In Which Jamie Dimon Misunderstands Banking and Fixed Income Markets

I’ve had a number of readers send me this link from yesterday’s interview with Jamie Dimon at the Council on Foreign Relations so it’s obviously worth a brief comment. Although I’ve been debunking the USA’s “bond vigilante” and “bond bubble” myths for years now, this is a good time to nail home some of the principles of Monetary Realism and use Mr. Dimon as an example of someone who doesn’t fully understand (gasp) the fixed income markets or our banking system (I know, this is blasphemous, but please read on).

In case you missed it, Jamie Dimon said the following:

CFR:  ”How worried are you that one day you wake up and your your blackberry or iphone is red hot because the bond market is essentially moving against the United States?”

Jamie Dimon: “It’s virtually assured.  It’s not a matter of when, but how….it’s a matter of time.  It will happen.”

These are odd comments.  First of all, Dimon runs the key Primary Dealer in the USA.  The Primary Dealers are required to do the Fed’s bidding in government bonds. As the NY Fed says:

“Primary dealers are also required to participate in all auctions of U.S. government debt and to make reasonable markets for the New York Fed when it transacts on behalf of its foreign official account-holders.”

If you’ve ever wondered why US government bond auctions never fail it’s because the banks are harnessed by the government to bid at auctions.  They are “required” to do so.  And they pick up fees and other benefits in return for doing the government’s bidding.  The banks know the US government can’t “run out of money” and that the Fed is there to backstop the whole operation in a worst case scenario (something Dimon is all too familiar with) so it’s nonsensical for Dimon to worry about bond vigilantes attacking the USA due to some solvency crisis.  He seems to be mistaking the USA for Greece or another nation whose central bank, treasury and policy makers have no unity.  He should know that the USA has already implemented the fix for Europe – an integrated central bank, Treasury and political system.*

Dimon isn’t the first one to make claims like this though.  David Einhorn mentioned it many years ago, Alan Greenspan constantly discusses it and Bill Gross has famously said the USA’s bond markets are bound to run out of buyers.   Many people said we might have a bond market crisis after the USA was downgraded from AAA status.  Of course, yields FELL after that and continue to fall despite constant concerns over the USA’s debt levels.  But when one understands Monetary Realism you understand that the US government can’t “run out of money” because the system is designed not to run out of money.  And while MR shows us how the banks are in control of the monetary roost as the primary issuers of money, it’s also important to understand the symbiotic relationship between the banks and the Fed.  The banks are only in control of the monetary roost because our government chooses to have a market based monetary system (controlled by private for profit banks) as opposed to a government controlled system (such as a nationalized banking system).  In return for this incredible profit generating power, the banks do the government’s bidding when it asks them to.

But the real moral of this story is that the USA isn’t going to have a sovereign debt crisis like Greece because Mr. Dimon’s bond traders aren’t going to stop buying bonds because Mr. Dimon is in the business of doing the Fed’s bidding.  As I’ve stated on many occasions, bond traders in the USA (and in Japan for instance) know that the government can’t run out of money and that the solvency of government debt is never an issue (ie, getting paid at maturity is never a worry).  So the thing that keeps bond traders up at night is inflation.  And as we all know, inflation isn’t exactly scaring bond traders out of their holdings.

* It’s possible that the banks could revolt in the case of a hyperinflation during a total economic collapse (it would obviously be unprofitable to buy government bonds when the currency is cratering), but hyperinflation is a very different phenomenon than a sovereign debt crisis.  Of course, the natural response to this article is “what might cause interest rates to rise?”  The answer is here.

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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Comments

  1. Isn’t OUR system designed such that the Treasury can run out of money, i.e., we have a self-imposed debt ceiling that only Congress can raise?

    • The Congress would never let the Treasury run out of funds. It’s an unrealistic and stupid constraint.

      • Yeah, damn those unrealistic and stupid constraints, otherwise known as the Constitution.

        • The debt ceiling serves no real purpose. Some will say it forces some fiscal discipline, but really it just causes a bunch of bickering and then gets pushed higher so we can have the same silly arguments again at a later date. Also, could it be that a 230 year old document is a bit outdated? Our monetary system has changed in pretty incredible ways since then….It should better represent our true constraint in my opinion and that means a Congressional constraint that focuses on spendings impact on inflation and living standards rather than a mythical solvency constraint.

          • Not to mention the debt ceiling is not in the Constitution. It’s only been around since WWI. The Constitution gives Congress the authority to borrow money. They themselves put this self-imposed constraint over them, we know is unecessary.

      • Interesting factoid: The US Treasury almost went bankrupt in 1933. Federal revenue had collapsed, the budget deficit was huge, the bond market had collapsed because of the banking collapse, and the Fed was in no position to lend because it was heroically trying to maintain the $20 gold price. When FDR took over, the Treasury was nearly empty. The US was a bad credit from 1931 until 1934. FDR fixed this by guaranteeing the banks and by going off the gold standard (a contractual default).

        • It is interesting to know about financial history. However, whenever you are looking at financial events in history and considering whether they could happen again you need to consider whether things have changed.

          The most important thing to be aware of is that the monetary system presently in place in the USA has only been in force since 1971 (the collapse of the Bretton Woods system). Just remember that for whenever you’re looking at events related to the monetary system that occured prior to this date…

          • Countries have gone on and off a gold standard throughout history. So what. The USA went off gold temporarily during the Civil War as well.

            The question about Jamie Dimon’s statement is not whether the “bond vigilantes” could crush the Treasury market, but whether there are any conditions possible that would make it very unprofitable for Dimon’s bank to carry out its role as primary dealer.

  2. I think Dimon has to understand this at some level. He just can’t not play along with the debt/deficit crowd because of politics, dont ya think?

    • Wh10
      I don’t see this as a ” no one understand” issue for a regular reader of Cullen.
      What is not understandable is why people like Dimon and Gross are misleading their audience on the workings of the “machine”. Cullen says that they have a misunderstanding of how modern monetary systems work. But given the many dollars that Dimon has allocated to his “fiscal cliff war room” I would imagine that all possibilities are being subject to analysis so MR type thinking has to be in that relm of possibility.
      These gentlemen manage the largest pools of capital on planet earth so I have to assume this is no accident. We simply have to assume they know what is the correct system.
      Given this assumption, I would like to know why they are using thier enormous influence to cloud and confuse the real understanding.
      What they are saying is disputing an important principle of MR .
      I am greatful that Cullen has responded to this as this post needed to defend a core principle of MR dispite having to take on one of the big guns.

  3. when i saw the interview my initial thought was that you will rip Dimon for not not understanding the monetary system ;)

  4. Dimon understands quite well that the US is required to fund itself in the markets, by Congress’s will.
    The primary dealers make markets, carry inventory, but there are in no position to buy all US debt, they need customers and the Fed doesn’t fund primary dealers that’s also market driven.
    So yes the bond market can move against Uncle Sam again as it has before ( 30 year treasury above 15% was presumably before your time)

    • Right, but the 70′s rise in rates was due to inflation fears. That’s my main point. Bond traders weren’t selling bonds in the 70′s because of some mythical insolvency. It’s a totally different phenomenon.

          • I think you can draw a number of parallels between the era that led to the runup in inflation in the 1970s and now. Government spending, long drawn-out wars, Middle East tensions, etc. The similarities are there. If the market starts to anticipate inflation, interest rates could very easily move in a direction the Fed does not want them to go.

      • So there is no “default” risk as such. But don’t the default risk and the inflation risk come down to the same thing in the long-run? If the Treasury can’t find buyers, then the Fed can always step in and buy, but that implies higher inflation – so that real returns on bonds will ultimately be lower. So higher risk of default = higher risk of inflation = higher nominal interest rates.

  5. Think your missing a very big point, It’s not UST auctions that’s the worry, it’s current UST holders dumping their holdings that’s the fear. The bad auction won’t come until current holders (of which China is the largest)starts dumping..

    You could discount this possibility saying that large holders would stand to lose too much by dumping UST’s but if it’s looked at as a choice between losing ‘some’ money or ‘all’ your money it’s not hard to figure out which choice they’ll make. The Yuan peg is the main reason China holds so much UST’s but if Romney is elected and does what he says he will in labeling China a currency manipulator that could change overnight.

    Further more I’d bet anything that you don’t understand banking or fixed income better than Dimon, nor do I just off the level & quality of info he receives.

    • China isn’t going to cause a USA bond market crisis by dumping all its treasuries – its just nonsense. There’s plenty of real things to worry about in the financial world and that isn’t one of them.

      The Fed could “swap” China cash for all its bonds tomorrow if they want. And then what? China has $1.3 trillion in non-income generating USA. It wouldn’t be inflationary in the USA because the cash would in essence be held outside of the USA monetary system. Sure, they could perhaps go on a buying spree in USA but do you think President Romney would allow that to happen? Then what can China do with their USD and how would it impact its own currency?

      Any way you look at it China’s holdings of treasuries are much more of a burden than a blessing to it… Its their fault – they want to pursue aggressive mercantilist policies that have usually ended badly that’s up to them…

      • Exactly. The Fed is free to buy in the secondary market to peg Treasuries of any duration at any price it wants. Any primary dealers who doesn’t play ball won’t stay a primary dealer for long. China can change rooms but they can’t check out.

        On the shopping side, the President does indeed has the legal authority to step into, block or even unwind any purchase of US assets by a foreign power.

  6. Cullen

    I usually like what you write, but if there ever was a strawman attack, this is one. Dimon spoke about bonds markets moving against treasuries. You took on the idea of default, a position he doesn’t hold or say.

    Of course the US can’t default. That in itself should not be cause for complacency. India can’t default either. And so can’t many sovereigns of various hues with their own currencies and primary dealer systems. The US is not unique in having one. Last week, India borrowed 5 yrs at 8.2%, 10yrs at 8.25% and 30 yrs at 8.4%. Inflation is running over 8% (expected long run inflation is probably lower). The yields were exactly at the cutoffs specified by the RBI. The auction got filled, as it would have because of the RBI backstop anyway. Does this mean India has as much operating fiscal space as the US? Of course not.

    In fact, I’d argue that it is precisely the ability of the CB to set any price it wants for government debt that makes hyperinflation a non-trivial threat. In an inflationary environment, if the CB does not let safe nominal yields rise, it stokes a hyperinflationary spiral through the persistence of negative real rates at long maturities. Of course, the US does not face that threat immediately. But it could. And if it does, the power of the specific institutional arrangements you describe is actually a double-edged sword.

    The true fiscal operating space of the US government is a function of its commercial legitimacy, esp. when viewed in relation to the commercial legitimacy of other sovereigns. The institutional arrangement helps, but lots of states have similar arrangements. It’d be a mistake to think that just because the CB can backstop a bond auction, it creates additional fiscal space.

    All this is not to say that the US needs to engage in fiscal consolidation right now. Or that the bond market vigilantes are right in real time. On both counts, I agree with you.

    • I don’t think Cullen’s inference is misplaced. The question is why would markets move against treasuries “red hot” all of the sudden? Is Dimon saying that rip-roaring inflation fears are not only going to be priced into treasuries in a flash but are also inevitable? This is a highly specious claim as well.

    • The questioner asked him when bond markets will turn against the USA due to debt fears. How can that not be a solvency concern? It’s certainly not an inflation concern….

      • Actually it is an inflation concern. If rates are rising because of accelerating inflation, the value of 10 and 30 yr treasuries will crater. Current private Treasury note and bond holders will not want to hold them at all unless rates rise sufficiently. Private holders will want nothing but short term Treasury bills (and maybe TIPS and I-bonds) unless the Fed allows LT rates to rise. The Fed will not want to sell its T-bond holdings at all because it would have to book losses, and that is very very bad politics. Doing that would get a Fed Chairman impeached. So, there will be a mad scramble for everyone to dump their cash into gold, commodities, and stocks. Of course, the cash can’t go away unless the Fed drains the reserves by selling Treasury bonds and raising interest rates, so everyone keeps dumping the tar baby. If the inflation occurs without real growth as it would during a long term energy crunch, Congress will still have to fund an ever widening deficit. Congress will not be able to afford to pay sharply higher interest rates from tax revenues, and that means borrowing or printing the money to fill the gap. Congress will pressure the Fed to keep rates low. Congress could cut spending during an inflation if it is politically possible. But how likely is that during an inflation without any real growth? We have a completely intractable situation here. The moment a competing superpower energy exporter (Russia?) introduces a gold backed currency, the value of the dollar would crater.

        • My understanding from reading Cullen is that if inflation rises and investors demand higher rates, the Fed will simply buy up bonds to force the rates back down.
          I predict we will see rising inflation, low interest rates and low growth. As you say, that will drive up the price of hard assets.

  7. I really can’t get my head around this & would really appreciate if you could detail the mechanics a little more.

    Primary dealers are obliged to bid/make a mkt which subsequently causes their balance sheet to expand from the newly acquired assets. Then what? Assuming there wasn’t any QE programs underway, would banks’ b/s expand for ever? Some bonds would mature but I suspect excess ‘holdings’ are placed/sold-off in the market place. Is this correct? If so, what happens when the bid is removed? Sure the FED is the ultimate back-stop but if this were to occur on a consistant basis, wouldn’t this undermine the confidence in the US’s monetary system therby leading to some major sell-off at some stage? (ultimately, I am particularly interest in understanding the mechanics without the QE variable)
    Many thanks,

    • Leo, this may help:
      “When the Fed wants to increase reserves, it buys securities and pays for them by making a deposit to the account maintained at the Fed by the primary dealer’s bank. When the Fed wants to reduce reserves, it sells securities and collects from those accounts. Most days, the Fed does not want to increase or decrease reserves permanently, so it usually engages in transactions reversed within several days. By trading securities, the Fed influences the amount of bank reserves, which affects the federal funds rate, or the overnight lending rate at which banks borrow reserves from each other.

      The federal funds rate is sensitive to changes in the demand for and supply of reserves in the banking system, and thus provides a good indication of the availability of credit in the economy”

      See more here:
      http://www.federalreserveeducation.org/about-the-fed/structure-and-functions/monetary-policy/

    • This is the mistake Gross made when QE2 ended. Banks on-sell most of their inventory. They’re just middlemen for the most part. But what most people misunderstand with QE is that there’s huge demand outside of the Fed’s operations. How do we know? Because, when QE2 ended bond yields tanked even though the Fed wasn’t buying. So this idea that the Fed is just propping up the bond market is wrong. It was proven clearly incorrect following QE2 when Gross said bond yields would surge and people like me were saying they wouldn’t.

  8. The mythical threat of a failed auction is a rhetorical device which Dimon and his class use to browbeat those who would like to spend money on things they don’t want–a boogeyman, if you will. Like a parent, he knows very well his story isn’t true, but it keeps the children in bed. . .

  9. The Treasury market will never lack for bidders. It worked perfectly in May, 1981, when the government easily auctioned the 10-year at 14.7%. Should we ever visit those rates again, today’s treasuries would be worthless, but still highly liquid.

  10. If interest rates rise, the par value of Dimon’s Treasury bonds fall — I think we all understand that.
    What I suspect he is saying is that if that happens, his firm won’t be able to meet his capitalization requirements, and, might even be required to sell those holdings.
    The crisis in Europe, after all, is because the European banks are holding Euro bonds at less than par.
    MMR proponents are saying that if that happens here, the Fed would merely step in, buy the bonds at par and lower interest rates. I have no doubt that is true.
    But surely that creates hazards. I don’t understand a) the blithe disregard for the risks here, and b) the assumption that Jamie Dimon doesn’t understand the risks that his firm faces.

    • Banks don’t mark to market and Treasuries have zero default risk if held to maturity. So no, Dimon knows full well that his t-bonds (most of which they on-sell anyhow) aren’t going to break JPM. He’s just pulling a political card here (or worse, misunderstanding how the system works, which is my hunch).

      • Zero default risk just means the bond holder knows that he will get a piece of paper back that may or may not be worth his initial investment.
        Present policy pretty much guarantees the value of the dollar is whittled down every year.
        People understand that, and it alarms them.

          • What’s the difference, really? In a default, the government pays only to select bondholders or stops paying altogther. In an inflation scenario, the government pays with worthless or reduced-value credits.
            I guess in latter scenario, you can say, ‘I told you the government can’t run out of money.’

            • The difference is ENORMOUS. People who misunderstand inflation think it’s somehow equivalent to insolvency. That’s totally false. We’ve had inflation in the USA since the beginning of the fiat system. Inflation has averaged 3.5% EVERY YEAR since 1913. And what’s happened to our living standards? They’ve gone through the roof. So the lesson is, a little inflation in a fiat money system is not necessarily reducing living standards or bankrupting us. In fact, a low level of inflation is totally consistent with increasing living standards. The history doesn’t lie!

              Insolvency, on the other hand, is a totally different phenomenon. When a govt runs out of money it cannot operate. See Greece. The Greek situation and the USA’s situation are completely different phenomena.

              • Our living standards have improved despite inflation, not because of it.
                And I would argue that price inflation combined with wage deflation has reduced living standards for most of the country the past 10 or 20 years.
                And deep down, the U.S. and Greece have the same problem — we want to buy things we can’t afford and want non-working people to continue to consume at the rate they did when they were not working), and believe money creation is the answer. Maybe you are right about that; if so, surely there are better ways of getting money to the people who need it. That would be an interesting argument.

                • Yes, I know the standard Austrian argument. In essence, if we didn’t create more money (which is really just a political veil for less govt) prices would decline and we’d have higher living standards and stable prices. We tried that in the 1800s. It was a total disaster. It didn’t work. Prices are sticky. Wages are sticky. You guys just totally ignore this stuff. It’s basic economics. You create this convoluted and misleading anti-govt argument that has never worked in real-life and exists nowhere on planet earth. What we can prove, definitively though, is that a low level of inflation is perfectly consistent with a very healthy economy.

                  And cherry picking the last 10 years doesn’t disprove 100 years of data….

                • Inflation charts from Federal Reserve data proving that inflation has no relation to deficit spending on my links.

                  A growing population needs a growing money supply to grow/fund more jobs & more production (which offsets the increased money supply).

                  Our living standards improved hugely because of gov deficit spending(aka money creation) & private bank money creation (aka as statisitics show that 80%+ of all businesses, real estate sales, etc use business loans/credit/mortgages to grow/expand/startup)

                  ie, gov deficit spending/money creation that really improved living standards:

                  1. FDR’s REA that gave electricity to 90% of people in rural areas. Before that, electricity by private electric companieswas only for the cities

                  2. Antibitoics

                  3. Radar

                  4. GPS

                  5. internet

                  6. post-WW2 GI Bill that gave subsidized, low-interest, guaranteed mortgages/business loans to all military & free university (that was about 12+ million military or about 33% of all US households, transferable benefits to children/spouse). Before that, only 5% of the US could afford university & most lived in the cities. This massive gov money creation for mortgages for military/veterans stimulated the suburban housing boom.

                  7. Computers.. gov funding contracted & funded computer development for counting census, artillery ballistic tables, & missile flights.

                  8. nuclear power .. first 30 yrs of nuclear power was invented/developed by gov, which now provides 20% of US power, 80% of French power, etc

              • Great point!

                The”default via inflation” concept is a major factor confusing people who are trying to understand all this – its totally different to the main focus here – the idea of “default via insolvency”.

                • Yeah my favorite is “financial repression”. It sounds like a human rights violation Amnesty International should be denouncing, but its not.

              • How do you know that the rise in living standards weren’t due to a one-time technological revolution? You can’t run alternate histories to say what living standards would have been if somewhat less inflation had taken place. I suspect they would be about the same as long as enough money was created to accommodate real growth, as living standards were driven by the industrial and energy technological revolution from the early 1800′s to 1960 or so that was historically unique. That revolution ran its course, and the lesser (but current) revolution in microelectronics and computers has now nearly ran its course as well. Just because inflation coincided with growing living standards in the past, does not imply that the same will be true for the next 50 or next 100 years. In an environment of decreasing energy supplies, inflation could coincide with shrinkage instead of growth.

        • People DO understand that, which is a big reason why the bonds pay interest, i.e. to help compensate for inflation.

  11. As a market maker they can go short their positions. Either outright short ahead of an auction, or hedge with future’s contracts. If rates rise quickly banks won’t be able to hedge fast enough and get pounded. People aren’t going to want to touch Treasury paper. That’s what happened in the early 80′s. How else did the 10 year get to 14%. In 1949 the 10 year was 1.8%. Thirty three years later it’s 14% This time it’s not going to take that long. They’ll buy on the auction and then dump them. Forcing rates higher and higher. The cost of servicing the debt will become counter productive, spending and invest will stall. And finally rates will drop as well, leaving a lot of people crying in their beer.

    • Pas, as I understand it, if rates rise in the secondary market, the Fed will step in and buy bonds on the secondary market at par.
      We could see a situation in which T-rates are held artificially low at 2 percent and corporate bond and other type of rates are 5 percent or higher.

      • Yes, and that would result in a massive stagflationary spiral. You can’t keep such rate suppression up for long without huge consequences.

  12. Dear CR you are a smart guy but you’ve no clue what a market based monetary system means. Todays system is only designed for foreign currency holders to participate on a market. They can make a bid on the market to buy the dollar in exchange of their own currency. You as a US citizen you can’t buy a $10.- bill with an disagio or agio – that means $10.- are only redeemable with another $10.- bill (or ten $1.- bills). So the dollar, since it is irredeemable, is not a market based currency. Every US citizens is forced to buy the dollar at par – no matter how high inflation is.
    If the US had a hyper inflation you would wish to have a market based monetary system to buy the $10.- bill with a disagio. Let us assume that we have 10% inflation. That means your $10.- bill loses 10% value. Everyone understanding the basic market mechanism would offer you $9.- for your $10.- bill since after the inflation it is not worth more then $9.-.

    • When I say “market based money system” I mean that banks issue most of our money in a manner that is based on market demand with virtually complete independence from the govt. Money issuance in the USA is market based, decided by competitive banks making loans….The govt has outsourced money creation to private for profit entities who compete for private business….

      And you know I’ve done plenty of homework on inflation and hyperinflation. I’ve been fending off your hyperinflation and high inflation claims for years now.

      • Demand is only half of a market… A market defined through supply, demand AND most important PRICE. Since the price of money never changes (a $10.- bill is only redeemable with another $10.- bill) for US citizens we have not a proper market and therefore we have inflation or deflation to balance the supply and demand.

        And I wasn’t claiming that we have (hyper)inflation soon. I was discussing the issue of inflation and deflation for a long time and put my view into perspective many times. I used this inflation scenario only as an example so it is easier to grasp what a market based monetary system means.

        BTW I wrote some essentials about understanding inflation and deflation here:

        http://pragcap.com/3-points-on-exploding-central-bank-balance-sheets

        • You’re changing the subject to inflation, which is my whole point….You’ve been arguing that we might have higher inflation for years now. Well, how long do we have to wait before your argument finally pans out?

          • Whenever you are challenged on inflation, you respond that interest rates cannot possibly rise because the Fed will step in.
            So it’s a no-win argument.
            Your argument here, that inflation cannot happen because it hasn’t happened in the past few years, doesn’t have any heft to it, either.
            Saying that something can’t happen tomorrow because it hasn’t happened today — c’mon.
            ANd you can’t seriously argue that just because $1 trillion deficits and an expanding Fed balance sheet haven’t trigger inflation that $2 trillion deficits will be fine.

            • Johnny,

              You’re just not reading my work. I’ve never said “inflation can’t happen”. My argument is that inflation is likely to remain low because wages, economic growth and de-leveraging will put downward pressure on inflation. I’ve been saying this for years and years. And it’s been completely right. Your argument is “rates will rise one day because inflation will rise, just you wait! Government bad!” There’s no meat behind your analysis. I have a very long and public record of stating the reasons why inflation would remain low. You’re just choosing to ignore that….And since rates are an extension of the Fed’s expected inflation and economic outlook then….connect the dots. There’s a reason why I’ve been right about all of this for years now. It’s not just vague nonsense. But you choose to ignore all of my analysis because you don’t like the conclusions.

              • At this point, it might be best just to ignore, or ban Johnny. He’s proven he doesn’t intend on engaging you, or any of us, in good faith.

                • I understand that you are making the case that we will not see inflation. And so far, you have been right.
                  I’ve asked you several times to envision a situation in which inflation arises and you won’t do that. Any investor or forecaster must acknowledge that he could be wrong.
                  The financial crisis arose in part because investors believed that housing could never go down, and because of that there were no provisions to address a situation in which housing went down.
                  Similarily, you are saying that we won’t have inflation but won’t say what happens if you are wrong, or, more likely, if conditions change.
                  Conventional thinking is that if we fight inflation with higher rates, but the policies you espouse will leave us without that option. So you are advocating a very risky approach.

                  • Johnny,

                    I’ve described scenarios where interest rates and inflation could rise. I’ve even provided links here in this piece. But you’ve chosen to ignore those points. That’s fine. Have a good one.

                    • You say that interest rates cannot rise if the Fed does not want them to rise. I agree that the Fed can dictate T-rates simply by buying up the supply. We see it doing this to keep mortgage rates low. Would it also buy corporate bonds to lower corporate bond rates?
                      1. But does the Fed’s ‘bazooka’ carry risks? For one, what about the political risk of telling investors that we are going to pay them 2 percent in an infaltionary climate? Who would want to own such bonds? Won’t the Fed wind up financing government spending?
                      2. Conventional wisdom is that Fed raises rates to combat inflation. But can the Fed really issue $2 trillion bonds every year at 6 percent? Aren’t we stuck at low rates so long as the deficit is so high?

                    • The Fed can control all treasury issued interest notes at whatever rate it wants. They are the monopoly supplier of reserves to the banking system. There is no such thing as banks, for instance, being able to move the overnight rate against the fed’s set price. And if they wanted to set the long-term bond at 0% they could do this permanently. I am not saying that would be appropriate. I am just saying it’s a fact. As I’ve previously stated, the rate at which the Fed sets rates is a reflection of their view of the economy. So, if we had high inflation they’re not likely to keep rates low. See the 70′s. But that’s not their current view. And it’s not mine either. I might be wrong. But I have a pretty good track record so far….I don’t see surging inflation in our future….Therefore, I don’t see surging interest rates.

          • Dear CR, I didn’t change the subject. I used the inflation scenario just to explain what happens in a non-market based monetary system where the price is fixed ($10.- are only redeemable with $10.-). Since the price mechanism for the currency doesn’t work we experience inflationary and deflationary periods. This example was to show in a palpable way – so everyone can understand – that we have per definition NOT a market based monetary system – as you claim. A market based system is not defined on the basis of the supplier. It is defined on the basis of several subjects combined.

            And if you would have read my little article about the case of Japan you would know that I was not per se claiming inflation. I rather find your approach on inflation uninspired. You (and other economists) look at the balance sheet of the BOJ and notice that there is no inflation and you come to the conclusion that the monetary “swaps” are not inflationary. The QE swaps are in fact to raise the liquidity in the banking system and this has inflationary tendencies. But these are not the only forces working in an economy…

            • Dave,

              We’ve had this discussion before regarding fixed prices. We live in a global world. Fixed price regimes don’t work. They’re inherently depressionary. We learned this in the 1800s and again with the Euro project. Fixed price monetary systems don’t work unless you have some sort of rebalancing mechanism (which means bigger govt – something I am sure you’re against) or floating exchange rates.

          • If you base predictions of the future on US historical experience, it could take a long time (possibly as much as decades). Much longer than the time horizon of a short term trader. If the current era is analogous to the 1930s, it took until the end of WW II to have temporary high inflation (after price controls were lifted at war’s end), and until the 1970s to have persistent stagflation. The future won’t repeat the past exactly. It never does. But high inflation will happen – it is just a question of when.

  13. Jamie Dimon……CEO…….JPMorgan….
    mis-understanding….no
    dis-informing………yes

  14. Speaking of PD’s stepping up to buy bonds, they bought $7.7bn long bonds at today’s auction, which was a whopping 59% of the total.

  15. Bravo. Love the article and the comments. Found your article through realclearmarkets.com. Will be checking out some of your other stuff Cullen.

  16. “And while MR shows us how the banks are in control of the monetary roost as the primary issuers of money, it’s also important to understand the symbiotic relationship between the banks and the Fed. The banks are only in control of the monetary roost because our government chooses to have a market based monetary system (controlled by private for profit banks) as opposed to a government controlled system (such as a nationalized banking system).”

    The deeper issue for me is whether this ‘symbiotic’ relationship is healthy. I am increasingly convinced that both function best when there is a ‘wall’ between government and private business (akin to the separation of church and state’). Commingling leads to lack of accountability at best and rank corruption at worst.

    I am not a ‘big goverhment’ anti-free-market ‘socialist’ (although I do place priority on the welfare of the less advantaged, and the environment – here and globally). Market forces are clearly the most effective for a variety of purposes; I believe they could be harnessed effectively for the extension of credit, within circumscribed limits.

    The other point I would make strongly is that the past cannot be relied on for precedence, I have made the point that in a multipolar world approaching resource and environmental limits, the kind of credit-fueled expansion based on unlimited exploitation of natural and human resources may no longer be possible (and the last few decades of stagnant wages and rising living expenses for working people in the US may reflect better the realities of a new era, than the past couple centuries of its history).

    That “our government chooses to have a market based monetary system (controlled by private for profit banks)” rather than the American people is telling. Until MR taught me the degree to which this was the case, I did not understand this, and I doubt the public does either (and either Mr. Dimon does not or chooses to pretend not to).

    • I still want to see private citizens setting up their house loans with the state.

      Private banks have proven again and again and again in countries all over the world that they can’t keep housing bubbles from forming. Hell there’s even indications of regional housing bubbles taking shape in Sweden now, the country where banks only 16 years ago were told “get money from your owners or die” (some got saved by owners, some died).

      To clarify: I’m not advocating shutting down private banking. I’m only trying to make the case for housing.

      • Government owned banks and authorities in China didn’t avoid their own housing bubble, did they?

        • Nope but those are still banks that function as banks. I would advocate something less bank-ey for house loans.

  17. Cullen writes: “In return for this incredible profit generating power, the banks do the government’s bidding when it asks them to.”

    In recent years, I think you could make an argument for turning this sentence around to read instead: “The government does the banks’ bidding when they asks it to.”

    … More evidence for this is Sheila Bair’s recent account of what happened with Geithner and Vikram Pandit (CEO of Citigroup) in 2008 and 2009. As head of the FDIC she wanted to put Citigroup in receivership. Instead it was bailed out, and Pandit was left as CEO.

    • Well, that’s part of the way our system is arranged. We’ve given the banks this incredible power so they really control the economy to an uncomfortable degree. The govt needs the banks, but the banks also need the govt. There’s a certain give and take here. But when it comes to money creation the banks rule the roost. The govt has arranged itself as a facilitating or support feature to private competitive banking.

    • Not sure Shitigroup was “bailed” out. I think the govt bought an equity interest.

    • In Susskind’s accpimt. Geithner simply disregarded a direct instruction from Obama to at least put Citigroup into receivership.

      • Umpteenth-hand rumor has it that Krugman has been offered position if Obama is re-elected. I think that might be interesting in many ways if true & came to pass.

        2 big honking IFs mind you, I’m just parroting random comments on PK’s blog.