I was watching this video on Yahoo Finance this morning with Jim Rickards of Austrian economics fame. He calls the low interest rate policy of the Fed a “tax on savers”:
“[Interest payments] would have gone into the pockets of savers so they could invest and spend – people rely on it for their retirements. This is looting savers.”
But there’s a contradiction in his commentary. Rickards has stated that the “Obama deficit” is making things worse. In an article last year Rickards wrote:
“Citizens who insist that government stop talking about cuts and start the actual process of cutting spending now have got it right.”
The problem here, is that the Fed’s zero interest rate policy has substantially reduced government interest payments. In other words, if the Fed raised rates on government debt you’d start earning a lot more on your savings because all those retirees who own US government bonds would instantly start getting a government subsidy via the interest payments.
Interest outlays are part of the annual budget deficit. For instance, at present, the government pays about $225B a year in interest outlays. That’s about 1.4% of total debt with the current interest rate structure. Let’s say the government decided to raise interest rates structure to something equalling 4% of total GDP. That means the government would be paying total interest outlays of about $600B a year. That’s almost $400B+ more per year for savers to “invest and spend”. That’s a lot of money. And it’s a significant rise in the government’s budget deficit since the interest outlays are a cost to the US government.
So, Rickards is contradicting himself here. He wants higher interest payments so savers stop getting “looted” and a lower government budget deficit at the same time! So which is it? If you want higher interest rates on government debt (which makes up a huge portion of private saving since most of the government’s debt is owned by retirees, pension funds, etc) then you’re implicitly in favor of more deficit spending. You can’t have it both ways here Austerians….
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.
Follow Me:
Tom Brown on 
Rickards doesn’t seem to understand that the interest on government debt is part of the evil Obama deficit.
Maybe you should Tweet him for some clarification. I enjoyed your guys’ tweeting on the trillion-dollar coin debacle.
Rickards hates the Fed and the government and is just playing to populist rage. It’s popular to say savers aren’t earning enough and that the government spends too much. Amateurs cheer him on. Good economists like you see him as a clown. He obviously doesn’t seem to realize that you can’t hate zero interest rate policy at the same time you’re hating government spending.
I’m not an economist.
This is not completely about economics. There is moral undertone here, which puts savers on the moral high ground relative to borrowers. As a saver and generally risk averse person I have some sympathy with that… but of course I would
Your argument is flawed.
To suggest Richards is not aware of interest payments being a part of U.S. budget is disingenuous, simple minded, and ridiculous. In fact, it is a key to his very argument.
If you have massive, unsustainable debts, then you cut them. Not lower interest by manipulating markets so that consequences do not exist.
I’d rather be earning 7% on Treasuries because I played it safe and now reap the rewards, not have no saving interest so that homebuilders and bank balance sheets can recover. They played casino, leveraged up, and lost. They still received their massive pay, bonuses, and stock cash outs and leveraged it all to it broke – now we bail them out. How, low interest rates. If you stayed in a home you could afford and saved you lost to the guy who bought a house he couldn’t, lived like a king, went bust, had his mortgage adjusted, and is now far ahead of the rational guy.
I think I will stick with Richards view of the world, not with someone who believes the way to reward runaway spending is to lower the rates to the borrower.
Your argument is purely political. If you wanted to earn an average of 7% on your govt bonds you’re explicitly in favor of a govt deficit of 1,500 TRILLION per year BEFORE spending on ANYTHING ELSE.
You’re contradicting yourself. Your argument is not fundamentally sound in any way.
TexasHedger may want 7% interest rates, but he wouldn’t get them in free market, given how weak the economy. So your multi-trillion dollar deficit claim is bogus. In effect you are arguing that the government should spend as much as it wants on anything, no matter how stupid and wasteful, and the Fed should accommodate that by keeping interest rates at 0%.
I happen to know exactly what the correct interest rate should be: whatever number the free market comes up with, without any interference from a central bank. My guess is that under the current circumstances it would be above what the Fed is ordering, but well below 7%.
I thought that one thing all economists agreed upon was that price fixing doesn’t work. Set a price too high, and demand will be too low and supply too high; set a price too low, and demand will be too high and supply too low. Only by letting supply and demand interact will a correct (at that moment anyway) price be discovered. Yet for some reason most economists don’t seem to think that that rule against price fixing should apply to the price of renting money, which is all an interest rate is.
Statist supporters forget that all prices give information to the market about supply and demand. When you manipulate a price you are giving false information. People acting upon false information that they mistakenly think is true will make errors. In this case, artificially low interest rates induce capital spending that can’t be justified by underlying demand. This is why we have gone from one bubble and bust to another ever since Greenspan started at the Fed in 1987 and started what has turned out to be the Fed’s answer to everything: let’s lower interest rates.
This is pure nonsense. Sorry. But you are vastly misinterpreting the myth of a “free market” in govt debt. Here’s how the system actually works. If the Fed doesn’t control interest rates then excess reserves in the interbank market drive the overnight cost of money to zero. That is, with current Fed policy, the overnight rate would be 0% if they were not paying interest on reserves. The Fed ALWAYS MANIPULATES RATES HIGHER because the existence of the interbank market drives rates inherently to zero. There is no “free market” in govt debt. There is only the Fed market where the Fed must set rates to meet a policy course. If it doesn’t do anything then the rate falls to zero when banks lend their reserves to one another. This is an irrefutable fact of the current monetary design.
You seem to think the “market” would drive the term structure of rate much higher, but how would that happen? The Fed is the monopoly supplier of reserves to the banking system. If the Fed doesn’t set the rate on overnight lending then it falls to zero with excess reserves in the system. So it always manipulates the rate higher.
Lastly, when you say ” In effect you are arguing that the government should spend as much as it wants on anything, no matter how stupid and wasteful” you’re just projecting your own political beliefs onto me. I am not saying anything about the efficacy of ZIRP. I am simply pointing out the operational realities. If you want higher interest rates then you want higher deficits. There’s no two ways around that. And all the populist jargon in the world isn’t going to change the mathematical reality behind this.
[sorry of this is a dupe. I pressed "add comment" and it wasn't showing up.]
Are you forgetting the $85B per month of debt the Fed keeps buying? That isn’t overnight bank reserves.
Are you arguing that that has no effect on interest rates of any maturity? If so, then why should the Fed bother to do it?
If it does lower interest rates, as one would expect an additional $85B in demand to do, then the Fed is fixing the price of renting money (interest rates) below what the market would produce, and sending a false message to the markets, which will induce unsupportable investments.
The Fed’s increased balance sheet size puts natural downward pressure on overnight rates and interest on reserves pushes the rate UP. If they did not pay interest on reserves the rate would fall to zero. It wouldn’t increase. The natural state of the banking system is to get rid of reserves. In other words, all reserves are “excess” to private banks who view reserves as a cost. They will naturally try to get rid of them. Therefore, the very existence of the reserve system sets a zero interest rate. The Fed must ALWAYS force it up from zero. You claim the fed is manipulating rates lower. That’s not right. The fed always forces rates UP from zero. If we let the banks play “free market” they’d send the rate to zero. In other words, your “free market” rate on overnight loans is zero. Not “higher” than 7%….
I’m not talking about overnight bank rates. I am talking about the rest of the curve, all the way out, because that is what affects everyone other than banks. Is the Fed buying $85B in debt every month making those interest rates go down, or not? If not, why bother? If so, don’t you think there are any negative consequences of that?
Long rates are a function of short rates. The Fed currently sets short rates and lets long rates float. But long rates are “set” by the market based on the perception of future economic outcomes and how the Fed will respond to the environment. If the Fed wanted to set the entire term structure of the curve at 0% it would just announce it and it would happen instantaneously. The fed is the monopoly supplier of reserves to the banking system. If it wants govt debt to be a particular rate it just sets it. It doesn’t ask Jamie Dimon if it’s okay with him.
I’m still trying to get an answer to this question: Is the $85B/month Fed purchases making interest rates (OTHER than overnight bank rates) go down, or not?
If not, why is the Fed bothering?
If so, why is the distortion of rates compared to what the market would set not a problem, as opposed to every other example of price fixing?
Thanks.
Rick,
I don’t know why your comments keep getting spammed. Sorry about that.
The interest rate on overnight loans would be zero if the Fed stopped QE tomorrow. It wouldn’t go up. Excess reserves cause rates to go to zero. So, any rate above 0% is manipulated UP. That’s what the Fed does via interest on reserves.
I think what you’re misinterpreting (and most people don’t know this) is that the mere existence of the reserve system puts downward pressure on overnight rates. Why? Because without a reserve system the banks have no reserves! In other words, all reserves are excess to bankers. So they get rid of them when they can by lending them out. This puts downward pressure on rates. So the Fed must fix prices higher if it wants to alter the spread on bank lending. So your real question is – would we be better off without an interbank system? I say no because that means the payments system is less efficient. But what you might really be getting at is “is QE good”? I also say no because I think QE is an example of the Fed abusing its powers over the reserve system and implementing misguided policy to encourage particular behavior. The good part of the reserve system is that it creates a highly efficient payments system. The bad part of the reserve system is often the way the Fed uses it to implement policy. Some of which is useful at times and some of which is downright misguided in my opinion (like QE, though not for the reason most people think).
Cullen,
Please clarify your statement a few slots below about excess reserves: “So they get rid of them when they can by lending them out.” Banks are capital constrained, not reserve constrained, right? I thought you said that banks don’t lend reserves.
Banks ONLY lend reserves to one another, but in the aggregate cannot get rid of them….sorry to be unclear.
Thanks. I had an idea that’s what you were talking about.
http://brown-blog-5.blogspot.com/2013/03/list-of-ways-reserves-leave-banking.html
I think that covers most ways reserves leave the system… let me know if there’s an error!
Perhaps he wants the government to be forced to “privatize” all of it’s assets to reduce the debt (and thus the higher deficit we’d have with higher interest payments). Sell off the national parks, highways, BLM land, military bases, the capital mall, the white house, the military’s hardware, the Senate, House and Supreme Court buildings… etc. Then fire all the government employees except for a skeleton staff. Private industry can do all that stuff better because it’s private and thus superior in every way.
Our government should be able to operate from a few leased trailers in a cheap rental district… perhaps in the middle of Oklahoma somewhere. Anything else is just infringing on the rights of citizens and we all know that government is completely useless except for the absolute minimum it needs to do to enforce private property rights.
Tom Brown, much of government being less efficient than industry may be a myth. The few truly comparative figures I see are in healthcare. Medicare is far more efficient than private care, particularly because of no advertising and promotion costs much smaller staff, and no need to show a profit (and the privates cost of staff and time challenging so many claims). Also, the Pentagon has to pay much more for contract staff than their volunteers. Do you have contrary examples?
Sorry!… that was just me trying to make a joke. I agree with you. I grew up on a Navy base where the civilians that worked there invented the Sidewinder Air to Air missile. They did it in record time (6 months), and they had to violate the law and divert funds to do it because the Navy actually rejected the idea. Devoted Navy civilian engineers and scientists, living in the middle of the Mojave desert, cut the red tape on their own initiative, and went above and beyond to make something that is STILL USEFUL!!! (of course it’s been through a lot of iterations since… the original’s “brain” consisted of just seven vacuum tubes!). I know first hand that the government can do a great job … at least sometimes!
Since interest outlays do not account for 100% of government spending, why can’t interest rates go up and return more to savers, while the government cuts other parts of spending?
That’s my point. You could cut the ENTIRE annual budget and if we paid 7% on the debt as you propose it would cost us EVEN MORE than we currently pay….Your proposal would increase govt debt. Not reduce it.
Thanks, that makes it clearer for me. I guess my next question would be… Is there an equilibrium point where rates could rise some, and spending cuts could still cause the deficit to shrink?
Another idea, and i think you might have mentioned this before. Why doesn’t the government stock up on long-term debt at these record low rates, and then allow interest rates to rise?
A couple of things:
1) there is no such thing as ‘equilibrium’ in financial markets.
2) the authorities should not be worried about the cost of funding, in the way your question implies, because the government’s balance sheet is not like that of the private sectors. The private sector’s balance sheet would be severely hurt if the authorities decided to issue a bunch on long dated debt and then raise interest rates.
Good point. I’m confused by Cullen’s logic here, and I think that’s a first for me.
Sure, if Bernanke allowed rates to normalize, the government’s debt service payments would increase. But if interest rate normalization was introduced simultaneously with across the board “austerian” spending cuts, the overall government deficit would surely still shrink.
Isn’t this common sense?
The math is rather simple. If the govt raised rates today to TH’s 7% payment structure, the deficit would be 1.5 trillion on its own without any other spending. So you could cut every single other item from the budget and interest alone would cause the deficit to INCREASE from its current level.
I’m sorry, but since when does the Fed increasing the FFR increase rates payed on debt that has already been issued?
And you are basically using the $16 + trillion cumulative debt outstanding as an excuse to justify keeping interest rates artificially low (lower than market forces would require absent Fed involvement).
Not sure if I’m with you on this Cullen.
Interest rates float. If the price of your current bond declines its interest rate increases.
Let’s be careful about what we say here. Less than 8% of federal debt held by the public are TIPS, which fluctuate based on CPI. The remaining 92% are fixed rate bills/notes/bonds.
That leaves 0% of government debt that is currently based on floating interest rates.
The government’s debt payments include on and off balance sheet items. The US Treasury auctioned 8 trillion in bonds last year alone. The debt gets rolled over in no time. I don’t see the point you’re making. Floating or not, the interest rate increase would instantaneously impact the annual budget deficit by a huge amount.
Stephen is making a more nuanced point though. I am being rather vague in my calculations here, but the general point is still irrefutable in my opinion.
I am generalizing. I don’t know what the precise term structure would change to, but it would change pretty quickly and put upward pressure on govt deficit spending. That’s my point…Sorry for the imprecision.
Interest rates could rise to 7 pct, but the T-bond you bought last year would still yield 2 pct.
But eventually, yes, 7 pct rates would mean most of the budget would be going for interest.
Which means we are stuck at zero percent rates forever.
The average duration on government debt is 5 years so while Cullen’s 225 billion figure is not perfect it’s approximately right. But his point is still correct. If you want higher interest rates then you want the government to spend more on interest expenses.
Be careful Johnny, there are no constants in the social world.
Not just “eventually”. It would start immediately with every single new bond auctioned off. It would take just a few years to get that interest cost up to the 1.5T level. Point is, higher interest rates mean higher deficit spending. I don’t see why this is even controversial?
I’m in agreement with Cullen and Frederick here in that eventually interest payments (AT CURRENT DEBT LEVELS, with a lag based on debt rollover) would balloon up to > $1 trillion per year under a hypothetical 7% FFR environment.
But your argument is based on the premise that there is a roughly $16 trillion floor on cumulative debt outstanding. If the government ceased spending today, and focused on paying down debt (I’m not advocating this, just playing devil’s advocate), the debt service costs will go down every year in conjunction with the outstanding debt balance shrinking.
That is why I think your logic is somewhat controversial.
That would mean running a budget surplus to reduce the amount of outstanding debt. And if you’re in favor of budget surpluses in this environment then you’re against corporate profits. I have the irrefutable math on that one also in case anyone is interested.
I’m not advocating for budget surpluses, I’m simply pointing out that if government forces (Fed, Congress) were determined to normalize interest rates and run surpluses for an extended period of time, nominal interest payments would decrease along with nominal debt outstanding.
I think your initial argument unfairly leans on the massive federal debt balance as justification for minimizing government debt service payments at the expense of savers.
Well, of course. And if Rickards had come out in favor of budget surpluses the title of this post would have been “Jim Rickards hates corporate profits” and then I would have shown the math behind that….Same difference really, but I totally see your point and it’s a valid one. But he’s trying to have it both ways. He wants corporate profits high, deficits low and interest rates high. Something doesn’t add up….
Hey, what more can you expect from these crazy gold bugs?
(just kidding, Rickards is OK in my book)
I like Rickards also which is why I was confused by this video. But I don’t think he totally understands all the moving parts here and how the balance sheet recession has so devastatingly wrecked the private sector to the point of needing govt help. Austerians are like medieval doctors. They want us all to just tough it out. Well, sometimes a little modern medicine is helpful. Except in the case of QE where The Beard is reaching into his voodoo bag….
Johnny Evers, your interest would still be 2%, only if you held to maturity, but if sold at a current value the principlal value may be reduced to accomodate competing bonds offering higher interest.
Right. But I do think it is fair game to criticize the Fed for penalizing savers. If you have $200,000 in a FDIC insured savings account at Chase, you’re being paid $20 per year. Where’s the fairness in that? Your reward for being a prudent saver is seeing the purchasing power of your life savings being intentionally eroded by negative real interest rates.
It’s not fair to savers, period. I applaud Rickards for pointing that out.
Haven’t savings accounts almost always provided negative real interest rates? I don’t honestly know, since the closest I’ve ever had is a CD and an interest checking account. How many times in our past have interest rates on savings accounts exceeded the inflation rate?
The FDIC only insures non interest bearing accounts. If your getting interest it is not insured.
That’s not true.
FDIC insurance covers all deposit accounts at insured banks and savings associations, including checking, NOW (Negotiable Order of Withdrawal) accounts, savings accounts, money market deposit accounts, and certificates of deposit (CDs) up to the insurance limit.
Don’t you think it would penalize savers even more to go through a greek style recession?
Just look at the savers on Cyprus. They had high interest rates, but now the government has to dip into each and everyone’s bank accounts to make ends meet.
I don’t understand. I’ve gone from MMT to MR, and I still don’t understand. QE doesn’t ‘print money.’ Selling bonds at an ever-increasing rate to finance an ever-increasing deficit/debt does not ‘print money.’ And paying interest on this debt does not ‘print money.’ Is that correct? So where would inflation possibly come from?
Money is “printed” primarily by banks as loans that create deposits. If you want to get really technical, you could say that QE via non-banks is similar in that it alters the composition of pvt sector financial assets from govt bonds to deposits, but this isn’t “printing” in the sense that most of us have come to think. It’s really just swapping current savings for something like a checking account. But all of that then brings the discussion to “what is money” and “is money inflationary”? It depends. Is it inflationary when a corporation issues stock out of thin air? Is it inflationary when the value of that stock increases in value and increases the net worth of the private sector? Is it inflationary when the govt issues a bond as a net financial asset? Is it inflationary when the banking sector issues money as debt? The answer is it depends.
Spending is a function of expected income relative to desired saving. Spending can be inflationary when it outstrips supply. So it’s about understanding the relationship between aggregate demand and aggregate supply. Right now, I’d say we have a aggregate demand problem and not an aggregate supply problem. That is why inflation has remained low. But the tables are turning on that to some degree which is why I am shifting more into the inflation camp (though not expecting high inflation).
Cullen, do you accept that formula that looks like:
M*V = P*Q
Where M is the stock of money, V is the velocity of money, P is the price level, and Q the “real output?”
“Needing government help.” That line cracks me up every time, Cullen.
Economies are made up of people. And people, sometimes, need help from outside sources. If you’ve ever had a medical problem you know what I mean. We don’t just heal ourselves and protect ourselves and all that. There are TIMES (not all the time) when an outside entity can serve a good purpose. This black and white view for or against govt is silly.
Not me Cullen! I’m a rugged individualist. I popped out of my mother’s womb all on my own! I didn’t need any collectivist doctor hands there to help. I gummed my own umbilical cord in two, hopped down to the floor, and I was off! I didn’t need ANYBODY’S help, especially from that band of collectivist looters known as my “family.” I knew they’d try to keep me penned in and dependent on their welfare. No sir! I left the reservation! I’ve been pulling myself up by my own boot straps ever since.
Self Reliance is a delusion. Unless you live in a biblical paradise you’ll always rely on something other people provide.
So you don’t believe me when I say I gummed my umbilical cord in two, and refused my mother’s collectivist looter milk? (my Dad worked for a inefficient redistributive collectivist government bureaucracy known as the “Navy” where everybody dressed the same, and walked around in a version of the Mao outfit). Well it’s true!… I wasn’t going to let that “government milk” touch my lips! . I had my first job before I could walk or talk… unlike all those other lazy looter toddlers, still clinging to “Mommy” and balling their heads off when they got hungry… cause they were too lazy and incompetent to go out and fend for themselves.
Tom Brown, the others may be ‘Bawling’ their heads off, but they feel safer with a police force and Pentagon, and clean food and water laws, don’t you think? I am impressed with your cutting your own umbilical cord, but is that part of your satire?
Yes! … this is a joke! … just taking the “rugged individualist” concept to an extreme to poke a bit of fun at it.
Government is not an “outside source” for our economy. Martians would be “outside source”. When government helps you it means it took it from you before or will take after, and it would take more than you get back. It can be justified in the case of externalities (army for example), yet not in majority of cases it is being used now.
Yes, govt takes from inside the pvt sector and redistributes for public purpose. Maybe you don’t like my precise terminology, but you’re saying the same basic thing. Outside money refers to money that is a facilitating add-on to inside money. It is created outside the private sector.
Well, it seems we are talking about different things here, or using different language. I never mention any sort of money. I am talking about resources/goods/services/assets. These things are always taken from you by the government, even when somebody tries to claim the government “produces” something. In that case it took the means of production from you, which is quite different form the case when you are investing willingly. Thus come various Solyndras…
And please, pay attention – I am not against the government, it is necessary to deal with externalities. Yet I insist the market is not really one of those.
Cullen,
As far as I remember, Austrians want the Fed not to “normalize” rates, but to get out of the setting rates business altogether. Secondly, if rates “normalize” or go up, as you imply, the interest payments would certainly increase. Yet, it does not matter the deficit would increase. It simply matters the government needs to cut another spending more than increase in the interest payments.
Your bigger, and more fundamental mistake though, is your strange fascination with all these money-schmoney mental games. Please, forget about these digital units of accounting for a moment. It is all about re-distribution of goods, services, and assets. By engaging in deficit/QE con game, the government significantly distorts “normalized” re-distribution of goods/services/assets. Assets go to top 1%, unemployed get cell phones they “deserve”, people without money can buy cars using “no-checks” credit from Ally, and so on…. You see, a pensioner, who would otherwise get those interest payments, is much more unlikely to buy iphone or a new car, or a new mcmansion. You can also add an education bubble. Thus, an artificial demand is created, and is supporting artificially high corporate margins. All is fine, but the resulting mix of goods/services/assets is absolutely unsustainable.
I have no idea what a “normal” market would look like. Do you mean something closer resembling Somalia where there is no govt to interfere in anything? Is that “normal”?
I’d settle for an economy not built upon lies such as Libor, zero interest rates since 2008, QE 1-4, market swings based upon the Fed Chairman’s every word, major banks receiving an $83 billion subsidy from TBTF status, 1 in 6 Americans on foodstamps, banksters escaping prison time, and finding out that “when its serious you have to lie.”
A college degree without unaffordable debt levels and a labor participation rate not at 1980s levels would also be nice for our future citizens.
But hey, I’m still hoping that given enough time, everything will turn out decent and the Great Depression part 2 will be avoided.
None of what I’ve written in this post is an approval of policies. I am simply stating the undeniable mathematical realities. You can be in favor of higher interest rates if you want. But you can’t do that and be in favor of lower govt deficit spending because you’re kidding yourself if you think you’ll get both of those things in this environment.
Exactly, Cullen, you have no idea!!!! This is what I am try trying to convey all of the time. And I do not have slightest idea too! And, most importantly, nobody in government has no idea, and nobody in the fed has no idea of what “normal” market would look like! And yet, they act like they do. More than that, they act like they know the best.
And part of this misdoing is re-distribution of income from savers to the government. Of cause the government would love to do just that – because they know much better what to do with these resources comparing to some stupid saving chumps…
Sorry, I forgot to add. these statements would be meaningless, if you actually believe that some toady in the government knows what is “normal” or “right” market, and knows how to get to it. If you believe in this, then all arguing is pointless.
Calling it re-distribution from savers is a bit far fetched. Let’s say the government negotiates the price of F-22 planes down by 10%. Are they re-distributing Lockheed’s (or whoever builds those things) money?
You say help at times as if “government help” was temporary. In reality, its permanent. I realize there will always be some freeloaders, but today’s level is quite amazing. Everyone’s looking for a handout from the very people who fail to regulate the TBTF banks.
http://www.jsmineset.com/wp-content/uploads/2013/03/clip_image0048.jpg
I think what they want is a more natural cost structure for government, rather than the subsidized one we currently “enjoy” thanks to the Fed’s bond purchases. We’re running up the size of government beyond what is sustainable at least in part because interest payments are being held lower than they otherwise would be absent the Fed’s actions. Yes, normalized interest rates would drive up the cost of government, which must then be offset by cuts in spending, which should, at least theoretically, result in faster private sector economic growth as a result of the replacement of deferred taxation with current investment income as a federal expense, as well as the removal of the perverse incentives imposed by the artificially low rates.
“In the economic sphere an act, a habit, an institution, a law produces not only one effect, but a series of effects. Of these effects, the first alone is immediate; it appears simultaneously with its cause; it is seen. The other effects emerge only subsequently; they are not seen; we are fortunate if we foresee them.
There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen
Yet this difference is tremendous; for it almost always happens that when the immediate consequence is favorable, the later consequences are disastrous, and vice versa. Whence it follows that the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil.” Frederic Bastiat
Cullen often forgets that in his mental games, if he ever understood it. The higher rate on debt will obviously as a first, direct, “seen” effect increase the deficit. But it will make spending money without thinking about the return on investment more difficult, which will reduce future deficit spending. I do not want to engage in a discussion what is the best course of action now (surplus or deficit etc.), as the time horizon is another important factor that is often forgotten, as everyone focuses on the now and the short term.
That’s it in a nutshell.
Present policy is to boost GDP by tiny amounts at the risk of losing lots of GDP later.
Austerity, which is much sneered at it, exchanges sacrifices now for a sounder footing going forward. Proper austerity would require the most sacrifices from the financial system and the asset wealthy, and not the working class.
Current policy is to requires sacrifices from the working class (savers, for example, or wage earners) in order to boost GDP for the wealthy, in order to boost GDP on the aggregate.
Johnny Evers, Austerity reduces or removes Food Stamps, Unemployment insurance and healthcare, the workers suffer, the rich (0ver $500/yr income), can use lower taxes to buy more Bonds (they already own the yachts, pools, cars and houses they want). How does that make the GDP go up?
I meant 500 thousand a year. Sorry.
You know, I just wrote that we should demand sacrifices from the wealth and not the working class, but you went ahead and argued against what you think I said.
“it will make spending money without thinking about the return on investment more difficult”
So it will reduce economic output which will kick automatic stabilizers into gear which will increase the deficit. I’ve thought through this in the PRECISE way you accuse me of not having done….
Cullen, you are really helpful, thanks. The point of Austerians is to NOT have “Automatic Stabilizers” kick in.
I don’t believe that is so. Austrians have nothing against reasonable economic shock absorbers. What they are against is handcuffing the economy with stifling regulation, smothering the job market with unaffordable employment mandates, and then subsidizing the resulting jobless with indefinite unemployment compensation, generous food stamps and free health care. That is how you get long, sluggish economically painful “recoveries” like the 30′s and now the current one.
Sorry to reply so late, but…
“So it will reduce economic output” – where do you get that from? Less mindless govt spending can be supplemented by private more mindful govt spending. (Or not. Whatever.)
Look the aim is not to keep money flowing in the system, be it to dig holes and fill them up (that is only the aim of a short-sighted politician or a banker crony), the aim is to generate value added by emplyoing limited resources economically.
Some people just like to criticize, and I think Rickards is one of them. However, there is a scenario under which raising interest rates could reduce the deficit. If income tax revenues from interest income exceed the added cost of interest payments by the government, then raising rates could reduce the deficit. I think this might actually be the case–remember that the federal government’s interest payments are taxable, so there is a net effect here.
If this is true, then Bernanke’s ZIRP and QE are inhibitng economic growth (by reducing national income) as well as worsening the deficit. Think of interest on the national debt as a subsidy to savers and you’ll see why lower rates and Fed purchases (which reduce the stock of available interest-paying instruments) are deflationary.
So interest rates increase would increase our interest payments, which would increase the deficit.
Well, that is the price we need to pay in order to encourage people to save other than through (an inflated) stock market.
It’s kind of ironical that peoiple are complaining ABOUT INCREASING INTEREST RATES, WHEN WE HAVEN’T EVEN TOUCHED PAYING BACK THE PRINCIPAL.
Don Levit
I still don’t get this part. When the bonds mature that are held by the Fed, what happens?
The Fed created the moola to buy the bonds, and the bond holders traded bonds + the interest they were getting for currency (savings account -> check book)? The Fed now has on it’s books the bonds bought with moola, (check book -> savings account that pays interest that is then given back to the Treasury), no new assets created. OK?
All of this was made possible by the Treasury and Uncle Sam’s deficit spending. The Fed is downstream from deficit spending.
The only way this process could be called “Fed money printing”, is if the bonds at maturity are cancelled. Or the Treasury paid out the money at maturity to the Fed and the Fed gave this back to the Treasury as part of its Fed profits. This would be like buying back the bonds with Fed created moola.
Shouldn’t Uncle Sam’s total never reach the debt ceiling? Or at maturity are the bonds paid off by the Treasury and the tax money used to replace the Fed created moola? If that were the case then our children would be on the hook for paying off the National Debt? Or the Fed is creating moola that dilutes value of the dollars held by people who are not in debt (rich folks), and dilutes the cost of debt dollars held by the people who are in debt (most of us)?
Somebody just answer one of these questions: When the bonds mature that are held by the Fed, what happens? and don’t tell me that the bonds are just “rolled over” because those bonds will also mature at some point.
When the bonds mature, the government must pay the principal to the Fed. I’ve actually worked through an over-simplified example of one cycle of government deficit spending wherein ALL treasuries are purchased by the Fed and held to maturity. Like I say, this example is oversimplified, but I tried to bring it back to a place similar to the start (ready for another round of bond auctions)… this “cycle” includes two bond auctions: one for the original deficit spending and one to finance paying the principal back to the Fed (and BTW, that principal is not remitted to Treasury… the interest payments are, but not the principal):
http://brown-blog-5.blogspot.com/2013/03/banking-example-6-cb-holds-gov-debt-to.html
Dennis, you write “The only way this process could be called “Fed money printing”, is if the bonds at maturity are cancelled.”
I don’t fully agree. If the Fed were buying ALL Treasury bonds out there and holding them to maturity, then that looks indistinguishable to just turning over the money creation process to the government. It doesn’t really matter that the government has to pay back the principal to the Fed (even if the Fed doesn’t remit it back to the gov). It wouldn’t even really even matter that the Fed DOES remit the interest payments back! The gov can go into unlimited debt paying principal and interest to the Fed and financing more government spending. This is a VERY different system than what we have however!! I’m just pointing out that such a policy would create an amount of bank deposits out there in the private sector EQUAL to the entire government debt… and that those deposits would essentially be created by this gov debt. That doesn’t preclude bank created money (money created by private banks loaning money to other private entities). However, I think that Cullen has pointed out that this system would be so different it would probably mean the end of private banking.
To the extent that the Fed does hold gov debt, then that dollar amount in private bank deposits can be said to be based on gov debt rather than private debt. Read the next to last paragraph of this post starting with “Only to the extent” and follow the link to another comment in pragcap:
http://brown-blog-5.blogspot.com/2013/03/list-of-ways-reserves-leave-banking.html
BTW, I’m not 100% on this, so if you can demonstrate an error here, please let me know!
What I’ve described is essentially equivalent to the “Government Spends (Without Borrowing)” operation on this macro BS visualizer:
http://econviz.org/macroeconomic-balance-sheet-visualizer/
In the notes you’ll see that they say “Governments currently do not use this spending approach…” … so it’s more fantasy than reality.
I don’t think it’s likely that the principal will EVER be repaid. Nor do I think that’s really necessary or even desirable. Perhaps it’s desirable to lower the overall level of public debt (at some point). One reason we’ll probably never pay off the debt is that there will always be a demand for 100% safe assets (which Treasury bonds are).
I don’t have a reference for the following, but somewhere I read that the Australian government, having paid off, or nearly paid off, its entire debt, was motivated to accumulate debt again (in part) to satisfy the public’s demand for government bonds. If somebody can provide more facts on that matter, I’d appreciate it!
Tom,
Thank you for your consideration of my question. I had already looked at your analysis. I had not heard that the Fed had done something like this before. Buying $Trillions of Treasuries and “nationalized” Fannie, Ginnie and Freddie bonds that were already sold and then purchased off the secondary market is unprecedented as far as I understand things. So when you say the Treasury must make good on the bond’s principal when they mature at the Fed (vs. everywhere else — which of course they have to), I wonder? Why should they need to do that if the Fed and Treasury are a “husband and wife” relationship?
But if you’re correct, then I guess all of us are on the hook at least theoretically for tons of fiat currency created and distributed by the Fed to buy US Treasuries, and GSE bonds (Freddie Mac, Fannie Mae and Ginnie Mae) off the secondary market. Do we really have to pay the Fed back for moola they created out of whole cloth? Why can’t we just call it even?
There is no way the Fed’s bonds will mature and the taxpayers redeems them.
Can you imagine a scenario in which you would give money to the Fed so that the Fed could put that money in a bonfire and burn it? That would be the equivalent.
Well, the scenario would be rampant inflation, I suppose.
To your question, ‘Why can’t we just call it even,’ my answer would be that we have to pretend we’re not printing money to save certain actors. As long as we maintain the fiction, the system works.
If you look at that link, you see at the end (the final set of BSs) that after everybody else pays back their intermediate loans, it looks like Treasury just paid Person x with a $100 bond. Now if the Fed buys it, it’s as if the combined Treas/Fed just paid Person x with $100. So that’s what it amounts to… pure deficit spending (with no taxes)and with the Fed acquiring every bond… it looks like the combined Fed/Treas is just buying services with printed money. Inside money is only temporary in this process (though it could exist outside this process). I do think that’s the M M T ideal.
So that fiat currency is getting injected into the real economy (in this situation)! It’s not so bizarre to me that we would “be on the hook” for it. Those gov bonds have to be repaid in either case. If the Fed holds them, then with no interest essentially. So that is a benefit over the private sector holding them (regarding taxes).
I think the Fed has always held SOME Treas bonds because that is it’s primary instrument in setting non-zero overnight rates (pre-QE days). It either sells or buys Treas bonds (to remove or inject reserves, resp.) into the banking sector to make the rate come out right.
Re: the gov having to pay back the princiapl to the Fed: Actually, it’s not just me that thinks that. If you play w/ that econviz tool you’ll see that’s the assumption they make (again, using the Gov Spends (No Borrowing) operation). Also, I verified that with Cullen a while back. Look here:
http://pragcap.com/ask-cullen-2/comment-page-2#comment-139651
Take a look here:
http://pragcap.com/ask-cullen-2/comment-page-2#comment-139651
Tom … were you directing me to the ‘Bonds are conjured out of thin air’ comment?
Bonds are conjured from investors, so I don’t necessarily see that.
I would agree that bonds are conjured from thin air … if we have the understanding that the debt will not be repaid. With corporate bond, I don’t think that is so. With government bonds? Probably, so why issue them. Why not just spend the money directly and avoid the interest payment.
To your comment below, I see that he qualifies the option that ‘it’s just hypothetical.’
Don’t you think that’s the end game here? Introduce ‘hypothetical’ solutions, convince people that debt doesn’t matter … it’s part of the plan to eventually monetize federal spendigng.
Not saying that’s a bad thing, just before we discuss the pros and cons I’d like to see proponents of the ‘debt doesn’t matter’ crowd admit this is where they are going.
Johnny/Dennis: The link I provided above is regarding the repayment of T-bond principal to the Fed. I postulated that’s what happened (in response to Charles) and Cullen confirmed it (Cullen’s comment right below mine). I was really responding to Dennis on that.
Regarding the hypothetical operation on the econviz page: I’m not making a judgement call there. I’m just pointing out that’s one version of the em em tee recommendation for gov self financing (the others are spelled out in the comments at the bottom). Cullen has gone through the logic of that many times with various em em tee commeters here like philip and Peter. I think his position is clear: That would dramatically alter the system we have now and would probably mean the eventual end of private banking. I don’t think Cullen was making a judgement call either, he just wanted the em em tee crowd to be honest about the consequences.
The govt does not issue money because it is not in the business of issuing money. The private banking system dominates the business of issuing money. As I’ve explained before, govt money is a faciliating money. Cash, coins, reserves all facilitate the use of inside money (bank money). If the govt starts getting into the business of money issuance then the banking system has serious competition that threatens its entire existence. This is why I said the trillion dollar coin was a big deal for banking. If the govt just started creating money (as opposed to coins, notes, reserves and bonds) then the money issuance business is altered (perhaps permanently). Banks, as private profit motivated entities, obviously are in the business of OBTAINING market share, not ceding it to powerful competitors. And nothing is a more powerful competitor than a potential monopolist (like the govt).
Also take a look at that econoviz macro BS page and run the “Gov Spends (Without Borrowing)” operation. That’s a misnomer, because the gov IS borrowing form the Fed in that case. Again, that’s not the way it works in our system now… that’s more the em em tee ideal. Look at the em em tee referencing notes at the bottom too under the operation. It’ll give you a feel for what some em em tee-ers have suggested (some suggest like you that you call it even).
Again, I don’t see anything wrong w/ what’s on that econviz page…. all the other operations are real operations and I think he’s done them correctly (so that’s why I’m not too concerned w/ that one em em tee inspired operation… he points out that it’s just a hypothetical).
I will admit to some confusion regarding Cullen’s points regarding the Fed. The argument for overnight rates going to zero without the Fed seems reasonable at first but I have some issues with this. Even with reserve level requirements set by the Fed, this money has little value to a bank if I understand correctly, but even in the limit of infinite clearing transaction rates every bank has some stochastic daily fluctuation in it’s need for reserves. Take a simple two state model. As long as the banks are independent entities it is possible on day n that all debits on bank A may all end up being credits on bank B and on day n+1 all debits on bank B may be credits on bank A. As long as these fluctuations remain symmetric, bank A and bank B have an incentive to keep overnight rates between them at 0, but in fact they can be any level as long as symmetry holds. But this seems to ignore the same tail risk that resulted in the recent financial crisis. If there is a “run” on bank A, then bank B realizes it has a risk in overnight loans to bank A and raises the rate to try and compensate for the perceived risk.
The second confusion I have is with Cullen’s comments regarding QE in light of his arguments that overnight rates would go to zero without the Fed setting them higher and that long rates are a function of shorts rates. “Long rates are a function of short rates. The Fed currently sets short rates and lets long rates float. But long rates are “set” by the market based on the perception of future economic outcomes and how the Fed will respond to the environment. If the Fed wanted to set the entire term structure of the curve at 0% it would just announce it and it would happen instantaneously. The fed is the monopoly supplier of reserves to the banking system. If it wants govt debt to be a particular rate it just sets it. It doesn’t ask Jamie Dimon if it’s okay with him.”
I find this to be illogical with regards to the Fed being able to set the entire curve at 0% when it is true that long rates are set by the market. It seems the only way to have this be true is that if the Fed said overnight rates will be 0% in perpetuity (or n years, longer than the longest outstanding Treasury bond) AND people trusted this as being true. But with a lot of outstanding T-bonds in the market, the long bonds will not go to zero unless people trust the Fed to hold course for the duration of the bond (if someone can borrow overnight at 0% forever, the market will drive the price of an interest bearing instrument to close to that level).
QE seems to refute Cullen’s point above. The overnight rate is near zero (0 − 0.25, averaging 0.15 for some time) and the Fed has signaled this will continue for some time (though not in perpetuity). So QE is an attempt to influence the long market by buying a tiny percentage of the daily trade in Treasury securities because the market doesn’t know/trust the Fed to keep overnight rates near 0%. The market will never trust the Fed over the period of the current existing long bonds so it can’t magically set the whole curve to 0%.
The Fed is the reserve monopolist so if it wants to buy something and set the rate at 0% like bonds then it just starts buying and dares the market to compete with it. The market can’t compete with the Fed who has a bottomless wallet so they don’t. This isn’t what they’re actually doing and Cullen has explained that’s part of why he doesn’t think QE is doing as much as some think.
Cullen has discussed an aversion to QE. My issue is that relative to the total daily volume in TS, or the relative Fed holdings of TS, the current Fed actions are not exceptional. We don’t know what the T-security market would be without Fed actions, but I think most rational arguments put the influence in the range of 100 to 300 basis points. These do not seem exceptional