Ask Cullen
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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What is MR’s stance on social security? (this isn’t the US is going bankrupt question) What’s the best balance to allowing people to invest for retirement on their own without letting it become so large that it over-financializes the U.S. What’s a good solution to balancing out demand leakages associated with IRAs/401ks? Thanks
Cullen,
I recently had an exchange with you in regards to an article you published with SA, “Gold is not an investment”. Before our comments to each other I was convinced you were a true MMT’er. I had asked you for your writings on Monetary Realism to understand your beliefs on our monetary system. I have now read your “A critique of MMT From The MR Perspective”, and now have a new found respect for your view points. I agree with much of your critique and your desire to seperate political view points from monetary theory. Refreshing!
I am really happy to hear that. Glad the material helped. Let me know if I can ever help with anything.
Hi Cullen. I just wanted to commend you on your founding of Orcam. I just took a look at the website and I think what you’re building is a fantastic idea and potentially paradigm changing. Your focus on empowering investors is a step in the right direction for financial services. I look forward to your firm’s great success.
Thanks Jon. It’s been a lot of work getting things up and running, but I am really excited about creating a company that is true to my vision and word.
Cullen. These days many people say Argentina is the latest “proof” that fiat money always leads a country to ruin. Those of us who understand the modern monetary system know better (thanks to you).
Nevertheless, what are your thoughts on Argentina’s terrible inflation? Is it solely caused by bad government decisions? Does their large foreign-denominated debt bill play a role? Or is there something else?
Enjoying the site tremendously. Thanks in advance.
Many of the South American nations are cases of rampant corruption, lack of production, mismanaged money supply, etc. Argentina has been a hotbed of govt mismanagement and corruption. It proves that a fiat currency that is mismanaged will be destroyed.
I was just about to type the same question. Today’s story about currency flight from Argentina and blocking trade is mind-boggling. It’s more complicated than corruption. The citizens love their leader but she/somebody is screwing up big time. Since we understand that Argentina is not Greece, there must be a lesson here that shows how not to carry out MR. http://www.telegraph.co.uk/expat/expatlife/9565126/Damming-dollar-flood-comes-at-a-huge-cost-to-Argentine-economy.html
Hello – Please explain why anyone would want to place an order to buy/sell “market at close”. I see that a lot of shares are traded like this, but why?
Also – are you on stocktwits? If so, I can’t find you.
Thanks
I don’t use StockTwits. I don’t discuss individual stocks often so I don’t have the need. I am more of a macro guy. In my opinion, if you can predict the direction of the river there’s no point trying to predict which branches in the river will flow faster than the others….Unless you’re using a highly differentiated strategy. Most traders don’t do this. They’re just long/short fighting an index for the most part.
Good question on the MOC. I have never used it, but I know indexes are rebalanced at the MOC price. Maybe institutions use it for this purpose? Or maybe it’s just for someone who wants to get the EOD price. That’s my best guess there. There’s no need for a retail investor to use these orders.
Okay, now it’s my turn.
How the heck do I convince the website to let me use an avatar? =)
I see others doing it but can’t find anything in the profile page.
Register your email (that you log comments with) here. http://en.gravatar.com/
It will show up automatically.
Can you comment on the risk of the derivative market if either Greece or Spain or even Germany leaves the Euro. As I understand such a move would trigger defaults on interest-rate swaps and the collateral’s market value is much less than the stated values of the sovereign bonds they hold as collateral. It’s why so much money has been pledged to banks to keep the system afloat. Isn’t this a time-bomb waiting to explode because of the huge leverage of contracts written versus the over-stated collateral pledged?
Everyone seems to be looking away from this problem yet the amounts that would be involved could destroy the entire global financial system as we know it.
Thanks in advance
James Dodderidge
Cullen, do you have a view as to the vulnerability of the markets due to the derivative markets and the possible impact a Greece exit would have on the collateral used to backstop derivatives? Will it be a problem?
Banks are all leveraged up through their various operations. With these massive trading arms their derivatives units have only compounded this issue. So yes, it’s a big problem if massive defaults start occurring in a specific economy. So yes, it has the potential to be an enormous problem. That’s why the ECB is trying so diligently to avoid a Greek default on a wide scale.
Just about every time I try to explain MR to someone that I believe should understand where money/fiat currency actually comes from, I get reasoning that basically follows the teachings in this 1992 booklet. 1992 is not that long ago. http://www.rayservers.com/images/ModernMoneyMechanics.pdf
I guess this is pure Friedman. This booklet is basically correct, right?
Dennis, that paper is not accurate on many things. The most glaring mistake is the idea that the money that matters most is central bank money. This is just not true. They use the money multiplier argument to claim that banks are reserve constrained and multiply their loans. This is just not how modern banking actually works. Banks make loans and find reserves later. The banks are not reserve constrained. The money supply in the USA is essentially privatized and banks can create this money almost entirely independent of the US govt. To claim that bank money (inside money) is not real money is just flat out wrong. It’s not only money. It’s by far the most dominant form of money in the economy.
Cullen, Thank you very much. You often write that the “money multiplier” is a myth. But what you are really saying is that the money multiplier (although the math makes it appear that a LOT of money can be created out of whole cloth), is a “constraint” that does not exist. The banks and many non-bank institutions can multiply money at will is what your saying. This money, or better called “credit”, is real fiat currency in that is in the economy. Thanks again for all your help on this stuff.
So, now that brings up my real dilemma, where does the money ultimately come from that is required to pay the interest on all this credit? I fully understand “rollovers” but that doesn’t get to the answer.
It comes from more loans. As the economy expands and people borrow, invest, etc, the money supply expands. So old loans are essentially repaid with new loans.
Sorry to jump in, but I have a follow up question on that:
What happens when you have a country with an aging population that takes out less new loans and almost no population growth to compensate. Further, if those retired people transmit their wealth to their offspring, those won’t need to take out a loan to build a house etc. Isn’t the system build on perpetual growth in a limited world?
A country with very negative economic trends has a substantial hurdle to overcome in their attempt to increase living standards because you’re expecting fewer and fewer people to increase more and more output. This can be done through improvements in productivity, but it’s a massive hurdle.
I don’t buy that. We are massively productive and only getting more productive every day.
Prices and wages tend to grow all the time because that’s how humans work – we all want it a little bit better than the year before.
Now, if wages/prices (times speed) hits the ceiling of the money supply available in the general circulation (which has a big drain in the form of money moving to the financial sector circulation), you get to choose between six things:
1. Move more money from the financial sector or 1%ers back into everyday circulation (how?)
2. Inject new money via household debt
3. Inject new money via govt debt
4. Inject new money via corporate debt (not happening while demand is depressed)
5. Print debt-free money
6. Go through a recession that lowers prices & wages (or at least keeps them constant while debt increases)
The IT bubble was #1
The housing bubble was #2
Now we are doing #3
#4 is unlikely
If #3 is stopped without #2 picking up, we have #5 and #6 left… unless something new and big comes along that brings us back to #1.
Cullen,
I just read that Mauboussin piece you posted last week.
“Find realms where the variance of skill is still wide.”
Are there particular areas of the financial world in which you see this maxim applying?
I tend to believe that bond investing still has room for skill to triumph. I don’t use options myself but that also seems like an area that might be ripe for skill. Maybe developing equity mkts as well.
This could be also why I am drawn to the value investing strategy. It seems more likely to rely upon skill rather than luck.
Thanks.
Yes, developing markets are certainly a good place to start. I often talk about money managers who add value through non-correlated strategies. For example, when I ran my partnership I added enormous value through my event driven strategy. It was a niche approach. Most people aren’t willing to get down and dirty in the specifics of a balance sheet or income statement.
It’s all about differentiation. You need a competitive advantage. The only way to do this in the investment world is to become an expert in a niche market, niche approach, etc.
Cullen,
i´d like to ask if you have any thoughts on the battle between BOJ and politicians in Japan?
http://online.wsj.com/article/SB10001424127887323353204578129941008595924.html
“…Mr. Abe publicly called for radical measures, including “unlimited easing,” to achieve a 2% to 3% inflation target, cutting interest rates to below zero, and having the BOJ directly underwrite government bonds. He also has said revising the BOJ law that grants independence from the government was an option, and suggested putting a more dovish new head at the central bank should his LDP return to power…”
how would this affect JGBs, if at all?
do you see any dangers here? and what is your take on central bank indepence as a whole?
Thanks a lot!
I think the discussions over central bank “independence” are just political. The reality is that the central bank is an intermediary between the banking system and the govt. It’s not in the govt and it’s not in the private sector (at least in most countries). The BOJ is essentially the same design as the Fed in the USA. So it’s useless to debate “independence” in my opinion.
What’s important is understanding how policy can influence the economy. I think it’s a mistake for Japan to engage in more QE as I don’t think it will do much.
Greets. Sorry for not writing shorter. I think we agree QE is largely irrelevant and the money supply is only influenced, not controled by the Fed (although it has great power in setting interest rates unless prevented by other considerations). To me, interest rates are the ultimate power that guides the ‘invisible hand,’ the divine intelligence that guides good capital allocation. I am greatly afraid that with Fed rates at near zero for such a long time, investors are misallocating capital on a structural basis, hurting growth if not destroying it entirely.
If you were a benevolent dictator with control of both fiscal and monetary policy, would you raise interest rates at least to some minimal level while boosting spending?
And to take a double contrary position, I would argue Japan is not nearly as bad off as GDP figures suggest (low unemployment, high standard of living), but it is approaching a major change that will produce winners (young workers) and losers (savers, the elderly). With interest rates so low, investment decisions have been distorted and domestic growth anemic for a very long time, similar to what is just getting underway in the U.S. In Japan, the combination of gov’t debt, deficit and now trade deficit means if nothing else, the country is soon to experience some combination of a significant yen decline and (cost-push) inflation increase (not hyper inflation though). Do you disagree with this analysis and if so why?
In particular I’m curious what you think of low interest rates, because I suspect it may be a key differentiator between MMT and other schools of thought.
Toby,
I am not an MMT advocate. Monetary Realism is quite different from MMT. You might better understand the differences here. http://pragcap.com/mmt-critique
If I were dictator of the USA I would not raise rates yet. I don’t think we should raise rates until the de-leveraging has played out further. We don’t want to hurt the debtors at this point. But, we also need to help the savers and investors. So, it’s best to implement a plan where we cut taxes. I would also embed my innovation initiative on top of this. This is a plan that creates a specific govt entity to oversee the allocation of capital to private equity firms for private investment. This would help fund innovation and spark entrepreneurship. I’d literally do monthly awards that would be similar to lotteries. I want a line of college students and innovators pitching private equity firms (with largely govt funding, but some skin in the game) for the purpose of acquiring funding for investment….
Apols, gave wrong email address above.
How bout this as a chart for the day:
http://usda01.library.cornell.edu/usda/current/TurkRaisSu/TurkRaisSu-09-28-2012.pdf
Hi Cullen Thanks much for this very educational forum. After thinking through the logic of MMR, I have concluded that the government could retire the National Debt in an operation which would be very similar to “QE”. That is, the government would “print money” (no tax money needed) to buy the bonds and then retire the bonds (instead of placing them on its balance sheet as the Fed does with QE). Despite the “money printing”, as with QE, no net financial assets would be created for the private sector. Hence no “inflation, etc” issues. Is my “operational” logic correct? While I am not recommending the debt be eliminated (the Treasury market does serve several purposes, as you explain), doesn’t this hypothetical example, if correct, illustrate that the debt is no burden on the future – as it could be reduced or eliminated if desired? Also just a technical question, in this hypothetical example of retiring the debt, would it be the Treasury or the Fed engaged in the transaction? Thanks much for any thoughts on what is an important question for myself and friends who are also beginning to understand MMR.
Charles,
Just an FYI, it’s Monetary Realism (just one M for MR). We often get confused with MMT so the name matters. We’re very different from MMT. Please see my critique if you’re uncertain here. http://pragcap.com/mmt-critique
What we leave our children is a certain living standard. We don’t leave them with a debt burden they need to pay off. They will inherit a certain living standard with certain output, goods, services, inflation rates, tax levels, certain size of govt, etc. The national debt doesn’t get “paid off” so there’s no need to worry about things like that.
In theory, we could retire the national debt as you’ve stated. We’d need to totally overhaul the financial system though. And I don’t see the purpose aside from being able to say we have no “debt”. Really, people just need to move beyond the notion that the debt is something that’s banktrupting us. Instead, it’s impacting living standards in a certain way. That’s the key to understanding govt spending and what we can “afford”.
Cullen, In what “certain” way is the national debt “impacting living standards”? I’m guessing you mean in a positive way because it represents a private sector financial asset.
I am using certain as in “particular”. We leave our children a particular living standard. That could be worse it could be better. But we don’t leave them a debt they need to pay off. We might leave them higher tax rates that they have to pay, but theoretically, we should hope that that is still consistent with a better general living standard though that’s not guaranteed….
You’re very inconsistent about your description of federal debt.
Sometimes you say that it doesn’t have to be paid back. Other times you say it’s backed by a $16 trillion economy.
What I’m taking away is that federal debt creates money, which is needed, but we’re not able to do it without a) creating a ‘debt’, which is what gets people all worked up, and b) creating a financial instrument.
I think you could help the debate if you told people that the ‘debt’ never has to be paid back. That would make the fur fly. It would probably lead to massive borrowing, but maybe not.
What’s inconsistent there? There’s no such thing as paying back the national debt. I’ve never said otherwise. And yes, the only reason anyone would save in US T-bonds is because it’s backed up by $16T of output. There’s no inconsistency there. That’s just the simple reality….
The expression ‘backed by’ normally implies that you can pay back the debt out of future production. I think you know that, so I’m not clear why you use the expression.
If we are not ever paying down the debt, we should make it clear that what we are doing is exchanging a dollar (which is spent into the economy) for a financial instrument.
And, as you say, we can create as many of those financial instruments as we want, provided we don’t spark inflation. As long as those financial instruments are held passively, there is no danger of that, but once they are spent, that could change.
One reason that debt hawks have power is that we all understand the precept: ‘Don’t spend beyond your means’ because that is a very specific instruction. But if you say, ‘Don’t spend beyond your future inflation risk’ then we lack specifics. Can we double the deficit? Triple the deficit? What’s our number?
No, stock prices are “backed up” by their underlying output. You don’t pay back stocks. Same thing here.
THe stock analogy is interesting. You’re saying that buying debt is like buying stock in America.
Taking the analogy a step further, if America has a $16 trillion economy, what would the fair stock price be? What’s our PE?! And remember to factor in future claims against our taxing power.
And remember that your stock is being diluted every year.
That’s a decent parallel there – thinking about T-bonds like stock. Not quite true but might help people start thinking along the right lines.
“You live in the past. Your cash economy is dead.”
Cullen Roche
Cullen, are you familiar with the Bible verse Revelation 13:17 ?
If not, please let me share it with you.
New International Version (©1984)
so that no one could buy or sell unless he had the mark, which is the name of the beast or the number of his name.
New Living Translation (©2007)
And no one could buy or sell anything without that mark, which was either the name of the beast or the number representing his name.
English Standard Version (©2001)
so that no one can buy or sell unless he has the mark, that is, the name of the beast or the number of its name.
New American Standard Bible (©1995)
and he provides that no one will be able to buy or to sell, except the one who has the mark, either the name of the beast or the number of is name.
http://bible.cc/revelation/13-17.htm
So you see Cullen, Not to get all religious here, however… Your Prophecy of No cash in society hence LONG been predicted before you OR Apple Ipod/phone/pads..
Predates your predictions, just wondering your thoughts, seeing as you have been a pretty big proponent of a Cashless Society.
Cashless Society.. Sounds Good doesn’t it, Just whip out the Iphone a scan and all is great..
The Bible paint’s a different story. Remember, “No one could buy or sell unless he had the mark”.
Now again, not to get all religious BUT also not to get all dumb down secular.. This stuff has survived thousands of years for a reason.. Just Sayin..
OR Askin,
Do you take Biblical prophecy into account when you make such grandiose statements as “Cash economy Is DEAD”?
Your answer does have biblical ramification believe it or not.. At Least to a few Billion people anyhow.
You misinterpret, “No one could buy or sell unless he had the mark” as a prophecy, when in reality it was a means of social conditioning. Around the time The Revelation to John was written, the Jews were coining their own money in their revolution against Rome. In an attempt to halt the revolt Nero, the Roman Emperor at the time, needed to destroy the legitimacy of the Jewish currency. If no one accepted the Jewish currency, then they revolutionaries would have no way of mobilizing resources against the Romans. The Greek word for mark also means a stamped coin or the impress on the coin. Thus the sentence reads, “No one could buy or sell unless he had the stamped coin (of the holy Roman Empire).” So really what the Bible is not talking to you, the modern reader, nor is it making a prophecy, but rather trying to convince the average person living in 70 A.D. Rome that the only legitimate currency was the money that carried the official imprint of the Emperor (i.e. not the Jewish currency.)
Also, the Bible is a little over 2000 years old. However for the 3000 years before the Bible was published, we had a money less society, (i.e. system of debits and credits.) The usage of gold, and other arbitrary objects, as money is a relatively recent phenomena.
Thanks Undergrad, you have given me some food for thought.
I have spent a fair amount of time studying prophecy and know that within the church there are many differing views. Preterism, Dispensationalism etc.. However, I simply try to keep things as has been proposed keeping with respect that human nature is basically unchanging.
Therefore, when I see/read things such as ” Why cash is losing its currency”OR Children Scanning their Palms to pay for lunch, it does give me pause to reflect on who ever controls this system rules the world.
Therefore, for the sake of argument, we go with your view that:
” it was a means of social conditioning. Around the time The Revelation to John was written, the Jews were coining their own money in their revolution against Rome. In an attempt to halt the revolt Nero, the Roman Emperor at the time, needed to destroy the legitimacy of the Jewish currency.”
Could not the same be said now? “Social Conditioning” of HOW we view currency and WHO we allow authority over it and finally over us, because he who controls the currency controls us.
Wow, the more I read the more it is plain that a “Cashless Society” is pretty much a done deal already here. just need to remove the actual cash.
Whether it be of religion prophecy or simply secular by need design.
I don’t think it a good thing that one authority have the ability to turn on or off someone’s economic life.
One paper I read talked about what if an EMP electromagnetic pulse) wiped out a large portion of the electric grid.
A cash-less society is part of two disturbing trends.
One, constant flation will take away a man’s ability to save today’s money for future income, thus discouraging saving and making him reliant on the state to support him.
Second, he will be lured into accepting goods and services in exchange for debt, which makes him a servant to the state. (Student loans, for example.)
Just because we use electronic money, does not mean constant inflation, nor does it mean we must take on debt.
That’s true, but there is an underlying assumption that to grow the economy we must take on debt. For example, because the consumer can no longer borrow more, it is opined that the federal government must borrow more. Even deleveraging is now defined not as paying down debt, but a momentary pause before borrowing is resumed.
As for inflation, without inflation, there would be less incentive to borrow. The only way to induce a man to borrow is to convince him that he should take the dollar now because it will be worth less in the future. Also, inflation means that we constantly need more and more money, and since we have given the power to create money to insiders, those insiders need to create inflation so they can create money (at a profit to themselves.)
It’s just another way of thinking about things. We should be very careful not to accept the conventional wisdom of the times without examining the consequences.
First, that has nothing to do with electronic money. The same thing happened when we used gold as our currency and when we used physical paper money in our everyday lives.
Second, (this compliments, not contradicts, your view) there is an assumption we need to be growing at our old trend lines, about 3-4% a year. That is unsustainable for as we all know, the private sector went on a 33 year long, credit induced, spending spree. Hence the persistent boom bust periods. To my mind, that seems like a terrible way to structure economic growth.
Cullen, you asked me earlier “how to change the system” (re monetary policy) and unsurprisingly I didn’t have an answer.
Something struck me now though. If we work on the theory that a large share of unemployment is a result of lack of money supply in the everyday circulation… would it not make sense to flat-out print a largish fraction of the money going to unemployment benefits?
I can’t say I’ve given it much thought.. but it seems nice and self-adjusting to me on a cursory look. (The exact fraction would have to be discovered though)
Depends on the environment. In an environment like today where spending is depressed because private credit creation is weak then the govt spending just fills a void. But what if we’d been running 10% budget deficits with lots of spending going towards unemployment benefits during the 2000s? It’s not hard to imagine that the housing bubble and the misallocation of resources would have been much much worse.
In fact, the MMT job guarantee isn’t far off from what you’re saying. Except it makes people work for the income. The problem there is finding productive jobs for all those people to do.
I am not against full employment. But I am against full employment just for the sake of full employment if it actually exacerbates big problems. You don’t make 100% of the economy worse off just so you can stake your claim on the difference between 96% employment and 100%….Lots of Keynesians just assume you can steer the economy through govt policy. I don’t think the world is so black and white.
Well, the housing bubble was built because of low interest rates, which were low because of depressed demand. If demand was less depressed, the Fed would have set interest rates higher.
And yes I saw the connection with the JG but still it’s not what I’m advocating, really. I’m merely suggesting that covering a % of already-existing jobless costs via outright money printing is a good automatically adjusted stabilizer. And very different from just handing the keys to the printing press to the politicians.
Personally, I’d probably prefer something like automatic tax cuts tied to the unemployment rate, but spending would get the job done also. To be honest, I am not sold on UE benefits as an optimal form of govt spending….
An automatic tax cut in the form of raising the point where you start to pay taxes might work. Something that lowers percentages would buy few cents per dollar – the cut goes to the wrong demographic.
It also becomes politically problematic because it causes the debt to grow, which gives the deficit hawks something to hawk about. (And even if I’m no deficit hawk, it strikes me as somewhat silly to go into too much debt. It ends up throwing a lot of money to rent-seekers who don’t need the money.)
And just to clarify – no, I’m not advocating excessive UE benefits for the sake of economic stimulus. But keeping people fed and with a roof over their heads even when unemployed does carry costs.
My idea was that a (largeish) fraction of these costs translate to amount of money gone missing in the everyday circulation. Either through rising money&prices, or through deleveraging, or profits extracted – the reason matters less when the shortage is a fact.
And yes I am working on the assumption that we are living in a modern industrialized society where lack of productivity is not a concern.
I’d say money is a tool we use to allocate our scarce resources, time, in the most productive means possible. Obviously we don’t get everything right, but we do pretty well all things considered. Our system’s strength is that no one entity controls the money. So really we control the currency therefore we control us.
Wow, never thought I would talk about the Bible outside of my humanities class but here it goes. Always remember the Bible was not written with us in mind. It was written for the people who were living at the time it was written. Therefore in order to understand the Bible, you must understand the historical context each book was written in. Otherwise you will commit Dante’s sin of heresy, mistaking a part for the whole, and sodomy, focusing on superficial appearances and missing the deeper meaning.
Also remember that it is written by a bunch of normal guys. They had no special powers, although Isaiah was very gifted with words, who had very curious minds. Together, they captured how they saw the world at a moment in time. Whereas others issued warning to their target audience to reform, otherwise they will be punished in some form or another (these are usually the prophecies.) So to your credit, there are some authors who have very timeless insights in what it means to be human. However none of them have been to the future, and therefore they cannot predict it.
Whoops this was supposed to be a reply to Cowpoke.
Except these days, money is way more scarce than the actual resources. There’s plenty of people that would love to work. There’s plenty of people that would love to buy more. If only they could be paid more. If only there were people buying more.
An economy by default raises prices and wages (everyone wants this year to be a bit better than last year) until the money supply no longer allows raised prices and wages. At that point you either get recession OR you expand the money supply.
“Always remember the Bible was not written with us in mind.”
Friend, you musta got your Biblical understanding from a collegiate podium and not a Church pulpit, what part of the 10 Commandments are irrelevant today?
All kidding aside, I have not had time to research your point about currency at the time of Jesus, I do know that there is a very well know Biblical verse Mark 12:15 :
“15 Should we pay or shouldn’t we?”
But Jesus knew their hypocrisy. “Why are you trying to trap me?” he asked. “Bring me a denarius and let me look at it.” 16 They brought the coin, and he asked them, “Whose image is this? And whose inscription?”
“Caesar’s,” they replied.
17 Then Jesus said to them, “Give back to Caesar what is Caesar’s and to God what is God’s.”
And they were amazed at him.”
SO, Jesus made it a point to point out that CAESAR’s face was on the coin at the time.
Undergrad, would you be so kind as to paste a few links I can read about the differing currencies at the time that could reference the use of differing currencies at the time?
Thanks
Cullen-are there particular economic metrics you look at on a daily basis when synthesizing your market/inflation/interest rate views? (swaptions/swap spreads etc. via bloomberg terminal)
The only indicator I look at on a daily basis is my equity market algorithm. Aside from that, there’s nothing all that secretive about what I look at or use.
Cullen,
Sorry if you’ve explained this before, but I can’t seem to find a definitive answer to this question. Would not passage of a federal balanced budget amendment either a) eliminate federal borrowing and obviate the need for Treasury securities or b) allow federal borrowing and Treasury securities to continue but require a massive tax increase to pay for it?
Thanks.
Hi Jim,
There are many problems associated with running a sustained balance budget. The Clinton administration did a pretty thorough analysis of some of the issues when they ran a surplus for a brief while.
http://www.npr.org/blogs/money/2011/10/21/141510617/what-if-we-paid-off-the-debt-the-secret-government-report
Hope that helps.
Hi Cullen,
I think I’ve asked this before but I’m still confused about it…
Since money creation occurs via credit, it seems like the process is like building a house of cards that must collapse because of compounding interest, i.e. in order for their to be money to cover the interest on top of the principle, more credit has to be issues, but that credit also has interest attached, and so on.
Do you think it’s accurate to say that when the U.S. government deficit spends, it in a sense transfers liabilities that were on bank’s balance sheets onto the U.S. government’s balance sheet… And then when that money is spent back into the economy, that money then economy with the dollars to prevent the compounding interest problem?
thanks.
JK, your question is a bit confusing, If a bank creates credit to a person or entity, it is generally doing so because that person or entity is credit worthy. Which means the bank is issuing credit based on the ability of the entity to pay it back. Therefore, that entity is able to leverage the capital in a productive (Legal) way so that the initial loan can repaid and a profit garnered to to the original loan recipient.
Cowspoke, sorry the last line I wrote is jumbled.
What I’m getting at is this: imagine a one bank and two person economy. if the bank the bank give me a $250,000 loan to buy your house, and charges me interest on that loan, where does the money “come from” to pay for the interest payments? Assuming the principle alone was created, I could give you the $250,000 and you give me the title to your house, and then somehow I need to get that $250,000 back from you in order to pay off my loan.
Hence, all inside money nets to zero, right?
But once you introduce interest on top of the loans, then it seems like there must be ever expanding loans in order to keep up with the interest payments. See what I mean? It’s a compounding problem.
So what I’m asking is: does the U.S. government via deficit spending technically provide those dollars to keep up with interest payments… by shifting liabilities from the balance sheets of banks unto itself, and then spending that money back into the economy?
Does that make sense?
A few things here. Private credit is almost always expanding. There’s no such thing as the aggregate private sector paying back its debts any more so than the govt pays back its debts. The economy is a perpetual growth machine and the liquidity that helps grease this growth comes primarily from borrowing to invest, spend, etc. So where does the interest to pay loans come from? It comes from other loans! Using a micro example to expand on a macro point does not provide the full picture because that’s not how things work in reality. Your borrower does not pay off his loan all at once. He obtains income (perhaps from someone else who borrowed to invest in their new business) and that income helps him pay off his loans plus interest. It’s a system of flows, remember. And yes, the govt can help increase the flow and they can even increase the health of balance sheets by providing NFA that solidifies balance sheets. But there’s no such thing as the private sector paying off its loans in the aggregate. The system is built on inside money and it simply can’t sustain such an occurrence without failing (as should be obvious following the recent credit bubble).
“He obtains income (perhaps from someone else who borrowed to invest in their new business) and that income helps him pay off his loans plus interest. It’s a system of flows”
Cullen, do you see how “FRACTIONAL BANKING” concept get’s intertwined?
look at what you just said.. It’s all accomplished over “TIME” which we all pay a fraction here and there allows the system to continue on.
Not that I hold to the typical fractional reserve concept, but just saying that even your model points to a fractional flow (based on trust) that allows for continued flow.
In the end, I am starting to think that it is really not about the currency or money supply that matters, but more about Trust, trust in the human org structures that are in place and that they are put there by a society that is most reflective of human honesty and integrity.
Absolutely. Any money is trust. Even gold. Without money we have to go back to barter.
MR Olsson, is that saying that barter is also trust? OR is barter a more simplified way of assessing value for ones goods OR productivity?
Funny thing is, when we talk in terms of productivity it is an all encompassing sort of production gain with out reality cost factored in.
Case in point, Take this read from an Eastern Congo Aid Worker Diaries:
“Julie had just blown out the kerosene lamp and was lying in bed next to her husband when suddenly the stillness of the night was pierced by enraged shouts and the sound of a door being kicked open. Eight armed men burst into her house in a small village in Democratic Republic of Congo’s North Kivu province, wielding machetes and automatic rifles.
“They ran over to my husband first,” Julie recalled a few months later as she sat in a rural health clinic run by the International Rescue Committee (IRC) where rape survivors receive counseling and medical care. “They cut open his stomach with a machete and he fell over in agony, bleeding. Then two of the men raped me. When I tried to resist, they cut my arms with the blade. When they finally left, they took our goat and our chicken.”
http://www.trust.org/alertnet/blogs/aid-worker-diaries/eastern-congo-women-are-afraid-they-could-be-raped-any-night-here/
Interesting out of that Horror and all she was able to complain about them stealing her Goat and Chicken.. WTH (What The Heck) so that shows how valuable Items other than Cash can be to people, especially in a dysfunctional society.
I’m making the point that when we work for someone, we accept money as payment. – Because we trust that the money can be used to buy what we need. Without that trust, we would insist in being payed in food & gas.
Cullen,
Thanks. Everything you said makes sense. And I know it can be unconstructive to use a micro example to make a macro point. I just did it to clarify what I was suggesting.
I’ll broaden the question to get to the point…
Could an economy successfully and sustainably grow long-term on only inside money via loans+interest?
My sense is that compounding interest would quickly become a problem, which is why I’m suggesting that it seems like deficit spending is constantly “refreshing” non-government balance sheets in order to keep the ‘house of cards’ (compounding interest) from collapsing the economy.
For example the recent housing bubble. The credit creation (plus interest) expanded so fast, that it eventually it became apparent that the weight of those loans could not be sustained, i.e. too many borrowers that couldn’t make their payments.
BUT… if the U.S. government had hypthetically deficit spent during that time, let’s say crediting households with $3000/year, then the collapse never would have occurred (all borrowers able to make payments)…. because defcit spending would have “kept pace” with credit creation and the weight of those loans+interest.
Thinking of it like that, it seems like deficit spending is a necessary component to a properly functioning private banking system whereby Loans Create Deposits + interest.
I think you’re falling into the MMT trap (at least a little bit) here. MMT uses a deficient definition of saving. That’s what the S=I debates were all about. Much of the confusion in this discussion comes from MMT changing (another) definition. In the MMT world net saving is (S-I). But in the rest of the accounting and economics world net saving is as the OECD defines it. ”Net saving is net disposable income less final consumption expenditure.” The OECD definition comes from the United Nations system of national accounts, and is consistent with the BEA definition too. It’s also consistent with every economic school apart from MMT. For all these economists, saving is “income less consumption”, and for the private sector this is “S”. This is in contrast to the MMT definition of saving as “income less spending”, which is S-I. The economist or layperson who learns this from an MMT economist will come away not understanding that the economy is built on a stock of financial assets, not a stock of cash, which is the primary takeaway from understanding the net finanical assets are created through government spending. This is not to imply that net financial assets don’t matter, but the MMT view again tries to create a government centric view of the world where NFA matters most when the reality is that the stock of assets built up by the private sector far outweighs NFA in terms of balance sheet importance and real economic importance.
Your question is much more complex that that though. The flows I like to reference are incredibly complex and unevenly distributed. Europe is essentially a closed system right now and their primary problem is not a lack of govt spending, but really a lack of redistribution. The flow isn’t getting to where it needs to get to. So you have half the region that’s wealthy and the other half that’s poor and indebted to the other half. Imagine if the US banks just retained all of their interest profits and never spit any of it back out into the economy. What would happen? The system would get clogged up. Govt is a redistributor just like your heart is a redistributor of blood. In a closed system with balanced trade and a balanced budget you could potentially have a perfectly workable system based entirely on inside money. But the problem is that we don’t have that kind of natural stability. So we have natural imbalances that build. We have misallocations of resources and imperfect flows in the system that result in clogs that need to be fixed on occasion. So you need that entity that can take from New York and give to Mississippi to avoid Mississippi defaulting (Europe doesn’t have this system). And govt just so happens to be a pretty damn good plumber for these sorts of issues (although it can also be the cause of them at times). So don’t get me wrong. I am certainly not saying govt is bad, but I think you need to keep the govt’s role in the proper context and not try to assume that govt is the key player. I like to always emphasize that govt is a facilitator when used properly.
I’d argue that it’s dangerous to claim that the govt could have avoided the housing bust by spending more. My guess is if we’d been running 10% deficits back in 03-07 that the housing bubble would have been much larger and it would have eventually burst regardless of govt spending. And then we would have had a much bigger problem on our hands. But that’s obviously a guess.
Hope that helps.
Alot to consider to in your response. Thanks. Appreciate it.
Agreeing with everything up to the last paragraph. If the govt was hugely deficit spending, inflation would have picked up, and the Fed would have raised interest rates, which would have slowed the bubble’s from expansion rate because the size of interest payments would increase. (Would it STOP the bubble from growing? Didn’t say that.)
I’m not saying that the govt SHOULD have been deficit spending. I’m saying I don’t see how deficit spending automatically leads to bigger bubbles, rather the opposite.
Cullen, Thanks so very much for helping with the question I’ve had since way before I started following your Pragcap 3 years ago. CR: “So where does the interest to pay loans come from? It comes from other loans!” This answer is consistent with what you are proposing BUT it has a problem. This proposes that the economy can kick the interest payments down the road forever. This depends on growth in the economy and the expansion in the stock market over time BUT again this is but a drop in the huge bucket of interest due each year. The credit market far far outstrips the funds in equities. The interest payments must ultimately come from property confiscated by the loan holders. Otherwise the bank money creation system must break down.
How do you mean that the stock market ties in?
I don’t see how the system has to break down from the situation you describe. In a SANE system it should be able to be perpetual.
But what we have is a leaky system where an expanding share of the money supply exits the consumption-production circulation. And that’s why central banks keep having to adjust their interest rates downwards – so we can afford to borrow more. And THAT is worrying.
Will central banks cancel government debts?
http://blogs.ft.com/gavyndavies/2012/10/14/will-central-banks-cancel-government-debt/#axzz2DYSTkG3S
This was discussed by Gerard Minack from MS in his recent notes and really got me thinking. Is this possible? Is this quasi fiscal policy? What are the implications for inflation and asset prices? Wondering what you think, Cullen. I know there are not operational constraints given the monetary system for the UK, US, Japan. Thanks as always for the great site and forum here.
Q, in the end it’s all about TRUST. (IMO)
Think about it, with your dying possession, being passed on to your most current relatives. Would you pass it on to the Jesus Freak In-law, Or The Gay Transgender one?
The divorced in law or the newly wed one?
Choices choices.. what are we to do?
Where does social fiber become moral rope for a culture of people?
It seems strange to me. To cancel the debts would mean to remove the savings bonds from the holdings of many people who hold them. I don’t see how this is possible. Can we just eliminate the debt in every pension fund in the USA?
I am not sure this would even be possible….Not to mention the moral hazard of just wiping debt off the books in such a mass manner.
suppose just the FED held its debt to maturity and then destroyed the cash received at maturity?
This is what I am thinking, canceling the treasury/cash held at the fed, but since this is not private sector funds, then perhaps it would not matter at all. Or would it matter a great deal as being fiscal policy enacted by the treasury/fed in concert?
Hi Cullen,
I think consumption is a type of work, and I would like to get your thoughts on that idea. An example that illustrate this is unemployment compensation. Money is transferred from the government to the unemployed person, the unemployed person uses their time to decide what to consume with the money, and they also user their time consuming the desired good or service. The consumption of the goods and services by the unemployed person provides a desired service to the public by stimulating the economy while providing essential goods to the unemployed person and employing workers who supply health care, groceries, housing, etc.
Thanks,
Jim
Jim,
You might want to read this piece about how living standards actually increase in the economy. http://pragcap.com/the-role-of-the-entrepreneur-in-a-capitalist-economy
Demand is a huge component of all this and extremely necessary so there’s some merit to what you’re saying. But I like to say production and consumption are two sides of the same coin. But what ultimately makes us all better off is the quality of the output that’s generated from the meeting of consumption/production.
Hope that helps a bit.
Cullen
Cullen
When the government (Fed or Treasury?) redeems a U.S. Treasury bond
does the money come from additional borrowing (as some believe) or does the money come “out of thin air” (as when the Fed buys bonds with QE).
I believe the latter is true but I’m not sure. Of course, as with QE, if the money does come “ex nihilo”, this does not mean that money is “being printed” since the bonds are being taken away. That is, private sector financial assets are left unchanged.
In any case, I wanted to verify that my understanding is correct or
not – that the money is provided ex nihilo not from additional
borrowing. Thanks for any help.
Hi Charles,
Are you referring to QE specifically? When the Fed buys bonds they are printing a reserve and exchanging it for a t-bond. But this doesn’t alter the net financial assets of the private sector. So, technically, the Fed is creating outside money to buy t-bonds, but they are not actually changing the NFA of the private sector. That’s why QE is not the same as printing money. Printing money implies an increase in the overally money supply. And I don’t think that’s a fair representation since QE doesn’t alter the amount of private sector NFA or the amount of inside money in the economy.
Hi Cullen thanks for responding. I was not asking about QE, which I understand as you describe. I was asking about the case where the government (Treasury or Fed?) retires a maturing Treasury bond. That is, in this case does the money come “ex nihilo” or from additional borrowings?
I assume the money is created by simply crediting accounts (ex nihilo) but I was not
sure. I understand that if the money is
created ex nihilo that no financial assets are
being added because the bonds are being taken
away so no need to explain that. Thanks.
Hm.. a bond reaching maturity does not create money. The money needs to come from the govt’s balance sheet.
Whether or not that money needs to come from a NEW bond or not depends on the current state of the govt’s finances.
Cullen,
If QE is just an asset swap which adds Reserves to the banking system… how/why can this lead to commodity bubbles in something like gold? Aren’t Reserves only used for inter-bank lending?
What’s the transmission mechanism?
It’s part psychological and part interest rate impact. If QE actually has an impact on long-term rate then it drive real interest rates lower which can make commodities more attractive. But I presume it also has a substantive psychological impact. For instance, in China following QE2 there were widespread fears that the Fed’s money printing would cause worldwide inflation. So there were reports of Chinese farmers hoarding cotton and other commodities in preparation for this. This sort of inventory stocking effect is very real and can have a meaningful impact on prices. Of course, it reverses over the long-term when the inflation fears don’t pan out (which is precisely what we saw following QE2), but that doesn’t mean there isn’t a short-term impact….
Hope that helps.
It sort of helps. I think what I’m confused about is “where” and “of what type” of money gets moved around.
Lets say I own a T-bond and the government purchases it via QE. My money then, within the banking system, changes from one type of financial asset (T-bond) to another (Reserves). As far as the bank is concerned, if I don’t touch that money, the bank can only use those Reserves in inter-bank lending. But for me, I can withdraw that money, and purchase gold with it. When that happens, I get a claim on gold, and the person that sold me that claim then gets Reserves in the banking system?
Does that sound correct?
The fed doesn’t come knocking on your door wanting to buy your bonds. They buy whatever is being sold on the market. And when banks are in a liquidity crunch, they’ll have A LOT of bonds up for sale.
What they are doing now is buying MBSes, which is something Joe Worker will never be holding.
If you had a bond up for sale which got bought via an open QE aimed at bonds, you would end up with money ahead of time (now instead of at maturity). Now if you went and spent that money into the economy, it would result in a temporary increase in the money supply available in the everyday circulation. (Until the govt pays the bond back at maturity – to the fed that is now holding the bond)
Of course this is such a minority event that you can pretty much ignore it.
The Fed isn’t buying from individuals. It’s buying from banks. So, presumably, if you include individuals in this equation you have to include the fact that you’ve ALREADY sold a bond to the bank BEFORE the Fed even gets involved in any sort of transaction that someone might claim involves bank deposits (inside money). So individuals have to sell on to banks before the Fed can even get involved. Otherwise, the Fed is just adding outside money to the system via their swaps. And as you know, outside money doesn’t make the banks more “liquid” than they were before.
They do it that targetted? I thought they were constrained to secondary market purchases.
http://www.zerohedge.com/news/2012-12-04/10s-turn-special-repo
Hey Cullen, can you please explain the significance of the article above please?
Sounds like much ado about nothing. In other words, that article is not significant.
Cullen, what’s the word on the street out West in regards to that port strike?
Thanks
Just ended. http://www.thegrower.com/news/Port-strike-ends-in-California-182228201.html
http://onpoint.wbur.org/2012/12/04/the-liberal-take-on-the-fiscal-cliff
Lisa Mascaro, covers Congress for the Los Angeles Times.
Stephanie Kelton, founder and editor-in-chief, New Economic Perspectives.
Paul Krugman, columnist for the New York Times. Professor of economics and international affairs at Princeton University.
Stan Collender, national director of financial communications at Quorvis.
Hey Cullen,
How does MR think about eurodollar deposits at foreign banks? Do you view those as USD?
Scott
Eurodollars would be considered inside money.
Why does the Treasury issue bonds of different maturities?
I can only think of one reason, that being to allow citizens a risk free rate of savings, which you have mentioned many times here. Are there any other reasons? If that is in fact the only one, then it would be the only thing stopping the treasury from only issuing 3 month bills and effectively eliminating all borrowing costs, right?
Different durations for saving. Tsy is just meeting market demand for different products.
I know personally that the existence of the 30 year Treasury has provided remarkable diversification benefits for my portfolio.
I imagine that the existence of this safe long duration bonds are also extremely useful for the insurance industry.
Let’s hope they keep meeting that demand
Only issuing 3 month bills would in no way eliminate borrowing costs. They do not get bought for their at-maturity value. They get bought for less.