MMP Blog #22: Reserves, Governement Bond Sales, and Savings

By L. Randall Wray

Last week we showed that government deficits lead to an equivalent amount of nongovernment savings. The nongovernment savings created will be held in claims on government. Normally, the nongovernment sector prefers to hold that much of that savings in government IOUs that promise interest, rather than in nonearning IOUs like cash. This week we will look at this in more detail.

Bond sales provide an interest-earning alternative to reserves. We can say that short term treasury bonds are an interest earning alternative to bank reserves (as discussed earlier reserves at the central bank often do not pay any interest; if they do pay interest, then government bonds are a higher-earning substitute). When they are sold either by the central bank (open market operations) or by the treasury (new issues market), the effect is the same: reserves are exchanged for treasuries. This is to allow the central bank to hit its overnight interest rate target, thus, whether the bond sales are by the central bank or the treasury this should be thought of as a monetary policy operation.

Reserves are nondiscretionary from the point of view of the government. (In the literature, this is called the “accommodationist” or “horizontalist” position.) If the banking system has excess reserves, the overnight interbank lending rate falls below the target (so long as that is above any support rate paid on reserves), triggering bond sales; if the banking system is short, the market rate rises above target, triggering bond purchases.  The only thing that is added here is the recognition that no distinction should be made between the central bank and the treasury on this score: the effect of bond sales/purchases is the same.

There is a surprising result, however. Since a government budget deficit leads to net credits to bank deposits and to bank reserves, it will likely generate an excess reserve position for banks. If nothing is done, banks will bid down the overnight rate. In other words, the initial impact of a budget deficit is to lower (not raise) interest rates. Bonds are then sold by the central bank and the treasury to offer an interest-earning alternative to excess reserves. This is to prevent the interest rate from falling below target. If the central bank pays a support rate on reserves (pays interest on reserve deposits held by banks), then budget deficits tend to lead banks gaining reserves to bid up prices on treasuries (as they try to substitute into higher interest bonds instead of reserves)—lowering their interest rates. This is precisely the opposite of what many believe: budget deficits push interest rates down (not up), all else equal.

Central bank accommodates demand for reserves. Also following from this perspective is the recognition that the central bank cannot “pump liquidity” into the system if that is defined as providing reserves in excess of banking system desires. The central bank cannot encourage/discourage bank lending by providing/denying reserves. Rather, it accommodates the banking system, providing the amount of reserves desired. Only the interest rate target is discretionary, not the quantity of reserves.

If the central bank “pumps” excess reserves into the banking system and leaves them there, the overnight interest rate will fall toward zero (or toward the central bank’s support rate if it pays interest on reserves). This is what happened in Japan for more than a decade after its financial crisis; and what happened in the US when the Fed adopted “quantitative easing” in the aftermath of the financial crisis that began in 2007. In the US, so long as the Fed pays a small positive interest rate on reserves (for example, 25 basis points), then the “market” (fed funds rate) will remain close to that rate if there are excess reserves.

Central banks now operate with an explicit interest rate target, although many of them allow the overnight rate to deviate within a band—and intervene when the market rate deviates from the target by more than the central bank is willing to tolerate. In other words, modern central banks operate with a price rule (target interest rate), not a quantity rule (reserves or monetary aggregates).

In the financial crisis, bank demand for excess reserves grew considerably, and the US Fed learned to accommodate that demand. While some commentators were perplexed that Fed “pumping” of “liquidity” (the creation of massive excess reserves through quantitative easing) has not encouraged bank lending, it has always been true that bank lending decisions are not restrained by (or even linked to) the quantity of reserves held.

Banks lend to credit-worthy borrowers, creating deposits and holding the IOUs of the borrowers. If banks then need (or want) reserves, they go to the overnight interbank market or the central bank’s discount window to obtain them. If the system as a whole is short, upward pressure on the overnight rate signals to the central bank that it needs to supply reserves.

Government deficits and global savings. Many analysts worry that financing of national government deficits requires a continual flow of global savings (in the case of the US, especially Chinese savings to finance the persistent US government deficit); presumably, if these prove insufficient, it is believed, government would have to “print money” to finance its deficits—which is supposed to cause inflation. Worse, at some point in the future, government will find that it cannot service all the debt it has issued so that it will be forced to default.

For the moment, let us separate the issue of foreign savings from domestic savings. The question is whether national government deficits can exceed nongovernment savings in the domestic currency (domestic plus rest of world savings). From our analysis above, we see that this is not possible. First, a government deficit by accounting identity equals the nongovernment’s surplus (or savings). Second, government spending in the domestic currency results in an equal credit to a bank account. Taxes then lead to bank account debits, so that the government deficit exactly equals net credits to bank accounts. As discussed, portfolio balance preferences then determine whether the government (central bank or treasury) will sell bonds to drain reserves. These net credits (equal to the increase of cash, reserves, and bonds) are identically equal to net accumulation of financial assets denominated in the domestic currency and held in the nongovernment sector.

We conclude: since government deficits create an equivalent amount of nongovernment savings it is 
impossible for the government to face an insufficient supply of savings.

RIP Shareholder Value Meme: Make Way for A New World

By Rob Parenteau and Marshall Auerback

We have never quite been able to pin down why "maximize shareholder value," the mantra of the world in which we have both worked for the past three decades, always left us with a bad feeling.  But considering the actions of the markets over the past few days, particularly the perverse response to the consolidation of the rentier class's power grab in Europe (which will consign millions of people to years of poverty and indentured servitude), it is easier to understand a little better why.

There is perverse logic at work here. You're a fund manager who, at the start of the fourth quarter, was down 25%.  Neither hard to do nor a particular sign of incompetence, given the uncharacteristically huge volatility, the hidden role of derivatives, the highly "politicized" nature of the markets themselves, etc.  A market that rises 4% in Q4 doesn't really help you. But if you're up 15% in Q4 and therefore "only" down 10% for the year or, even better, UP for the year, then you might be able to stay in the game a bit longer. So you have a massive incentive to play in the casino, under the guise of "maximizing shareholder value."

It's sort of like managing one of the so-called Too Big To Fail (TBTF) banks now. You know you're basically insolvent. You know the game is going to end at some point and, if and when rationality returns, your bank will be restructured (maybe via an FDIC forced takeover a la WaMu) and you'll be out of a job. So you get even more reckless in the meantime, inflating the numbers as much as possible via accounting tricks and taking the huge "performance" bonuses which accrue to you. It is the fund management equivalent of Bill Black's control fraud writ large.

Of course, as Bill always points out, the "F" word (fraud) is never taken seriously in the economics profession. In fund management, there's another "F" word which is now pervasively ignored - "Fiduciary" as in "fiduciary responsibility." The same control fraud dynamics at work in both areas.  "Cash is trash," as the system is set up to force the fund manager to play.

The funny thing is, the looters inside the banks used the phrase "shareholder maximization" to con the shareholders into believing they too would be taken along for the ride to mega riches. In the case of Lehman, AIG, etc. the true nature of the con was revealed. The insider managers operating both simple and elaborate control fraud schemes often walked away quite wealthy, the shareholders got little more than an invitation to the back row of the bankruptcy court.

What is truly amazing is that shareholders, fund managers, retail investors, etc. fell for this over and over and over again, perhaps because the Grifters and psychopaths in the corner office were just that good, or perhaps because they wanted to believe and so suspended disbelief, or perhaps because it was the only game left in town and they did see some shareholders get very wealthy by financing what we will one day soon understand were the storm trooper MBAs working their best reptilian angles to plunder and pillage the last spoils of the empire of global, fully deregulated, cowboy/casino capitalism. We speak as market practitioners, who are keen to see capital markets work the way they are supposed to: finance as the handmaiden to industry, and not the other way around. Gresham's Law is operative here as well: bad money is driving out good.  It needn't be this way.

RIP, shareholder value meme. You were a pretty damn powerful one, almost as powerful as TINA. Arise AWIP ("another world is possible"), new true stakeholder economy, which can  trump TINA. Because the old structures are corrupt to the core. And at some level we all have known it, but we haven't known how we could effectively contest it and change it.  Perhaps the Occupy Wall Street protests growing around the world is finally showing us another way.

* TINA = There Is No Alternative (Myth killed here)

Bank of America's Death Rattle

Marshall Auerback on CBC's Lang and O'Leary Exchange

"The ECB is the only entity that can create literally trillions of euros till the cows come home..that's not really issue, the fundamental problem is that you have a currency union without a fiscal structure..."

Watch here (Marshall comes in at about 16:00)

Pavlina Tcherneva on at Issue with Ben Merens

Boots on the Ground

Budget Deficits and Saving: Responses to Comments on Blog 21

By L. Randall Wray

Sorry this is late—there were a lot of comments and I am traveling. Before we begin, a note and plea: we are getting an increasing number of emails with comments and questions (sent to NEP email and to mine). Please understand I cannot respond to those—I get hundreds of emails a day and it would consume all of my time to respond individually. That is why I am collecting comments on the Primer page and responding to all at once. I know some people are having trouble posting comments (I do too!) but what I’ve found is that “three’s a charm”: if you hit “post” three times it inevitably works. Sorry about that.

Some of the comments were quite long and dealt with several issues. So this week I am posting most of the text, followed by my response.

Iris: So from my point of view, what you obviously neglect is to insert all the additional references to presupposed material, which us, especially with less "previous knowledge of MMT" could help to better understand the matter you're dealing with. My impression is for example, that not only general accounting basics are necessary but also knowledge about the structural system of inter-firm-, inter-bank- and government banking-institutions' accounting to private sector. Would it be asked
to much of a favor for you to perhaps offer, at least via footnotes, these hints too?

A: Well there is always a trade-off. We don’t want to get into defining the meaning of “the” (as a former President tried to do). I do presume some knowledge and it is tricky just how much should be assumed and how much explained in detail. Sometimes the reader with less background is probably going to have to accept some statements without fully understanding all the details behind them. I have been leaving out detailed accounting for two reasons: it is more detail than most will want, and it is hard to produce these in Word (and I have no idea how hard it is for our techie to post them to the blog). However, since there have been a number of requests, I will devote a blog to “T Accounts”.

Hugo: Ok, "excess deposits" results in increased "demand for profitable savings vehicles". And if demand for savings vehicles exceeds supply, the market will adjust. Savers will have to accept lower yields on their savings. Firms would find it more easy to borrow money. Interest rates for corporate bonds would likely decrease (in the financial markets?). But I feel the transmission to an increase in government bonds is somewhat weak here? What you are suggesting seems to be: "Excess deposits seeking profitable savings vehicles"  -> "excess reserves in the interbank lending system" -> "overnight rate maintenance" -> "bond sales" -> "equilibrium" ..?But how does "excess deposits" necessarily lead to "excess reserves" here?

A: Before I get into a response, Guest responded to Hugo, trying to straighten this out:

-Guest: It is a result of double-entry book keeping. Whenever government credits deposits of someone in the banking system, it alse credits banks reserves to create asset that offsets banks deposit liability.

A: Ok I am not sure what an excess deposit would be. When I get my paycheck my deposit goes up and surely I do not think it is excessive. I then buy consumption goods and services. I might also make some portfolio decision over what is left, allocating some of my accumulated savings to higher earning financial assets. Hugo says I might bid up bond prices, on both private and government debt, lowering interest rates on the outstanding stock. Right. He is not convinced that a government deficit will put downward pressure on government bonds, however, because he does not see how my “excess deposits” creates “excess reserves”. Remember that reserves are on the asset side of the bank’s balance sheet while deposits are on the liability side. When government makes a payment, both sides go up—the bank’s reserves at the Fed are credited, and my demand deposit is credited. Most of those additional reserves will be excess reserves (details on this are complicated as reserve requirements are calculated after a lag—let us ignore those details for now). Banks make a portfolio decision: buy something that earns higher interest rate. First they can lend in the overnight, fed funds, market, pushing that rate down. Next they can buy a close substitute, treasuries (government bonds), and then diversify into other assets. (Note: unless they buy treasuries from the central bank, this shifts reserves about but does not reduce aggregate reserves.) Since central banks target an interest rate (ie: the fed funds rate in the US) they will react once the interest rate falls below the target. They will begin to buy treasuries. That eliminates the excess reserves and the downward pressure on interest rates.

-Luigi: "The impact of the deficit on bank reserves has been emphasized by the neo-chartalist school (Bell 2001; Wray 1998), but neochartalist writers do not explicitly draw on the conclusion that it supports the complete exogeneity of the long-term rate of interest". Parguez writes this in 2004, it's right? How MMT consider long-term rates of interest?

A: Sounds OK to me. A central bank CAN target a long term rate (ie 30 year treasury bond) and hit it if it wants, but central banks normally do not. Instead, they target the short end and when they want the longer term rates to fall, they make statements like “we expect to hold the overnight rate at a low level for the foreseeable future”. That makes holders of longer maturity bonds more confident that the short term rate will not rise soon—which would cause capital losses. There are a number of approaches to the determination of longer term interest rates: expectations theory, habitat theory, and interest rate parity. As a great philosopher once said “you can look it up”. But in conclusion, yes, MMT agrees that longer rates are complexly determined and are not normally exogenously controlled by central banks.

WH10: "Finally, the fear that government might “print money” if the supply of finance proves insufficient is exposed as unwarranted. All government spending generates credits to private bank accounts—which could be counted as an increase of the money supply (initially, deposits and reserves go up by an amount equal to the government’s spending)."That's only half the picture for those concerned.  People perceive govt spending as being counteracted by bond sales, so the money supply seemingly does not go up.  HOWEVER, is it not the reality that a significant proportion of bond sales come from bank Primary Dealers, which 'spend' from their reserve accounts, such that effectively there is a net credit to deposit accounts (as opposed to them being offset by purchases of bonds out of deposit accounts)?  In other words, it seems we're almost always 'printing money,' if this is the case.

A: Minsky said: “anyone can create money (things), the problem lies in getting it accepted”. Yes, we are almost always “printing money” in the sense of issuing IOUs denominated in the state money of account. Get over it. On some conditions, that can cause prices of output or of financial assets to rise. It all depends. There is no automatic channel that causes an increase of “money supply” however defined to lead to “inflation”, however defined. And there is nothing that magical with respect to inflation effects of government spending as opposed to private spending. If I get an auto loan to buy a car, on some conditions that could push up car prices and hence the CPI. And we could find that some measure of the money supply also had increased. If government strokes some keys to add a vehicle to its fleet of cars, on some conditions that could push up car prices, the CPI, and some measure of the money supply. Yes, it is a possible outcome and if you really want to point your finger at the increase of the money supply, I guess you can. I would say that it was the increased purchase of autos that in tight markets (full employment, full capacity utilization) would induce manufacturers to increase prices. Note that could also happen without any additional loans or “printing money”.

WH10: Was there a time when did the U.S. Govt could spend before requiring the Treasury’s account to be marked up?  If we imagine a fiat currency starting out, but Fed overdrafts are not allowed and the same institutional restrictions that we have today are in place, then what are the accounting statements which allow the government to spend without a positive account?  Does this necessitate the existence and willingness of primary dealers that to have their reserve accounts go negative to facilitate government spending?  Why are they willing to do this? 

A: Not exactly sure when the US government decided to tie its shoes together by requiring Treasury to have a credit to its account at the Fed before making a payment, but it could date to creation of the Fed in 1913. What if there were no Fed? Bank clearing could take place on the books of the Treasury, and the Treasury could simply credit them with reserves whenever it makes a payment. Even simpler, it could just pay with paper notes or coins. Or, in the old days, with tally sticks. These would be the debt of the government and the financial assets of the nongovernment, accepted in tax payment.

Dave: I guess I've missed something (though I've reviewed the two previous posts): Given that reserve requirements are defined by the Fed (http://www.federalreserve.gov/... how does the non-governmental sector as a whole acquire "excess reserves" i.e. don't reserves only grow as much as (in proportion to) the surplus the non-governmental sector accumulates from deficit spending? Or do you only mean that SOME agents/banks/actors of the non-governmental sector accumulate "excess reserves"? Or....?

A: Banks can get reserves from either the central bank or the treasury. When treasury buys goods and services, bank reserves are credited. We normally call that government spending. When the central bank buys financial assets from banks (ie: buys government bonds, or private debt, or the IOUs of a “borrowing” bank) that also increases bank reserves. But we do not normally call that “government spending”. Really it is, but it is spending on assets not on goods and services (so does not show up in GDP).

Joe: OK, so we're starting to get to the answer of "What if people don't want to buy the bonds?" Perhaps some example numbers, accounts etc. would make thing a bit more concrete as 'portfolio preference' is rather vague. Also, the idea the deficit spending comes first, to provide the reserves to purchase the bonds, seems logical(money must exist before you can buy bonds), but doesn't the treasury need a positive balance in order to spend? Bond sales increase the balance, so there's a very strong illusion that the proceeds from bond sales are recycled into the treasury's account (which I believe is the traditional, pre-1971 view).  Did the interpretation just change in 1971; pre-1971 money from bond sales went into tsy account, post-1971 cash assets are converted to bond assets while new money is put into tsy accout? And how can the deficit be mandated to be covered by bonds, if you have to wait for preferences to adjust, there must be some time lag between spending and bond ales?  (sorry, lots of questions, I'm patient, hopefully it'll all clear up in the coming weeks)

A: Not sure how numbers would help. In the US, where we tied the government’s shoes together, the Treasury first sells bonds to special banks that buy them by crediting the Treasury’s deposit account. Treasury moves the account to the Fed before spending. These bonds will be bought by the special banks, so at this point the portfolio preferences of the nongovernment sector do not matter. Deficit spending will increase bank reserves dollar-for-dollar (cash withdrawals will reduce that a bit). As discussed the banks will try to buy earning assets such as government bonds. The Fed and Treasury coordinate how many bonds will need to be sold by the two of them to offer earning assets as alternatives to reserves, to allow the Fed to hit its interest rate target. A complication is that in the Treasury’s new issue market, it pursues “debt management”, offering a range of maturities. Occasionally the Treasury might offer a maturity that does not match “portfolio preferences” of potential purchasers.

Hugo: According to Vickrey, private capital in the U.S will have trouble seeking profitable productive investment. Is government bond sales needed as savings vehicles for the private sector to prevent assets bubbles?

A: Not sure I follow. To prevent asset bubbles, I’d use rules, regulation, and supervision of financial institutions. The problem really is not one of “excess saving”, so trying to “soak up” saving through government bond sales will not resolve it. If I want to speculate in Martian ocean-front condo futures, I do not need any savings. All I need is a bank.

Kostas: "In reality, the Chinese receive Dollars (reserve credits at the Fed) from their export sales to the US (mostly), then they adjust their portfolios as they buy higher earning Dollar assets (mostly, Treasuries)". It would be nice if you could elaborate on how foreign central banks get a hold of dollars in their Fed accounts. My understanding is that this happens when central banks (of surplus countries) intervene in foreign exchange markets in order to maintain their currency foreign exchange value (by offering their currency in exchange for foreign assets). Is there any other way for Bank of China to acquire US$ reserves?

--Dirk: Of course. The People's Bank of China can borrow/buy dollars from abroad. Not only from the US, but from anybody who holds dollars. In case of buying dollars, the counter-party has to accept yuan (not a problem) and the exchange rate might be changing (indeed a problem).

A: Thanks, Dirk, I think you answered.

Neil: "Recipients of government spending then can hold receipts in the form of a bank deposit, can withdraw cash, or can use the deposit to spend on goods, services, or assets." Can't they also swap it for another currency with a willing party at an agreed exchange rate?  So the 'shifting of pockets' surely has an exchange effect as well, not just an interest effect. Or do you see currency exchange as just another asset purchase and that it will effect the macroeconomy in the same way as any other asset price shift?

A: Yes, I can use a dollar deposit to buy foreign stuff, take vacations abroad, or to buy foreign assets. The dollar deposit will be held by someone else. My spending abroad can affect the exchange rate.

Andy: What effect,if any, does a reduction in bank deposits have on central banks' day to day operations? For example if repayment of private debt is greater than bank lending and fiscal tightening by governments at the same time.

A: Let us say bank deposits decline due to loan repayment. When it comes time to calculate reserve requirements (in the US, more than a month later), banks will find they have excess reserves relative to what is required on their deposits. They will attempt to individually reduce reserves held by purchasing bonds (etc). That just shifts the reserves about. But it also pushes the overnight interest rate down. The central bank responds with an open market sale of treasuries. So it “forces” the hand of the central bank that reacts to the interest rate decline.

Suspicious: When will we get the MMP  explaining how to credibly regulate a banking sector ? Banks have always managed to circumvent doctrines, ideologies, regulations, etc. and to wreck havoc the financial system. What's the purpose of the central bank reserves not being inflationary if banks can loot it via control fraud, and raise prices like in the commodities, and even cause hyperinflation if only they were not as greedy as preventing anyone but themselves to make money on it ?

Does Obama's Housing Plan Miss the Mark

William K. Black's appearance on the Dylan Ratigan Show for Tuesday, October 25th.  For those interested in cutting straight to the chase, Bill comes in around 2:30 min.

Visit msnbc.com for breaking news, world news, and news about the economy

Europe's Non-Solution

By Marshall Auerback

Today is supposedly the day where the problems of the euro zone get resolved once and for all. And when have we heard that before? Truth be told, it’s hard to get excited about any of the “solutions” on offer, because they steadfastly refuse to acknowledge that the eurozone’s problem is fundamentally one of flawed financial architecture. The banking “problems” and corresponding “need” for urgent recapitalization, are simply symptoms of that problem. Offering the “cure” of banking recapitalization for a problem which is ultimately one of national solvency (of which the banking crisis is but a symptom) is akin to offering chemotherapy to solve heart disease. Despite the current “thumbs-up” from the markets, the treatment is likely to exacerbate the disease, rather than represent the cure.

Let’s go back to core principles. We agree that the concern about Portugal, Ireland, Italy, Greece and Spain (PIIGS), indeed ALL other Euronations is justified. But using PIIGS countries as analogues to the US is a result of the failure of deficit critics to understand the differences between the monetary arrangements of sovereign and non-sovereign nations. Greece, Italy, France, and yes, Germany, are all USERS of the euro—not an issuer. In that respect, they are more like California, Massachusetts, indeed, any American state or Canadian province, all of which are users of their respective national government’s dollar.

But the eurozone’s chief policy makers continue to ignore this fundamental point and therefore, steadfastly avoid utilizing the one institution – the European Central Bank – which has the capacity to create unlimited euros, and therefore provides the only credible backstop to markets which continue to query the solvency of individual nation states within the euro zone. The ECB is so loath for everybody to agree on a Greek default, on the grounds that they bear "the loss" even though it is a notional accounting loss that has no bearing on their ability to create euros until the cows come home. By contrast, when you get national governments funding the European Financial Stability Fund (EFSF), then it does ultimately threaten the credit ratings of France and Germany once the markets begin to call their bluff on how far they're prepared to go to support this political fig-leaf called the EFSF. And because NONE of these countries is sovereign in respect to their currency (they USE the euro, but they don't ISSUE it), it expands the potential insolvency problem, taking Germany down along with the rest.

Beyond Pump Priming

Pavlina Tcherneva:  "There is no question that this economy needs more demand. But
if we want to short-circuit the forces driving long-term unemployment
and unequally shared prosperity, we need to go beyond pump priming."

http://www.levyinstitute.org/pubs/op_16.pdf

Bill Black: What I'd Demand of the Fed

Bill Black on The Real News with Paul Jay:

Wanted

Greece: the ECB’s Daily Floggings will Continue until the Greek Economy Recovers

By WilliamK. Black

The European “troika” that has been driving Greece into a deepening depression has just completed an analysis documenting the failure of its policies.  The analysis has leaked.  Here are its introductory paragraphs.

Greece: Debt Sustainability Analysis

October 21, 2011

“Since the fourth review, the situation in Greece has taken a turn for the worse, with the economy increasingly adjusting through recession and related wage-price channels, rather than through structural reform driven increases in productivity. The authorities have also struggled to meet their policy commitments against these headwinds. For the purpose of the debt sustainability assessment, a revised baseline has been specified, which takes into account the implications of these developments for future growth and for likely policy outcomes. It has been extended through 2030 to fully capture long term growth dynamics, and possible financing implications.

The assessment shows that debt will remain high for the entire forecast horizon. While it would decline at a slow rate given heavy official support at low interest rates (through the EFSF [European Financial Stability Facility] as agreed at the July 21 Summit), this trajectory is not robust to a range of shocks.  Making debt sustainable will require an ambitious combination of official support and private sector involvement (PSI). Even with much stronger PSI, large official sector support would be needed for an extended period. In this sense, ultimately sustainability depends on the strength of the official sector commitment to Greece.”

MMP BLOG #21: GOVERNMENT BUDGET DEFICITS AND THE “TWO-STEP” PROCESS OF SAVING.

By L. Randall Wray

In the previous two weeks we have shown that government budget deficits take the form of net credits to bank reserves at the central bank and as well to the deposit accounts of those who receive net government spending. Normally, this leads to excess reserves that are drained through the offer of government bonds, sold either by the central bank or by the Treasury. Hence, budget deficits normally result in net positive acquisition of Treasuries. But even if they do not, the nongovernment sector ends up with net saving in the form of claims on government.

To put it as simply as possible: government deficit spending creates nongovernment sector saving in the form of domestic currency (cash, reserves, Treasuries). This is because government deficits necessarily mean the government has credited more accounts through its spending than it debited through its taxes.

Remembering the comments on Blog 20 we need to make clear that we are talking about net saving in the domestic currency. The domestic nongovernment sector can also net save in foreign currency assets. And some members of the nongovernment sector can save in the form of claims on other members of the domestic nongovernment sector—but that all nets to zero.

It is now obvious from the previous discussion that the nongovernment savings in the domestic currency cannot pre-exist the budget deficit, so we should not imagine that a government that deficit spends must first approach the nongovernment sector to borrow its savings. Rather, we should recognize that the government spending conceptually comes first--it is accomplished by credits to bank accounts. And finally we recognize that both the resulting budget deficit as well as the nongovernment’s savings of net financial assets (budget surplus) are in this sense residuals and are equal.

As a side note (for now) those who claim that the US government must borrow Dollars from thrifty Chinese don’t understand the most basic accounting. The Chinese do not issue Dollars—the US does. Every Dollar the Chinese “lend” to the US came from the US. In reality, the Chinese receive Dollars (reserve credits at the Fed) from their export sales to the US (mostly), then they adjust their portfolios as they buy higher earning Dollar assets (mostly, Treasuries). The US government never borrows from Chinese to “finance” its budget deficit. Actually, the US current account deficit provides Dollar claims to the Chinese, and the US budget deficit ensures these are in the form of “currency” (broadly defined to include cash, reserves, and Treasuries).

More generally, as J.M. Keynes argued, saving is actually a two-step process: given income, how much will be saved; and then given saving, in what form will it be held. Thus many who proffer the second objection—that nongovernment portfolio preferences can deviate from government spending plans--have in mind the portfolio preferences (that is, the second step) of the nongovernment sector. How can we be sure that the budget deficit that generates accumulation of claims on government will be consistent with portfolio preferences, even if the final saving position of the nongovernment sector is consistent with saving desires? The answer is that interest rates (and thus asset prices) adjust to ensure that the nongovernment sector is happy to hold its saving in the existing set of assets. Here we must turn to the role played by government interest-earning debt (“treasuries”, or bills and bonds) to gain an understanding.

For the purposes of this discussion, we can assume that anyone who sold goods and services to government did so voluntarily; we can also assume that any recipient of a government “transfer” payment was happy to receive the deposit. Recipients of government spending then can hold receipts in the form of a bank deposit, can withdraw cash, or can use the deposit to spend on goods, services, or assets.

 In the first case, no further portfolio effects occur. In the second case, bank reserves and deposit liabilities are reduced by the same amount (this can generate further actions if it reduces aggregate banking system reserves below desired or required levels—but those are always accommodated by the central bank to the extent that attempts by banks to adjust reserve holdings cause the targeted interest rate to move away from target). In the third case, the deposits shift to the sellers (of goods, services or assets). Only cash withdrawals or repayment of loans can reduce the quantity of bank deposits—otherwise only the names of the account holders change.

Still, these processes can affect prices—of goods, services, and most importantly of assets. If deposits and reserves created by government deficit spending are greater than desired at the aggregate level, then the “shifting of pockets” bids up prices of goods and services and asset prices, lowering interest rates. Modern central banks operate with an overnight interest rate target.

When excess reserves cause banks to bid the actual overnight rate below the target, this triggers an open market sale of government bonds that drains excess reserves. (As discussed in the response to comments last week, we modify this if the target interest rate is zero; or if the central bank pays a support rate below which excess reserves cannot push market rates.)

So the answer to the second objection about inconsistency of portfolio preferences is really quite simple: asset prices/interest rates adjust to ensure that the nongovernment’s portfolio preferences are aligned with the quantity of reserves and deposits that result from government spending—and if the central bank does not want short-term interest rates to move away from its target, it intervenes in the open market.

It is best to think of the net saving of the nongovernment sector as a consequence of the government’s deficit spending—which creates income and savings. These savings cannot pre-exist the deficits, since the net credits by government create the savings. Hence, the savings do not really “finance” the deficits, but rather the deficits create an equal amount of savings.

Finally, the fear that government might “print money” if the supply of finance proves insufficient is exposed as unwarranted. All government spending generates credits to private bank accounts—which could be counted as an increase of the money supply (initially, deposits and reserves go up by an amount equal to the government’s spending).

However, the portfolio preferences of the nongovernment sector will determine how many of the created reserves will be transformed into bonds, and incremental taxes paid will determine how many of the created reserves and deposits will be destroyed.

Next week: we’ll get more deeply into bond sales by government and impacts of budget deficits on interest rates.

The Anti-Regulators are the “Job Killers”

By William K. Black

The new mantra of the Republican Party is the old mantra – regulation is a “job killer.”  It is certainly possible to have regulations kill jobs, and when I was a financial regulator I was a leader in cutting away many dumb requirements.   We have just experienced the epic ability of the anti-regulators to kill well over ten million jobs.  Why then is there not a single word from the new House leadership about investigations to determine how the anti-regulators did their damage?  Why is there no plan to investigate the fields in which inadequate regulation most endangers jobs?  While we’re at it, why not investigate the areas in which inadequate regulation allows firms to maim and kill.  This column addresses only financial regulation.

Deregulation, desupervision, and de facto decriminalization (the three “des”) created the criminogenic environment that drove the modern U.S. financial crises.  The three “des” were essential to create the epidemics of accounting control fraud that hyper-inflated the bubble that triggered the Great Recession.  “Job killing” is a combination of two factors – increased job losses and decreased job creation.  I’ll focus solely on private sector jobs – but the recession has also been devastating in terms of the loss of state and local governmental jobs. 

US Senator Bernie Sanders' Dream Team Includes Deficit Owls and Elite Fraud Fighters

WASHINGTON, Oct. 20 - Nobel Prize-winning economist Joseph Stiglitz and other nationally-renowned economists agreed today to serve on a panel of experts to help Sen. Bernie Sanders (I-Vt.) draft legislation to reform the Federal Reserve.

Sanders announced formation of his expert advisory panel in the wake of a damning report that faulted apparent conflicts of interest by bank-picked board members at the 12 regional Fed banks.
Top executives from Goldman Sachs, J.P. Morgan Chase, General Electric and other firms sat on the boards of regional Federal Reserve banks while their firms benefited from the central bank's policies during the financial crisis, the Government Accountability Office investigation found. The dual roles created an appearance of a conflict of interest, according to the GAO.

After the report was issued Wednesday, Sanders said he would work with top economists to develop legislation to restructure the Fed and tighten rules on conflicts of interest, ensure that the Fed fulfills its full-employment mandate, increase transparency, protect consumers and reduce income inequality.  
Sanders' panel of experts includes:

• Joseph Stiglitz, the 2001 winner of the Nobel Prize. The economics professor at Columbia University is a former chief economist for the World Bank.
• Jeffrey Sachs, director of The Earth Institute and an economics professor at Columbia University. He also is special advisor to United Nations Secretary-General Ban Ki-moon.
• Robert Reich, Professor of Public Policy at the University of California, Berkeley. Reich has served in three national administrations, most recently as secretary of labor under President Bill Clinton. He also served on President-Elect Obama's transition advisory board. In 2008, Time Magazine named him one of the ten most successful cabinet secretaries of the century.
• James K. Galbraith, Lloyd M. Bentsen Jr. Chair in Government/Business Relations and Professor of Government at the Lyndon B. Johnson School of Public Affairs, University of Texas at Austin. Galbraith served in several positions on the staff of the U.S. Congress, including Executive Director of the Joint Economic Committee.
• Lawrence Mishel, president of the Economic Policy Institute, the premier research organization focused on U.S. living standards and labor markets.
• William Black, associate professor of economics and law at the University of Missouri, Kansas City. He worked with the Federal Home Loan Bank Board, the Federal Savings and Loan Insurance Corporation and the Office of Thrift Supervision.
• Nomi Prins, a senior fellow at Demos, was a managing director at Goldman Sachs, a senior manager at Bear Stearns in London, a senior strategist at Lehman Brothers, and an analyst at the Chase Manhattan Bank (now JPM Chase)
• William Greider, author of Secretsof the Temple: How the Federal Reserve Runs the Country, a monumental account of how the American central bank, cloistered and protected from public accountability, exercises its control over the US economy - workers, consumers, investors.
• Jane D'Arista, an Economic Policy Institute research associate, has written on the history of U.S. monetary policy and financial regulation, The former Boston University School of Law professor previously served as a staff economist for Congress.
• Tim Canova, professor of economics and law and co-director of the Center for Global Law & Development at the Chapman University School of Law in Orange, Calif. He was an early critic of financial deregulation and warned of the dangers of the bubble economy.
• Robert Johnson, senior fellow and director of the Project on Global Finance at the Roosevelt Institute. He was chief economist of the Senate Banking Committee and a senior economist for the Senate Budget Committee.
• Dean Baker, co-director of the Center for Economic and Policy Research in Washington, D.C. He was a senior economist at the Economic Policy Institute, a consultant for the World Bank and the Joint Economic Committee of the U.S. Congress.
• Gerald Epstein, chair of the economics department at the University of Massachusetts at Amherst. Epstein also is the co-director of the Political Economy Research Institute.
• Robert Auerbach, professor at the Lyndon B. Johnson School of Public Affairs with the University of Texas at Austin. Auerbach was an economist with the House banking committee during the tenure of four Federal Reserve Chairmen: Arthur Burns, William Miller, Paul Volcker, and Alan Greenspan. Auerbach also served as an economist in the U.S. Treasury's Office of Domestic Monetary Affairs during the first year of the Ronald Reagan administration and as a financial economist with the U.S. Federal Reserve System.
• Robert Pollin, co-director of the Political Economy Research Institute and economics professor at the University of Massachusetts-Amherst. He has worked with the Joint Economic Committee and the U.S. Competitiveness Policy Council.
• L. Randall Wray, a professor of economics and research director of the Center for Full Employment and Price Stability at the University of Missouri-Kansas City, and a Senior Scholar at the Levy Economics Institute.
• Stephanie Kelton, associate professor of Economics at the University of Missouri, Kansas City and a research scholar at the Center for Full Employment and Price Stability.

The need for major reforms at the Federal Reserve was driven home by the GAO findings announced Wednesday and in an earlier report issued on July 21. Both unprecedented audits of the Federal Reserve were required by a Sanders' amendment to last year's Wall Street reform law. 

To read an analysis of the GAO report prepared for Sen. Sanders, click here.

To read the full GAO report, click here.

Say W-h-a-a-a-t?

Warren Buffet told CNBC reporter Becky Quick that he could fix our nation's deficit problem real quick — in precisely five minutes. Problem is, the US doesn't have a deficit problem. We do, however, have an aggregate demand problem, as MMTers have been arguing for more than two years. And we could fix that in five minutes too, if we could just circumvent Congress.

The Occupy Wall Street Protestors have announced that Nov. 5th is "Move Your Money Day." A few folks started early and discovered an unusual new penalty for "early withdrawal." You have to see it to believe it.

Prior to Sept. 17, 2011, no one would blink (or cringe) at a photo like this.  But with the Occupy Wall Street movement drawing so much attention to the cosy relationship between Wall Street and the politicians who serve them, this photo of Mitt Romney and his colleagues at Bain Capital just doesn't seem very funny.

In this private letter from Charles Koch to Fredrich Von Hayek, Koch urges the grand poobah of free-market economics to be sure to take advantage of the benefits he is entitled to under Social Security.

Until today, the bloggers at New Economic Perspectives had ever heard of Ben Strubel. But he's definitely got our attention (and our respect) now. He posted a very nice summary of our macro approach — often dubbed MMT — and made a strong case for increased deficit spending. Maybe it's just easier for people like this (practitioners/traders who haven't had their heads fuddled with mainstream economic theory) to grasp how the modern monetary system actually works.

Here's a terrific parable on de-leveraging from an anonymous author.  We recommend using it the next time someone takes out a chart of outstanding debt (public, private, or both) and the money stock (monetary base, M1, M2, MZM) and tries to make the asinine point that we don't have enough money to pay off all the debt.

CNBCs John Carney says that "very few people understand how the modern banking system really works." He praises MMT for its more accurate depiction of finance and banking.

 

 

 

Here's an incredible statistic on the FIRE economy:  Interest on mortgages is now over 20% of personal consumption expenditure vs. 5% in 1980.  And this is in spite of the fact that 60% of the housing stock is owned outright.

Budget Deficits and Saving, Reserves and Interest Rates Part 2: Responses to Blog #20

By L. Randall Wray

Q1:  Andy. What does "wonky" mean? 

A: Think “policy wonk” someone who gets all data-heavy and into the deep technical details to do policy analysis. So it is used to warn the reader that only those really interested in details needs to read on.

Q2: Ryan. Let's assume the economy already works with full capacity, and the government would like to maintain it without any further inflation or deflation. Does the government now have to make an educated guess (regarding the exogenous part of gov. deficit) what the nongovernment saving desire might be, so that it (government) fulfills its goal (full employment and price stability). Kind of trying to hit moving target? And in this regard, is the ELR governmental program kind of "shoot and forget" mechanism, which automatically, always finds, or helps to find the moving target (nongov.  saving desire)?

A: No, not really. Let us say government puts in place the ELR and 20 million show up for work. Before the program was in place, everyone was worried about the future—paying bills, losing jobs, etc. Net private financial saving desires were, say, $1 trillion. No one wanted to spend. Now with 20 million new jobs and the certainty that you can find one reduces these saving desires. You go shopping. You feed your family. The private sector starts hiring, producing. GDP starts growing. You get recruited out of the ELR program into a hiring paying private sector job. You pay more taxes. Federal government spending on ELR falls, its budget deficit falls into line with the lower net financial saving desires. The only planning you need by government is the “real stuff”—create jobs. Govt does not need to try to hit the net saving desires—that is done automatically.

Q3:  Paolo. "this also means it is impossible for the aggregate saving of the nongovernment sector to be less than (or greater than) the budget deficit"Take the "greater than" option. What about a nongovt. sector export surplus? Wouldn't that add net financial assets to the nongovt. sector aggregate savings above the amount generated by govt deficits?

A: Yes, Americans might also save in foreign currency denominated assets—ie UK pounds. Those can come from export surpluses. I was talking about domestic currency. But you are correct, in some countries the net saving desire could largely take the form of foreign currency (ie in places where US Dollars are desired).

Q4. Guest. Prof. Wray,  On page 7 of "Waiting for the Next Crach: The Minskyan Lessons We failed to Learn"(http://www.levyinstitute.org/p..., you said Goldman Sachs let hedge fund manage Henry Paulson design sure-to-fail synthetic CDO's. Did you mean John Paulson? If I'm not mistaken, Henry Paulson was Sec of treasury during the GFC...   Just checking, cause I'm sure John Paulson wants his credit for being one of the world's premier **s****s.

A: Yes a helpful editor added the wrong first name. I think it is now corrected.

Q5: MamMoth, Dale, Neil, Samuel.  Many questions and comments on exogenous vs endogenous.

A: In economics the distinction between endog and exog is used in three different senses: control, theoretical, and statistical. Only the econometricians reading this care about the last one so I’ll leave it. In the control sense it means the govt can “control” the variable: ie control the money supply, control the interest rate, control the price level. MMT shares with the “endogenous money” or “horizontalist” approaches the view that the CB cannot control the money supply or bank reserves. Instead the CB must accommodate the demand for reserves. HOWEVER these theories were formulated back when the interest rate paid on reserves was zero but the Fed’s target overnight interest rate was nonzero. Excess reserves drove the market (fed funds) rate below zero so the Fed would have to drain reserves by selling Treasuries. But now the Fed has a near zero interest rate target (like Japan) and so can leave excess reserves in the system and pay 25 basis points on them and the market rate remains near 25 basis points.  So you could say that with QE the Fed “exogenously” increases bank reserves. There is an asymmetry, though, because the Fed can leave banks full of excess reserves but cannot leave them short reserves—which would drive the market rate above the target. On the other hand, the CB’s target interest rate is clearly exog in the control sense: the Fed can set its target at 25 bp, or raise it at the next meeting to 150 bp. Finally, the control sense and the theoretical sense are related but not identical. Let us say the US had a fixed exchange rate and used the interest rate policy to hit the peg. We can say the interest rate is exogenously controlled (set by the Fed) but it is not theoretically exog because the overriding policy is to peg the exchange rate.

Marshall Auerback's Talk at FEASTA

Marshall Auerback's discusses strategies for Ireland in dealing with its debt crisis at FEASTA. Watch below:

Marshall Auerback from Feasta on Vimeo.

Prof. Bill Black and #OWS: "This is Not a Red State / Blue State Issue"

Dylan Ratigan speaks with William K. Black, and two Wall Street occupiers in his latest podcast of Radio Free.

Ep 73: Prof. Bill Black and Occupiers Goldi & Calvin by Dylan Ratigan

William K. Black on Democracy Now: 10/19/2011

For those of you who missed the live interview this morning, watch Bill Black on Democracy Now with Amy Goodman:

Not with a Bang, but a Whimper: Bank of America’s Death Rattle

By William K. Black

Bob Ivry, Hugh Son and Christine Harper have written an article that needs to be read by everyone interested in the financial crisis.  The article (available here) is entitled: BofA Said to Split Regulators Over Moving Merrill Derivatives to Bank Unit. The thrust of their story is that Bank of America’s holding company, BAC, has directed the transfer of a large number of troubled financial derivatives from its Merrill Lynch subsidiary to the federally insured bank Bank of America (BofA).  The story reports that the Federal Reserve supported the transfer and the Federal Deposit Insurance Corporation (FDIC) opposed it.  Yves Smith of Naked Capitalism has written an appropriately blistering attack on this outrageous action, which puts the public at substantially increased risk of loss.  

I write to add some context, point out additional areas of inappropriate actions, and add a regulatory perspective gained from dealing with analogous efforts by holding companies to foist dangerous affiliate transactions on insured depositories.  I’ll begin by adding some historical context to explain how B of A got into this maze of affiliate conflicts.

Pavlina Tcherneva on At Issue with Ben Merens

Ben Merens, of Wisconsin Public Radio's At Issue, hosts Pavlina Tcherneva on how to address unemployment.  Listen here.

William K. Black: "Enforce the Laws for the 99"

This segment of yesterday's Dylan Ratigan show features William K. Black and David DeGraw of AmpedStatus.com.  Black argues that we need, "fire Geithner, fire Holder, and demand Bernanke's resignation, and ... replace them with people who will actually enforce the laws for the 99[%]."

This meets with David DeGraw's approval, who then enlists our favorite white-collar criminologist to serve as the Attorney General for the Occupy Wall Street movement. Watch the entire segment here.

Two Billion Dollars Lost because the FDIC Ignored United Commercial Bank’s Frauds

By William K. Black

The good news is that we finally have the second group of indictments of senior bank officers.   The prosecution involves officers of United Commercial Bank (UCB), a roughly $10 billion San Francisco bank that originally specialized in lending to Chinese-Americans and became primarily a commercial real estate (CRE) lender.  The indictment deals only with the cover up phase of UCB’s senior officers’ frauds.  I will show in future posts that the reported facts on UCB’s loans were consistent with accounting control fraud.   The UCB case is so rich in lessons that it will take a series of articles to capture what the case reveals about the degradation of regulation and prosecution of elite accounting control frauds. 

Here are the most essential facts.  In 2002, a court found that UCB’s senior managers had engaged in fraud to hide losses on a large loan for the purpose of fraudulently inducing another bank to bear the losses.  It found the senior officers’ conduct so outrageous that it awarded substantial punitive damages.  The FDIC, the SEC, and the Department of Justice did nothing in response to the fraud.  

There is no indication that the FDIC filed a criminal referral.

Creative Ways to Promote MMT

We always knew our readers were a smart bunch, but we had no idea how imaginative you are! Please keep sharing your creative endeavors with us (merchandise, animated videos, signs/slogans, etc.), and please keep spreading the word about MMT and NEP.  Understanding the monetary system is the first step in a long journey toward creating a better world for us all.

Courtesy of Tschaff Reisberg

Today's Modern Money Primer

Complications and private preferences. There are often two objections to the claim that government spending effectively takes place by simultaneously crediting the recipient’s bank account as well as the bank’s reserves: a) it must be more complicated than this; and b) what if the private sector’s spending and portfolio preferences do not match the government’s budget outcome?
Read More...

MMP Blog #20: Effects of Sovereign Government Budget Deficits on Saving, Reserves and Interest Rates, (continued)

By L. Randall Wray


Complications and private preferences. There are often two objections to the claim that government spending effectively takes place by simultaneously crediting the recipient’s bank account as well as the bank’s reserves: a) it must be more complicated than this; and b) what if the private sector’s spending and portfolio preferences do not match the government’s budget outcome?

The first of these objections has been carefully dealt with in a long series of published articles and working papers (by Bell (a.k.a. Kelton), Bell and Wray, Wray, Fullwiler, and Rezende who look at actual operating procedures in the US, Canada, and Brazil; I’ll provide references later as well as more details). In practice, the treasury cannot directly credit bank accounts when it wants to spend.

Rather, a complex series of steps is required that involve the treasury, the central bank and private banks each time the treasury spends or taxes. The central bank and the treasury develop such procedures to ensure that government is able to spend, that taxpayer payments to treasury do not lead to bounced checks, and—most importantly—that undesired effects on banking system reserves do not occur. While the end result is exactly as described above (treasury spending leads to bank credits, taxes lead to debits, and budget deficits mean net credits to both demand deposits and bank reserves), it is more complicated

.

This often generates another question: what if the central bank refused to cooperate with the treasury? The answer is that the central bank would miss its overnight interest rate target (and eventually would endanger the payments system because checks would start bouncing). Readers are referred to the substantial literature surrounding the coordination (more details for the wonky coming up in a later blog). Nonspecialists can be assured that the simple explanation above is sufficient: the conclusion from close analysis is that government deficits do lead to net credits to reserves, and if undesired excess reserves are created they are drained through bond sales to maintain the central bank’s target interest rate.

The operational impact of bond sales is to substitute government bonds for reserves—it is like providing banks with a savings account at the central bank (government bonds) instead of a checking account (central bank reserves). This is done to relieve downward pressure on the overnight interest rate.

With regard to the second objection we first must notice that if the government’s fiscal stance is not consistent with the desired saving of the nongovernment sector, then spending and income adjust until the fiscal outcome and the nongovernment sector’s balance are consistent. For example, if the government tried to run a deficit larger than the desired surplus of the nongovernment sector, then some combination of higher spending by the nongovernment sector (lower nongovernment saving and lower budget deficit), greater tax receipts (thus lower budget deficit and lower saving), or higher nongovernment sector income (so greater desired saving equal to the higher deficit) is produced

Since tax revenues (and some government spending) are endogenously determined by the performance of the economy, the fiscal stance is at least partially determined endogenously; by the same token, the actual balance achieved by the nongovernment sector is endogenously determined by income and saving propensities. By accounting identity (presented above) it is not possible for the nongovernment’s balance to differ from the government’s balance (with the sign reversed—one has a deficit and the other a surplus); this also means it is impossible for the aggregate saving of the nongovernment sector to be less than (or greater than) the budget deficit.

So those are the general responses to those objections. I will do a wonky blog later with more details. But next week we look in more detail at the private saving decision.