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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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?
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.
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…
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.
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?
You can actually search this data here.
http://www.federalreserve.gov/releases/h41/
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
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.
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.
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.
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!
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!
Cullen, just out of curiosity, how many hits does pragcap get per day?
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.
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?
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.
“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.
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.
Agree completely.
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?
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?
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!)
Right on Tom. The only thing I’d add is the deficits directly add net financial assets because the deficit results in Peter buying a bond, Peter’s money going to Paul (via spending) so Paul ends up with money, Peter ends up with a govt bond and the bond came from outside the private sector and has no private sector liability attached to it (because it’s a govt liability).
So govt deficits directly add to pvt balance sheets.
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
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/
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?
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?
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?
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?
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://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?
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.
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!
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