for the bond) . There has been no increase in NET Financial assets
    and no increase in the capital from which a bank lends”

    Increase in Net Financial Assets and no increase in capital from which
    a bank lends ? Are you sure about that ? what has increased
    dramatically is the M3 money supply and more directly “excess reserves
    of Depository Institutions / Banks” held directly at the FED reported near
    zero in 2008 to approximately 1.5 Trillion Usd’s !!!! What is that then ??.
    Why are the banks not lending this Capital into the system – Money
    Velocity is broken, simple reason is the banks are actually still insolvent
    and need Capital to shore up their dreadful asset valuations on their
    balance sheets.
    The European Banking System is leveraged at over 26 to 1 with net assets
    at nearly 300% of GDP (Europe’s GDP is $16 trillion and its banking
    system is $46 trillion)., that simply requires a loss of just 4% on its asset
    side to completely wipe out the system. Well independent reports put their
    losses closer to 12 % which is only Euros 5.5 Trillion that have to found
    !!!!!!
    http://seekingalpha.com/instablog/3774191-ecpofi/1025011-excessreserves-federal-debt-held-by-the-fed-and-the-u-s-bond-bubble

    As far as QE is not actually money printing but some elaborate accounting
    illusion, my immediate response would be why has the German
    Bundesbank fought so hard against any further QE policies by the ECB
    (and hence they had to go via the back door with LTRO programs) and
    does not the FED and now the BOE return 100% of the interest earned on
    their Government Bond purchases back to said Treasuries – if that is not
    money printing then what is it ?
    http://www.zerohedge.com/news/2012-12-14/qe-4-folks-aint-normal-whatyou-need-know-about-feds-latest-move
    The fact is that the Western governments (including China, Japan) are
    involved in ever increasing doses of QE that just cannot be unwound, which
    in effect is real money printing.

    KIND REGARDS
    KEith Patton

  • Joe in Accounting

    Hi Cullen,

    Are you familiar with Matt Levine and his blog on dealbreaker.com? The blog is mostly a gossip site for wall street, but he is the one adult in the room that writes about the banking industry, wall st, shadow banking and TBTF from the perspective of a guy who worked at Goldman. Not sure if he is in the MR paradigm, but his posts seem to imply he gets it. Here are some examples, http://dealbreaker.com/2013/02/banks-doing-too-much-too-little-lending/#call04
    http://dealbreaker.com/2013/01/turns-out-wells-fargo-doesnt-just-keep-your-deposits-in-a-stagecoach-full-of-gold-ingots/

    It would be very interesting to see the discussion between the author and you, Mike S. and JKH regarding these topics.

  • Joe in Accounting

    http://dealbreaker.com/2013/02/banks-doing-too-much-too-little-lending/

    sorry that first link takes you down the page to one of his footnotes. Yes, the guy is intense, he has footnotes in his blog posts. Of course, most of the comments are just shots at him from the wall st frat boys calling him a nerd.

  • http://www.orcamgroup.com Cullen Roche

    When a corporate bond is issued the company obtains existing capital and issues the bond buyer a security. When the bond matures the bond buyer gets his capital back plus interest.

    When a govt bond is issued the govt obtains existing inside money and issues a bond. If they were to let the bond expire they would pay the bond buyer back at par with interest. All of this adds to the deficit as an expense of the US govt.

    Remember, the govt doesn’t create ex-nihilo money permanently to buy bonds. It obtains existing money and redistributes it. Similarly, if the govt pays interest it adds to the deficit by obtaining existing capital to pay other bond holders. The uses existing money just like a corporation does.

    The only thing that’s created from thin air in all of this is the govt bond, which is a net financial asset.

  • http://www.orcamgroup.com Cullen Roche

    I am actually not an expert on China’s monetary system or their private debt system. I also don’t find the data there to be terribly reliable so I am afraid I can’t really provide a confident answer. Sorry.

  • http://www.orcamgroup.com Cullen Roche

    Hi Keith,

    QE changes the composition of private sector financial assets. It does not change the quantity. So, if the Fed buys a bond from a bank then the bank gets reserves for bonds. Before QE it had a bond. Afterwards, it has a reserve. No change in NFA.

    BUT, the reserve holder might decide it wants to offset the lost interest income so it might go into the market to buy other assets which can push prices of other assets higher.

  • Tim

    Cullen,

    Regarding your statement: “BUT, the reserve holder might decide it wants to offset the lost interest income so it might go into the market to buy other assets which can push prices of other assets higher.”.

    Isn’t it likely the reserve holder spends some of the new reserves from the sale of the bond on salaries in lieu of assets and thus increase money in circulation?

    Thank you in advance for the reply and all the excellent knowledge you share.

    -Tim

  • http://www.orcamgroup.com Cullen Roche

    He could. But the important point to understand is that people spend based on their income relative to desired saving. If I have $100 and want to save $20 of it every year and spend $80 and the Fed comes along and buys part of my savings from me leaving me with a lower interest bearing asset then I still save $20 if my income doesn’t change. And that’s the kicker. QE doesn’t increase income for the pvt sector. AND it doesn’t change net financial assets. So, if I decide to spend more I have to dissave, lets say, $5 so I only save $15 now. This is why QE has no broad impact on the economy except through the interest rate channel and portfolio rebalancing.

  • Steve W

    Cullen,

    If federal deficit spending remains high enough during the BSR, what would happen (in your opinion) if the Fed stopped QE?

  • Chas W

    from Bloomberg “Stan Druckenmiller, one of the best-performing hedge fund managers of the past three decades, has a warning for the youth of America: Don’t let your grandparents steal your money.

    Druckenmiller, 59, said the mushrooming costs of Social Security, Medicare and Medicaid, with unfunded liabilities as high as $211 trillion, will bankrupt the nation’s youth and pose a much greater danger than the country’s $16 trillion of debt currently being debated in Congress.
    “While everybody is focusing on the here and now, there’s a much, much bigger storm that’s about to hit,” Druckenmiller said in an hour-long interview with Stephanie Ruhle on Bloomberg Television’s Market Makers. “I am not against seniors. What I am against is current seniors stealing from future seniors.”
    Druckenmiller said unsustainable spending will eventually result in a crisis worse than the financial meltdown of 2008, when $29 trillion was erased from global equity markets. What’s particularly troubling, he said, is that government expenditures related to programs for the elderly rocketed in the past two decades, even before the first baby boomers, those born in 1946, started turning 65.”

    I understand this is the old argument that we are impoverishing our children, but help me explain this? It is hard to counter a very successful investor’s argument.

  • http://www.fanbrowser.com/ Cowpoke

    Can a Horse Meat to Beef correlation in food products be a future metric that Orcam could start tracking?
    Seems this may be a decent margin indicator that is developing.

  • Geoff

    Chas, this story from Mr. Mosler’s book might help:

    “Here’s a story that illustrates the point. Several years ago, I ran into former Senator and Governor of Connecticut, Lowell Weicker, and his wife Claudia on a boat dock in St. Croix. I asked Governor Weicker what was wrong with the country’s fiscal policy. He replied we have to stop running up these deficits and leaving the burden of paying for today’s spending to our children.

    So I then asked him the following questions to hopefully illustrate the hidden flaw in his logic: “When our children build 15 million cars per year 20 years from now, will they have to send them back in time to 2008 to pay off their debt? Are we still sending real goods and services back in time to 1945 to pay off the lingering debt from World War II?”

    And today, as I run for the U.S. Senate in Connecticut, nothing has changed. The ongoing theme of the other candidates is that we are borrowing from the likes of China to pay for today’s spending and leaving our children and grandchildren to pay the bill.

    Of course, we all know we don’t send real goods and services back in time to pay off federal government deficits, and that our children won’t have to do that either.

    Nor is there any reason government spending from previous years should prevent our children from going to work and producing all the goods and services they are capable of producing. And in our children’s future, just like today, whoever is alive will be able to go to work and produce and consume their real output of goods and services, no matter how many U.S. Treasury securities are outstanding. There is no such thing as giving up current-year output to the past, and sending it back in time to previous generations. Our children won’t and can’t pay us back for anything we leave them, even if they wanted to.”

  • http://freemarketfascism.org Dmitry Vyatkin

    Hi, Cullen. What is your opinion on Free Market Fascism?

    What is Free Market Fascism?

    ree market capitalism provides fastest economic growth possible. However free market capitalism is “unfair”, leads to extreme income inequality and destroys jobs through automation. Economic cycles produce unemployment which can lead to revolution, or redistribution of capital by the democratic government to create demand for excess human supply (e.g. The Great Depression). If being poor and unemployed was a crime then revolutions/redistribution of capital wouldn’t happen. The first country to adopt free market fascism will experience huge economic growth because the bourgeoisie will be able to accumulate capital exponentially, and replace obsolete human workers with machines without any government intervention to protect the proletariat. In the end, such an economy will attain 90-95% of the world GDP. Everyone else will become mere natural resource exporters because keynesian/socialist/marxist economies won’t be able to compete with free market fascism.

    Free market fascism comprises 3 social classes:
    The 1st class(fascists) consists of people who guard and regulate the system, and protect the capitalists from jealous proletarians (the artificially created middle class in the USA). If there are elections within this system, then only members of this class can vote. Though consulting the capitalist class is still possible. 1 to 10 million people are needed for this class. Tax revenue (approximately 10% of the GDP) from exploitation of capitalists is distributed more or less equally among members of the ruling class. They are the shareholders.
    2nd class(“haves”): capitalists, entrepreneurs, investors, speculators, lenders, rentiers, etc. Up to 1 million people.
    3rd class(“have-nots”): proletarians, including highly skilled workers, scientists and intellectuals. They are needed in the beginning, but most of them will eventually be replaced with machines and AI. Up to 100 million people.

    Japan and Germany have huge economies, yet relatively small territories (less than 400,000 km2). In free market fascism a large population won’t be needed either. A territory of similar size can be created (sea platform/artificial island), or the population of a country that nobody cares about can be displaced (Somalia, Colombia, Uganda, etc.)

  • http://freemarketfascism.org Dmitry Vyatkin

    Also what is your opinion on technological singularity?
    Also you believe that the ultimate goal of an economy is to eliminate all jobs(as Peter Schiff said)?

  • http://www.Staff.com Rob Rawson

    Hi. I have a question/theory about future interest rates and wanted to get your thoughts if my theory is crazy or accurate. This would apply especially for Australia, the UK but also to some degree to the US.

    1. Interest rates remain low for a while
    2. Banks start lending again and the average household become (even more) indebted
    3. The Central banks (of Australia, the UK), cannot raise interest rates by too much (more than 100%) because this would literally cause a very large percentage of the population to go bankrupt, it will cause too much backlash, and will cause a housing collapse etc. So in effect interest rates will stay low for a long time. Also note that in Australia there very few fixed rate long term mortgages.
    4. With these low interest rates, households will over time borrow more, houses will continue to go up and households will again borrow more
    5. The economy will essentially be “stuck” with low interest rates. The rates will never be able to increase significantly again (as they did in the 1980s for example) because if they do too many people will go bankrupt. They could fluctuate between 0 and 6% but will never go much higher than this

  • Joe in Accounting

    Can you elaborate on point three a bit. How would rising interest rates “literally” cause a very large percentage of the population to go bankrupt?

  • SS

    Cullen,

    I was hoping you’d comment on this appearance by Stephanie Kelton on MSNBC this weekend. In the segment at 4:20 she says:

    “We have absolutely no reason to suppose that there’s a medium for a long-term problem with the deficit.”

    I know you disagree with MMT on a number of things, but do you also view the deficit this way? She seems exceedingly confident in her view that there is no long-term risk of the deficit aside from inflation.

    http://moslereconomics.com/2013/03/04/kelton-on-up/

  • Tom Brown

    Chris has had her on before. That show comes on at about 4 AM on Saturdays right?

  • Geoff

    Chris seems very open to Stephanie’s ideas.

  • http://www.orcamgroup.com Cullen Roche

    Can you be a bit more specific? What do you mean by “what would happen? To the economy? To the markets?

  • http://www.orcamgroup.com Cullen Roche

    I touched on this in my recent Druckenmiller post. In essence, we leave a certain living standard to our children and not a bill that they have to pay off necessarily. That living standard could include higher tax rates (with more social benefits) or it could include lower taxes (with fewer social benefits). The standard of living we pass on to our children will ultimately represent the ability of one generation to innovate, produce and create goods & services that make lives better. We have to balance that with social benefits. I don’t think there’s a one size fits all, but I think it’s dangerous to assume that more govt spending = reduced living standards. It’s not so black and white.

  • http://www.orcamgroup.com Cullen Roche

    The problem with fascism is that it’s ripe for corruption. You can’t balance what you think is a corrupt market system with a corrupt govt system. Power corrupts and fascist states tend to concentrate power too much.

  • http://www.orcamgroup.com Cullen Roche

    I am not as afraid of robots as most other people are. Ultimately, I think an economy needs demand to grow and corporations without income generating customers can’t grow. So, there’s a certain logical ceiling to a robotic economy. You can’t have an economy where no one works and robots control everything because then there’s no income to generate the profits that the robots are supposedly trying to maximize….

  • http://www.orcamgroup.com Cullen Roche

    Yes, that seems to be the key question here….If consumers are borrowing more it’s most likely because their balance sheets have healed. So, more borrowing or even higher rates does not automatically equate to more bankruptcies.

  • http://www.orcamgroup.com Cullen Roche

    I think the MMT position is extreme here as it often tends to be. How can someone say there is “absolutely no reason” to worry about the deficit? MMTers often get mad when people accuse them of claiming that they say “deficits don’t matter”, but then they go on national TV and say things like this. I haven’t seen the interview, but I presume Kelton thinks inflation could become a problem. Well, that could evolve out of several different problems. We could see a rise in inflation due to stronger demand. Or we could see production stagnate and inflation will simply eat into our productive capacity. That slowing rate of production absolutely could evolve out of poor govt policy. For instance, if we just paid everyone in the USA to sit on their couches that would almost certainly happen. You’d get the same amount of spending and less overall production.

    So yes, I think it’s a bit much to claim that there is definitely no long-term risks from running a budget deficit. Kaldor’s circuses of Rome quote comes to mind. MMT makes the same mistake on the current account deficit. They seem to make the exorbitant privilege all too often by using developed nations like the USA to build their argument. Is there a risk of spending outstripping productive capacity in the USA in the long-term? Probably not. But I would never say there’s “absolutely no reason” to worry about deficits. Even if you think inflation is the constraint.

  • http://www.orcamgroup.com Cullen Roche

    Chris doesn’t understand why MMT is wrong. He’s just enamored with their policy ideas and probably has no idea how distorted the reserve accounting and banking focus is.

  • JK

    Cullen,

    I think your above comment is why there is confusion (for me too) over EXACTLY what QE has is doing.

    (1) Sometimes you say it’s just an asset swap, Treasuries-Reserves, and this does not inject money into the economy (no ‘money printing’); Reserves are used for inter-bank transactions.

    (2) But then you say something like you just did: “the reserve holder might decide it wants to offset the lost interest income so it might go into the market to buy other assets which can push prices of other assets higher.”

    If the “Reserve holder” goes into the market to buy other assets, is he using the money that was previously in the form of Treasuries? If yes, this seems like ‘money printing’ because what was before locked up in government Treasuries is now free to make purchases.

    Or is the idea that the “Reserve holder” might use other money they have to buy other assets?

    Can you clarify?

  • Geoff

    Agreed, though to be fair, she was just countering those who say that the deficit is going to be a problem in the mid to long term. If that were the case, we would see it in the inflation indicators. She simply said that the mid to long term inflation indicators (like the 10yr TIPs) are not currently indicating any kind of inflation problem. Therefore, there is no deficit problem at this time.

  • LVG

    I think what he means is this. Let’s say a bank has $100 in assets that are comprised of $10 in reserves, $10 in t-bonds, $70 in investments, $10 in cash (non-reserve deposits). If the bank sells a t-bond in QE it will now have $20 in reserves, $70 in investments and $10 in cash. The bank can’t use reserves to buy securities, but it could use some of its $10 in cash to buy bonds to offset the lost interest income.

  • LVG

    We already have a slowing rate of output. We live in a world where more and more people want handouts and less and less people want to actually produce something that they earn an income for. See the rising levels of welfare for instance.

  • Jay

    That’s total bullshi+. Productivity is at an all-time high…more people want handouts because there aren’t any jobs and they’re broke.

  • LVG

    Then explain to me why the rate of change in nominal GDP is at a generational low? We haven’t had really strong growth in the USA in almost a decade and despite all the calls for larger deficits it doesn’t seem to matter at all. Something’s going on and it doesn’t look good.

    http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=GDP&scale=Left&range=Max&cosd=1947-01-01&coed=2012-10-01&line_color=%230000ff&link_values=false&line_style=Solid&mark_type=NONE&mw=4&lw=1&ost=-99999&oet=99999&mma=0&fml=a&fq=Quarterly&fam=avg&fgst=lin&transformation=pc1&vintage_date=2013-03-04&revision_date=2013-03-04

  • http://www.orcamgroup.com Cullen Roche

    Personally, I think you’re cherry picking a very unusual period in economic history to make your point. But I completely agree that there is the potential that output can get “watered down” by govt spending. I don’t think it’s happening on any grand scale in the USA, but it could.

  • Jay

    Because the producing companies don’t pay decent wages any more or use machines. But the stores are all still packed w/ shi+. Problem is, nobody has any money to buy it.

    http://en.wikipedia.org/wiki/File:US_productivity_and_real_wages.jpg

  • johnw

    Quite correct . . . and there aren’t any jobs because technology has taken them over. Just wait and see what happens to jobs when robotics take even more of them away!

  • Tom Brown

    Cullen, what do you think of this John Carney banking article? I found a link to it on Steve Keen’s site:

    http://www.cnbc.com/id/100497710

    I need to go through it again, but he takes a stab at folding not only reserve requirements but capital requirements into a simple example.

  • Tom Brown
  • ChasW

    Thank you, I have read that,and i do understand it on a conceptual level, but i wanted something more in accounting terms. No, we won’t ship cars back in time but debt moves repayment dates into the future.

    I’m slogging thru Monetary Economics by Lavoie and trying to think how to explain these concepts in more concrete terms.

  • Tom Brown

    Cullen, I like concrete examples this article delivers (I just re-read it). There’s one sentence though that I’m not sure about:

    “To raise the $10 of required capital, Scratch Bank will have to sell shares, raise equity-like debt or retain earnings.”

    What does Mr. Carney mean by “raise equity-like debt?” Does he mean sell bonds in the bank?

  • Ted

    B/c the nominal GDP is influenced by inflation, which is at a generational low. Also lower rates of growth in the population, but especially the labor force, might be contributing.

    To answer your larger question, I think as a wealthy nation we’re in a period where we run into a real GDP per capita growth “ceiling” (2%) that just comes from the difficulty in innovation. China on the other hand can play catch-up for a little longer and have higher growth rates by going where others have gone before.

  • Tom Brown

    CharlesD, this is news to me!! I thought that the ONLY payments the gov can make to the private sector come from its Fed reserve account. Thus to pay back the principal of Treasury bonds when they mature, the gov needs to have those funds in its Fed reserve account, and thus this implies the funds would have been obtained from other Treasury bond sales or from taxes, tariffs, or from interest remitted to Treasury from securities that the Fed holds (i.e. the gov has to raise money like it usually does to obtain funds in its Fed reserve account)

    Cullen… have I been holding a misconception about this?

  • Tom Brown

    Cullen, am I wrong in my response to CharlesD here?:

    http://pragcap.com/ask-cullen-2/comment-page-2#comment-139651

  • ji1824

    Cullen, I’m aware of how loans create deposits and banks are really capital constrained, not reserve constrained. But if a Central Bank decides to raise reserve requirements does that force banks to turn some of their loan assets into reserve assets and thus decrease the money supply? (i.e. if loans create deposits which creates money “out of thin air” wouldn’t a decrease in loans to meet higher reserve requirements create the opposite effect – the destruction of money “out of thin air”)?

  • Tom Brown

    ji1824, take a look at this simple set of example balance sheets for 10% reserve requirements:

    http://brown-blog-5.blogspot.com/2013/02/banking-example-2.html

    Here’s the exact same situation with 0% reserve requirement:

    http://brown-blog-5.blogspot.com/2013/02/banking-example-1.html

    After the first step, when bank A loans to x, imagine that the reserve requirements had been 20%, then A would just have to borrow $20 of reserves. The reserves would be an asset and the borrowing of them a liability on its balance sheet. In normal times, when there’s no interest on reserves (IOR), bank A would be forced to keep the reserves on it’s balance sheet as long as it held the deposit, all the while paying to borrow them from someone else (another bank, the Fed, etc.). Thus that would have a negative spread, a bad thing for the bank. However, the deposit almost always gets transferred after the loan is made (see the final set of balance sheets in the above example) because loans are generally made with a purchase in mind! Once the deposit is transferred, there are no longer reserve requirements on the originating bank! See these two John Carney articles, I think they’re pretty good on this:

    http://www.cnbc.com/id/100497710

    http://www.cnbc.com/id/46970418

    Of course w/ IOR (our current situation), it hardly matters what the reserve requirements are, since what the bank must pay to borrow reserves is matched by the IOR it gets from the Fed.

    As to your question about decreasing the money supply: I don’t see it! If anything the *base* money supply (reserves) would likely need to increase to match the higher requirements (despite the slight increase in “interest rate risk”). Of course as long as there are excess reserves (again, our current situation), the reserve requirements can be increased right up until the point where there are no longer any excess reserves without much effect at all.

    As to the money supply that matters for the real economy (inside money), I think the reserve requirements have very little effect on this.

    Keep in mind that reserve requirements are requirements on deposits! Aside from perhaps a possible slight temporary increase in interest rate risk (that I referred to above), the lending bank is not affected.

  • ji1824

    Tom,

    Thanks for the reply. My question came about because China is quoted as using reserve requirements as their major tool for managing inflation.

    Since many countries don’t have any reserve requirements at all, it seems like this is a less effective tool for managing demand for money and the inflation environment.

    In the U.S. we have reserve requirements, but the Fed manages the COST of reserves, rather than the amount to achieve its policy goals.

    I guess if Chinese banks are forced to hold assets (reserves) that earn nothing, but are financed at the Central Bank policy rate they are discouraged from lending because each deposit created by that loan requires a higher amount of expensive reserves to finance it. Banks are forced to charge a higher spread on borrowing, thus slowing the demand for loans and limiting the growth of money supply.

    If this thinking is correct, it seems like China is just behind the times in understanding/accepting that the money multiplier doesn’t really exist, banks are not reserve constrained, but capital constrained and effects to influence the demand for money are best achieved through targeting the COST of money rather than the AMOUNT of excess reserves required.

  • Tom Brown

    Oh, that’s interesting. I was aware that China had reserve requirements, but I didn’t know much about it.

    From a macro perspective, I think it’s generally fine to imagine that there’s just one commercial bank, in which case my examples get even simpler! Then you are correct, making loans directly increases the cost of deposits to the one and only commercial bank as it must borrow reserves from the central bank to meet the requirements on it’s deposits. In this one bank example, if there was a hard limit on the amount of reserves the central bank issued, then I believe the amount on deposit at the bank, and thus the amount the bank could loan would also be limited.

    This seems like a disaster though! Are you sure that China actually limits the AMOUNT of reserves?

    Let’s say the Chinese central bank has reached the limit on the amount of reserves they’re willing to create. Now swiping your Chinese credit card (I assume they have credit cards!) is a problem, right? Because what this does is simultaneously create a loan and immediately transfer the deposit to the seller’s bank… but if there’s no more reserves to borrow (to meet reserve requirements on this new deposit), then something has to give! It doesn’t matter if there’s just one commercial bank or multiple commercial banks.

    I guess I’d be shocked if this is how the Chinese system worked. I’d also be shocked if they were so “behind the times” as you surmise.

    Check out Adam K’s final paragraph in this pragcap post:

    http://pragcap.com/all-your-dorks-are-belong-to-this/comment-page-2#comment-136540

  • Tom Brown

    Also, check out Adam K’s response here:

    http://pragcap.com/all-your-dorks-are-belong-to-this/comment-page-2#comment-136438

    Specifically this paragraph:

    “Do we have an alternative theory? I think so. I strongly believe that the alternative school of thought I keep in mind has a very strong influence in China – not on universities which largely follow the mainstream Western macroeconomics but among central planners, people who have “Red Phones” on their desks. We have to keep in mind that the Chinese call their economic system a “socialism with the Chinese characteristics” which is basically a cross between laissez-faire at the micro level and central planning / strict state control at the macro level. The reforms bearing fruits in 2010s were seeded in the late 1970s and germinated in the 1980s. The Western socialist reformers who contributed at the early stages were Wlodzimierz Brus and Kazimierz Laski. Both of them belonged to economic school of Michal Kalecki. It was not “orthodox Soviet Bloc Marxism” any more. The Kaleckian reformist school could be considered more “post-Keynesian” than Marxist. Kalecki was not initially trained as an economist, he studied engineering. He was able to build correct mental models of macroeconomic reality precisely because his mind had not been already possessed by the classical marginalist thinking and supply-and-demand curves explaining everything.”

  • http://www.orcamgroup.com Cullen Roche

    Tom, haven’t read it yet, but it’s on my list of things to read.

  • http://www.orcamgroup.com Cullen Roche

    Tom, you’re correct. When the t-bond is retired (if that ever happens) then the TGA account must have credits which means that the govt must have obtained tax revenue to make the payment. There is presently no means by which the govt spends without having credits in its TGA account prior to taxing or selling bonds. It’s not allowed. As I always tell the MMT folks, there’s a clear flow of funds that has to occur here. The money can’t just come “ex nihilo” because the govt doesn’t spend that way.

  • http://www.orcamgroup.com Cullen Roche

    Looks like Tom nicely sorted this one out for you. Reserves are supplied by the Fed, so if the Fed raises reserve requirements then they need to supply the reserves to allow the banks to meet the reserve requirement. It, the banks need to borrow reserves at the cost of the overnight which, as Tom noted, with IOR, is kind of a pointless policy tool when you’re paying them the same amount of interest….

  • Tom Brown

    TGA? What’s that stand for? I assume that’s the same thing that I called the “gov’s Fed reserve account.” (BTW, good to know I haven’t had this wrong the whole time — thanks for responding!).

  • Tom Brown
  • http://www.orcamgroup.com Cullen Roche

    TGA is the Treasury General Account. The Treasury also hold Tax & Loan accounts at commercial banks. The way it sweeps money between these is where the reserve accounting gets messy and can often be conflated to mean something it doesn’t….Money goes into the TT&L accounts first at the commercial banks and settles in the TGA where the Tsy spends from.

  • Steve W

    Cullen,

    I just read the WSJ opinion piece (2-8-13) titled “The Federal Reserve’s Fiscal Crunch Trap”. It starts off talking about the danger of increasing debt-to-GDP ratios. Interestingly, there’s no mention of Japan’s very high ratio. Much of the article seems out of paradigm. It states that “countries with gross debt above 80% of GDP and persistent current-account deficits…face sharply increasing risk of escalating interest payments on their debt.” The article mentions a term that’s new to me: fiscal dominance. It then states that if the Fed “does not monetize the government debt (by purchasing it or, in other words, by printing money), then interest rates will rise sharply as private lenders demand a higher rate.”

    Later in the article it says that if interest rates climb higher…this could lead to substantial losses on the Fed’s holdings of Treasurys and MBS, losses that “could approach several times the size of Fed capital”. They go on to say “without monetization, the government could end kup defaulting on its debt.”

    I didn’t think that the Fed was “monetizing the debt” via its purchases of Treasurys and MBS. I’m also confused about potential losses on the Fed’s holdings. Assuming there are no defaults, it seems like the only “losses” would be due to receiving par (eventually) on bonds the Fed is paying fat premiums for now. Seems pretty straight forward. When a premium is paid for a bond, the buyer knows the YTM. Perhaps the article’s writers are suggesting the Fed would be forced to sell bonds before they mature.

    If you have time, please read the article and share your thoughts. It seems too focused on debt-to-GDP. You’ve pointed out that it’s just not that simple and that there are many other factors to consider.

  • http://freemarketfascism.org Dmitry Vyatkin

    But you are wrong! Capitalists don’t need working class for consumption. They can consume everything themselves. Only structure of production would change.

  • Elwood

    Cullen, read this by by Wolf Richter originally posted on his site which BI picked up this morning: businessinsider.com/a-politically-explosive-secret-italians-are-over-twice-as-wealthy-as-germans-2013-3

    It looks like Europe may well be facing a euro/political crises which can’t be overcome. Also, I found it interesting how this relates to your posts about public sector debt being assets for the private sector. Very interesting….and troubling.

  • Steve W

    I meant to the economy. Sorry I wasn’t more specific.

  • Happy Swede

    Hi Cullen,

    According to Wolfgang Schäuble (today in FT) the germans are going to balance their budget until 2015 with cuts of 5 billion EUR, “growth-friendly consolidation”.

    Whats your view on Europe given these renewed austerity measures, is there any way that they can escape further and worsening recession?
    My guess is private investment and credit growth will not be coming to the rescue any time soon either?

  • MFH

    Hi Cullen, thanks for all your great work here. What is your opinion of Austrian economics in general? Have you ever written anything in-depth about it? Thanks.

  • http://www.orcamgroup.com Cullen Roche

    The idea seems to be based on the idea that rates will rise sharply. Long rates are an extension of short rates and economic conditions. Theoretically, the Fed could pin long rates on govt debt at whatever they want. So all this worry about rates is silly. If rates rise it will almost certainly be due to easier Fed policy.

  • http://www.orcamgroup.com Cullen Roche

    Europe’s problem is inherent in the currency design. The nations in Europe are like the states in the USA. They are all users of a currency and have no floating exchange rates. So, when poor nations need money they must be able to procure it. BUT, they don’t have a central redistribution mechanism like the USA has through its federal govt in which rich states pay more into a system that redistributes to poor states and keeps them from going bankrupt. There’s only one way forward in Europe. Either you create a transfer union via e-bonds or a central tsy or you break it apart and go back to floating exchange rates between different nations. As is currently being seen in Cyprus, this whole thing is like a flame just waiting for someone to pour gasoline all over it….

  • http://www.orcamgroup.com Cullen Roche

    Germany runs a current account surplus so they certainly sustain a balanced budget in the same way Norway and Singapore have for decades. The problem is for the peripheral nations who don’t have the same trade balance and don’t have any private sector debt growth. Those nations are sitting ducks in an austere environment.

  • http://www.orcamgroup.com Cullen Roche

    Austrian economics is a policy agenda masquerading as a school of economics. It has some unique and important insights, but their operational view of the world is largely based on an anti govt view of the world that conforms an operational view to a policy agenda. So you learn about things like “crowding out” and how the govt is “running out of money” and other silly concepts that don’t apply to the actual US system, but confirm a policy bias that anti-govt people love to hear.

    It’s like MMT, but the opposite political view. Although MMT is better from the operational side, but just as politically motivated. Very similar schools in many ways. It’s funny that I once considered myself an Austrian, then an MMTer and then had to create my own paradigm to fit my operational (and apolitical) based views around.

  • Lukey

    Or is it an economic theory designed to ideologically counteract the tendency for big government ideologues to view alternative economic theories potentially as a fiscal “free lucnh.”

  • Bob B

    Cullen–

    Given their situation, I don’t understand why the CyPIIGS are so adamant about retaining the Euro as their currency. Do the benefits really outweigh the costs that are being inflicted on their economies? I haven’t found much commentary explaining why it’s helpful for Greece, for example, to stay with the Euro. Your thoughts?

    Best regards,
    Bob B

  • http://freemarketfascism.org Dmitry Vyatkin

    ATTENTION! ATTENTION! ATTENTION!
    Cullen Roche doesn’t understand basic economics. Capitalists don’t need working class for consumption. They don’t need workers to sell them goods. Capitalists can consume everything themselves. Only structure of production will change. It is possible to have fully automated economy without anyone working. The only thing that matters is distribution of wealth/income.
    Peter Schiff was right. The ultimate goal of an economy is to eliminate all jobs.

  • http://www.orcamgroup.com Cullen Roche

    Capitalists don’t need customers? According to US GDP statistics the consumer is still a pretty important part of the economic engine. Where is your evidence that the consumer is dying? Personal consumption expenditures as a % of GDP have been growing for 50 years. So your theory seems entirely backwards. Consumers are becoming a larger part of the engine of growth. Not a smaller part.

    http://research.stlouisfed.org/fred2/graph/fredgraph.png?&id=PCE_GDP&scale=Left&range=Max&cosd=1947-01-01&coed=2013-01-01&line_color=%230000ff&link_values=false&line_style=Solid&mark_type=NONE&mw=4&lw=1&ost=-99999&oet=99999&mma=0&fml=a%2Fb&fq=Quarterly&fam=avg&fgst=lin&transformation=lin_lin&vintage_date=2013-03-20_2013-03-20&revision_date=2013-03-20_2013-03-20

  • http://freemarketfascism.org Dmitry Vyatkin

    Demand for human workers is created artificially through banking system. Yes capitalists won’t need workers for consumption when production will become fully automated. Capitalists will sell good to each other and there will be no human workers in an economy. Machines already produce much much more than human workers.

  • http://www.orcamgroup.com Cullen Roche

    So, the owners will buy their own goods and services? Do you have evidence of this actually occurring? Can you prove that the average worker in the USA is no longer consuming?

  • http://freemarketfascism.org Dmitry Vyatkin

    “So, the owners will buy their own goods and services?”
    Owners will sell automatically produced goods to other owners and buy goods that their robots/AI can’t produce.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Cullen, in making the following post:

    http://brown-blog-5.blogspot.com/2013/03/list-of-ways-reserves-leave-banking.html

    I made the bold statement:

    “It also does not include anything the Fed itself holds as an asset: reserves are never a Fed asset; they are always a Fed liability.”

    When describing what “reserves in the banking system” included and excluded.

    Is that really true? When reserves get paid to the Fed I always think of them as being “destroyed” (i.e. erased as a liability from the Fed’s BS… which implies an equal amount must be erased from the Fed’s BS in the asset column too, depending on what the payment of reserves to the Fed was for). However, what happens when money is “remitted” from the Fed back to Treasury? Does the Fed destroy the reserves and then re-create them to credit the TGA? Does this remitting process happen when the Fed receives interest payments, say for MBSs on its BS?

  • http://brown-blog-5.blogspot.com/ Tom Brown

    BTW, in case anybody’s interested, I’ve been following where most of the hits come from on the “blog” I put up a few weeks back for the purpose of helping people to visualize on balance sheets some of the concepts that get talked about here on pragcap:

    http://brown-blog-5.blogspot.com/

    The VAST majority of hits have come from the US, and almost all of those from pragcap… with a few scattered all over the rest of the world. But today, for some reason, several Italian websites have posted links, and so hits from Italy far exceeded anywhere else! Very funny to me…

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Here’s one:

    http://www.cobraf.com/forum/coolpost.php?topic_id=5744&reply_id=123518263

    I did a Google translate on one (not this one) just to make sure they weren’t writing something like “This American fool is so stupid he actually thinks that blah blah blah… take a look at his moronic blog!”

    Perhaps that’s what the one above says!… not sure I want to know actually. :)

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Cullen, I understood that prior to QE and the ZLB that the Fed would defend it’s non-zero overnight rate target by primarily by making OMPs or OMSs (rather than by making loans of reserves to the banks through the discount window). I know that repos and reserve repos get folded in the mix here too… I’m always a little confused by that, but basically we can think of the target being hit by use of OMPs and OMSs, true?

    If that’s correct, then the Fed must have maintained an inventory of Treasury bonds on its BS in order to have some something to perform OMSs with, should they be required, correct? Do you have any idea what that inventory of Treasuries amounted too? In other words, how big was that inventory compared with the one today?

  • Scott K

    Cullen, I just read this article posted in Slate and would be very interested in your response. Thanks.
    http://www.slate.com/articles/business/project_syndicate/2013/03/great_recession_you_have_to_raise_taxes_to_get_stimulus_done_right.html

  • Dunce Cap Aficionado

    Cullen,

    Have you seen Tyler Cowen’s latest on Cyprus?

    http://marginalrevolution.com/marginalrevolution/2013/03/what-to-look-for-in-the-cyprus-deal.html

    He’s saying that if a Cypriot Euro is worth less than a Euro elsewhere, it a de facto form of withdrawl from the currency.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Cullen/Joe/Anybody

    Can someone tell me if either of these two comments is close to how you’d calculate Tier 2 capital (with subordinated debt on the BS)?

    http://pragcap.com/towards-a-mostly-cashless-monetary-system/comment-page-1#comment-141398

    http://pragcap.com/towards-a-mostly-cashless-monetary-system/comment-page-1#comment-141415

    Thanks!

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Update: I’ve added a blog post to describe the calculation of capital in various ways. If anyone is so inclined, please give it a look and see if it’s correct:

    http://brown-blog-5.blogspot.com/2013/03/banking-example-7-calculating-capital.html

    Thanks!

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Cullen, just out of curiosity, how many hits does pragcap get per day?

  • Ballast

    We often hear about Japan’s economic woes, but for a
    “sick” country, it continues to develop and manufacture
    phenomenal, reasonably-priced products, which I
    remain a steadfast fan of. This begs the question:
    how many of Japan’s misfortunes are the result of caused by
    structural problems, and therefore difficult or
    impossible to overcome, and how many are caused by
    poor leadership, which (in principle, at least) are
    far easier to overcome?

  • http://www.orcamgroup.com Cullen Roche

    It’s mostly for a few reasons. I think they realize the costs of going back to an old currency at this point. And they also see that Europe is naturally converging with time as proximity and trade brings them closer together. A monetary union makes sense. But it also needs political and fiscal union. This is simply not enough as a single currency system.

  • John Wilkins

    “The central bank [of Japan] said it would aggressively buy longer-term bonds and double its holdings of government bonds in two years, doubling the amount of money in circulation in the process. The bank will aim for a robust 2 percent rate of inflation “at the earliest possible time,” it said.”

    Is that really true? Just like the US won’t the Japanese central bank be doubling the amount of reserves over two years? If this is true I don’t get the point of massive QE in Japan at all since they have near zero rates and have had for two decades. Of course, there could be a psychological effect like the US where people believe the central bank is printing money, will cause inflation, and thus the stock market soars.

  • Jonathon McKitrick

    Two questions:

    1. I’m going out on a limb, here, but I might have figured something out about MR. If inside money is created by banks according to demand, then that means when the Treasury sells bonds, exactly the same thing is happening, correct? *IF* the Fed is buying them, that is. The Fed is creating money and lending it, just like if I applied for a mortgage. If the Fed does not buy the bonds, the money comes from the market, in the form of bids and purchases by the Primary Dealers, correct?

    2. If the government continues to spend more than it brings in, and taxes do not rise to cover the shortfall, rather bonds are sold, we are essentially borrowing from future growth, correct? Borrowing from an expected increased money supply in the future (increased economic growth leading to increased money supply ostensibly without increased inflation), correct?

  • Jonathon McKitrick

    One more:

    3. If #2 is true, then don’t increasing bond sales and deficits starve the public sector of funds, if government bond sales outstrip growth of the inside money supply?

  • Tom Brown

    I’ll take a crack at this one.

    1.) To the extent that the Fed buys Treasuries, you can trace that amount of money in the economy to government debt. The part of government debt not purchased by the Fed (the vast majority of it) results in Treasuries in the economy instead of $. I think you could say that about 2.5 to 3% of all $ in the economy can then be said to be created by gov debt. All the rest are created by private debt (bank loans).

    2.) I’m not sure you can say that. The gov has a lot of debt out there right now at a low rate. If economic activity starts to heat up substantially and risk inflation, I think this will be correlated with higher government revenues (even w/o higher gov taxes), perhaps even surpluses. The bulk of gov debt will still be at a low rate until it is gradually replaced by higher rate bonds. Also if the gov wants to try and reduce inflation it can raise taxes even more. If the Fed wants to try and decrease inflation it can sell Treasuries. If we ever get to the point were enough Fed assets are sold to eliminate excess bank reserves, then the Fed can try and target inflation through its traditional method of targeting the overnight rate (rather than its current method of setting the rate of IOR). I know I haven’t really answered your question, but I’m trying to offer an alternative view. Essentially that view is that if inflation starts to become a problem, the way to address that will naturally lead to lessening deficits and perhaps lessening public debts.

    3.) Did you mean to write “public sector” or “private sector?” If “private sector” I don’t think that’s the case because all those funds get put right back in the economy when the gov spends them. If you meant to write “public sector” I don’t think so either because the bond sales provide the public sector with funds.

    OK, that’s the best I can do. Hopefully Cullen will give you the real answers! (I’ll be fascinated to know where I went of the rails!)

  • http://www.orcamgroup.com Cullen Roche

    That’s a fine description. I’m not 100% certain on the actual remittance flow, but off the top of my head that sounds right.

  • http://www.orcamgroup.com Cullen Roche

    You can actually search this data here.

    http://www.federalreserve.gov/releases/h41/

  • http://www.orcamgroup.com Cullen Roche

    Makes some intuitive sense. If we raise spending AND taxes we raise the flow of funds in the economy because the govt spends more AND taxes more. Thing is, govt spending is more effective when it adds net financial assets to the private sector and makes their balance sheets better so they can spend on their own. So a deficit is the only way to achieve that. Shiller also seems to think the debt:gdp ratio is a hard constraint. That’s obviously wrong. There’s no solvency constrain in nations like the USA.

  • http://www.orcamgroup.com Cullen Roche

    He’s wrong. A cypriot Euro is still going to trade as a Euro on FX markets which means Cyprus is just as effed as they’ve ever been.

  • http://www.orcamgroup.com Cullen Roche

    Depends. If I work on the site a lot in a given month it can do a million page views a month. If I am busy with other stuff it can be as low as 500,000.

  • http://www.orcamgroup.com Cullen Roche

    Yeah, probably more to do with their demographic and structural problems than quality of output. In fact, Japan’s persistent deflation is in part the result of high quality output. So Japan’s problem isn’t about aggregate supply. It’s more about aggregate demand.

  • http://www.orcamgroup.com Cullen Roche

    Japan thinks they can devalue their currency and jam their stock price up resulting in perpetual prosperity. I think they’re just making a mockery of their markets and economy.

    If economic prosperity was as easy as setting the stock market at a particular level and devaluing the currency then everyone would be prosperous. The idea that this can be sustained is ludicrous even though it can work in short periods of time.

  • InvestorX

    Agree completely.

  • http://brown-blog-5.blogspot.com/ Tom Brown

    For anybody that’s interested that didn’t see this, it’s kind of interesting: Krugman vs Stockman (sitting at the same table!)

    http://www.huffingtonpost.com/2013/04/07/paul-krugman-david-stockman_n_3033003.html?utm_hp_ref=politics&ir=Politics

  • http://brown-blog-5.blogspot.com/ Tom Brown

    BTW, I should really credit Mike Sax for this link and some of the others. You may not like the partisan nature (or title!!) of his blog, but he actually does a pretty good job “monitoring” economic schools of thought he doesn’t necessarily agree with and reporting on his understanding of them (from a layman’s point of view). Despite the title of his blog, he’s pretty fair IMHO.

    http://diaryofarepublicanhater.blogspot.com/

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Cullen, you’re going to hate this, but looking at this chart again:

    http://www.zerohedge.com/sites/default/files/images/user5/imageroot/2012/12-2/Bank%20Deposits%20and%20Loans%20Difference_0.jpg

    The deposits shown look like they only total to about $9 trillion. Am I correct to assume that there’s about $65 Trillion in “existence?” If that chart is accurate, where are the other $56 trillion? Somewhere other than bank deposits? I’m not sure where I heard the $65 trillion figure. Is that M3 or M4? Am I wrong about that $65 trillion figure?

  • http://brown-blog-5.blogspot.com/ Tom Brown

    Ah, I think it must have come from something like this:

    http://ei.marketwatch.com/Multimedia/2012/06/07/Photos/ME/MW-AR995_debt_f_20120607165649_ME.jpg?uuid=5754af3c-b0e3-11e1-ab8d-002128049ad6

    Which shows total debt to GDP at about 3.4. I think by “total” they must mean “total public and private”. From Steve Keen’s public and private debt to GDP curves I see about 88% and 260% respectively, which agrees. So if we count the whole 3.4 we get about $51T. Just the 260% (private) is about $39T. Still not adding up… where have I gone wrong?

  • me

    On a day like today where stocks are up over 1% where does that money come from to lift the market. Maybe a better way of asking is who does a majority of stock buying? Big banks, hedge funds, pensions, companies themselves?

  • Charles Fasola

    http://neweconomicperspectives.org/2013/04/what-does-paul-ryan-not-understand-about-reserve-banking.html#more-5178

    Cullen,

    Since I am in the process of reading about MR and absorbing its premises after reading extensively the ideas at MMT, I am hoping you would provide a comment and some perspective on the article whose link is shown above. I believe as you state that private banks create money in reality. It seems that MMT states that banks must receive their money from the FED/Treasury, which implies one does not function independently of the other. Is this assessment correct?

  • http://www.orcamgroup.com Cullen Roche

    I am surprised the moderators post that article at an MMT site. There are some big time problems there.

    First, this comment: “Reality No. 2: Sovereign Dollars have to Pre-Exist bank dollars” is totally wrong. The banking system does not “leverage” sovereign dollars or use reserves. The banking system creates loans totally independent of their level of reserves. A bank can create new loans as long as it has capital. MMT is restating some form of the money multiplier, which they reject. They try to have it both ways here by stating that all money is essentially state money and that banks are just “leveraging” state money. No, the banks create the money and the rest of us use it (including the govt). The reserve system only exists to support private banks. Without pvt banking there would be no need for the reserve system. This point alone debunks MMT and renders it inapplicable to the current system.

    Second, this comment: “Reality No. 3: The Federal government HAS to deficit spend.” is also wrong. There are plenty of examples of countries where budget surpluses are persistent. Singapore and Norway come to mind. These countries run trade surpluses and have for decades run simultaneous budget surpluses. That’s because the foreign sector contributes huge amounts of income to the domestic economy. MMT calls it “off balance sheet” deficit spending or something. But the fact is, the government doesn’t HAVE TO run a budget deficit.

    If you haven’t read my MMT critique you might want to take some time to review it. I think MMT gets the description more right than wrong and is far better than most other descriptions, but I think they misconstrue the reserve accounting and the flow of bank money through the monetary system.

    http://pragcap.com/mr-different-from-mmt

    Let me know if you have any questions.

  • http://www.orcamgroup.com Cullen Roche

    It’s better to think of money as flowing THROUGH a stock market. When you buy a stock there isn’t more money flowing INTO stocks. For example, if you buy GE then you give someone cash and someone gives you GE stock. The seller gets your cash and they give you the stock. It’s an exchange. Of course, there can be more dollars competing for (more or less) shares outstanding, but that doesn’t change the transactional dynamics which are an exchange.

    Make sense?

  • me

    The flows makes sense. Thanks.

    Since the market is just people trading things back and forth I’m just trying to understand who’s the players with the biggest chip stack that can make a market move one way or the other. Is there even a way to know where a majority of the market moving flows come from?

  • http://- R Koh

    Hi Cullen,

    Thanks for a great website and it’s very informative. There has been a lot of hype recently about monetary systems and how central banks are printing etc etc. I have learnt a lot from your 4-part post ‘Understanding the Modern Monetary System’.

    Let me get straight into the question. Is it possible for this modern monetary system to work, when interest is never created? I may not be able to be this eloquently, but the following posts emphasise my point. (Please note I am not asking for a change in currency, nor asking for a forecast on impending doom. I am merely trying to get my head around how the monetary system can work with interest)

    http://www.zerohedge.com/contributed/2013-03-20/it%E2%80%99s-time-collapse-system

    http://www.toxicdrums.com/pyramid-economy.html

    http://home.earthlink.net/~cadman777/treadmill-Jenkins.htm

    I wanted to post this question on this post http://pragcap.com/understanding-the-modern-monetary-system-part-4-2 because your graphics at the end of the post indicated money creation but left out where the interest portion is created from.

    Or as it was best put by Paul Grignon, Money as debt.

    http://www.youtube.com/watch?feature=player_embedded&v=e6LWqgohO4E

    Of course some (or all) of these links might pander to the conspiracy theorists and end of world fanatics. My question is not in regards to that, but is basically ‘Do we live in a world of perpetual unpayable debt?’

    Thanks!

  • http://orcamgroup.com Cullen Roche

    Koh,

    Can you ask this in the forum please? That’s where all the new Ask Cullen stuff is going. Thanks.

    http://pragcap.com/forum?mingleforumaction=viewforum&f=1.0

    CR