Why the USA Isn’t Going Bankrupt….

The first question on the new Q&A page was:

“Can you explain why you don’t think the USA is going to have a Greek style debt crisis?”

Good question! This is one of those things that really confuse people because they understand how their own lives and businesses work as revenue constrained entities. But the currency issuer to household or business analogy doesn’t hold true. The reasoning is actually quite simple.

The USA has an institutional arrangement in which it is a contingent currency issuer. That is, while the Treasury is an operational currency user (meaning it must always have funds in its account at the Fed before it can spend those funds) it has the extraordinary power to tax and issue risk free bonds that the public will always desire to hold so long as inflation is not extraordinarily high. In addition, even in a worst case scenario, the US Treasury can always rely on the Federal Reserve to supply the funds necessary to fund its spending.  Therefore, the US government can be thought of as a contingent currency issuer who can issue the funds to spend.  This makes it very different from a household.

The US Treasury is a currency user, but the government as a whole can be seen as a contingent currency issuer by institutional design because of this implicit funding guarantee.  So the key here is that there’s no solvency constraint as in, “running out of money”. Greece doesn’t have this arrangement. In fact, since the ECB is essentially a foreign central bank there is a real solvency constraint. So banks and private investors have become hesitant to buy Greek bonds because of this flawed institutional arrangement and the lack of an implicit guarantee. It’s apples and oranges compared to the USA.

Of course, this means the constraint for the government is different from that of a household or business who can really “run out of money”.  The US government’s constraint is not that it will run out of funds, but that it could supply too much liquidity to the private sector thereby causing inflation.  So the US government’s real constraint is inflation and not solvency.  This is a vastly different issue than the one the US media usually harps on with regards to the budget deficit and the US government’s ability to “afford” its spending.

I would highly recommend reading the links at this page for more info.

Understanding the Modern Monetary System

Monetary Realism’s recommended reading page.


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

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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  • DanH

    Thanks Cullen. That was my question. I actually read the post by JKH last night. It’s stunning in its detail. I hope you’ll thank him for me.

  • http://www.pragcap.com Cullen Roche

    He certainly deserves the thanks. The amount of time and effort he’s put into this stuff is really remarkable. I don’t know if there are too many people who understand all of this better than he does.

  • http://trucklicense.net/get-cdl Jacko

    Bankruptcy is an admission buy an entity that it cannot pay its creditors.

    The United States will never “go bankrupt” in terms of yeah they will provide paper for paper. But you will loose value. There is no option.

  • http://www.pragcap.com Cullen Roche

    Right. But loss of purchasing power is very different from solvency. We’ve had inflation since the day the Fed came into existence. And yet our living standards have soared through the roof. The true constraint for an autonomous currency issuer is always inflation. Not solvency. So next time you hear a politicians talking about our Greek moment or our need to cut spending because we might go bankrupt, remember that they have no clue what they’re talking about.

  • hangemhi

    not just politicians but everyone in the mainstream – the media, most of the public, most economists and so-called pundits and financial gurus. John Mauldin, Kyle Bass, Peter Schiff and the list goes on… some of these guys have built their careers on being right (or claiming to have been right) about the housing bubble collapsing, and now rant on and on about US Gov debt being the same as private sector debt, and since one bubble collapsed, the other will too. The media and public eat that stuff up which makes it impossible to get most people to even entertain a conversation about this topic without them thinking you’re nuts. Reading pragcap is like therapy after frustrating conversations elsewhere where clearly no one wants to even listen.

  • Dunce Cap Aficionado

    I could not agree more about how this place feels like therapy after discussions elsewhere.

  • Don Levit

    What a relief!
    I feel so much more secure now.
    So, do you really think our living standards have improved over the last 30 years?
    Don Levit

  • KB


    While you are generally correct, the situation is not that simple. Do not forget that the market is, quite frequently, a short-term balance of supply and demand. While your thesis would work over medium and long term intervals, short-term, an excessive UST selling/absence of demand might create excessive volatility, which, coupled with (as usually:) “unexpected” swaps unwind and counterpaty failure, might lead to “2008 like credit crunches”…. And do not forget the UST market is now 24h, but Fed only open during 8-5….
    Obviously, it is not quite close to “bankruptcy”, yet the consequences might be severe.

  • KB

    Some time ago, during and after college, I lived off my credit cards. My living standards went through the roof too during those glorious times….. So bad i am not a “currency issuer”, I would have continued that for a bit longer.

  • http://www.pragcap.com Cullen Roche

    Difference is, you have to pay back your debt at some point. The currency issuer just keeps rolling it over.

  • KB

    Yes sir! we have got iPads and GPS systems in the cars! Also, some clever people got multi-year free rent for their McMansions. And do not forget new cancer therapies increasing average livespun for 0.5 – 1.5 months.

  • http://www.pragcap.com Cullen Roche

    There’s really only one situation in which the PD’s would forego their bid requirement. Hyperinflation. But again, we’re talking about an inflation constraint. Not a solvency constraint.

  • http://www.pragcap.com Cullen Roche

    Using real per capita wage and salary disbursements they’ve gone up by roughly 40% over the last 30 years. Using common sense, they’ve gone up even more. That is of course, unless you like driving around in Pintos, using rotary phones, and all the other technological delights of 1980. Personally, I’d prefer to live now than in 1980. :-)

  • KB

    Myself, being a looser, indeed had to pay. Some of my clever friends, though, left the country keeping their maxed-out credit cards (and college debt statements) as souvenirs…..

  • http://www.pragcap.com Cullen Roche

    You guys don’t really think life was better in the early 80’s than it is today? Do you? Maybe you really do. I lived in the 80’s also. They were not that cool.

  • KB

    Well, if PDs have special arrangement with the Fed, it might even include something to guarantee their bid during hyperinflation episode… Who knows….
    My concern is rather technical and related to secondary market. What if , during off hours, we would see repeated yield gyrations of more than 50 bips, or more than 100 bips? With much higher than usual volumes? What would happen to the markets then?

  • Patrick

    There are several problems with your response:

    The first issue is that countries don’t go bankrupt. Bankruptcy is a legal process which simply doesn’t exist for nations. Rather than go bankrupt, they default, and there are generally several ways they can default:

    a) Outright default, meaning they refuse to pay their loans back, or only partially pay them back.
    b) Currency devaulation. No too different from a), but generally more severe as it is accross the board and affects every currency holder, although I believe it to be healthier than default as it’s an acknowledgement that all parties will have to suffer in order to resolve the issue, and it’s a controlled situation, but can potentially get out of controlled if not managed properly.
    c) Inflate the debt away with high, but controlled, inflation for a number of years. This is a sneakier method, but if handled properly can be a viable solution, which appears better than the two above as it can be argued that it’s not a default at all. In my opinion it is, but a slow default which is not obvious. The biggest problem with this approach is that it’s very difficult to control and if you lose control you can get:
    d) hyperinflation, generally the worst case scenario as it is almost always entirely uncontrolled and symbolic of a failed government/ currency.

    The U.S. is unlikely to do an outright default, as it would be too embarassing, but it may default on internal promises such as social security or other obligations which can be swept under the table of politics. The real concern is default on externally held debt, which would be catastrophic.

    In my opinion the U.S. is likely to devalue the currency withing the next 20 years (sure it’s a long time, but not far enough out for us to ignore the possibility, it could also happen much sooner). Devaluation will happen because the current value of our currency is based on the reserve status, which does not appear to have too much life left to it, a couple decades at most. China and Russia are already doing international trade without the U.S. dollar.

    The U.S. cannot inflate the debt away because we have too much of it and constantly have to roll it over. If the U.S. does not devalue (and possibly even if it does) we will have hyperinflation once the treasuries around the world start being repatriated. The only way to stop hyperinflation is to set the interest rates higher than the inflation rate, but the U.S. cannot do this as the debt service load would become higher than our ability to service it.

  • KB

    Cullen, this is the real question. The real question is, how our living standard would change over 30 years if we still lived on a “quasi” gold standard, and did not have all credit bubbles we had. How to separate growth in productivity and scientific progress from changes in fiat system? Remember, during late 1800 and early 1900, humankind had much more significant scientific and quality of life advancements than during last 30 years. Was it beause of gold standard and absence of the Fed?

  • http://www.pragcap.com Cullen Roche

    a) The USA has no foreign denominated debt. it is not going to default in currency it can create.
    b) loss of purchasing power is VERY different from default. There has been inflation in the USA since the inception of the Fed. Yet living standards have exploded higher. You have to understand that low levels of inflation are not inherently bad. I’ve been debunking this inflation/hyperinflation meme for years. It’s the myth that just never dies.

  • http://www.pragcap.com Cullen Roche

    Hard to say. Impossible really. All I know is that a gold standard imposes the same constraints that a single currency system like Europe is currently suffering. So, if you think things are bad in the USA with floating FX, then go have a visit in Greece where there is no floating FX, currency users in a single currency monetary system. It’s the closest thing we have to a modern gold standard and it’s an unmitigated disaster.

  • LVG

    People, read the links Cullen provided before making your political talking points.

  • KB

    Good comment. Some countries do go bankrupt in “traditional” ways, for that they need to loose a war.
    Besides defaulting on internal obligations like SS, USA can, under certain circumstances, refuse to pay its external debt. For that, it needs to escalate the relationship with countries/entities in question to near-war level….

  • Patrick

    The second issue is with your premise that since the primary dealers are required to bid, the bond auctions cannot fail.

    This is only true as long as the system is healthy. If the banks that are required to bid are themselves going bankrupt, then the requirement is meaningless. MF Global, Countrywide, Merrill Lynch , and Lehman Bros were all once primary dealers that failed. The current list of primary dealers are TBTF banks, foreign controlled banks, or both, meaning they will either need government support to exist, or can end their relationship with the FED, in the next crisis.

    If the investors that the primary dealers then sell to are not interested in the returns at what the primary dealers are buying at, then the primary dealers will go bankrupt, or run out of the funds to bid. Either way the auctions will eventually fail. The FED could provide the funds the PDs need, but that is only a short term solution and would be a sign of failure itself if kept on for a significant length of time.

    Thus the requirement that PDs bid would become meaningless in the scenario that would lead to some form of U.S. default.

  • KB

    Yes, with one exeption. Under a gold standard, nobody would lend to Greece at Germany rates, and absolutely nobody would lend to Greece up to the level it was able to borrow under EURO fiat.

  • David

    Living standards in the 80’s were not on par with today but they were in fact cool! Seriously, has there been an album that came out in the last 10 years that comes close to Appetite for Destruction? Even Def Leopard’s Photograph album has held up exceptionally well over the years. Our cars couldn’t go as far and a lot more people smoked, but it was still a pretty cool time.

  • http://www.pragcap.com Cullen Roche

    I’ll one up you. Let’s just go back to the 70’s and crank out some CCR. If we do enough drugs we won’t care what era we’re in. :-)

  • Patrick

    a) I didn’t say foreign denominated. Foreign owned, which there is a lot of.

    b) If by loss of purchase power you are referring to a devaluation then I disagree, and I doubt you will find any bondholders who will consider a devaluation to be different than a default.

    If you are referring to high inflation then I agree it is very debatable.

    I’m not sure why you are referring to low inflation as I didn’t say anything about that, and I don’t have any major issues with low inflation.

    I find your attempts to debunk hyperinflation unconvincing, in part for the reasons in my part 2 below.

  • http://www.pragcap.com Cullen Roche

    Yes, I already covered the hyperinflation scenario. Your big “if” scenario is filled with low probability qualifiers. I’ve written quite extensively about hyperinflation over the last 5 years. http://pragcap.com/understand-the-modern-monetary-system/understanding-hyperinflation

  • Patrick

    what political talking points might you be referring to?

  • http://www.pragcap.com Cullen Roche

    a) If China wants to be “repaid” then the US Tsy and Fed can gladly buy back their bonds and swap them out for cash. Easy.
    b) Of course. Bondholders understand that inflation is the true constraint in the USA. That’s my whole point and it’s why yields aren’t tanking or why PD’s aren’t boycotting auctions.

  • The Undergrad

    The Fed increased base money by a 1000% in 2008 but yet the money supply decrease and we saw deflation, not inflation. Simply swapping “paper for paper” won’t cause inflation because it doesn’t increase the money supply. Imagine the Fed gives you 15 trillion dollars, which you then bury into the ground. There is no fundamental economic reason the economy would see inflation for the money won’t enter the real economy, it’ll just sit there, not harming anyone, as if it were never created at all. This is why quantitative easing has been such a spectacular economic failure; the interest bearing paper that is being swapped for non-interest bearing paper never enters the real economy.

  • Patrick

    My comment about PD requirements being meaningles has nothing to do with hyperinflation. The same scenario would occur under expectations of default or devaluation, or just a return the healthy global economy if the FED did not raise rates accordingly (which it can’t due to our debt load).

    I’ll respond to hyperinflation above, where I mentioned it.

  • Patrick

    I don’t think China expects to be repaid in full.

    Yes the FED can print dollars, but not without consequence. If the FED is the only buyer of treasuries then the game is clearly over.

    I’m not sure what you part b) is referring to.

  • Wulfram

    Is there a solvency constraint other than inflation? For example, our levels of inflation may be low but we are sending a lot of claims on production overseas. So we have a large account deficit, but it leaks outside of the country.

    China is importing inflation as well as technical knowledge and human capital while we import cheap crappy goods that we toss out yearly. As a result, although the inflation numbers look benign, the effect is anything but. Over time, they will have a larger percentage of our claims on production – see any West Coast cities with foreign cash buyers.

    Fortunately, it doesn’t look like they’re any better than us at allocating capital. At least we had the good sense to build our empty boxes next to Vegas.

  • http://www.pragcap.com Cullen Roche

    Your thesis essentially comes down to “just you wait and see”….It does not appear grounded in any factual evidence or convincing explanation of potential outcomes. Perhaps you’d like to connect the dots on an actual scenario you’re envisioning?

  • http://www.pragcap.com Cullen Roche

    That’s a real production constraint. If we enter Kaldor’s “circuses of Rome” environment where we produce little, consume much and print over the demand leakages, then a high inflation becomes likely. Personally, I don’t think the USA is there (or even close), but the risk shouldn’t be entirely discounted. Either way, it’s still an inflation constraint.

  • Patrick

    I’ve read much of what you’ve written regarding hyperinflation, and remain unconvinced. I agree with much of what you write about the root causes, but you seem to not see some of them existing in the U.S. today:

    Rampant government corruption? check (How many of the responsible parties have gone to jail after the biggest financial crisis in U.S. history? S&L scandal resulted in about 800 convictions, I think the number to date is about 2-3)

    Regime change or regime collapse? That will have happened if we lose reserve status, which I believe is likely. The Chinese (and many others) have made it clear they are moving away from the dollar.

    Loss of a war. I would change this to include too many wars (which we are clearly in).

    Having said that, I don’t believe hyperinflation is guaranteed, or even the most likely scenario at this point (although high enough probability to be concerned about). I don’t even think default or devaluation are guaranteed at this point.

    But they are guaranteed if we do not change our direction. We still have some years to fix the issue, but if we haven’t fixed our major problems within about the next 5 years, preferably sooner, I think it will be too late to avoid some form of default.

  • http://None Midas II

    Cullen, I am impressed by your patience in answering the same questions over and over. Remarkable how people don’t understand what they are reading (in plain English) on your blog. Can bias be that powerful?

  • Wulfram

    I’m also concerned with the type of production we’re allocating at home. Too many claims are going to FIRE and not enough towards things that improve the quality of life.

    Also, my 20 year old wireless Uniden beats the crap out of my smartphone and 5 GHz wireless phone in voice quality, reliability and ease of use. The 21st century can pry it from my cold, lifeless hands.

  • http://www.pragcap.com Cullen Roche

    Well, I guess we’ll just have to agree to disagree. If the hyperinflation comes you can hunt me down and we can duke this out mano a mano. I will warn you though. I have a vicious little Australian Shepherd puppy and she will cuddle you to death if you get too close.

  • Patrick

    I could say the same about your thesis, which is based on the assumption that everything will continue to move smoothly and nothing will change in the world.

    I’ve actually laid out the dots above, but I’ll give it another go:

    Here is one scenario:

    A new crisis of equal or more severe than the recent 2008 one. (I think we can all agree this will happen at some point yes?)

    The U.S. PDs are all TBTF at this point, so will of course require government intervention to continue to exist.
    The other banks are foreign held, many european. Their governments determine that they can no longer afford to support the U.S. ZIRP as their own banks are failing so they remove them as PDs.
    China decides the time is right to exert it’s power and make a move for global dominance so they stop buying UST.
    Only failed banks supported by the U.S. government are buying, yet the USG/FED has less ability to prop up the banks due to 1) no longer having an external source of buyers for UST and 2) having used all it options keeping things on the rails during 2008-present.
    It becomes more and more obvious that the treasuries are only at their current values due to massive USG/FED intervention so there is less and less interest from the free market.
    The auctions may technically still happen, but it becomes obvious that the only real buyer is the FED.

  • http://www.pragcap.com Cullen Roche

    One little flaw in that theory. As per the last crisis, Tsy’s became the safe haven asset. So your thesis rests on the dreaded “this time is different” bet. Ultimately, US govt paper is good because it’s backed by 25% of world output. So really, your theory rests on a production collapse since Tsy’s will remain a safe haven so long as they’re backed by 15 trillion dollars of output. Is that really a bet you want to make? That Americans are just going to roll over and stop producing great things? It’s pretty much one of the only things we’re good at it….You’re better off betting that Ray Allen will miss free throws, in my opinion.

  • Patrick

    Scenario 2:

    The global economy recovers and general growth resumes.
    The FED keeps interest rates low (it must since our debt service would become too great, and eat up all discretionary spending).
    There are other much more lucrative investment vehicles to free market investors.
    PDs still buy, but suffer massive loses as nobody is interested in paying the prices they are.
    Foreign PDs withdraw their names as they are losing too much money.
    U.S. banks either withdraw for the same reasons, fail, or become wards of the state.
    The rest is much like the above.

    Many banks have voluntarily withdrawn themselves as PDs in the past.

  • http://www.pragcap.com Cullen Roche

    You haven’t connected the dots properly. Prices go down when rates go up. Bond markets 101. Why will rates rise? Because growth is improving? Because inflation is rising? In the better growth scenario, net worth of the private sector expands as equity values surge. Bond prices might fall some, but that’s just asset class differentials. Big deal. A booming stock market isn’t going to crush the US economy. Quite the contrary. On the other hand, if rates rise because of high inflation or stagflation then we’re back at the inflation constraint.

  • Pierce Inverarity

    For christ’s sake it’s “lose” not “loose”. I can’t take it anymore.

  • LVG

    You sound like you’re just regurgitating something you read on Zero Hedge or some other right wing partisan hack website.

  • Pierce Inverarity

    The Fed swapping USD for Treasuries has the same net effect on financial assets in the system. China’s holding onto Treasuries because they’re the safest, most liquid way to hold the USDs we sent to them for their goods. They may trade these for USDs which they could then use to buy other things, but they haven’t done that yet…why not?

  • Patrick

    Like I said, the FED can prop up the price of UST, but any government can do that for their own currency… until they can’t. The UK propped up the pound until Soros broke them.

    Regarding China, some months they are a net buyer, others a net seller. Since 2001 (possibly longer, I couldn’t find numbers) China was steadily buying UST, until about mid 2009. Since then their holdings have been essentially flat. That’s a big change. Maybe they’ll start buying again, who knows, but right now the reality supports my position.

    More importantly, China clearly wants to be the dominant global power, when you look at the arrangements they are making with other nations it becomes pretty obvious they no longer see the dollar as the reserve currency of the future.

  • Patrick

    You sound like a closed minded person who can’t stand to have their beliefs challenged.

    I still haven’t heard what political talking points you were referring to.

  • Patrick

    Yes, rates go up because growth resumes, people demand higher return in order to invest in bonds.

    Obviously bond prices go down when rates go up, why did you feel the need to state that? In fact I’m not really clear on how any of your statement is a refutation of my example.

    Here’s a summary of my example: The U.S. gov cannot afford to service it’s debt in a scenario where the global economy is healthily, and interest rates on UST would go back to their historic levels (4-6% for 30 year). Therefore the FED will be forced to keep interest rates artificially low. As alternative investments will be more desirable to independent investors, the PDs will lose money on resale, thus either withdrawing as a PD, going bankrupt, or be propped up by the FED, thus showing they are not independent. The only way the auctions can continue to succeed is for the government to be the only buyer.

    This scenario can obviously be avoided by reducing our debt load, as then there will be no need to keep rates artificially low, but that requires a pretty drastic change from where we are.

  • Pierce Inverarity

    Why do we have to keep our Federal Government debt load low? We can always service our debts. Just look at Japan for the last 20 years…

  • Pierce Inverarity

    And so what? As Cullen likes to point out, we have 25% of the world’s productive capacity. The next best is less than 1/2 that. We’re not going away. And if China wants to stop buying our treasuries, who cares? Your Soros analogy would be correct if the U.S. decided it wanted to keep its currency pegged as the British did. We don’t currently have any explicit or implicit pegs.

  • The Undergrad

    Three things. First there’s no such thing as the US government being able to service its debt under the current structure of our monetary system. Second any PD that’s worth its salt as an investment bank will hedge itself against rising interest rates. Third no PD will go bankrupt for if we learned anything it is no matter how insolvent a bank may be it will stay solvent as long as the Fed provides enough liquidity.

  • The Undergrad

    It is truly incredible no? Its as if they don’t take the time to read the education part. Although I do get the feeling that a lot of new people are just coming here and asking the obvious, which is much better than this site not generating any new and people asking the same basic questions.

  • Patrick

    Every single currency has failed, and every reserve currency has lost it’s reserve status. So it seems more that your arguments rest on a “this time it’s different” bet.

    Yes, I believe at some point the current safe haven asset will stop being the safe haven asset, but that’s really a bet that things will stay the same, and I disagree that this belief is a flaw in my scenario.

    But if it happens 30, 50, or 100 years from now I’ll happily say I was too early to the point of being completely wrong. I think it will happen in less than 10 years.

    Regarding the rest of your comment, putting words in my mouth is not a valid debate tactic.

    The US gov paper is backed by the full faith and credit of the US government, not 25% of world output. While many businesses would fail, most of that output would keep right on if the US lost reserve currency status.

    But if you think the US dollar’s strength is based on our output then I’ll point out that the US’s share of global output has been dropping for decades, as while we are good at producing great things (I’d contend that we are also good at other things as well, but that’s a tangent), so are many other countries, and they can often do it for a lot cheaper. So in that scenario as well the dollar’s foundation is weakening and has been for decades. On top of that China is set to surpass us in less than a decade.

  • Patrick

    Our global output share has been declining for decades.

    Every American will care if China stops buying our treasuries. It certainly won’t happen all of a sudden, but they are already laying the groundwork to transition away from US dollar dominance.

    Who says we are going away? Did the British go away when their empire ended? Or the Spanish? Every empire ends, but it’s not a matter of going away, but living through tough and unpleasant times.

    Most importantly to me it’s not even a matter of ending, but of recognizing that the actions we are taking today are directing us towards the end of our position in the world. It will happen, but it doesn’t need to happen soon, we’ve got plenty of life left if we stop pretending like nothing is wrong.

  • Patrick

    Japan’s debt is internally held, so they can keep their interest rates low, at least as long as their population keeps getting older. The U.S. does not have that luxury.

    And of course Japan has grown at only 1% or less on average over the last 20 years. Japan is quite unique, and still I wouldn’t look to Japan as the model to follow.

    We should keep our debt load low because debt service is expensive, and if interest rates rise we will not be able to make the interest payments without devaluing our currency, or worse. Japan shares the same problem, but has more control because 95% percent of their debt is held domestically. It’s still a problem for them, but not as dangerous as it is for us.

  • Patrick

    First, your comment doesn’t really make sense, but the US gov has to make interest payments on it’s debt. If interest rates go up, interest payments also go up. Sure we could pay it, but at a certain point there are only 2 ways: Devalue the currency, or increase taxes, neither of which are good for individual Americans, or our position in the world.

    Third, Lehman brothers and MF Global were both PDs and both have recently gone bankrupt. A number of other PDs would have gone bankrupt had the US Gov not brokered (forced) their acquisitions, which also renders your second point irrelevant.

  • Patrick

    No need to fight, in fact I’ll buy you a billion dollar beer, as it won’t cost me more than a fraction of an ounce of silver ;)

    But seriously, we obviously have wildly differing opinions on this matter, but I’d rather continue the debate than agree to disagree as even though I don’t agree with you, I still respect your opinion. I was once a Keynesian, now I’m Austrian, much like you were once an MMTer, but are now an MMR aficionado. I’m open minded, but the only way I’ll change my mind is through vigorous debate.

    Regardless of whether you respond, keep making your great site!

  • http://www.pragcap.com Cullen Roche

    Thanks Patrick. I certainly don’t expect everyone to agree with me so the debate is always good for hashing things out. Even if we don’t agree in the end. Have a good weekend.

  • Charles

    Can’t you apply your logic to almost every human on earth. Has not every human on earth, respective of country or economic system, have it “better off” than in the 1980s, especially if “better off” means better technology? Technology will always advance hence the reasons you list we are better off will by definition always be true. 2050 will be better than 2020. 2080 will be better than 2050. Does that have to do with the economic system?

    Is a Swede in 2012 better off than 1982? A German? A person from Singapore? UAE? Thailand? China? Russia? All disparate economic systems.

    Take out “technology”. Most Americnas have “more things” (material). But our healthcare system WHILE BETTER THAN IN 1980s DUE TO TECHNOLOGY is ranked far worse. We used to be #1. I see now we are ranked 37th. So on a relative basis we have decreased. Our life expectancy is FAR ABOVE where it was in 1982… as is almost every person on earth…due to technology. But has our economic system delivered us RELATIVE improvement versus other countries? It appears not – we have fallen way behind, even in basics like infant mortality. Same goes for our education system – a shard of what it once was in K-12.

    In the 80s many could enjoy life on 1 income and have “the wife” stay home and have a middle class income. Now people struggle with 2 incomes. And not just those who want a Lexus… a lot of common people. That is due to the belief that trade fixes all things and many jobs that were once here available to middle class with associates or heck HS in 1982 are gone forever. Is that person or family better off because they have a cell phone? I doubt it.

    I don’t buy the argument because in the modern age you can argue almost any human will be better off due to technological advancement than someone 30 years ago. But quality of life factors such as spending time with your kids is way down from how it used to be. Now the white collar person is expected to be “always on” at home, ready to work, and stay at work til 6 or 7 pm many days – missing out on their kids growing up. The average blue collar guy makes the same wage as he did in the 1970s – despite cost of living increasing significantly. Yes they get an extra 250 sq ft of living space now – but that is “happiness”? Many people are larded with debt for basic college education – kids, and now their parents. Whereas that was not an issue in 1982 for many. Many people had pensions for life in 1982…now only if you are in the government. Many people had the same job (stability) for 30 years in 1982. (Some did not!) Can you put a price on peace of mind?

    So I would not be so simplistic to say “everything is better in the 2010s” simply because we all have better technology and better medicine. A lot of quality of life outside of technology has degraded for many in the “middle class” or “former middle class” (working poor).

  • http://www.pragcap.com Cullen Roche

    Charles, “technology” goes much broader than computers, phones and medicine. The reason why families have two working adults is because they choose to. If you wanted to live in a house without air conditioning, without a washing machine, without a refrigerator, without hot water and many other things that homes didn’t have in the 70’s and 80’s then I am sure you could probably afford to live on one income just fine. There are many things that modern Americans want that they don’t necessarily need. I could probably list off hundreds of things in every day life that are far superior to life in the 80s. From the car you drive, to the house you live in, to the office you work in, to the gadgets you, to the hobbies you enjoy, etc etc.

    More importantly, we all have more time. The example I usually use is an hour at home in which I can order dinner, put my laundry in the wash, throw the dishes in the wash, and do some work. And all within an hour I’ve done what was impossible to do in an entire day just 50 years ago. That’s phenomenal progress. You might downplay these technological advancements, but I think that’s mistaken. It’s much more than just phones and computers….

  • anonymous

    Back in the early 1960s a dollar of new debt added almost a dollar to the nation’s output of goods and services. As more debt enters the system the productivity gained by new debt diminishes. This produced a path that was following a diminishing line targeting ZERO in the year 2015. This meant that we could expect that each new dollar of debt added in the year 2015 would add NOTHING to our productivity.
    Then a funny thing happened along the way. Macroeconomic DEBT SATURATION occurred causing a phase transition with our debt relationship. This is because total income can no longer support total debt. In the third quarter of 2009 each dollar of debt added produced NEGATIVE 15 cents of productivity, and at the end of 2009, each dollar of new debt now SUBTRACTS 45 cents from GDP!


    If debt/consumption growth rate is higher than wealth(GDP)/output growth rate all the time, then it is not sustainable/bankrupt after the accumulated wealth were all spent.

  • anonymous

    Middle class in UK today have higher living standard than their King/Queen 100/200 years ago(though they have less wealth/money).

  • MoveOn.org

    Cullen, you have been a true teacher for me and many others (and the insight from your site allowed me to make some money in 2010 and 2011). But it is time for you and your core readers to move on from understanding the US monetary system. Understanding Europe/China monetary mechanics is where alpha now resides in my opinion. Let’s all try to understand that. I’ve read things about Target2 in the last few months that lead me to believe that understanding these
    Mechanics in a truly basic way is the way to destroy the macro market in the next couple years. Let’s all figure that out together rather than continuing to debate the nature of the US monetary system.

  • hangemhi

    sorry anon, but your chart is so full of holes it’s worthless. stick around pragcap and you’ll learn what your source is totally clueless about… the difference btwn the “debt” of a currency issuer like the US gov and the debt of a household. i do love the hubris of “the most important chart of your lifetime. It relegates almost all modern economists and economic theory to the dust bin of history.” LOL. It does nothing of the sort.

  • dbomb12

    One point from the article “understanding the monetary system”
    Government deficit spending and tax collection should be maintained at a rate that does not impose financial hardship on the private sector. Because the Federal government is not a business or household it should not manage its balance sheet for its own benefit. Rather, taxes and government spending should be managed in a way that most benefits the private sector and encourages private sector prosperity, productivity, innovation and growth.
    Taxes and regulation has imposed undue hardship on the private sector in case you have not noticed recently, and when the new healthcare law kicks in and the bush tax cuts expire then the private sector will be taxed even more. So the above paragraph is meaningless as is the rest. practicality no longer applies in a system that is totally corrupt and continually provides FALSE statistics.

  • http://www.financialgraphart.com JP Koning

    “That is, while the Treasury is an operational currency user (meaning it must always have funds in its account at the Fed before it can spend those funds) it is always able to harness the banks to procure funds. This is achieved through bond auctions in which the dealers are required to bid… So there’s never a concern about auctions failing in the USA. That is, the Treasury is a currency user, but the government as a whole can be seen as a currency issuer by institutional design because of this implicit funding guarantee.”

    In the above paraphrase of you answer to the initial question comparing the US to Greece, you are implying (and this is before your “worst case scenario”) that what makes the US different from Greece is that it requires dealers to bid at government auctions (it “harnesses” them), and therefore US auctions can never fail.

    Yet Greece also has a primary dealer system (http://www.bankofgreece.gr/BogDocumentEn/PRIMARY_DEALERS_RULES.pdf) in which, as primary dealers, financial institutions are required to provide some minimal level of participation. Thus the Greek government can also “harness” financial institutions to float its debt.

    By analogy, and using your wording, there is therefore never a concern about auctions failing in Greece because primary dealers step in (note that this material is all being derived from the that part of your text prior to your “worst case” scenario).

  • http://www.pragcap.com Cullen Roche


    That’s not my “wording”. I said:

    ” In fact, since the ECB is essentially a foreign central bank there is a real solvency constraint. So banks and private investors have become hesitant to buy Greek bonds because of this flawed institutional arrangement and the lack of an implicit guarantee.”

    The whole purpose of JKH’s contingent institutional approach is to detail this relationship. And we’ve been very clear about how it works. The PD bid requirement only holds true because the Fed makes an implicit guarantee. The ECB is a foreign central bank in essence, so there is no implicit guarantee. AS I explicitly stated, “apples and oranges”. Hope that helps clarify.

  • Obsvr-1

    yep, and when that happens you have the debt deflation which causes the recession and/or depression cycles.

    Steve Keen has nailed the system problem focusing on the credit issuers, private banks, that create money (debt) out of thin air.

    see Steve Keen’s site with the Headline Video which is really good

    A Minsky Singularity


  • Obsvr-1

    seems our problem is the political leaders and the financial elite seem to be the drug users … actually when I think about it, they are the drug pushers, the drug being debt.

  • Obsvr-1


    you make some good points, but I believe Charles was spot on; I observed what he said back in the late 80’s when my wife was working to help pay the day to day, this was early in my career and we were not living the high life; yes good solid upper middle income, but far from the high life. We worked diligently on a budget to get to the point where she did not have to work so she could stay home and be with the kids more. After 3 years we were able to have her quit “work” and stay home. My income continued to increase with my job advancement, but my observation was valid in that the masses needed to have more than 1 pay check to live a good middle class lifestyle; yes more than 1 but less that 2. The extra income allowed for more “luxuries” and toys. This all transpired while the bankster class continued their bubble blowing ways with their business model as what can be said as “Put them in debt, keep them in debt and when they can not pay back, get a gov’t bailout”. Now we are observing (living) the great debt deflation to pay back (or not pay back) all that “debt based increased standard of living”.

  • Obsvr-1


    keep it up, I like your debate based responses …

    Now, there is another option for the FED / Trys for servicing the massive debt buildup, which the FED has been “Testing”

    Quantitative Easing, where the FED is essentially buying the US Trys bonds from the UST (with a bit of vig passed to the PDs in the process).

    Once these bonds land and live on the FED balance sheet (BS) then that debt is effectively zero interest, such that the interest payments from the UST to the FED is remitted back to the UST. And when (if) the bond matures (which never really happens as they are just rolled over in perpetuity) the money from the UST to redeem the bond paid to the FED is remitted back to the UST ….

    wow – if everyone would just understand this process – they would see a process that would make the Mafia blush.

    End result, debt the lives on the FED BS is not debt at all … um … pay no attention to the man (The Bernanke) behind the curtain.

  • http://rodgermmitchell.wordpress.com/2010/04/06/more-thoughts-on-inflation Jason Hun

    In addition to what Cullen & JKH wrote:

    1. US Federal Reserve can buy back US gov bonds as a last resort

    2. the President can appoint & replace the Chairman & Board of Governors on the US Federal Reserve every 4 yrs to get the US Federal Reserve to work with/accomplish the government’s goals (ie, fund all gov spending)

    3. the Federal Reserve Act of 1913 in it’s own charter specifically states that should there ever be a conflict, the Federal Reserve must defer to & obey the Secretary of the Treasury (the US presidential appointee that the President can replace at any time)

    None of the EURO countries have such power over the EUROCentral Bank who are much more independent.. the EURO countries are powerless over the EUROCentral Bank just like a US city/state has no power over the US Federal Reserve –and the EUROCentral BAnk’s own charter stipulates deficits must be 3% or less unless approved in extenuating circumstances –the US FEderal Reserve has no such stupid restrictions.

    Austrian economists will object & wrongly cry hyperinflation (Hayek/Mises have been chicken-littles crying hyperinflation ever since FDR & the 1st Fed Chairman Mariner Eccles took the US off the gold standard in 1934)

    Official data on charts here show federal deficit spending do NOT cause inflation:
    Oil/energy prices cause inflation, NOT federal deficits -evidence/facts here: http://rodgermmitchell.wordpress.com/2010/04/06/more-thoughts-on-inflation/
    http://rodgermmitchell.wordpress.com/2009/09/07/introduction/ &

  • http://rodgermmitchell.wordpress.com/2010/04/06/more-thoughts-on-inflation Jason Hun

    also as Cullen noted, hyperinflation only happens in severe circumstances when there’s shortages or severe supply shocks because increases in money supply actually increases & stimulates increased production/hiring to match the increased money supply & thus offset any inflation
    if there’s a supply shock or shortage
    such as Weimar Germany’s 90% drop in production
    almost all their industrial, manufacturing, energy, etc workers went on strike for 8+ months to protest war reparations & France/Belgium invading the Germany’s Ruhr Valley to confiscate German coal, steel, & other hard goods because the Allies only accepted gold or hard goods as payment for reparations…

    and Germany’s gov paid the striking workers to stay on strike to deter France/Germany from staying & confiscating production.

    In Zimbabwe’s hyperinflation, production dropped by 30% to 57% in food, textiles,manufacturing, depending on sector because Mugabe expelled all the whites(who made up almost all the educated, the managers, professionals, engineers, foremen, supervisors, skilled manufacturing,etc)
    installed uneducated cronies/peasants who did not know how to run a factory or farm.

    In the stagflation of the 1970s, inflation actually went down in 1972 after Nixon took the US off the gold standard completely in 1971…

    but in 1973-74 & 79-80, OPEC embargoed oil to the US as well as jacked up prices 400% by cutting production by 15 million barrels/day (the US only uses 20 million/day total, importing half that at 10 million/day)

  • http://rodgermmitchell.wordpress.com/2010/04/06/more-thoughts-on-inflation Jason Hun

    yep.. on the official inflation charts, inflation for the past 80 yrs has averaged only 2.6%, which is incredibly low considering that
    the population has been growing at about 3% to 5% per year, which thus increases demand for food, housing, goods, etc by 3% to 5% per year also unless supply/production of food, housing,etc also increases by at least that amount

    and the money supply also has to increase by that amount or else there’s not enough money to hire those extra new people & more unemployment/poverty results

    in the past, on gold-standard countries, it required finding new sources of gold (colonies, conquering other countries, etc) or private bank money creation which is unsustainable as Austrians point out..

    but fed fiat gov money creation is perpetually sustainable forever

  • chris

    I dont know my mullet was pretty cool back then.

  • Edmund

    The real question is, how our living standard would change over 30 years if we still lived on a “quasi” gold standard, and did not have all credit bubbles we had.

    There were enormous credit bubbles under the gold standard. Enormous. Look at all the leverage in the 1920s.

    Remember, during late 1800 and early 1900, humankind had much more significant scientific and quality of life advancements than during last 30 years.

    The number of people lifted out of poverty since 1980 has been unprecedented – the late 19th and early 20th centuries have nothing on what’s gone down in the third world recently.

    It’s somewhat disingenuous to trumpet the scientific achievements of the previous era over what we’ve seen recently, or tie them in to the financial system in some way. The special and general theories of relativity, for example, were the brainchild of one man working without regard for money whatsoever. The atomic age, on the other hand, was ushered into existence by an enormously large government apparatus – the Manhattan Project – in a fiat monetary system.

    Speculating on things potentially being better under a gold standard is bogus unless one can identify the causal mechanism that would be at play: how would strongly limited fiscal space and ceding monetary policy to the deflationary imperative of hoarding gold improve growth, the standard of living and scientific advancement? I’d also suggest going back before 1980, and even before the closing of the gold window: although the world was technically on a gold standard under Bretton Woods, in practice it was a dollar standard with fixed exchange rates. The “real” gold standard died with the Depression and never came back.

  • Bond Vigilante

    Eurozone countries have much more control over the ECB than you think. If e.g. the Bundesbank would like to pull the plug on the ECB then they can do that. And the Bundesbank could be forced by the german government. That’s why the position of Mrs. Merkel matters more than anyone thinks.

  • Edmund

    Unless, perhaps, it was in a currency union with Germany under the gold standard. In practice, with the ECB acting as it does (inflation uber alles), the Eurozone really is an artificial gold standard.

  • Edmund

    Reminds me of the best scene in all cinema:


  • Edmund

    Interest rates staying low in the face of an improving economy and shrinking deficits would not allow us to not depreciate the dollar.

    It’s not terribly relevant that Japanese debt is held domestically. China sits on Treasurys. They mature. They now have dollars. They can…buy more Treasurys, or move into the dollar denominated stock and bond markets like a fat dude entering a small hot tub, or they can buy US real assets, or they can buy other currencies, or they can sit on slowly inflating dollars. If they buy other currencies, US imports decline and exports surge. And if you don’t like that, you can rest assured that US trading partners aren’t going to like a huge dollar depreciation screwing up their exports and they’ll probably intervene in a massive way. You know, just like there was coordinated global action on the yen not so long ago.

  • Patrick

    I don’t understand your first sentence.

    People ask why Japan has been able to keep it’s interest rates low for 2 decades. The answer is that almost all of their debt is held internally. But even holding their interest rates artificially low has held their growth back. It is also part of the reason they have hardly any foreign held debt, nobody else wants their crap returns. It is pretty clear evidence that when you hold your interest rates artificially lower than what can be attained in the free market, legitimate investors are not interested.

  • Edmund

    What I’m getting at with the first sentence is that holding interest rates low in the face of an improving economy is going to increase inflation and devalue the dollar. This isn’t true:

    We should keep our debt load low because debt service is expensive, and if interest rates rise we will not be able to make the interest payments without devaluing our currency, or worse.

    Devaluing the dollar is not an option in that instance, it’s simply a result of the policies being pursued.

    People ask why Japan has been able to keep it’s interest rates low for 2 decades. The answer is that almost all of their debt is held internally.

    So what? There’s nothing stopping the central bank there from targeting the entire yield curve, although it hasn’t been. There’s also nothing stopping the bond holders from shopping for yield elsewhere.

    But even holding their interest rates artificially low has held their growth back.

    How? For much of the past twenty years, the Japanese business sector had been paying down the enormous debt they accumulated during the property bubble. That would have simply made the repayment process more costly and longer, stymieing the growth they did see.

    Are you coming at this from…what analytical framework? IS/LM doesn’t agree. Neither does Koo’s balance sheet recession, MMT/MMR, Godley’s slightly different models, etc.

  • Bond Vigilante

    More signs that a rising US rates are coming down the pike:

    The chinese yuan is falling against the USD (since say the 1st quarter of 2012) and that implies that the chinese have begun selling T-bonds.

  • free lunch

    In Physics, there is no Perpetual motion machine in real world.
    In Economics, there is no Free lunch.
    Fed can print Dollar/money, but can not print wealth/output.
    It is insustainable/bankrupt if spend/consume more than earn/produce for a period of time(no matter how much money was print).

  • nwcynic

    Cullen, your points are correct on the surface. But registered dealers & the Fed (being a private corporation) can stop buying the debt. Currently the Fed and SSI (Social Security Funds) are 70% of the buyers of US debt, meaning most investors (registered dealers) and countries around the world have already stopped buying the debt (treasury notes).

    The only reason our Gov hasn’t gone bankrupt yet (YET means it’s coming) is because of the ponzi scheme that is the Fed and stealing US Citizen’s SSI deposits. At some point ponzi schemes unravel and this will happen thru hyper devaluation of the US dollar as the Fed has to print more and more Fed notes (US Dollars) to back our Gov’s escalating debt.

    No – the Gov won’t go bankrupt – but every private citizen holding US Dollars will. That’s the sadistic nature of FIAT currencies and private Central Banks.

  • http://www.pragcap.com Cullen Roche

    Right, I do acknowledge, that, in a hyperinflation, the PD’s would stop buying bonds most likely.

  • Patrick

    I agree that there’s a good deal of hyperbole by the author, and it certainly does not overturn economic theory, but what holes are there in the chart itself? It seems pretty simple: The change rate in debt over the change rate in GDP. It shows a weakening benefit from the addition of debt, with a recent and abrupt change to the negetive.

  • Patrick

    Devaluing the dollar is not an option in that instance

    Agreed, but I wasn’t talking about devaluation in this scenario.

    There’s also nothing stopping the bond holders from shopping for yield elsewhere.

    That’s exactly my point, independent investors have long ago sought yield elsewhere and have stopped buying Japanese bonds, they can only sell domestically.

    You ask how holding rates low has stunted their growth. Here is how:

    They held off the proper correction, thus keeping their zombie institutions afloat which leads to mis-allocation of capitol, thus leading to lowered growth.

    The Japanese situation is not even over, they keep growing their debt. While for now the Japanese population is able to absorb the debt their government is requiring, that will not always be the case as their population is now shrinking.

    My framework is basically that the government is less effective than the free market, and while it is worthwhile to intervene to keep a correction from becoming a depression, 20+ years of intervention is too much. The fact that there are almost no external buyers of Japanese debt is strong evidence that their rates are held artificially low. The correlation between their low rates and low growth is also pretty strong evidence.

  • Yo mismo


    If I am not mistaken, due to other “peculiar” institutional arrangements, the Treasury Department has the right and duty to print dollar bills and coins?

    In most countries, the central bank is the sole issuer of physical and virtual currency, whereas in the US, the federal government mints coins and prints bills.

    Although the physical-to-virtual ratio is normally low (<10%), is it theoretically possible for the federal government to print bills ad
    infinitum to finance its deficit? The limit will, of course, be the panic effect of the government paying for supplies and services and contracts with 10,000-dollar bills or truckloads of 100-dollar bills.


    Latino desde el Sur

  • Pod

    Cullen, oh my. If the metric is music, then the 20XXs are a bone-crushing depression compared to the 1980s!

  • http://www.bubbleshort.blogspot.com Ajit Kumar

    We don’t need no QE3, market looks to have got the taste of blood and wants to front run….Bears had good reasons to be excited “as reported in popular media”, Europe is imploding, emerging markets are slowing down, equity is looking least bit exciting or trustworthy by any and all standards to common man.
    Yields are dropping like stone in developed markets… negative 50bps yield on Swiss bond, negative yields on German bunds (where is all the contingent liabilities…question will come but later:) )…record low on US and Japanese treasuries …personally i would park there if I m in a hurry and pay the fee but will get out as soon as i find better investment, yield wise or capital appreciation wise……..yes sir this is the power of money-flowing to park itself temporarily at any storage cost before it readies to move to its preferred investment.

    All this sound like worlds imploding, there is really something that has imploded. Its the trust banking system had in Sovereign bonds as collateral for shadow banking. Private capital in next one year “Will” (yes this constitutes a forecast and we will revisit this theme in upcoming posts) shun low yielding high tail risk Sovereign Bonds and move to private assets.

    This is going to be the genesis of the upcoming “One of Greatest BULL market of our lifetime” …we will revisit this topic in pieces in upcoming posts ….
    Equities..YES THIS MEANS THAT INDIAN MARKET HAS IN HIGH “PROBABILITY” BOTTOMED…..we will keep a close watch on which sectors could be the leaders in follow-up posts…… Asian Equities including Nikkie..infact Nikkie and Shanghai appears to be making long term bottom,and thus looks really good to speculate……
    Commodities…Gold and Silver (I would prefer silver between both if I have to speculate), Agri-Commodities, Natural Gas..follow up posts we will post trading set-ups

    Currencies: Yen appears to be making a significant top against lot of currencies…we will keep a close eye on this theme as Indian markets allows speculation in Yen. Dollar also looks overbought and Euro looks over sold, both have enough fuel of trend traders to make a good opposite move