THE “KEYNESIAN END POINT”?

Kyle Bass, Managing Partner of Hayman Capital, had an interesting interview on CNBC earlier today.  Bass is a great thinker and I’ve generally been a big fan of his commentary (particularly his ideas on regulation), but he seems to make the same fatal flaw with regards to sovereign debt that many of the defaultistas and hyperinflationists are making.  In discussing Japan Bass keeps referring to the fact that a debt restructuring is right around the corner.  This is essentially the old “bond vigilante” argument that people have been making in Japan for two decades and have been recently making here in the USA.

He compares Japan to the European sovereigns without recognizing that the monetary systems are entirely different.  Like the USA, Japan is not experiencing the “Keynesian end point”.  You would think that 20 years of this failed argument would have silenced it completely, but people still fail to understand that a nation with monetary sovereignty that is the supplier of currency in a floating exchange rate system never has a problem funding itself.  In fact, contrary to popular opinion, the funding mechanism is the currency supplier itself.  Such a system is not unlike an alchemist who simply makes gold from essentially thin air.  To be specific, in the USA the government is always able to harness its banking system to procure funds.  This is how the system is designed.  Therefore, the idea of the “Keynesian end point” based on a necessity to fund ones self via bond markets is inapplicable to these systems.*

The only solvency risk to such a nation is the risk of inflation (or hyperinflation) and that clearly isn’t a risk in Japan.  This whole outlook leads Bass to believe that stocks are impossible to own in the current environment and while I agree with him that the problems in Europe are substantial I believe he is making a huge error in his thinking on Japan:

 

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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. Aren’t we splitting hairs when we discuss this? Sure, we nor can Japan ever “default” in the literal sense. That said, we can definitely default in the technical sense. In that regard and to your point, we’ll always have an ifinite amount of cash to print for every last dollar of funding needs. However, if in fact we ever reach that point, the value of those “infinite” dollars we can use to fund ourselves become worthless and hence…currency debasement hyper inflation when nobody wans to hold the currency anymore because the gov’t has implicitly conveyed to everybody that is no longer a store of value…

    What am I missing?

  2. From a trading perspective the differences are astronomical. For instance, if you bet on govt insolvency you bet on higher rates, higher CDS and plunging equity prices. However, if you recognize that solvency is not the issue you would never make such bets. Now you can focus on inflation and by understanding the monetary system and the transmission mechanism through which hyperinflation can be started you would quickly realize what I have been saying for years – that deflation is the only risk here so the whole hyperinflationist argument is bunk to begin with. Besides, a moderately high level of inflation would almost certainly coincide with a huge lending boom and so the last thing we’d be discussing here is doom and gloom, but rather how to slow this beast of an economy.

    From a policy perspective the changes are equal in magnitude. You quickly realize that monetary policy is not the end all be all and that saving banks is not the goal here. You quickly realize that main street has a debt problem and is causing deflationary trends. Govt solvency is not a concern so if we can alleviate the problems (perhaps lower taxes?) then we’re on the road to recovery….Instead, we’re discussing austerity and higher taxes, etc.

    Quick and dirty examples, but the differences are monumental in my opinion.

  3. TPC – I agree that a sovereign with a free floating currency and the independent power to create it at will can never technically default. However, at the end of the day, even this attempt of thwarting the laws of thermodynamics (no free lunch) has its limits.

    At the end of the day, such a system still needs to have a semblance of sustainability. It still needs to “look” mathematically rational. That is, the debt levels, interest payments, and corresponding gdp percentage need to make sense. A fiat currency relies on well grounded and rational faith, and when that is breached – that faith is lost along with the currency.

  4. Hyperinflation or a currency crisis need not be purely a domestically originated issue.

    Keep in mind that money is also a unit of account and we live in a world of finite resources. How much longer will resource exporting nations allow others to consume their nonrenewable resources in return for easily created units of account, i.e., IOUs paid off by irredeemable currency?

    This current global financial system is barely 40 years old. As resource depletion and energy constraints intensify, the free luch crowd will be increasingly scrutinized by those that export real “stuff.”

    A “game over” moment is well within our lifetime.

    Another argument is the propensity for malinvestment by sovereign deficit spending which distorts economies by making them less robust and more prone to crises, or as I would describe them, natural corrections. Bigger spending, bigger bubbles = bigger corrections down the road.

  5. It’s bogus for a sovereign nation to borrow money anyway. Alexander Hamilton used this scheme to tie the interests of the wealthy with the survival of the fledgling US government. That need is long gone.

  6. TPC,

    I think I understand what you’re saying about the U.S. not being able to default because it creates its own currency. Could you explain why the U.S. government then even has a deficit? Why doesn’t the government just “create” enough money each year to balance the budget? Why even have a $13 trillion dollar debt when we could technically “pay it off” tomorrow? Thanks for the excellent information you post daily!

    Ben

  7. F.Beard, bumper corn crop this year? Say hi to Master jefferson for us.

    I think the issue on sovereign restructurings is that it may be viewed as less painful a “solution.” The post ignores issues around central bank independence. Doesn’t the US Treasury, in fact, ultimately have to go to the bond market? Granted, they can be completely interest rate insensitive and continue to go back again and again. So politically, if the Fed is unwilling to be a monetizer of debt, putting a hair cut to Fannie / Freddie holders near term and Treasury holders long term is possible under crushingly high real interest rates.

  8. That’s a good point, but how applicable is this to the whole deficit debate and the current deflationary episode? Perhaps more applicable as a long-term discussion….

  9. I think it is because he is not distinguishing between the Treasury and the Fed. Only the Fed could create,or hit the button to simply pay off all the holders of Treasuries with new base money….

  10. I have heard this argument many times before and it is very tempting in all its logic and simplicity. But facts are facts, sovereign nations with the ability to print their own currency (not linked to other currencies or gold or anything) HAVE defaulted in the past. Seems like having a printing press does not equate to a get out of jail free card.

    Of course you may argue that they defaulted because they chose to do so. But that is often the case. It is not the reason of the default that counts, but the default.

  11. Why do we have a deficit at all? Well, the deficit doesn’t really represent debt as we might think it pertains to a household or state. Net household financial income = current account surplus + government deficit + Δbusiness non-financial assets.

    So the government deficit is really just an accounting identity. People think of it as some big burden, but that’s not accurate. To keep things simple the deficit basically just represents the public’s desire to save. So the government appears to be picking up an excess amount of the tab. We can argue about the various causes of this and possible ramifications, but the one thing it does not represent is this horrible debt burden that will one day result in insolvency.

  12. That’s like saying there was no housing bubble because all the homes sold in 2006 were bought.

    We all agree, tautologically, that it is an accounting identity that one person’s assets are another’s liabilities, that debt issued by the government represents someone else’s savings. You are completely ignoring “price” / interest rate… ie what price does this identity occur at.

  13. I am not ignoring the ROI of govt spending. I am simply explaining that the idea that the deficit represents a debt burden (as a deficit burdens a household that needs to be funded) is misguided. A govt that prints its own currency and has no foreign denominated debt cannot default unless it chooses to. This is of vital importance when trying to understand the current environment.

  14. Doesn’t the US Treasury, in fact, ultimately have to go to the bond market? cdosquared5

    No. The US Treasury could print some debt and thereby interest-free United States Notes and just spend them into existence. Legal tender laws and US taxing authority and ability (read guns and bullets) would give them value. Government bonds are a gift to those who desire a risk-free investment based on the government’s ability to tax future generations. They are an abomination, IMO.

  15. TPC, what about losing our reserve currency status – what impact would that have? As for prolonged unsustainable deficits, according to the Obama administration we’ll be adding another $13 Trillion in debt over the space of 10 years i.e. we’ll have accrued 13 Trillion on top of the 10 Trillion we already had when he took office by 2019. In addition in 2019, the deficit for that year is projected to be $1.15 Trillion. I also don’t buy into their optimistic GDP growth rates of 4% per annum. At what point would you call deficit spending unsustainable? 10, 20, 30 40 years?

    I want to make this point again by 2019 we’ll still have a deficit of $1.15 Trillion. i.e. no end in sight.

  16. However, if Japan does end up with hyperinflation, it’s political impact(e.g. Ron Paul for president?) may force the US government to formally default.

    As shown by Richard Koo, the Japanese government debt has taken the place of private debt so the total debt(public + private) in the Japanese economy has been stable. If total debt starts to increase again, the hyperinflation scenario may not be as far-fetched as you think. It’s not imminent, but not impossible.

  17. You have to ask yourself why we’re the reserve currency though? It is largely because we are the largest, most productive and safest economy in the world. Is that going to change any time soon? Eventually, but is it imminent? No.

    I think that once we get beyond this credit crisis the deficit worries will be largely alleviated and then we can turn to worrying about the limited growth of our economy and possible resource restraints. Those are not near-term concerns, however, and not really applicable to the current environment so these points, though very valid in the long-run, are not really pertinent to the current debate.

  18. I think Japan is more concerned with getting a wee bit of consistent inflation and maybe a return of the credit markets before hyperinflation becomes a justified concern.

  19. @janice is it Iceland default in their own currency or their borrowing in Euro

  20. When they come back to the credit markets they’ll have to offer more than 0-1% on their JGBs for foreigners to buy. Not sure how the rest of the Japanese that have been buying Japanese debt will respond as their existing JGBs lose value.

  21. Foreign denominated debt. Their “problems” were not in kronor. You’re not truly sovereign when you borrow in someone else’s currency. This is kind of what Europe is like….It’s apples and oranges when compared to the USA.

  22. TPC, well aware why we are the reserve currency, but we don’t have to be dislodged completely, it could be a gradual if not accelerated process – it’s already started to happen look at Brazil, Argentina, and not sure who else China has arrangements with.

    You also seem way more optimistic about the deficits and our debt obligations. As someone pointed out losing faith in the USD is a psychological event, may not happen anytime soon but when it does trigger it’s likely to be very quick. The interesting thing is Japan can be viewed as the canary in the gold mine, they are way ahead of us, it’ll be interesting to see how far they can push the debt to GDP ratio before things start falling apart and foreigners even locals flee the Yen. The population demographics are not on their side and their anti-foreign-immigration policy ain’t helping them much either – that at some point may have to change to buy them more time.

  23. I am optimistic in the sense that I see approximately a 0% chance of USA default. Is there a chance that the govt could continue to run astronomically high deficits at times when they are not needed which could result in very high inflation – of course. But again, I don’t see that as an immediate concern because I am quite confident that the private sector will continue to de-leverage.

  24. Both, default to Europe (legally) and default to the citizens via high inflation (technically).

  25. The BOJ and Fed have proven that they can control the ENTIRE yield curve. TPC

    But, but, but … Greenspan. He said the Fed could not control long term interest rates.

    See how dangerous it is to have a single failure point in charge of the nation’s money supply?

  26. I hear you, but Iceland made the kronor a problem when they nationalized the banks. The citizens of Iceland are having inflation of 14%.

    I am an arm-chair economist…..
    I read an interesting article that stated that the reason the the US governmnet stepped in for Fannie Mae & Freddie Mac was because China and Russia had purchased a large interest in the MBS of each. If this is that case, it’s it also true that the US does now have external debt via the nationization of Fannie and Freddie? Basically the same thing that Iceland did when it nationalized the banks.

    Didn’t Britian have the reserve currency prior to the US? How did they lose reserve currency status?

  27. Thankyou so much PragCap for finally declaring your ideology: you are a chartalist.

    You should probably reveal your belief more transparently, however, to your readers. You know, just so they understand.

    –Aldous

  28. Saying that I am a chartalist implies that I believe in all of the theories and applications of the theories of chartalism (which I don’t). When it comes to explaining the monetary system, however, chartalism is about as crystal clear as it gets and I believe this financial crisis has proven this to be correct. The application of this theory is in fact more theoretical, however.

  29. Didn’t Britain have the reserve currency prior to the US? How did they lose reserve currency status?

    The British economy was dragged down by the ongoing costs of maintaining an empire and a demographic blowout caused by World War One. (As it happens, major wars tend to kill off a lot of young men who would otherwise gone into the civilian workforce, where they would have produced GDP.)

    Keep in mind that despite all that, there was no sovereign default. Britain dropped a notch in prestige, lost its superpower status and saw its currency decline in value, but the country remained prosperous. The US outperformed it on the whole, but Britain did not devolve into a third-world country.

    In the gold standard era, sovereign defaults often came as the result of costly wars that the nations in question could not afford. Since then, sovereign defaults occur in nations with smaller, low-to-no growth economies and corrupt or opaque governance.

    I don’t agree with MMT theory, but I would agree with TPC that the US is a highly unlikely candidate for a sovereign default. The US lacks the primary drivers of default: It does not have a small economy, it is not hostile to capital formation, and the government is relatively transparent.

    The risks here are low, hence the flight to US treasury debt when investors get nervous. The bond markets tell us that the US is still the world’s safe haven, despite the fact that some of those who post on internet forums may believe otherwise.

  30. This is an important and excellent comment. Most people like to throw around default and hyperinflation as if they are common occurrences, but these events are generally caused by some extraordinary exogenous event (such as a massive war).

  31. Doesn’t the US have an empire to maintain? I personally believe that some country is going to decide that they want to be the reserve currency and will link their currency to gold (just like we did to get the reserve currency status from Britian)or create a global currency backed by gold….too much pressure from Arabs who distrust the infidels, then all those dollar float back to the US and we will be using 100s to light fires.

  32. I personally believe that some country is going to decide that they want to be the reserve currency and will link their currency to gold (just like we did to get the reserve currency status from Britian)or create a global currency backed by gold

    This doesn’t make much sense, honestly. A gold standard worked in a pre-industrial era, when GDP barely budged and economies produced very little output. It was aided by the Age of Exploration, as there were lands held by less technologically advanced peoples in the New World whose gold could be stolen by some of those in the Old World.

    The US dollar became the reserve currency when gold was detached from money. FDR seized domestic gold and overpaid for foreign gold in order to make it irrelevant, and migrated the US to a fiat system. Smart move on his part; it worked.

    The industrial revolution and the end of the Age of Exploration put a torpedo to a gold standard. Today, we produce wealth far more quickly than we can produce gold, so it no longer works. Now we have modern capital markets that allow investors to invest on income statements pulling up balance sheets, and output is far more valuable than is a static, arbitrary asset of questionable value. Sorry, but you’re a good 100 years behind the curve.

  33. Japan can not default? The US can not default ?

    What is the definition of a non-performing loan?
    A loan is nonperforming when payments of interest and principal are past due by 90 days or more.

    Rates are now at 0% and there are no payements of principal. Only Rollovers.
    Can’t default ? Injoy 0% and convince your self there is no default.

  34. It may not make sense, but what happened in East Point, Ga over applications for Section 8 housing didn’t make much sense either. Never underestimated the raw force of the uneducated masses. An oil pumping Arab may not believe in your modern capital markets. Also, the art of accounting relies a great deal on the honesty of the numbers. The phrase “accurate and fair representation” comes to mind.

    To further the point, why are central banks buyers of gold? If I was a central bank I’d be buying cocoa, sugar and vanilla. Why buy gold unless there is a “master plan?”

  35. Why is the interest rate zero? Because the Federal reserve puts it there. People have been placing this bet against Japan for over two decades. That bond market has sent traders to their graves for 20 years beccause they did not understand these principles. How one can look at history and come to the conclusion that this time is different (even though everything is the same) is beyond me.

    Some people think I am wise because I said we were Japanese before any of this started. All I did was read a history book and say, “hey, that sounds an awful lot like the United States”….

  36. Once the debt can not be finance internaly. Is saying that a country can not default not the same as saying that eventualy its curency will?

  37. TPC dont you think that Japan was the carry trade paradise and made good money recapitalising by keeping rate low. But we are in a very different situation now and also there debt was finance internaly. ???

  38. See the above link which clearly explains my thinking. You might also want to read through the comments. Let me know if you have questions (which you almost certainly will :-))

  39. My mistake, I should not have used the term Bretton Woods.

    Per Wiki:
    As in previous major wars under the gold standard, the British government suspended the convertibility of Bank of England notes to gold in 1914 to fund military operations during World War I.

    The Gold Standard Act of the United States was passed in 1900 (ratified on March 14) and established gold as the only standard for redeeming paper money, stopping bimetallism (which had allowed silver in exchange for gold). It was signed by President William McKinley.

    The United Kingdom’s pound sterling was the primary reserve currency of much of the world in the 18th and 19th centuries. The dire economic cost of fighting the First and Second World Wars, the increasing dominance of the USA in world economics (and, importantly, the establishment of the U.S. Federal Reserve System in 1913) as well as economic weakness in the UK at various intervals during the second half of the 20th century resulted in Sterling losing its status as the world’s most reserved currency.

    US was under gold standard and UK was not. My thoughts, we will be under a gold standard again. Like it or not….never underestimate the uneducated masses.

  40. US was under gold standard and UK was not.

    Firstly, all of us ought to know better than to rely upon Wikipedia, which is an open source to which anyone can contribute, even if what they contribute is false, partially false or incomplete.

    The UK was on the gold standard until 1931. FDR (famously among the gold bugs) took the US off the gold standard in 1933.

    Bretton Woods created a fixed exchange rate regime with the value of gold limited to a fixed dollar amount, rather than the other way around as would be the case with the gold standard. Bretton Woods collapsed when it effectively became possible to buy gold too cheaply, as the fixed gold price that was above market in the 1930s turned out to be artificially low by the 1960s.

    So no, you’re wrong on some basic facts here. It’s no wonder that you think that a gold standard will return; if you’d just do some basic arithmetic, you could see how our inability to create gold quickly enough to match economic growth makes this next to impossible.

  41. TPC
    My God, I already have a vertical headache.
    I wil save it and read later.
    Thanks I apreciate your blog and didactical approach.

  42. TPC, one thing that sets us apart from Japan I think is demographic power.

    This should not be underestimated, nor should the US consumers propensity to spend. So I guess my point is that I think we may do better, or at least end the process quicker, than Japan.

  43. TPC,

    Even though I’m still trying to wrap my head around the topic, I am grateful that you’re taking time to explain the nature of this country’s monetary system in a post-gold standard era. You are one of the only authors on the web who are providing a cogent explanation on the subject. It’s amazing how many educated and well-informed authorities there are out there seemingly getting it wrong (Jim Rogers, Faber, Roubini) on the subject. However, if the bond market only serves to target the FF rate, why raise taxes? Is it a way to control inflation? If so, why is Congress and Obama seeking to raise taxes in an inflationary environment, along with an expansion of fiscal policy? Am I making any sense here?

  44. Most people think of the govt as they do their household. It’s easy to understand that way, but it’s totally wrong. The govt doesn’t fund itself like a household does. Taxes are one way of essentially controlling the money supply and/or the temperature of the economy. If we’re running hot we might raise taxes and/or cut spending (smaller deficit) and if we’re running cold we might cut taxes and/or increase spending (larger deficit).

    The key to all of this is not that government spending is the solution to every problem, but that deficits will not bankrupt the country at a time of high private sector debts. This is why tax cuts are preferable.

    We should have implemented tax cuts for small business and the middle class back in 2008 rather than bailout the banks. Unfortunately, we’ve used that bullet and now the country is convinced that we’re bankrupt. We’ll see what happens, but we don’t seem to be moving in the right direction for now.

  45. How is that possible, isn’t that one of the reasons the Greeks, Portuguese etc joined the EU so they could issue cheaper debt. If they could control the rate and issue debt in their own currency then why even bother joining the EU. Same would apply to Zimbabwe, Argentina. I think your putting too much faith in the Fed being able to keep this going, but granted I don’t think we have an imminent problem thus far. As I said Japan has been able to balloon its debt to 200% of GDP, we should be able to do likewise – after that, who knows. As long as our banks and the government itself are the ones buying the bulk of our debt I guess they can keep things going. No wonder Bernanke will need to implement QE2 to the tune of trillions to keep this illusion going for a few more years.

  46. My problem with all this is I understand the gov’t can’t go bankrupt. To me that is not the problem at all. It is the abuse of the monetary system that is the problem. When someone has the power to create money, for wars, banks, their good buddies at banks, their favorite political party, ect, that power inevitably gets abused which is exactly what has happened here in the U.S. I don’t think it matters if our leaders understand or not how money gets created, they know where the money comes from and they know which teat to pull on to get it out. That is why I belive that money needs to be backed by something. It helps to eliminate a lot of the political and financial abuse. To say we don’t produce enough gold to use it as a standard is wrong. Gold does not have to be physically carried around, and it also can be worth however many dollars it is worth. The more scarce it becomes the more it is worth, the more goods and services it will buy. That seems to me to be more honest. How will we ever get control the malignant financial sector of our economy as long as we have the current system in place?

  47. If it didn’t result in so much pain and suffering I’d say that it is hilarious that this man still has so much influence….

  48. I am referring to the USA and Japan. none of the situations you mentioned are applicable. EMU – single currency system with no monetary sovereignty. Zimbabwe – dependent on IMF loans (foreign denominated debt) and an absolute wreck of an economy that was run by totally corrupt regimes. Argentina – pegged to the dollar which is essentially the same as removing monetary sovereignty.

    None of these situations are similar to the modern day USA….

  49. No, there’re more similarities between the US and Euro zone than our TPC would like to admit. Like in Europe the central bank (FED) is the only one that can print money. But the states can’t print money and that’s where the deflationary forces are coming from. The states have their own budget (deficits) and they can’t print their way out of the economic misery.

    It would be something else when a country has debts denominated not in it’s own currency. e.g. japanese debt denominated in USD or in Euro.

  50. I’ve covered these facts thoroughly in the past. In short, Europe is not truly united so the differences remain vast. Without one central bank, one treasury and one rule of law the EMU will remain different from the US monetary system.

  51. Yes, I have read the your thoughts on this topic. And it made a lot of sense when I read it. And yes, my head was spinning when I read your story. But if you’d ask me to reproduce it I wouldn’t be able to do so.

    And that’s – IMO – the reason for the disconnect. That’s why I think we’d better “”Agree to Disagree””.

  52. Now we have modern capital markets that allow investors to invest on income statements pulling up balance sheets, and output is far more valuable than is a static, arbitrary asset of questionable value. Sorry, but you’re a good 100 years behind the curve.

    Spoken like a true MBA, angry!!

    A static, arbitrary asset of questionable value?? Obviously FDR thought the same thing when he issued the confiscation order on april 5 1933!!

    A static, arbitrary asset of questionable value which was worth $20 or thereabouts back then which is now worth $1200…doesn’t seem to static to me. seems to me gold has gone one way and the fiat currencies have gone the other way???? i’m sure you’ll have an explanation….MBA’s always do!! xoxo

  53. That is why I belive that money needs to be backed by something. It helps to eliminate a lot of the political and financial abuse. To say we don’t produce enough gold to use it as a standard is wrong. Gold does not have to be physically carried around, and it also can be worth however many dollars it is worth. TNO

    Then let’s have two types of money: government money backed by its taxing authority and private monies backed by whatever. As for gold, I predict that in a truly free market that common stock as money would out perform it. The distinction between money and common stock is an artificial one, IMO.

  54. You didn’t answer his question…

    “How is that possible, isn’t that one of the reasons the Greeks, Portuguese etc joined the EU so they could issue cheaper debt. If they could control the rate and issue debt in their own currency then why even bother joining the EU”?

    Why didn’t they all just sell 10 year bonds in their domestic currency (before they joined the EMU or became reliant on the IMF or pegged to the dollar) at 2.6% interest, or 1%, or 0% as you explicitly stated a sovereign can do?

    “The BOJ and Fed have proven that they can control the ENTIRE yield curve.”

    Why didn’t this apply to PRE-EMU Greece and Portugal. Why didn’t this apply to PRE-dollar pegged Argentina? Why doesn’t this apply to Latvia today?

    John

  55. Yeah I know Latvia pegs their currency, so replace the example with Mexico.

    Their central bank can print Pesos, so why aren’t they issuing 10 years at 2.6% yet? Why not 1%?

    John

  56. Lo & behold. Today an article on Zero Hedge about a province of Malaysia going to silver and gold. Of interest, take note of all the comments of support from the readers. I am not an advocate of the gold standard, as I believe that it will never work. But when the common people lose faith in the government and the currency, the masses move the government. Gold as currency has its roots in both Islamic and Christian beliefs. History repeats itself, nothing new under the sun. It’s just a matter of time before the masses clammer for “real” money.

    http://www.zerohedge.com/article/malaysian-province-moves-gold-and-silver-based-currency-main-islamic-event-last-100-years

  57. seems to me gold has gone one way and the fiat currencies have gone the other way????

    What you goldbugs fail to understand is money in a modern economy is not primarily a store of value, but an incentive for output.

    A modern economy gets more benefit by avoiding the gold standard, in that it can manage the money supply in order to motivate production. Prices increase in time, but so do wages.

    Gold was useful as money in a pre-industrial age when economic growth was minimal. (Economists estimate that per capita GDP was essentially flat from the beginning of mankind until 1500 AD, so growth wasn’t an issue.)

    The gold standard no longer works, now that annual global output exceeds the value of gold by a wide margin, and that normal economic growth rates exceeds the pace at which new gold can be mined. If you would do five minutes’ worth of arithmetic, this would become very obvious.

    The people of Yap famously did the same thing: they used huge quartz stones for money, in place of gold. http://www.visit-micronesia.fm/eng/yap/gallery/64.html Like gold, quartz was shiny and hard for them to get. But I’m willing to bet that you don’t worship rocks in the same way that you worship gold…

    If you want stores of value, then convert cash into the right assets. The economic system is engineered to encourage you to produce, and to invest most of what you haven’t consumed. (And no, a lumpy mattress full of overpriced gold coins is not much of an investment.)

  58. Yes I have read it.

    “Moreover, government debt is not true debt either. At the macro level, the reserves that are transferred to banks through government disbursement are used to buy Treasury’s. That is, when a Treasury is bought, this involves a transfer of reserves from the buyer’s bank’s reserve account at the Fed to the government’s account (consolidating Central Bank and Treasury as “government”).

    “When the Treasury’s are sold or redeemed, the reserves that were “stored” at interest are simply switched back, creating a deposit again. It’s pretty much the same as buying and redeeming a CD. It’s just a switch from demand to time back to demand in a bank account, and a switch between reserves and securities at the government level. That is to say, the government doesn’t have to draw on revenue, borrow, or sell assets to cover its “debt,” as households and firms do. It’s just a matter of crediting and debiting accounts on the (consolidated) government books, even though it may appear that there is a financial relationship occurring between the CB and Treasury due to the accounting. However, it’s just a fiction.”

    As an accounting identity:

    Step 1. Treasury $$ —–> Entity.
    Step 2a. Entity $$ ——-> Federal Reserve.
    Step 2b. Federal Reserve Treasuries ——> Entity.
    Step 3 Federal Reserve $$ ——- Treasury.

    All on balance, right? Yes, until time adds interest and

    Treasury $$ ╘ Treasury $$ value; Treasury $$ does not change while Treasuries issued does. To balance, treasury debt goes up over time as private sector assets rise on the other side of the ledger. That sounds like real, actual, not technical, distinguishable sovereign debt to me.

    Using the mechanism quoted above combined with accounting identities, the switch can run in reverse UNTIL all Treasury funds are drained yet the Treasury liabilities are not extinguished (and continue to grow). That’s sovereign default.

    Please point me to where MMT has answered this issue. I’ve not been able to find anything yet.

  59. “Gold was useful as money in a pre-industrial age when economic growth was minimal. (Economists estimate that per capita GDP was essentially flat from the beginning of mankind until 1500 AD, so growth wasn’t an issue.)”

    I haven’t read these estimations, but first intuition is that this may be true on average. Societies would rise and fall. I’ve read estimates that Mayan cities had the most dense populations that earth has ever known (even more populous than LA today). Those societies grew, progressed, experienced divisions in labor, advanced, and output grew. However, progress can get wiped out when civilizations collapse. This could account for flat GDP, but does not argue that economic growth was minimal. Just a proposal, not an argument.

    On another note, I agree with your incentive to produce point. However, one issue I have with our system is these incentives can be reversed by the Fed at any moment, crushing those who were once incentivised and working to advance society. It’s like we’re randomly picking winners and losers as they’re either in the right place (monetary environment) at the right time, or they’re not. Can’t we find a better way?

  60. TPC, I now understand you’re explantion concerning US monetary policy. However, I have never heard you espouse what you think would happen if the US crosses the “prolonged and unsustainable deficit” line. Would you care to illuminate us?

  61. This could account for flat GDP, but does not argue that economic growth was minimal.

    Basically, most of the history of mankind has consisted of humans using simple tools, a few inefficient resources such as water and wind power, and a whole lot of labor to do all of its work.

    The inability to mass produce naturally put the brakes on pre-industrial economies; labor is just not particularly efficient. Here is a summary compiled by Brad DeLong of a couple of different estimates, both of which end up at roughly the same place: http://econ161.berkeley.edu/TCEH/1998_Draft/World_GDP/Estimating_World_GDP.html

    one issue I have with our system is these incentives can be reversed by the Fed at any moment, crushing those who were once incentivised and working to advance society.

    I don’t see the Fed doing that, frankly. To a degree, Congress and the presidency, yes, but not the Fed.

    If anything, central banks are losing control of the economy, as securitization further constrains their ability to control real-world interest rates. That’s what I worry about; we are using markets to increase volatility and systemic risk, which is exactly what we shouldn’t be doing. But again, that’s a regulatory failure, not a problem with the central bank, per se.

  62. I too listened to Bass on CNBC. What I dont think you addressed with your comment of ” this has been going on for 20 years” was Mr. Bass’s comment that a ponzi scheme can go on for a long time as long as there are new buyers. Whats different this time is that there are beginning to be more sellers than buyers because of japan’s aging and declining population. Likewise currencies backed by nothing are good only as long as people believe that they are not worthless and that other people will accept them. With today’s financial expertise my guess its only a matter of time before financial behemoths start to market- monetary units backed by various asset classes, which may in turn change our existence in a big way.

  63. Likewise currencies backed by nothing are good only as long as people believe that they are not worthless and that other people will accept them.

    It is woefully false to claim that a currency supported by $11 trillion in annual GDP is based upon “nothing.”

    US GDP is certainly more stable than is the value of gold. Even during the Great Depression, US GDP didn’t fall by 2/3rd’s, whereas gold did plummet to that degree during the early 1980’s.

    Output is a more consistent and predictable component in a modern economy than are the values of speculative commodities that have histories of boom and bust cycles. It is far better for a productive economy to tie its currency to national income than to a random substance that has little real-world use but is prone to erratic fluctuations.

  64. It’s clear that policy makers such as the President, Fed, Treasury and business leaders strategy is to slow grow the economy in hopes of eventually working off the excess housing inventory and unburden the banks of these dead assets (which look more like liabilities) over a long period of time. Washington and private sector money (the wealthy) are more than willing to live with long term high unemployment as the tradeoff…after all, the politicians will be taken care of by the wealthy who have no concerns.

  65. Which rates are 0%? Even if you could find them, in a deflationary environment a 0% bond still gains relative value as the currency appreciates (ie. your 2010 dollars can buy more European goods now than they could in mid-2008). As rates continue to plunge new lows, rates being at 0% signal that the global market is looking to maintain value instead of generate high interest based returns as these would signify a great risk of repayment of principle (let alone interest).

  66. Good question. Why do we allow the market to set rates in the USA? I have no idea. I’ll mark it up as sheer ignorance. This Federal Reserve is only just now realizing that they control the entire curve.

    If the USA is behind the curve on this one then don’t even bother asking where Latvia and other countries are on the matter. As for specifics on each and every country – I cannot really answer that question. I am not an expert on the Latvian legal system, monetary system or really anything Latvian. I probably couldn’t even find Latvia on a map. Many of these nations feel the need to issue debt in a foreign currency (for various reasons) or they need IMF loans (for various reasons) so they will never truly control their monetary policy, however, the Euro system has put many of its participants in the same exact foreign denominated debt risk position while also removing any capability to fight recession or allow for floating exchange based alleviation.

  67. Interest paid on bonds is merely another form of government spending. It’s a credit to the private sector and a debit to the govt. Just like when the Fed pays interest on reserves. It’s removing potential income from the Fed’s balance sheet and adding it to the private sector balance sheet.

    Not sure if I answered your question fully or not….

  68. Ask Obama in 2 years if he is willing to live with high unemployment. I am sticking to my guns on this one – if he can’t get the UE rate below 8% he is toast.

  69. This Federal Reserve is only just now realizing that they control the entire curve.

    I believe that you’ll find that this ultimately isn’t accurate. The Fed can’t buy enough LT treasury debt so that it can set the rate independently of the market.

    In many ways, central banks are followers, not leaders. They can’t just set a rate arbitrarily and necessarily expect the market to follow.

    Case in point: When the Fed cranked up interest rates during the middle of this decade, mortgage rates ultimately stayed flat and actually declined during the interim. The Fed wanted to increase the rate, obviously, but the market just chose to cut its spreads, instead.

    Right now, it looks to me that we are in the midst of a bit of a mini-bubble for long-term Treasuries. Hedge funds are jumping into them, and the volatility of the 10-year as measured by intraday spreads, etc. has increased considerably since Q3 2008.

    I haven’t looked into the data yet, but my gut tells me that part of the move in treasuries is a reaction to Fannie and Freddie bonds, which used to be seen by the market as a safe quasi-government-guaranteed alternative to treasuries, but with a higher return. Now that there are questions about the fate of the GSE’s, those seeking a hedge will just take the lower-return treasury, which then drives demand, which lowers the yield.

    Just like every other bubble, I would expect this one to correct, and 10-year yields will be back into the 3-4% range. It’s hard to time, and I don’t think that it would be wise for small investors to try to time a short, but I’d certainly not go long when yields are this low.

  70. Gold as currency has its roots in both Islamic and Christian beliefs Janice

    I don’t know about Islam but I see nothing particularly Christian about gold as money. Chapter and verse please?

  71. “Gold was useful as money in a pre-industrial age when economic growth was minimal. (Economists estimate that per capita GDP was essentially flat from the beginning of mankind until 1500 AD, so growth wasn’t an issue.)”
    GDP per capita wasn’t essentially flat until 1500 AD.

    For an excellent perspective on World Economic growth since 1 AD, I recommend reading the fantasctic book from Angus Maddison, Contours of the World Economy, 1-2030 AD, Essay in Macro-Economic History

  72. Case in point: When the Fed cranked up interest rates during the middle of this decade, mortgage rates ultimately stayed flat and actually declined during the interim. Angry MBA

    Well, there is a limit to how many assets the Fed can sell to raise interest rates, isn’t there? (Though I suppose the Fed could create bonds if it ran out of assets to sell.) But there is no limit to how many Treasuries the Fed can buy at any interest rate, is there?

  73. Angry MBA.

    The Fed drives every one nuts but:

    The problem with “Gold bugs” is that they are using a good argument to justify a wrong one.

    The Gold bugs argumentation is based on only one thing and that is that Gold is real and fiat money as no intrinsic valuation.

    They are correct in the fact that fiat money can be issued for political reasons,to pay for wars,to disguise fiscal irresponsibility,to export by default or even in some Bananas Republic to screw there population by paying them with depreciating paper and export the products of labor against a stronger currency for the Oligarch.

    They are correct about the several abuses of central banking and the management of fiat money but totaly wrong about Gold has being real money.

    Recessions and depressions and even inflation can and did happen during the period of “Gold standard”. Inflation for example happened in the nineteen century because of Gold discoveries in South Africa and to think that Government would act differently than the present Central Banks because money is gold is naïve. History is full of example when Gold was diluted with other metals.

    It’s no diffrent with fiat money. A country can choose sound fiat currency or it can have a Zimbabwe kind of fiat Currency.

    I do not understand how Gold can be the underlying valuation of a currency. Gold is a metal and as such is only a part of the total production of an economy wile a currency is based on the purchasing power with in that economy.

    In addition to the cost of its production using Gold as money makes almost as much sense as moving back to bartering goods and services.

    Could buying a gold be more of a nostalgic perception?

    The mistake that Gold Bugs are making in my humble opinion is that they are accumulating gold for reasons that 50 years ago would have made sense. Back then Gold was perceived as commodity units that a person could easily store, hide or travel with in times of wars of economic disasters such as in Germany before and during world war two. But today any one can purchase thousands of dollars of units of almost any trading commodities in a few seconds and transfer the certificates to a custodian almost any where in the world.

    There is nothing wrong about buying Gold as an investment if it’s a judgment call on its economic valuation in the future but other than its expensive perception it is not especially different as an edge against inflation or disaster than most other commodities.

  74. But there is no limit to how many Treasuries the Fed can buy at any interest rate, is there?

    But the market doesn’t have to buy them. If the yields are too low, the market will flock to something else.

    Imagine that the government opens a burger stand. At this burger stand, Uncle Sam offers a burger and fries combo for the low price of $3,999.95.

    Can the government keep the burger stand in business? Sure it can throw money at it and keep it afloat, the workers employed, etc.

    But can it get people to pay 4 grand for a sandwich? Not likely. There are other options, and the market will take those.

    If the Fed decided to set the 10-year at 0.5%, for example, that would be achievable, in that this would be the rate that you’d find in the Wall Street Journal. But that doesn’t mean that there would be much interest from genuine market players to buy that debt, when they can go somewhere else to get higher returns.

    The US offers the “risk free” rate, but at too low a level, the opportunity cost becomes too high for investors to bother. Since I don’t subscribe to MMT, I see that we genuinely need at least some of that money, and we won’t be able to raise it if the debt is too costly. The market ultimately decides this.

  75. I agree with most of your comment. There is a lot of naivete among those who post on financial websites, hence the heightened interest in gold among some of the most zealous.

    The simple response is that most people don’t understand what “money” is. They want deflation when they shop at WalMart, yet want inflation when it comes to their own paychecks. These are contradictory beliefs, but self-interest tends to interfere with common sense.

    A functioning modern economy provides just enough inflation so that people want to go to work where they can get the occasional raise, which encourages them to spend more money (they’re feeling good about themselves and their prospects), which in turn keeps the business cycle moving.

    There is also a tendency among money to rewrite history. They assume that the grass was greener in the old days, while not realizing that it usually wasn’t. Factory work was brutal, tenement housing was brutal and there was no social safety net to speak of, yet some of these folks obviously never read Dickens or The Jungle.

    There is a reason why the rise of Marxism accompanied the rise of the Industrial Revolution; because things sucked for a lot of people. Folks weren’t joining labor unions and demanding social services in the early 20th century just for the hell of it.

  76. The US offers the “risk free” rate, but at too low a level, the opportunity cost becomes too high for investors to bother. Angry MBA

    Well, since I don’t believe the government should borrow money at all that is just fine with me. So, the shell game the Fed and Treasury play achieves what I would do directly. However, the deception confuses the public into being concerned about the public debt and gives the gold-bugs plenty of ammunition too.

  77. A functioning modern economy provides just enough inflation so that people want to go to work where they can get the occasional raise, which encourages them to spend more money (they’re feeling good about themselves and their prospects), which in turn keeps the business cycle moving. Angry MBA

    Except the central bankers still haven’t figured out how to make it work properly (much less optimally) which is why I argue for maximum decentralization.

  78. “Marxism accompanied the rise of the Industrial Revolution”
    But it did not seem to bother them later abusing workers and children’s in communist countries.

  79. It is amazing to read the media being happy that there is some consumer’s price inflation. Thank God my new car will cost more. Are we going nuts or what?

  80. GDP per capita wasn’t essentially flat until 1500 AD.

    I can’t claim to have the read that book (although I probably should — thanks for the tip for that), but according to Maddisson’s obit in the New York Times, “He argued that per capita income around the globe had remained largely stagnant from about 1000 to 1820, after which the world became exponentially richer and life expectancies surged.”

  81. i wouldn’t have ANY gold if i didn’t believe a double dip and a bad one. what happens when the 1$tril euro bailout runs out in a year? you think the germans are going to throw good money after bad? i don’t. the can has been kicked down the road all over the world.

    everyone from bernanke to osbourne doesn’t understand issuers of soveriegn paper are not revenue constrained as long as money velocity doesn’t go hyper. something TPC and i(thanks to him) understand. this ensures deepening further problems……BIG ones.

    like it love it hate it or say its meaningless and an archaic relic but gold is still the asset(and there would just be something else if it didn’t exist) of last resort…….and financially that is where we are going.

    if you think everything is going to be fine without a convulsion………… great….buy IBM

    we are in the early stage of this financial collapse, not the end of it.

  82. anonymoose

    Interesting but since the recession started I hear every day that the Dollar is going down the tube. It’s at about the same place it was in 2008 in relation to most currency except that I can buy two homes instead of one, 73% more oil, 50% more natural gas and actually cash as done much better then the market even at 0%

    But Gold did very well so we are both happy.

  83. Argentina and Russia are either IMF poster children or were pegged to the USD. They gave up their moentary sovereignty. The fact that Russia defaulted on its rouble denominated debt was due to pure ignorance, but if you want to chalk that up as an actual default then I’ll submit. But for your one default of a country (which is still arguable because they did not have true monetary sovereignty) I can name hundreds and perhaps thousands of defaults that have occurred due to single currency systems and or the gold standard….

  84. Russia was pegged to a basket of currencies, the Argentinian Peso to the dollar. Does that really matter? Of course it does, as long as the peg holds. Argentina broke the peg, carried through a compulsory conversion of dollars to the new peso and defaulted on its bonds.

    What I am trying to say is really this: your statement that any country able and willing to print money will never default on its debt is in my opinion counterfactual. I think that any country, faced with domestic political pressures (whatever they may be) will default on its debts, as long as the perceived economical and political benefits in the short and medium term outweigh the costs.

    While Russia may have done a stupid thing from an economical viewpoint in 1998, from a political viewpoint it was a masterstroke.

  85. A peg effectively relinquishes monetary sovereignty so yes it matters quite a bit. If I have given you the impression that the Japan and USA scenarios are applicable to all countries then I am sorry. That is not my intention. Obviously, there are countries who simply are not in a position of economic power to simply start printing up a currency. If it was that easy then we’d all do it. At the end of the day some real economic output has to back that currency. Zimbabwe is a great example of a nation whose economy was in tatters and ultimately succumbed to a total lack of output. The hyperinflation really initiated in its economic decline. The currency printing was merely a response to an already horrible situation.

    Ultimately though my point is valid – all nations should desire monetary sovereignty. Pegs rarely turn out well and relying on a foreign central bank to live is never a good strategy. Your example of Russia is actually a good one. Things did not really stabilize in Russia until they removed the peg and took back control of their money.

    I hope that clarifies my thinking on this.

  86. Dear Angry, Dude, i can tell why you are so angry. Makes you mad to have to deal with us lowly cretins who have no understanding of how the world REALLY operates like you do. Actually you have a lot of valid points on the economy and fiat money as opposed to hard currencies. In no way is either side a cut and clean prospect. Both systems have inherent flaws. I don’t think any gold bug ever said that the world was a utopia when it was on the gold standard (all right, some of them may have implied that it was). Obviously if someone wants to be corrupt bad enough they will be (Josef Stalin, Woodrow Wilson come to mind). But just because people believe differently than you do about the economy and currency does not mean that we all just crawled out of caves and eat our food from a trough. Just a quick glance through any top finacial web sites will show that many apparently intelligent people believe in hard currency, if only for a profit, (like me). Also if gold is so irrelevant to life today, why is there so much energy put into keeping the price down through leasing and derivitives. You can be right and still be wrong. Give us poor ignorant gold bugs just a little slack. We not going to be taking over anytime soon that’s for sure.

  87. Also if gold is so irrelevant to life today, why is there so much energy put into keeping the price down through leasing and derivitives. TNO

    Central bankers love gold as a fall back position to fiat. If the population worships that shiny metal then it makes them easier to control. The only thing the PTB and their bankers can’t control (by definition) is liberty which I advocate. But hey, let the rest of the world adopt a gold standard; the US will survive with liberty and the rule of law, Lord willing.

  88. “All nations should desire monetary sovereignty”

    That statement is very true. But how can it be achieved? In my opinion the ultimate sovereignty consists in the willingness of civilians and companies to relinquish some of their income to the state, because the state uses it for the benefit of all.

    At the same time a currency peg is an (imperfect) insurance that politicians will not abuse their printing & spending powers at the expense of the civilians.

    Once the insurance is too costly, (i.e. the politicians have failed to adjust their printing and spending powers to match those of the pegged currency AND the market has noticed) the peg will go.

    On the point of the currency peg: a peg is a political decision. It can be reversed, so in a sense no currency is really pegged, not even a single currency. That is something that is not understood very well actually (by the msm, the bond markets understand it perfectly well).

  89. There is a reason why the rise of Marxism accompanied the rise of the Industrial Revolution; because things sucked for a lot of people. Folks weren’t joining labor unions and demanding social services in the early 20th century just for the hell of it. Angry MBA

    Actually, the Industrial Revolution and government backed fractional reserve banking (BOE 1694) got started around the same time. One is based on the effective use of energy (the steam engine) and the other is based on systematic theft of purchasing power. The Industrial Revolution was thus financed with stolen purchasing power. It’s no wonder then that misery resulted. Government backed FRL continues to cause misery to this very day.

  90. It is amazing to read the media being happy that there is some consumer’s price inflation. Thank God my new car will cost more. Are we going nuts or what?

    A bit of inflation is a good thing. It’s a sign of economic activity.

    Too much inflation is bad, of course. But so are disinflation and deflation.

    The belief that all inflation is a problem is commonly held, but it is wrong. It is not possible to have a healthy market economy without a bit of inflation to accompany it; that inflation is a sign of the cycle in action, and should end up in peoples’ paychecks (and more people getting paychecks).

  91. So, it sounds to me as if you feel our fiat monetary system requires some inflation (which the fed can control) to be “well-greased”; but deflation (which the fed can’t control when it’s already at 0%) is its nemesis. It also seems that you do not see any likelihood of any kind of US monetary collapse, no matter how much debt we acquire.
    If I may wax philosophical: if our money is backed by the full faith of the government (and the people are the government), then loss of faith in the government (or its monetary system) by the people would be the death-blow to our monetary system. Could this be the most likely worst possible consequence of our national debt?
    I can now see why our monetary system is so complicated: if people understood it, they would lose “the faith”.

  92. I think the reference to inflation is perhaps misleading. We need to increase the money supply over time because there are more people, more productivity, etc. This is not necessarily inflationary in that it is destroying our standard of living. In this regard I think Milton Friedman’s comments are misleading. Inflation is not always and everywhere a monetary phenomenon. Inflation is always and everywhere a transfer of wealth.

    Your philosophical comment is dead on. The currency is enforced by the US govt, but people must accept it as well. If they lose faith in it or there is no reason to use it (loss of productivity for example) then the system collapses. So yes, it is a faith based system, but is generally backed by real productivity and output. Betting against American output over time has been a bad idea. That’s not to say it won’t always be that way, but it looks like a bad bet to me for the next few decades at least….

    Hope that clarifies my thinking. Thanks.

  93. The US has no foreign debt right now, but that situation could change very suddenly. Those who sell us oil could demand payment in something other than dollars. The only things that have prevented this from happening are the massive US military power, and the lack of a suitable alternative to the dollar. The thing that could cause a sudden change is a deployment by China of massive numbers of their new carrier killer missile. Once China can kill US carriers at a distance of 5000 miles at will, and demonstrates this power on a couple of US carriers, our ability to project power will be gone. Once they do this and the US does absolutely nothing in response, geopolitics will change overnight. And the US will do nothing, because the only option to do something will be nuclear war. Now the RMB will become a serious reserve currency, and oil will be sold in Yuan.

    People do not fully appreciate how much our reserve currency status depends on the ability to project power with our aircraft carrier groups.

  94. No major country can link their currency to gold. There simply isn’t enough gold.

    Unless someone finds the true mother lode of undiscovered gold. Fat chance of that happening anytime soon.

  95. The Fed knows full well that they control the entire yield curve, because they did this in WW II. The Fed held all LT interest rates at 2% in order to keep the war funding costs manageable for the US Government. It is purely a policy decision to leave LT rates to the market. It is probably done to prevent excessive inflation during normal times by forcing the government to limit its spending. But world wars, great depressions, and great recessions are not normal times.

  96. The EU does have one central bank. I am beginning to wonder how much the lack of a true federal government matters as long as the ECB can monetize state debt outright, and can do so without limit. As I see it, the primary risk is political. It is possible for key powerful states such as Germany to secede from the EU, despite the horrendous costs for doing so. So, how much monetization of Greek and Irish debt can the ECB get away with before the German voter says enough, and makes a credible threat to kill the EU by pulling out? The markets understand this, which is why the ECB has to be cautious in order to have “credibility” with the markets. “Credibility” means the ECB can’t afford to get out too far on a limb ahead of the German voter.

  97. Really? He can only be reelected once anyway. If he can blame a Republican Congress for high UE, and the Republicans nominate a poor candidate, he might just squeak by in 2012. Especially if he naturalizes about 10 million illegals. By the looks of it, Obama wants to have a Republican Congress next year, but his party’s ground game might just be good enough to prevent this from happening.

    In any case, Obama has not given me the slightest indication that he cares a rat’s rear about unemployment, except where union jobs are concerned.