THOSE DREADED BOND VIGILANTES ARE COMING!
Alan Greenspan was on CNBC this past Friday saying that he’s worried the markets will revolt against the US government and the dreaded bond vigilantes will attack sending yields shooting higher and sending the USA into some source of downward spiral similar to Greece. CNBC reports:
The former central bank leader — nicknamed “The Maestro” by his supporters — said he worries the current economy could be heading on a path similar to 1979, when the 10-year Treasury note was yielding around 9 percent before surging dramatically, gaining 4 percentage points in just a few months.
“I listen to a lot of what people say that we don’t have to worry. We can do it in our own time,” Greenspan said in regard to trying to bring down Washington’s $1.2 trillion budget gap. “Good luck. The markets have not been told this.”
Dr. Greenspan’s been saying this for a long time now and I’ve been taking the other side of this coin for a long time. The difference in opinions is quite simple. So bear with me while I elaborate a bit. The United States Treasury has a very unique relationship with its banks and Central Bank due to political unity. While it’s true that the US Treasury must always have funds in its account at the Fed, it’s also true that the Treasury will never have trouble procuring funds to credit this account. It’s a simple process. The Fed and Treasury have a symbiotic relationship in which they coordinate their actions. The debate over Fed “independence” is a semantic one. Whether you want to call the Fed “independent” or not doesn’t accurately portray the reality that the Fed works very closely with the Treasury to ensure that funding is always available. And they do this by harnessing the private banks as agents of the government. The Primary Dealers are required to bid at US Treasury auctions. That’s just part of the gig. And so long as the Fed is coordinating their actions with the Primary Dealers (which they do daily) then we shouldn’t expect Treasury bond auctions to fail (these are well coordinated events designed NOT TO FAIL).
So what’s the key for bond investors? Well, they know that they never have to worry about getting paid by the US Treasury (unless Congress decides to default via some silly self imposed constraint like the debt ceiling). It’s also important to note that this is nothing like Europe where there is no political unity between the governments and the ECB. It’s a design flaw that creates a solvency risk. What Europe really needs is an autonomous currency issuer either in the form of each nation having its own currency (and control of that currency) or some form of US of Europe.
Now, to be clear, there is a form of solvency risk in the USA which could send rates shooting higher. And it comes in the form of inflation. But this is a very different constraint than the solvency constraint that many assume exists in the USA. In the USA, with high unemployment, low capacity utilization, stagnant wages and a persistent balance sheet recession (de-leveraging) there is no fuel for very high inflation like we had in 1979. I’ve been downplaying the potential for high inflation or hyperinflation for 5 years now. It’s just not happening! The de-leveraging is barely being offset by the government budget deficit (which is slowly shrinking now). Of course, that doesn’t mean it can’t happen, but we have to understand that the most likely causes of higher inflation would be the following:
- A big economic boom resulting in higher wages, lower unemployment, pricing power, etc (Did he say “economic boom”, hahaha – seriously, given the mounting headwinds, it’s just not happening – I wish I was wrong about this one).
- A supply side shock in the oil market reverberating through the economy and likely ending in recession (not out of the realm of possibility, but looking increasingly less likely given the weakness in the global economy).
- A colossal collapse in domestic production (not happening).
What about hyperinflation? Well, you might be interested in reading my paper on this because I’ve found that hyperinflation is a very unusual phenomenon that occurs in specific instances. None of which currently applies to the USA. This is another event I’ve been downplaying for years now (not to toot my own horn, I get plenty wrong, but I’ve been very right on much of what’s being discussed in this story)….The bottom line is, the reasoning behind the argument for surging interest rates just doesn’t add up. If anything, we’re looking more and more Japanese and not Greek.
* I would highly recommend reading my paper on the monetary system to better understand all of this. It’s absolutely crucial to your understanding of the macro and micro understandings of the world. And always feel free to email me or leave questions. I’ll be back this Friday with a Q&A so feel free to queue those questions up…..
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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85 Comments
It’s always fun to throw in some results of recent bond auctions for added effect. Here’s the latest 30yr;
http://www.treasurydirect.gov/instit/annceresult/press/preanre/2012/R_20120510_1.pdf
PDs bidding at over 1.5x the final amount on 3% 30yr debt.
Yea, imminent bankruptcy and such…
A supply shock in oil is more likely than you think. I agree that the weakness in China and India, and more fuel efficient cars in the USA, will forestall an oil shock for at least a few years. However, the depletion of conventional oil is inexorable, and we will hit the wall one day. I don’t know when this happens, but it will happen.
True. I could be wrong here….
Hello Andrew,
I am in the oil business and can assure you that if oil were to go parabolic, there are many options that are coming online in the US that will ameliorate any supply shock. With the amount of natural gas coming online and new gas to gasoline plants announced, and the tar sand production that is being de-bottle-necked in Canada, this country wont be hit for the next 10 to 30 years. By then, electric cars will be the rage and some smart sparks will have some Thorium based nuke plants to take care of them.
Given the falling oil demand and the rising production of fuels in the USA, I think Cullen’s “supply shock” is more of an Iran-Israel armed conflict than a “peak oil” issue.
I’m sure I know far less about the banking/monetary system than most readers here, so my understanding probably has some holes in it, but….
In my view, the 2008 bailout was done to save the Primary Dealers. As you write, the PDs are required to bid at US Treasury auctions. But what if the the PDs go bankrupt? Then who will buy the bonds? Is it possible to think of a scenario with some degree of possibility in which the primary dealers become insolvent? If the PDs are levered up with derivatives and there is another systemic crash and there is no political will to bail them out again, then what is the result? Would the Fed simply then print the dollars to buy the bonds? If yes, then wouldn’t that scenario cause hyperinflation? Or would the Fed bail them out again? This would not cause hyperinflation, but it would again be a huge expansion of the Fed balance sheet.
So the whole game for the Fed and the US gov’t is to keep the PDs alive, even if they have to give them the money to keep them in business (which was what the 2008 bail out was all about). Isn’t this what the policy decisions are all about? The Fed is not looking directly at the Dow, but at how the level of the Dow will effect the PDs?
Is this a correct view of the system?
If a PD blows themselves up they can kicked out of one of the most privileged clubs in the world….. and another bank replaces them.
PD’s get reserves from the Fed to buy the bonds, and the fed cant run out of money.
The PD could also borrow from its banking arm to purchase bonds. The Fed just needs to settle transactions. It doesn’t need to provide the money. This has been hotly debated at the MMR website where some of the MMRists have noted that MMT’s “spend first” description is not totally accurate. The private sector can and does borrow from itself to create money to buy government bonds. All the central bank does it help make sure the banks can settle payments if needed and meet reserve requirements.
Currency issuer or C. user, it doesn’t matter. When the FED monetizes debt/”"prints”" money then it effectively buys US T-bonds. But the Treasury still has to cough up the money (from taxrevenues) to pay the FED the interest on those T-bonds held by the FED. Otherwise the FED will face a liquidity crisis. Then the FED would go bankrupt.
The most destructive thing about rising interest rates today is that households and companies will have to pay those higher interest rates. Those “currency users” have benefited from 1981 up to 2007/2008 from interest rates going lower and lower. It allowed them to go deeper and deeper into debt. And higher interest rates will have a negative impact on taxrevenues.
Yes, Primary dealers are required to bid for T-bonds. And then they sell those T-bonds to other investors. But when the primary dealers can’t find any buyers anymore then those primary dealers are forced to sell other assets, like e.g. older T-bonds, corporate bonds, muni bonds. And selling those bonds means higher rates for corporations, municipalities. And that has a negative impact on taxrevenues in the economy.
Guess what would happen when (not IF) the US Trade deficit disappears. Then foreign demand for T-bonds would drop to zero.
Yes, the FED can monetize the whole “kit caboodle”, but it’s merely a matter of “”kick the can down the road” even more. But sooner or later the road WILL end. And then the financial pain will be much severe. And that’s why it’s better to take the pain now instead of “kicking the can down the road” more.
About Hyperinflaion:
In 2007 and 2008 some $ 12 trillion in wealth disappeared and then the Hyper-inflationistas think that “printing” a “mere” $ 1 trillion can/will cause Hyperinflation. Absurd.
Mr. Market says: — Currency issuer or C. user, it doesn’t matter. When the FED monetizes debt/””prints”” money then it effectively buys US T-bonds. But the Treasury still has to cough up the money (from taxrevenues) to pay the FED the interest on those T-bonds held by the FED. Otherwise the FED will face a liquidity crisis. Then the FED would go bankrupt.
The taxpayer doesn’t pay the interest on Bonds that the FED holds, as the FED reverts the interest payments right back to the US Trsy.
The FED can not go bankrupt as the FED can print (digitize) unlimited amounts of money by having the control of the printing press passed to them by the FRA 1913.
“…. otherwise the Fed will face a liquidity crisis”. LOL. How does a printing press face a liquidity crisis?
As mentioned many times before on this blog, the FED doesn’t create money, it creates credit/debt. And all that debt needs to be repaid or rolled over, and, most importantly, serviced (=paying interest on the debt). And when even the Government can’t service or repay its debt anymore then the gig is up. And that’s the point where the bond vigilantes show up. And the FED faces a liquidity crisis.
Yes, the FED can literally print tonnes of new banknotes like in Weimar Germany. but it won’t do so until the entire/most of the credit market has collapsed. Because printing tonnes of banknotes would let sink the USD (=deflationary in the current situation) and it would let the credit markets collapse as well (=deflation).
Credit is money. Sometimes I wonder if you even read the website or just repeat neoliberal myths here….
You believe credit is money. Saying it as if it’s an established fact is a mistake. Merely writing about it does not make it true.
I, and many others, disagree with such a statement. By the common definitions, and common uses, of credit & money they are not the same.
It’s not hard to prove. I can go to the bank this afternoon and obtain credit to go purchase just about anything I want (well, not ANYTHING!). So unless your definition of money falls outside its primary role (as a medium of exchange) then you’re just not right. So it’s not just that I believe credit is money. It’s that anyone I introduce my bank account to will agree with me and try to obtain my credits in exchange for something of relative value.
Second, in your example, you have not actually exchanged anything. You’ve received goods, there are 2 credit relationships created, one between you and the bank, and a second between the bank and the seller. Unless the bank goes bankrupt, the seller gets his money, regardless of whether you pay the bank back or not.
An even simpler example can be used to show how the proof is wrong. Skip the bank entirely and set up a credit account directly with the seller. You go into the shop each day and receive the goods you desire, the seller notes it in a leger entry. At the end of the month you go in and give the seller money and the transactions are settled. Money is transfered once a month, while credit is created daily.
Money is used to extinguish a credit relationship. It is not the same as credit.
Where does most of the “money” come from to “extinguish a credit relationship” in a fiat monetary system? It comes from banks crediting bank accounts with what you’re referring to as “money”. When I walk in the store to “pay back” the store owner I will have almost certainly obtained credits from someone else in the economy in order to transfer them to the store owner where he will debit my account and credit his own. Most money is credit.
First, a medium of exchange is only ONE OF the requirements for something to be money, many things can be a medium of exchange without being money. An airplane ticket is a medium of exchange (you give it to an airline and they give you a seat on a plane), but it is not money.
True, but it is the primary factor determining what is and what isn’t money.
An airline ticket is not a medium of exchange. It is a proof of purchase, like a theater ticket. The airline does not want your ticket back. They want the money you paid with in advance (which is most often in credit form). If you don’t show up with the airline ticket they still take your credits from you.
Actually both are mediums of exchange, a theater ticket is probably a better example, as they are usually transferable, and they are required for entry, and if you lose it it’s usually not recoverable.
I disagree that being a medium of exchange is the primary, it is one of the primary criteria, all of which are necessary.
And credit isn’t even a medium of exchanges, it’s a means of delaying exchange. Credit and money are not the same.
Where do you think most of the money in our economy comes from? It comes from banks crediting bank accounts through loans. That’s how our monetary system works.
I’m not clear on how that’s relevant in a discussion of whether money and credit are the same. Both existed long before banks did.
Exactly. Money is credit. A bond. Money is broadly found in social primitive animals. They exchange things based on social needs. You groom me, I’ll have sex with you later. You have sex with me, you take care of my kids, I’ll make sure that other big meat head ape doesn’t come in and kill the kid. That kind of thing. It’s all credit. Societal bonds. Promises that have to be upheld. Break your promise in a primitive society and you get killed or kicked out of the society. We’re a bit more advanced now, but not by much….Modern money is just a tool taking unspoken bonds to an organized institution.
Just stating they are the same over and over does not make it true.
I’ve already shown differences between money and credit, and things that are different cannot be the same. You need to now show how my differences are actually not true in order to continue to credibly say money and credit are the same.
Both money and credit require society, but they have different roles and functions in society. Credit requires 2 distinct entities (and their mutual agreement) in that society to exist, while money does not.
Your example above is another example of the difference between credit and money. It’s actually a barter society, with credit, but no money. There is no unit of accounting. And even in a more advanced barter society there can still be credit with no money. I give you 5 chickens, or 10 potatoes today, and you give me 1 goat next year: credit, but no money.
Money and credit are certainly closely related, but they are different.
Are you saying that money can exist in a 1 person economy? I guess technically it can, but who cares? The reason why money is a formalized institution is because the society that creates specific forms of money (such as the USD) uses it for societal purposes (primarily in the arena of exchange).
You seem to be making some weird individualistic argument about money as though you can go out to the desert by yourself and deem rocks money. Sure you can. But who cares. Not the rest of us. You say credit is not money. Except we keep borrowing money from banks and settling payments in this borrowed money every single day. Credit is the primary form of money in a fiat monetary system. I don’t know how anyone can deny this….It’s just a fact of life.
This is our reality:
http://research.stlouisfed.org/fred2/series/TCMDO
Of course not, and I’m not really clear on how you came to such a conclusion. There’s no exchange between an individual so there can be no money.
Borrowing money does not mean that credit and money are the same thing. I can borrow a car, does that mean cars and credit are the same thing? Of course not.
What I said is that money is always posessed by a single entity (being a real person, or legal construct), while credit is always a relationship between 2 entities. That is just one of the differences between money and credit.
Credit and money are closely related, but they have different purposes, roles, and accepted definitions. If there are differences, then they are not the same thing. I’ve shown that there are differences, therefore I’ve shown that they are not the same thing.
You keep saying that money is possessed by a single entity. So what? The only reason you possess money is to you can exchange it with someone else. Money is a tool for achieving social needs. If you don’t involve that other entity then there’s no reason for it to exist. You’ve admitted this. Money does not exist so you can hoard it all and hide out in a bunker somewhere with it. It exists so you can transact business with other entities. When I walk into a gas station with cash I am the only one holding that money. But when I pump gas into my car I am expecting that Exxon is giving me real gas (and not water or something else) in exchange for payment. You might not think of this as a credit (coming from the latin word credere for faith), but it most certainly is. You’re putting your faith in Exxon that they give you gas that will power your car. And if they didn’t give you gas you’d sue them and get your money back. All of these exchanges are faith based transactions. And money/credit exists as a tool to make these transactions possible. The unit of account is simply a way to track these transactions. And the store of value is simply to ensure that this money will have future PURCHASING power (purchasing, as in, involving other entities).
Yes, I certainly respect your opinion, even if I don’t agree with all of them!
Anyway, I go by the standard? definition:
Money is a medium of exchange, a unit of account, a standard of deferred payment, and a store of value.
Further, money is a concept, and then there are things (or nothing) that represents that concept. In the real world there is no perfect money, but there are things that are better monies than others. And that can, and generally does change over time.
The perfect money would never fluctuate in value, and would always be sufficiently available for the needs of the economy. It would be equally available to all (not in the sense of free money, but as compared to gold, which is not equally distributed around the world), but impossible to counterfeit, and it would be indestructible. There’s probably other criteria as well, but that’s a decent start.
Gold is money, but less so than it once was. The dollar, and euro, and some othes are also money, but not very good money as they don’t store value well (amongst other reasons).
I also believe that having the same thing being money and currency at the same time is bad, which is one of the reasons why the dollar is not a good money. It’s also the reason a gold standard is bad, as it tries to make gold both money and currency.
Thanks Patrick. I certainly don’t have all the answers to everything so don’t take my above comments as implying such.
I think gold is a fairly good example. To me, gold is money because it meets the criteria you describe. But it’s a bad form of money because it doesn’t meet the primary purpose of money to the degree that other forms of money do. That is, it’s a poor medium of exchange. It’s A medium of exchange. but not a good one. I can’t walk into Wal-Mart or really any store with it and use it. To me, the medium of exchange feature of money is the overriding factor. The other components such as unit of account and store of value are secondary features. After all, if you can’t exchange money for goods and services then what good is it really? Not much….
My pleasure, I love these types of conversations, and I know I’m far from an expert, I always see it as opportunity to learn more, and I definitely learn a lot from your postings.
We touched this above for a bit, but here is another area where we disagree. To me the primary purpose of money is a store of value, and the medium of exchange aspect is secondary (but still necessary). The store of value is the main difference between money and currency. Money doesn’t need to be an excellent medium of exchange when there is a good currency available. Most transaction will be handled via the currency, and money is only exchanged periodically to “realize” the surplus or deficit. Aka, people would use dollars for day to day transactions, and if at the end of the month you have dollars left over you convert them into gold, or whatever other money is desired, as savings. Even further, the money need not be physically transferred even that often, you simply inform your banker that you would like your dollars converted into your gold savings, and nothing physically moves. It only need be moved if you lose faith in your banker or need to use it for a large purchase. So dollars/ currency are used on a daily basis, and gold/ money is only used periodically or for large transactions.
More examples of differences:
Credit requires 2 parties, money does not.
Money can be stolen, credit cannot.
The entire reason “money” exists in the first place is to satisfy the social needs of its users through exchange. The unit of account designation is an evolved tracking of this money system. And the store of value designation is a newer necessity defining the moneyness of certain things in a financial economy. The medium of exchange overrides all of these other factors in terms of importance and basic economic necessity. Without exchange, there is no need for a unit of account or a store of value. Unless you collect things by yourself in a bunker, which I doubt you do.
And I disagree, credit can most certainly be stolen. Borrow money from someone and don’t pay it back. You might as well have stolen something of equal value from them.
Being a medium of exchange is not sufficient for something to be money, so to me it’s irrelevant whether it’s the first most important element, or the last most important. It’s insufficient alone. Many things can be mediums of exchange, but not be money. It is necessary for money that it be a medium of exchange, but it is not sufficient to make it money.
Failing to honor ones credit/ debt obligation is not theft, it’s defaut, and defaulting does not extinguish the relationship, it can only be extinguished by fulfilling the agreement, agreement to new terms by both parties, or the social framework built around it. I do understand that it doesn’t feel any different to the party who has lost! but societies, both ancient and modern, recognize there being a difference. Today the social framework is bankruptcy, in the past it was improsonment, or other punishments. It is different from theft.
When something is stolen, you do not get to seize other assets from the thief if they no longer have your stolen goods, but you can recover them from other parties if they are found in their possetion. On the other hand, if the defaultor has transfered your goods to a 3rd party they are no longer available for recovery, but you can take other assets from the defaultor that had nothing to do with the original transaction. Now these rules may change over time, but the point is that they are social constructs, and if society treats them differently, then they are different.
I can see we’re not going to agree here. Which is fine.
So what is your definition of money? And what are some examples of things that would meet this criteria?
Oops, I pasted in the wrong order, sorry for any confusion.
Mr. Market is a troll, CR. He refuses to engage in any constructive dialogue, simply repeating his same tired points over and over again.
1. Money is a medium of exchange.
2. Credit is the right to access money. (to demand the money lent)
3. Debt is the obligation to repay money (+ interest).
Source: Robert Prechter (“”Conquer the Crash”", page 87).
When the FED “”prints”" money it effectively buys debt (toxic waste, T-bonds, etc.), it becomes the creditor for e.g. the government. The Treasury is the debtor and has to repay/roll over those T-bonds and pay interest on those T-bonds, to the FED. And where does the Treasury gets its money from ? Never heard of a thing called “taxes” ?
Yes, the FED can “print” more money. But that allows the government to go deeper into debt but then that government needs to roll over more debt and pay more interest in the future. That’s a matter of “”kick the can down the road”" even more. But sooner or later that road WILL come to an end when (NOT IF) it dawns on the investors of T-bonds that the debt service burden becomes too large.
The holders of US banknotes are the creditors of the debtor called the FED. So, the USD is backed by the FED’s credibility and the FED is backed by the T-bonds of the US government. So, the credibility of the USD is based on the ability of the US government to service its debts.
That’s why – IMO – Greenspan is so worried. He simply gets it.
Eliminate in this story above the words FED and then you’ll get the situation in Greece. In this regard the FED in the US is merely the middle man. And that’s where – IMO – both MMR & MMT go “”off the rails”".
Is it just me who get the feeling that Mr. Market is a bot?
LOL again Mr Market “And when even the Government can’t service or repay its debt anymore then the gig is up”. Why do you kepp repeating your nonsense? Why not read Cullen’s work, or that of any MMT blog or monetaryrealism? The gov can ALWAYS service it’s debt, and NEVER has to be paid back. I just love “the gig is up”. Really? Kablooey, huh? LOL.
Precisely. The US gov’t simply can’t repay its massive debts. So, it’s going to default on its debts.
Mr Market, the broken record troll.
LOL. Yes, I like pizza too.
What if inflation takes off? Let’s say there is an oil shock, for example.
What policy actions would the Fed best take in that instance?
….
I’m coming around to the possibility that rates are going to zero. That would be the logical conclusion to monetizing government spending to combat deflation.
I could even see a bizarre situation in which prices rise, wages remain flat and interest rates stay at zero.
At this point, there is no way the Fed can let the interest rates rise. This is not related to the economy or the inflation. It has to do with the still fragile financial situation of banks and loans. Increasing rates would push “marginal” borrowers off the cliff and trigger another wave of defaults at the least desirable time, not to mention the unknown consequences on the books of many banks. You can recognize a liquidity trap when you see one …
“Now, to be clear, there is a form of solvency risk in the USA which could send rates shooting higher. And it comes in the form of inflation. But this is a very different constraint than the solvency constraint that many assume exists in the USA. In the USA, with high unemployment, low capacity utilization, stagnant wages and a persistent balance sheet recession (de-leveraging) there is no fuel for very high inflation like we had in 1979.”
And I think Bernanke is aware that you don’t combat cost-push inflation (such as from an oil shock) by raising interest rates. That would be a ridiculous response. If people started selling bonds en masse the Fed could buy them. They set interest rates across the entire yield curve through OMO, and they’re not about to let mortgage rates go to the moon.
Help me understand how the Fed can keep mortgage rates low if a bank or S&L believes it needs higher rates to be profitable?
Fed controls the prime rate, individual banks add as much margin as they think the can to stay both competitive and profitable. They are following the fed, not leading them.
If an institution makes a 30-year mortgage loan at 4 pct and then rates go back to 6 or more, is the institution then sitting on a loan it can’t sell, or has to carry as a losing proposition?
Yes, and TRYING to front-run the Fed when communications are clear. Think of the bond market as a dog on a leash. Communications let the leash out. And it gets yanked back in when necessary….
I noticed you used very careful wording in this post. You didn’t simply say that “the US govt is a currency issuer and therefore can’t run out of money”. Instead, you outlined the specific relationship between the Treasury, the Fed and the Primary Dealers. Although the general message is the same, the language is tighter, and the argument is more sophisticated and nuanced. Although newer readers might prefer the more general, base message, I think your longer-time readers appreciate that you are taking it up a notch
Glad some people are noticing.
The details really matter here. I’ve been very loosey goosey in the use of some metaphors and terminology in the past. JKH has really straightened me out there. Precision is necessary when discussing these things. Hopefully, MMR provides people with a better understanding by avoiding vague descriptions that might help with understanding, but could actually confuse on the details.
I’ve also tightened it up in my MMR paper. I’d recommend people have a closer read if they’re really interested. The MMR recommended readings are also good. Though some of them are quite wonky. The recent ones by JKH have been described as “masterpieces” and “the industry standard” by other economists (and please note, I am not an economist, just an investment manager who plays an economist on TV!).
http://pragcap.com/understand-the-modern-monetary-system/mmr-recommended-reading
Any idea what caused the interest rate spoke in 1979 that Greenspan fears–ie how is today’s environment?
I second Geoff’s comments Cullen – stunning job, very impressed with the new discipline
Thanks! I really can’t stress enough how important JKH’s work is. He has seamlessly taken the best parts of MMT (the parts we all like like the understandings of being a currency issuer) and meshed it beautifully with the actual operational realities. It’s really brilliant work. It takes a while to digest some of it, but it’s well worth the effort if you’re really trying to understand our approach and the operational realities. I’ve contributed some of the bigger picture concepts (like the idea of time and how entrepreneurs expand the coin, etc), but he’s really tied the pieces together on the operational side. MMR could be a huge break through approach in economics if people start to use it. Our unbiased operationally focused approach is totally unique….
Credit money is a euphemism. Better to call it debt money.
If PDs are required to buy Treasuries, they are forced to buy them.
Each successful auction where the PDs buy Treasuries is a failed auction; real investors didn’t buy all the offering. The inventory of Treasuries the PDs are carrying is probably big enough that the Fed will have to do more QE to reduce their inventories. Then the PDs can buy more Treasuries since investors won’t buy them all.
Completely ignored is the consequences of all the debt money in circulation. Too much money is out there and it chases the same rates of return thus reducing those rates. Didn’t anybody hear of mal investments and risky investments.
All this debt money is a bail out of congress which won’t and can’t institute structural economic reforms.
Money is credit. It has been thus since the dawn of civilization. Whether you believe that money later became controlled by the State (aka Chartalism) or by the private sector , it doesn’t change the fact that money is credit. Therefore, it seems to me that both the MMR and MMT folks are on the same page on this issue.
To a large degree yes. I don’t really like the way MMT says money is a state IOU though. Settlement in state money is excessively emphasized in the MMT literature even though most money is not state issued, but bank issued. They try to tie it back to the state through their hierarchy, which I think is misleading. And it all comes with the “taxes drive money” idea which I also disagree with. But those are just details beyond the scope of this discussion. Money being credit and a social construct is something we should all agree on….
Agreed! Thanks for the elaboration.
Even bank-issued money is denominated in the unit specified by government. The bank extends a loan to me in $US, and not in some private currency.
Of course. That doesn’t change anything though.
The discussion seems to reflect a fundamental difference in thinking about how words and concepts and ideas acquire meaning. Cullen is emphasizing the “pragmatic” notion that ideas acquire meaning in their consequences in action–thus, he talks about the social construct and the difference things make in action and consequence. On the other hand, the older (outmoded in my view) notion is that meaning is somehow absolute, eternally assigned in some Platonic realm, and static–thus, there is this desire for money to “store wealth,” in a way that immortalizes forever something that is really just social function.
Nope, this was not about whether meaning is absolute. Personally I don’t think money has changed in any significant way, but that has nothing to do with whether meaning is absolute.
This debate was about whether credit and money are the same, and diverged into what is the primary aspect of money. Cullen and I disagree on these issues, but I enjoyed the discussion.
The storing of value is part of money’s current definition and Cullen did not dispute this, just stated that he feels it is of secondary importance, while I think it is of primary importance. In my opinion the storing of wealth/ value is still a pretty important human desire, while the exchange aspect of money is handled quite effectively by currency, so as I’ve stated above I do not consider it to be the primary attribute of money.
Currency and money can be represented by the same thing, but personally I don’t think they should be, which is why both the current dollar as money, and the gold standard, are flawed. The dollar is a decent currency, but a bad money; while gold is a good money, but bad currency.
CR,
I am interested in your expectations of the future movement on the 10 yr treasury. We saw a ~7% decrease on Friday followed by a ~4% increase today. I know these are unique times, but holy smokes, that’s some volatility. Care to share your thougths? BTW, I ask NOT because of concerns of hyperinflation, but because I am interested in where 30yr mortgages are headed.
Thanks,
NaE
NaE, you asked where are 30-yr mortgage rates headed? Of course I can’t speak for Cullen, but I do know that his US GDP growth model is calling for a growth slowdown in 2nd half 2012 followed by a probable dip into recession in 2013. Given this slowing growth, it is reasonable to think that 30-yr mortgage rates will continue to trend down. If/when the US economy weakens, the Fed’s next step will likely be not only buying long-term Treasuries, but also buying mortgage-backed securities, which will have the effect of driving down mortage rates. Cullen, correct me if I misintepreted your work.
Thanks Larry, I appreciate your input…and excellent article you linked in your comment below too.
Slightly off topic but illustrates how federalism works and why the US states won’t go bankrupt (and why EMU needs fiscal integration on a large scale) in a good one from Krugman:
http://krugman.blogs.nytimes.com/2012/06/02/florida-versus-spain/
Good article on the Balance Sheet Recession. “Nomura’s Richard Koo has termed a “balance sheet recession.” From my perspective, it is the clearest and simplest explanation I have seen of why the economy has not bounced back as well as it has from previous recessions, as well as why we can continue to expect sluggish [if any] growth going forward.
http://seekingalpha.com/article/637771-balance-sheet-recession-ensures-slow-growth-going-forward Recommends: Utilities Select Sector SPDR ETF (XLU). Of course, we who frequent TPC are familiar with Richard Koo through Cullen.
Good article. Thanks!
Credit and debt are perfect inverses of each other. When they get together they destroy each other into nothingness. An example: I give you a chicken, then you are in debt to me for one chicken. I am the creditor and you are the debtor. If you give me the chicken back immediately, then credit and debt instantly cancel out. If you give me back my chicken in a year, then some form of interest is usually owed, maybe some eggs or baby chicks. This is how sterile money wants to grow, when it is not organic and cannot pull energy from the sun. Society is still grappling with the usury error at the root of money.
Weaker forms of money evolved to settle the space between credit and debt. At first there were marks, or tallys. Then later came tokens, which stand in for something else. The tally marks are high information, e.g. you owe me a chicken at this time. Whereas money does not have an strong information component to it. Money depends on the law and the system to infer that the information is sound. In effect money is faith in the system and laws, or force.
Fast forward to the future, and banks have injected themselves between creditor and debtor. In effect, they create money as a market to settle between debts and credits. This is where everybody gets confused, especially most neoclassical and neo liberal economists. I’m still developing this theory, but the world doesn’t have time to wait for me. Credit money circuits that have markets attached and additive feedback loops, is not a good system design, and the world is held hostage.
I’m still waiting for MMR theory to evolve; it seems you are on the right path. Keep it up. Yes, money is a social construct, but it is much more….keep digging. There is time, information, markets, and other factors behind money and not immediately obvious. Draw the loop paths and derive the equations, it will help you understand. The path money takes and its derivation point make a difference, which is why credit money is different than government money. Simply conflating them together because they mix in the supply and are good for taxes does violence.
I agree with you that hyperinflation is certainly not imminent.
But your paper on hyperinflation begs the question– why have some countries, historically, borrowed in a foreign currency?
The answer is obvious– if you can’t trust an issuer not to debase their currency, you must make them borrow in something they cannot print. At one point this was gold, but today (for countries like Argentina, Zimbabwe, etc) it is the US dollar or perhaps Euros.
Those countries do not borrow in their own currencies from foreigners because the interest rates would be too high. They didn’t have the foreign creditors trust.
What happens if our foreign creditors started to feel the same away about us? I don’t think anything of this sort is imminent, at all for a number of reasons, but what about 10, 20 years down the road? Medicare, medicaid, and SS costs look to spiral out of control and our creditors may begin to fear that we will have to run the presses. At that point they will begin to charge us higher interest rates for USD denominated debt.
Trust is one of those things that must be gained over a long period but can be shattered much more quickly.
In your paper I think you ignore the persistent, destructive inflation that has historically been present in many third world countries, which ARE driven largely by deficit spending, and the resultant money printing, and focus too much on the “hyperinflation” periods (which as you correctly point out, tend to have additional catalysts besides high deficits followed by money printing).
You keep referring to Cullen’s paper, but based on your comments it is clear you didn’t read it, or maybe skimmed it, and definitely didn’t understand it. The trust in the dollar has to do with the fact that 300 million people produce a $15t GDP vs say, China with 1.2B people and $5T GDP. Further the Chinese don’t fund the US, they simply deposit their earnings from their US trade surplus at the US treasury. Try to read his paper without preconceptions
Maybe you don’t understand the true independence of the FED AS IT CURRENTLY EXISTS.
Our money supply is FEDERAL RESERVE NOTES not US issued dollars. The US is a currency USER not a currency ISSUER. The FED is not required to fund the Treasury or buy its debt. That is not one of its mandates. This issue was last settled in 1951 with the “Accord”.
http://www.richmondfed.org/publications/research/special_reports/treasury_fed_accord/background/
“The Federal Reserve System formally committed to maintaining a low interest rate peg on government bonds in 1942 after the United States entered World War II. It did so at the request of the Treasury to allow the federal government to engage in cheaper debt financing of the war. To maintain the pegged rate, the Fed was forced to give up control of the size of its portfolio as well as the money stock. Conflict between the Treasury and the Fed came to the fore when the Treasury directed the central bank to maintain the peg after the start of the Korean War in 1950.
President Harry Truman and Secretary of the Treasury John Snyder were both strong supporters of the low interest rate peg. The President felt that it was his duty to protect patriotic citizens by not lowering the value of the bonds that they had purchased during the war. Because bond prices vary inversely with bond interest rates, a rise in interest rates would have made the same bonds purchased at the lower interest rates worth less on the government securities market. Unlike Truman and Snyder, the Federal Reserve was focused on the need to contain inflationary pressures in the economy caused by the intensification of the Korean War. Many on the Board of Governors, including Marriner Eccles, understood that the forced obligation to maintain the low peg on interest rates produced an excessive monetary expansion that caused the inflation. A fierce debate between the Fed and the Treasury then ensued as both vied for control over interest rates and U.S. monetary policy.
This website tells the story of how the Federal Reserve and the Department of the Treasury settled their dispute. The resulting agreement, known as the Treasury-Fed Accord, eliminated the obligation of the Fed to monetize the debt of the Treasury at a fixed rate. This agreement became essential to the independence of central banking and laid the foundations for the monetary policy pursued by the Federal Reserve today.”
Who should know better the FED’s view of the its independence you or Alan Greenspan ?
What this shows is that the FED is only independent as long as the US Gov’t wants it to be independent, which means it is not independent, it only has the appearance of independence. But as son as it’s no longer convenient, the independence will be revoked.
So you do agree that as we stand today, the FED is independent ?
In 1951 was it convenient or inconvenient for the FED to allow interest rates to increase ?
No, I don’t agree, I thought I was quite clear. The FED is not independent as it exists at the will of the US government.
It’s not a matter of what’s convenient for the FED, it’s what’s convenient for the US gov’t.
If you don’t like the word “convenient” then pick another one, the point is that the FED is not independent as it owes it’s existing to the government.
From Richard Fisher Dallas Fed president:
“And there is a growing sense that we are unwittingly, or worse, deliberately, monetizing the wayward ways of Congress. I believe that were we to go down the path to further accommodation at this juncture, we would not simply be pushing on a string but would be viewed as an accomplice to the mischief that has become synonymous with Washington.”
This does not sound like a guy willing to keep funding deficit spending by monetizing debt or “working closely with Treasury to make sure they always have the funding they need”. If it comes down to killing the currency or killing long bond holders I bet the bond holders go first.
1. There’s a good reason why the bond vigilantes haven’t shown up YET (!!). Keywords: Falling interest rates. Currently the US pays about the same amount of interest on its debts as in 1999. The impact of sharply rising US federal budget deficits and debts has been mitigated by falling interest rates.
In 1999 both the 10 year yield and the 3 month T-bill rate were both at about 5% or 6%. Currently the 10 year yield is under 2% and the T-bill rate is at about 0.1 (0.01 ???) percent.
2. ONE MAJOR reason the bond vigilantes will rear their ugly heads, is the mismatch between the US Trade Deficit (TD) and the US Budget Deficit (BD).
In 2007 the TD was at about $ 720 bln. and the BD was at about $ 400 ($ 500 ???) bln. This meant that foreign central banks were able to buy all US T-bonds issued in that year. And they had still some $ 320 ($ 220 ???) bln. left to buy other USD denominated securities, e.g. Agency paper.
Currently the TD is at about $ 600 bln. (annualized) but the BD has risen to about $ 1900 bln. So, foreign central banks are still able to buy $ 600 bln. worth of US T-bonds. But now the remaining ($ 1900 – $ 600 =) $1300 bln. has to funded by US investors (domestically). And that’s one force why the bond vigilantes are bound to show up somewhere in the future.
And I presume Greenspan is very well aware of the math presented above and therefore is rightfully very worried.
The story above gives also the reason why foreigners aren’t buying any Agency paper any more. If foreigners want to buy USD denominated securities then there’s ample supply of T-bonds.
You’ve been beating this drum here for 3 years….
Agree. And I will continue to do so.
Well, could you do us all a favor then and just cut and paste your repetitive rant AND our replies that debunk you?
Last (final ?) thoughts is this thread:
1. I think Benny B. (Bernanke) was the one that does here the worrying. He can’t go out and critisize his own employer. So, Greenspan was used to convey the message.
2. Currently I am short the 30 year T-bond future. But this is a short term trade. I expect another (final ?) leg up in this future. The precise shape of the line in the chart of this future in conjuncture with other markets determines what’s in store for this future.
3. Ironically, the set up of the gold and interest markets remind me of the very late 1970s and the very early 1980s.
“”History doesn’t repeat itself, but it rhymes”".
Mark Twain.
I need to elaborate. In the late 1970s and early 1980s we saw two spikes of higher interest rates. Today I expect two spikes of LOWER interest rates. And the current/recent spike lower suggests that we have seen the first spike lower.
At secular bear market bottoms the yield on (corporate) bonds is about equal to the yield on stocks. (1933, 1981) Since I expect stock prices to go (much) lower, stock yields will inevitably rise (to about 6%, what stocks yielded in 1981 and 1933). So, corporate bond yields will rise as well. A corporate bond yield of 6% would suggest that the 10 year yield ($TNX) would settle at about 4% or 5%. But that would/could be after a spike of the $TNX to, let’s say, 10%.
And up to now I still have to see the first piece of evidence that disproves this scenario. Including all the socalled “debunking” by e.g. the MMT or MMR folks.
It seems we agree, to some extent, but for different reasons. I expect yields to go down yet again as a reaction to a worsening economy (fiscal cliff, and/or euro crisis and/or china slow down), and then eventually yields will rise as the economy gets back on track. The diff of course is that you think private investors are running the show, and I think the Fed is running the show.
Even the Office of Management and Budget assumes that interest rates are going to rise in the next years. But they also assume the US economy will grow by over 2% in the next coming years.
“When the facts change I change my mind, what do you do sir”
John Maynard Keynes.
I’ll repeat why – IMO – the “bond vigilantes” will show up. Because investors will find greener pastures. And I have three examples from the past:
1. 1979: gold went throught the roof in the second half of 1979. So, investors sold T-bonds and bought gold and gold stocks. Hence the rising interest rates.
2. 1994+1995: Interest rates went up from under 7% to slightly over 8%. Pull up a chart of loans growth and you’ll see that it went through the roof as well in 1994/1995. Again, investors pulled their money out of T-bonds and invested that money into the real economy, e.g. real estate. 1994/1995 was the start of the US housing bubble which popped in 2005/2006. Mr. Jim Puplava thought the “bond vigilantes” didn’t like the spending plans of the Clinton administration in 1994/1995. But that’s nonsense.
3. Benny Bernanke monetized some $ 600 bln. worth of T-bonds in the second half of 2010. Instead of interest rates falling, interest rates went up. Investors pulled money out T-bonds and put that money in the stockmarkets (confirmed by a rising silver-gold ratio).
And now in 2012 the situation resembles what happened in 1979. Yields on T-bonds are at a record low. So, when a new asset class offers higher returns then investors flee the bond market and chase the goldstocks hihger. Pushing the vulnerable 30 year T-bond yields (much) higher.