The Disastrous Consequences of not Raising the Debt Ceiling

By Comstock Partners

As we face another brutal fight over the federal debt ceiling at a time when the economy still remains fragile, the stock market is oddly complacent.  Even if the debt ceiling crisis is resolved, the result would be some combination of spending cuts and tax increases that would weaken the economy in 2013.  A settlement, however, is far from a done deal as both sides remain far apart and determined to defend their positions.  Far worse, if the debt limit is not raised or eliminated, the effect on the economy and markets could be disastrous.

Republicans are insisting on major spending cuts in exchange for raising the debt limit while President Obama is adamant in saying that he will not negotiate on that basis.  A number of Republicans have voiced the opinion that government shut-downs have occurred in the past without any great consequences, and that we can do it again.  However, a failure to reach agreement this time would involve not only a shut-down, but a failure to pay many billions of dollars of U.S. government obligations, something that has never happened before in the U.S.  On the other hand, it is not clear how Obama can avoid negotiations over the debt limit, as other proposals floating around appear to be unfeasible or unconstitutional.

This week the Bipartisan Policy Center issued a 41-page report detailing the disastrous consequences of not raising the debt limit.  We outline the report as follows.  The full report can be found at

The U.S. government hit its debt limit on January 1st. The Treasury secretary then tapped into the $201 billion emergency borrowing authority to allow for an additional period of fully-funded government operations.  It is estimated that the emergency funds will run out sometime between February 15th and March 1st.  After that, the government can pay out only what it receives in revenues, which covers only about 60% of the obligations due between February 15th and March 15th.

The Treasury then has two choices as to how to make the payments.  It can make all of each day’s payments once enough cash is available.  In this case all payments would be late, and they would get later and later with the passage of time.  An exception could be made for interest payments on the debt so that no default actually occurs.

The second choice would be to pay some bills on time while others would not be paid.  It is unclear whether this method is legal or even feasible, given the design of the Treasury’s computer system.  The department makes about 100 million individual payments monthly, and would be forced to pick and choose which ones to make and which to skip.

The problem is that the monthly cash inflow would be roughly $277 billion and the obligations at $452 billion, leaving $175 billion unpaid.  Let’s suppose that Treasury chooses to pay interest on Treasury securities, IRS tax refunds, Medicare and Medicaid, Social Security benefits, military pay and retirement, and unemployment insurance benefits.

That would eat up all of the cash flow leaving the following items unfunded:  defense vendor payments, veterans’ benefits, federal salaries and benefits, Pell grants and special ed. programs, food and nutrition services, civil service retirement payments, health and human services grants, supplemental social security income, the Department of Justice, the FBI, the federal courts,  the Department of Energy, the Federal Highway Administration, the FAA (air traffic control), the Environmental Protection Agency, FEMA and the National Flood Insurance Program.  These payments and non-payments can be calculated in other combinations, but the point is that about $175 billion of obligations can’t be funded.

The disastrous consequences of not increasing the debt limit are easy to see.  It amounts to a sudden 39% decrease in government spending, resulting in severe recession, plunging global markets, rating agency downgrades, widespread uncertainty and public unrest.  Moreover, the damage to the credit rating of the U.S. would lead to far higher interest payments for years to come.

In our view the stock market is not discounting either the disastrous consequences of not raising the debt limit or the still negative growth impact of additional spending cuts and tax increases. The S&P 500 is near a 5-year high while the VIX volatility index is at its lowest point since May 2007. All in all, it is similar to the conditions in early 2000, when the market ignored the vulnerability of the boom and late 2007, when the “experts” ignored the importance of falling home prices and record household debt.  In both cases the S&P 500 plunged about 50%.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.


Comstock Partners, Inc. analyzes economic and financial conditions from a long-term macro-economic perspective and makes adjustments based on cyclical and shorter-term considerations. In pursuit of its goals, the firm invests in various asset classes including domestic and foreign stocks, bonds, currencies and derivatives including indices and options

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  1. The entire discussion about the debt ceiling is just kabuki, a dog and pony show. Nothing can prevent the US sinking into a depression. Not raising the debt ceiling kills the economy. But raising the debt ceiling is only a matter of kicking the can down the road. And the more the US kicks the can down the road the heavier the can will become.

  2. Recently on NBC Steve Liesman and Bill Frezza discussed the chart here:
    I don’t get this but it looks like “inside money” creation by the banks and non-bank institutions has flattened out since 2008. Loan creation and loan payoffs must have been about equal, thus little growth in “inside money” been the rule for half a decade. According to the chart “outside money” has grown considerably and has caused a huge rise in “deposits” (what ever that means). I think Steve tried to explain that this represents an increase in the Fed’s balance sheet and this is not going into the general economy and therefore cannot cause inflation (although these amounts are counted against the “debt ceiling” apparently). The issue was disputed by Bill Frezza of the Competitive Enterprise Institute who thinks the USA is coming to some sort of end. My question is what happens to the Fed balance sheet since it must be mostly made up of US treasuries and Fred and Fanny bonds. The interest “earned” on these assets goes back to the Treasury, but what will happen when the bonds mature. The Fed “bought” these bonds with funds created and then put an asset (bonds) on their books, thus the increase in the chart? I actually don’t get this chart but it must have something to do with the “debt ceiling law” and why it’s so stupid.

  3. I fully realize that a drastic cutback in government spending results in lower economic activity, but I struggle with the concept that we know a huge swath of our economy is built on unsustainable levels of government spending but we don’t dare acknowledge it and take the hit to GDP that we need to to get back to a sustainable level of government spending because it involves someone feeling some economic pain. I understand also that it can be paid for (at least in the short run) by money creation, but again, unless you truly believe another great economic boom is just around the corner (that will produce the tax revenues to pay for this spending spree), why would you advocate doing that to avoid the eventual (and ever larger) economic problems it creates?

  4. The safest place on earth right now is the stock market. You can not lose. If the market were to correct just 10% it would be a complete disaster. The Federal Reserve and its crony banks must support the market and hold a bid no matter what or it is over.

    Just as Reagan took down the Soviet empire via the collapse in oil prices, the United States will collapse through offering prices.

  5. “The fact that we are here today to debate raising America’s debt limit is a sign of leadership failure. It is a sign that the U.S. Government can’t pay its own bills. It is a sign that we now depend on ongoing financial assistance from foreign countries to finance our Government’s reckless fiscal policies. … Increasing America’s debt weakens us domestically and internationally. Leadership means that ‘the buck stops here. Instead, Washington is shifting the burden of bad choices today onto the backs of our children and grandchildren. America has a debt problem and a failure of leadership. Americans deserve better”.

    Senator Obama, 2006

  6. We have undergone a wholesale revision of how we used to treat debt. 100 years ago, debt incurred by the older members of society — including those in government — was assumed to be their responsibility. The current paradigm is debt incurred by the older members is passed directly to the younger members, who see new money placed largely toward fixed obligations at an ever-expanding cost. This strategy is literally rotting us from within, yet all we keep hearing about is more and more and more spending from people who only care about keeping their jobs (politicians) or making more money (Wall Street, special interests). This article is nothing but more scare-mongering by a Wall Street which has NO morals and NO concern for the future welfare of this country. Really, Cullen, I expect better of you than to post this trash.

  7. Interesting – from Modern Money Mechanics
    “Suppose that the demand for loans at some Stage 1 banks is slack. These banks would then probably purchase securities. If the sellers of the securities were customers, the banks would make payment by crediting the customers’ transaction accounts, deposit liabilities would rise just as if loans had been made. More likely, these banks would purchase the securities through dealers, paying for them with checks on themselves or on their reserve accounts.”

    When they say “securities” are these risk assets (stocks)? And “checks on reserve accounts” mean the reserves that have been increased via QE?

  8. inDC, the MR paradigm is that federal debt is merely a net financial asset.
    It doesn’t have to be ‘paid back.’
    I think we are all trying to figure out the consequences of this new paradigm. Many in here believe that these net financial assets are backed by national output and don’t profess any output about their growth.
    Others, perhaps more studied in history and human nature, worry about the unintended consequences of creating more and more NFA to facilitate government spending and therby avoid making difficult policy and resource allocation decisions to create a better society.

  9. Just like Japan? 25 years of kicking the can down the road has kept their economy from spiralling into depression.

    When will you understand the meaning of Keynes’ quotation “In the long run, we are all dead.”???

    “The long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.”

  10. Pezhead, I am not sure I fully understand what they are saying, but I don’t think a bank just creates money out of thin air to purchase securities.
    A bank makes loans to credit worthy borrowers, this is how it’s created.
    From what I am reading there, what would stop a bank from just printing and buying what ever it wanted if it was that simple?

  11. No wonder people don’t trust economists.
    It’s like you went to the doctor with the flu and he kept you in bed sick for 25 years, then took credit for not killing you outright.

  12. Obligations aren’t necessarily debt, and do not have to be paid. We are in no danger of default unless Obama tries to spend money on government operations instead of debt payments, and he would be subject to impeachment if he does. To repeat, entitlement obligations are NOT constitutionally protected debt, and your article attempts to mislead readers into thinking they are.

  13. “More studied in history”? How can your view of money be more complex and historically thorough than mine when I take my views back to primitive apes? Your view strikes me as the standard hard money type who thinks that money takes the form of some physical thing….That’s not a historical view. It’s an ideology based on a narrow view of history.

  14. Anonymous, don’t you think the Fed and all the Central Banks tried to prop up the stock market in the last quarter of 2007 and all during 2008? They failed to prop it up then, and they could also fail in their attempts to prop it up this year. The stock market feels very safe until it isn’t. In October of 2007 we hit a new SPX high, and many like you were arguing that you couldn’t lose money in stocks.

  15. When the Fed buys “securities” so far it has always been either treasury bonds or mortgage-backed bonds (MBS). The Fed has never purchased stocks and I think it is highly unlikely that they ever would.

  16. “Deposit expansion can proceed from investments as well as loans.” Sentence prior to this section.

    Given the repeal of Glass-Steagall, can banks in fact leverage reserves to use within their investment divisions – thus “printing” via investments (investment loans)??

  17. Just to understand what you’re saying, Dave – if the law stays the same and government doesn’t pay someone it is meant to pay under the statute, are you saying that person wouldn’t be legally owed what the statute says he’s entitled to receive? I’m not really contesting this – since I know nothing about the legal minutia of the entitlement system – just seeking clarification.

  18. Curious what you think Keynes meant, and what conventional wisdom thinks he meant (could be different.)?
    Personally it comes across as a cynical quote used to shut down attempts to create beneficial long-term effects.

  19. I asked this on separate thread but not sure I ever got a response. I’m no expert, just trying make sense of our financial system as much as I can, so I read Modern Money Mechanics as well. It indicates pretty clearly in the first few pages banks can use excess reserves for loans AND investment, does it not? So what exactly does that mean?

  20. Having accurately described the current man-made system, why do you feel the need to defend it, as if you now have personal ownership of the system?
    You seem reluctant to recognize the dangers if there is no check on deficit spending.
    We both agree that the inflation constraint is the limitation, but what I mean about human nature is that if you give the men in government that kind of vague restriction you can’t possibly expect it to create any restaint.

  21. When did I say I want “no check” on spending? I’ve repeatedly stated that the CBO should regularly audit spending so that it is in-line with national goals.

    Who is giving politicians “vague restriction”?

    You regularly just make things up….

  22. We’re borrowing 40 cents of every dollar we spend, and yet you’re on a campaign to criticize those who say that’s out of control spending.
    It seems to me we are already at the point in which the CBO should warn that such deficit spending is not in line with national goals.
    In fairness to the CBO, I would suspect it is already nervous about deficit spending.

  23. OK, I’m venturing into dangerous waters here (made dangerous by my own ignorance), but in live in CA. I know *nothing* of the details, but our governor announced today (or yesterday) that we no longer have a deficit (something the state has struggled with for a LONG time), and in fact we will be able to start paying down our debt as well as investing more in education. This is astounding news! … I’ve been hearing about bloody, drawn out, down to the wire budget fights here for YEARS (perhaps a decade or more)! … with layoffs, furloughs, the state issuing IOUs, you name it! CA was the butt of jokes on late night talk shows… up until just a few short months ago. Of course right wingers LOVED to hold CA up as an example of disastrous liberal governance. How was all this made possible? Again, I really couldn’t tell you the details, but basically I think it was because we put an initiative on the ballot here to actually RAISE taxes! … and amazingly enough… it passed by a majority of the popular vote! Am I happy my taxes will go up? No! … and am I happy my state won’t be bankrupt any longer and I won’t have to hear the constant drumbeat of bad news from Sacramento… Yes! Was it worth it… maybe! I guess it depends on exactly how much MY taxes go up… something I haven’t worked out yet.

    My point is that the electorate here apparently put the welfare of the state above themselves (perhaps foolishly you might argue), but this was done through raising more revenue! That is always an option for the US Fed gov. Taxes are still at an all time low. Perhaps they need to be rebalanced and simplified and loopholes closed, but overall they are low. I think CA is proof that you don’t HAVE to keep kicking the can down the road. Now is it a good idea to raise taxes right now? Probably not… but perhaps things aren’t as bad (regarding the debt and deficit) as we make them out to be. As Steve Keen always points out, the PUBLIC debt is still dwarfed by the private debt, which is probably a LOT more unhealthy. I really think the comparison w/ Greece is unfair (but politicians and pundits LOVE to do it). Japan is another story! It’ll be interesting to see how this new $13 Yen stimulus works out.

  24. Banks don’t USE their reserves. They remain on deposit at the Fed. But, the bank could leverage its balance sheet if its capital adequacy allows for this. QE does not increase the capital of a bank. Banks lend and make investments based on their capital levels. Not their reserve levels.

    Zero Hedge has gone and caused the whole world to misunderstand how this all works from start to finish. Those idiots called for hyperinflation at first and now are changing their story. I don’t know why anyone believes anything they say after their horrible hyperinflation prediction. They’re just scare people for page views. It’s a scam website.


  26. You seem completely unwilling to do engage in any intellectual rigor.

    The U.S. has MASSIVE amounts of idle real and financial assets. The financial assets have been accumulated over the last 2-3 decades due to historically low tax rates. There is no way for the government to efficiently recirculate the stock of hoarded financial assets that are stored away in bank accounts, brokerage accounts, savings accounts, Treasuries, etc, either politically (“don’t tax the job creators!!!”) or logistically: our federal government’s largest revenue generator is income, which has little to nothing to do with the vast amount of wealth available to recirculate).

    So, given the current state of affairs, which is the result of actions taken in the past, what would you propose we do Johnny? If you’re so overwhelmingly concerned with “out of control spending”, you would just have us turn it off? For some moral imperative you absolutely cannot quantify, you would have us cut deficit spending when it is the only thing that’s letting the private sector get on its feet again? Are you an ideological sadist willing to let your fellow citizens start losing their jobs in droves again,? or an ideological masochist who believes there is no gain without pain? It seems like there is no other alternative to explain for why you cannot see what is plainly laid out on this site and

    Given the political realities, and the ACCOUNTING realities, the deficit spending is necessary to avoid your neighbors, your relatives, your friends hitting the dole again.

    Does it have to continue? No, not when the private sector gets back on its feet. Should we deficit spend to eternity? No, not as a policy. But no one here is suggesting that.

  27. Dennis, truthfully I don’t get the chart either. You can go to the “Ask Cullen” section and Cullen has a long discussion about it and the article and the CNBC piece… with posters such as Romeo Fayette, among other.

    I read the comments (kind of quickly) and scanned through the ZH article, and watched the CNBC debate. I haven’t REALLY dug into the logic here yet in too much detail, but I was confused by that chart as well.

    I think I understand the left hand side where loans track deposits with a 1:1 ratio (that makes perfect sense during times of high demand for credit if you consider that each loan creates an equal and opposite deposit). But then why do DEPOSITS keep going up while loans flatten out and/or decline. And what does that have to do with banks using the “gap” between deposits and loans to speculate with? That last bit made NO sense to me. The 1:1 ratio part makes sense only if these deposits are counted as liabilities! … I know that “capital” appears on a bank’s balance sheet on the right under liabilities, but I always thought of that as more of an accounting gimmick to make the balance sheet balance (so that it’s equal on the right and left hand sides). In other words, you work out the liabilities and assets of the bank, w/o regard to “capital” and then the assets in excess of the liabilities is placed on the right (liabilities) and called “capital.” Since it represents the difference, it makes the balance sheet balance perfectly. So this makes intuitive sense… more “capital” means more assets in excess of liabilities — which is a good thing for the bank. Some balance sheets actually label the right hand column “liabilities and capital” which I think makes a lot of sense and is less confusing to us non-accountants.

    See one of the things that it’s easy to get confused about is what side of the balance sheet these items appear on. In general, when they talk about loans, I think of bank loans to customers, so they should be on the left hand (assets) side of the balance sheet, while deposits (customer deposits) should be on the right hand (liabilities) side. “Reserve deposits,” that a bank holds, however, are the bank’s deposits with the Fed, and they should appear on the left under assets. I think part of the confusion of the interview and ZH article for me was that I kept asking myself “Are they conflating banks’ customer deposits with the banks own reserve deposits?” … because those are ENTIRELY different animals!

    The conclusion I’ve come to after reading the comments here is that those “deposits” ARE customer deposits (liabilities) and they have continued to grow as a consequence of the banks buying treasuries from non-banks (thus increasing non-bank deposits, and thus increasing bank liabilities under the heading “deposits”). Why do the banks continue to buy non-bank held treasuries? … OK, this is where my story unravels… because the banks SELL those treasuries to the Fed during QE. OK, I stated it, because that’s what I understood from the comments, but I have to say that makes no sense to me now. Because were do banks get the money to buy treasuries from non-banks in the first place? … the logic above would imply they get it from reserves (that they get from the Fed in exchange for treasuries), but as I understand it, reserve accounts can’t be used for those kinds of transactions (transactions w/ anything that’s not another bank or the Fed). OK, so I’ve talked myself into a corner. Help! Where did I go wrong here?

  28. Balance sheet recession. Private Sector is trying to net-save but since what you spend is other’s income and your income is others’ spending, that causes slack in the economy. If the government does not fill that slack in demand, the economy falls or the private sector takes on net debt which 180 degrees away from its desires.

  29. I never understand arguments like Anonymous. Do people really think the Fed can control the stock market? Is there any report ever of the Fed buying stocks?

    Yes, the Fed can make fixed income unattractive via low to no rates, but it does not directly buy stocks nor can it make others do so. So how can it put a floor on the market?

  30. Ok fair enough, I’m just curious why Modern Money Mechanics seems to indicate they can. If they don’t in practice, then why put it in there to confuse the reader. Unless I’m reading it wrong, maybe I am I don’t know

    “…banks are required to maintain reserves equal to only a fraction of their deposits. Reserves in excess of this amount may be used to increase earning assets – loans and investments.” – Page 6

  31. Take a look at this chart:

    Perhaps I read too much into it, but I love to compare the point in time right after WWII to now: At the conclusion of WWII (after four years of MASSIVE government spending), and almost two decades of private sector deleveraging, the USA was primed for several decades of unprecedented economic growth! Yes, I understand there are other factors that this chart doesn’t show… like the fact that we WON WWII… which didn’t hurt. However, not long after the conclusion of WWII the US, through it’s influence, forced the forgiveness of almost all of Germany’s debt (and they were a loser in the war!). I don’t know the story in Japan, but perhaps it was a similar policy? Anyway, those two countries also became premier economic engines over the ensuing decades.

    The upshot is very low levels of private debt seems to have left us in a position to really make strides DESPITE the enormous levels of public debt. Look how quickly that public debt was paid down!

    I realize our circumstances are different now, and that Japan (in recent decades) serves as a kind of counter example to this argument, but it doesn’t negate the fact of what happened then.

    The bad part is that it implies we may have another decade or so of PRIVATE deleveraging ahead of us before the situation improves. :(

    Market Monetarists (like Scott Summer) would disagree vehemently with my assessment! They’d say all that private debt doesn’t matter.

  32. It must have been written by some guy who believes in the money multiplier and the idea that bank use their reserves to make loans and investments. It’s totally wrong.

  33. I think he’d ask what is your definition of “long-term”? Short term dramatic unemployment for a prolonged period of time will mean nothing long-term to those who starve.

    And, before you say that’s a ridiculous example, it’s the logical conclusion of your view. I’m simply employing the same argumentative technique you’ve been using for months around here.

  34. BTW, I say “after almost two decades of private sector deleveraging” and I know the chart doesn’t really show that… more like 12 years (1933 to 1945). But I’m counting from 1929 (when the depression started)…. so maybe 15 or 16 years. As I understand it, the “private debt to GDP” curve continues to climb from ’29 to ’33 because the denominator (the GDP) was shrinking rapidly… not because private debt was actually increasing. So yes, having these curves normalized by GDP is handy in some ways, but can also obscure some information.

  35. ‘We can’t run out of money. We can’t run out of money. We can’t run out of money.’
    Got it. Agreed. Let’s move on.
    ‘We have an inflation constraint.’
    Got it. Agreed. Let’s move on.
    ‘When we’re borrowing too much, the CBO will let us know.’
    Ha ha ha ha ha ha.
    What will really happen is the the primary dealers will let us know that we have an inflation constraint AFTER the inflation has begun.
    However, you, being a sharp macro guy that you are, will have predicted that a month earlier and gotten to a safe place.

    Pierce, you are confusing present spending with stimulus, which will be turned off when the economy recover (a concept which Keynesians cling to, even though it doesn’t work.) Today’s deficit spending is structurla in nature — open ended and forever, or at least until the boomers die.
    I don’t have any moral reasons to oppose deficit spending. Just a practical matter, it’s making the situation worse.

  36. Regardless of ZH, Modern Money Mechanics (put out by the FED) states investments and gives a clear example of when loans are weak banks can go to “investments” and reference their reserves.

  37. JE, if the constraint is inflation and you’re so concerned about the deficit causing big problems then where is the inflation? You say you understand the inflation constraint, but your own argument is “it’s coming”. Well, you’ve been saying that for years. WHERE IS IT? How come your argument about inflation is totally dead wrong?

  38. Banks don’t “invest” their reserves. Reserves are deposits that remain on deposit at the Fed. Reserves don’t get used for investing any more so than they get used for lending. This whole concept is some form of the money multiplier. ZH said the Chicago paper was “the best” description of the money system even though it spends several pages describing the money multiplier and propagating that myth throughout. This confuses the absolute most important form of money creation our system. Ignore it. It’s dead wrong.

  39. But is it really? How much worse? Perhaps it’s insignificant compared to the still HUGE levels of private debt, which actually dwarf the public debt. Here’s a chart and argument I make in a comment above:

    I don’t know the answer, but I think that chart tells a compelling story.

    The “debt jubilee” advocates don’t advocate government spending exactly (not that I’m arguing FOR their position here, and I know Cullen is opposed to it)… they’d just have the gov cut everyone in the country a significant check w/ the proviso that it be used to pay down current personal debts first. So yes, the gov distributes the money, but we spend it (if we’ve got anything left over). Inflation? Sure! … evaporate bank assets? Absolutely… Add a LOT to the public debt? Yes! … all side effects… but I think it’s an interesting idea. I wonder if OVERALL it wouldn’t get us back on track much faster than our slow private sector deleveraging that’s taking place now.

  40. Cullen – Are you saying ignore this Money Mechanics pamphlet put out by the Fed itself? That would seem odd.

  41. The thing about all the government spending during World War 2 is that it STOPPED when the war was over. … The post-war recovery didn’t come about because Uncle Sam was building tanks and aircraft carriers. It also came about even though tens of millions of men and women were thrown out of work when the Armed Services contracted.
    If Paul Krugman was in charge back then, we’d have kept the war plants running and kept the service men in uniform getting three square meals and a cot.

  42. Ha… maybe you’re right about Krugman. And I completely agree that we stopped spending quickly. But the thing is that when we stopped we had a very very SMALL private sector debt…. totally unlike the situation today! If you look at the public-debt/GDP ratio, it was higher at the end of WWII than it is today… unfortunately not a lot higher… but still from a public debt perspective, we were worse off then.

  43. Because we’re on a path that by the time we see nascent signs of inflation it will be too late and too impossible to address it with any of the traditional means.
    You sound like somebody debunking global warming this way: ‘Where is the global warming? Al Gore has been warning us for years and it hasn’t happened! Heck, it’s snowing today. Global warming advocates are crazy!’

  44. Ignore anything relating to the money multiplier. There are parts of that paper that are EXCELLENT! But not these sections relating to use of reserves for investment or lending.

  45. You sound like somebody in Japan circa 1995. You have ZERO evidence that what you’re repeating DAILY here will actually come true. You literally present no factual evidence that inflation is coming. Why don’t you explain where and how the inflation is going to come rather than just repeating what is nothing more than a belief….

    Me, on the other hand – I’ve not only understood our true constraint, but I’ve told you for years why there won’t be inflation. And I’ve intricately detailed why. You’ve done nothing close. Yet you expect people to believe that you’re right.

  46. This is really a reply to Cullen, but the “Reply” is gone… too indented I guess.

    Cullen, I was attempting to explain my confusion and understanding of this ZH/CNBC debate article/chart to “Dennis” above:

    At the end I talked myself into a corner and pleaded for help! (last bit of last paragraph). Sorry to pile on about this article, but where did I go wrong in my description?

  47. Tom: Responding to you here for this comment and your comment about the private debt level after WW2.
    I agree that private debt levels must shrink before we can see a recovery. (I disagree that public debt must rise to compensate.)
    As for debt jubilee, an idea I find interesting, what if we started debt jubilee in a small way, assessed, and then either continued or stopped.
    For example, ‘What if we started by forgiving the student loan debt of every student who has graduated from college?
    Would that be inflationary? I don’t really think so, because the money has already been spent — you are just getting rid of the debt. You electronically pay off the bank and the bank electronically uses that to retire the debt. But now the student is freed up to spend his money on more constructive things.
    If that works, we could expand the program for all students. Or we could rescue certain types of homeowners. Etc., etc.
    Appreciate your thoughts.

  48. Well it boils down to the question: Who do you want to spend your money. Also note that while the USA can’t be compared to Greece given the different monetary system, California can be compared to European countries in that it’s constrained in it’s spending by tax revenue and ability to borrow.

  49. Johnny Evers, I personally think that’s a great idea. Steve Keen (an advocate for the debt jubilee idea) has also proposed that this idea could be tried out in a small way.

    I can see where you’re going with the idea to try an limit inflation by forgiving student loans (rather than cutting checks). I think the political problem with that though is that people might say “Hey that’s unfair! I paid off my student loan! Why don’t I get any benefit” … that same argument could be applied to house loans. I think that’s why Keen proposed the “cut a check” path. While true that it would almost certainly cause some inflation, if the check amount were carefully selected, you could pick a value that MOST people would just end up using to pay off debts with… and I think that would be mostly non-inflationary. The other side effects would remain. Thanks!

  50. There’s two things going on in QE depending on who the seller is. I oversimplify this most of the time because it can be confusing. When a bank sells Tsy bonds it’s a pure swap. Reserves for bonds. When a non-bank sells bonds the bank is acting as an intermediary. But the accounting is simple. It’s bank reserves up, bank deposits liabilities up, non-bank deposits up, and Fed holdings of Tsys up. So there’s no change in pvt net financial assets. In other words, the bank has more reserves, but more liabilities. The non-bank has a deposit, but no longer has a t-bond.

    Make sense?

  51. You have no evidence that it is making the situation worse. None. You provide none, you never attempt to provide any. You simply have your fears, which have proven to be unfounded, not only in the USA but in our closest analog, Japan. THIS is the reason people wonder why Cullen hasn’t banned you. You don’t engage in debate, you simply tout your fears as inevitable outcomes.

    You also continue to ignore the automatic stabilizer argument. Tom’s chart shows how brilliantly deficit spending can prop up the private sector so that…GASP…the deficits disappear, the public debt you’re so fearful of…GASP…decreases.

  52. Seriously. Cullen, why don’t you do us all a favor and ban this guy? He’s just repeating the same old tired crap day in and day out. It’s a waste of space.

  53. And no, I’m not confusing deficit spending with stimulus. They’re all related by the accounting identities, which you still seem confused by.

  54. Honestly, if you were willing to engage in some fact-based debate, where your opinions are backed by hard data (actual numbers, projections, etc) everyone here would be 100% willing to reconsider. But you haven’t done anything of the sort, thus far.

  55. You could ban me — or address the concerns that I am raising.
    Just remember that you’re not going to convince anyone in the general public if you ignore or mischaracterize their points.

    And Cullen, I’m going to stop saying this because you aren’t listening, but arguing that a future event is not possible because it does not exist today is not a rigorous argument.
    And Japan?!
    Good luck if that’s your model.

  56. C’mon. I’ve explained in vivid detail why inflation isn’t coming. You don’t come close to making an argument. I am not going to ban you, but if you keep leaving comments that are based on no factual evidence then you’ll leave me no choice eventually….It’s a huge waste of time to argue with someone whose argument essentially comes down to “just you wait”.

  57. Ah, Cullen, just one more question on this: Is there anything else (other than treasuries) that banks can serve as an intermediary for (for the Fed)? Anything else the Fed buys through this mechanism (e.g. mortgage backed securities, Monday morning donuts)?

    OK, I lied, one more: The “gap” between deposits and loans that ZH talks about… I don’t get their point… they make it sound like that represents money the bank can speculate with. I don’t see that at all. Even if that were true, how would that even work? So they have more liabilities than assets under those two sub-categories, so what?

  58. That’s the best and simplest description of this I’ve yet seen. Cullen, you should write a post on this debunking the Zero Hedge story because A LOT of people are out there assuming they’ve stumbled on some sort of game changer.

  59. I guess you are right about that. ‘Just you wait’ and ‘Japan’ is the best I’ve got, because none of us really know what will happen as a result of adding federal debt at the rate we are doing, especially when demographics and politics made it appear that the debt load will double and perhaps triple in relation to output in the coming decades. This is new territory.

  60. Yes, the PD’s could theoretically on-sell anything to the Fed. But this confuses several things. First of all, prices are the result of the desires of owners to hold those assets based on their underlying fundamentals. This idea that the Fed can set stock prices without actually influencing underlying fundamentals is wrong. The ZH post implies not only that banks are using their loans or some fungibility of reserves, but that this would automatically cause asset prices to rise. That’s like claiming that “money on the sidelines” causes stock prices to go up. It might influence price to some degree in the short-term, but in the long-term the fundamentals rule.

  61. Addressing points that have no factual information to consider is impossible. It’s like trying to box smoke.

  62. Cullen, got tired of that narrow column, so I moved over hear. I’m going to have to scratch my head a bit on that one. I knew I should have left that “donut” reference out!

    OK, so theoretically, the PDs could “on-sell” (meaning, “act as an intermediary?”) for the Fed for anything. But they actually only use it for Treasuries and MBS, correct?

    You wrote: “The ZH post implies not only that banks are using their loans or some fungibility of reserves, but that this would automatically cause asset prices to rise.” … OK… that’s what’s really got me. Maybe I should just try reading the ZH article again rather than waste your time. I forgot about that “fungibility” bit. OK, before I do though… so you’re saying that THEY’RE saying that the deposit-to-loan gap is evidence of… the banks using their … loans?? … fungibility of reserves? What?

    OK, but the Fed isn’t buying equities (using PDs to do so), right? They could, theoretically, but they don’t. So I don’t get how the Fed influences anything but the prices of the things they DO buy (or is the proper term “on-buy” since the PDs are still intermediaries?).

    OK, I’ll go read it again. But we’ve already established that QE does not change the capital position of the banks. So what’s not shown in the chart is the upward sloping line indicating “Fed Reserves” of the bank, climbing in lock-step with the “deposits” graph (if “Fed reserves were flat, then the banks would be in a WORSE capital position, and in no position to leverage anything!). So the bank doesn’t have more capital to leverage anything with… to make any asset prices climb… right? So maybe that’s it then? Just ignore it? No need to re-read? It’s just a silly (and confusing) argument by ZH?

  63. Addressing points that have no factual information to consider is impossible. It’s like trying to box smoke.

    Telling people that their concerns are groundless because your newly minted model rules out negative outcomes is silly. It’s blowing smoke.

  64. The model has been around for a while. We are trying to engage you with data, information gleaned from sectoral balance equations and the like. I don’t see how that is blowing smoke.

  65. You’re still not saying anything. Your comments are void of value when they contain no analysis explaining why future inflation is a risk….

  66. The banks might invest more due to QE (for other reasons like, they think asset prices are going up), but they’re not going to invest more just because they have more reserves. That’s the key point here.

  67. Cullen in discussing this with someone else they responded that this QE also includes MBS so getting MBS of their balance sheets and replacing with reserves gives banks more collateral for gambling (compared to selling treasuries with a zero change). My reply was that you would need to look at the market depth for MBS before and after QE3 started and how the prices changed. Do you have any thoughts on this and any data on the MBS market?

  68. Other people showed us data that a 40 pct correction in stocks was a once in a millenium event. They might have won a Nobel prize but they were wrong.
    Other people had data that showed you could leverage investments on housing because home prices never fell. They were smart guys, too, but they blew up the markets.

    You know, maybe we’re speaking different languages. It’s like a mathemetician fighting with a poet.
    Your models show that we’re on the right path. But your models take us into uncharted territory, so you have a responsibility to give us an escape hatch. If you are wrong, it is going to be spectacular.
    My contention is that there is much government debt piling up that a) IF it becomes a problem, there is no way out of the swamp, at least that you have shared, and b) your models can’t account for human nature, politics, unexpected Fed decisions, resource shocks, etc.

  69. Cullen, I posted in the wrong place somehow…


    1) QE does not change the capital position of the banks. Confusingly, the ZH chart shows “deposits” (liabilities) climbing above “loans” (assets) after QE (which is only evidence for a WORSE capital position for the banks’), but we can assume that a third line, “bank Fed Deposits” would be climbing in lock step w/ deposits, to at least demonstrate that their capital was not getting any worse, correct? Still this does nothing to make asset prices climb. The banks are in no position to “increase their leverage” because their capital is the same, correct?

    2) The Fed can use PDs as intermediaries to buy anything, but in reality they only buy treasuries and MBS, correct? Again, no (big) effect on equity prices (i.e. the Fed’s NOT buying equities). Perhaps because one asset class (treasuries, MBS) have gotten pricier with lower yields (because of the Fed), it could cause some distortion in equities, but that’s about it, right? And all those non-banks out there that used to have their money tied up in treasuries (and MBS?) are now sitting on flush bank deposits, so they’ll naturally want to buy something else (equities) with it, thus “proping up equity prices?” That’s the gist of their argument?

    3) If that’s basically correct, I’m going to declare victory and forget about trying to re-read and understand the ZH article.

  70. OK, thanks. I get it. I lost track of where this comment went, so I made another along the same lines at the bottom, but I think you’ve covered it here.

  71. … actually if the Fed does buy sketchy MBS (would they?) from the banks, then the banks’ wouldn’t have to play games about that on their balance sheets (games the gov helps them play, like “stress tests” and so forth)… and people would be more likely to believe their stated capital positions… so there’s that!

  72. ” we know a huge swath of our economy is built on unsustainable levels of government spending”

    Right there is your huge mistake. This assertion is totally without any base in reality. It is just a myth the US citizens have been fed for years. Even if you take the military spending, which is huge, it is still peanuts and doesn’t result in anything like “unsustainable levels of government spending”. The only “unsustainable” spending we have in this country is on healthcare, but not because it is govt spending but because it is not enough of a govt spending. Single payer systems (and approximations) have been proven all around the world to result in lower healthcare costs. Even here in the US the limited single payer Medicare and Medicaid are cheaper than private insurances.
    For years people on the right and on the left tried to find what spending to cut and always failed miserably, even then they cut almost everything, to come up with anything but crumbs here and there. You may want to check this, for reference:
    “Why Republicans Cannot Propose Spending Cuts”

  73. 1) Vital resources (fuel, fishing, potable water, agri land…) = fixed or decreasing

    2) Methods to replace depleted resources with new one = not available if not partially and not fast enough

    3) Number of years before the vital resources will be so scarce to threat human life in most of the planet = debatable but mostly unknown, but every year gone is one year less. A theme which is avoided like illness and death. We must be happy all the day don’t we ? In the long term we will dead anyway, as Keynes wrote, so all is fine ?

    4) Number of people fighting to have more of those vital resources = increasing fast

    5) Amount of money (an accounting unit, nothing real and valuable per se) = increasing fast to extremely fast depending in what nation you’re living

    6) Investments in research on science/tech necessary to cope with (2) = decreasing, at the lowest ratio respect GDP of the last 60 years, a tiny fraction of what is spent for weapons or financial bailouts

    Conclusions: you perfectlty know the answer, this is just a remainder of how much stupid we are

  74. The government spends $3.5 trillion a year and takes in less than $2.5 trillion a year. The big deal that finally raised taxes, if it produces the revenue it is projected to, which is dubious, only takes care of about a tenth of that deficit. Just because no one wants to cut spending doesn’t mean we are willing to tax enough to pay for it all (hence the burgeoning federal debt). Again, I get the procedural logic behind this argument but I don’t see the purpose in using it to justify and encourage fiscal irresponsibility. If our political leaders were trust worthy enough to properly use the currency presses, we wouldn’t be in the difficult position we are in.

  75. Well there’s Big Bird (first thing Romney thought of to cut in a jam), right? He and his pals have got to be sucking up what? … at least 10% 15% 20% of our budget poisoning our kid’s minds with their lets-all-get-along-and-learn-stuff left wing ideology, right? … Hahahahaha!

    The Republicans know what the big ticket items are (SS, Medicare/Medicaid, and Defense) and that everything else is chump change. Defense is off the table for them. Some of the chump change is off too (McConnell wouldn’t let the fiscal cliff bill through till it FULLY restored the perverse farm subsidies that he and other erstwhile “anti-socialist, free market types” love SOOO much (he was very annoyed that somebody tried to cut them in the bill I hear). Farm subsidies!!! The essence of the WORST kind of socialism!

    So what’s left to cut? The extremely popular programs: SS, Medicare/Medicaid. Recall the confused Tea Party Patriots who angrily held signs up at rallies saying effectively “KEEP YOUR DIRTY GOVERNMENT HANDS OFF **MY** MEDICARE!!!”

    Republicans know the danger of SAYING they want to cut those programs… they know the Democrats will run more ads showing heartless Republicans wheeling more grandmas off of cliffs… they know their rural, aging, white base (the non-wealthy part of the base — the part that provides the votes, and the angry Tea Party protesters — NOT the money!) relies on those programs, and even they will get upset if they try to cut them. So what do they do?

    McConnell (the effective leader of the GOP now) goes on the Sunday talk shows and complains bitterly that Obama is “Failing to LEAD on spending cuts” and that any more revenue is “off the table.” Translation: “We desperately want to cut SS and Medicare/Medicaid because we find it offensive that government should provide services like that… without letting any plutocrat CEOs and CFOs take a HUGE cut in bonuses! … all that gov spending and no bloated corporate hierarchy to enrich themselves with it… it’s a violation of everything we in the GOP stand for! We don’t actually give a hoot about the deficit. But we also know that proposing cuts in those programs is political suicide AMONGST OUR VOTERS! We cannot survive w/ the money and votes of a few billionaires alone! Thus we want to FORCE Obama and the Dems to commit suicide by proposing cuts to these popular programs, and we’re willing to threaten defaulting on the debt in order to get our way!”

  76. Where exactly do you see “fiscal irresponsibility”? What is it exactly beyond being a nice slogan repeated by people who have no idea what they are talking about. Again, people who actually look at – you know – actual numbers don’t see anything that makes sense to cut. Just keep repeating your mantra if it makes you feel good.

  77. Calling this fiscal policy irresponsible is justified enough by the simple fact that spending greatly exceeds revenues. It is not sustainable in the current form.

  78. Wrong. This does not apply to the sole creator of net financial assets in the economy. In fact, the sole creator of net financial assets MUST run deficits for the economy to function. Fiscal responsibility is to provide the private sector with enough NFAs that it desires.

  79. :) Coming out of the woods every once in a while. But I know how dangerous it is to get sucked into full blown discussions – a huge investment in time and effort.
    Meanwhile, MMT slowly but surely is moving into “self-evident” of three Schopenhauer stages :)

  80. As I’m sure you’re aware, this isn’t an MMT website and we’ve come to disagree with substantial portions of the “self evident” theory. :-)

  81. I have my own take on the MMT/MR divergence which I would not elaborate at the moment for the lack of time and will. But the self-evident part is the one that I would imagine is on the intersection (as in set theory) of the two.

  82. and now that Dem’s are in power, you can find that quote almost verbatim out of Rep mouths. And once the GOP is back in power, the Dem’s will go back to saying that. And of course the various media who support each side will also flip flop when the time comes.

  83. You are missing the big picture here. As it turns out, S&P doesn’t agree that running huge deficits and rising national debt doesn’t apply, this related to the United States federal government credit-rating downgrade. This downgrade carries the usual repercussions and with the fiscal policies unchanged and having recurring debates about the debt ceiling, why wouldn’t further credit-rating downgrades happen?
    Why would the USA be immune to having it’s bonds rated as junk?

  84. They said this same thing 75 years ago when the debt was like $40 billion. The same uninformed people will be saying the same thing in 75 years when the debt is $500 trillion. Just more uneducated fear mongering because people can’t grasp $16 trillion. It’s really not that much money when you understand what fiat debt is to a currency issuing nation. Especially when you consider a third of it is owned and owed to the Govt.

  85. Yes, and it clearly states that investments in essence are no different than loans. I was always under the impression that banks purchased debt from the Govt through the same process of lending (that whole TT&L account thing). Then when the Treasury wants money, they call up their deposit from the bank and the bank transfers the reserves over to the Treasury account at the Fed?

  86. Paul, I’m getting confused now where all the comments about this are… but Cullen stated lat night that there are (at least) two methods that treasuries are purchased at a Treasury auction. The more common way involves repos.

    He’s posted that quote several times. Another way is for the banks (I guess the PD banks) to buy the treasuries directly by crediting a TT&L account for the Treasury, which the Treasury can then instruct them to move over to the Treasury’s Federal reserve account. I think the direct TT&L method is illustrated here (look for the two “TT&L” operations under the operations list box at the bottom):

    This second, less common method, with the TT&L accounts, is what you describe above. And you’re right, I don’t see any difference really between this method and a loan a bank makes to a customer (the loan here represented by the treasury on the bank’s balance sheet). Cullen speaks of “ex-nihilo” creation of money via this method (i.e. the usual method of money creation — from nothing). It’s only when the TT&L account is transferred that the bank has to come up with reserves. I’m still confused about some things though. In these various descriptions we talk about:

    1) Primary Dealers (AKA “dealers” in the NY Fed official’s quote Cullen uses?)
    2) Special Depository Banks (econviz tool above)
    3) Clearning Bank

    Do some entities (banks?) get to wear two or more of these hats during these transactions? Do they typically do that?

  87. Yes, that’s one way (according to Cullen), but the more common way is using the repos. I made essentially the same reply to one of your comments elsewhere (I think on this page). Here’s the comment I was looking for where Cullen talks about these two ways:

    Look above at Stephen’s comment too:

  88. But how do repos change the fact that new deposits are being created in the banking system?

  89. OK, first off, in case you didn’t see it, here’s Cullen’s quote about the repos from the NY Fed official:

    I personally don’t know if the “dealer” they speak of is a “primary dealer” or not. I used to think “yes” but I’m thinking “no.” Also, the “clearning bank” … what is that? Is that the “primary dealer?” Again, not sure. But I’ll say “yes” for now.

    So, it sounds like the bank loans the dealer money and “wires that to Treasury” meaning the bank transfers its reserves to the Treasury’s Fed Reserve account? Or does it mean the bank creates a TT&L deposit account for Treasury (ex-Nihilo, as Cullen likes to say).

    If the former, then the bank transfers the treasury to the dealer, who then enters into a repo agreement with it, meaning he sells-with-the-promise-of-buying-back the treasury to yet another party, typically a “money market fund.” The dealer then uses those funds to re-pay the bank. So in this case I don’t see any new deposits created. Am I missing something? (one is presumably transferred from the money market to the dealer, but I don’t see any net new deposits).

    Now for the latter case where the bank creates a TT&L deposit for Treasury (well there’s a deposit right there!), but instead of hanging onto the treasury as an asset, it transfers that to the dealer… and all the rest of the stuff happens as above. So there’s a net new deposit, the TT&L account. However, that account disappears when Treasury requests to have it transferred to its Federal Reserve deposit. I don’t know when that typically happens.

  90. In the case above where I don’t see any new deposits… well I guess there’s a new deposit at the Treasury’s Fed reserve account, but no net new deposits in the private banking system.

  91. The comparison with Greece shows that many people do not understand the difference between Greece and the US. The US can create currency. Greece cannot create currency. It is tied to the euro and it cannot create euros. Only the ECB can do that. This means Greece is comparable to a State in the US. That is the position all countries put themselves in when they joined the euro system. That is the position all US States put themselves in as well.

  92. Got it in one……………It ain’t never going to correct itself. A fact that many people have not yet grasped. It is going to get a lot worse before the 98% of America even begin to understand what is going on.

  93. Absolutely correct…….! But the problem is the consequences of reversing the process are unacceptable to politicians……..America will see a massive depression if any significant reversal of deficit spending is implemented. Doing that is probably more uncertain than riding out a re-shuffle with others in the world that have the capital to bail-out America…………….

  94. There is a massive pundit world out there that totally believes that hyperinflation is just around the corner… has to follow from all this money printing