BUFFETT’S “SILLY TALK” ABOUT THE U.S. DEBT
* This post was written in 2011 before Mr. Roche founded Monetary Realism, a post-MMT school that was formed due to several disagreements Mr. Roche and many other former MMT proponents had with the school of thought. For more info on the difference in views please see here. For more on MR’s views please see here.
Some pundits are unhappy with the Oracle of Omaha’s proclamation that a debt crisis is not an issue for the USA. They reference the following comments from a few weeks ago and cite the comments as “silly talk”:
“The United States is not going to have a debt crisis as long as we keep issuing our debts in our own currency. The only thing we have to worry about is the printing press and inflation.”
And when someone starts claiming that Buffett is talking “silly” you should probably start wondering who is actually being silly because, as Buffett likes to say, “If you’ve been playing poker for half an hour and you still don’t know who the patsy is, you’re the patsy.” I can assure you of two things – this MarketWatch article will take you less than half an hour to read and Warren Buffett is not the patsy in it.
The article uses all the same misconceptions that are common in the media today. In some form, they argue that the USA, being just like a household, is fiscally constrained and must maintain its balance sheet in the exact same way that a household or business would. Of course, this is totally illogical because the USA is a sovereign currency issuer with an endless supply of currency in a free floating exchange rate system. Households, businesses, US states and EMU members are all constrained in their ability to spend because they are all currency users. They must always collect revenues or amass debt before they can spend. The USA works in the exact opposite way. As a currency issuer, the US government can always procure funds so it has no solvency constraint.
Now, an interesting aside arose the other day during my conversation regarding Austrian economics (feel free to skip the next two paragraphs if you were not involved in the Austrian debate as it is a minor tangent). A very astute commenter noted that the Fed could provide reserve balances with which the private sector can save. In other words, the government need not deficit spend in order for the private sector to save. That’s all well and good, however, it is not realistic. We did not create a government so that the Federal Reserve could feed its various minions with reserve balances. We created a government because we believed that this supra entity could provide some public purpose.
As highly social pack animals, it’s not surprising that we form large united groups that work to generate some public purpose. In establishing these supra entities we establish ways in which the members of these societies can interact in attempts to achieve greater prosperity by leveraging the abilities and knowledge of the entire group. In modern times, that has always involved a common currency and some level of public spending by the supra entity on these various public works. Spending necessitates taxation. And the tax system in a modern fiat government is the glue that binds. But in order to tax this government must first name the thing that can be used for tax payments and it must actually create these notes. So, while it’s technically correct that a government need not spend in order for the private sector to save, it is not realistic because reality shows that governments exist for specific reasons and they therefore spend for specific reasons. Removing the government from the equation and concluding that the private sector can still save because of the Federal Reserve is not based in any sort of reality.
But I digress. The article cited several “experts” on the history of debt. Of course, the king defaultista, Niall Ferguson was trotted out to show how “silly” Buffett is:
[Buffett] “must know this is nonsense.” Ferguson continues, “Britain had complete monetary sovereignty in the mid-1970s and yet the IMF had to be called in. I could give numerous other examples. And then there is the inflation risk, which is implicit in his statement. We won’t have a debt crisis because we can print unlimited quantities of paper dollars. If that’s the good news, I don’t want to hear the bad.”
Now, it’s helpful to put things in perspective. Ferguson has been predicting the demise of the US empire for well over a decade. In a 2003 working paper he said the following:
“So what will happen? And when? The answers to both these questions depend on how quickly Americans wake up to fiscal reality. Perhaps the hardest thing to figure out is why they haven’t done so already. Even financially sophisticated Americans seem not to appreciate the fragility of the country’s fiscal position.”
He went on to discuss how the bond market would one day awake and yields would surge and catastrophe would strike:
“A widening gap between current revenues and expenditures is usually filled in two ways. The first is by selling more bonds to the public. The second is by printing money. Either response leads to a decline in bond prices and a rise in interest rates – the incentive people need to purchase bonds.”
There’s a reason why Ferguson writes books, teaches and doesn’t run a fixed income trading desk – he could have blown up several hedge funds betting against US government bonds since 2003. And yes, it is important to point out these horrible calls because someone who has been wrong as long as Ferguson must reconsider their thesis or be shunned by the investing public. Being right matters in this world. Particularly when we are discussing matters that influence millions of people. This is not a joke to me and should not be a joke to anyone else. And frankly, we should all be sick and tired of people who trot out the same old tired arguments year after year and fool people into buying their new book. We are talking about people’s lives so if you’re going to spend the better part of a decade being wrong you should do everyone a favor and either alter your thesis, stop pretending to be an expert in these matters or start writing books on different subjects.
But despite being wrong about the collapse of America and its inevitable bankruptcy for a decade now, Ferguson’s points are not entirely without merit. As Britain proved, a monetarily sovereign government can choose to go bankrupt or accept aid from an outside entity. The USA could choose to default on its debt tomorrow if it wanted to. The game of chicken that is currently being played with the debt ceiling should make that clear. But that’s a political choice and not an operational choice. Only the USA can issue dollars and because our debt is entirely denominated in the currency that we have endless supply of it is operationally impossible for the USA to default on its debt in the same way that a household, state, business or EMU country can. It is an irrefutable fact that the USA cannot run out of the dollars that only it can produce.
But as Buffett pointed out, the government can cause horrid inflation by spending in excess of productive capacity. This clearly isn’t the case currently. Core inflation is just 1.3% and the headline figure is just 3.1%. And almost the entire spread over core is due to motor fuel prices. To blame the USA’s below trend inflation (yes, below trend even with near record high gasoline prices) on spending policies is simply misleading. In addition, the US money supply is not growing above trend (see here for proof) so all of the fear mongering about Fed “money printing” has turned out to be flat out wrong.
As for hyperinflation - I have studied the history of hyperinflations and written extensively on it. Hyperinflation is a uniquely psychological event that results in complete rejection of the sovereign currency. It primarily occurs during a regime change. Is hyperinflation a risk currently? I would put the odds at slightly higher than 0%. There is very little in the current environment in the USA that is consistent with past cases of hyperinflation.
Next up was “pre-eminent scholar of monetary policy”, Allan Meltzer who brought out another classic fear mongering point:
“We can have a crisis if the Chinese or Japanese start selling their mountains of dollar debt, or if the dollar collapses instead of declining, and if we get a big inflation.”
This is beyond misleading. China accumulates dollars reserves because they choose to run a FX peg with the USA and a trade surplus. By definition, their central bank accumulates dollar reserves because of this. There are only a few things China can do with their dollar reserves. They can let them sit in the equivalent of a checking account collecting dust. Or they can buy USD denominated assets. Now, they can try to buy Chevron again, but we all know how that ended up. Instead, they choose to buy interest bearing paper in the form of US Treasuries. The USA doesn’t need China to buy treasuries. Their purchases don’t “fund” anything. We don’t call China before we sell bonds and make sure that they are there to buy. China gets pieces of paper with old dead white men on them in exchange for real goods and services. If they choose to stop accumulating these pieces or paper then they need to dramatically alter their domestic economic policy. Ironically, most of the people who argue that China is manipulating their currency are the same people saying that we need China to buy our bonds….And as for China selling? Well, who are they going to sell to? And why would they do anything that might be to the detriment of the trade partner that they willingly choose to rely on for much of their economic growth? As you cans see, the fear mongering doesn’t add up when you think about it all rationally.
Next up is Desmond Lachman of the conservative American Enterprise Institute who cites the good old bond vigilantes:
“If the markets think that the U.S. public debt situation is out of control,” he says, “and that the Fed is going to print money to inflate the U.S. out of its debt problems, blood will be spilt in the bond market as people dump Treasuries until interest rates rise very high to compensate them for the inflation risk. That will be disastrous for the stock market and for the U.S. economy.”
Ah yes, those beloved (and very sleepy) bond vigilantes. For some perspective on how dreaded these vigilantes are we should reference the recent history of long bond yields:
Long bond yields are a function of Fed policy and inflation. As previously mentioned, core inflation is hardly a concern and the Fed remains at 0%. I won’t bore readers with the mechanics of the bond market, but let’s just all agree that, at 3.1%, these vigilantes sure are bad at their job. Actually, they’re quite good because they’ve correctly predicted that high inflation and government default are low probability events currently.
Senator Alan Simpson, who co-chaired the bipartisan debt commission is later quoted in the piece saying:
“It won’t be the old slippery slope crap that we read about,” he said. “It’ll be very swift and very dramatic, like in Greece or Ireland or Portugal or Spain or wherever. I don’t know where this is going, but I tell you, it won’t take long.”
It’s amazing that this man was running the debt commission. He doesn’t even understand the difference between the EMU and the USA. The EMU nations are the functional equivalents of the US states – they are currency users! Yes, they are revenue constrained and yes, they are susceptible to debt crisis. But comparing the USA to the nation of Greece is entirely illogical and misleading. Just because they are both countries doesn’t mean they are equivalent in terms of their monetary systems. This sort of mistake speaks magnitudes about the state of our current leadership. The people in the very highest offices are making the simplest of mistakes when it comes to understanding our monetary system. It’s no wonder the country is such an economic mess currently….Unfortunately, most of this stuff is such high finance that we could never expect the average citizen to understand it to any extent that they would actually get upset and demand change. So people like Alan Simpson continue to influence policy.
Next up is Laurence Kotlikoff of Boston University (who co-authored the inaccurate working paper from above with Niall Ferguson). He says:
“On the face of it,” he says, “his statement is true right up to the point that it’s not. That is to say, we have some capacity to borrow, but it is not unlimited and the market will shortly make that clear, in my opinion.”
He wrote the same exact thing in 2003. Again, there’s a reason why Kotlikoff isn’t running a fixed income trading desk. Kotlikoff clearly believes that the bond market funds our spending. And he clearly doesn’t understand the mechanics of the bond market. If he had understood this in 2003 he would have never written such comments. Since he’s writing it today it’s clear that he still doesn’t understand.
The article concludes by demanding that Warren Buffett elaborate on his comments and explain why he is not wrong:
“With the debt stakes so high, Warren Buffett owes it to his legion of admirers and the public at large to explain more fully what he means in saying categorically, “the U.S. is not going to have a debt crisis.”
Warren Buffett doesn’t owe anyone anything. What the American public owes to itself is to learn how our monetary system actually works. And these academics and policymakers that are cited in the MarketWatch piece owe it to the American public to learn how the system actually works. There is one thing that is helping to destroy this great nation and that is the persistent fear mongering that is constantly peddled by people who are pushing a political agenda based on false perceptions of the US monetary system. This environment of perpetual fear is helping to scare the greatest entrepreneurs in the world from doing what they do best. In the meantime, the rest of the world is eating our lunch.
All of this fear mongering is misguided, but helping to do one thing well – cause the currency users to fear the economy they exist within. And therein lies the most interesting component of this entire debate. These misguided fears could be the very thing that threaten this country the most. It’s time for Americans to stop being scared by old rich white men selling books and newsletters. And if we had a leader who understood all of this he/she would stand up in public and tell the American citizenry that they have nothing to fear but fear itself. Unfortunately, that leader doesn’t exist.
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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89 Comments
Excellent!
But…without the fear…how will they sell their newsletters?
Or their rocks! We need to sell more shiny rocks to Americans!
Yes, sooner or later interest rates in the US WILL go up but not as a result of (Hyper-)inflation but as a result of folks who are forced to sell all what they have left in assets in an desparate attempt to avoid bankruptcy. A lot of folks still equate high interest rates with (high/hyper-) inflation. Best example is Greece: they’re clearly in deflation (contraction of money and credit) but interest rates are going through the roof.
But falling rates (as they have started to do again) have a flipside as well: It hurts folks that need income. And that’s where another trainwreck will show up in the near or distant future. And that WILL have a negative impact on tax revenues and then the jig is up for the US and it’s massive debt.
China’s will be hurt as the US and European economies start to weaken further in the near future and then that trade surplus and current account surplus WILL vanish and then the US is in deep, deep trouble. China was willing to absorb A LOT OF US debt and that allowed the US to run such massive current account deficits in the last 10 years. So, I would say: “Deficits don’t matter until they do”.
Yes, the US can “print money”‘ (i.e. increase bank reserves) but the banks decide where that money is going to be invested and if the banks think that they can invest that money more profitly outside the US then the USD is going to tank and that WILL result in higher PRICE inflation in the US. A contraction of money and credit in combination with increasing price inflation is a deadly potion for the US and WILL – IMO – result in bankruptcy. No matter how much money the FED “”prints”".
Willy, your comments about deficits not mattering show that you haven’t been reading closely enough…..you might want to pour over this for a few hours:
http://pragcap.com/resources/understanding-modern-monetary-system
Ask questions. There are lots of people here who are very generous with their time and willing to help.
Cullen,
I just want to thank you for fantastic articles you put on your website everyday, the professionalism of your comments and arguments to other readers, and your dedication to educating visitors about MMT.
I’m a professional bond trader and whenever at work if the markets are slow, I eagerly visit this site and read through almost every article. I’ve learned more by coming to your website regularly for the last 1.5 yrs and everyday for the last few months than I have reading most other websites and economists. I can say with certainty that by learning more about MMT as well as articles you put up, I’ve improved as a trader and have a better understanding on how to capitalize on market inefficiencies and put on trades at inflection points(all via spreads).
Keep up the great work.
Forever indebted,
AC
Thanks AC. Glad to help!
TPC, currently China is running a Trade Deficit. So, as a result of that demand for USDs and T-bonds & notes already has weakened. Now only the chinese currency reserves are resulting in a net demand for USDs. And the chinese have issued debt denominated in Yuan, in a clear attempt to diversify out of the USD, for their trade with e.g. asian countries. And that (attempted) diversification out of the USD is precisely why the US has been waging war in the last 10 years.
And when (not if) interest rates are going up in the US then that could be the signal for the chinese to (dramatically) shorten the duration of their US T-bond holdings or to dump all their US Agency paper. Or go back to (USD-)cash. Then they would simply act as any (wise) investor. But that would push up the USDX even more.
I never said that deficits don’t matter. I said “Deficits don’t matter until they do (matter)”. And somewhere in the future deficits will matter.
A lot of my knowledge I aquired from a man called Michael Hudson (www.michael-hudson.com) (“”The USD is dying”") and he worked as a Balance of Payments expert at Chase Manhattan from the late 1960s through the 1970s (1980s ??). And he has a very good idea on how and when debts and deficits do and don’t matter. He already warned in the early 1970s that the US was on a road to selfdestruction. But the folks in the Nixon administration didn’t listened to Hudson’s warning and simply doubled down. And he also knows what the reason is for the US invasion of Iraq.
Yes, I`ve read a lot of your thoughts but you’re – IMO – a little bit too much “academic”. Like our Benny (Bernanke). He probably still thinks that he can prevent deflation.
BTW: In the current situation Hyperinflation doesn’t stand a chance because we have “”an ocean of debt”" (Robert Prechter) that won’t be repaid. But as soon as that entire debtload has been eliminated then Hyper-inflation most certainly has a chance. Especially when our Benny (Bernanke) (an academic too) starts the (massive) dropping of USD notes onto the nation from helicopters or B(5)2 bombers in combination with currency controls. And that’s precisely what Germany did in 1921 through 1932: they literally printed banknotes. Because there was no credit market to speak of back then.
You are not fully analyzing the dollar risk here. Yes the US has significant risk import inflation risk if China (or any other signifcant foreign holder of US dollars) sells, but it is a two way street. The counter side of the inflation risk is a rapidly rising Yuan (for China). China has followed an export orientation in its development. It is primarily DEPENDENT on the US to buy its exports. If the dollar declines rapid do to a Chinese sale of dollars then the counter side of that is a rapidly rising Yuan. US consumers will then be forced to buy fewer Chinese exports and China will have rising unemployment. They can’t simply switch their economy to domestic consumption and production. While we have an inflation risk in our current imbalance with China, China races an employment risk. China does not hold all the cards, as a mater of fact I would wager that the employment risk is far more damaging of a regime risk to China than the potential inflation risk to the US – hence China keeps its dollar peg.
No, in the current situation, if China were to cut the USD/Yuan peg then the yuan would – IMO – actually collapse against e.g. the USD.
Well said Cullen!
Its going to be very interesting few months following the end of QE – if bonds don’t plummet/yields rise it will dis-prove a lot of peoples’ theories – I can’t wait to see what excuses are then pulled out.
Lol yay! These academics are truly mind bogglingly unbelievable. If you mention the USA can print USD they just fire back with ‘HYPERINFLATION’, it just show’s their idiotic understanding.
The first statement by Kotlikoff really sums up pretty much everyones views and understandings.
Do they honestly believe a trillion$ would put into treasuries paying half a percent if the US was bankrupt? It’s absurd, obviously they do believe it… They’ll come and go over the rest of their careers when this sort of rubbish fires up again, but they’ll alway’s be wrong and never change.
I read “Understanding The Modern Monetary System” and it about the best description of MMT that I have seen. Good work.
As far as the fear mongers causing damage to our nation, I’m not sure that the corporations that own our politians really care about our nation. After all, they consider themselves transnational and are only concerned with profits. If our government collapses from inept politics, what is to prevent certain corporations forming their own private government on some island in the Caribbean? That corporate country would probably recognize your description of MMT.
Very good article.
Even though Buffett seems a bit concerned about inflation. What is your view?
Regards,
TraderHMS
I still think we end the year with below trend inflation. There’s too much slack in the economy. Unless something blows up in the middle east. Then we could continue to see this cost push increase….I actually agree with BB on the transitory effect mainly because oil’s seasonal trends should weaken in H2 and bring down all motor fuels (which are dragging inflation around by the nose right now).
“The United States is not going to have a debt crisis as long as we keep issuing our debts in our own currency. The only thing we have to worry about is the printing press and inflation.”
this statement is an oxymoron.
Only to someone who doesn’t understand the operations of a fully sovereign fiat currency.
How so? Please elaborate.
A nation that is fully sovereign in its fiat currency is NEVER fiscally constrained (so by default it can never have a fiscal debt issue – debt issuance is optional anyhow). It is only constrained by the availability of real resources – hence if there are not enough resources for the given amount of spending you get inflation.
Adam, how about some exclusionary examples….
Please no Somaliland answer! lol
While I agree that most of these people do not understand our system, sometimes I think that spending so much time on this lack of knowledge obscures from the most important fact–namely, that the consequences of our debt accumulation can still be crippling.
I understand that the US is not Greece. But who to say that a formal default is a significantly worse outcome than what the US faces? Long-term ZIRP, slow robbery of savers, wealth transfers to re-capitalize banks, wasteful Keynesian spending forays which will produce what exactly? Higher deficits, a greater percentage of our output going toward debt service, neglect for capital investment, alienation of small business owners, and long-term economic stagnation. And what will be the end result? Likely higher rates that will ultimately still damage the leveraged and financialized society that we are trying so desperately to save.
SO while I appreciate the difference between Greece and the US, I find it more important to consider and discuss the fact that the economic fate of the US is not necessarily preferable to that of Greece. Do people really think that the Japanese route should be strived for?
All of the outcomes you’ve listed are basically political decisions formed by people who have no clue how the system works. Their lack of knowledge has caused them to devise bad policy – thought it also probably got them elected too.
a typical keynesian’s answer. our theory’s are sound, they haven’t been implemented correctly.
lol
Mainstream Neo-keynesian’s are just as misguided. Nobody has even attempted (knowingly) to implement an MMT solution (to the best of my knowledge).
well, i don’t totally disagree with mmt, the real problem is relying on government to implement it correctly. personally, i think government does as much harm as good. so i’d just soon see government just get out of the way.
First off, we’re not Japan, and we won’t be Japan. We have a more productive workforce, net immigration, and far more natural resource wealth — all of which will contribute to long term growth. Oh, and we’re far fatter.
Secondly, have you been to Japan? Why would “turning into Japan” be such a bad thing? They have the highest life expectancy of any nation in the world. Their quality of life is good and stable.
Anyone know why UK chose to go bust in 1970s rather than following USA game plan?
I was wondering about that myself. The UK issues their own currency and, as far as I know, all their debt is denominated in that currency. So what went wrong? I haven’t had time to research that and the thought came up when I read the article yesterday. TPC touched upon that in his post but did not elaborate. This is a case of a country whose monetary system is similar to ours but went through a crisis that should not happen according to MMT. I know I am missing something. Care to comment, Cullen?
It’s never simple. I also recall something about Soros having his hand in that debacle. I’ll have to read up on it when I get a chance. Thanks, Cullen, and good piece.
I guess it was similar reasons why after the last election they decided to drastically cut their public spending, raise their sales taxes and then even raise their interest rates because commodity price increases and also the same sales tax increase has driven up inflation. Total political misunderstanding of how their economy works?
In any case, the results are clearly negative, but still they blame the weather for it.
good job cullen.
as i look at ferguson and his UK analogy, i wonder whether the difference between the US and UK experience can be explained by the status of the US$ as a reserve currency.
if you think that the euro and yuan (and maybe even some imf basket) will eventually challenge the US$ over the next ten years or so, then perhaps ferguson was not dead wrong, but just way early.
Remember, reserve status is acquired. The British lost it largely because they lost market share. Their economy weakened in comparison to others. So, when people say that America will lose its reserve status they are predicting that someone will come along and knock America off the #1 spot in business. And while China might be a viable competitor I think it’s a long ways off.
Much of what you contend here I agree with including, money supply is not growing in the US, the US is in a deflationary period with imported inflation, there is no evidence of bond vigilantism towards US treasury debt, china will not sell its dollar debt, government finances are not the same as household finances, the US is not in the same position as Greece and hyperinflation is unlikely baring serious political unrest.
What I would say is that the decisions about using the printing press and potentially inflation are not completely devolved from the US treasury debt market and the deficit.
Next up is your belief that China will not change the US dollar portfolio of holdings. Perhaps not a Chevron but the fact that more of Chinas buying of the US debt is through London suggests China is thinking carefully and exploring options. That might be a slow change but it is still a change.
Perhaps the UK choosing to call in the IMF during 1976 cannot be dismissed that easily. Notice that I use the word choose rather than forced, but what interest me is what lead up to that, namely stagflation and the attempts to stop the value of sterling dropping too quickly.The backdrop being high unemployment and a certain amount of social unrest. With the dollar as a reserve currency it is much less likely to happen, but printing dollars or political policy miss steps could change that.
What I think perhaps is missing is a closer look at the flows of investment particularly private portfolio flows in relation to the trade deficit (TIC data). For instance during 2007 net private inflows went from postive 200b to around negative 350b on a yearly basis. That did have an affect on the dollar relative to the euro, this was somewhat mitigated through the reserve growth in emerging economies and high official inflows to the US from emerging economies. I would take this as a sign that significant appreciation of emerging market currencies could cause problems in the US treasury markets. Its a different way to think about bond vigilantes. All this was complicated by central bank policies in Europe and the US being divergent which also affected the flows. This also suggests that if central bank policies become too divergent then the FED may have to resort to defending the dollar for price stability despite what inflation is doing.
For me the risks to the US economy are not zero and the size of treasury issuance is important if external factors change. A large trade deficit along with a large government spending deficit make things inheritantly more unstable and susceptable to short term changes in flows becoming more emphasized. I am not suggesting default, hyperinflation or dollar collapse, but more volatility in bond yields, inflation and currency valuations, ultimatey damaging the economy.
Correct me if I’m wrong.
My understanding of our current situation is as follows:
1. the U.S. has spent $14 trillion more into the private sector than it has taken out.
2. some peple call this debt, but MMT calls it an imbalance.
3. history has shown that reducing this imbalance precipitates depression
4. we must pay interest on money borrowed, therefore, every time we increase the debt (the imbalalance), we decrease the worth of the money that is taken back (through the loss do to the increasing percentage of interest payments).
If this is an accurate understanding, then either:
1. we eliminate this imbalance and cause depression
2. continue increasing the imbalance and hope every one “maintains the faith” in the USD (but which also would eventually lead to loss of faith – i.e. inflation or hyper-inflation).
3. we run a balanced (or slightly inflationary) budget and maintain the status-quo of sub-par economical performance
Is there another scenario of which I am ignorant?
“1. the U.S. has spent $14 trillion more into the private sector than it has taken out.
2. some peple call this debt, but MMT calls it an imbalance.”
This may be your perception but it is not quite true. As long as the US government is willing to run a deficit the deficit will be ENDOGERNOUS to its existance. You’ve implied in #1 and #2 that the government has chosen to net spend but that is not the case.
By accounting identity we know that the Net Spending of the Government MUST EQUAL the Net Savings of the Private Sector + Net Savings of Foreigners (inverse of the trade deficit).
So as long as the private sector chooses to save more than it borrows and the US runs a trade deficit the US government will have a fiscal deficit the size of which will be determined by the level of net savings and the trade deficit. If the private sector lowers its savings rate (and doesn’t spend it all on imports) then the US deficit will fall; why, because private comsumption went up and so did private incomes and tax collection – its endogenous.
While the US government could choose to run a balanced budget, the accounting identity would still have to hold, meaning private net savings would have to balance with the our trade. With the US running a $500B trade deficit and $300B of that in imported oil it does not become an easy balancing act and would likely precipitate a major depress trying to force the balance.
Also, from a stock-flow perspective that $14T in government debt is the counter side of $14T in savings held by the non-government sector. Is savings a bad thing?
I forgot to mention that I am an econmic ignoramus.
However, it sounds to me like what you described to me is just a fancy economical way of saying we are officially $14 trillion dollars in the red.
Now that we are in this situation, how about a comment on the three scenarios that I could come up with?
Well I don’t think MMT’ers would refer to it as an imbalance, its just the endogenous outcome of preferences of the non-government sectors (private & foreign). Many people don’t like the implication but that is a personal preference and probably based upon a lack of understanding.
I would recommend trying to understand MMT better. It’s not easy to get since we’ve all had bad economics shoved down our throats for so long – it took me a good 3-6 months to really understand it.
http://pragcap.com/resources/understanding-modern-monetary-system
PS – I’m not trying to ignore your 3 scenarios, but I find them so far off from where I would start with an MMT reply I just suggest you spend more time trying to get your arms around it.
Excuse me, I said I was an economic ignoramus, not a blatant ignoramus like the smug (vs the not so smug) MMTers who have up to now brushed aside the ramifications of a government that has ignored MMT.
I don’t see a way out of this mess without a major depression (either by way of defacto default – i.e. hyperinflation – or self-imposed austerity – almost as bad – to get us back to fiscal responsibility OR a languishing in the present economic doldrums for decades.
Is it too much to ask just one MMTer to take a stand and tell me what they think needs to be done, or are you just going to stand around pointing fingers claiming a superior intellect of economical knowledge?
You sound offended, I’m sorry. That said I don’t think you will like my answer because my estimation is that you wont fully grasp it in relation to MMT.
If we want to end the economic issues currently impacting the USA, then the government needs to pursue a Full Employment policy and that could be via tax cuts or direct job creation or other increased spending. And yes that means a bigger deficit, but so what.
So what? You’re bitching about the tremendous debt (I still like imbalance) we’ve accrued, and then you want to resolve the issue via preventative measures (which should have been taken in the first place, but wasn’t).
I see that we have a problem NOW (lower value of every USD that the U.S. creates due to the increasing amounts of interest we must pay on the ever-increasing amounts of money we create – and, therefore, borrow).
It appears to me that the success of EVERY (not just MMT) economical theory is based on preventing imbalances. In reality, one more constraint was removed after the gold standard was lifted (and, Yes, I know MMT offers a more fluid movement to the economy). But was this this the last constraint that was needed to control feduciary foolishness? I don’t know. However, what I do know is I don’t see any way out of the hole we are ALREADY in, and I don’t see MMT coming up with any miracle cures – just more miracle preventative methods (and, apparently, an “I told you so”).
You say we need to increase the deficit. Even that’s a preventative action, but it is a preventative action from a position we are already in. Increase the deficit, decrease the value of the USD. Is anyone out there understanding the lose-lose situation we are in? I certainly don’t have the definitive answer. I am still waiting for one from the MMTers.
“You’re bitching about the tremendous debt”
I’m not bitching about the government debt and I would assume most if not all MMT’ers would not complain either.
You see MMT is build upon 3 fundamental components. 1) Chartalism or the operations of a fiat currency; 2) Functional Finance – or the understanding of how the banking system actually works (and not how some economist wishes it worked); 3) Is stock-flow consistent with national accounting.
So MMT’ers understand via stock-flow analysis that the debt held by the government is equal to the net savings of the non-government sector. We don’t consider that a bad thing. Additionally, we know that savings/deposits/bank reserves are not what generate loans so we know that under most circumstances a government deficit is required to support the economy while the non-government sector net saves (which is what it historically prefers to do).
Right now the non-government sector is attempting to save about 10% of GDP so therefore the US governments deficit is about 10% of GDP. As an MMT’er I also can see that with 8% (or more) unemployment there is a lot of idle people and resources that can be put to use. Growing the deficit now (tax cuts or spending what ever floats the political boat) could put those resources to work AND we know that there are no fiscal constraints preventing this – just political.
As for the debt it doesn’t typically concern an MMT’er. We recognize it as nothing more than a swap of money (which pays zero interest) for a government bond which does pay interest. And we don’t typically concern ourselves with excess money when there is this much slack in the economy. If we spent so much as to push us to full employment and the economy got too hot AT THAT TIME it would be wise to reduce the spending (or reduce the private sectors spending with higher taxes).
Cullen
Questions about your aside regarding the federal reserve simply providing reserve balances which can be saved.
Wouldnt that qualify as “spending”? Increasing reserve balances is exactly what happens when the govt spends is it not?
The reserve balances are later drained when the “bond” is issued, correct?
This would in fact be a fiscal operation if the CB simply increased reserves and did not make a loan would it not?
Thanks
It’s not technically spending. When a bank lends money they can go to the Fed to cover their reserve deficiency. But don’t let this all confuse you because it’s a mythical point in the first place. We live in a world where the govt serves a public purpose and the Fed is part of helping achieve that. Talking about one as if the other does not exist is fantasy.
Greg, I was also thinking along those lines. But, no, the big difference between deficit-spending and reserves add is that deficit spending creates deposits in the private sector that can be used to do stuff in the real economy out there – like buying stuff etc. Reserves add only supplies the banking sector with the necessary clearing balances among themselves. So, unless this somehow induces banks to lend more (and create more deposits) then there is no impact on the real economy (as Scott points out, this is basically the austerity stance).
I discussed it with Scott Fullwiler starting from this comment:
http://pragcap.com/final-thoughts-on-the-austrian-school/comment-page-1#comment-55941
Actually, I would say that deficits create income, whereas Fed lending does not. Fed lending can create deposits if it is via repos with dealers, since dealer deposit accounts at banks increase. The deposits aren’t the point, as deposits will be created whenever there is a desire to spend, while more deposits don’t force more spending. if my stock holdings are suddenly in the form of cash instead, do I necessarily go out and spend them? note (1) how different that is from a choice to liquidate my stocks for the purpose of spending and (2) that if I am suddenly flush with cash that I don’t want to spend I can put it into the money markets, time deposits, etc. Overall, it’s the CHOICE to spend that matters, and that choice is quite a bit more weighted toward spending when income increases than when it doesn’t, all else the same.
Scott, thanks! This clarifies things. I guess my deposits vs. reserves point could still be salvaged (somewhat) by emphasizing that deficit spending usually creates deposits for the non-banking sector, and these are the income of the “real” economy, while all the Fed machinations can target only the banking sector.
Didn’t see your response. Thanks Scott.
Thanks Cullen, Peter and Scott
Alright just so I’m clear. Are you saying that increasing spending does not necessarily increase reserves? I’ve been under the impression that a fiscal operation which increases incomes shows up in the banking system as an increase in deposits AND an increase in reserves. And its this reserve level increase which makes available that which is necessary to create the bond to offset the spending $4$. I’ve always understood bonds to be a reserve drain which means that they were first increased to give them something to drain, correct?
Im not trying to be pedantic but I want to make sure I am clear about what operations lead to what and keep my terminology straight.
Increasing spending does increase reserves, but the other direction is not true: reserves can increase without there being increased spending.
In your original question you asked:
“Wouldnt that qualify as “spending”? Increasing reserve balances is exactly what happens when the govt spends is it not?”
The answer, per above, is “no”.
“The reserve balances are later drained when the “bond” is issued, correct?”
Correct, but they don’t have to be drained unless the FFR moves below target. But I am not sure what this has to do with the previous point about deficit spending vs. reserve increases?
“This would in fact be a fiscal operation if the CB simply increased reserves and did not make a loan would it not?”
Yes, this is correct if you are talking about the CB simply “granting” reserves to the baking sector (instead of loaning those reserves; another similar scenario is if ABS swapped in QE1 becomes worthless – in both cases the Fed takes a hit to its equity.) But I think there is still a distinction with “traditional” deficit spending. Both add NFAs for the non-govt sector, but reserves increase only targets the banking sector while deficit spending also adds actual income to the real economy. That’s my understanding.
I hate to agree with WB, but he’s right. Thanks for laying this all out for about the thousandth time–your persistence is remarkable.
There’s a lot of people out there who still just don’t get it….and it’s very important that they do.
“And therein lies the most interesting component of this entire debate. These misguided fears could be the very thing that threaten this country the most. It’s time for Americans to stop being scared by old rich white men selling books and newsletters. And if we had a leader who understood all of this he/she would stand up in public and tell the American citizenry that they have nothing to fear but fear itself.”
Hi Cullen,
While I completely agree with your point on US default, I think there is still an aspect of the deficit spending that is very much worth worrying. And it is to the extent that it is linked to the financialization of the economy and the service of special interests groups. So I still think Americans should worry about these developments. I think you know the details.
100% agree. This is why I complain about the Fed so much and programs like cash for clunkers and homebuyers tax credits. Trust me – there is a lot of spending that I see as detrimental. I like to say that we should fill holes with seeds and not just dirt.
Cullen (or PeterD),
I think I’m doing well the the MM theory, but the specifics are getting me. You usually talk about the Fed and the Tsy as the same entity for brevity, but I don’t understand how the operations unfold. The Tsy (?) spends the money into existance, then auctions bonds that primary dealers are required to market. The amount auctioned at a given time is determined by the Fed (?), according to their reserve balances (those of the Fed and commercial banks)? Why would would an auction ever fail?
And if the debt ceiling isn’t raised, then the Treasury can’t auction off any bonds, and hence, can’t credit account balances?
Give this a read. Come back if you’re still confused.
http://pragcap.com/n-y-fed-explains-government-spends-issues-bonds
Yeah, I was reading that when I wrote the first message. I have a patchwork understanding of the whole Fed-Treasury relationship, so reading that didn’t necessarily make sense to me.
The Treasury credits the Fed with reserves, and in turn the Fed can lend those reserves to banks? All POMO are about manipulating reserves, right?
While a Treasury auction could theoretically fail without consequence, wouldn’t there be some real-world negative reaction? I still don’t understand why they’d fail.
Auctions are reserve drains from spending that placed the reserves there. Think about it logically. How can the banks buy the bonds unless they’ve been given the money to buy the bonds? By simple logic, the govt must spend the USD’s into existence before anyone can use them to buy USD denominated bonds.
freemarketeer, Cullen’s post is great. Let me add this to maybe make things somewhat clearer. Bonds that US Treasury issues serve two purposes:
1) To cover any spending that is in excess of its reserve balance at the Fed, because by law there cannot be an overdraft.
2) Allows the Fed hit its target Fed Funds Rate.
Now, think about it this way. Suppose Tsy knows it needs to spend $X in excess of its balance at the Fed. It issues $X worth of bonds and thus covers the overdraft. Now, this issuance of bonds may cause shortage of reserves in the banking system and the FFR may be bid up above the Fed’s target rate. In this case the Fed would buy some Tsys in the open market operations and thus add reserves to the system, preventing the FFR from exceeding the target. So, while the amount of US bonds outstanding does not change, in this scenario the Fed owns some of those bonds. This means that the consolidated govt sector (Fed+Tsy) owns its own debt, so, basically it is a wash. The Fed would remit all the interest earned on those govt bonds back to the Tsy anyway. So, effectively US debt outstanding is less than the absolute number since some of it is owned by the govt itself!
Now suppose the situation is such that there are excess reserves in the system. This may cause the FFR to be bid down below the Fed’s target (potentially to 0). In this case the Fed would sell some of its Tsys and drain those excess reserves to maintain the target FFR (If for some reason the Fed did not have enough Tsys to sell, then I can imagine it can coordinate with the Treasury to issue some more bonds, but I am not sure about this point – maybe Cullen or Scott will know.)
As Scott likes to say, they would just name a price. Evidence over the years shows that the Fed needs to name a price and not size. So, if the Fed names the FFR of 0% then the rate moves there.
Cullen, that a slightly different point that you’re making about the so-called “open mouth operations” – that, indeed, by announcing the rate the Fed usually does not need to defend it and the market simply moves there (knowing that the Fed can always defend the rate.) Here is a paper by Marc Lavoie about that:
http://www.economia.unam.mx/amhe/pdfs/conferencia_marc_lavoie_01.pdf
But what I am saying is that if the Fed was ever forced to defend the target and needed to sell Tsys in order to mop up the reserves and was short Tsys – would it just call the Treasury and ask them to issue new Tsys? Because the Tsy could be constrained by debt ceiling or something like that from being able to accommodate such a request.
Hmm. I am not sure that can even really play out can it? If they bought the tsys in the first place then they were establishing some target rate. If they were forced to defend the rate then they would just sell the bonds back which should theoretically take the rate back to where ever it was before they bought them. Am I misinterpreting you?
Well, at least theoretically the Fed could decide to have such a hike in the FFR that even selling all of its holdings of Tsys would not be enough.
Suppose tomorrow all the Fed’s Tsy holdings are sold and the new FFR settles X%, but the Fed wants it to be still greater than %X. The only thing the Fed can do is to issue more Tsys to mop up more reserves, but if it doesn’t have any, then it has to turn to the Treasury, I suppose.
Peter D, this is an interesting question. I think it can’t happen though.
Logically the amount of reserves in the economy should be:
1) all that Treasury has ever spent
2) minus all that Treasury has ever taxed
3) minus all that Treasury has ever drained by issuing bonds
4) plus all that the Fed has ever credited to accounts by buying financial assets
5) plus all that the Fed has ever credited to accounts via helicopter drops
I think logically 1+2+3 should sum up to 0.
As far as I know 5) is also 0.
So this would leave us with 4) which means that if the Fed were to sell all of it’s balance sheet there would basically be no reserves left.
The FFR would then be “infinite” if the demand for FF is non-zero, I guess.
So this means there’s a level between current-sized balance sheet and zero-sized balance sheet that would enable the Fed to target any rate they want.
As an aside, this would not be true anymore if the Fed had conducted helicopter drops at some point. Unless Treasury goes out and taxes in order to run a surplus large enough to mop up those reserves.
Does that sound correct ? If not, what is wrong ?
Ivan, nice points, I was wondering whether the situation I was describing can happen. So, you’re saying that instead of selling Tsys to drain the reserves the Fed can simply sell the other assets it bought (such as ABS in QE1) – I guess this is correct, but what if the market price of those assets is now much lower than the price at which the Fed acquired them? Seems to me the sale won’t be able to drain all the reserves created in (4)?
Also, I think you might be missing all the reserves provided thru the discount window to accommodate credit expansion, but I don’t know whether there is a possible scenario that would require drainage of those to achieve a higher FFR.
I have hard time wrapping my head around this and I am not sure it is really a very important point but I’m still curious. I wonder if Scott will see this and help.
You’re right I did not get the full picture here.
On the reserves through the discount window, I’m actually not clear whether those are provided “unsecured” or via repos/purchases of assets from the discount window borrower. If the latter then it’s just as in point 4). If the former, then yes, this is a helicopter drop as in 5) and then we may have a problem.
Re. your other point I would say if the assets subsequently drop in value, this creates a loss on the Fed balance sheet which is then remitted to Treasury. Since Treasury cannot issue more bonds to “fund itself” in your scenario, it needs to raise taxes in equal amounts to cover the loss, thus removing the reserves in question.
Seems we are progressing, just not sure how much…
Not sure it’s important either but fascinating still imo.
Help welcome from anyone caring about this level of detail !
I’m actually talking BS here, the discount window lending is just an overnight loan, so the Fed can just recall the loan to get the reserves back.
If the borrower goes bust overnight and can’t repay then we go back to the Treasury loss leading to taxes scenario.
Only in the case of true helicopter drops (i.e. crediting accounts with no strings attached) do we have a possible problem I think then.
Extremely helpful, PeterD. Thanks!
The overlap in economic jargon amongst various theoreticians and players with opinions tends to muddle and confuse. These days with foreign participants in the ‘global economic village’ the picture becomes even more complicated.
Thanx for separating the wheat from the chaff. MMT gives me a place to jump in, grab hold and hang on.
The USA does not issue its own fiat currency.
The fiat currency in use are Federal Reserve Notes issued by the Federal Reserve Bank.
The Federal Reserve Bank is under no compulsion to accommodate the US Treasury.
See the 1951 Federal Reserve Accord.
http://www.richmondfed.org/publications/research/special_reports/treasury_fed_accord/background/
Therefore, MMT does not apply to the US under current US law.
The Treasury may have to go begging to the FED just as Greece is begging at the European Central Bank.
You can speculate that the FED will accommodate, and I can speculate that they won’t.
We will know when we know. I don’t think complacency is warranted based on the theory that the FED will simply do as they are told.
I think Anon makes a valid point (Scott Fullwiler calls it general vs. specific aspects of MMT: http://www.moslereconomics.com/wp-content/graphs/2010/08/MMT-Scott-Fullwiler.doc)
But then the Tsy also goes begging to the Congress to allow it to spend above the debt limit.
MMT recognizes there are actual constraints and self-imposed constraints. Feds independence – however binding in reality – is another self imposed constraint.
You could say that MMT does not apply to the US, but that would be like saying a person with his feet shackled cannot run. This would be only true because his feet were shackled. On the other hand, saying that a person cannot run at 100mph is an actual constraint applying to all people – regardless of whether their feet are shackled or not.
Nice analogy. I might have to steal it from you!
I believe Warren used something along these lines first!
Yes, and the Euro nations cannot lay off their shackles without sawing off their feet first because they lost the keys somewhere in the Netherlands. They’d have to wait for them to grow back on before they could run again… Not an impossible constraint to overcome but rather much tougher than bribing the prison guard to unlock the shackles.
Mr. Roche,
Remember your article “where is the excessive risk right now.” I really loved it, and I am suggesting a part II or follow up – perhaps a monthly tradition?
If I recall correctly, the UK was suffering from double digit inflation that was worsening at the time it hit the wall. If the UK central bank had begun to more aggressively acquire government debt and laughed off the IMF, the psychology of “money printing” hysteria at the time could have triggered a serious failure of confidence in the pound and a velocity crisis. That just shows that Warren Buffet and MMT are correct; the risk is inflation rather than insolvency for the dollar.
However, it is important to remember to respect psychology and the madness of crowds when admiring the elegant operational realities of MMT. If masses of investors, consumers and producers(dollar users) start to act irrationally because of what they perceive as a US “debt crisis”, the inflation risk can get ugly much more quickly than we think, even though productive capacity has not been exceeded and there is a lot of slack in the economy. TPC had QE2 nailed operationally as a big yawn of an asset swap; and yet the commodities markets (and nations) seem to have been destabilized by it to a significant degree, and the stock market jumped.
Very important and excellent comment JWG.
This well-written article is exactly the reason I stopped coming to this site on a daily basis. I support your idea that fear-mongering is not good for the markets. However, it was a pretty silly statement that Buffet made, and I think someone had to put some prudent perspective into the mix. This feels like an over-reaction to me. But then again, you are really passionate that inflation is still not an option. That’s clear, and yet so confusing.
Also it surprises me that you are so willing to cheerlead an apparently meaningless measure of inflation. If you are talking about the effect of emotions on the market [such as fear], the price of food and fuel must be considered in the equation… [Or is it only the above average people who's emotions matter?]… because when average people are cold and hungry they lose their minds. That is the pink elephant of a black swan in your version of this. Caution is warranted. Cheerleading will not change that reality. I caution readers to add salt on both sides of this discussion.
Sorry about that. I didn’t feel the need to elaborate since I thought Niall Ferguson did such a good job. It’s silly to say that we cannot have a crisis because we issue debts in dollars, but watch out for that printing press. It seems to contradict itself and tend towards ridiculous over-optimism.
And It just seems that the CPI, regardless of what else is being said, should not be used as a measure to defend any economic decisions because it completely disregards two of the primary uses of money. The ingnoring of which has opened the doors to international instability. That said, I realize that it is not considered appropriate to just make up a more useful gauge… although that would be helpful.
All that said, thanks for continuing to bring your own version of clarity to the discussion.
It’s silly to say that we cannot have a crisis because we issue debts in dollars
He said “debt crisis”, for chrissake. Default and inflation are different animals. Who’s silly?
I would only counter by putting things in perspective. Inflation is low by most standards. The ECRI is showing just 1.7% yoy inflation. And I think you can make an argument that CPI is overstated because it has housing prices RISING! If you’re just looking at commodity prices and inflation then you’re making a huge mistake. There is very little historical correlation between commodities and broader prices.
So yes, the distinction between inflation and solvency means a lot. You agree that inflation is our only concern. We can’t run out of dollars. Therefore, solvency is never a concern. And we have inflation at 1-3% depending on various metrics. So, inflation is low by any standard and here we are quibbling over debt ceilings and other ways to try to turn ourselves into Japan or Greece. Tell me how that makes sense because it makes no sense to me!
Above meant with all due respect. No offense meant, just opinion. Thanks.
Ciao, wOW
Claiming someone is wrong just because they were wrong on bonds is silly.
The bottomline is if you went back to the late 90′s and looked at the recommendations of a deflationist like Gary Shilling compared to an inflationist like Jim Rogers, you would’ve made far more money listening to the inflationist. Granted, people like Rogers have been wrong about bonds, but that’s been more than made up for, with recommendations on commodities and emerging markets. Incidentally, Ferguson’s gloom and doom was right, just not about bonds. You just had to wait till 2008 for it to happen. It’s possible you may have to wait longer for his bond prediction to come true. Or maybe not. Nobody truly knows.
Of course inflation is a better long-term bet. That’s the natural progression. That’s why I was a deflationist for a period of about 2 years. Inflation is a trend you’d be a fool to fight…Ferguson, has essentially been arguing for hyperinflation though (I don’t think he knows it though). And he’s been disastrously wrong.
TPC,
Thanks for this thought-provoking article.
I keep hearing various contradicting arguments from all kinds of experts about US debt. I wonder if anybody can really grasp this complex topic to its full extent (involving future economic growth, population development, emerging markets, inflation, exchange rates, and so on).
But there are some basic rules, I do believe in.
As you said: “It is an irrefutable fact that the USA cannot run out of the dollars that only it can produce”. That is true by definition.
However, another basic law I do believe in is.
If you keep spending more than you earn year over year, at some point in time you will be in trouble.
How this whole thing will actually play out will probably be quite interesting to observe in future.
As cullen Says, you point out the fact that everyone is missing – theres an inflation constraint and not a solvency constraint.
“If you keep spending more than you earn year over year, at some point in time you will be in trouble.”
This is absolutely true for a USER of the currency since they are fiscally constrained.
In literal terms it does not apply to a currency ISSUER because they don’t really have income to earn – they just spend/create money. That said, there are spending limits and they are the limits to the economy’s ability to produce. Beyond that you only generate demand pull inflation.
Cullen,
Do you believe the growth rate of combined private and public sector debt can exceed the growth rate of GNP forever?
Tom
Spending well in excess of output would cause inflation….eventually. What is the breaking point? I don’t know. In Japan it’s not even 200%. But inflation is the constraint. That’s all I know. For more on sustainability you might be interested in this:
http://pragcap.com/discussion-forum?mingleforumaction=viewtopic&t=75#postid-329
http://mises.org/daily/5304/Can-Governments-Finances-Be-Compared-to-a-Households
Dear Lord that man is clueless….