No dating questions this week. I am beginning to get the sense that the readership does not understand the breadth and scope of my understanding in this department. Oh well. Back to wonky questions about the monetary system I guess. Here goes:
brazzo: I have a simple doubt regarding the concept of Currecy issuer vs Currency user. The ECB can issue Euros at will so how does it differ from the FED?
CR: The key point to understand here is that the US government can always essentially fund itself through its relationship with the private banking system and the Fed. The Primary Dealers are required to make a market in government bonds and the Fed ultimately can serve as lender of last resort. The existence of a printing press is not a secret as we all know. Due to what the Fed has called a “symbiotic relationship” the only real risk of insolvency is through inflation or a self imposed default. So there’s no such thing as the US government “running out of money”. It just won’t happen. Europe’s national central banks can also tap the ECB for funds (in theory), but there is no political will for this. In essence, there is a political divide between the state governments and the ECB, which is essentially a foreign central bank. So you have a real funding risk and a real solvency risk for each of these governments. Getting Euros to them is not a matter of whether they can create the Euros. It’s a matter of political unity. And it’s not there….
FrankH: I am interested in understanding why you felt the need to start MMR? Was it just so you can explicitly remove the politics from all these discussions?
CR: I have always had just one intention regarding my work on the monetary system: to teach the operational realities of the system to the readers in an unbiased and objective manner. In this regard, I was very attracted to many of the operational realities of MMT. Ideas like an autonomous currency issuer not being able to “run out of money” are potentially world changing ideas. Unfortunately, as I’ve gotten deeper and deeper into MMT I’ve found that it is not just a description of the monetary system and in fact creates a completely alternate reality in some cases. I’ve compared MMT to the movie Inception in which the dream sequences get increasingly blurry the deeper you get. Now, there’s a lot of really great material in MMT and it’s far better than the neoclassical stuff we’re all used to, but it’s got some baggage I prefer not to carry around with me. With MMR I am trying to truly create an unbiased and objective understanding. Nothing more, nothing less. It’s an unusual approach in economics….
I’d add that MMT’s descriptive components are directly intertwined with its prescriptive components. It’s like most of modern econ. The real goal of the thinking is creating a cure for economic woes, rather than just understanding the monetary system. Market Monetarists use NGDP Targeting. Keynesians use counter-cyclical spending. MMTers use the Job Guarantee. And in doing so they all try to conform a policy response to the economic reality. MMT creates a description that fits their prescriptions and parts of these descriptions are just flat out wrong in my opinion. Ideas like banks serving public purpose, the hierarchy of money and the money monopolist are all inaccurate descriptions of our reality, but help MMT explain why the Job Guarantee is necessary.
Some people think my split with MMT was political, but this is entirely wrong. What irked me about MMT was its inflexibility in its stances on policy. I naively believed that I could change 20 years of academic work on MMT and separate the descriptive from the prescriptive. I was obviously wrong. And in splitting off from the MMT crew I’ve discovered how their prescriptive ideas appear to have cluttered even some portions of the descriptive elements of MMT.
MMR takes a totally different approach. In a recent article I described how Leonardo Da Vinci had a huge impact on medicine through his anatomical work. He wasn’t performing surgeries and saving people. All he wanted to do was understand how the human body worked. And in doing so he gave the world a great gift. Economists are always offering solutions to everything. Which is great. But I don’t even think the world understands how the monetary system works so we are getting ahead of ourselves. How can you apply the right policies if your view of the world is based on an inaccurate foundation? Obviously, I am no Da Vinci, but I am trying to copy his model here. I want to offer a purely descriptive understanding of the monetary system. How people use that in their politics and solutions for saving the world is up to them. But get the operational realities right first….
In Accounting: Is there a way for us iPad users to opt-out of being redirected to the ‘onswipe’ version of this site and instead receive the desktop version? I appreciate what onswipe is trying to do but the user interface is pretty rough at the moment and a lot of the “swiping” features they are trying to do dont really work that well at all.
CR: Yes, if you swipe the bottom left hand corner on the iPad you can bypass the Onswipe page. If readers really hate this format then please just complain en masse. I’ll get rid of it. No problem.
Since the year two thousand and eight,
The debt has grown so very great,
By nine trillion dollars as a matter of fact,
So if there’s no inflation, where’s it at?
CR: Inflation is a function of aggregate demand,
With slack so great, the economy has been less than grand,
A balance sheet recession has caused near depression,
Thanks to political ignorance, we risk further economic compression. :-)
Seriously, that’s it in a nutshell. With 8.5% unemployment, low capacity utilization and just a general malaise, you’re not going to get high rates of inflation. The demand and pricing power just isn’t there because consumers are still way too weak, primarily due to the balance sheet recession and its lasting impact.
jaymaster: I’m struggling a bit with this recent article published by some employees of the NY FED:
But I’m pretty sure I disagree with this line : “Loan growth (in percent). More lending by banks, much like higher reserves held by banks, requires banks to attract deposits or other liabilities to fund the loans.”
What’s your take on that? And if you have the time to dissect it, what’s your take on the whole piece?
CR: Banking is a business of spreads. So banks want to attract the lowest cost liabilities they can. I wouldn’t use the same terminology the NY Fed uses. Banks don’t “fund” their loans with deposits. Rather, they match the cheapest liabilities with their assets to maximize profits.
whatisgoingon: Does student debt meet your criteria for a bubble? And if you had to make a wild guess do you think the dollar is more likely to appreciate or depreciate or remain flat over the next year and next 3 years? Related to that – does a strong dollar pose a problem for the US economy?
CR: It’s certainly a worry, but nothing of the magnitude that we saw with the housing crisis for instance. Don’t quote me on these figures, but a quick google search shows that there is about $1T in student loan debt outstanding and $14T in mortgage debt outstanding. So the student loan problem is roughly 1/14th the size of the recent housing debt crisis. Nothing to scoff at, but not the ticking time bomb that housing was in 2006….So it’s a big concern and a potentially disastrous trend if it grows larger, but it’s not going to crash the global economy like the housing bust did.
On the dollar – you have to be more specific. Remember, currencies are always relative to another currency. The dollar relative to what? The Euro, the Yen, etc? The USD basket is relative to many currencies. Personally, I am not afraid of a broad currency decline in the USD relative to global currencies. Unfortunately, this is such a broad index that it’s very difficult to be specific about it.
As for USD strength, it depends. In a secular bull the USD will likely rally as it’s seen as a strong relative currency. In a secular bear like we’ve been in the USD will likely remain a safe haven asset where it declines during periods of so-called growth and rallies when fear comes back. This chart is good for reference:
On reserve currency status – remember, reserve currency status is largely a function of economic size (there are other factors as well, but production is the primary driver). The primary reason why foreigners hold dollars is because they accumulate them during foreign trade. They don’t just end up with dollars for no reason. If the USA is going to lose reserve status then some other country or region sharing a currency has to prove to the world through production and economic prowess that their currency is superior to the USD.
reemarketeer: I’ve read several predictions for a stronger dollar from here. Do you agree (and think the Fed allows it), and what do you think the rammifications are?
Stronger dollar should mean lower commodities, aiding consumers on input and import costs, but will hurt exports. How do you think that nets out?
CR: See question above on stronger dollar. The US economy is largely consumer driven so lower commodity prices would likely mean lower oil prices which means a stronger consumer. It’s hard to envision how that wouldn’t help the US economy….
Roger Ingalls: Probably a dumb question, but why can’t the European countries have a floating exchange rate with each other? Wouldn’t that ease the balance of trade issues that is at the core of the EZ problem?
CR: There’s no such thing as a dumb question. Only dumb answers (see this post). The EMU is made up of nations sharing the same currency. So it’s a lot like the USA and the states. The states in the USA don’t have trade rebalancing via currency exchange rates. So they require the fiscal aid of the federal government to alleviate periodic imbalances. The EMU has neither a floating exchange rate nor a federal entity to spend.
Frenchy: Could you go over the problem of Japan as of today? My knowledge of the issue is limited. I understand it’s a currency issuer and therefore not limited in its ability to spend. But given their debt/gdp ratio and you mentioning hyperinflation as a possible outcome for Japan, I wanted to hear more on all this from you.
CR: Japan suffered a massive bubble in both real estate and equities in the 90′s. When the asset prices collapsed they suffered a balance sheet recession very similar to the Great Depression in the USA in the 1930′s and somewhat similar to the USA’s recent crisis. They’ve experienced a series of starts and stops in the economy largely due to policy errors, negative demographic trends, etc. The big difference between the USA and Japan was that Japan suffered a business-led balance sheet recession while the USA suffered a consumer led BSR that was tied mostly to real estate as opposed to the double whammy Japan had with collapses in both equities and real estate at the same time. Japan’s businesses have spent 20 years de-leveraging so while other negative trends might persist in the Japanese economy, they’re likely moving beyond the big broad negative trend that has hampered their corporations for the last 2 decades. I certainly don’t agree with Kyle Bass’s idea that Japan is the next Greece. As a currency issuer they aren’t going to “run out of Yen”. So the bigger risk is hyperinflation and not a debt crisis. But given the health of Japan’s corporations, the diversity and size of their economy and the role of the Yen as a partial reserve currency, I’d say hyperinflation is a relatively low risk in Japan.
pat: Hi Cullen, The USA has a Fiscal Union and a Monetary Union. The EU only has a Monetary Union. Everyone is talking about how the EU should adopt a Fiscal Union like the USA. Does it really matter: Some states in the USA are in real bad shape, similar to the countries, (states) in the EU. Think California and others. California has a mandate to balance the budget, but there sure was a lot of talk the Fed would bail out the states in a pinch. That’s what the EU is doing with their members, ( bailing them out)So really what good would a fiscal union do?
CR: I only see two real solutions in Europe. You either give each country sovereignty by establishing their old currencies and giving them the chance to rebalance growth through the ability to print money and devalue their new currencies relative to their trade partners. OR, you create a fiscal union like the USA has. Personally, I think Europe is likely to become further integrated as time goes on so going backwards towards the old currencies makes very little sense to me. A fiscal union in Europe would achieve the same things it has achieved in the USA. The biggest advantage would be stability. The USA doesn’t suffer state insolvency crises once every few decades because they have the power of the US government backing them. The Federal government is ALWAYS spending money on the states. On average, about 20% of state budgets are aided by federal spending. This is a huge persistent “bailout” if you want to think about it like that, but it avoids constant imbalances and creates stability. California is never going bankrupt. The Federal government would never allow it to happen. Greece doesn’t have this backing. The USA has lots of weak states or members who don’t pull their weight. But we don’t kick them out because we’re politically unified. Europe doesn’t have that unity. They need to find it.
MG: Cullen, Its sure taking a long time to get your bio up.
CR: A lot of big changes are happening with my business so I am kind of in a state of flux right now. More to come.
Ted: What do you think about Warren Buffett’s proposal to issue “import certificates” as a way to force the USA to balance its trade deficit?
CR: Buffett’s idea is attractive. These trade imbalances are generally a sign of big broad trends, which, if persisting, can boil over. Any measure that helps to keep these imbalances from getting out of control is beneficial. I discuss the MMR position on the current account balance in section 3 here.
BG: Cullen- You have pointed to the “United State of Europe” or something similar as a possible solution to the Euro crisis. And Ray Dalio noted that the current situation isn’t too dissimilar from the US after the Revolution. I feel from the historical/cultural angle this will be near impossible. I mean for the better part of 1000 years some of the cultural groups have at a minimum disliked each other and have fought many many wars. They had a war called The Hundred Years war! I know that was France and England, but you get my point. So I don’t think the citizens of these countries will be jumping to give up some of their sovereignty, especially since its more or less to Germany. I wondered if you have any thoughts on this?
CR: Yes, the social and historical aspects are the hardest part to overcome. The USA had a similar problem though obviously not to the extent that Europe has. The north and south in the USA still get at each other in many regards. But through unity we’ve become the most powerful economy in the world. I know the problems in Europe are far larger and have persisted much longer, but they’re not becoming less intertwined. The global economy is becoming a smaller place as time goes on and Europeans are essentially being forced to live under one roof. There’s just no escaping it. So it’s best for Europe to live and let live. Easier said than done!
Larry - Cullen, how much weight do you give to Technical Analysis in your own investing and trading? There have been many academic studies that argue that T.A. is not very effective, and it’s accuracy is not a whole lot better than 50-50. How effective do you think it is? Are there a few practitioners, like Jeff Saut and Ned David research, who do it well? In your investing, how much weight do you give to fundamental economics vs. T.A.?
CR: Depends on what you mean specifically. Some forms of technical analysis, such as historical data, can be extremely helpful in understanding the probabilities of certain events and how the future rhymes with the past. Charting, a form of TA, is little more than a visual of this data and the fundamentals driving past prices. Charting is excellent for perspective, but is only a compliment to fundamentals in my opinion. I don’t put much weight in “bear flags” and “inverted hammers” and stuff like that. There’s a lot of datamining in those “indicators”. I use TA and historical data quite a bit in my work, but that’s more an effort to understand how the past is prologue.
My investment approach uses a big top down approach. So I start with an understanding of the monetary system, break this down to an understanding of its impact on specific markets, and filter that into a specific strategic approach. That’s all driven much more by fundamental work than anything else, but I do certainly utilize elements of charting and TA in my work….
Quaternion: I’ve heard many say that the rally off the March ’09 bottom has been by QE(s), but is that really true? The current P/E ratio is a fairly moderate 15, which suggests that the rally is warranted by fundamentals to a large degree. Perhaps the QE(s) provided nudges, but did they really do any more than that?
CR: This is a common idea. To me, the market rallied for simple reasons. Yes, QE1 helped stabilize a crashing market. But so did lots of other policies. The main driver, to me, has been the 10% persistent budget deficit. If you’ve read some of my stuff on Kalecki, then you know that deficits can have a huge impact on profits. Once the govt stabilized the markets by essentially backstopping them via various policies, the deficit did a lot of the work driving profits. For instance, the ECB has had QE in place at times, but many of the European markets have crashed. Why don’t these analysts ever discuss this when claiming that QE did all the legwork? I think they want to claim that “money printing” helped boost prices, but I don’t think they quite connect the dots. Yes, govt spending helped. But the govt doesn’t need the Fed to fund its spending. That implies that without the Fed’s help the Treasury couldn’t obtain funding in its account. That’s simply not accurate.
Ray - I have read your papers on QE, but have some further questions if the FED swaps cash for treasuries, your say this is purely an accounting swap, but it seems to me to be a form of credit creation, because the cash is a liability on the feds balance sheet, therefore the overall credit in the system has increased. My second question has most the QE transactions by the FED been purchases of treasuries off investors rather than commercial banks or are the commercial banks just the intermedtries in the transaction. Hope you can clarify.
CR: When the Fed buys bonds they take an asset from the private sector and replace it with another (reserves). This doesn’t increase the net financial assets of the private sector. The Fed implements monetary policy through the Primary Dealers so they’ve buying bonds from the banks. It’s impossible to know where these bonds come from though….Certainly, the banks are acting as intermediaries in some of these transactions.
theppel - Three questions. 1. How does printing money (government deficit) put people to work? If there is deflation and the price of goods fall it would increase peoples purchasing power and at some point create more demand. Printing more money without an increase in productivity just increases prices and people cannot afford any more than they did before. Were the Japanese really worse off with deflation? Using your analogy of keeping score; it doesn’t change the total number of baskets made just because you credit each basket with 4 points versus 2. The same is true if you only give 1 point per basket versus 2. If government can create more productivity with their spending than the private sector can with their spending perhaps it makes sense. Also given this is a balance sheet recession it seems that if the government is going to run a huge deficit it would make the most sense if the government gave the money directly to people through a check or tax cuts.
2.Do you think that labor’s decreasing share of the GDP is a contributing factor to the high unemployment rate. That is, as labor contributes a smaller percentage to each good or service produced, does labor get enough in wages to buy the goods and services they are producing or does a greater percentage go to people who own the capital and therefore create unemployment.
CR: That’s a pretty broad question. Personally, I think govt has one big strength – it can’t “run out of money”. So if we could learn to harness this power of govt in a productive manner it would be an extremely powerful resource. Instead of entrepreneurs financing new operations through onerous loans or private partnerships, we could learn to harness the govt as a funding source. I’ve offered up my Innovation Initiative as a possible solution here.
Of course, the govt does finance a lot of things and over time has produced many great benefits to our society (national highway system, the internet, etc). So govt is not all bad as it is often portrayed. Can it become corrupted and abused? Absolutely. The lack of a profit motive often makes the govt more lax in its decision making. So the fear of govt is understood, but we the public need to check these measures and ensure our leaders aren’t abusing their powers. I think we can rectify these issues to some degree by streamlining spending and forcing spending to meet certain requirements that are in-line with the true goals of an autonomous currency issuer as they stand with regards to inflation, production, etc. But before that can ever happen we have to get over the myth that the govt is “running out of money” or becoming the next Greece. So for now, it looks like the austerians and the “govt is always bad” crew have the upper hand.
jt26 - I’ve been spending some time reading Sumner’s blog on NGDP targeting (inc. the archive). He writes well, and his urgency seems sincere, but I find many of his arguments unsubstantiated or weak. I’m just an investor, not an economist, so maybe his deep academic work substantiates all his assertions. You haven’t written on NGDP targeting in a while, have your thoughts changed?
CR: I’ve had some moderately productive discussions with David Beckworth and Scott Sumner. We’ve discussed ways in which I believe NGDP Targeting can “work”. For instance, the Fed could buy municipal bonds and finance the states directly or they could peg long rates at 0% or something essentially making credit a true cash equivalent. But the muni option is really fiscal policy so why not just use fiscal policy? And the rate pegging idea just adds more debt to a private debt problem. So my big problem with NGDP Targeting and monetary policy in general has been the basics of the balance sheet recession. And monetary policy and trying to get debtors to take on more debt (when they’re trying to pay down debt) is a self defeating policy. So no, my position on using QE and NGDP Targeting hasn’t really changed much.
Brian - Could you please explain asset pricing in an MMR/ZIRP regime? The standard model is that an asset that returns x dollars per year costs as much at the principle that would yield x dollars per year in interest (adjusted for risk). If interest rates are zero and expected to be zero forever, this suggests infinite asset prices. Clearly something’s wrong. How does MMR get around this problem?
CR: MMR isn’t really a “regime”. It’s just an understanding of the monetary system. It always applies. And MMR doesn’t say rates should be zero forever. MMT says this. MMR does not agree with the MMT stance that rates should be permanently zero and that monetary policy is useless at all times. Monetary policy is a blunt instrument particularly in a balance sheet recession, but this won’t last forever. So maybe your question is best asked at a MMT website?
Curvo - What do you think of VII and BFerro’s calls this week? Looking at comments on 5/21 VIi said we’re on crash watch and 2 days later he is “all in long”. BFerro was calling for 1800 and now says a crash by end of month. You seem to have some readers who are not only ‘flexible’ but make 180 degree variant changes within hours.
CR: I really prefer not to opine on specific reader’s investment positions. I just don’t know enough about their approaches to do so. It would be inappropriate of me to say whether their ideas are good or bad based on the anonymous comments made by some on a website like this one. Sorry.
JK - MMT says that the JG is a price/inflation anchor. You’ve said it’s more like a buoy. Can you explain what you mean by that? i.e. what is the difference between a anchor and a bouy? Also, would a Basic Income Guanrantee have the same bouy affect? Thanks.
CR: At the risk of being attacked by MMTers – see this article.
KG21 - You (correctly i guess) say that the gvt is able to add NFAs to the economy through deficit spending.But in the case of Eurozone where both the public and the gvt sector have to borrow in order to net spend, is it correct to say that no NFAs are ever added?
CR: The EMU govt’s are currency users due to political constraints. They can technically print money and create NFA’s because they have their own central banks with access to the ECB. But there are rules hampering this access. This is a political constraint. So it’s not so much about creating NFA’s in Europe as it is having the ability to eliminate the risk of solvency.
Colin, S.Toe - So, enough of these minor issues. What’s your take on whether Coronado Beach deserves its #1 ranking?
CR: Coronado Beach is a pretty spectacular beach. The Hotel Del on one side and the hills off Pt Loma on the either side make for pretty spectacular scenery. Then again, I think San Diego is pretty much the best city in the USA so you’re talking to someone with a serious bias here!!!
Nils - So, got any good BBQ recipes? Also, the way the monetary system in the USA works, isn’t the social security trust fund just an accounting gimmick?
CR: I don’t do anything fancy with a BBQ aside from your standard fare (steak, chicken and corn is about the extent of my repertoire), but I can give you a mean fish taco recipe if you’d like. But I recommend you catch your own fish for it. :-)
On SS – the amount of “funding” Social Security has is largely a political choice. If we want to credit SS with more funds then we have that choice. I’ve used the analogy of the govt being a scorekeeper in the past, but I really shouldn’t use metaphors like this because they’re misleading to some degree. The govt really does need to obtain funds to spend (the Treasury is technically a currency user while the Fed is technically the currency issuer) and through this symbiotic relationship the US govt is a currency issuer without a solvency constraint. But we should be precise on the operational realities. The short answer is, SS really does need to have “funds”, but the amount of that funding is largely a political choice. So I wouldn’t say it’s just an “accounting gimmick”, but it’s a myth to say SS is “running out of money”.