The EU: Towards and ever closer Union

Over the weekend, a friend of mine argued that the founders of the Eurozone knew that a monetary union without a fiscal union would come undone. So they sowed the seeds of a fiscal crises into the EZ, gambling that the unavoidable pain would be enough to force fiscal union but not so much that the monetary union itself would crumble. At the heart of all of this would be to bind Germany and France together irrevocably.

The ECB continues to try and thread this needs with its latest bail out -- more money, more time, but more pain. If the pain ceased, the push for fiscal union would also cease.

Kicking the can down the road is normally considered idle procrastination. This is different. This is deliberate procrastination. If Greece falls today, nobody knows what kind of economic domino effect it will have on other debtors like Portugal, Italy, and Spain, or the rest of the Europe. Europe has selected the muddle-through and draw-random-recovery-lines option. The honest and inevitable choice -- a wild default or even Greece's departure from the EU -- is impossible for euro ministers to imagine suffering through, for today. Meanwhile, Greece suffers.

Not deliberate procrastination. An engineered application of political pressure. We'll see if it's been calibrated correctly.

MMT is not Monetarism

Interfluidity claims that monetarism shares more with MMT than we all think.

I think MMTers, market monetarists, and Keynesians have almost everything in common other than tribe and affiliation.

He then goes on to recommend a pro-cyclical inflation indexed government savings account. Crazy.

When seeing these hare-brained schemes, I always wonder just what problem SRW is trying to solve. There must be some policy reason I'm not seeing for complicated, rube-goldberg, counter-productive ideas. But let's review in detail:

SRW would give people a government backed, $200,000 max, inflation indexed savings account (real rate of zero). This is meant to help people with inflation.

Fine, so US has 300M people, so assume we have a 50% usage rate of this account, so a total of $3x10^13 is going to be in this thing. I don't even know what this number is.

Saudi decides to jack up oil prices. We get cost-push inflation of, say, 7%. In Steve's world, the Government would need to print an extra $2,100,000,000,000 and pump that into savings accounts. 12 zeroes makes that a US Trillion. The US National debt is $15T.

So, because of inflation, SRW is going to print $2T, an increase of over 10% of the national debt (not deficit).

What does everyone think is going to happen to inflation now? Instead of helping people during high-inflationary periods, this will trigger hyperinflation by design.

It gets worse in periods of negative growth -- account holders will need to take haircuts. So, you guessed it, when the economy is shrinking, the Government is going to start reducing the number in people's bank accounts. Nominal outstanding debt will stay the same, of course, so you'll get debt deflation the way we did in the Depression.

I can see the middle class singing Hosannas now.

If Steve claims MMT and monetarism are the same, maybe it's because he doesn't understand the differences.

S=I+(I-S)?

Commenter Greg points me to this post: More on Savings and Investment

“It is perfectly possible to hold the international balance constant, have the government reduce debt, and have “people” save more.

“People’s” financial savings consists of claims on firms and claims on government. If I perform some work for a firm that (however infinitessimally) increases the firm’s real economic value, and I accept as payment a share of that firm’s stock, I have performed the economic act of saving, and increased the net saving of “people” — of the household sector. Net private sector financial assets have not increased: my “savings” is the firms’ obligation, the household sector’s surplus is offset by the business sector’s deficit.

But much of what we call saving is exchanging real resources for claims on the private business sector. And as long as the private business sector doesn’t entirely squander those real resources, that act contributes to macroeconomic S. If the private business sector does squander the resources, then while I still perceive my contribution as “saving”, the value of macroeconomic S = I does not increase, and my claim amounts to a transfer from other shareholders of the firm.

It seems similar to this same theme raised in Interfluidity (here and here). At any rate, I think they are all related.

Honestly, I'm having difficulty making head or tail of the discussion. I'm not sure what distinction they are making, and I don't know why the distinction I think they are making is important. It seems to be that, the usual sector de-composition is between the Government and non-Government sector, where Government is the currency issuer (consolidated Treasury and Federal Reserve function) and non-Government is everyone else (all currency users, includes foreign Governments). I think they are saying that within the non-Government sector, distinguishing the household from commercial sector is important, but I don't know why.

Anyone care to enlighten me?

Thanks

End the Money Market Fund

According to Megan McArdle, new rules may put money market funds out of business:

At last, the government is proposing new rules, which are supposed to make MMFs less risky. The funds would have to raise new capital, and some minor withdrawal limitations would be imposed on customers. They would also have to offer a floating net asset value instead of the current "guarantee" that if you deposit a dollar, you'll always get at least that dollar back...

...If passed as proposed, the rules would seemingly put the MMFs out of business. And perhaps that's the point--Paul Volcker, for one, has been an outspoken critic of money market funds, which originated as a way to dodge the interest rate caps on bank accounts during the inflationary 1970s."

There shouldn't be money market funds. There should be unlimited FDIC insurance on all bank accounts. It should be easy to "put a dollar in, get a dollar bank" (with no guarantee as to what that dollar will get you).

LBO Chop Shop

With Mitt's running for president, Private Equity is in the spotlight. Mitt hasn't done a great job of defending it, but large parts of what they do are pretty indefensible. For the best attempt, check out Epicurian.

Carried interest, in particular, is clearly a loop hole written into law by the Private Equity industry, for the Private Equity industry. If they wish to be taxed at capital gains rates, then they should invest as LPs. This area is clearly indefensible, but I don't anticipate it changing.

Second is the financial engineering that comes with that tax benefits of leverage. If one is to have a tax on corporations, then there's a good argument for making interest payments on debt tax deductible. Better, though, to stop taxing corporations altogether.

Third, there is Epicurian's defense of the infamous dividend recap, where the PE firm takes cash out of the company as a dividend, and lets the firm take on more debt. If the firm goes bankrupt, the PE company keeps the money they extracted earlier.

One more wrinkle is worth discussing. This is the relatively recent phenomenon of financial sponsors borrowing additional debt through their portfolio companies during the life of their investment, and using the proceeds to pay equity dividends to themselves and their limited partners. These are known as dividend recapitalizations, or “dividend recaps.” Often, financial sponsors can use such recaps to withdraw money equal to or even in excess of their initial equity investment. This leaves the portfolio company with an increased debt burden and the financial sponsor playing with house money. Many people outside the industry, including our friends Messrs. Kwak and Surowiecki, don’t like dividend recaps, because it loads up the portfolio companies with risky debt while appearing to reduce private equity’s skin in the game. This is very true.

However, having participated in or observed a number of such deals, I must strenuously disagree with Mr. Kwak’s contention that the lenders which participate in such transactions are unsophisticated dupes. They lend with eyes wide open, and an impressive amount of company-specific due diligence. Normally, a company is able to take on a bigger debt load because the financial sponsor and company management prove to new lenders that they have improved the company’s earnings power and free cash flow enough to sustain it.

Epicurious fails to mention whether the lenders in question get paid when they make the loan, or when the loan gets paid back.

Look for shocks

Baseline Scenario succumbs to its bias, and gets the causality wrong.

So there are two possible reasons why these people make the top 1 percent. One is that they are talented, hardworking people who succeed (financially) despite what they majored in—but then why are talented, hardworking people overrepresented in these majors? The other is that they are children of the elite who go to elite schools, study whatever they feel like, and succeed because of their upbringing and connections. (The reasons are not mutually exclusive.) Given the increasing evidence that America, the land of opportunity, is actually one of limited social mobility, I think we can’t overlook the latter explanation.

If talent and a strong work ethic is heritable, through genetics or upbringing or some combination of the two, then one would expect limited social mobility.

The real test of social mobility in a system is how it responds to shocks. Say, someone who is lazy and an idiot is born into Bill Gates' family. He might be wealthy, but what would his income be? Or suppose a hard working genius was born to a poor family in New York? Would they be left to languish, or would they be successful?

What Google cannot help you with

Google's PageRank algorithm is good at goal directed queries -- "flowers", "cheap airline tickets", or "nearest library". It is not good at non-directed queries, like "funny", "inspirational", "entertain me".

Facebook is great at entertaining people who have no goal cheaply. Instead of making content like TV stations do, it just parades photos of your friends, which are very entertaining because they are your friends. If you want to waste time, Facebook is the place to go (and this is why social games on Facebook are so inane, but also so successful).

This new Google ad is interesting because the queries are exactly the type of queries that Google was bad at, but Google+ hopes to be better at.

"Awesome things you can do with a paperclip"
"Awesome things you can do"
"Awesome things"

Delicious was actually great at this, back when it was a live product. TechCrunch doesn't get it at all.

Building Credit

Megan McArdles has a number of good posts about credit unions, and how they help (or don't) build credit.

When I graduated from college, I had a well paying job, was living in New York, but had no credit history. I was a foreigner, and had used my parent's credit card in college, so although I had reasonable income, debt etc. I could not get a credit card of my own.

I ended up getting a secured card from Capital One, with ruinously high fees, and I had to send in a check for $200 (which was the limit on that card). Using the card for convenience, my credit score improved, and I switched to a regular Visa card a few months later.

I don't know what the details are with the teacher in Megan's examples, but I would like to add that there are lots of instruments out there that seem (and are) pretty awful deals, but once you start borrowing and paying back, you build credit very quickly and don't need to stay in those products long.

RIP: Kodak

Kodak seems to be filing for Chapter 11 bankruptcy.

The thing is, that Kodak was well aware of the digital photography revolution, and launched digital cameras as well as online photo sharing sites etc. But more focused consumer electronics companies won in digital cameras, and more focused online photo sites won in the upload and print business. (Although I think Facebook is now the biggest photo serving service in the world).

I don't think it's right to criticize Kodak for not innovating. Companies are very specialized to do a particular thing, and when that thing is no longer valuable, it's very difficult to re-deploy those assets to do some different thing.

Not understanding banking is an impediment to regulating banks

MacroResilience demonstrates why not understanding banking is an impediment to regulating banks:

Amar Bhide’s idea essentially seeks to turn back the clock and forbid much of the innovation that has taken place in the last few decades... But it is not enough to mitigate the moral hazard problem... Let us assume that banks can only take deposits and make loans to corporations and households... Banks can simply lend to other firms that take on negatively skewed bets. You may counter that banks should only be allowed to lend to real economy firms. But do we expect regulators to audit not only the banks under their watch but also the firms to whom they lend money?

In a word--yes!

First, bank lending is capital constrained (not reserve constrained), so limits to leverage (especially derivatives, which hide leverage very well) are at the very core of regulation. When a bank makes a loan, the impact of that balance sheet expansion must be risk weighted. So, buying US Treasuries -- go nuts! Buying anything else -- you'll hit your cap earlier.

And yes, this means that regulators need to look at the loans banks are making. In fact, regulators cannot regulate without looking at the loans banks are making. This is baked into the Basel accords that specifically risk-weight capital requirements.

Second, if banks were also required to keep all their loans on their books, then they would have an incentive to make good credit decisions, something they are not motivated to do if they can offload risk to third parties.

Third, if counterparties failed, loans went bad, and banks went under, so long as the Fed gave the bank open access to the discount window and didn't shut it down when it fell under it's capital requirements, a bank with a negative equity position can continue to clear checks.

But, if you believe "unless short-term deposits are deployed to match long-term investment projects" then these regulatory options are inconceivable.

Mosler makes the Economist

Warren Mosler has made it into the Economist. Nice way to end the year!

People thought that blogs would replace journalism--and that isn't true. But blogs are influential because journalists read blogs. They need to feed the Beast, and they Google just like you or I. MMT's influence in the blogosphere can rival that of the academy, and seeing Warren in the Economist is proof of that.

It's unsurprising that Market Monetarism gets the kindest write-up as it is essentially orthodox Monetarism taken to its logical extreme. This is great, because it makes the absurdities clearer:

In pursuing this target, the central bank would use many of the same tools as today: tweaking the short-term interest rate and, when that reaches zero, increasing NGDP by printing new money to buy more assets (ie, quantitative easing). And the very creation of the NGDP target would make such intervention more effective, Mr Sumner says. If people expect the central bank to return spending to a 5% growth path, their beliefs will help get it there. Firms will hire, confident that their revenues will expand; people will open their wallets, confident of keeping their jobs. Those hoarding cash will spend it or invest it, because they know that either output or prices will be higher in the future.

Confidence fairies and more quantitative easing. Ho hum.

Merry Christmas

Merry Christmas, all!

I must confess, I have yet to go through all the excellent comments folks left on the last few posts. But I will. I am also hesitant to post anything new until I have absorbed all the thought that folks shared. Unfortunately, this may take a while.

One point I will add, though, is that I think attempts to pin the failure of MMT to spread (Steve Keen, Steve Keen! seems to be doing better) on politicians is misplaced, as are attempts to make it easier to understand to laymen, and attempts to reconcile it with standard macro.

This stuff is technical, and on technical material like this the government takes its marching orders from the University. If Obama or Paul or Cain or whomever were to take to the podium and begin spouting MMT he would be a laughing stock before the ink on Paul Krugman's takedown column was even dry. The Fed and the Treasury are staffed by guys who learned from the same textbooks written by professors at Harvard or Princeton. A populist movement to take over the academy in this day and age is ludicrous, it ain't 1968 and it ain't going to be.

This, incidentally, is the problem OWS has.

Secondly, while making MMT easier to understand is a laudable goal, the outcome of this will be to win over Austrians, the other leading candidate for a "people's economics". This will not help in the Academy, but it will fill the blogosphere with semi-correct rantings and it will make Austrians really mad.

Finally, the history of paradigm shifts in the Academy is well documented, and they have always happened via dead bodies, never by the future playing nice with the past. When something is true, that is enough.

Steve Keen on Hardtalk

I don't much like Steve Keen because, although he gets private credit creation correct ("banks create money out of thin air by making loans that then create deposits") he does not get public debt creation correct ("federal deficits create the private sector net financial assets which can then be used to "buy government debt"). How you can understand horizontal money without understanding vertical money is beyond me, but there you go.

Anyway, here is a transcript of Steve on "Hardtalk" -- so, good for Steve for getting on the BBC!

At times, it seems like the understands vertical money:

SK: I wouldn’t say it was a case of making a choice between one individual and another. It has to be a systemic process by which we reduce the level of debt-finance money in the economy and increase the amount of government-created money. Because we have two sources of money in a capitalist economy. The banks can create money by extending loans. The government creates money by running a deficit. Now back in the early 60s the ratio of government created money to the overall money supply was 15%. It’s fallen so far that we’ve got an entirely debt-based system which has driven speculation. We need to create the government money to balance out the credit. So I’d actually have a government creation of money system approach to try to rebalance the system and reduce the private debt.

HT: The government, the central bank, prints money to pay off people’s debts? What I’m wondering is, you say, “Write off debts.” And it’s basically private debt that you want written off. Mortgages, companies’ debt. How is that working?

SK: We’d have to give the money to the debtors rather than to the creditors. If you look at what’s been happening in the last three or four years, all the rescues Bernanke has done, the banks around the world have done, have been to give money, to create money and give it to the banking sector in the belief the banking sector will lend to get the economy starting again. Now that is bizarre because we know one reason they won’t lend is they’ve lent too much already. So all that money has been ineffective.

It is true that the Govt creates money by running a deficit, and that stimulus needs to focus on giving money to households. But from here, why is the solution not to have bigger deficits based on spending/taxation policy that increases household savings?

To Read:

Scott Fullwiler:Modern Monetary Theory—A Primer on the Operational Realities of the Monetary System

Marc Lavoie:The monetary and fiscal nexus of neo-chartalism: A friendly critical look

From the comments: technical details on MMT

In a recent post I said that

A country that runs a fiat currency doesn't "borrow", it prints and unprints money whenever it spends and taxes. If it issues bonds, it is to change the term structure of extant pre-printed currency, not to print more, or "sterilize" outstanding money.

This is technically not true, as was pointed out in comments by JKH. The comments are now about 100, so I wanted to pull out this point.

I've found that the greatest challenge in understanding MMT, or getting someone else to understand it, is that our heads are filled with lots of preconceived notions that limit our ability to see things from a new perspective. As Chuck Norris would say "you cannot fill a cup that is already full".

So I exaggerate and say that a government neither has nor does not have money, and that all spending is printing, all taxing unprinting, so shock the system out of its current paradigm into the new one. Maybe it works for some, maybe it doesn't. I found this helpful in making the leap, but it may not work for others. YMMV.

Technically, the central bank is the currency issuer, while the Treasury is just a user like everyone else. So now the question becomes, to what degree is the central bank part of the Government, and even if the central bank is ultimately a creature of Congress (in the US) then Congress needs to actually enact legislation that would combine the CB and Treasury functions to make the Federal Government proper a true "currency issuer".

Thanks to everyone, but JKH especially, for their comments.

Between Depression and Hyperinflation

Contra Megan, there is a middle ground between a Depression and Hyperinflation:

But it is not true that loads of debt is just fine as long as you're borrowing in your own currency, except in the trivial sense that a government which borrows in its own currency can always resort to hyperinflation. This is rather like saying, "Don't worry about that cancer--you can always shoot yourself!" If you take too much advantage of the benefits of borrowing in your own currency, pretty soon you have trouble borrowing in your own currency, which means that practically, the distinction is not necessarily as strong as some people pretend.

This is the conventional wisdom, believed by Austrian, Paul Krugman, and Greg Mankiw alike. A country that runs a fiat currency doesn't "borrow", it prints and unprints money whenever it spends and taxes. If it issues bonds, it is to change the term structure of extant pre-printed currency, not to print more, or "sterilize" outstanding money.

Too much printing can generate hyperinflation, but too little printing leads to low aggregate demand, unemployment, and lost real resources -- the very thing a country should be looking to maximize.

Bluff called -- no deal

The Supercommittee seemed not to reach any deal on debt. The question now is, will the automatic austerity measures go into full force, or will the Government find some way to defang them?

A New Deal for Europe

During the Great Depression, the New Deal represented a dramatically different sovereign structure in the US than what had existed before. Individual states--who had given up monetary sovereignty long ago--gave up political sovereignty as Academics joined forces with national politicians to run America.

The days of corporate paternalism and local politics was over.

I don't know how much State level resistance there was to this takeover. I'm guessing that your average unemployed worker didn't think much of his local politicians, and may have believed that the wise technocrats in DC were going to usher in better governance, and a better life. Maybe local politicians saw this centralization as a meal ticket to plummer plum jobs, and even more opportunities for power. Or maybe people saw it as a dreadful curtailment of States rights and fought against the changes. I don't know.

Nevertheless, I see parallels to this and the situation in Europe right now, as member nations, who gave away their monetary sovereignty when they joined the Eurozone, are now losing their political sovereignty as well and don't seem to have any desire to go back to their old currencies or their old politicians. I think Italians and Greeks would rather be ruled by Germans, they just want the Germans to be less stingy.

The Greek Central Banks wants to stay in the Euro

Greece will stay in the Euro and tolerate high unemployment for no reason because the Greek Central Bank wants to remain chained to the European Central Bank.

Greek central bankers, just like all central bankers, went to the same economics programs and learned the same nonsense about how deposits create loans, and how governments must tax in order to spend. Even if Greek wanted to go back to the drachma, I don't think there's anyone in Greece capable or interested in actually running a sovereign currency. Why bother when you can't tell the difference anyway?

Both Monti and Papademos look to be corporate liberal internationalists of the kind that in the U.S. end up in the Treasury Department. Papademos went to college and grad school at MIT and taught economics at Columbia from the mid-70s to the mid-80s. He even served as senior economist for the Federal Reserve Bank of Boston in 1980. Returning to Greece in 1985 to work as chief economist of the Bank of Greece, he rose to the post of the bank’s Governor; then served as Jean-Claude Trichet’s chief deputy at the European Central Bank from 2002 to 2010, returning again to Greece in 2010 to become an economic adviser to Prime Minister George Papandreou.

Monti went to college in Italy, but completed his graduate studies in economics at Yale, where he studied under James Tobin (which I suppose increases the chances that he supports a financial transaction tax). He was an economics professor and university administrator in Italy from 1970 through 1994, then was appointed to the European Commission, where he was handed various economic portfolios, including those on financial services and competition.

Where is their Financial Bismarck? How could such a man survive grad school?

Economists don't understand accounting

I don't much like Steve Keen, because while his understanding of private sector credit expansion is good, he does not understand how an out-of-sector source is needed for private sector net (not gross) financial assets. In other words, he does not understand how the Government is a currency issuer.

Nevertheless, this observation from a recent talk he gave is interesting:

One part of the discussion that I found quite notable was that, even after showing empirical evidence on the impact that rising and then falling private debt had on the economy both now and during the Great Depression, I couldn’t convince several of the academics in the audience of the importance of private debt: they kept coming back to “one person’s debt is another person’s asset, therefore the level of debt doesn’t matter”. They therefore argued vehemently that the distribution of debt was important, but its aggregate level was irrelevant.

This is the core miscomprehension about debt that economists have. They see bank debt as the same as personal debt -- if I lend $10 to you, then I do not have $10 to spend myself, so the aggregate level of spending money available is unchanged.

However, bank lending does not work like this. If a bank lends $10, the $10 gets deposited in some other bank and is therefore available to lend again, limited only by capital requirements. In this sense, one person's asset is not another person's liability, and the total (gross) quantity of financial assets can expand and contract, while the total (net) quantity of financial assets remains the same.